About once or twice a month for the past few years, it's been a steady ritual of mine to conduct a Google search for the words "all-time high" and "all-time low". The results provide an interesting big picture perspective on what's happening in the world.
Some of my first memories of television are of a series called The Rocky and Bullwinkle Show, which was a witty combination of animated cartoons about the exploits of the title characters, Rocket "Rocky" J. Squirrel and Bullwinkle J. Moose and their nemeses, two Pottsylvanian nogoodniks spies, Boris Badenov and Natasha Fatale. The show was filled with current event commentary, political and social satire. The show was also filled with commentary on economic and market conditions that resonated with the parents watching the show while the kids focused on the cartoons. Each show ended with the narrator describing the current cliffhanger with a pair of related titles, usually with a bad pun intended. So let's adapt some of my favorite Rocky and Bullwinkle episode titles to modern day; we might see that there are some political and economic challenges that are timeless, as it appears we have been doing the same thing over and over for decades and expecting different results.
The Dow Jones Utility Index is down 35% in the last two weeks - the largest drop since March 2009. Across the board, what looked like being a normal BTFD day around midday, equity markets were monkey-hammered lowered with the S&P 500's worst 2-week run in 6 months. The Dow dropped over 270 points intraday (and 400 from its Monday highs) - attributed to a large month-end sell-side imbalance. Equity markets appear to be playing catch-down to credit's warning messages (though stocks are only down 1% from Friday's close, it feels like more as they are -2.5% to 3% from the highs). JPY strengthened into the equity sell-off and commodities all legged lower (with WTI -2.5% on the week and Gold unch) even as the USD weakened 0.5% on the week. The reality of the one-way trade was very evident. Treasuries came well off their worst levels of the day but remain 11-14bps higher in yield on the week. VIX, which had also been sending its warning messages, smashed 1.75 vols higher to 16.25%. It seems a lot will be reflecting on the Dow/NKY convergence and the behavior in Japan this week as they note there was no bounce at all in today's closing crash.
Everything was going so well in the overnight session, following some mixed Japanese data (stronger than expected production, inline inflation, weaker household spending) which kept the USDJPY 101 tractor beam engaged, and the market stable, until just before 2 am Eastern, when Tokyo professor Takatoshi Ito, formerly a deputy at the finance ministry to the BOJ's Kuroda, said overvaluation of the yen versus the dollar has been corrected, which led to a very unpleasant moment of gravity for the currency pair which somehow drives risk around the world based on what several millions Japanese housewives do in unison. The result was a slide to just 30 pips away from the key 100 support level, below which all hell breaks loose, Abenomics starts being unwound, hedge funds - short the yen and long the Nikkei - have no choice but to unwind once profitable positions, the wealth effect craters, and streams are generally crossed.
JPY is clinging sheepishly to the 101 level versus the USD almost as if there is an 'agreement'. It has been testing this level for a week now with many viewing the 100 line in the sand as a pass/fail mark for Abenomics. Tonight's heavy data flow is mixed. While we noted yesterday the inconsistencies in Abenomics, there are two interesting anecdotes this evening worth paying attention to. First, Household spending missed expectations by the largest amount in 18 months (not a good sign for real growth coming back); and second, in a brief moment on CNBC this afternoon, the CEO of Japan's mega corp Sony admitted that while, "the preconception is that a weaker Yen is good overall. Unfortunately for us, versus the USD, it goes the other way." Futures markets signal a green open (just like last night) for the equity markets and a slight red open for JGBs.
Traders and speculators are watching the $1,413/oz resistance level. A daily close above this level will likely trigger the beginnings of a short squeeze. Holdings in the largest bullion-backed exchange-traded product expanded yesterday for the first time since May 9. Strong premiums for gold bars in Asia show that jewellers and investors are busy buying bullion on this dip. In Singapore, Reuters reports that “supply constraints” have sent premiums to “all time highs” at $7 to spot London prices. Animal spirits are returning to the gold market in the ‘Land of the Dragon’ in this the ‘Year of the Snake’. The volume for the Shanghai Gold Exchange’s benchmark cash contract surged to 19,599 kilograms yesterday from 15,641 kilograms the day before. In two days the volumes have nearly doubled and surged from 10,094 kilograms to 19,599 or 94%.
To an extent that reveals a thorough misunderstanding of the market forces, the financial media has failed to consider the different motivations and beliefs that drive the different types of investors who are active in the gold market. By treating the gold market as if it were comprised of just one type of investor, analysts have drawn false conclusions about the recent volatility.
What happened in Japan last week (a 14% decline after a 85% rally since last fall) is an example of markets getting ahead of the facts on the ground. How much optimism was priced into the success of Japan’s monetary policy bazooka? As JPMorgan's Michael Cemblaest notes, P/E multiples rose from 11x to 17x since last Labor Day, and breakeven inflation implied by (admittedly thin) Japanese JGB-i bond markets rose to 2%, a level Japan has not seen consistently since 1990. On top of that, net long positions on the Tokyo Stock exchange were close to the highest levels in 20 years, and foreign participation in Japanese equity markets was also elevated. It did not take much detailed market research to see that Japan had become a crowded and popular trade. But what happens next? After a 70% run-up over 6 months, how have stocks performed? The answer may surprise many...
As the markets elevate higher on the back of the global central bank interventions it is important to keep in context the historical tendencies of the markets over time. Here we are once again with markets, driven by inflows of liquidity from Central Banks, hitting all-time highs. Of course, the chorus of justifications have come to the forefront as to why "this time is different." The current level of overbought conditions, combined with extreme complacency, in the market leave unwitting investors in danger of a more severe correction than currently anticipated. There is virtually no “bullish” argument that will withstand real scrutiny. Yield analysis is flawed because of the artificial interest rate suppression. It is the same for equity risk premium analysis. However, because the optimistic analysis supports the underlying psychological greed - all real scrutiny that would reveal evidence to contrary is dismissed. However, it is "willful blindness" that eventually leads to a dislocation in the markets. In this regard let's review the three most common arguments used to support the current market exuberance.
After a disastrous day yesterday a bounce in bonds was at least on-the-cards and they went out at the low yields of the day (-6bps). Equity markets oscillated around their opening level of the US day-session with the S&P futures ending the day down over 8 points (in the middle of the range) glued to VWAP at the day-session close. Credit markets faded rapidly and while stocks are unch from last Thursday's close, high-yield and investment-grade spreads are significantly wider. VIX had another up-day (breaking above 15% intraday) but closing at 14.8% (highest in 5 weeks) but more criticaly MOVE (bond VIX) spiked to its highest in 9 months. Many talked about bond-like stocks getting hammered but it is noteworthy that homebuilders suffered the most today. USD weakness (and JPY strength) were the theme in FX markets as carry continued to be unwound of yesterday's peak and in turn this helped gold and silver push around +0.5% on the week. Oil prices slumped most in a month, testing below $93 at their lows. Equity volume ended above average, average trade size was low, and the S&P closed below its up-channel trend.
The conventional wisdom is that oil should decline in nominal price as global demand weakens along with the global economy. In the hot-money-seeks-a-new-home scenario outlined above, demand could decline on the margins but speculative inflows - demand for oil contracts by speculators - push prices higher, potentially a lot higher in a geopolitical crisis. The central banks that are creating all the "free money" that is available to large speculators fulminate against oil speculators, as if all the free money is only supposed to go to "approved" speculations in equities and bonds. Unfortunately for the central bankers, they only create the money, they don't control what the financiers who get the free money do with it. Gasoline is expensive at the pump, but by one measure oil is cheap and poised to go higher and despite the endless MSM hype about U.S. energy independence and U.S. exporting energy abroad, the U.S. still imports over 3 billion barrels of crude oil every year and when oil becomes expensive: the economy sinks into recession.
For no good reason, equity markets woke up this morning with a "Tuesday" hangover. Perhaps it is the realization that there is no great rotation and bond weakness is a sign of global capital market queasiness (not growth expectations). Perhaps it is a drying up of collateral to cover the over-levered, over-crowded, reach-for-yield trades. Perhaps the whisper of a well-known large hedge fund manager forced to liquidate his $18.7bn portfolio, into a stock market with no capacity to cope with 'negative' liquidity at the margin, are actually true. Or just perhaps it is time for a snap back to reality (the reality of VIX, credit, macro, micro, lumber, and copper perhaps?)
Following yesterday's blow out in US bond yields, which have continued to leak wider and are now at 2.20% after touching 2.23%, the overnight Japanese trading session was relatively tame, with the 10Y JGB closing just modestly wider at 0.93%, following the market stabilization due to a substantial JPY1 trillion JOMO operation which also meant barely any change to the NKY225, while the USDJPY slipped in overnight trading below the 102 support line and was trading in the mid 101s as of this moment, pulling all risk classes lower with it. There was no immediate catalyst for the sharp slide around 3am Eastern, although there was the usual plethora of weak economic data.
Spanish and Italian stocks are up 3% this week, European sovereign bond spreads are compressing like there's no tomorrow, and Europe's VIX is dropping rapidly. Why? Aside from being a 'Tuesday, we suspect two reasons. First, Hungary's decision to cut rates this morning is the 15th central bank rate cut in May so far which appears to be providing a very visible hand lift to risk assets globally (especially the most junky)' and second, Spain's deficit missed expectations this morning (surprise), worsening still from 2012 and looking set for a significant miss versus both EU expectations (and the phantasm of EU Treaty requirements). As the following chart shows, Spain is not Greece, it is considerably worse, and the worse it gets the closer the market believes we get to Draghi firing his albeit somewhat impotent OMT bazooka and reversing the ECB's balance sheet drag. Of course, direct monetization is all but present via the ECB collateral route and now the chatter is that ABS will see haircuts slashed to keep the spice flowing. What could possibly go wrong?
As if the overnight session in Japan was not bad enough, futures markets are indicating yet more weakness from the market that seemed (until 3 days ago) incapable of falling. With a 14.3% drop from its May 22nd highs, Japan's Nikkei 225 is struggling to find buyers for this dip. What is interesting is the bid for European peripheral debt and equity markets this morning and the bounce in US futures (with no commensurate move in JPY which is hovering around 101). Gold and Silver are up around 1% with the USD unchanged. Treasury Futures imply a rise of 1-2bps in yield.