This page has been archived and commenting is disabled.
The Bubble Machine Is Complete: Soaring Stocks Push Investors Into Bonds Whose Issuers Buy More Stocks
It’s no secret that central bank asset purchases and investors’ desperate hunt for yield have driven yields to record lows on everything from government bonds, to SSAs, to IG, to HY. This has regrettably had the effect of ensuring that spreads signal virtually nothing to investors about the riskiness of any particular issue as the market has become so distorted that it can no longer facilitate price discovery. This is great if you’re a company looking to leverage your balance sheet because it means you can borrow for next to nothing, and the beauty of the whole thing is that what looks like next to nothing to you looks great to investors who have seen yields on their risk free assets fall to zero or below, so finding buyers for new issues is easy (unless you’re a Australian iron ore producer that is). Corporates can then funnel the proceeds from new bond offerings back into their own stocks via buy backs, driving prices higher and artificially boosting the bottom line. Here’s what this looks like:
As it turns out, there may be yet another circular dynamic at play which serves to push the bubble machine even further into hyperdrive. As JPM notes, soaring equity prices have had the effect of altering investors’ asset allocations, effectively tipping the balance towards equities even as money flows into bond funds:
Retail investors remain strong buyers of bond funds. YTD retail investors poured more money into bond than equity funds, with the former attracting $73bn YTD vs. $47bn for equity funds. This pattern of higher bond vs. equity fund buying has been repeated in every year since 2009 with the exception of 2013’s Great Rotation…
We note that the speculative motive has been important for most of the past seven years as the almost steady decline in bond yields have provided strong capital gains to investors…
But we note there is another reason that has motivated retail investors to buy bond funds, which is the large capital appreciation of equities in recent years. Equity prices have risen by 50% in the US and by 30% globally over the past three years and this has made retail investors more overweight equities vs. bonds even as they bought more bond than equity funds over the same period…
This is reflected in the US Flow of Funds data released last week for Q4. The equity weighting for US households stood at 35% at the end of the year, six percentage points above its level of three years ago and above its previous 2007 peak. In other words US households appear to be very overweight equities by historical standards and have thus an incentive to buy even more bonds funds to prevent their equity overweight from becoming more extreme. Similarly, US pension funds and insurance companies appear to be overweight equities and underweight bonds as can be seen in (ZH: note that we have discussed this on a number of occasions, see here and here). This increases their incentive to buy even more bonds to prevent their bond weighting from falling too much as equity prices rise…
Household, pension, and insurance fund allocations:
The bigger picture for pension funds:
And at the 30,000 foot level, the picture remains the same:
Most of the rise in equity allocations is due to price appreciation. With new equity issuance very limited compared to outstandings, the world as a whole can only raise its equity holdings by pushing up its price. The equity weighting of the global investor stands decisively above the bond weighting, a sharp contrast to the 2008-2012 period when the bond weighting was above that of equities for most of the time. By now, the shares of bonds and cash are below their 25-year averages while the share of equities is 2% above its historical average...
The result is ever more demand for bond funds, driving borrowing costs still lower and stamping out the last vestiges of the market’s price discovery mechanism:
The more equity prices increase, driven by either hedge funds or investors with low equity allocations, such as Japanese pension funds or economic agents with high cash allocations such as corporates and EM households, the higher the incentive by other investors, such as US pension funds and US households, who are already very overweight equities to buy bonds to prevent their bond allocation from falling too low or their equity allocation from rising too high vs. historical averages. In other words, higher equity prices can increase bond demand by investors who are already very overweight equities, thus boosting bond prices and depressing bond yields further.
* * *
Summing up, central banks first drove interest rates to the zero bound which encouraged corporates to borrow and drove investors into riskier assets. The lower yields went, the more desperate investors became, and the more debt companies issued. Rather than spend the proceeds on capex, companies funnelled the money back into their own stocks, driving up equity prices, which distorted the asset allocations of the very investors who just bought their bonds, which means that ironically, re-leveraging companies utilizing financial engineering to boost their share prices have actually managed to kill two birds with one stone by not only inflating the value of their equity, but by simultaneously ensuring they’ll be still more demand for their debt. Meanwhile, the central banks of the world are now buying ETFs and will soon be buying individual stocks, which will serve to further drive up equity prices creating demand for corporate debt only to have the companies buy back stock, and around we go.
The bubble machine is thus complete.
»
- 24646 reads
- Printer-friendly version
- Send to friend
- advertisements -
sad but true.
Bubble machine, meet bursting machine.
Doesn't that produce just what buying each others CDOs did at the start of this crash?
Creampies are great but sooner or later somebody has to clean up the mess.
If this thing opens down on Monday and goes to take out Thursday's low we will be be in for fireworks. We just saw the flat bottom I've been waiting for for years. Try to find another example in recent years. The 50 and 100 dmas were taken out and then the market hovered right around the 100 from then on. The low beta, low liquidity S&P components did NOT soar like they normally do when .GOV steps in to turn the dip into a rally by buying ETFs. This time is different so be ready with the popcorn and and positions you want to place to take advantage of a steep decline. The perfect buying machine decribed in this post will be a perfect selling machine when the switch is flipped.
Low liquidity stocks may hit their 20% down limits if buyers disappear.
Options are not pricing in a large short term drop.
My posts are often (usually) an attempt at wry humor but my money is behind this one.
Interesting take on the situation. I need to re-read it a few times. Learning a lot on ZH.
So you think that the Fed made an announcement last week that should have boosted the marked but didn't? If so, might a stronger announcement keep the bubble inflated.? Interesting stuff. I'm still too new/ignorant at it to jump in. Instead I let my genius 401K manager, Bill Miller, lose 70% of my 401K for me last time...
401k managers have set up their folks for a real problem. my sister set up 401k s for the bank. she was a bank trustee, and has NO part in any investment vehicle. All cash, or stocks she picks and buys herself. I would get out before I end up angry at Miller again. THe ride of 2009 will end badly, and you dont even know where you money is do you.
I did get back in with Miller after the 70% loss. Much was recouped but not all. But, yes, I got out, into cash, about six months ago, assuming that there will be another crash. Who knows if that was a good move or not. It is good for my stress level.
Circle jerk
The bubble machine is complete
There's going to be blood in the street
Our system won't work
It's a big circle-jerk
It's time for Ctrl-Alt-Delete
Turn off-a da bubble machine-a
https://www.youtube.com/watch?v=X0TSDcPW2Kk
When math attacks...
Digital 00's vs digital 00's.
All stawks soaring ... except for dozens of commodity stawks and related miners, drillers, and equipment suppliers.
and transports.
Bullish!
See how easy it is? Rainbows and puppy dogs forever!
Yes, we have finally reached Nirvanna.
" This is great if you’re a company looking to leverage your balance sheet..."
Until leverage increases losses, as happened to the investment banks. Parabolic increases are followed by parabolic decreases.
We're buying shekels! Jewmer has almost made it and the fucking of the world is almost complete! Jewbucks for the Jews unite!
Why don't you become Pen Pals .... with a disabled Israeli veteran ?
I only have two things to say: 1. Circle Jerk ! 2. Picking yourself up by your own bootstraps ! 3. This is SYNERGY
It's all going according to plan.
The JOKERS says buy more stocks and bonds.
https://www.youtube.com/watch?v=pfmkRi_tr9c
I suppose I could say it's a rigged game, but that psyop has been played.
Played to death!
LOLOLOLOL.................
We are on a circle jerk spaceship to the Sun.
Tyler, I have been following you on these posts. You have enough material to write an interesting book on the impact of inflation (as strictly defined by the Austrian school) on the macro capital structure. You should go ahead with it because as you know, this is precisely THE intellectual deficit of Austrians: They have still to explain the business cycle from a capital structure perspective. Best,
The Austro-Ponzian school of economics !
Speaking of intellectual deficit...
What deficit? Rothbard laid this all out in detail many, many years ago (as did Mises when he coined the term 'malinvestment'). Both wrote plenty about the distorting effects of debt-fueled crack-up booms upon the market's capital structure.
Mises was very vocal about debt fueled booms, but he was a full supporter of compound interest and compound interest is an exponentially growing function.
If someone lends you the very first ounce of gold for 5% interest or the very first coin or paper money for 5% interest, you must pay it back PLUS the interest, which does not exist! The interest can only be brought into existance by economic exponential GROWTH or by making more loans. Paper money just makes it easier to create loans, but the underlying problem, that compound interest means there is always too less money than what needs to be paid back, is not solved with a gold standard.
The Rothschild's grew that powerful among gold currency regimes and paper currencies. It doesn't matter. It's the compound interest that matters.
We are on a limited planet and money, which is based on exponential growth, can never be stable. It doesn't matter if you use gold, copper or paper.
Mises is like Marx: Jewish smoke and mirrors to hide the real problem of compound interest for the goyim.
No, Fed ZIRP and QE work perfectly...maintains the bloated government power structure and deflects any move to reduce the size and scope of government in Japan, EU and USA.
There is no problem...until there is.
So, basically, more evidence that rates will go negative...
fucked.
And you're powerless to stop it.
Don't forget that, because that is the lesson.
Embracing slavery is the lesson.
Not really, I turn my FRNs into physcial assets, have been for 20+ years. Mostly revenue-generating assets. I knew it was going to be a return to a feudal system long ago. If you are nice, I might let you sharecrop on my property.
As the Comedian said, you'll be the smartest man on the cinder Oz.
Indeed, but life can be worse. I am reminded of this everytim I am in China or Brazil.
Life underground, covered by a glacier, is better?
I have no idea what the fuck you are talking about, life for my tribe and I is great.
You will, if you survive.
No man is an island. So, same as it ever was then?
how insightful... NOT.
except the ice zombies
Imagine a financial system controlled by JOKERS.
Now come to grips with reality, there is no Batman to save any of you.
You are the Batman.
It's a beautiful psyop convincing you that following the JOKERS is the only way.
Madness is like gravity I suppose.
Saturday morning roll call: All of you .... who didn't get drunk .... last night .... report for blog duty !
The synergy from the merger of kraft and heinz will bring us a delicious new product called "Finance Wizz". It's a wholesome spray in a can the 1% can put on anything and make extra money.
(sorry spring weather can't come soon enough)
Old news. The monetary base is now starting to deflate
http://research.stlouisfed.org/fred2/graph/?chart_type=line&s[1][id]=AMBNS&s[1][range]=1yr
LMFAO!!!!!!! You mind running that chart back 10, 20, 30 years? You do expect to live more than 30 years don't you?
Most disingenous psot of the day!
Here let me help;
http://research.stlouisfed.org/fred2/graph/?id=BASE
What counts is what's happening now, not what happened for the last 30 years.
Right, because all those paper claims on real goods and services will simply never start seeking them out...
History is not on your side. Even in light of the last 8 years, I'd say that the monetary base has "leveled off" at best douchebag.
I wouldn't exactly consider that a downtrend. There is no effort by the Fed to deflate asset or equity prices. They want moar inflation. The moment equities markets go down 10% the monetary based will increase again
So we can ignore from 2009 to yesterday - great!
Thta's like saying an alcoholic who normally drinks five 6-packs of beer each day is now drinking four 6-packs and five cans of beer a day and is no longer an alcoholic.
Let me know when it deflates another 75% to get back to normal levels.
look at the change of the base
Why do we have a debt-backed monetary system at all that necessitates the existence of a "monetary base"? Long story short, private banks should not be able to create money as M1, M2, M3 or MZM deposits that the proles must borrow into existence. There needs to be a single money supply M, coined by and spent into circulation by the government as an exercise of its sovereign rights.
At least you are higher up in the capital structure when you're a bondholder.
When the company eventually goes bust you will probably stand to recover 20 cents or so on the dollar. Equity holders, zilch.
But then again, most stock market "investors" don't have any idea what "capital structure" even means.
Yes, words/terms that have been removed from all modern economics; price discovery, capital, value, collateral, counterparty risk, "mark to market"... etc. etc.
why do you believe collateral and counterparty risk have been removed ?
The companies are not worth shit and the taxpayer foots the bill (the taxpayer is always the counterparty of last resort).
not sure that answers my question. Don' t companies go bankrupt anymore ?
I thought that in the fiat currency era it was all about counterparty risk, as opposed to gold as money were there is no counterparty risk.
Just trying to keep up with ZH terminology and concepts.
never heard of "too big to fail"?
Ok I get your point.
On the other hand, Detroit was not too big to fail in the USA. Detroit is creative destruction on a scale I could never imagine European politicians to allow to happen.
Yes, odd that it hasn't happened to those bankrupt cities in California. A big "tell" in my book. The Chinese own California. Honestly, I see the rocky mountain states (Texas, Utah, Colorado, Montana, etc.) doing their own thing in the not so distant future. These states have lots of natural resources and nukes. Something like 15% of the active duty military personell are from Texas already. The lessons of the former Soviet Union have been forgotten.
Detroilet was destroyed by stupid American polliticians.
Detroilet was destroyed by communists - fixed it....
Detroit was created and then destroyed by the American Automotive Industry.
At the present time, there most definitely is an implicit promise that the government/taxpayer will be there to provide BAILOUTS.
Or have you been living under a rock for the last 15 years? Ever hear of "too big to fail". Wake us when just one of those boys fails and all those "arsonist who burnt down the American financial system and profited from it" (hat tip to Tim Geithner) actually goes to a real pound-you-in-the-ass prison.
I have come to understand that one of the most defining characteristics of any elite is that the rules do not apply to them in the same way as they do to common people. The rules are a means, not an end.
Correct, and such "let the majority eat cake" monetary experiments have been done before. This one will end no differently. This time we are talking about a global scale as well. Interesting times.
That depends - ask GMC bond holders
You are right of course.
Bondholders get something.
But shareholders still remain owners of productive assets.
Guess who wins in long term.
you mean like the GM bond holders .... oh wait.
Gosh, so it’s all interconnected and all asset prices are similarly affected by rates. Who could have seen that coming. Definitely not the Fed, they don’t even know when they’re going to change rates.
"The problem is not with our theory .... the problem is with our THIEVERY !" .... Monedas
Harry Reid, Nancy Pelosi trump Austrian economics ! Here's to the guy .... who "trumped" .... Harry's face !
So then Paul Krugman was right all along then?
Btw how worse wd it have been if thr was no QE ?
How worse? Depends if you wish to fix it or not.
That would depens on what real services you provide really. The bankers and financiers do nothing but push worthless pieces of paper around (remember money creation is no longer dependent on collateral or real risk anymore thanks to ZIRP).
No QE sure as hell would have returned the power and compensation to people with real fucking skills. looks like that might happened now anyway, but with a much larger crash. Congrats.
Real riskers are those who r stayin cash since 2009. Much worse they lost it all on FAZ SRS back in 2009. Worthless fiat paper bla bla bla. Crash is comin hahaha. Nothing of that sort will be allowed to happen. Massive Deflation will never ever kick in again. Hyper inflation my ass. Dedollarization gold wtf? Money supply intelligently grows and gets diluted into equities bonds keepin the UE rate lower. Jobs investments steady. Rewrite the books. Steady inflating the steady deflating bubble. That raises the base asset prices. Btw- no one answered: if all banks went burst back in 2008/9 how worse wd it have been compared to whr we r now with all the QE cheap $ around ?
It would of been fixed in 2009 - ugly but fixed.
no doubt
you mean 'fixed' the way a 9 year old boy with ADHD fixes a laptop with a sledgehammer.
perpetual motion (up)!
The bubble machine is complete? I didnt even know we were working on a bubble machine.
Sounds like fun for the whole family, especially for the children.
All this only points to a grand plan.
All Bond holders are going to get screwed.
Companies will default massively and share values will crash. (But it will not matter to the real owners of all those companies.
And after all said and done, the companies will quietly make a comeback thru their subsidiaries which would have taken over productive assets like those in China, and certain specific technologies backed up in South Korea, Europe and Singapore.
Better start running from Bonds.
Buy stocks. Keep stock. But be sure you can afford and not borrow to buy.
Have fun.
I would love to see the following DBags comment on this article:
1. Steve Liseman
2. Paul Krugman
3. Diane Swank
Defenders of this psychotic Fed policy, all of them
I wish gold were incorporated in the bubble machine.
No company is going to default with leverage at 2x. Most IG companies are underleveraged relative to their free cash flow. Buying back stock is a logical response in a low interest rate environment where capex opportunities are scarce. In fact I would argue that IG companies should be more aggressive in borrowing long (30 yrs) at average spreads around 200 bps (absolute yield of around 4.5%) using the proceeds to buy back stock. Reducing the float does create value even if it is financial alchemy.
As for the corporate bond market, there is little doubt this is the dumb money (but not as dumb as people suspect) in today's markets unless one hedges the UST risk. Long, unhedged, bondholders will eventually suffer mark to market losses when rates eventually rise. Rates will eventually rise but will do so to a lesser extent than most people expect due to the structural impediments to inflation. Technologolical improvements across all industries has acted and will continue to act as a depressant to inflation. Think about oil and gas. Excess supply due to new drilling techniques will keep the price of oil and gas low for a long time. This is just one example.
Stocks may not be cheap based on historical valuation parameters but stocks are cheap relative to other asset classes. Moving into an asset class, long duration fixed income, that is even more rich than stocks is not the answer. Like it or not ZeroHedge doomers and gloomers, stocks are the only game in town and will continue to grind higher as measures such as free cash flow yield and earnings yield still provide excess returns relative to fixed income alternatives,