Europe's VIX limped sideways and broadly speaking European stock markets also did the same on a relatively slow day. Intriguingly Spain's equity market was the best performer today (some high beta grab?) as Italy's was the worst -0.75% as the disconnect between the two grows in CDS markets also. Italian bond spreads pushed 8bps wider to 346bps over Bunds - a new three-month high. Credit and equity markets are moving in lockstep but chatter is that activity is quite mutes ahead of the EC meetings and their streams of useless anecdote due anytime. EURUSD is holding its lows as Europe closes - back under 1.2990.
Overview of the drivers of the fx market, a discussion of the price action and a review of the latest Commitment of Traders report from the futures market. Contrary to ideas that QE3+ is the dominant force and dollar negative, the net speculative position is now long dollars against all the major currency futures but the Australian dollar and Mexican peso. The dollar's gains though appear to be a function of events outside the US.
Aided by QE and ZIRP, the-powers-that-be tried to end February with some bullish records designed to pump-up Main Street. Theoretically, if new market record highs were achieved this would then suck more money into financial products, as the WS marketing machine would be energized.
Chris Martenson is issuing an official warning of a major stock market correction within the next few months. He's only done this once before (in 2008). He's seeing a convergence of both technical and fundamental data that are flashing oversized risks to the downside for asset prices, despite the Federal Reserve's money printing mania (which is showing signs of hitting diminishing returns). He expects the fall in equity prices to happen within the May-September window. This downdraft will be characterized by lots of volatility, formed by market routs and Fed-inspired rescues, alternating until some form of bottom is reached. Along the way there will likely be a flight for "safety" into the dollar and Treasury paper, but only during the first stage of this crisis. Once a bottom is reached - he expects anywhere from 40% to 60% lower than the current ~1500 level on the S&P 500 - the process will begin to be dominated by rising government borrowing which will cause interest rates to begin to rise. When that happens, expect capital to flee the paper market for hard assets. In particular, that's when the upwards price revolution in the gold and silver markets will kick into high gear.
Stocks surged their most in 2013 today on slightly above-average volume as the Dow pushed towards its all-time closing highs and Transports went vertical (up 3.5% in Feb). While it no longer matters, it is worth noting that Treasuries and FX markets were not partaking as a broad basket of risk-assets suggests the S&P going out 20 points rich to reality. Materials are stil -1.5% on the month and Staples are leading +2.4%. In the last hour, the S&P even left behind its main driver - VIX - as the 'fear' index could not break below 14.5%. Of most notice today was the fact that equities have retraced all of their losses from the Italian election headlines and recoupled with gold on the week. The high-yield bond ETF HYG rose along with stocks but also notably the underlying HY bond market actually saw selling pressure as HYG's intrinsic value dropped markedly. Late on, trade size rose notably as S&P futures touched the under-side of the 3-month up-trend channel.
And yay verily there was much rejoicing that Italy managed to sell a few billion euros worth of its sovereign debt to its banking system (albeit at the highest accepted yield since October 2012). However, the rejoicing was hardly effusive as bonds and stocks gained only marginally, buoyed by catch-up from yesterday's US equity markets. Swiss 2Y rates remain at zero and EUR-USD basis swaps came back a little but overall this bounce is nothing to celebrate with Italian 10Y spreads still 47bps wider on the week and Spain 23bps wider. Italian stocks outperformed credit, now down 2.6% on the week as Europe's VIX followed US down but remains above Monday's close at 22%. EURUSD ran up to test the 1.3130 stops and faded back to its comfort zone around 1.3100. As a reminder, European bank spreads are holding at their widest in 3 months and point to notably weaker prices in European financial stocks (were of course they allowed to trade in a free non-short-sale-banned market).
The underlying question in Bill Gross' latest monthly letter, built around Jeremy Stein's (in)famous speech earlier this month, is the following: "How do we know when irrational exuberance has unduly escalated asset values?" He then proceeds to provide a very politically correct answer, which is to be expected for the manager of the world's largest bond fund. Our answer is simpler: We know there is an irrational exuberance asset bubble, because the Fed is still in existence. Far simpler.
Equities dead-cat-bounced today on minimal upside volume (and low average trade size) to get the S&P back to unchanged for the month. Broadly speaking risk-assets stayed well correlated with stocks though bonds and the USD looked somewhat dead trading in a very small range given recent shenanigans. Gold and Silver had their best day of the year so far as the former broke back over $1600 (and has now seen the best 4-day jump in 6 months). It seems Bernanke's relative dovishness is losing its equity appeal (as gap prices continue to rise) but precious metals (post China new year) have rediscovered some central bank balance sheet reality. Homebuilders, buoyed by the craziest seasonal adjustments ever to sales, swung from worst-to-first on the week. Equities tracked spot VIX most of the day but even VIX did not fully partake of the exuberance in the last hour or so. AAPL's rumor-driven tom-foolery pushed it handily up to yesterday's closing VWAP +1.4% and supported the broad equity market (just as HD did in the Dow). Despite the best efforts of the media, putting lipstick on this pig day after yesterday is a push in our view.
Equity markets relatively collapsed intraday yesterday given the recent lack of volatility with the range around four times larger than the three-month average and volume at its highest in that period. While that is significant of itself, as the S&P broke its uptrend, Nanex has found a much more serious shift in the market structure that occurred yesterday. Soon after the open on the US day session, market-making HFTs surged their quote-stuffing efforts to the highest level in months. Whether this was intended to artificially inflate orders to enable institutional sell-orders to be crossed with falsely hopeful retail orders is unclear but given the order flow and direction of trade, it seems something significant changed yesterday.
Italy is driving the markets. Japanese developments means the market is closer to give Abenomics its first test. Bernanke to set the record straight after many gave the regional non-voting Fed presidents too much weight in understanding trajectory of Fed policy.
For most portfolio managers, investable assets can be thought of as sitting somewhere on the risk-return curve. If we look at the risk-return curve today it is obvious that 75% of global financial assets are now locking in real losses, unless of course, inflation collapses and deflation takes hold in the major economies. If we are spared a massive deflationary wave the assets at the bottom left of the curve will lose 1.5% real per year for the next five years. This means that, for global assets to stay roughly in the same place, equities will need to provide a real return of 4.5% per year for five years. However, it is important to note that such returns will only serve to compensate for the capital destruction taking place in the fixed income market. Real returns on equities of 4.5% will not leave us any richer compared to our starting level. This means that investors will have spent five years on a treadmill running to stand still. When you consider that no asset growth was registered in the previous five years, we are facing a whole decade devoid of capital accumulation. Given the world’s aging population, isn’t this bound to be problematic?
The publication, earlier this week, of the FOMC minutes seemed to have a similar effect on equity markets as a call from room service to a Las Vegas hotel suite, informing the partying high-rollers that the hotel might be running out of Cristal Champagne. Around the world, stocks sold off, and so did gold. The whole idea that a bunch of bureaucrats in Washington scans lots of data plus some anecdotal ‘evidence’ every month (with the help of 200 or so economists) and then ‘sets’ interest rates, astutely manipulates bank refunding rates and cleverly guides various market prices so that the overall economy comes out creating more new jobs while the debasement of money unfolds at the officially sanctioned but allegedly harmless pace of 2 percent, must appear entirely preposterous to any student of capitalism. There should be no monetary policy in a free market just as there should be no policy of setting food prices, or wage rates, or of centrally adjusting the number of hours in a day. But the question here is not what we would like to happen but what is most likely to happen. There is no doubt that we should see an end to ‘quantitative easing’ but will we see it anytime soon? Has the Fed finally – after creating $1.9 trillion in new ‘reserves’ since Lehman went bust – seen the light? Do they finally get some sense? Maybe, but we still doubt it. In financial markets the press, the degrees of freedom that central bank officials enjoy are vastly overestimated. In the meantime, the debasement of paper money continues.
Every year over 1.5 million Americans go through some form of drug and alcohol abuse treatment, according to the last large survey done by the Substance Abuse and Mental Health Services Administration, an agency of the Federal government. Only about half – 47%, to be precise – complete their treatment. One quarter drop out, and the remaining 25% either transfer facilities or end treatment for some other reason. In general, the more intensive the treatment – inpatient hospital care, for example – the more successful the outcome. The length of treatment varies, as one might imagine, based on what addiction is being treated. Heroin and other opioids take over 150 days, but the median is anywhere from 90 – 121 days. Needless to say, these are long days for anyone who goes through them as well as the family and friends who support them. Somewhere over the past few years, the serious term ‘Addiction’ has entered the lexicon of capital markets watchers as it relates to how central bank policies enable and distort the price of debt and equity securities. Essentially, the analogy is that markets have become dependent on both artificially low interest rates and the cash provided by liquidity programs such as “Quantitative Easing” in much the same way that a person can become addicted to a dangerous drug or alcohol. If you’ve ever seen addiction first hand, you know this is a spurious anthropomorphizing of financial markets. If you haven’t, well, just trust me.
After the spectacular moves of late 2008, currency market volatility slowly reverted to more normal ranges, with a few exceptions over the course of 2009-2011. However, as Saxo Bank notes, since the start of the year, firebrand rhetoric is forcing currencies lower. The yen has fallen a stunning 17% against the US dollar and over 20% versus the Euro in the three months since Japan’s newly elected prime minister Shinzo Abe took charge. This has reignited the global currency wars. But who are the winners and losers? Follow the three step process outlined in the infographic below and have your say at the #FXdebates. As you can see, currency debasement has given rise to a rally in equity markets (for now), but major economies, both advanced and emerging, have been slow to recover.
Presented with little comment except to note that US and European credit markets have been sending warning signals all year; whether they rally to meet stocks or stocks crack to credit's concerns is not for sure - though the truism that credit anticipates and equity confirms remains as prescient as ever. However, it appears the macro-economy is better reflected in credit and with the Fed suggesting its liquidity anxiety is rising, perhaps equities will recouple once again...