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January 6, 2020

Global Market Comments
January 6, 2019
Fiat Lux

2020 Annual Asset Class Review
A Global Vision

FOR PAID SUBSCRIBERS ONLY

Featured Trades:
(SPX), (QQQQ), (XLF), (XLE), (XLY),
(TLT), (TBT), (JNK), (PHB), (HYG), (PCY), (MUB), (HCP)
(FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)
(FCX), (VALE), (AMLP), (USO), (UNG),
(GLD), (GDX), (SLV), (ITB), (LEN), (KBH), (PHM)

October 2, 2019

Global Market Comments
October 2, 2019
Fiat Lux

Featured Trade:

(TEN MORE REASONS WHY BONDS WON’T CRASH),
(TLT), (TBT), (ELD), (MUB)
(COFFEE WITH RAY KURZWEIL), (GOOG)

Ten More Reasons Why Bonds Won’t Crash

I have never been one to run with the pack.

I’m the guy who eternally marches to a different drummer, not in the next town, but the other hemisphere.

I would never want to join a club that would lower its standards so far that it would invite me as a member. (Groucho Marx told me that just before he died).

On those rare times that I do join the lemmings, I am punished severely.

Like everyone and his brother, his fraternity mate, and his long-lost cousin, I thought bonds would fall this year and interest rates would rise.

After all, this is normally what you get in the eleventh year of an economic recovery. This is usually when corporate America starts to expand capacity and borrow money with both hands, driving rates up.

Of course, looking back with laser-sharp 20/20 hindsight, it is so clear why fixed income securities of every description have refused to crash.

I will give you 10 reasons why bonds won’t crash. In fact, they may not reach a 3% yield for decades.

1) The Federal Reserve is pushing on a string, attempting to force companies to increase hiring, keeping interest rates at artificially low levels.

My theory on why this isn’t working is that companies have become so efficient, thanks to hyper-accelerating technology, that they don’t need humans anymore. They also don’t need to add capacity.

2) The U.S. Treasury wants low rates to finance America’s massive $22.5 trillion and growing national debt. Move rates from 0% to 6% and you have an instant financial crisis, and maybe even a government debt default.

3) Constant tit-for-tat saber-rattling by the leaders of China and the United States has created a strong underlying flight to safety bid for Treasury bonds.

The choices for 10-year government bonds are Japan at -0.25%, Germany at -0.50%, and the U.S. at +1.62%. It all makes our bonds look like a screaming bargain.

4) This recovery has been led by consumer spending, not big-ticket capital spending.

5) The Fed’s policy of using asset price inflation to spur the economy has been wildly successful. But bonds are included in these assets, and they have benefited the most.

6) New rules imposed by Dodd-Frank force institutional investors to hold much larger amounts of bonds than in the past.

7) The concentration of wealth with the top 1% also generates more bond purchases. It seems that once you become a billionaire, you become ultra conservative and only invest in safe fixed-income products. The priority becomes “return of capital” rather than “return on capital.”

This is happening globally. For more on this, click here for “The 1% and the Bond Market.”

8) Inflation? Come again? What’s that? Commodity, energy, precious metal, and food prices are disappearing up their own exhaust pipes. Industrial revolutions produce deflationary centuries, and we have just entered the third one in history (after No. 1, steam, and No. 2, electricity).

9) The psychological effects of the 2008-2009 crash were so frightening that many investors will never recover. That means more bond buying and less buying of all other assets.

10) The daily chaos coming out of Washington and the extreme length of this bull market is forcing investors to hold more than the usual amount of bonds in their portfolios. Believe it or not, many individuals still adhere to the ancient wisdom of owning their age in bonds.

I can’t tell you how many investment advisors I know who have converted their practices to bond-only ones.

Call me an ornery, stubborn, stupid old man.

Hey, even a blind squirrel finds an acorn once a day.

 

 

 

April 24, 2019

Global Market Comments
April 24, 2019
Fiat Lux

Featured Trade:

(WHY ARE BOND YIELDS SO LOW?)
(TLT), (TBT), (LQD), (MUB), (LINE), (ELD),
(QQQ), (UUP), (EEM), (DBA)
(BRING BACK THE UPTICK RULE!)

Why Are Bond Yields So Low?

Investors around the world have been confused, befuddled, and surprised by the persistent, ultra-low level of long-term interest rates in the United States.

At today’s close, the 30-year Treasury bond yielded a parsimonious 2.99%, the ten years 2.59%, and the five years only 2.40%. The ten-year was threatening its all-time low yield of 1.33% only three years ago, a return as rare as a dodo bird, last seen in the 19th century.

What’s more, yields across the entire fixed income spectrum have been plumbing new lows. Corporate bonds (LQD) have been fetching only 3.72%, tax-free municipal bonds (MUB) 2.19%, and junk (JNK) a pittance at 5.57%.

Spreads over Treasuries are approaching new all-time lows. The spread for junk over of ten-year Treasuries is now below an amazing 3.00%, a heady number not seen since the 2007 bubble top. “Covenant light” in borrower terms is making a big comeback.

Are investors being rewarded for taking on the debt of companies that are on the edge of bankruptcy, a tiny 3.3% premium? Or that the State of Illinois at 3.1%? I think not.

It is a global trend.

German bunds are now paying holders 0.05%, and JGBs are at an eye-popping -0.05%. The worst quality southern European paper has delivered the biggest rallies this year.

Yikes!

These numbers indicate that there is a massive global capital glut. There is too much money chasing too few low-risk investments everywhere. Has the world suddenly become risk averse? Is inflation gone forever? Will deflation become a permanent aspect of our investing lives? Does the reach for yield know no bounds?

It wasn’t supposed to be like this.

Almost to a man, hedge fund managers everywhere were unloading debt instruments last year when ten-year yields peaked at 3.25%. They were looking for a year of rising interest rates (TLT), accelerating stock prices (QQQ), falling commodities (DBA), and dying emerging markets (EEM). Surging capital inflows were supposed to prompt the dollar (UUP) to take off like a rocket.

It all ended up being almost a perfect mirror image portfolio of what actually transpired since then. As a result, almost all mutual funds were down in 2018. Many hedge fund managers are tearing their hair out, suffering their worst year in recent memory.

What is wrong with this picture?

Interest rates like these are hinting that the global economy is about to endure a serious nosedive, possibly even re-entering recession territory….or it isn’t.

To understand why not, we have to delve into deep structural issues which are changing the nature of the debt markets beyond all recognition. This is not your father’s bond market. 

I’ll start with what I call the “1% effect.”

Rich people are different than you and I. Once they finally make their billions, they quickly evolve from being risk takers into wealth preservers. They don’t invest in start-ups, take fliers on stock tips, invest in the flavor of the day, or create jobs. In fact, many abandon shares completely, retreating to the safety of coupon clipping.

The problem for the rest of us is that this capital stagnates. It goes into the bond market where it stays forever. These people never sell, thus avoiding capital gains taxes and capturing a future step up in the cost basis whenever a spouse dies. Only the interest payments are taxable, and that at a lowly 2.59% rate.

This is the lesson I learned from servicing generations of Rothschilds, Du Ponts, Rockefellers, and Gettys. Extremely wealthy families stay that way by becoming extremely conservative investors. Those that don’t, you’ve never heard of because they all eventually went broke.

This didn’t use to mean much before 1980, back when the wealthy only owned less than 10% of the bond market, except to financial historians and private wealth specialists, of which I am one. Now they own a whopping 25%, and their behavior affects everyone.

Who has been the largest buyer of Treasury bonds for the last 30 years? Foreign central banks and other governmental entities which count them among their country’s foreign exchange reserves. They own 36% of our national debt with China in the lead at 8% (the Bush tax cut that was borrowed), and Japan close behind with 7% (the Reagan tax cut that was borrowed). These days they purchase about 50% of every Treasury auction.

They never sell either, unless there is some kind of foreign exchange or balance of payments crisis which is rare. If anything, these holdings are still growing.

Who else has been soaking up bonds, deaf to repeated cries that prices are about to plunge? The Federal Reserve which, thanks to QE1, 2, 3, and 4, now owns 13.63% of our $22 trillion debt.

An assortment of other government entities possesses a further 29% of US government bonds, first and foremost the Social Security Administration with a 16% holding. And they ain’t selling either, baby.

So what you have here is the overwhelming majority of Treasury bond owners with no intention to sell. Ever. Only hedge funds have been selling this year, and they have already done so, in spades.

Which sets up a frightening possibility for them, now that we have broken through the bottom of the past year’s trading range in yields. What happens if bond yields fall further? It will set off the mother of all short-covering squeezes and could take ten-year yield down to match 2012, 1.33% low, or lower.

Fasten your seat belts, batten the hatches, and down the Dramamine!

There are a few other reasons why rates will stay at subterranean levels for some time. If hyper accelerating technology keeps cutting costs for the rest of the century, deflation basically never goes away (click here for “Peeking Into the Future With Ray Kurzweil” ).

Hyper accelerating corporate profits will also create a global cash glut, further levitating bond prices. Companies are becoming so profitable they are throwing off more cash than they can reasonably use or pay out.

This is why these gigantic corporate cash hoards are piling up in Europe in tax-free jurisdictions, now over $2 trillion. Is the US heading for Japanese style yields, of zero for 10-year Treasuries?

If so, bonds are a steal here at 2.59%. If we really do enter a period of long term -2% a year deflation, that means the purchasing power of a dollar increases by 35% every decade in real terms.

The threat of a second Cold War is keeping the flight to safety bid alive, and keeping the bull market for bonds percolating. You can count on that if the current president wins a second term.

 

 

 

 

 

Why Are They So Low?

The Liquidity Crisis Coming to a Market Near You

I had the great pleasure of having breakfast the other morning with my longtime friend, Mohamed El-Erian, former the co-CEO of the bond giant, PIMCO.

Mohamed argues that there has been a major loss of liquidity in the financial markets in recent decades that will eventually come home to haunt us all, and sooner than we think.

The result will be a structural increase in market volatility and wild gyrations in the prices of financial assets that will become commonplace.

We have already seen a few of these. Look no further than superstar NVIDIA (NVDA), which announced earnings in line with expectations in November but nevertheless responded with a 50% decline. It was a classic “Buy the rumor, sell the news” type move.

The worst is yet to come.

It is a problem that has been evolving for years.

When I started on Wall Street during the early 1980s, the model was very simple. You had a few big brokers servicing millions of small individual customers at fixed, non-negotiable commissions.

The big houses made so much money they could spend some dough facilitating counter cycle customers trades. This means they would step up to bid in falling markets and make offers in rising ones.

In any case, volatility was so low then that this never cost all that much, except on those rare occasions, such as the 1987 crash (we at Morgan Stanley lost $75 million in a day! Ouch!).

Competitive, meaning falling, commissions rates wiped out this business model. There were no longer profits to subsidize losses on the trading side, so the large firms quit risking their capital to help out customers altogether.

Now you have a larger number of brokers selling to a greatly shrunken number of end buyers, as financial assets in the US have become concentrated at the top.

Assets have also become institutionalized as they are piled into big hedge funds and a handful of very large index mutual funds and ETFs. These assets are managed by people who are also much smarter too.

The small individual investor on which the industry was originally built has almost become an extinct species.

There is no more “dumb money” left in the market, at least until this month.

Now those placing large orders were at the complete mercy of the market, often with egregious results.

Enter volatility. Lot’s of it.

What is particularly disturbing is that the disappearance of liquidity is coming now, just as the 35-year bull market in bonds is ending.

An entire generation of bond fund managers, almost two generations worth, have only seen prices rise, save for the occasional hickey that never lasted for more than a few months. They have no idea how to manage risk on the downside whatsoever.

I am willing to bet money that you or your clients have at least some, if not a lot of your money tied up in precisely these kinds of funds. All I can say is, “Watch out below.”

When the flash fire hits the movie theater, you are unlikely to be the one guy who gets out alive.

You hear a lot about when the Federal Reserve finally gets around to raising interest rates in earnest this year. They say it will make no difference as rates are coming off such a low base.

You know what? It may make a difference, maybe a big one.

This is because it will signify a major trend change, the first one for fixed income in more than three decades. Almost all of these guys really understand are trends and the next one will have a big fat “SELL” pasted on it for the fixed income world.

El-Erian has one of the best 90,000-foot views out there. A US citizen with an Egyptian father, he started out life at the old Salomon Smith Barney in London and went on to spend 15 years at the International Monetary Fund.

He joined PIMCO in 1999 and then moved on to manage the Harvard endowment fund.

He regularly makes the list of the world’s top thinkers. A lightweight Mohamed is not.

His final piece of advice? Engage in “constructive paranoia” and structure your portfolio to take advantage of these changes, rather than fall victim to them.

 

See the Long Term “Head and Shoulders” Top in the (TLT)?

 

 

January 9, 2019

Global Market Comments
January 9, 2019
Fiat Lux

2019 Annual Asset Class Review
A Global Vision

FOR PAID SUBSCRIBERS ONLY

Featured Trades:
(SPX), (QQQQ), (XLF), (XLE), (XLI), (XLY),
(TLT), (TBT), (JNK), (PHB), (HYG), (PCY), (MUB), (HCP)
(FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)
(FCX), (VALE),

(DIG), (RIG), (USO), (UNG), (USO), (OXY),
(GLD), (GDX), (SLV),
(ITB), (LEN), (KBH), (PHM)

September 11, 2018

Global Market Comments
September 11, 2018
Fiat Lux

Featured Trade:
(A NOTE ON ASSIGNED OPTIONS,
OR OPTIONS CALLED AWAY), (MSFT),
(TEN MORE REASONS WHY BONDS WON’T CRASH),
(TLT), (TBT), (ELD), (MUB)

The Liquidity Crisis Coming to a Market Near You

I had the great pleasure of having breakfast the other morning with my long time friend, Mohamed El-Erian, former co-CEO of the bond giant, PIMCO.

Mohamed argues that there has been a major loss of liquidity in the financial markets in recent decades that will eventually come home to haunt us all.

The result will be a structural increase in market volatility, and wild gyrations in the prices of financial assets that will become commonplace.

We have already seen a few of these in recent weeks. German ten-year bund yields jumped from 0.01% to 0.20% in a mere two weeks, a gap once thought unimaginable. The Euro has popped from $1.08 to $1.03.

Since July, we have watched in awe as the ten-year Treasury yield ratcheted up from 1.23% to 2.40%.

The worst is yet to come.

It is a problem that has been evolving for years.

When I started on Wall Street during the early 1980s, the model was very simple. You have a few big brokers servicing millions of small individual customers at fixed, non-negotiable commissions.

The big houses made so much money they could spend some money facilitating counter cycle customers trades. This means they would step up to bid in falling markets, and make offers in rising ones.

In any case, volatility was so low then that this never cost all that much, except on those rare occasions, such as the 1987 crash (we lost $75 million in a day! Ouch!).

Competitive, meaning falling, commissions rates wiped out this business model. There were no longer the profits to subsidize losses on the trading side, so the large firms quit risking their capital to help out customers altogether.

Now you have a larger numbers of brokers selling to a greatly shrunken number of end buyers, as financial assets in the US have become concentrated at the top.

Assets have also become institutionalized as they are piled into big hedge funds, and a handful of big index mutual funds, and ETFs. These assets are managed by people who are also much smarter too.

The small, individual investor on which the industry was originally built has almost become an extinct species.

There is no more ?dumb money? left in the market.

Now those placing large orders are at the complete mercy of the market, often with egregious results.

Enter volatility. Lots of it.

What is particularly disturbing is that the disappearance of liquidity is coming now, just as the 35 year bull market in bonds is ending.

An entire generation of bond fund managers, and almost two generations of investors, have only seen prices rise, save for the occasional hickey that never lasted for more than a few months. They have no idea how to manage risk on the downside whatsoever.

I am willing to bet money that you or your clients have at least some, if not a lot of your/their? money tied up in precisely these funds. All I can say is, ?Watch out below.?

When the flash fire hits the movie theater, you are unlikely to be the one guy who finds the exit.

We’re hearing a lot about when the Federal Reserve finally gets around to raising interest rates next month that it will make no difference, as rates are coming off such a low base.

You know what? It may make a difference, possibly a big one.

This is because it will signify a major trend change, the first one for fixed income in more than three decades. That?s all most of these guys really understand are trends, and the next one will have a big fat ?SELL? pasted on it for the fixed income world.

El-Erian has one of the best 90,000-foot views out there. A US citizen with an Egyptian father, he started out life at the old Salomon Smith Barney in London and went on to spend 15 years at the International Monetary Fund.

He joined PIMCO in 1999, and then moved on to manage the Harvard endowment fund. His book, When Markets Collide, was voted by The Economist magazine as the best business book of 2008.

He regularly makes the list of the world?s top thinkers. A lightweight Mohamed is not.

His final piece of advice? Engage in ?constructive paranoia? and structure your portfolio to take advantage of these changes, rather than fall victim to them.

Mohamed El-Erian

The 1% and the Bond Market

With the bond market confounding forecasters and prognosticators once again, I thought I?d delve into one of the more mysterious reasons why the bond market keeps going from strength to strength.

To a man, hedge fund traders expected bond prices to take a dive in 2014 and 2015 and for yields to soar. Isn?t that what?s supposed to happen in recovering economies?

Instead, we got the opposite, and yields have plunged, from 3.05% for the ten-year Treasury to as low as 2.80% this week.

There are many important lessons to be learned here. This is not your father?s bond market.

The internal dynamics of the fixed income markets have changed so much in the last three decades that it has become unrecognizable to long term practitioners, like myself.

A big factor has been the takeover of the bond market by the 1%, the richest segment of the US population and, indeed, the global economy. As wealth concentrates at the top, its character changes.

Let me stop here and tell you that the ultra rich are different from you and me, and not just because they have more money.

I have learned this after nearly half-century-long relationships with the planet?s wealthiest families, including the Rockefellers, Rothschilds, DuPonts, Morgans, and Pritzkers, first as important contacts of mine at The Economist, then as clients of mine at Morgan Stanley, then as investors in my hedge fund, and now as subscribers to The Diary of a Mad Hedge Fund Trader.

The wealthier families become the more conservative they get in their investment choices. Their goal shifts from capital appreciation to asset protection.

They lose interest in return on capital and become obsessed with return of capital. This is how the rich stay rich, sometimes for centuries. I have even noticed this among my newly minted billionaire hedge fund buddies.

What this means for the bond market is that they never sell. When they buy a 30-year Treasury bond, it is with the expectation of keeping it for the full 30 years until maturity.

That way they can avoid capital gains taxes and only have to pay taxes on the coupon interest. When they die, spouses get the step up in the cost basis, and then the wealth passes from one generation to the next. Taxes are never paid.

Back in the 1980s, when wealth was more evenly distributed, the top 1% only accounted for 1% of Treasury bond ownership. Today, that figure is closer to 25%.

Add this to the 50% of our national debt that is owned by foreign investors, primarily central banks, who also tend to hold paper for its full life. Central banks don?t pay taxes either.

China and Japan are the biggest holders with around $1 trillion each. This means that 75% or more of bonds are owned by investors who won?t sell. What does that mean for the rest of us? Bond prices that never go down.

With bonds very close to 30-year highs, keeping your bonds has been the right thing to do. I can?t tell you how many investment advisors I know who have distilled their practices down to managing fixed income instruments only.

This involves the entire coupon clipping space, including municipal bonds (MUB), corporates (LQD), junk (JNK), and even emerging market debt (ELD).

This is driven by customer demand, the 1%ers, not from any great insights or epiphanies they achieved on their own.

Of course, there is a certain amount of “driving with your eyes firmly fixed on the rear view mirror” going on here. Maybe the rich will finally sell their bonds once prices fall hard, stay down and then go down some more.

Inflation rearing its ugly head might also do the trick since it is always bad for bond prices as it reduces the purchasing power of money. Selling is certainly what they were doing in the early eighties, when the ten-year yield hit 12%.

Again, the rear view mirror effect, when bond were called ?certificates of wealth confiscation.?

There are other matters to consider with the 1% owning so much of the bond market and keeping it there.

This money is not getting invested in new start ups and creating jobs. It is money that is not being used to engender new economic growth. One of the fantasies of the last election was the claim that the 1% were creating so many jobs. They weren?t, not as long as their money was parked in a risk free bond market.

Instead, it is just stagnating. This is one reason why economic growth is so flaccid this decade and will remain so. This is fine for the 1%, but not so good for the rest of us.

The bottom line here is that while bonds are overbought and due for a pullback, they are not by any means going to crash. We could be living in the 2.60%-3.50% range for the 30-year for quite some time, maybe for years.

That is if the new Federal Reserve governor and my friend, ultra dove Janet Yellen, has anything to say about it. She has only just started and could be with us for another eight years.

Personally, I don?t foresee any appreciable rise in interest rates until we get well into the 2020s, when real inflation finally returns from the dead.

That is when bonds will become the asset class you don?t want to know, whether you?re in the 1% or not.

TLT 1-15-16
TYX 1-15-16

MUB 1-15-16

DraculaBonds Will Stay Up Until Inflation Returns from the Dead