Posts

July 31, 2019

Global Market Comments
July 31, 2019
Fiat Lux

SPECIAL FIXED INCOME ISSUE

Featured Trade:
(ITALY’S BIG WAKE UP CALL),
(TLT), ($TNX), (TBT), (SPY), ($INDU), (FXE), (UUP), (USO),
(WELCOME TO THE DEFLATIONARY CENTURY),
(TLT), (TBT),

July 5, 2019

Global Market Comments
July 5, 2019
Fiat Lux

Featured Trade:

(FRIDAY JULY 19 ZERMATT SWITZERLAND STRATEGY SEMINAR)
(WHERE THE ECONOMIST “BIG MAC” INDEX FINDS CURRENCY VALUE),
(FXF), (FXE), (FXA), (FXY), (CYB),
(WHY US BONDS LOVE CHINESE TARIFFS),
(TLT), (TBT), (SOYB), (BA), (GM)

Why US Bonds Love Chinese Tariffs

For many, one of the most surprising impacts of the administration’s tariffs on Chinese imports announced today has been a rocketing bond market.

Since the December $116 low, the iShares 20+ Year Treasury Bond ETF (TLT) has jumped by a staggering $16 points, the largest move up so far in years.

The tariffs are a highly regressive tax that will hit consumers hard in the pocketbook, thus reducing their purchasing power.

It will dramatically slow US economic growth. If the trade war escalates, and it almost certainly will, it could shrink US GDP by as much as 1% a year. A weaker economy means less demand for money, lower interest rates, and higher bond prices.

There is no political view here. This is just basic economics.

And while there has been a lot of hand-wringing over the prospect of China dumping its $1.1 trillion in American bond holdings, it is unlikely to take action here.

The Beijing government isn’t going to do anything to damage the value of its own investments. The only time it actually does sell US bonds is to support its own currency, the renminbi, in the foreign exchange markets.

What it CAN do is to boycott new Treasury bond purchases, which it already has been doing for the past year.

The tariffs also raise a lot of uncertainty about the future of business in the United States. Companies are definitely not going to increase capital spending if they believe a depression is coming, which the last serious trade war during the 1930s greatly exacerbated.

While stocks despise uncertainty, bonds absolutely love it.

Those of you who are short the bond market through the ProShares Ultra Short 20+ Year Treasury ETF (TBT) have a particular problem that is often ignored.

The cost of carry of this fund is now more than 5% (two times the 2.10% coupon plus management fees and expenses). Thus, long-term holders have to see interest rates rise by more than 5% a year just to break even. The (TBT) can be a great trade, but a money-losing investment.

The Chinese, which have been studying the American economic and political systems very carefully for decades, will be particularly clever in its retaliation. And you thought all those Chinese tourists were over here just to buy our Levi’s?

It will target Republican districts with a laser focus, and those in particular who supported Donald Trump. It wants to make its measures especially hurt for those who started this trade war in the first place.

First on the chopping block: soybeans, which are almost entirely produced in red states. In 2016, the last full year for which data is available, the US sold $15 billion worth of soybeans to China. Which are the largest soybean producing states? Iowa followed by Minnesota.

A major American export is aircraft, some $131 billion in 2017, and China is overwhelmingly the largest buyer. The Middle Kingdom needs to purchase 1,000 aircraft over the next 10 years to accommodate its burgeoning middle class. It will be easy to shift some of these orders to Europe’s Airbus Industries.

This is why the shares of Boeing (BA) have been slaughtered recently, down some 13.5% from the top. While Boeing planes are assembled in Washington state, they draw on parts suppliers in all 50 states.

Guess what the biggest selling foreign car in China is? The General Motors (GM) Buick which saw more than 400,000 in sales last year. I have to tell you that it is hilarious to see my mom’s car driven up to the Great Wall of China. Where are these cars assembled? Michigan and China.

The global trading system is an intricate, finally balanced system that has taken hundreds of years to evolve. Take out one small piece, and the entire structure falls down upon your head.

This is something the administration is about to find out.

 

 

 

June 4, 2019

Global Market Comments
June 4, 2019
Fiat Lux

Featured Trade:

(WEDNESDAY, JUNE 26 SYDNEY, AUSTRALIA STRATEGY LUNCHEON)
(TEN UGLY MESSAGES FROM THE BOND MARKET),
(TLT), (TBT), (USO), (GLD), (GS), (SPY)

May 16, 2019

Global Market Comments
May 16, 2019
Fiat Lux

Featured Trade:

(WHY US BONDS LOVE CHINESE TARIFFS),
(TLT), (TBT), (SOYB), (BA), (GM)
(THE BEST TESTIMONIAL EVER)

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?

April 11, 2019

Global Market Comments
April 11, 2019
Fiat Lux

Featured Trade:
(THE UNITED STATES OF DEBT),
(TLT), (TBT), ($TNX),

The United States of Debt

My “exploding national debt” trade has been one of my most profitable and consistent positions of the past three years.

As I write this, my 64th profitable trade alert for bonds over the last three years is about to go out, now that the iShares Barclays 20+ Year Treasury Bond Fund (TLT) April 2019 $128-$130 in-the-money vertical BEAR PUT spread is approaching its maximum profit point of $2.00.

Many followers have already notified me of their short April $128 puts being called away, meaning they get to cash out at the $2.00 price today.

Sellers of the iShares 20 Year Plus Treasury Bond Fund ETF (TLT) and buyers of the ProShares UltraShort 20 Year Plus Treasury ETF (TBT) have seen riches rain down upon them.

With ten year Treasury bond yields grinding up from 1.33% to 3.25% during this period, what else would you expect?

It looks like things are going to get a whole lot better. For not only is the federal government now on an endless borrowing binge, so is the rest of the country.

We are, in fact, becoming the United States of Debt.

That Washington is taking the lead in this frenzy of borrowing is undeniable. Since the new administration came into power two years ago, the annual budget deficit has nearly tripled from $450 billion to $1.2 trillion.
 

Add it all up and the United States government is on track to take the National Debt from $20.5 trillion to $30 trillion within a decade.

The National Debt exceeded US GDP in 2016 taking the debt to GDP ratio to the highest point since WWII.

Former Fed governor Janet Yellen recently confided to me that, “It’s the kind of thing that should keep you awake at night.”

It gets worse.

According to the Federal Reserve Bank of New York, total personal debt topped $16 trillion by the end of 2017. An overwhelming share of personal consumption is now funded by credit card borrowing.

Some 33% of Americans now have debts in some form a collection, and that figure reaches an astonishing 50% in many southern states (see map below). Call it the Confederate States of Debt.

Corporations have also been visiting the money trough with increasing frequency taking their debt to $6.1 trillion, up by 39% in five years, and by 85% in a decade.

The debt to capital ratio of the top 1,000 companies has ballooned from 35% to 54% and is now the highest in 20 years.

Another foreboding indicator is that corporate debt is rising faster than sales with debt rising by a breakneck 8.5% annualized compared to 4.6% for sales over the past decade.

Automobile debt now tops $1 trillion and with lax standards has become the new subprime market.

And remember that other 800-pound gorilla in the room? Student debt now exceeds $1.6 trillion and is rising as is the default rate. Provisions in the new tax bill eliminate the deductibility of the interest on student debt, making lives increasingly miserable for young borrowers.

Of course, you can blame the low-interest rates that have prevailed for the past decade. Who doesn’t want to borrow when the inflation-adjusted long-term cost of money is FREE?

That explains why Apple (AAPL), with $270 billion in cash reserves held overseas, has been borrowing via ultra-low coupon 30-year bond issues even though it doesn’t need the money. Many other major corporations have done the same.

And while everything looks fine on paper now, what happens if interest rates rise?

The Feds will be in dire straight very quickly. Raise short term rates to the 6% seen at the peak of the last cycle, and the nation’s debt service rockets from 4% to over 10% of the total budget. That’s when the sushi really hits the fan.
 
You can expect the same kind of vicious math to strike across the entire spectrum of heavily leveraged borrowers going forward, including you and me.

Remember, all this new bond issuance is occurring in the face of rapidly flagging demand now that the Federal Reserve is out of the quantitative easing business and in to quantitative tightening. Their current plan is to suck $4 trillion of liquidity out of the system over the next decade.

We are also witnessing the withdrawal of the Chinese as major Treasury bond buyers who, along with other sovereign buyers, historically took as much as 50% of every issue. 

Don’t expect them back until the dollar starts to appreciate again, unlikely in the face of ballooning federal deficits.
 
Rising supply against fewer buyers sounds like a recipe for much higher interest rates to me.

Keep in mind that this is only a decade long view forward. The next big move in interest rates will be down as we slide into the next recession, possibly all the way to zero. As with everything else in life, timing is everything.

So, like I said, things are about to get a whole lot better for the bond shorting crowd. Just watch this space for the next Trade Alert regarding when to get back in for the umpteenth time.

 

 

 

March 13, 2019

Global Market Comments
March 13, 2019
Fiat Lux

Featured Trade:
(WHY BOND YIELDS ARE GOING TO ZERO),
(TLT), (TBT), ($TNX),
(TESTIMONIAL)