Bonds Finally Noticed What Is Going On... Stocks Are Next

It is safe to say that one of the most popular, and important, charts of 2017, was the one showing the ongoing and projected decline across central bank assets, which from a record expansion of over $2 trillion in early 2017 is expected to turn negative by mid 2019. This is shown on both a 3- and 12-month rolling basis courtesy of these recent charts from Citi.

The reason the above charts are key, is because as Citi's Matt King, DB's Jim Reid, BofA's Barnaby Martin and countless other Wall Street commentators have pointed out, historically asset performance has correlated strongly with the change in central bank balance sheets, especially on the way up.

As a result, the big question in 2017 (and 2018) is whether risk assets would exhibit the same correlation on the way down as well, i.e. drop.

We can now say that for credit the answer appears to be yes, because as the following chart shows, the ongoing decline in CB assets is starting to have an adverse impact on investment grade spreads which have been pushing wider in recent days, in large part due to the sharp moves in government bonds underline the credit spread.

And, what is more important, is that investors appear to have noticed the repricing across credit. This is visible in two places: on one hand while inflows into broader credit have remained generally strong, there has been a surprisingly sharp and persistent outflow from US high yield funds in recent weeks. These outflows from junk bond funds have occurred against a backdrop of rising UST yields, which recently hit 2.67%, the highest since 2014, another key risk factor to credit investors.

But while similar acute outflows have yet to be observed across the rest of the credit space, and especially among investment grade bonds, JPM points out that the continued outflows from HY and some early signs of waning interest in HG bonds in the ETF space in the US has also been accompanied by sharp increases in short interest ratios in LQD (Figure 13), the largest US investment grade bond ETF...

... as well as HYG, the largest US high yield ETF by total assets,

This, together with the chart showing the correlation of spreads to CB assets, suggests that positioning among institutional investors has turned markedly more bearish recently.

Putting the above together, it is becoming increasingly apparent that a big credit-quake is imminent, and Wall Street is already positioning to take advantage of it when it hits.

So what about stocks?

Well, as Citi noted two weeks ago, one of the reasons why there has been a dramatic surge in stocks in the new years is that while the impulse - i.e., rate of change - of central bank assets has been sharply declining on its way to going negative in ~18 months, the recent boost of purchases from EM FX reserve managers, i.e. mostly China, has been a huge tailwind to stocks.

sdf

This "intervention", as well as the recent retail capitulation which has seen retail investors unleashed across stock markets, buying at a pace not seen since just before both the 1987 and 2008 crash, helps explain why stocks have - for now - de-correlated from central bank balance sheets.  This is shown in the final chart below, also from Citi.

 

And while the blue line and the black line above have decoupled, it is only a matter of time before stocks notice the same things that are spooking bonds, and credit in general, and get reacquainted with gravity.

What happens next? Well, if the Citi correlation extrapolation is accurate, and historically it has been, it would imply that by mid-2019, equities are facing a nearly 50% drop to keep up with central bank asset shrinkage. Which is why it is safe to say that this is one time when the bulls will be praying that correlation is as far from causation as statistically possible.

Comments

MK ULTRA Alpha BaBaBouy Sun, 01/28/2018 - 11:49 Permalink

The Fed tightening by selling off it's balance sheet will soak up dollars at a time when hundreds of billions are coming home and hundreds of billions for investment to capitalize upon the new tax reform.

It will mean total economic dominance of the world according to Trump.

Already, we're winning in crude oil production, soon to be the number one crude oil producer in the world. Trump has directed global energy dominance is the destiny of America.

We're winning, we are conquering the known business world. Naysayers to the back of the line. Fed tightening by selling off it's balance sheet is welcome news, capital and equity market risk must be a factor going forward to build the foundation for long term economic growth.

Weak capital and equity market investors will be shaken out. The measure of risk will be restored to the markets. Capital flows are being redirected from the financialization of the US economy back to a diversified mix of growth across key industries.

Naysayers need to wait 18 months from the tax cut to make statements of doom and gloom. Liquidity is being bled off by the Fed, this is a natural development and one that was expected.

In reply to by BaBaBouy

new game Posa Sun, 01/28/2018 - 16:43 Permalink

can add to your response(yes, go ahead), thanks. the equity in my home is my poor mans saving account that has increased bigly, but I and you know it will come back down but land higher that the start of this recent asset bubble run. i will have paid moar down and hence be all in, in one asset class, but at least be sitting at home with a bunch of equity(along with the repairs)that i wouldn't  have had renting. not saying this the answer, but is working for me, with very little risk longer term.

In reply to by Posa

Fed-up with be… new game Mon, 01/29/2018 - 01:31 Permalink

This is so fucking true.  We said, as INFLATION is INSIDIOUS in nature because people ABSORB inflation on GOODS that they MUST have and repudiate those NOT-NEEDED new assets, like a brand new stinking car.  It is slow brewed, meant to only distract and then the Government STATS show us:  "OH NO, there is not ENOUGH inflation yet."  This crock of shit has been brewing a long time.   I track what my family spends and we are SPENDING A LOT more on daily consumables and a lot less on new Motorcycles, RV's, cars, homes, etc.

In reply to by new game

harrybrown Fed-up with be… Mon, 01/29/2018 - 10:24 Permalink

This statement by Alan Greenspan in 1966 should be a major wake up call all.
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert
all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold [and silver] stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists’ antagonism toward the gold standard.”

In reply to by Fed-up with be…

InnVestuhrr MK ULTRA Alpha Sun, 01/28/2018 - 21:34 Permalink

The MSM is full of comments like "bringing offshore US corporate profits back to the USA" and by implication to the USD.

Most people, including the MSM commenters, do not know that most of the so-called "offshore US corporate profits" are actually already in:
1. USD or USD-denominated assets
2. located in accounts in the USA

The fact is that the so-called "offshore US corporate profits" are only just an accounting classification of the profits, NOT the physical location of the profits, so that the money/assets get subject to income tax when the money/assets are moved out of the "offshore" account and into an "onshore" account.

This is similar to the kind of taxation event which occurs when you move money/assets from your IRA/401K account to your bank or brokerage account, ie you are subject to income tax when the money/assets changes accounts, not international borders.

In reply to by MK ULTRA Alpha

Simplifiedfrisbee MK ULTRA Alpha Mon, 01/29/2018 - 02:27 Permalink

The fed has 2+ trillion of shit securities on their balance sheet. Economic lags restrict the reactionary speed of the fed to fight inflation. That means the markets will experience inflation prior to the impacts of rate hikes. 

Increase in oil prices is inflationary. Again, this reaffirms that inflation is coming(actually it is already here).

Capital markets have already priced in repatriation and are still pricing in the tax plan and deregulation. Risk is a unicorn you idiot! Everything about our market is built on speculation. Risk has normalized and now irrational exuberance is at peak levels. We are reaching the end of our business cycle. 

The majority of the market is built on the fed expansion and looking for growth that doesn't exist in material. The fed is the growth. All the GOP did was enact supply side growth for the fed this time. Which fucked the dollar!

Dollars are not being invested as response to demand but as a hedge against inflation. Companies are diversifying but they are putting the cart before the horse.

Liquidity is a factor of real economic growth. Artificial growth soaks up liquidity. The emperor will soon be exposed. 

 

Cognitive Dissonance is your reckoning Trumptards. 

 

 

 

 

 

 

 

In reply to by MK ULTRA Alpha

JRobby YUNOSELL Sun, 01/28/2018 - 11:36 Permalink

Yes indeed. 2 issues:

1. What is the effect of this increasing supply of junk on the market?

2. If sold at a (fire sale) big loss (likely) the debit sits on the FED's books and may be neutral or positive on the buyers books.

Of course this assumes anyone even cares what is reflected on "the books" anymore..........

 

In reply to by YUNOSELL

gatorengineer J S Bach Sun, 01/28/2018 - 15:59 Permalink

No, it wont and here is why.

Under Trump alone the market cap of the US STAWK market is up over 12Trillion.  Taking away a few Trillion from the fed still leaves the market up grossly in excess of what the Fed Printed.  Now imagine all of those stocks (are collateral, and have been rehypothecated..

 

Said another way Ponzi-net is now sentient.... and no longer requires Control P to continue.  If I am wrong, tell me where other then the spelling of re-hypothecated

 

 

In reply to by J S Bach

spastic_colon Sun, 01/28/2018 - 10:28 Permalink

complete bullshit.......has anyone looked at the SOMA report? shrinkage my ass. look at TIPs purchases and the fact that the principal difference is not counted in the totals....is fake inflation being reported while the fed piles into TIPs? they would never..............