In this series of articles, we include important or interesting
videoclips with our comments. This is an article that expresses our
personal opinions about comments made on Television and in Print. It is
NOT intended to provide any investment advice of any type whatsoever.
No one should base any investing decisions or conclusions based on
anything written in or inferred from this article. Investing is a
serious matter and all investment decisions should only be taken after a
detailed discussion with your investment advisor and should be subject
to your objectives, suitability requirements and risk tolerances.
1. Rising Sun or Solar Flares?
“Success in QE = Higher bond yields”, said Andrew Mowat of JP Morgan this week. That is what began in Japan two weeks ago with JGB yields shooting up in a volatile manner. On Friday, May 10, yield on 10 yr JGB shot up by 10bps and the Nikkei rose by 415 points. This Thursday 10-yr JGB yields rose up to touch 1% and Nikkei fell by 7% or 1,143 points. Goes to show that fast & shooting rise in bond yields ends up as the biggest failure of QE.
The goal of QE is to create a happy wealth effect that is supposed to lead to spending and investment. Even when successful, this takes time. In contrast, panic, especially panic in the Sovereign bond market, blows away the wealth effect and does so very, very fast. This is why we began worrying about the state of the JGB market two weeks ago.
Frankly, we still worry but not so much. Because it is clear now that both Prime Minister Abe and BoJ boss Kuroda are panicking. They will throw whatever they need to throw at the JGB market to cool it down. Central Bankers are the sole exception to the certainty of Gambler’s ruin, at least in the near term.
Clearly, the volatility in Japanese markets was a market phenomenon. But what about the volatility in US markets that arose from Bernanke’s comments on Wednesday? Did he slip up or was he trying to create uncertainty? Or was he simply revealing Fed’s predicament? Will they taper their QE? If so, when and how?
2. QE-Taper as Virginia Woolf or Grizzly Bear?
David Tepper isn’t afraid of a taper by Bernanke, as he told us before this week’s convulsion. Jim Paulson, a consistently bullish voice, is not afraid of a taper either:
- “I don’t agree this
is so dependent on the Fed. I believe the Fed could do more improvement
by curtailing QE. I think that would build confidence that even the Fed
sees some improvement in the economy. I
think what would help is if the Fed itself showed confidence by
suggesting they need to start adjusting or normalizing. I think that
would be more beneficial.”
On the other hand, Jon Hilsenrath, the man Steve Roach called the real Fed chairman, revealed Fed’s fears about QE-taper by using the analogy of tip towing away from a grizzly bear.
- “ you are not going to hear that term taper out of the Fed. That is exactly the message they don’t want to be sending to the market right now. Because when people say taper, the implication is that when they make one move, it is going to be followed by a succession of other moves…”
- what they are trying to say and they are having a very very hard time saying it is that they are going to make a move and then they are going to see how things go..they are taking things one step at a time..so if they take things back a little bit. it doesn’t mean that the full exit has begun..
- what they’re doing, I kinda liken it to tip towing away from a grizzly bear. you know, they don’t want to move very quickly because they’re afraid they’ll get attacked by the grizzly bear. But unfortunately you always run the risk of upsetting the grizzly bear.
- they’re having a very hard time communicating the when and how. Next few meetings – that was the “when”. Then there’s the “how”. The how is, they take a step and then they look around and see what happens. And if things get worse they go back up again. If things get better they keep going.
Larry Lindsey, former Fed-head, went to a magic kingdom in his analogy instead of the animal kingdom. He also had a completely different take about Bernanke’s comments and the “how” described above by Hilsenrath.
- “I doubt very much that the Chairman intended to signal a taper… It would take extraordinary conditions for it to happen..the problem is the Fed has let the genie out of the bottle…unlimited liquidity that is what is driving the market. Look at the size
of the adjustment we got from the Chairman saying the answer to a
question that they could possibly begin to taper around labor day.
that’s it. and we got a massive worldwide sell-off. Imagine if they
actually did taper how big the selloff would be. This is not something
they can risk.”
- “I think Fed had
better hope that the market keeps going up. if we go side ways —
remember, the whole QE story is to drive a weight effect which boosts
consumption, get GDP going, employment. that is the whole story. has
been the whole story from the beginning. At the moment we have some
progress. but just back out the math. If you stop the wealth effect at
this point, you will not get what the Fed wants. If the market were to
stop, i think we will stall out pretty quickly. I think the Fed has no
choice. It is committed it has to hope, pray, do everything it can to
get the market higher.”
This debate may be why Bill Gross tweeted that Bernanke was speaking out of both sides of his mouth.. a new paradigm for a profession that used to upset Presidents by speaking of two hands…
3. A Reverse Tepper Corollary?
Frankly, we think Bernanke intended the confusion he caused. It is better for the market to worry about a yellow traffic light today then come to a rapid halt when the traffic light suddenly changes to red. And if the markets worry about the traffic light changing to yellow, then hopefully the markets won’t charge to the intersection all reved up.
Every stronger than expected piece of data will make the stock market wait and wonder about the QE-taper coming early. And every weaker than expected piece of data will lead to a sigh of relief but with increased worry about the state of the economy. So, in either case, the stock market will worry more and perhaps pause more. Sort of a reverse Tepper corollary of 2010?
If this is what happens, then Bernanke will have pulled off a tapering of market fervor without reducing his flexibility in any way.
4. Does Unlimited Liquidity lead to Systemic Risk?
Remember municipal auction rate securities? These “cash-equivalent” securities had been sold to high- networth investors for decades. They paid tax-exempt interest, often higher than money market funds & Treasuries. And they could be put back to issuers at regular auctions. A couple of years ago, virtually all of a sudden, this proclaimed liquidity simply vanished. The demand-supply between issuers-investors had gone one extreme and so liquidity disappeared.
At some point in 2007, demand for CDOs & stuff slowed down but the issuing calendar didn’t. So Wall Street firms began holding more of these CDOs in inventory because demand was sure to return and underwriting fees were too lucrative to pass up. We all remember what happened to Wall Street balance sheets in 2008.
What if both these conditions come together? That is the fear we heard this week, first from Larry McDonald of Newedge and then in a Bloomberg.com article titled Dealers Absorbing Junk Bonds as ETF Demand Drops. The main point of this article:
- “Wall Street banks are expanding holdings of speculative-grade bonds as prices fall from record highs with investors retreating from exchange-traded funds that buy the debt.”
- “The dealers are soaking up supply as firms from JPMorgan Chase & Co. (JPM) to Barclays Plc (BARC) predict demand will return. Even with banks facing new limits on risk-taking and higher capital requirements since the credit crisis, the pullback from investors is prodding them to act in their traditional roles of facilitating trading with their own money as they underwrite an unprecedented volume of new speculative-grade debt.”
The key statement in this article is:
- “There’s just so much demand for high yield it’s outstripping supply,”…”People think it’s painful now when they can’t buy; wait until
they can’t sell.”
Larry McDonald of NewEdge lived through the Lehman crash and so remembers that period very well. He argued this week on CNBC Fast Money that this dangerous cocktail of QE & liquidity mismatch can lead to a big systemic risk.
- If you remember ’07, there was a period like this, markets are roaring, but the biggest risk in ’07 was the wall street’s balance sheets were at risk because of mortgages. Now here we are all these years later. The threat really is the little guy that’s exposed to the yield thirst, the yield hunt. If you look at the amount of capital that’s flown into not just utilities, leveraged loan funds, high-yield funds, it’s up 500% from ’06 levels. So it’s the most crowded trade in the world.
- … the portfolio managers that manage that capital don’t have the liquidity we had back in ’06. The Street balance sheets because of Dodd-Frank are much lower. At the end of the day, QE plus Dodd-Frank equals a big, big, big systemic risk at some point in the near future.
- I think the Fed when it does exit as Bernanke alluded to yesterday, I think it’s going to be because of this dangerous cocktail of side effects they’ve created again.
But aren’t default rates low, very low? To this question from CNBC FM trader Josh Brown, Larry McDonald answered:
- “I remember the same kind of comments about the auction rate securities in the mortgage space. same pitch. you can make the same point. the point, I think the danger is liquidity. In other words if the street balance sheet is 80% lower than it was in ’06 and you have this huge, huge pile of capital that’s flown into utilities, loans, that means that even if the loan is a high-quality, senior secured asset, if the fund manager has to exit because shareholders want out as we saw yesterday with that utility fund that dropped 7% in five minutes...”
Tony Scaramucci, another CNBC FM trader, sort of agreed:
- “I agree with you, but I don’t think it’s a ’07, it’s sort of like a ’05/’06.”
Look at the picture tweeted by Larry McDonald on Friday and decide for yourselves whether today is 2005, 2006 or 2007? The red line is the market cap of the U.S. stock market and the blue line is assets in high-yield ETFs (corporate, mortgage bonds, high-yield stocks).
The U.S. stock market is basically back to 2007 levels while the “yield appetite” assets have jumped by over 500% over 2006 levels, according to Larry McDonald. Who will step up to buy if & when investors decide to sell these high yielding assets?
Of course, one happy solution is to have the stock market rise to bridge this chasm.
5. U.S. Equities
The U.S. Indices went to new all-time highs on Tuesday, the day before Bernanke tossed in his wrench. What lies ahead?
Lawrence McMillan of Option Strategist on Friday:
- “The stock market finally took a hit this week, but it hasn’t really changed the overall picture — yet.
- Yesterday’s low at 1635 has to be considered a support level as well as 1625-1630, and then the more important support at 1600. if THAT were violated, it would be bearish.
- In summary, despite the nervousness that Wednesday’s action created, the picture remains rather bullish — at least until actual sell signals materialize, which has not yet occurred.”
Jeff Weiss of Tejas Securities on CNBC FM on Tuesday:
He was bullish about the breakout about weekly closing trend lines connecting the March 2000, October 2007 & today’s market. But he added a caveat “even if we do have a near term top here“.
Jim Paulson of Wells Fargo has been one of the most consistent bullish voices. Now he seems content with what the stock market has achieved:
- “well, I’ve been of the view that the market would touch 1700 this year, Becky, since year end. we basically have gotten to that level here. And I’m not inclined to raise at target for the rest of the year.“
- “… confidence …has been the driving force here for increasing the stock market. I think people are finally giving up the armageddon ghost and looking at a slow, slow but sustainable recovery, and that’s allowing them to have higher multiples….evidence is in gold market junk bonds yields in recovery….that’s all about confidence.”
- “the problem I have for the second half for the stock market is I think it’s going to digest its gains because the confidence that we have run through these other markets is going to run through the bond market. I think the hurdle is going to be rising bond yields in the U.S. Treasury in the second half. and then, you know, that’s also going to bring up the debate we’re already having about whether the Fed needs to pull back on QE. Although I think that’s a positive, it will create some consternation. I think we’re going to be a trendless side ways market from the 1700 level.”
- “I just think this
year we’re going to have to digest a repricing of the bond market just
like we have repriced these other markets. I think we’re going to reprise
bonds and I think that’s going to take a bit of digesting the rest of
this year. Maybe then once that happened we can sustain another run. if we keep
inflation in control the next several years we have recovery ahead
of us, another five years’ worth. if we do that there’s a lot more
upside in the out years.”
David Kostin of Goldman Sachs explained on CNBC SOTS the reasoning behind raising of his S&P targets for 2013-2015. A summary of the Goldman call is on CNBC.com at Goldman Sachs Upgrades S&P 500 Target:
- “Goldman Sachs has upgraded its target for the S&P 500, forecasting that the U.S. benchmark index will climb a further 5 percent to 1750 by year-end, from an initial estimate of 1625,…”
- “…the U.S. investment bank also raised its targets….expecting the index to rise by 9 percent to 1900 in 2014, and advance by 10 percent to 2100 in 2015, compared to earlier forecasts of 1775 and 1900, respectively.“
- “Strong earnings and dividend growth will be a key support for the market, according to the bank. It forecasts dividend growth of 30 percent for the S&P 500 between 2013 and 2015, with 11 percent growth in both 2013 and 2014 and 9 percent in 2014.”
6. U.S. Treasuries
Dennis Gartman once again called for the end of the 30-year bull market in bonds this week on CNBC Fast Money:
- “for the past three weeks or so I’ve been bearish on the bond market.first time in a long time I’ve been aggressively bearish….in retrospect we can look back and see that bond futures made their high almost 14 months ago in autumn 2011, failed to meet a new high since, failed badly a couple of weeks ago. I think we’re seeing a very important turn in the long end of the curve. This looks like the absolute inverse of what happened in 1982 to 1984 when bonds fail to make new lows and the beginning of a bull market began that lasted 30 some years. I think we’re now seeing the end of that bull market, the beginning of a bear market, that could last for some long period of time. I’m short the long bond. I’m long the 10-year note. Short the nob-spread as we call it. I think I’m going to be that way for a long period of time. Today, the fact that it broke on what should have been decent news from Bernanke, I thought was the kiss of death.”
The other side of the argument was presented by Michael Mackenzie of the FT on Friday in his article Bet against Treasuries at your own risk. Mackenzie argues:
- For all the bearish talk about interest rates, betting big against the Treasury market in the coming months may well prove another false step as investors wait for the Federal Reserve to start trimming its bond purchases in the coming months.
- Inflation, the prime enemy of fixed rate debt, is falling and that makes Treasury yields look a lot better when lumped together in a beauty contest with other big government bond markets. Meanwhile, the US budget deficit is improving rapidly, which means the Treasury will sell fewer bonds later in the year, potentially offsetting any modest cut in Fed purchases.
- Tempering the froth in mortgages, equities and other markets in the near term may well limit the selling pressure we have seen in Treasuries this month. It’s an outcome that could leave interest rate bears with a familiar feeling of frustration as the QE3 exit takes time to evolve and Treasuries benefit from their haven status.
The 30-year Treasury Bond is the purest contrary measure of inflation. This week we saw that PCE measure of inflation, Fed’s favorite measure, is tracking about 1%. And thanks to the melting away of the Budget deficit, the supply of long maturity Treasuries will decrease in the 2nd half of 2013. Color us dumb, but this doesn’t look so bad.
But none of it matters right now. The monthly employment report is what has mattered. The employment report in April was weaker than expected and Treasuries rallied virtually all through April to top out on May 2, the day before the employment report in May. That report was much stronger than expected and Treasuries have been selling off since May 3. On Friday, Treasuries closed just above the bottom in mid-March. Will they bounce off that level to create a double bottom? Or will they crash through it?
Two weeks ago, Michael Novogratz of Fortress told us that Gold was in a bubble. But even the busted Nikkei & the Nasdaq mounted sharp rallies in their long term downtrend. Could Gold be ready for a rally?
Francisco Blanch of BAC-Merrill Lynch on CNBC Fast Money:
- “look, I think in the short run you can argue if interest rates go up from here, there’s no doubt gold is going to go down. But I think this market is very fickle. It’s very QE dependent…I think obviously if the Fed goes and removes quantitative easing, gold’s going to have a bad time ahead. Can they really do that? I think the Japanese market has sent a big warning. If you start to doubt QE, if the data comes back, you’re going to have to keep printing or even put more money into a system, right? And that’s kind of the support point for gold…we might realize that we need QE more than we realize.”
- “remember, every end of QE has come on the back of a significant move down in equities, also a rally in bonds and gold has regained the footing….The bouncing of gold overnight shows that if we have a bad equity market movement, whether it’s Japan or somewhere else, investors are going to get back to Gold. I think that’s the main point we’ve learned over the last 24 hours.”
Tom McClellan in his Friday’s article – Gold Coins Can Bring a Message
- I don’t know if this is a case of the smart gold coin dealers sensing that a rally is coming, and thus bumping up their prices to take advantage, or if some other market dynamic is at work. I just know what I see in the data.
- Interestingly, this momentary pricing anomaly for gold coins arrives at the same time that the Commitment of Traders (COT) Report data are showing that gold and silver traders are at historic extremes of sentiment. In other words, things looks like a bottom for gold prices which should matter not just for a few days to follow, but for weeks or months.
Then you have the chart below from the Bespoke article titled A Double Bottom for Gold?:
(source – Bespoke Investment Group)
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