Barclays

The Big Buyers ... Unmasked

With the first arrow of Abenomics perhaps hitting its limit, it will be the second and third arrows that need to occur quickly and aggressively to carry this momentum forward (and for the economy to grow into stock valuations). Barclays lays out 15 of its most frequently asked questions below but concerns remain as the BoJ’s planned absorption of nearly 80% of new JGB issuance from the markets this fiscal year has triggered a dramatic change not only in JGB supply/demand and ownership structure but in the JGB market risk profile itself, which has moved from “low carry, low volatility and high liquidity (superior to other assets from perspective of risk-adjusted returns or Sharpe ratio)” to “low carry, high volatility and low liquidity (inferior from same perspective)”. Barclays added that with a wave of major political and policy events ahead, starting with a crucial Upper House election, there was no big change in the basic belief among foreign investors that Japan is likely to be the main source of surprise for the global economy and of volatility in financial markets.

• Global shares sink, following 7.3 percent drop in Japan's Nikkei (Reuters)
• When all fails, pull a Kevin Bacon: Japan Economy Chief Warns Against Panic Over Stock Sell-Off (BBG)
• White House Feeds IRS Frenzy by Revising Accounts (BBG)
• In any scandal, lying to Congress is tough to prove (Reuters)
• Debt limit resets at higher level, budget impasse grinds on (Reuters)
• China factory data to test political calculations (FT)
• European Leaders Saying No to Austerity (BBG)
• And yet, nobody wants in anymore: Iceland’s new coalition government suspends EU accession talks (FT)
• Oil Manipulation Inquiry Shows EU’s Hammer After Libor (BBG)
• The Fed Squeezes the Shadow-Banking System (WSJ)
• Diamond Said to Weigh Backing Barclays Alumni in Venture (BBG)
• Spain’s Private Jets Disappearing as Tycoons Cut Flights (BBG)

A major asset class is "topping" out.

Argentina's president Kirchner, a keen observer of recent events in Cyprus, has figured out a way to kill two birds with one stone, namely attempt to put an end to tax evasion, and fund the capex of the recently nationalized state oil company YPF (now that its former owner, Spainish Repsol, is less than keen to keep investing in its former Argentine subsidiary). To do that she will present the local tax-evading population (pretty much anyone with any disposable income and savings) with a simple choice: buy a 4% bond to fund YPF "growth" or go to prison.

Yesterday, the rumor turned out to be a joke. Today, there was no rumor, but as we warned four hours ago, it was only a matter of time. Less than four hours later, the time has come, and Jon Hilsenrath's "Fed Maps Exit from Stimulus", conveniently appearing after the close, has just been released.

The reason for yesterday's late day swoon was a humorous tweet, which subsequently became a full-blown serious rumor, that the WSJ's Hilsenrath would leak the first hint that the Fed is contemplating preannouncing the "tapering" of its $85 billion in monthly purchases. Naturally, this did not happen as we explained. And yet, judging by the market's response there is substantial concern that the Fed may do just that. To be sure, it is quite likely that in addition to just rumblings out of economists, which are always wrong and thus ignored, that one of the Fed's unofficial channels may hint at some tightening in the monthly flow (if certainly not halt, and absolutely not unwind). Which makes sense: all previous instances of non-open ended QE took place for up to 6-9 months before the Fed briefly let off the accelerator to see just how big the downward response is. The problem now, however, is that even the tiniest hint that the grossly overvalued "market", which has risen only thanks to multiple expansion for the past year, would lead to a massive overshoot not only to whatever an ex-Fed "fair value" may be, but overshoot wildly as the liquidation programs kick in across a Wall Street that is more liquidity starved today than it has been in a decade. This is precisely what Scotiabank's Guy Hasselman thinks: "Few care about “right-tail” events, but should investors decide to pare risk in reaction to a hint of ‘tapering’, the overshoot to the downside may surprise many. The combination of too many sellers, too few buyers, and dreadful (and declining) liquidity means a down-side overshoot is highly likely."

As the global economic slump continues central bankers, such as Mario Draghi, and politicians have vowed “to do whatever it takes” to get economies back on track. Such policies while having near term benefits are considered extremely risky in the longer run by many commentators as they could beckon runaway inflation or stagflation, with ruinous results.

Shinzo Abe unleashed his plan with the blessing of the Bank of Japan to begin aggressive government bond purchases. This has led to a massive growth of 60% on the Nikkei and is deflating the yen and boosting their exports.

• Einhorn's advice to investors: don't take my advice (Reuters)
• Next: floating dead vegetables: Chinese inflation rises on soaring vegetable prices (FT)
• The scramble for the bottom dollar is on: McDonald's, Wendy's Battle for Value-Centric Customers (WSJ)
• Cheaper iPhone coming after all: Apple supplier Pegatron boosts China workforce by 40 percent in second quarter (Reuters)
• House set to pass tactical Republican debt bill (Reuters)
• Underwriting bonanza: Goldman Said to Earn $500 Million Arranging Malaysia Bond (BBG)
• G7 finance chiefs to discuss bank reform push (Reuters)
• Big Banks Push Back Against Tighter Rules (WSJ)
• University endowments trim holdings in US Treasuries (FT)
• Ex-Pakistan PM's son abducted as Taliban threaten poll (Reuters)
• China Dowry Filled With Gold Signals Gains for Jewelers (BBG)
• As discussed here over a year ago: China inflation data shows central bank policy dilemma (Reuters)

While most comprehend that when buying credit-risky instruments the most critical aspect of return is the spread (or additional compensation over the risk-free rate) which itself is in 'bubble' territory; it is nevertheless spell-binding that the so-called 'High Yield' corporate bond market is now trading with a yield below 5% for the first time on record - a level at which 10 Year Treasuries were trading in July 2007...

The Federal Reserve's extreme monetary policy has done nothing but repress 'safe' assets to the point of making 'risky' assets relatively cheap. This is of course not the case were you to isolate each risky or safe asset and consider its value standalone. Choosing stocks over bonds because "well, what is the alternative?" is akin to the red-pill/blue-pill choice from The Matrix and the reflationary 'normal' that we are supposed to believe in is what 'apparently' justifies a 1.7x rise (12%!) in multiples since QE4EVA was announced. During that same period, consensus earnings expectations have plunged (merely pushed out one more year for the renaissance) and global trade and growth has collapsed. However, while we have shown many divergences from reality in the past, it is the manic/depressive difference between inflation expectations and stock valuations (implicitly supported by reflation) that is the clearest example of the short-term triumph of hope over reality.

You know the market is frothy when the greatest concern among professional money managers is "Asset Bubbles." As interest rates rose in the early part of this year, the 'great rotation' - with outflows out of bonds and in to stocks - was heralded by many as ammo for the next leg higher in stocks; now over a quarter of investors - a share that rose 100% since BofAML's previous (March) survey - believe 'the great rotation' will never happen (only another 73% to get to reality). Instead, there are increasing concerns about inflows leading to bubbles – mainly in high yield, where investors appear uncomfortable with flows-driven spread tightening without fundamental improvement and higher interest rates (and implicitly the linkage between equity valuations and credit bodes ill for the latter, as opposed to supportive). In fact, asset bubbles now rank as the number one concern on investors’ minds, while a slow recovery moved up into second spot. So despite the best efforts of the 'marketing' arms of the big sell-side shops (so-called 'strategists'), the professional buy-side is not 'adding' at these highs, but becoming increasingly skeptical.

With any and every asset-gatherer capable of forming a sentence being trotted out on business media to proclaim victory and elucidate on why "there is no where else to invest but stocks" and "the US is the cleanest dirty shirt," we thought it might be useful to reflect on just how clean that shirt can remain as the rest of the world's growth slows down significantly. In the last decade, there has been particular growth in inter-regional trade, with a dramatic expansion in trade vis-à-vis Asia, reflecting globalization. At the same time, the deepening in global trade relationships means that the potential for a sudden shift in demand in one region can have a more significant impact on the rest of the world. This has been seen particularly in recent years, with the sharp retrenchment in domestic demand in southern Europe affecting the economy of Asia, particularly Japan. Looking at the rate of increase in regional imports (which we assume is what the 'heads' believe will power the US 'clean' shirt) and the picture is ugly. And while copper is enough of a tell for most, even the IMF (usually extraordinarily optimistic) sees World Trade slowing dramatically - and given these interconnections, perhaps being the cleanest shirt merely shows the stains even more clearly when they finally hit.

• The number of bond funds that own stocks has surged to its highest point in at least 18 years (WSJ)
• Clubby London Trading Scene Fostered Libor Rate-Fixing Scandal (WSJ)
• Cheap money bankrolls Wall Street's bet on housing (Reuters)
• Bank of Japan reveals concerns over easing policy (FT)
• iPads and low-end rivals propel higher tablet shipments  (Reuters)
• China Cyberspies Outwit U.S. Stealing Military Secrets (BBG)
• Draghi Fuels Bets on Rate Cut With Risk of Limited Impact (BBG)
• China guides renminbi to fresh high against US dollar (FT)
• Japan is preparing to start up a massive nuclear-fuel reprocessing plant (WSJ)
• Apple’s Ive Seen Risking iOS 7 Delay on Software Overhaul (BBG)
• UBS faces calls for break-up at investor meeting (Reuters)

The Fed may or may not be able to afford schizophrenia regarding the future of its monetary decisions (for now), but the ECB, in charge of a continent mired deep in depression, does not have that luxury. While consensus overwhelmingly expects a 25 bps cut in the main refinancing rate, some have warned that should the ECB not engage in such a cut, the EUR will tumble as the short covering squeeze ends with a thud. What exactly are the individual banks expecting? The following bulletin from Bloomberg summarizes it all.