Fund Flows

While, as we recently destroyed here, the current meme is that "bonds are mispriced" due to the Fed and so holding them is an idiot's play as at some point they will normalize (which somehow means equities are a great investment - as they apparently never drop in price). DoubleLine's Jeff Gundlach appeared on CNBC this morning laying out a few very obvious (but entirely overlooked by the mainstream) reasons why a 'rise' in interest rates (and the bond price drop implicit in that) is not necessarily positive for most of the equity-type investments currently. We see four reasons why the "bonds bad, stocks good" meme is fundamentally flawed and why a great rotation remains a myth... Gundlach also warned flow-driven equity bulls, "QE effects are in the eighth inning."

The investment environment is changing at a rate that's representative of global economic imbalances, fund flows, and geopolitical risks. We believe this decade will continue to witness greatly increased volatility and instability in the economies of the world and the global financial system. Very few past models are still valid (and most have been proved 'empirically' in real-time to be entirely fallacious). Such a situation has contributed to the extreme uncertainty that currently prevails. Our guiding principle is to help investors understand and navigate through all the complexities of an unstable, inflation-prone world. The following ten themes will be key drivers of financial market performance over the next 1 to 5 years.

When a month ago we wrote "It's Deja Vu, All Over Again: This Time Is... Completely The Same" as the endless din over some non-existent "Great Rotation" had the TV anchors on the financial comedy channel giddy with excitement, we said one thing, when we compared the current environment with its carbon copy observed back in 2011: "Fund Flows into equities were unstoppable. Yes - that was 7 consecutive weeks of major equity inflows into stocks... back in January 2011." Moments ago ICI just released its latest weekly US equity mutual fund flow data for the week ended February 27. We can now officially end the 2013 version of the "great rotation" myth because we just got our first outflow, after how many weeks of inflows? That's right: seven. Just like in 2011.

There is a simple reason why the real money (as opposed to fast money tweakers) has been far less excited about the domestic equity fund inflows than the financial media and their sponsoring commission-takers would suggest. The reason is - as Goldman shows empirically, not anecdotally - fund flows 'lag' performance, 'not lead'! As we have noted previously, the great rotation myth is simply that - a unicorn-like belief that the investing public will sell down their bond portfolios (high-yield, investment-grade, and sovereign) to stake their future on stocks - when the reality is the flows (which are not rotating to stocks 'net' anyway) simply reflect the sheep-like herding of performance-chasing index-huggers hoping to beat the greater fool. There always has to be someone left holding the bag...

It would appear that the hopes and commissions of each and every talking head wealth manager and/or central banker has been dashed on the rocks of 'fiscal cliff' tax-hike front-running and a citizenry who remain far more cognizant of the unreality of the real world than the reality being preached by the market. There were some fund flows this week into equity funds (the lowest in six weeks) but, as Reuters notes, it was all into international funds as domestic funds saw outflows and domestic bond funds once again saw inflows. As Goldman Sachs' funds flow and positioning monitor shows - Rotation, Over.

We have gone from a supply and demand market to a funds flow market and this really sucks for consumers. 

It was the deep of winter... CNBC was talking about "animal spirits", had just touted "the best January in 14 years", was quoting Raymond James' Jeff Saut as saying that "The market "is amazingly resilient, and is no longer overbought" and desperately doing everything it could to get retail back into stocks, and was succeeding: retail inflows into stocks were surging and seemed unstoppable... The Chicago PMI had just printed at its highest level in decades... the VIX was dropping fast... Stocks were soaring... Bonds were sliding... NYSE margin debt had just risen to the highest level since 2008... A few brief months earlier the Fed had unleashed a new, massive round of unsterilized bond buying...  Bank of America was blaring about the "great rotation" for stocks, and yes - just shortly prior "global currency warfare" had broken out. 

Name the year?

From the close on Dec 28th (pre-fiscal-cliff), the Dow is up over 7% (for its best January since 1994), the long bond is down 3.3% in price, gold is up marginally and the USD is down marginally. From around November 2012, the current in stocks is eerily reminiscent of the same run from November 2011's dip and co-ordinated easing. It would appear that if 2011/2 was the world normalizing to ZIRP, 2012/3 is the world's central banks fighting currency wars with their ever-expanding balance sheets (and while Europe won last year in stocks, the ECB's fading balance sheet is leading its stocks to underperform a renewed Fed expansion). Credit markets are notably not buying this risk-on move (and nor is VIX) in January but JPY-cross-based carry is leading the way, so the world better hope that no one doubts the BoJ's ability top unilaterally 'win' the currency wars. Energy and Healthcare are the month's winners as JPY loses 6.4% on the month and EUR gains 2.7% against the USD. ES clung to VWAP into the close. with a second down day in a row

If Peter Schiff is selling gold, then maybe you should too!

Everyone's favorite bull made another magnificently arrogant appearance on TV this morning. Following his recent CNBC embarrassment, Bloomberg TV interviewed the outperforming hedge fund manager this morning - during which he explained his 'where else ya gonna go' bullish stocks thesis. From expectations for an "explosion of greatness" in the US to his gratuitous flirtation, he appears to have the inane ability to use many words where few are needed and his bullish thesis has the ring of any and every guest pumper (with nothing new to add): the same supposedly 'low' multiple, central-banks-are-printing, and wide spread between bond and equity yield argument that everyone's mom can explain. From expectations for the 'great rotation' from bonds to stocks and his 50%-upside prediction in Citi, Tepper is "balls to the wall" the best guest ever on any stock-touting network. However, one little thing gets in the way - the last time the Great-and-Powerful Tepper appeared so overtly bullish of stocks (and financials specifically), he also was dumping his holdings into the rally that followed.

Over the course of the last two weeks, I attempted to explain to the general investing public how, thanks to the virtual impossibility of distinguising between 'legitimate' market making and 'illegitimate' prop trading, some of America's systemically important financial institutions are able to trade for their own accounts with the fungible cash so generously bestowed upon them by an unwitting multitude of depositors and an enabling Fed. 

As we have been warning for over half a year, and as conventional wisdom has finally caught on, the economy most impacted in Europe by the recent surge in the EUR exchange rate (not because of an improvement in the economy but due to wholesale engineering of asset prices by central banks) is the one that has so far been able to keep it all together - Germany, the same country where Angela Merkel last night suffered an embarrassing last minute loss which may be a harbinger of things to come should Germany slide deeper into recession. This, as also noted repeatedly before, is part of the grand paradox in Europe: unlike every other central bank in the world, the ECB's interventions achieve only one thing: to push the EUR higher, in the process stabilizing secondary market indicators (bond prices, the DAX, swap spreads) but destabilizing EUR-denominated exports. And while the adverse impact on core exporting countries from ECB intervention is by know understood by everyone (and this is ignoring the impact of potential inflation as a result of fund flows to the few safe regions in Europe), few appreciate just how big the EUR impact on the periphery is as well. The chart below from the Spanish economy ministry showing the recent stunning divergence of Spanish exports, should explain why a low EUR is good for not only Germany, but certainly the PIIGS, in this case Spain. And vice versa.

Even if the US economy really takes off in 2013, don`t look for oil and gasoline demand to overtake supply in the equation.

It took the charming three tries for Greece to get its third "bailout", which incidentally does not bail out anyone except the hedge funds who went long GGBs because the only actual winners resulting from yesterday's transaction - those benefiting from Europe's AAA club fund flows are hedge funds as explained previously. As for Greece, what the "deal" did was buy it more time to get its hockeystick GDP forecast in order as the only thing that may win the country some future debt forgiveness is hitting an unbelievable 4%+ current account surplus and GDP growth of a ridiculous 4.5% per year. That said, of the cash proceeds going to Greece, to be released in three tranches, totaling €43.7 billion, only a de minimis €10.6bn for budgetary financing, i.e., the Greek population (read government corruption) and €23.8bn in EFSF bonds for bank recapitalisation, read keeping German and French banks solvent. Once the €10.6 billion runs out in a few months, the strikes will resume. So what does this third, latest, greatest and certainly not last can kicking exercise mean? Simple: in the words of SocGen, a short-term reprieve has been hard bought, nothing has been fixed, and "more will be likely."

While the developed world's central banks may enjoy trading FX and stocks, either directly or indirectly, with each other in a demonstration of monetary policy "stability", the historically biggest source of capital inflows into stocks - the retail investor - has once again just said "nein", for the 17th consecutive week, and excluding tiny inflows of $95 million in the week of July 18 and $907 million in the week ended May 30, has pulled money from stocks for an unprecedented 39 consecutive weeks, with $6.6 billion pulled out in the last week, the most since the first week of October. In fact going back to the beginning of 2010, according to ICI, while $44.5 billion has been invested into domestic equity stock funds, $412 billion has been pulled out. Where has the money gone on an almost dollar for dollar basis: bonds, confirming that the New Normal mantra is all about return of capital.