Bond

For the second week in a row, those claiming that flows will any.minute.now. shift away from bonds and go to equities are proven dead wrong. ICI has just reported that in the week ended December 15, not only was there another massive outflow, the 33rd in a row, from domestic equity mutual funds to the tune of $2.4 billion, but taxable and municipal bonds saw a stunning $8.6 billion in outflows, including another record $4.9 billion in muni outflows. At this point absent another major pull back in bond prices, we anticipate that bond inflows will once again resume, even as stock outflows persist indefinitely. Year to date investors have pulled just under $100 billion in money from US-focused equity mutual funds, offset by just $16 billion in comparable inflows into equity strategies via ETFs as we described yesterday. The reason for this seemingly endless boycott of stocks via the bulk of the population was given best by Geoff Bobroff, who told Bloomberg: "I would guess most retail investors are staying put
because you aren’t seeing the money go anywhere else." Another explanation, and just as spot on: nobody, save for a few hedge funds, gives a rats ass about manipulated stocks prices anymore.

In the past few days, European peripheral spreads have once again taken to widening both in absolute terms and relative to Bunds. The culprit: the ECB's permabid for insolvent debt has plunged from €2.7 billion to €603 million in the past week: this represents the lowest amount of bonds purchased by the ECB since the beginning of November. And without the backstop of wanton ECB buying sure enough the sellers emerge. Total debt holdings in the ECB's SMP program are now €72.5 billion. Incidentally one country which is certainly not benefiting from Jean Claude Trichet's largess with his bank's money is France, whose CDS earlier today hit an all time wide of over 100 bps on completely unfounded rumors that the country may be downgraded by one or more rating agencies. At this point expect to see the chart below yoyo in direct correlation to just how steep the sell off of European bonds may have been in the prior week.

While it was no surprise to readers that equity mutual funds saw the 32nd consecutive outflow from domestic stock funds (for a total of $95 billion YTD), what was far more surprising is that flows out of credit, and particularly high grade, surged. As Bank of America notes, "high grade mutual funds saw outflows of $2.5 billion, the largest dollar amount on record and just the fourth occurrence this year so far, according to data from EPFR." The question then becomes where did, and will, all this cash go: if now following such a massive outflow from the traditional flow safe-haven, no money still goes to equities, then it will be fairly simple to conclude that no matter what happens, that equities are now thoroughly embargoed by the vast majority of retail investors: those that, incidentally, account for just under 40% of market capitalization (a number which curiously is almost comparable to the amount of stimulus notional, both fiscal and monetary, since the Lehman crash).

Diapason Securities' Sean Corrigan is rapidly emerging as one of our favorite macro commentators. With his dose of weekly skepticism, he has quickly assumed the position vacated by Goldman Sachs' Jan Hatzius when it comes to the 3Ms: market, monetary and macroeconomic commentary (courtesy of the now well-known and very infamous flipping by the German strategist on his outlook on the economy). In his latest outlook piece, Corrigan dissects recent moves in the bond market, noticing a 6 sigma, three-decade statistical aberration when it comes to the 2s5s30s butterfly, and continuing through the implications of increasing bond vol on other risk assets (a topic which we believe will receive much more focus in the coming weeks and months), on fund flows (his views on the implications of the December Z.1 statement are worth the price of admission alone), on the cooling off of the European "economic miracle", and lastly, on what China's refusal to attempt a soft landing means for global risk. His conclusion is as always absolutely spot on: "in short, that risk assets can continue to rise, pro tem, it also means that RISK itself will be climbing inexorably up the scale and on into the danger zone."

That ICI has just confirmed the 32nd consecutive outflow from domestic equity mutual funds is not surprising. After all, we have long been saying that retail's love affair with stocks has gone straight to the bitter divorce stage. That the amount of outflows was a massive $2.7 billion is a little more surprising: after all last week was just $1.7 billion, and the market really surged since then in its last ditch attempt to get the dumbest money in. It failed (and total outflows year to date are not $96 billion: we expect $100 billion through the end of the year). But what is truly surprising, and what debunks every myth that investors are now rotating out of bonds and into stocks, is that in the last week in addition to a surge in domestic equity outflows, for the first time in what seems forever, there was also an outflow of $401 million in taxable bond funds (in addition to $1.3 billion in outflows from muni bonds). Hopefully we can now leave all debate about capital rotation out of fixed income into stocks, courtesy of rising rates, in the dust (same as debunking the whole "money on the non-repatriated sidelines" falacy). In fact the only asset class that saw any inflows were foreign equities. Of course should the reverse decoupling that the "experts" on TV are predicting, and the US outperform developing markets, the foreign asset flows will promptly reverse as well. Yet the bottom line is that all who were expecting a rotation out of bonds and into equities, are proven wrong, and just as we have been predicting for 32 weeks now, equity-related capital withdrawal decisions are completely disconnected from what happens in the rates domain, and the primary objective is capital extraction. Simply said: the latest target of all outbound sector rotation is cash.

According to Simon Hobbes over at CNBC, rising yields are good for stocks (just as dropping yields were, gasp, good for stocks). Which is why the following chart which shows how BAB bonds after going parabolic are now going vertical should send the Dow to 36,000 post haste. Also, for those who care about facts and not propaganda, the last time yields were here was on December 28, 2009.

But see, it's all good, cause it's all based on the strong economy. And the suddenly dropping stocks completely confirm this.

The most important piece of news announced last week was the Fed’s release of the schedule for its second round of QE 2 bond buying. All told, the Fed intends to buy $105 billion worth of bonds through January 11, 2011. The purchases will occur practically every other day and are broken down into $6-8 billion increments. Now, the Fed has made it clear that it intends to prop stocks up at ANY cost.

The big story this morning is that Treasury yields continue their grind higher - this despite the strong 30 Year auction last week which many expected had put a bottom on bond prices at least for the short-term. As can be seen on the attached chart, the 10 Year has resumed its drift lower, with yields once again touching multi-month highs, not to mention the 10s30s continue to flatten and is about to hit 100 bps. The move prompted an early wake up call for David Ader, head of government bond strategy at CRT who sent out the following note earlier: "Just when we thought it was safe to say something nice about the market, we get a sharp move lower (alas in price, not yield) in an active overnight session. We say active as volumes were 114% of the average, but to be sure it’s harder to find a new reason for the weakness other than the price action itself. Thus we’ll caution that the weakness is in part a function of liquidity and fear." There are two schools of thought as to what is causing the gap lower: i) the realization by various bondholders that nobody is concerned about US funding levels and that the next target of the bond vigilantes will be the US itself, and ii) that courtesy of the latest round of fiscal stimulus, the economy may have bought itself a short-term bounce and it is time to fade the deflationary move in bonds which was the prevalent trade of 2010. Either way, the inflationary threat is now all too real, and with rates jumping and mortgages surging, it is difficult to envision a nascent recovery in which the prevailing price of housing just dropped yet again courtesy of higher rates. So what does this mean for stocks? Once again, courtesy of some historical perspectives by Sentiment Trader, we look at what happened in the past to stock prices when bond yields started a gap move wider.

There’s no question that the last thirty years have been very good to the bond market. In fact, the chart above may even paint the picture of what could be called the Great Bond Bull Market with price moving inverse to yield. While I have been writing for months about thinking the “bond bash” is coming to an end, I think we may have seen the true beginning of that end this week with the 10-Year Treasury yield spiking almost 40 bps higher in just three days to an intra-day high of 3.33% from 2.95%. And what might have been the impetus to bring about this potential end to the bull market in bonds? Interestingly, the most obvious possibility is also all but impossible and perhaps the reason why many seem to be surprised by the 95 bps or almost 1.0% move up in the 10-Year on an intraday basis in less than two months.

Today's CFTC data reveals some interesting inflection points. First, looking at the perishables, there seems to be a resumption in bullish sentiment, especially in coffee and corn. This is to be expected as the last week saw an inflation scare which prompted many to expect a fresh rise in commodities (despite concerns of year-end profit taking which has materialized pretty much as anticipated in the year's best performing asset class - precious metals). Where things get more interesting is looking at the various parts of the Treasury curve: after 3 weeks of rather indiscriminate selling, net spec contracts in both the 2 Year and the 10 Year have seen a modest resumption in buying, although that previously most beloved part of the curve - the 5 Year is still unable to find a base. Although the 5 Year is still the only bond that has a net positive spec balance: all others are now negative. In other words, where we go from here is pretty much a crapshoot, as this is nothing more than a coincident indicator in the latest volatile asset. Lastly, looking at currencies, we see an interesting trend - after the USD saw a substantial pick up in the past two months as Europe faced its second sovereign bankruptcy (but has for now been buried under the rug), bearish sentiment is coming back again. Yet unlike before when there was a rather obvious inverse relationship between the EUR and the USD, this time the deterioration in USD sentiment has metastasized to the Yen, and the Euro (the CHF has been rather insulated, which is as expected, as the currency continues to to be the last ditch safety currency and thus less volatile to sovereign insolvency risks).

When you are running the World's largest fiat currency system, trust is pretty much all you do have going for you - unless you plan to resort to force, of course.

The MOVE index measuring bond volatility has hit 112, a 2010 peak second only to the turbulent days following the flash crash and the first European bankruptcy. And speaking of European bankruptcy, CDS on Italy is back on the upward sliding track, last seen at over 200 bps, over 10 bps move on the day. And since there is no volatility left in a levitating market, the only market that vol hunters are now pursuing is the sovereign bond and FX markets. If and when intraday gyrations in the 10 year approach the equivalent of a stock VIX of 20+, then Bernanke will have finally achieved his goal of complete subjugation of the Banana States of America.

Yesterday's highlighted chart was the plunge in the 30 Year bond. Today, we take it one step further and demonstrate what happens to an asset class once it become clear (or unclear) that the government may not prop it in perpetuity. Presenting the average yield on Build America Bonds, which has just hit an 11 month high. If this collapse is a harbinger of what will happen once a Federal props are removed, feel free to just imagine what would happen to stocks if and when the Fed were to withdraw its support of the stock market...

Looks like the market does not like the massive flattening we discussed over the past two days. To wit, we present market commentary from a trading desk, appropriately titled "dead cat" bounce: "Another "dead cat" bounce in the Treasury complex as prices are now sitting just above session lows. Additionally, while still outperforming, 30yrs are starting to feel some of the heat. The curve remains mixed depending on what your long end maturity is. Real money remains quiet aside from some light nibbling. Fast/pro/dealer accounts continue their defensive trade and remain in control. Techs are negative but cautious due to oversold conditions."