"No One Gets Rich Betting Against The Market - Until The Moment The Market Is Wrong"

Via Bill Blain of Mint Partners,

There a couple of good reasons to be more than moderately concerned about what’s happening in the fixed income space. Once more my gallant crew, we are sailing into choppy waters... which may mean trouble ahead, but it also spells opportunity! Two things concern me:

Firstly, despite global easing, global bond yields have backed up last few days. Immediately the Fed gets the blame with rumours they may scale back QE – which is reactive nonsense. The Fed has made clear we need to see clear evidence of growth, not just hints, before they change course. But the Treasury market is off across the curve. JGBs, Gilts and Europe are all higher last few days.

Is this a buying window after some mild panic, or has something really changed? Higher government yields don't fit with the thesis coordinated global easing from US QE, Japan Reflation, and ECB peripheral bond support will further fuel an asset grabathon.

Particularly worrying is the Japanese reflation package appears not to be working as predicted - it has caused the Nikkei to soar (next stop 16k!) and the Yen to weaken (through 102 and 110 in prospect), but it was also supposed to lead to a flatter and lower Japan yield curve. Instead we are seeing a massive bear-steepener in JGB yields.

The steepening is particularly relevant at the critical 2-5yr sector of the curve. This is where Japan banks hold their exposures:  some US$ 1 trillion 70% in JGBs and 30% in US Treasuries (which is risk!). Steeper yen curve triggers concerns bonds are in sell-off mode and a steeper dollar curve... Wider bond spreads in US$ trigger concerns on Europe – turning sentiment weaker.

There is so much folk have missed about the critical importance of the current Japan/Yen games in terms of global markets. The fact Japanese investors did not immediately start buying foreign assets was wrongly interpreted as proof it wasn't going to happen - conveniently ignoring the Golden Week fortnight and the fact Japan buyers were wrongfooted by the scale of BoJ intervention and needed to build a new consensus on new investment approaches. Now we are seeing Japan investors in foreign buy mode.

Similarly, the BoJ’s new QE buy programme is aimed at flattening the Yen curve, buying the long end and short. As we’ve said before.. don’t fight Kuroda. But that’s not the way the current steeper curve looks to nervous investors. Hence the fear in today’s market and the pundits screaming buy stocks. Is this a fundamental turnaround point? Or is it too early to call? (Happy to talk about each market anytime.)    

The second issue with the market currently is that global rates are so low the market is losing the will to live/play. When highly speculative CCC names yield less than 7% what's the point in investing? The risk-reward is just too skewed toward higher risk over lowering returns that it simply makes little sense to take.

One big fund in the more alternative space told me Friday “our buying interest has pretty much dried up of later – we’re not being paid for credit or liquidity risk, so it’s hard to justify doing much.” And that view is being echoed across asset classes in the fixed income sector. Again this fuels the “what’s the point in running further risk in bonds.. let’s move into stocks” calls of the market!

No one gets rich betting against the market, UNTIL THE MOMENT THE MARKET IS WRONG. And as we know the market is a pernicious beast that delights in nothing more than wrong-siding the maximum number of people with the maximum losses. Which doesn’t really help much.. is this the moment to buy more bonds on the slide or is it the start of something more significant and a shift out of bonds?

I think its worth paying attention to what’s happening re the JGB curve.. if/when it flattens, it’s a global buy confirmation. You want to be ahead of it.

Take a quick look at Gold this morning – after Friday’s weakness, the sell off continues. But gold volume in Asia is up (nearly double on COMEX futures), despite the apparent absence of global inflation and the dollar’s resumption of core global value yardstick. What does this tell us? Concern factor is very much there.