Credit Markets

     

 

 

A Well-Established Tradition

Seemingly out of the blue, equities suffered a few bad hair days recently. As regular readers know, we have long argued that one should expect corrections in the form of mini-crashes to strike with very little advance warning, due to issues related to market structure and the unique post “QE” environment. Credit spreads are traditionally a fairly reliable early warning indicator for stocks and the economy (and incidentally for gold as well). Here is a chart of US high yield spreads – currently they indicate that nothing is amiss:

 

As this chart shows, credit spreads do as a rule warn of impending problems for the stock market, the economy or both. Not every surge in spreads is followed by a bear market or a recession, but some sort of market upheaval is usually in the cards. Since the stock market normally peaks before the economy weakens sufficiently for a recession to be declared, the warnings prior to market tops are often subtle – usually all one gets is a confirmed breakout over initial resistance levels, at which time yields will still be quite low. At the moment credit spreads suggest that nothing untoward is expected to occur for as far as the eye can see (a.k.a. the near future). Will something intrude on that enviable and stress-free combination of Nirvana, Goldilocks and the Land of Cockaigne, where everything seems possible, especially good things? Will Santa Claus remain a permanent fixture of the junk bond and stock markets, handing out gifts to all those prepared to spice up their portfolios with bonds bereft of covenants and light in yield, triple-digit P/E stocks, or even CUBE stocks (=completely unburdened by ‘E’)? Perhaps Fisher’s permanent plateau has materialized 90 years later than originally envisaged, but we don’t think so.

 

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Running From “Risk-Free” to Not So Risk-Free Debt 

The price of gold blipped $13 last week, while the price of silver was unchanged. Speaking of interest rates and central planning by central banks, we note that in mid-2016, a correction (counter-trend move to the main trend) began in 10-year bond yields.

 

10-year treasury note yield vs. 10-year German Bund yield over the past decade [PT]

 

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A Month with a Bad Reputation

A certain degree of nervousness tends to suffuse global financial markets when the month of October approaches. The memories of sharp slumps that happened in this month in the past – often wiping out the profits of an entire year in a single day – are apt to induce fear. However, if one disregards outliers such as 1987 or 2008, October generally delivers an acceptable performance.

 

The road to October… not much happens at first – until it does. [PT]

 

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A Surprise Rout in the Bond Market

At the time of writing, the stock market is recovering from a fairly steep (by recent standards) intraday sell-off. We have no idea where it will close, but we would argue that even a recovery into the close won’t alter the status of today’s action – it is a typical warning shot. Here is what makes the sell-off unique:

 

30 year bond and 10-year note yields have broken out from a lengthy consolidation pattern. This has actually surprised us, as we felt that the large speculative net short position in bonds and notes was prone to trigger a short covering rally. Alas, the opposite has happened.

 

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Shifts in Credit-Land: Repatriation Hurts Small Corporate Borrowers

A recent Bloomberg article informs us that US companies with large cash hoards (such as AAPL and ORCL) were sizable players in corporate debt markets, supplying plenty of funds to borrowers in need of US dollars. Ever since US tax cuts have prompted repatriation flows, a “$300 billion-per-year hole” has been left in the market, as Bloomberg puts it. The chart below depicts the situation as of the end of August (not much has changed since then).

 

Short term (1-3 year) yields have risen strongly as a handful of cash-rich tech companies have begun to repatriate funds to the US.

 

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The Biggest Crashes in History Happened in September and October

In the last installment of Seasonal Insights we wrote about the media sector – an industry that typically tends to perform very poorly in the month of August. Upon receiving positive feedback, we decided to build on this topic. This week we are are discussing several international markets that tend to be weak during September and will look at what drives this recurring pattern.

 

Mark Twain, a renowned specialist in how not to get rich, opines on dangerous months to invest in the stock market. We should mention that he didn’t have access to the Seasonax app. [PT]

 

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Financial Potemkin Village

A rising stock market has the illusory effect of masking the economy’s warts and blemishes.  Who cares if incomes are stagnant when everyone’s getting rich off stocks?  Certainly, winning wealth via the stock market beats working for it.

 

Learning from history, 2018 style [PT]

 

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Data Interpretation Problems

Oddly enough, these days it has become more difficult to interpret positioning data. We get more granular data than before, such as e.g. the disaggregated commitments of traders reports (CoT – even if they are still released with a three day delay), but at the same time the goal posts in futures markets have shifted greatly. Former extremes in positioning have been left in the dust with the advent of QE (and the associated desperate “hunt for yield”) and the adoption of large scale systematic trading. Here is a glaring example illustrating the point:

 

Speculator net positions in crude oil futures: after decades in which net long positions rarely exceeded 100,000 contracts, a new post GFC era record has been set in the speculative position at 740,000 contracts net long in early February 2018.

 

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Junk Bond Spread Breakout

The famous dead parrot is coming back to life… in an unexpected place. With its QE operations, which included inter alia corporate bonds, the ECB has managed to suppress credit spreads in Europe to truly ludicrous levels. From there, the effect propagated through arbitrage to other developed markets. And yes, this does “support the economy” – mainly by triggering an avalanche of capital malinvestment and creating the associated boom conditions, while “investors” (we use the term loosely) pile into ridiculously overvalued bonds that will eventually saddle them with eye-watering losses.

 

The famous dead parrot

 

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Tightening Credit Markets

Daylight extends a little further into the evening with each passing day.  Moods ease.  Contentment rises.  These are some of the many delights the northern hemisphere has to offer this time of year. As summer approaches, and dispositions loosen, something less amiable is happening.  Credit markets are tightening.  The yield on the 10-Year Treasury note has exceeded 3.12 percent.

 

A change in pace: yields are actually going somewhere. There is a fly in the ointment for treasury bears though: the net speculative short position in futures across the yield curve is seemingly establishing new record highs every week. While this is not bullish for treasuries per se, it definitely makes yields vulnerable to a sharp pullback. The question is what might cause such a pullback. Our guess would be that either “unexpected economic weakness” will enter the scene, or crisis conditions in emerging markets will worsen and eventually spark “flight to safety” behavior. [PT]

 

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A Movie We Have Seen Before – Repatriation Effect?

There was a sizable increase in the year-on-year growth rate of the true US money supply TMS-2 between February and March. Note that you would not notice this when looking at the official broad monetary aggregate M2, because the component of TMS-2 responsible for the jump is not included in M2. Let us begin by looking at a chart of the TMS-2 growth rate and its 12-month moving average.

 

The y/y growth rate of TMS-2 increased from 2.68% in February to 4.85% in March. The 12-month moving average nevertheless continued to decline and stands now at 4.1%.

 

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Lord, Grant us Chastity and Temperance… Just Not Yet!

Most fund managers are in an unenviable situation nowadays (particularly if they have a long only mandate). On the one hand, they would love to get an opportunity to buy assets at reasonable prices. On the other hand, should asset prices actually return to levels that could be remotely termed “reasonable”, they would be saddled with staggering losses from their existing exposure. Or more precisely: their investors would be saddled with staggering losses. In this context we have noticed the emergence of a new consensus in the form of an invocation we hereby term the Augustine of Hippo Plea.

 

St. Augustine of Hippo, here seen doing saintly magic in his later years. In his Confessions the Saint admits that as a “wretched young man” he once inserted a phrase into one of his prayers that has become quite famous for the hopeful qualifier attached to it: “Da mihi castitatem et continentiam, sed noli modo.”, read: “Grant me chastity and temperance, but not yet”. At the time the future Saint feared that he might actually get what he wished for. “Timebam enim ne me cito exaudires et cito sanares a morbo concupiscentiae, quem malebam expleri quam extingui”, as he explains (“I was afraid that you might hear me right away and quickly cleanse me of the disease of carnal desire, which I would much rather have explored than expunged”).

 

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