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The Contrarian Market And The Liquidity Glut Dissected
BofA's credit strategist Jeffrey Rosenberg has shared some interesting insights with his clients. In a letter from August 2, Rosenberg explains everything one needs to know why the stock market continues to rise in the face of increasing adversity and ever more negative news:
“I can’t think of a reason to be bullish...so I guess that is the reason to be bullish.” That quote from a client at our June 30th credit roundtable dinner in our view best summarized investor sentiment at the beginning of July. It also highlighted a key technical reason to have been bullish in July as negative investor sentiment reached a peak at the beginning of the month."
Couple that with the sudden buzz that QE X.X is imminent, and a surge in market liquidity, and once can see how the market is now completely disconnected from fund flows, as contrarian animal spirits, and a rising liquidity tide have once again become the dominant, and only, factors in market tactics, if not strategy. And speaking of liquidity, here is an analysis of the key source and uses of liquidity in the market currently.
In a surprisingly candid piece from August 3, Rosenberg is honest that the only cause of the recent ebulience is liquidity, and the sudden impression that the Fed is en route to recreating the liquidity parameters from early 2009. To wit:
“I want to say one word to you. Just one word.” Not “plastics” but “liquidity”. Our longer term positive outlook on credit relies significantly on the technical condition of excess liquidity in financial markets. While eventually economic and credit fundamentals will need to catch up to those technicals to justify a continuation of spread compression (and credit market overweights), for now our year end outlook maintains that positive liquidity trends will lead to compression in spreads recouping much if not all of the European sovereign crisis induced spread widening.
In other words ignore fundamentals, ignore technicals, ignore everything you know about asset allocation and selection, and put your financial well being in the hands of the same people (the Fed) who have time after time proven the be the biggest wealth destructors of the US middle class year after year (unless of course one is a member of the privileged kleptocracy, in which case there is nothing to worry about). With all due respect, we prefer cash.
Yet despite our skeptical stance, it is useful to see where Rosenberg sees the imminent influx of cash, and what assets classes, in his opinion, will benefit the most from unsymmetric flows:
Financial market liquidity stems from monetary policy’s dual track: quantitative easing increases high powered money affecting primarily financial market liquidity, while zero interest rates increases allocated liquidity. Zero interest rates punishes as risk aversion with negative real returns forcing investments out the risk spectrum in either maturity or risk or both. Combined with overall deleveraging in consumer assets and stable leverage in corporate assets, the resulting negative net supply across all risky asset classes – Securitized Products (ABS/MBS/CMBS) and Corporates - lends a powerful tailwind to risky asset spread compression.
Figure 1 above highlights historical as well as our estimates for estimated 2010 net supply of risky debt and Treasury debt. We add to these estimates of net supply our estimates of annual cash flow generated in each asset class through coupons. To the extent this cash flow is reinvested back into the asset class, it represents a key source of investment cash before new asset allocation. Hence the bottom line on the table highlights that after accounting for the cash flow needs just from reinvestment flows, all risky asset classes show negative net supply in 2010. Only Treasuries provide net new investable assets. The reduction in supply relative to increasing demand for credit products (highlighted in Figure 2 and Figure 3 below) illustrates the positive technical conditions supporting risky asset spread compression.
Intuitively, all this makes perfect sense, and is to be expected in an environment in which ongoing corporate deleveraging is mitigated only by increasing public sector issuance. Essentially what BofA is saying is that the government will do everything in its power (and investors should sense this and front run it), to make spread differentials between public and private sector funding negligible, in essence making private debt as cheap as public (broadly speaking), in its attempt to allow firms to deleverage freely at the taxpayers' expense. The impetus for this broad move would be the far shortened duration allocation for corporate issues, in which the only trade off to duration is credit risk. In other words, at the same yield, a perfectly rational investor would be likely tempted to invest in a short maturity A-rated corporate bond, rather than a long duration (30 Year) Treasury. While many may laugh at this assumption, it is already in process of happening. To wit:
With weak economic growth having replaced the European sovereign crisis as the biggest investor concern, US fixed income markets have returned to their pre-crisis dynamics where strong liquidity conditions, and the absence of yield in the front end of the curve, have investors reaching for yield. Most relevant for fixed income risk markets, growth concerns – short of a double–dip – translate into the Fed remaining on hold longer, thus prolonging the period of time where investors reach for yield out the credit quality curve. For Treasuries, the reduction in inflation expectations encourages investors to reach for yield out the maturity curve. Thus growth concerns lead to curve flattening for both quality and maturity curves.
This is becoming all too evident with the recent daily records in the 2 Year Treasury, and the persistently sub-3% 10 Year (the question of whether and how this is sustainable is the topic of another analysis). To justify the point of investors fleeing from the ultra-short dated part of the curve, Rosenberg shows this notable correlation between money market assets and the Fed Funds rate:
Yet it is questionable whether the rate of decline in money market assets is at this point continuing to correlate with ZIRP. As we have pointed out, despite a nearly $1 trillion drop in MMF assets since the implementation of ZIRP, lately we have seen several consecutive weeks of money market inflows (not to mention the 13 weeks of straight equity fund outflows). Is not even ZIRP at this point sufficient to push the zero % yielding money on the sidelines into higher yields. Yet even if we assume that an investor is willing to chase some, any yield, what should one do? Rosenberg provides the following thought experiment:
For example, currently a fixed income investor with a modest 4% yield bogey can choose to take on considerable duration risk in 30-year Treasuries. Alternatively, if the investor is only willing to move out to the belly of the curve, as our rates strategists discuss below, she can trade off some interest rate risk for credit risk by buying A-rated 10-year industrial corporate bonds to achieve this yield target. Other fixed income asset classes - including CMBS and non-agency RMBS - offer yields that can meet the 4% bogey without maxing out duration as well, while Agencies and Agency MBS offer less yield pick-up. As more investors reach for yield, credit spreads compress within each risk asset class meaning that investors need to reach further out the curve to get yield. Thus a consequence of abundant liquidity is that the belly of the Treasury curve flattens, credit outperforms Treasuries, BBB-rated industrial corporates (or higher rated financials) outperform A or higher-rated industrials, and non-Agency MBS and CMBS outperform Agency securities (see also the mortgage section below).
The chart below is likely most telling of the ongoing change in sentiment toward risk. While the 7-10 year "belly" of the curve is indeed starting to provide a broader selection of options for comparable yielding securities across public and private domains (with the exception of CMBS, where as we have noted the deterioration across asset collateral just hit an all time record in June), the follow through of this argument is the ongoing flattening of the 2s10s. Should this phenomenon persist, the deterioration across the "originate to hold" mortgage business model (and without securitization, that would be pretty much all the banks) is inevitable. Ironically, should Rosenberg be correct in his assumption of ongoing spread convergence in risk and presumably risk-free assets, the profit margins fro the Bank Holding Companies will continue to erode to the point where the Fed will be forced to provide another round of assistance to undercapitalized from an equity standpoint financial system.
Yet going back to the question of liquidity, nowhere is the sudden perception that liquidity will be ample more visible than in the return of negative new issue concessions after over three months of investor favorable primary concessions. In other words, investors are willing to pay more for a primary issue than an near-identical piece of paper trading in the secondary market as far too much cash is once again sloshing around and chasing any and every piece of paper.
And another last place where the record liquidity overabundance can be seen is the new issuance of McDonalds 10 year paper, which came at an all time lowest on record yield of 3.5% among 10 year corporates.
To highlight the current strong liquidity conditions we consider the $750mm two-tranche McDonald’s corporate bond deal issued Wednesday. Demand for this deal was so strong that we estimate the 10-year tranche priced at a 10 bps negative new issue concession – that is, 10 bps tighter than secondaries. Normally new issues price wide to secondaries to accommodate the increase in supply. However, starting December last year liquidity has been at times so abundant – and available bonds so few - that we have seen many cases where investors are willing to pay a premium for any availability of bonds that the secondary market may not offer. Underscoring that liquidity conditions have returned to pre-sovereign crisis levels, this week was the first where the average new issue concession across all deals in high grade corporate credit was negative (-4 bps) since the week of April 19th.
The bottom line is that even strategists have given up pretending to put a narrative to asset yields. The only thing that matters once again is whether liquidity will be ample today, tomorrow and in one year, and whether the Fed can attempt to successfully recreate an asset bubble, which however unlike before, is asset agnostic and touches on anything and everything. And since fundamental asset values continue deteriorating, the Fed will be caught in the classical Ponzi dilemma of how to push prices ever higher without causing a Madoff-like collapse to fair value (i.e. zero). If previous examples are any indication, the Fed can only reflate a bubble for several years before the lack of inherent cash flows collapses the hollow house of asset cards on its head. We are already well into year two of the latest and final such experiment. All those who believe they can time the peak: by all means, invest in the riskiest of assets. For all the others who have been burned periodically trying to time inflection points (and let's fact it - that's pretty much everyone), the only safe bet is investing in hard assets or a cash under the mattress position. Because at the end of the day this is no longer a question of deflation or inflation: it is certain that the Fed will fail at achieving its preferred outcome in that regard as well. The real question is how should one be positioned when the tens of trillions of excess liquidity are, on the margin, found to be supported by nothing more than hopium, fraudulent accounting and the promises of a persistently wrong Federal Reserve that this "time is different." Sorry, it never is.
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they seem to be able to scare/push money from here to there, piecemeal, but they can't seem to make it "flow" anymore.
hmmm, "flow" would imply the existence of trust in the market(s).
might as well get comfortable folks, looks like we might be here for a while.
Except there is virtually no yield on US equities so to apply this logic to the equity market doesnt make much sense. Japan had tight credit spreads for years and their stock market is down for 2 decades
Down 75pc as well! Where are the stock vigilantes when you need them to drive a stake through the market's heart. Oh wait, they all got bankrupted trying to short based on fundamentals when the only thing that appears to count is Ben's FUNdamentals.
Yea, that's some good fact finding and I agr....HOLY FUCK, futures just went green!
its unbeleivable what passes for financial advice. If i sent a note like that to my clients "dont worry about the fundamentals, its a liquidity play" id have the compliance dept all over my arse! I guess that is one of the draw backs of not working for a TBTF where you give advice based on what is best for the client, not based on how to keep the ponzi, and your TBTF firm and salary package that depends on it, alive when it is clearly on its death bed.
If you are an "American Consumer" - you probably have a very distorted view of reality.
The american consumer no longer has the privileged status of the past. There are , guess what, lots and lots of "consumers" all over the world - billions.
Corporations, no matter where their notional headquartes are located, can increasingly make stuff anywhere and sell it to people anywhere.
So this obsessive attention to the plight of the american consumer is laughable - no one cares about the home equity loan , credit card problems etc of the american consumer ( unless you are directly involved).
However, Americans at this point have just as much opportunity as any one else to work, invest, start businesses, work for large corporations etc - its just they will be competing with smart, hungry , well educated types from all over - people that are willing to move to where they can utilize their talents best.
Americans looking for handouts, freebies etc - have a lot of competion as well - lots of people around the world looking too!!
LMFAO...WTF is this sermon for? This has eurotard written all over it.
Wow, talk about jealousy!
How many of those 'billions' of consumers have anything with which to consume?
So of your remaining billion, singular, how many aren't Americans?
Okay, of your remaining 600M, how many aren't in Greece, Ireland, Latvia, Hungary, etc ad nauseam?
You think China's bubble popping is going to hurt the US more than E-you?! Hahaha.
Fuck your 'handouts'!
Close out your liquidity swaps and let the EU fold or STFU, Fab Fab.
Just to finish the tought:
So - its not wise to be overly infuenced by the plight of the american consumer. As I recall the GDP number that just came out showed robust imports of capital goods by corporations. Hmmmmm.
Plenty of buyers for Intel chips , plenty of demand for all high quality products - really . Huge demand - from people who dont own a underwater mortgage in arizone - from people that live in bangalore or dalian. They love good stuff and have been saving up to buy it.
Thanks for finishing that up...I was on the edge of my privileged seat.
Pardon me, would you happen to have any grey poupon?
We have a strange sitution. The real world is in an extraordinarily prosperous condition. ( with a few exceptions like unemployed, undereducated, unmotivated, underwater mrtgage holders).
Technology is brilliant, more educated motivated people than ever before. Large regions (Asia) on a massive upswing. Lots of opportunities, lots of work. Millionnaires being created as we speak ( oops - mostly in Asia).
The Real World is actually in Great Great shape.
The PROBLEM is the FED ( also ECB, BOJ) - central planners with visions of grandeur - on a power trip. Creating instability . Creating international frictions. That is the only problem.
http://www.nbc.com/saturday-night-live/video/coat-store/805602/
Lol. The real world is in a perpetual bubble, sooner rather than later it's going to burst and the collapse in living standards is going to be extraordinary. Asia is overpopulated and too polluted. The wealth pie is contracting and when the margin call comes, the world will find itself bankrupt and economies will be mostly dead.
The real world is in an extraordinarily prosperous condition.
WTF??!!!!! Are you new to ZH?
Does Bernanke not realise what the problem with trying to push money into this economy are... it gets stuck going into the same risk-grinder over and over again: it's like the bankls want profit and the Fed , and the regulators keep just giving to them. In the Wheat market- the Banks were short, probably more contracts than would represent actual output... lower earnings for farmers, that's critically important!! That's a stable source of economic GNP....why, why would they be sizeably short Softs? ..this can't just be about regulation, this has to be about what the financial services actually do.
You bring up a good point, tic tock.
I think Bennie Mae realizes the problem. When you've lowered interest rates to zero and bolstered bank reserves by "renting" over a $1 trillion in MBS, one would think that the excess liquidity would work its way through the economy.
It hasn't. And probably Bennie Mae knew that even when he went on record saying that ZIRP and QE were intented to get banks back to loaning again. Banks are using both to simply build reserves, as they see that private sector deleveraging is a train that is just not stopping.
Hence the problem with another round of QE-- if it didn't work its way through the economy the first time around... why in Bennie's twisted world would it work on the 2nd pass??? The issue on the first round of QE is that it didn't effect 95% of the population-- though the banks didn't mind it at all. QE 2.0 (if it comes to pass) would have to be mighty sizeable to have any effect.
Of course, we also have a "stealth" QE 1.5 going on where the Fed is active on options expiration week and has agents at other junctures to juice the markets to give the illusion of "confidence". Market participants-- even on the last to know retail side-- aren't buying it.
Financial services companies aren't creating value... they are simply trying now to preserve what they have already taken. Why a bank would be making active bets against the wheat markets and farm incomes is well beyond my understanding... but those same banks appear to believe that 10 year T-Bonds below 3% is a bargain. And it is-- when your cost of funds is ZERO.
Much of the market is convinced Bennie Mae is going to inflate his way out of this mess. I'm more convinced that Bennie is coming to terms about how massive the next QE needs to be-- and the unintended consequences that come with the next liquidity flood. Despite all the talk, this market will need to tank in a pretty big way before the next QE trigger is engaged. And right now, the Fed is doing everything it can to keep those asset prices rich.
Liquidity is useless when nobody wants to borrow!
The housing bubble ran out of steam when it started reaching borrowers who weren't even making ONE payment.
There's no pool of creditworthy borrowers out there interested in loans! The only people interested are those who do not intend to repay
Pretty much sums it up....
Can you imagine, then, the unintended consequences if the Fed forced the issue, and made banks loan to those not interested in paying? Man, that would make for a grand hangover...
Perhaps the Fed should just stick with providing unlimited liquidity to our HFT buddies, so they can circle-jerk the market to Dow 36,000.
"Hence the problem with another round of QE-- if it didn't work its way through the economy the first time around... why in Bennie's twisted world would it work on the 2nd pass???"
I guess you are not familiar with how to ass-rape. Leave it to the FEDREZ BoG, they're professionals.
You scare me, Mr. Goldstein... as I assume you do know the primary ass-raping techniques. You might make a good Fed soldier... :)
never accosted anyone, but I have been bent over by FEDREZ enough times to know what's going to happen.
btw, I think Bennie Bernanke licks his lips every time he sees your avatar. ;-)
LOL! As he should!
Primefool, crumbs, what are the crime statistics like in the US and UK?
Yeah - oh those crime statistics -- they are -- ummm GOOD!!!!
Given how many market participants are now fully aware of Minsky, Ponzi schemes, Taleb's black swan, just how long can this central bank subterfuge continue. And, of course, it doesn't matter a cent whether the media provide their usual puppy dog coverage of the Fed.
Until the people riot or, in other words, after it's too late.
Futures up 31 <edit> on the DOW! Just like a faucet left on all night. They just fill it up. Drip...drip...drip...drip...
Hey Boiler:
Ignoring your earlier insulting comments...
That was my point - you are too focussed on the US consumer. The world is good and many stocks are quite cheap.
Have to do your own analysis and buy good quality cheap stocks around the world. Everything is fine - sure the Fed will create huge instability - but whatchoo gonna do aboutit eh?
"Ignoring your earlier insulting comments..."
Yep, we've an official self-absorbed, clueless, and riteous eurotard alert. I just love a good stern and oblivious but cock-sure talking down to...euro style!
Get bent. You a-holes are worse than us...and that takes a bit of doing.
I suspect you are part of the problem. But - its your problem - the World is just great.
+++ primefool.
either these guys have no idea how they present, or they are professional trollers. i really hope they are the latter.
either way, say your piece; look for signal, ignore the noise.
personnally, i don't think the world is quite so great, but the "good" news is we're all tanking together...
central control as it is currently manifested is clearly not a 'good thing'. actually not much of a fan of centralized overlords of any kind.
By the way the Fed is not creating instability because they are crazy psychopaths.
They are trying to retain the power structure, to preserve the ability of unskilled people with nothing to offer - to buy houses and cars and the latest technology. They are on a power trip.
Hey Timmy, shut the fuck up and get some sleep. Obama is gonna need you bright and early to be his cheerleading bitch today and tomorrow. A lot of economic data coming out and it will be your job to spin it.
As for the Fed not being psychopaths, I agree. They're just idiots.
When you get a little older, you might discover the difference between wealth and money. Take off the rose coloured glasses and do a little research on central banks. Then, you might want to edit your last comment. The FED is the power structure and the people running it are invisible- they also care not a wit about unskilled people and how much they "own".
That piece of paper is not wealth, it is a note.
Bingo!
today: more squeezing (if there are still some shorts, but if this forum is a sounding board in any sense, there are a few left alive obviously)
Meanwhile, european equities are adjusting to a 10/15% chance of a Weimar style parabolic outcome.
Whatever you say Alvy:
But I feel like Woody Allen (Alvy Singer) as a 9year old kid in Annie Hall, who discovered thermodynamic entropy:
Doctor in Brooklyn: Why are you depressed, Alvy?
[Young Alvy sits, his head down - his mother answers for him]
Alvy's Mom: Tell Dr. Flicker . . . It's something he read.
Doc: Something he read, huh?
Alvy: [his head still down] The universe is expanding.
Doctor in Brooklyn: The universe is expanding?
Alvy: Well, the universe is everything, and if it's expanding, someday it will break apart and that would be the end of everything!
Alvy's Mom: What is that your business? [she turns back to the doctor] He stopped doing his homework!
Alvy: What's the point?
"Alvy: What's the point?"
I was wondering that myself. Do you even have one?
Summers, Geithner and Bernanke apparently think they are gods. Their end is probably nearer than most think.
I'm on a gradual but sure path to remove most of my investments from the financial markets and put them in things like land and small businesses that generate cash.
I'm doing it slowly though, hoping the Fed and Wall Street won't notice. I'm afraid they might lock the exit door.
Good idea! The challenge in execution is that you will have to get down and dirty if you want to generate income from land. Ag land is the best insurance investment but do you know how to work it?
The paper/electronic assets have made it simple and addictive for most of us to manage our savings but we are now realizing that it involves high risk that is not within our control...
Retired farmers and widows share crop their Ag land. The one who does all the labor gets half the crop.
If previous examples are any indication, the Fed can only reflate a bubble for several years before the lack of inherent cash flows collapses the hollow house of asset cards on its head. We are already well into year two of the latest and final such experiment.
Exactly.
As my Ponzi "best case", the Fed and other over-indepted nation's central banks can keep it up for something around 5 more years. But they will not feel like boom years to (most of) us...
Needless to mention it could also end suddenly, a lot earlier.
I am getting a little tired of everyone becoming a contrarian in the market. Economy imploding, real unemployment at 18%, and the overall economy dying a slow death is now a contrarian buy signal in the stock market. How about when the US defaults and people are starving in the streets--would this be a super duper contrarian buy signal?
Uhhhh, this contrarian obsession is what you get on sites where the volk are trying to figure out a viable, positive future when the Ministry of Truth is overwhelming all comm channels with drivel-dreams.
For you, a great counter-contrarian-contrarian super buy would be a title insurance company, post-apocalypse timing recommended.
i'd consider ruger, etc.
i have to wonder how many folks just 'got tired' of the long slow march to the various mega-murdering mega-governments we've seen through history.
how many just ignored their hysterical neighbors with their constant shrill warnings of possible trouble on the horizon, and how this just doesn't feel 'right' if you don't trust those in charge.
i would assert that right now, the pumpers are making a much less viable case for recovery than the gloomers are making for the mathematic unsustainability of the current trends.
i'm tired of bearishness too, but being tired of the drought doesn't usually produce much rain.
Interesting SP500 chart ...
http://stockmarket618.wordpress.com
There are certainly a lot of details like that to take into consideration.I read and understand the entire article and I really enjoyed it to be honest.
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