High Yield

We already posted Howard Marks' most recent letter in its entirety previously, but it bears reposting a section from Art Cashin's daily letter which focuses on one segment of Marks' thoughts, which is especially relevant in light of today's most recent comment from one Warren Buffett - a person who very directly benefited from the government/Fed's bailout of the banking sector in 2008 - who said that "Bank Risk No Longer Threatens U.S. Economy." The same banks, incidentally, who are TBerTFer than ever. An objective assessment or merely yet another example of the "handcuff volunteerism" (not to mention crony hubris) Marks touches on? Readers can decide on their own.

The credit markets this week already look very different to how they ended last year. As BofAML's Barnaby Martin notes, beta-compression, flatter curves and credit outperformance versus equity have all been abundant themes of late. Relative value is still there, when one looks closely, but is unfortunately not what it used to be. He adds that "things in credit have started to feel a lot like 2007 again," and while he believes the trend is set to continue (though slower) and the liquidity-flooded fundamentals in the high-yield bond market have been holding up well, it is trends in the leveraged loan market, that continue to deteriorate, that are perhaps the only canary in the coal-mine worth watching as global central bank liquidity merely slooshes to the highest spread product in developed markets (until that is exhausted). The rolling 12m bond default rate among European high-yield issuers fell to 1.8% in December, whereas loan default rates rose to 8.5%. With leverage rising, the hope for ever more greater fools continues, even as everyone is forced into the risky assets.

The last time the US held a 10 year auction was earlier than its usual time on December 12, just before the Fed announced QE4EVA. The result from that particular auction were a total jumble, where Primary Dealers took down a tiny 33.1%, and where Directs were stuffed with a near record 42.7%. That and a big, 1.7 bps tail. In this light today's 10 Year was a little more casual, with the Treasury just issuing another $21 billion in 10 year bonds, this time not premonetized unlike tomorrow's 30 year auction, although the internals were just as ugly. The When Issued was 1.855%, with the final High Yield of 1.863% tailing (84% allotted at high). The Bid to Cover was 2.83, the smallest for a reopening auction since December 2009, and well below the average for 2012 of 3.03. Indirects took down just 28.5%, the second lowest in years, and better only compared to December's 24.2%, while Directs ended up holding only 14.8% of the final allocation, a big drop from December's 42.7%, which increasingly appears to have been a year end window dressing by various credit funds to show "safe securities" on their books. Overall, an ugly 10 Year auction following another ugly 10 Year auction, even if the past week has seen the yield on the paper drop substantially from 1.97% a week ago to 1.86% today. Was that it for the great "bonds to stocks" rotation?

In a somewhat surprising bid to avoid having even more Argentina assets impounded by the increasingly more belligerent hedge fund hordes, president Kirchner opted to squeeze the government's already dwindling coffers further and instead of using her official aircraft, she decided to pay British air charter Chapman Freeborn $880,000 for an airplane rental to take her to Cuba, the UAE, Indonesia and Vietnam. This happens even as Argentina is once again caught in a messy brawl with the UK over the Falklands. And while the nearly $1 million abuse of taxpayer funds will hardly pass unnoticed, we have no doubt that Argentina should be able to finance itself in the international markets efficiently should it choose to: just slap a high yield on the debt and pitch it to Elliott, already in possession of an Argentina boat, who may (or may not) gladly buy it. Stranger things have happened.

A month after December's 3 Year bond auction drew a record Direct bidder takedown, the Treasury has just auctioned off another batch of $32 billion in TSYs, which was almost a carbon copy of last month, with weak Indirect interest (28.4% Indirects), a stable Bid To Cover of 0.3623, increasing from last month's 0.3356%, a high yield of 3.85% (5.51% awarded at the high), just inside of the 0.386% When Issued, and another record Direct Bidder take down, rising to 26.4%, and just shy of surpassing the Indirects, as happened in December. The curious shift away from Indirects to Directs continues, even as Primary Dealers as usual pocket around half of the auction, to be used a near cash-equivalent collateral in various repo markets (and afterwards perhaps using the cash repo proceeds to sell IG9 indices?) Keep an eye on the Bid to Cover in future auctions as we may have hit a ceiling in this old-fashioned metric which has lately been moving sideways, and outright downward in some other TSY bond year.

Back in April 2012, in "How The Fed's Visible Hand Is Forcing Corporate Cash Mismanagement" we first explained how despite its best intentions (to boost the Russell 2000 to new all time highs, a goal it achieved), the Fed's now constant intervention in capital markets has achieved one thing when it comes to the real economy: an unprecedented capital mismanagemenet, where as a result of ZIRP, corporate executives will always opt for short-term, low IRR, myopic cash allocation decisions such as dividend, buyback and, sometimes, M&A, seeking to satisfy shareholders and ignoring real long-term growth opportunities such as R&D spending, efficiency improvements, capital reinvestment, retention and hiring of employees, and generally all those things that determine success for anyone whose investment horizon is longer than the nearest lockup gate. Today, one calendar year later, none other than Bill Gross, in his first investment letter of 2013, admits we were correct: "Zero-bound interest rates, QE maneuvering, and “essentially costless” check writing destroy financial business models and stunt investment decisions which offer increasingly lower ROIs and ROEs. Purchases of “paper” shares as opposed to investments in tangible productive investment assets become the likely preferred corporate choice." It is this that should be the focus of economists, and not what the level of the S&P is, as it is no longer indicative of any underlying market fundamentals, but merely how large, in nominal terms, the global balance sheet is. And as long as the impact of peak central-planning on "business models" is ignored, there can be no hope of economic stabilization, let alone improvement. All this and much more, especially his admissions that yes, it is flow, and not stock, that dominates the Fed market impact (think great white shark - must always be moving), if not calculus, in Bill Gross' latest letter.

It's the last trading day of the year, nothing has been resolved on the Cliff, the perpetually wrong media has now decided to change its tune and is spin the Wile E. Coyote plunge as a "good thing" (just as we expected), Congress is nowhere, the Senate failed to reach any resolution last night and is resuming the "negotiations" farce at the bright and early hour of 11 am, and yet somehow, in spite of everything, the strong bid under the futures refuses to go away (thank you Kevin Henry). This despite what is becoming clear to even this broken market (InTrade odds of a debt ceiling deal by the end of today are still a substantial 2.3%) that there will likely be no deal until some time in February or March when the debt ceiling extensions expire by which point the only question is how deep the US recession will be. And still everyone will be shocked, shocked, when nothing is done today either. Why? Because the market continues to price in an outcome which demands that it crash for it to be achieved. That so few grasp this is frankly, disturbing. Also, everything else is perfectly enjoyable theatrical noise. And just to keep the excitement factor really high, most rates and FX markets close early today, with rates and FX futures markets close at 1pm New York time while cash bond trading at 2pm.

When we commented on yesterday's 5 year auction, most remarkable for a surge in 5 Year Direct awards to a stunning 30%, which in turn followed a record low Indirect takedown, we wondered if "there some major shift in the underlying dynamics for US paper based on these recent results? You bet. What is said shift? We hope to find out soon enough." Today, we still can't confirm what the reason for said shift is, but we can certainly confirm that the same pattern continues, as the US Treasury just sold its monthly $29 billion allotment of 7 Year paper, at a high yield of 1.233%, well above November's 1.05%, and a bid to cover of 2.72, just below the TTM average of 2.75, but the most notable feature was that just like yesterday, the Direct award was the highest in series history, at a whopping 23.11%, and above last month's 19.71%, which also was a record. There is a distinct shift in awards to Direct bidders, especially with PDs getting just 37%, the lowest since December 2010. Just who these bidders are, and is this merely a year end window dressing phenomenon, seen periodically when money managers need quality collateral for year end purposes, remains unclear. Keep an eye on the Direct bid in the January auction to see if the trend persists. If it does, it may be time to ask some questions.

From the sheer hypocrisy of a fight over a few billion dollars when faced with trillion dollar deficits and the eventual austerity that will be forced upon the US, DoubleLine's Jeff Gundlach expounds during this excellent Bloomberg TV interview on his growing concerns at markets where fundamentals "are trumped by policy decisions," and while he does not believe that bond markets are bubbly at the moment, the impact of an inevitable recession could be devastating given valuations. His subtle suggestion to keep powder dry through 2013 and into 2014 (as deploying money at that future point will make all the difference), follows from his view that he does not see much value in US equities (people always want investments to go up like a line... That's just not reality) and suggests great care be taken in US bond markets (focusing on low volatility funds) as he looks at Japan's dismal record (and hyperinflationary possibilities) and reflects on the US that "the issue isn't the fiscal cliff. The issue is the fiscal crisis that the United States has been looking at for the past several years." Must watch.

For anyone watching the last hour or two of today's market, there was plenty to entertain. VXX (the implied vol ETF) collapsed in a haze of glory dragging stocks to the highs of the day with financials seeing their best day in three months. Treasury yields, Gold, and Stocks have all recoupled from the election and perhaps that is what this bond weakness is related to (as for example LQD fell to 3 month lows today, while HYG remains close to record highs). Stocks closed at Thursday's highs amid heavy and large size trades - the vertical rampathon (or inverse Baumgartnering) suggests a quiet market desparate to auction to stops. The USD ended unch, as did Gold while 30Y added 8bps as testicular fortitude appeared under pressure today. Perhaps Citi should downgrade AAPL every day? Today's #Teppergasm (h/t @gubbmintcheese) saw the NASDAQ back to unchanged for December and Citi up a measly 13.3%.

While generally a rather boring auction, with the 0.245% When Issued coming right on top of the final High Yield, in addition to bringing the US another $35 billion closer to the debt ceiling breach, today's 2 Year auction was remarkable for one more thing: the Indirect Take down of 17.7% was the smallest such award on record, which in turn confirms that last week's trend of collapsing Indirect interest is persisting. Has the Chinese boycott of US paper now moved to all foreigners? Forget the 2 month delayed TIC data, and keep an eye on the weekly updated Fed Custodial holding data - if we see a drop in this week's update for TSY paper, it may be time to start getting concerned.

The last time the USD closed down (DXY -1%) on the week, and so did stocks (Dow/S&P/Nasdaq -0.25%), was the week heading into QE3 which marked the top of the US equity market for the year. With contracts rolling, the futures were roiling into the close as they were ping-ponged between new week lows and VWAP. The Dow Transports stood alone in their outperformance +1.1% (but were sliding rapidly into the close) and while most sectors were weak (Discretionary worst -1.2%), Materials outperformed (+1.66%) in a world of their own today. Silver slumped 2.4% on the week while Oil added 1% with gold flatlining since yesterday morning down around 0.5% on the week. AAPL, obviously, was the story today -7.75% in last 3 days to 10 month lows on huge volume today. EUR strength (+1.75%) dragged USD lower but was stymied by JPY weakness (-1.25%) as Treasury yields came off the week's highs to end 7-9bps higher on the week. VIX at two-week highs closed above Europe for the first time this year. Some peculiar volume and behavior in bond ETFs to note also (HYG saw biggest 2-day drop in a month) - markets feel very brittle up here.

A.M. Kitco Metals Roundup: Gold Drops Below $1,700 Following another Mysterious Price Drop in Asian Trading

Gold set for dramatic correction: hedge fund manager

Within a few minutes of the day-session open, US equity markets decided today was the day to test the Election highs and QE3-announcement lows. Starting with a little jog, the chatter gathered pace as weak data was dismissed, eyes kept focused on the prize of running the stops above the Election highs leveraging the pre-FOMC 'habit' and hope of a fiscal cliff resolution. This was not to be. VIX was the leverage tool of the day early and led (beta-adjusted) stocks higher until the explosion of volume at the highs with shorts giving up amid a plethora of big blocks suggesting pros selling into that auctioned strength. The straw to break the rally-camel's back was Harry Reid's comments and sure enough we rotated all the way back down to the day-session open's levels. While all this excitement was occurring, risk-assets twiddled their thumbs in general, snickering the impetuous youth of the exuberant equity market and the pundits admiration that 'well, the market knows that a deal will be done'. Into the close, S&P futures ramped up to VWAP settling their at the day-session - only to extend a little after the close.

A rather curious result in today's just completed 3 Year $32 billion bond auction, which concluded on surprisingly weak terms, despite the High Yield coming at 0.327% or precisely where the When Issued expected it would, which also happens to be the lowest yield in the history of the auction. So far so good - where things got thorny is in the internals, first the Bid to Cover which printed at a surprisingly low 3.356, the lowest since February 2012, but a bigger surprise was the Indirect Take Down, which as validated by the recent trend, just dipped to 21.9% of the issue, the lowest Indirect Takedown since 2007! It also saw the Direct allocation surpassing the Indirect for the first time in history. Just as surprising is that the Indirect tender into the auction was a meager $9 billion, leading to a very high 77.3% hit rate. Obviously America's foreign lenders have better thing to do than to lock up cash with Uncle Sam even for 3 years, despite Ben's guarantee that there will be no volatility in the throutg "mid-2015." Or perhaps due to. Finally, it also means that ever more Fed monetization will have to take place to rotate bonds from PDs back to the Fed, and also means that with the Fed already monetizing 100% of all long-dated issuance, he will have to move ever further left.