Just as we warned previously (here, here, and here), the knife-catching, contango-crushed, BTFDers that piled over $6bn into Oil ETFs have severely underperformed this year. The USO ETF has fallen by more than 9% since the start of the year, whereas front-month U.S. oil futures have dipped by less than 3% on account of roll costs, and as of last week, investors have started to exit this massive position en masse. As Reuters reports, outflows from four of the largest oil-specific exchange traded funds reached $338 million in two weeks to April 8 - the first since September and largest since Jan 2014. It seems Goldman was right about "misguided retail investors."
A five sigma event signifies extreme conditions, or an extremely rare occurrence. To bring this discussion from sports and weather to the financial world, we can relate a 5 sigma event to the stock market. Since 1975 the largest annual S&P 500 gain and loss were 34% and -38% respectively. A 5 sigma move would equate to an annual gain or loss of 91%. With a grasp of the rarity of a 5 sigma occurrence, let us now consider the yield spread, or difference, in bond yields between Germany and The United States. As shown in graph #1 below German ten year bunds yield 0.19% (19 one-hundredths of one percent) and the U.S. ten year note yields 1.92%, resulting in a 1.73% yield spread. This is the widest that spread has been in 30 years.
"Despite much hope that the current breakout of the markets is the beginning of a new secular 'bull' market - the economic and fundamental variables suggest otherwise. Valuations and sentiment are at very elevated levels which is the opposite of what has been seen previously. Interest rates, inflation, wages and savings rates are all at historically low levels that are normally seen at the end of secular bull market periods. Lastly, the consumer, the main driver of the economy, will not be able to become a significantly larger chunk of the economy than they are today as the fundamental capacity to releverage to similar extremes is no longer available."
With the "Great Greek Tragedy" now behind the markets, for the time being, all eyes have turned towards the Nasdaq's triumphant march back to 5000. (The graphics department at CNBC have been working overtime on banners and bugs for when it happens....watch for them.) For now, it is all about the hopes of a cyclical upturn in the Eurozone economy supported by the ECB's QE program starting next month. Market participants have been bidding up stocks globally in anticipation that the ECB's program will pick up where the Fed left off, and the flood of liquidity will find its way back into asset prices
While there are many that suggest there is "no bubble" in the financial markets at the current time, a simple look at the extreme elevation of prices over the last couple of years is eerily reminiscent of the late 90's. Given the very elevated levels of investor bullishness, margin debt and complacency, there is more than sufficient evidence that a mean reverting event is highly likely at some point. However, at the moment, the perceived "risk" by investors is "missing the run" rather than the potential destruction of capital if something goes wrong. This is the opposite of what "risk" management is about...
"...I believe that the Fed understands that we are closer to the next economic recession than not. For the Federal Reserve, the worst case scenario is being caught with rates at the 'zero bound' when that occurs. For this reason, while raising rates will likely spark a potential recession and market correction, from the Fed’s perspective this might be the 'lesser of two evils.'"
At 30 basis points yield, a short on this German Bund via the futures market is basically a call option on the utter destruction of this Massive Yield Chasing Strategy on behalf of financial institutions...
The Fed has been supporting the market since the late 1980s. But there is an important difference between the actions of the Fed under Yellen versus Greenspan and Bernanke. In 2008, the Fed allowed Bear Stearns and Lehman Brothers to fail. Given the massive wipeout that followed, this decision is now viewed as a dangerous mistake. Having learned their lesson, the Fed is now rushing in to support the market in response to even routine 20% drops. In this way, the Fed is acting like a value investor who demands a small margin of safety before investing.... Since 2010, however, the Fed has changed tactics. The Fed is now reacting far more quickly. Small market selloffs are followed by immediate responses. By quickly riding to the rescue, the Fed is effectively front-running value investors.
For months now we have been discussing that despite the "hopes" that this time is different, there is little chance that the U.S. can remain an island of economic prosperity in the sea of global deflation. The following series of charts all suggest that current hopes of surging economic growth in the U.S., over the next several quarters, will likely be met with disappointment.
"People say, 'Sell government bonds and lend money to widget manufacturers.’ It doesn’t really work like that." Hayes says, adding that "Low yields don’t necessarily mean more lending to the real economy; time and confidence are key elements and last 6 years have shown QE can’t control those." In short: it hasn't even started and QE is already a complete failure. Good job central-planners.
Over the past couple of years there has been a rising chorus of individuals warming to the idea of a new secular bull market. This is not surprising given the seemingly unstoppable rise of asset prices since the financial crisis despite a litany of geopolitical and economic headwinds. But are the "ingredients" that spurred the previous two secular bull market periods in existence today?
Will 2015 be the seventh (7th) consecutive year of the current bull market cycle? It is possible. But with 100% of all analysts and economists betting on that outcome, it is quite possible that something else will happen.
After the worst week for stocks in years, and following a significantly oversold condition, it will hardly come as a surprise that the mean reversion algos (if only to the upside), as well as the markets themselves (derivative trading on the NYSE Euronext decided to break early this morning just to give some more comfort that excessive selling would not be tolerated) are doing all they can to ramp equities around the globe, and futures in the US as high as possible on as little as possible volume. And sure enough, having traded with a modestly bullish bias overnight and rising back over 2000, the E-Mini has seen the now traditional low volume spike in the last few minutes, pushing it up over 15 points with the expectation being that the generic algo ramp in USDJPY ahead of the US open should allow futures to begin today's regular session solidly in the green, even if it is unclear if the modest rebound in the dollar and crude will sustain, or - like on every day in the past week - roll over quickly after the open. Also, we hope someone at Liberty 33 tells the 10Y that futures are soaring: at 2.13% the 10Y is pricing in nothing but bad economic news as far as the eye can see.
"Over the next five years investors now expect inflation to average just below 1.3%. This level of expected inflation has always previously been associated with a decline in US equity prices. There have been no exceptions until today." Russell Napier
While on the one hand, Iceland's decision to inch towards lifting its capital controls is a positive step, it appears what they give with one hand they are taking with another. Just as we predicted three years ago, the muddle-through has failed and there are only hard choices left and sure enough BCG's envisioned 'wealth tax' appears to be rearing its ugly head once more. As Morgunbladid reports, Iceland plans to impose an exit tax as part of removing capital controls, anticipating all bank assets will be subject to the levy, regardless of whether assets are held in local (ISK) or foreign exchange.