Summary – A top-down review of interesting calls and comments made last week in Treasuries, monetary policy, economics, stocks, bonds & commodities. TAC is our acronym for Tweets, Articles, & Clips –our basic inputs for this article.
Editor’s Note: In this series of articles, we include important or interesting Tweets, Articles, Video Clips with our comments. This is an article that expresses our personal opinions about comments made on Television, Tweeter, 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. Macro Viewpoints & its affiliates expressly disclaim all liability in respect to actions taken based on any or all of the information in 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 tolerance.
1.Long-Short Trade of the past two weeks
Long TLT-Short SPY is that trade. A higher beta version would be Long Zero Coupon Strips vs. Short Russell 2000 or Short Transports. The long treasuries part of the trade seems to have fundamental support in the weakening trend in economic data and the increasing chatter about a recession. The short stocks component has pure price momentum driving it besides weakening data as well as support from damage to correlated asset classes like Oil, High yield & China.
While TLT is now stochastically overbought & SPY is stochastically oversold, the stock leg has exhibited a velocity & length that the treasury leg has not. On Friday, S&P tested the August 24 low of 1867 (also a 12-month low) while TLT remains 4 points below the August 24 high and about 13 points below the February 2015 high of 138.50. The 10-year yield closed this week at 2.03%, about 36 bps higher than the February 2015 low of about 1.67%.
Why this divergence? Shouldn’t Treasury yields have dropped much faster with money running into Treasuries from the waterfall decline in oil, the fast decline in stocks and the daily liquidation of high yield bonds? Is the Treasury market less impressed with the recession in US talk or is it simply the constant selling of Treasuries by China to repatriate reserves?
If Treasuries don’t have the momentum they should, are they at risk of a selloff? And will a rebound in stocks be a catalyst of such a sell off? Interestingly Tom McClellan discussed the reversal in both legs of this trade on two different occasions. His article Groundhog Day in T-Bonds discusses the possibility of such a sell off based on his observation that “T-Bond prices are repeating the pattern of a year ago “. His article points out:
- “A preliminary peak came on Jan. 15, 2015, en route to the final price high on Jan. 30, 2015. So based on last year’s script, we still have a couple more weeks to run before an equivalent final price high. If bonds stay on script, then February should be an ugly month for T-Bonds”
McClellan said the following regarding stocks on CNBC Closing Bell on Thursday:
- “preliminary bottom that we should bounce from into probably late February; down to that lower bottom in April & then the final bottom of the bear market not due till October; that bottom in October will finally be a good time for investors to buy & the uptrend from that October bottom should be a good one”
- “short-intermediate term bullish for traders with a view point of few days to few weeks on Wednesday, January 14; can see deadcat flopping around a few more times from now into middle of next week & then an uptrend due just into the end of February“
In other words, the month of February should see a uptrend in stocks and an ugly sell off in T-Bonds. We stress that he did not link his two forecasts and may not even be aware of how symmetric his words were. So if our logical extension fails, the fault is ours & not his.
Raoul Pal is also waiting to short S&P until after a bounce in stocks he expects in February. His long term target for the 10-year yield is now 1/2%, not in 2016 but in 2017. The rest of the world shows 10-year yields at 1/2% and so why not the US? So many indicators are suggesting a recession he says & there will be a gap of 6-9-12 months for the transition of the Fed from tightening to neutral to easing. Besides, the economy is structurally weak and inflation is structurally low.
Jeff Gundlach thinks the 10-year treasury yield is coiled for a big move. He places 55% odds on the yield breaking to the upside. But he does see some downward momentum in the 30-year yield for the next few days or weeks ahead.
So what US factors might cause a short term top in T-bonds in the next couple of weeks? The Fed could sound dovish yet confident on FOMC Wednesday, January 28 and then a decent jobs number could erase some recession fears on Friday, February 6.
Two smart guys essentially dismissed the recession talk this week. David Rosenberg termed it “irrational pessimism” and opined:
- “This time last year, all I heard was how everything was too expensive and there was nothing to buy. Today we have a smorgasbord of asset classes and geographies cheapening up dramatically and all I see are deer in the headlights”
- “Whether it is Oil, the CRB commodity price index, the Canadian dollar, the relative performance of the TSX (to the S&P), we are talking about more than one standard-deviation moves on the downside.”
- “The sharp widening in high-yield corporate bond yield spreads is getting very close to a one standard deviation event; pricing in a tripling of the default rate to 10 per cent (which would need a U.S. recession)”
- “Bearish sentiment is heading to very high levels and as such my contrarian instincts are being aroused. You don’t want to buy at peak optimism; you want to do so at peak or at least near-peak pessimism”
Scott Minerd of Guggenheim Partners was not sanguine about a stock rebound in his appearance on CNBC:
- “Haven’t really seen the panic, VIX hasn’t spiked into the 30s; haven’t seen large wholesale redemptions in mutual funds; there doesn’t seem to be fear here; NYSE breadth, continued deterioration in the transports & the massive price adjustment we have to do in China in terms of revaluation of currency & weakness is going to be an opportunity”
- “upside in stocks over next 2-3 years may be up 20-25% up from today; not a great risk-reward for the volatility“
But he dismisses the recession possibility and recommends Bank loans and even high yield:
- “every recession in US has been preceded by 3 or 4 downturns in leading indicators; we haven’t had one yet; recent budget deal is actually pro-growth; adds probably 1/2% to output, & the monetary conditions are not restrictive; Fed would reverse course if they have to”
- but sectors like bank loans in particular, or high yield, fixed income closed end funds are a lot better risk-reward tradeoffs; my favorite asset class is Bank loans, high yield is ok, CLOS have been beaten to the ground;
Speaking of high yield closed end funds, Bill Gross had recommended three such in his earlier conversation with CNBC’s Brian Sullivan. What are their distribution rates now & what are their discounts to their NAVs?
- DPG with 10.97% distribution rate & (-16.35%) discount to NAV; PCI 11.67% & (-14.62%) resp.; UTG 7.41% & (-10.86%) resp.
This week, Jeff Gundlach emailed Scott Wapner of CNBC FM 1/2 saying junk bonds should not be bought until they stop going down every day. But, as we recall, Gundlach had recommended a long closed end high yield funds vs short S&P trade at that time. More on this in the next section.
3. High Yield, Oil vs. S&P
Michael Contopoulos of BofA is still bearish on High Yield bonds. He told CNBC FM that “we are at a fork“:
- one is like 2011 & great buying opportunity;
- second is end of the credit cycle – pricing must fall and be bad for the economy – high yield indicators pointing to economic malaise in 2016 & 2017; hike in high yield defaults of 3% will rise to 5-6% in 2016; fear is the malaise lasts into 2017 & if default rates rise to 6-7% in 2017 then that’s not good for US economy;
His call is convergence:
- Chart shows high yield and S&P will catch up; either high yield rallies or S&P falls; usually high yield foreshadows what stocks do;
Gundlach had made this point in his conversation with CNBC FM 1/2 last year. In his view, S&P rally would imply a high yield rally and in such a high yield rally, the 15% discounts to NAV of high yield closed end funds would shrink substantially. In other words, these closed end funds would rally harder than the S&P. If high yield falls, then S&P would really fall hard and the discounts to NAV of closed end funds would protect especially given their declines already. Does Gundlach still support his long high yield closed end funds vs. short S&P idea? We don’t know.
The sharp sell off on Friday in US stocks was led by financials with Citibank down almost 7% despite decent numbers. Credit quality of high yield portfolios of banks is now a matter of concern.
- David Larew @ThinkTankCharts – Banks bought tons of junk bonds – now Junk is diving – Bailout again? Tied into the price of oil
- Javier Blas @JavierBlas2 – #BREAKING: @BofAML high yield #energy bond index soars to record high, above 08-9 crisis peak, as #oil prices plunge
Since high yield is correlated to Oil, shouldn’t another version of the Gundlach trade be Long Oil vs. Short S&P? That is precisely what Quant guru Marko Kolanovic of JPMorgan recommended on CNBC FM this week:
- Oil & Stocks move together for longer period of time; so we are likely to see convergence; either oil will go up or S&P goes down; a long & short trade
Kolanovic thinks both legs could make money. He said “Oil can get to 45-50 fully reasonable; double to 60 is also reasonable“. What about S&P? He said “S&P already down 10% can fall another 15-20%; targets 1700-1500 (worst case);”
Calling a bottom is notoriously difficult. Jeff Gundlach said mid week that a short term bottom was reached on Wednesday. Thursday seemed to suggest he was right. Then came the sick decline of nearly 5% on Friday. Why did Oil collapse so badly? Did it have anything to do with the conclusion of the Iran deal this weekend and the eventual release of Iranian oil into world markets?
Jeff Currie of Goldman Sachs was interestingly less bearish on oil on Friday. He said he was “starting to see makings of a capitulation” and stated that “material declines are behind us“. He added “a drop from $30 to $20 is significant from trading perspective but not from an economic perspective“.
After a horribly ugly action on Friday, speaking intelligently about a short term bottom seems useless. But that is not the most important point in protecting capital:
- Mike Valletutti, CTA @marketmodel – Too many called the bottom this week, even with their fancy software. Nobody knows, which is why you stay underweight size.
Can Dow stabilize without Transports stabilizing first?
- David Larew @ThinkTankCharts – Dow Theory Transports lower than the Dow and the Dow will drop to meet it. The problem is the Transports are diving
But sentiment is reaching levels that have created a bounce in the past:
- Charlie Bilello, CMT @MktOutperform – % Bulls, Individual Investor Poll (AAII)… March ’09 after a 57% decline: 18.9% Today after a 12% decline: 17.9%
At least, 1867-August 24 intra-day low held. Now we wait for Sunday’s data about China. If past events can have any predictive effect, then it should be ok. CNBC has announced special coverage of markets on Monday from 6 am to noon despite a market holiday in the US. And the timing of their specials driven by investor fear are a good contra indicator against fear.
6. China and S&P
Chinese stock market is looking sickly indeed, to use a Gundlach phrase. It is almost acting as if the growth in China is likely to be closer to zero% instead of the proclaimed 7%. If it is actually comes in that weak, then global growth is likely to be 1.9%, he said.
That brings us back to the question of the devaluation of the Yuan.
- Bloomberg BusinessVerified account@business – President Xi’s big dilemma: money is pouring out of China as rapidly as it once came in http://bloom.bg/202CMau
By now, everybody knows that the Yuan is going to be devalued. Why would anyone wait around to convert to US Dollars at a lower price? This is why, according to RBS, the Yuan needs to be devalued by 20% quickly to stem the outflows.
So their advice is Sell everything before China devalues. Why? Because, in the words of Albert Edwards of SocGen, we will see a “full blown trade war in the offing not unlike that in the 1930s“. And what would that do to the S&P 500?
- “If I am right, the S&P would fall to 550 (points), a 75 percent decline from the recent 2,100 peak. That obviously will be a catastrophe for the economy via the wealth effect and all the Fed’s QE hard work will turn (to) dust.”
On that cheerful note, we will turn our focus to the divisional games this weekend.
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