Following the overnight ramp in various JPY crosses (dragging equity futures higher, and the Nikkei up 0.8%) it is as if the market is desperate to put all of last week's geopolitical events in the rearview mirror, and while yesterday there were no economic events of note, today's CPI and existing home prints should provide at least some distraction from the relentless barrage of one-line updates on Ukraine and Gaza. Still, that is precisely where the biggest risk remains, with an emphasis on the possibility of more Russian sanctions, this time by Europe.
They call them ‘junk bonds’ for a reason. They now constitute an offence against linguistic decency: ‘high yield’ no longer even is. “By sacrificing quality an investor can obtain a higher income return from his bonds. Long experience has demonstrated that the ordinary investor is wiser to keep away from such high- yield bonds. While, taken as a whole, they may work out somewhat better in terms of overall return than the first-quality issues, they expose the owner to too many individual risks of untoward developments, ranging from disquieting price declines to actual default.” - Ben Graham, ‘The Intelligent Investor’.
There is a glaring divergence between the performance of US equities and high-yield credit's spread over investment-grade credit. As BofAML warns, "either HY rallies or stocks soon in a bit of trouble," because the only pillar left to hold up the fragile un-bubble-like stock market - buybacks - will disappear if costs of funding start to surge (there's always a limit to the leverage a credit cycle will bear). The more concerning aspect is that it appears investors are already rushing for the doors... as this week saw the largest HY outflows in over a year.
We show that equity markets are stretched (e.g., more than 80% of the S&P rally since last year is due to re-rating), but we also find that the fixed income market has become quite rich (we have been overweight European peripherals for more than a year on valuation grounds, we show that this argument no longer holds), and the same is true of the credit market. Second because capital has been flowing rapidly into risky assets, we document that argument and here too find evidence that the market might be ahead of itself. We read the market reaction last week to the Portuguese news as a sign that the market is indeed too complacent and could correct rapidly.
For a centrally-planned market that has long since lost the ability to discount the future, and certainly respond appropriately to geopolitical events, yesterday was a rough wake up call with a two punch stunner of not only the MH 17 crash pushing the Ukraine escalation into overdrive, but Israel's just as shocking land invasion of Gaza officially marking the start of a ground war, finally dragging global stocks out of their hypnotized slumber and pushing risk broadly lower across the globe, even if the now traditional USDJPY and AUDJPY ramp algos have woken up in the past few minutes and will be eager to pretend as if nothing ever happened.
If last week's big "Risk Off" event was the acute spike in heretofore dormant Portugese bank troubles (as a reference Banco Espirito Santo has a market cap at the close last night stood at around €2.1bn ($2.9bn), contrasting to Goldman Sachs ($78.1bn) and JP Morgan ($220.5bn)), then yesterday's acceleration in the Portuguese lender's troubles which as we reported have now spread to its holding company RioForte which is set to default, were completely ignored by the market. Today this has conveniently flipped, following a Diario Economico report that Banco Espirito Santo has the potential to raise capital from private investors. No detail were given but this news alone was enough to send the stock soaring by nearly 20% higher in early trading. Still, despite the "good", if very vague news (and RioForte is still defaulting), Bunds remained bid, supported by a good Bund auction, in part also dragged higher by Gilts, which gained upside traction after the release of the latest UK jobs report reinforced the view that there is plenty of spare capacity for the economy to absorb before the BoE enact on any rate rises. Also of note, touted domestic buying resulted in SP/GE 10y yield spread narrowing, ahead of bond auctions tomorrow.
The current elevation in asset prices is clearly beginning to reach levels of exuberance particularly in high yield "junk" bonds (and small caps). This time, like every other time before, will eventually end the same. However, while this time "is not different" in terms of outcome, the fundamental level from which the eventual "reversion to the mean" occurs will likely surprise most of the mainstream "bullish" clergy. Take a step back from the media, and Wall Street commentary, for a moment and make an honest assessment of the financial markets today. If your job is to "bet" when the "odds" of winning are in our favor, then exactly how "strong" is the fundamental hand you are currently betting on? (and are you willing toi bet your retirement on it?)
The Fed spends an inordinate amount of time focusing on increasing Lending with the idea that loan growth increases economic activity. Is it possible that it is Interest Income derived from Savings that is more important to economic growth?
A nervous peace prevails in the financial markets as central banks sit on their throne, fingers at the ready on the liquidity switch. As UBS' Bhanu Baweja notes, most volatility buyers have been 'rolled' into their graves. As they have explicitly targeted risk premia in addition to rates, a lot more hangs on the monarchs of monetary policy today than it has in previous cycles. While growth and inflation are both low, they are not necessarily uncertain; and although every crisis is different, certain patterns tend to repeat and certain events have reliably driven volatility higher.
10 Year Auction Spooked By Looming Minutes, Tails 1.1 Bps, Still Prices At Lowest Yield Since June 2013Submitted by Tyler Durden on 07/09/2014 13:13 -0400
Ahead of the FOMC Minutes, many seem to have taken a cue from DB's bond trading recos, and taken a flier on today's just concluded reopening of $21 billion in 10 Year paper (technically 9 year 10 month), which probably explains why the 10 year paper just priced at 2.597%, a rather gappy 1.1bps tail to the 2.586% When Issued. Still, pricing at just under 2.60%, this was the lowest 10 Year high yield in over a year, since the 2.21% in June 2013. Considering the recent surge in negative repo rates, expect any freely floating paper to be promptly mopped up despite the apparently weak auction.
If there was any doubt which way the market was leaning if not in stocks, then definitely in bonds, it was promptly crushed moments ago when the US sold $27 billion in 3 Year paper. The When Issued, which was trading at just shy of 1%, or 0.998% to be precise, suggested we could have our first 1% bond auction pricing since May of 2011. That however was not meant to be the case today when as a result of surprising demand for the short end, the Treasury sold TSYs at a high yield of 0.992%, stopping through the when issued by 6 bps, even if the final yield was still the highest in over three years.
Felix Zulauf, James Montier and David Iben: Three legendary investors share their views on financial markets. Everything is pricey ("we will continue to swim in a sea of liquidity; but there might be other events and developments that may not be camouflaged by liquidity which could cause a change of investor expectations.") the European periphery is a bubble ("The Euro crisis is not over...the European economies are not going to change for the better for years to come despite all the cheating and breaking of laws"), Value investors need to venture to Russia ("when you look at today’s opportunity set, you’re left with a set of assets where nothing looks attractive from a valuation point of view") or buy gold mining stocks (" The down cycle could be much bigger than anybody believes if the market realizes that all the actions taken in recent years do not work.") Summing it all up, "there is no question that [sovereigns] lack the fundamental economic base to finally service their debts," trade accordingly.
Once again, US equity futures are roughly unchanged (while Treasurys have seen a surprising overnight bid coming out of Asia) ahead of an avalanche of macroeconomic news both in Europe, where the ECB will deliver its monthly message, and in the US where we will shortly get jobless claims, ISM non-manufacturing, trade balance, nonfarm payrolls, unemployment, average earnings, Markit U.S. composite PMI, Markit U.S. services PMI due later. Of course the most important number is the June NFP payrolls and to a lesser extent the unemployment rate, which consensus expects at 215K and 6.3%, although the whisper number is about 30K higher following yesterday's massive ADP outlier. Nonetheless, keep in mind that a) ADP is a horrible predictor of NFP, with a 40K average absolute error rate and b) in December the initial ADP print was 151K higher than the nonfarms. Those watching inflation will be far more focused on hourly earnings, expected to rise 0.2% M/M and 1.9% Y/Y. Should wages continue to stagnate and decline on a real basis, expect to hear the "stagflation" word much more often in the coming weeks.
These Fake Rallies Will End In Tears: "If People Stop Believing In Central Banks, All Hell Will Break Loose"Submitted by Tyler Durden on 06/24/2014 15:11 -0400
Investors and speculators face some profound challenges today: How to deal with politicized markets, continuously “guided” by central bankers and regulators? In this environment it may ultimately pay to be a speculator rather than an investor. Speculators wait for opportunities to make money on price moves. They do not look for “income” or “yield” but for changes in prices, and some of the more interesting price swings may soon potentially come on the downside. They should know that their capital cannot be employed profitably at all times. They are happy (or should be happy) to sit on cash for a long while, and maybe let even some of the suckers’ rally pass them by. As Sir Michael at CQS said: "Maybe they [the central bankers] can keep control, but if people stop believing in them, all hell will break loose." We couldn't agree more.
While one may opine if today's 2 Year auction was weak or strong, one thing is indisputable: at a pricing high yield of 0.511% (even if 0.4 bps through the When Issued), this was the highest closing yield for 2 Year paper since May 2011 when it priced at 0.56% just before the US debt ceiling debacle and US downgrade firmly reset the bond market far lower. As for the other components of today's auction, the Bid To Cover came at 3.231, below the 3.519 from May, if just below the TTM average of 3.34. The internals were unimpressive, with Direct and Indirects splitting the post almost equally, getting just over 23% of the auction each, while Dealers were left holding 54.6% of the final allottment.