Investment Grade

"The best way to define the mood in the market right now is panic," warns one commodity broker, adding that "everyone understands why we are going down, but nobody can tell where the bottom is." As the WSJ notes, the economic slowdown in China is hammering prices of some raw materials, driving down industrial commodities from copper to iron ore and coal - exacerbated by the vicious cycle of credit-collateral-contraction. So what is the cheapest way to play continued stress (with potentially limited downside)? The diversified natural resources company Glencore has a huge $55 billion of debt, is drastically sensitive to copper (and other commodity) prices, and its CDS remains just off record tights...

Puerto Rico muni owners who never saw the Barron’s story or the rating firms’ downgrades are better off than those who kept up with the financial news.

With the world still on edge over developments in the Ukraine, overnight newsflow was far less dramatic than yesterday, with no "bombshell" uttered at today's Putin press conferences in which he said nothing new and simply reiterated the party line and yet the market saw it as a full abdication, he did have some soundbites saying Russia should keep economic issues separate from politics, and that Russia should cooperate with all partners on Ukraine. Elsewhere Gazprom kept the heat on, or rather off, saying Ukraine recently paid $10 million of its nat gas debt, but that for February alone Ukraine owes $440 million for gas, which Ukraine has informed Gazprom it can't pay in full. Adding the overdue amounts for prior months, means Ukraine's current payable on gas is nearly $2 billion. Which is why almost concurrently Barosso announced that Europe would offer €1.6 billion in loans as part of EU package, which however is condition on striking a deal with the IMF (thank you US taxpayers), and that total aid could be as large as $15 billion, once again offloading the bulk of the obligations to the IMF. And so one more country joins the Troika bailout routine, and this one isn't even in the Eurozone, or the EU.

Diversification with a solid strategy

In the aftermath of the recent Wall Street Journal profile piece that, rather meaninglessly, shifted attention to Bill Gross as quirky manager (who isn't) to justify El-Erian's departure and ignoring Bill Gross as the man who built up the largest bond fund in the world, the sole head of Pimco was eager to return to what he does best - thinking about the future and sharing his thoughts with one of his trademark monthly letters without an estranged El-Erian by his side. He did that moments ago with "The Second Coming" in which the 69-year-old Ohian appears to have pulled a Hugh Hendry, and in a letter shrouded in caveats and skepticism, goes on to essentially plug "risk" assets. To wit: "As long as artificially low policy rates persist, then artificially high-priced risk assets are not necessarily mispriced. Low returning, yes, but mispriced? Not necessarily.... In plain English – stocks, bonds and other “carry”-sensitive assets would outperform cash."

Three unlucky attempts in a row to retake the S&P 500 all time high may have been all we get, at least for now, because the fourth one is shaping up to be rather problematic following events out of the Crimean in the past three hours where the Ukraine situation has gone from bad to worse, and have dragged the all important risk indicator, the USDJPY, below 102.000 once again. As a result, global stock futures have fallen from the European open this morning, with the DAX future well below 9600 to mark levels not seen since last Thursday. Escalated tensions in the Ukraine have raised concerns of the spillover effects to Western Europe and Russia, as a Russian flag is lifted by occupying gunmen in the Crimean (Southern Ukrainian peninsula) parliament, prompting an emergency session of Crimean lawmakers to discuss the fate of the region. This, allied with reports of the mobilisation of Russian jets on the Western border has weighed on risk sentiment, sending the German 10yr yield to July 2013 lows.

For the second night in a row, China, and specifically its currency rate which saw the Yuan weaken once more, preoccupied investors - and certainly those who had bet on endless strenghtening of the Chinese currency - however this time it appeared more "priced in, and after trading as low as 2000, the SHCOMP managed to close modestly green, which however is more than can be said about the Nikkei which ended the session down 0.5%. Still, the USDJPY was firmly supported by the 102.00 "fundamental" fair value barrier and as a result equity futures, which had to reallign from tracking the AUDUSD to the old faithful Yen carry, have been propped up once more and are set to open at all time highs. If equities fail to breach the record barrier for the third time in a row and a selloff ensues after the open in deja vu trading, it will be time to watch out below if only purely for technical reasons.

It would indeed be supremely ironic if the "strong" foreign law bond indenture would be tested, and breached, not by Greek bonds, as so many expected in late 2011 and early 2012, but by one of the last contries in Europe which is still AAA-rated. We would find it less ironic if the next leg of the global financial crisis was once again unleashed by an Austrian bank: after all history does rhyme...

Debt is the great palliative that has enabled the US and other major economies to escape reality, at least for a time. Ayn Rand described such behavior:

You can avoid reality, but you cannot avoid the consequences of avoiding reality.

It is possible to steal from tomorrow to improve today but only at the cost of having less of a future. That is what both nations and citizens have been doing. The ability to continue doing so has about run its course.

The default cycle that should have occurred, given historical patterns of issuance cycles, has morphed (thanks to the Fed) into a refinancing cycle; but while DoubleLine's Jeff Gundlach suggests that fundamentals are supportive, "the valuation of junk bonds as a category is at its all-time overvalued versus long-time treasury bonds." So despite Yellen exclaiming that she sees no bubbles, one of the world's largest bond fund managers has never seen corporate bonds (investment grade and high yield) more expensive. Gundlach goes on to note he has sold some Apple (but believes it will remain range-bound), is baffled by the valuation of Chipotle, and sees 10Y Treasury yields dropping to 2.5% or lower.

Three days ago it was S&P that opened the can of Puerto Rico junk worms. Moments ago it was Moody's turn to downgrade the General Obligation rating of the Commonwealth from Baa3 to Ba2, aka junk status. We note this just in case someone is confused what the catalyst was that just sent stock to a new intraday high in the aftermath of today's disappointing jobs number which until this moment barely managed to push the S&P higher by 1%. From the report: "While some economic indicators point to a preliminary stabilization, we do not see evidence of economic growth sufficient to reverse the commonwealth's negative financial trends. Without an economic revival, the commonwealth will face difficult decisions in coming years, as its debt and pension costs rise. The negative outlook signals the remaining challenges facing the commonwealth."

"Financial systems are unstable with excessive risk-taking," warns PIMCO's now solo guru Bill Gross, telling Bloomberg TV's Stephanie Ruhle that in a "Soros reflexivity... Once you get the levered system going, it hardly knows when and where to stop." Credit, as we have noted, has been relatively more stable (though less positive on the the way up) Gross notes and "the way to get rich in the past was to borrow money and to lever [up]," but Gross explains that now, "assets are artificially priced... from this point forward, double-digit returns, getting rich on leverage, no. You better look elsewhere for – for your profits," and not Asia. China is "the mystery meat" of emerging market countries, Gross cautions, "nobody knows what’s there and there’s a little bit of baloney."

There are two major concerns that everyone should be concerned about that we see taking this sell-off further and faster than anyone else expects...

As a prelude to the following dismal market update, Japan just posted the largest annual trade deficit ever (ever ever ever) at JPY 11.47 trillion... so much for Abenomics and the magic J-Curve as the year just got worse (not better). With the Nikkei 225 (cash) down over 400 points (as we would have expected given futures action) and back under 15,000; Japanese stocks are at 7-week lows but Japanese credit risk is rapidly accelerating lower at its riskiest in 10-weeks. Japanese government bonds are well bid with yields on the 20Y having dropped to 1.443% - the lowest since April 2013. Away from Japan, the iTraxx Asia index (which tracks credit risk of investment grade corporates) has soared in the last few days to almost 5-month highs. Emerging Market Sovereign CDS are all notably wider with Vietnam and Indonesia topping the relative moves so far (and most at multi-month wides). Chinese repo is stable for now (CDS are wider by 2bps at 7-month wides) but so far, no good, for those believing the contagion in EM FX will remain contained.

The Dow Transports has outperformed the Industrials by over 3% year-to-date (+1.9% vs -1.1%) as both the Trannies and Russell pressed new record highs today (as the Dow and S&P lagged on bigger-cap earnings disappointments). Treasuries lost ground with the front-end worst (5Y +6bps) but 30Y was unch leading to a significant further flattening in the curve to its 2nd flattest close in 17 months. The USD ended the day (and week so far) unchanged as a big drop in CAD was offset by a rally in AUD and GBP. Gold & silver dribbled lower all day and were smacked into the close; with copper flat to slightly lower on the day as WTI surged towards $97 (narrowing the spread to Brent to 1-month lows). It was recent business-as-usual in VIX as it leaked higher testing 13% once again and credit markets remain divergent from stocks (though the relative safety of investment grade credit was bid this afternoon). For those keeping track, today's market was brought to you by the letters USDJPY and the number 17.62.