BOND BUBBLE - Showing Serious Leakage

“Bunds have been selling off as the market re-prices the ‘term premium’ [risk factors affecting bonds over and above the outlook for inflation and rates], which has been held down by a combination of ECB QE and uncertainties surrounding Greece,” said David Tan, Global Head of Rates at J.P. Morgan Asset Management.

“Liquidity has been very poor and this has exacerbated the price action. It is difficult to say when the selling will stop. The combination of higher bond yields in both [eurozone] core and periphery, weaker equities and stronger euro will ultimately arrest this sell-off in bonds as people worry about the pass-through into slower economic growth.”

‘’The thinking was that given there is limited issuance coming through the pipeline this year from core countries and the ECB is buying, then effectively net supply will be negative, so yields fall. It was a no-brainer people would have had us believe.”

Mohamed El-Erian warns of trouble as bond liquidity dries up 05-06-15 MarketWatch

The leap in German bund yields over the last two weeks is another sign that liquidity issues could eventually present serious problems for financial markets, former Pimco Chief Executive Mohamed El-Erian on Wednesday warned at the annual SALT investment conference in Las Vegas.

“There isn’t the countercyclical risk-taking we need,” said El-Erian, chief economic adviser at Pimco parent Allianz. That could spell trouble when there is a big shift market positioning, he warned at SALT, a gathering of around 1,800 hedge-fund and investment-industry professionals.

That is because

"Investors may not be able to reposition at a low cost.

Bond liquidity is a “delusion, not an illusion”

El-Erian’s remarks came during SALT’s opening panel, which included Peter Schiff, CEO of Euro Pacific Capital, and Gene Sperling, a former economic adviser to President Barack Obama and the Clinton White House.

Sperling argued that a lackluster U.S. economic recovery is the aftermath of a financial crisis, which typically gives way to less robust recoveries as banks, businesses and consumers focus on eliminating debt. Meanwhile, the Federal Reserve was left to do much of the heavy lifting as the federal government’s stimulus efforts were offset by fiscal contraction at the state and local level.

Schiff, a persistent Fed critic, charged that the U.S. economy is witnessing a bubble rather than a recovery and that the Fed was crowding out small businesses who would otherwise be creating jobs.

Fed Chairwoman may not entirely disagree with Schiff’s bubble assessment, On Wednesday, Yellen referred to stock valuations as “quite high,” and hinted that bond values may be even higher during a conversation with International Monetary Fund head Christine Lagarde sponsored by the Institute for New Economic Thinking.

Schiff, who has long argued that quantitative easing would be a disaster for the dollar, compared being long the U.S. currency now with being long subprime mortgages back in 2006. In other words, doomed to implode.

El-Erian later waded into the debate, saying that Schiff and Sperling were engaged in a backward-looking conversation. He likened quantitative easing to a “painkiller” that initially worked, but that policy makers now have become dependent.

On the fiscal front, El-Erian sounded more sympathetic to Sperling, saying that the appeal of investing in infrastructure building projects at near-zero interest rates shouldn’t be overlooked

Global Bond Rout Spreads to Japan as Three-Day Break Ends 05-06-15 Bloomberg

Why Are Bonds Taking a Dive? 05-07-15 Ed Yardeni

US bond yields have jumped recently. The 10-year Treasury is up from a recent low of 1.87% on April 17 to 2.26% yesterday. Everyone is blaming that development on the spike in Eurozone bond yields, particularly the surge in the 10-year German government yield from its all-time low of 0.033% on April 17 to 0.58% yesterday. That’s despite the implementation of QE by the ECB starting on March 9.

With the benefit of hindsight, the backup in yields isn’t a surprise. Yields simply fell too low at the start of the year on fears that plunging oil prices might trigger widespread deflation, especially in the Eurozone, and maybe cause another financial crisis if oil companies started to default on their debts. Now that oil prices have rebounded, those concerns are evaporating and yields are normalizing. I think it’s that simple.

In any event, the backup in bond yields is doing the same to mortgage rates in the US.

That could stall the already lackluster recovery in the housing industry, which might explain why lumber prices are falling.

So maybe the Fed should postpone its lift-off given the lift-off in bond yields?

GLOBAL RISK - World Economic Forum

CURIOUS SIGHTINGS!

Same Old Lessons

Published 05-02-15

THE "WANNA GET RICH QUICK" CROWD

In the old days you knew a market top was at hand when your local barber starting giving you stock tips. In our global market it is different as new people discover trading (and will soon learn some old lessons) .... It appears US barbers are too smart, too broke and too afraid of no pension income to fall for this trap again.

MEANWHILE THE GOLDMAN SACHS "NOUVEAU RICH" BANKERS COULDN'T FIND PARKING SATURDAY

The rich discovered a new problem Saturday! They can't find parking spaces for their tax deductible private jets during their weekend "boon doogles"

FINDING PARKING FOR THE SATURDAY "KENTUCKY DERBY" FIGHT AT THE VEGAS AIRPORT WAS IMPOSSIBLE!

SO WAS FINDING PARKING SATURDAY FOR THE MAYWEATHER-PACQUUIAO" FIGH AT THE VEGAS AIRPORT

Some had EVEN MORE serious problems. Tom Brady attended BOTH events Saturday?? No wonder they call him Tom Terrific!

THE REST OF US SIMPLY TRIED TO AVOID THE INEQUALITY RIOTS AND RALLIES

Rallies in Baltimore have spread to more than 20 US cities

GOD BLESS AMERICA!!!

LAND OF THE FREE?

In The New Paranormal, Junk Bonds Are A "Haven Asset"

When you devalue money and distort the supposed risk-free rate, you devalue every aspect of the capital structure, and of society itself.

We are now in the terminal stages of QE, during which the practical limitations of this fatuous and discredited policy are being revealed. The practical outcome of QE is that it turns the bond market into a no-go area for any rational investor.

Quantitative easing is a squalid little lie. It appeals to economists with no grasp of history. It pretends that too much debt can be simply resolved through futile attempts at price controls and money printing.

At some point, the free market returns with a vengeance, like a coiled spring made out of pure risk. That time may be coming soon.

There is one thing riskier than investing in a free market: investing in a rigged market when you think the central bank has your back.

In The New Paranormal, Junk Bonds Are A "Haven Asset" 05-05-15 ZH

"What's even more dangerous than the actual stock market is the high yield market,” Carl Icahn (who is perhaps talking his book) recently warned, before saying he “feels sorry” for all of those throwing their money into junk bonds in a desperate search for yield. We have of course long warned that a half decade of easy money policies have had the unfortunate side effect of allowing otherwise insolvent companies (most notably energy producers) to stay afloat by keeping rates artificially low, thus creating demand for HY debt while simultaneously ensuring that borrowing costs for issuers remain (very) favorable. Indeed, HY issuance is quite clearly correlated with successive rounds of QE as the following charts show:

More specifically, UBS notes that “the picture is crystal clear: In both periods, issuance was $130bn more than average, or about 50% greater than the average amount expected, over an 11 month period. The main drivers were lower yields, sharp drops in yields (we find that the speed of yield changes plays a significant role in impacting issuance), and strong inflows.”

Over time, this has had the effect of, in Citi’s words:

... destroying creative destruction by creating a legion of zombie companies which have continued to produce when they likely should have been long buried, contributing to a global supply glut and ultimately, to deflation.

Unfortunately, this dynamic will persist as long as the Fed keeps rates suppressed, as investors have virtually no alternative but to look for yield wherever they can find it, especially when many risk-free assets have a negative carry.

It’s no surprise then that Bloomberg is out calling junk bonds “the new haven asset”:

The new fixed-income haven is, of all things, the market for junk bonds.

With government bonds in Germany to Japan yielding less than nothing, money is pouring into exchange-traded funds that buy speculative-grade debt, traditionally the riskiest of fixed-income assets.

The pace is staggering. So far this year, about $9 billion has flowed into the funds globally, a significant chunk for the $44.4 billion market in junk-debt ETFs.

In the land of negative yields, even the most conservative firms such as Zurich Insurance Group AG and Assicurazioni Generali SpA, the biggest Swiss and Italian insurers, are planning to invest in sub-investment grade debt for the first time. One of the bond market’s brightest luminaries, Jeffrey Gundlach, says you’re better off in junk because the only money to be made on German bunds is from betting against them.

While last week’s sudden selloff in euro sovereign debt gives investors all the more reason to crowd into high-yield assets, the lingering concern is that buyers are exposing themselves to even greater losses. And with the European Central Bank’s bond purchases still keeping government yields close to historic lows, many bond investors have few other options.

“Investors are being forced by the central bank to assume more risk,” Jens Vanbrabant, a money manager at ECM Asset Management, which oversees $6.5 billion, said from London. “They’re trying to adapt their investment parameters to the new situation of zero or negative yields.”

While all of this may be true, the simple fact is that HY is HY for a reason — from a fundamental perspective, the issuers are not as sound as their IG counterparts. Combine this with the fact that in a pinch, HY will be the first to suffer and holders will be selling into a secondary market with no liquidity, and you have a scenario that could quickly turn into a rout. This is especially true for HY energy names which, as Barclays notes, look particularly overbought: 

High yield E&P bond prices have disconnected with commodity prices. High yield E&P bonds have been among the best-performing sectors in high yield, up 6.4% YTD through April 27, compared with a 3.9% return for the overall high yield market. At a current yield of 8.9%, the HY E&P sector presents a 300bp pickup to the high yield market’s 5.9% yield, but well below the 469bp premium offered on December 16, 2014, when WTI oil prices hovered $2/bbl above current levels (chart). 

Management teams have been quicker to respond to the downturn, so we continue to expect defaults to be modest in 2015, but they could accelerate in 2016 if oil prices do not rebound. High yield producers have cut costs aggressively, lowered spending by over 40% y/y, and have aggressively raised capital. Year-to-date, new issuance in High yield energy has been robust, with $15bn through April 9, 2015, compared with an average of $9bn in 1Q over 2007-14. Equity issuance has also been strong, with over $11bn YTD from all North American independent oil and gas producers. 

We think there are four main risks to investing in HY E&P bonds today. First, we do not think debt/EBITDA of over 4x is sustainable in a capital-intensive industry. In our coverage universe, we forecast that over one-third will have leverage above 4x in 2015. Second, about 42% of the high yield peer group’s 2015 production is hedged at oil prices of $88-92/bbl, providing downside protection this year but negative cash flow decrements in out years absent material price or production gains. Third, we think there is risk to priming of unsecured bonds with secured debt. As we and our credit strategy colleagues discussed in Don’t Get them While They’re Hot, April 10, 2015), we think more producers will look to first- and second-lien issuance to shore up balance sheets, which in most cases has led to significant underperformance of existing bonds given priming concerns. Finally, if equity prices begin to reflect valuations closer to current strip prices, bond performance could also be negatively affected, given the high correlation between high yield bonds and equities, especially for higher-beta producers.

No Really, Who Is Buying? 05-04-15 ZH

One week ago, when showing a BofA chart demonstrating the record divergence between the S&P500 and US equity flows... 

... and which BofA itself prefaced by saying "big decoupling in recent weeks between US equity flows and prices ...correction risks will grow in absence of fresh inflows in coming weeks" we asked: "who is buying?"

We bring this up because over the weekend we say a different manifestation of the same chart, this time from Deutsche Bank. This is what the German bank with the €50+ trillion in derivatives had to say:

There have been large inflows to bond funds and outflows from equity funds in the US, according to EPFR data. On a three-month basis, the flows are at or near extremes, a mirror image of those during taper tantrum. Over the long term, the flow differentials have correlated with equity risk premium. The recent heavy inflows to bond funds could be a result of changing perceptions of Fed hike timing. ECB QE has pushed investors into risk assets.

Except for stocks, of course, based on where the equity flows are not going. Because as the chart below shows, the cumulative three-month net flows into, or rather out of equities, is now the largest on record.

So, again, we ask: just who is "buying" stocks? Because the greatest rotation is here, and as far as non-central bank participants are involved, it is into bonds and out of stocks.

CUSTODIAL RISK- There is Counterparty Risk PLUS Custodial Risk

QUESTION TO ANSWER: What do you really own when you buy an investment?

In our complex financial world of securities, derivatives, counterparty agreement and rehypothecation of the collateral of assets under management virtually no one has the actual physical share certificates of stocks or other assets held by their custodial financial investment firm.

"Custody Risk is one of the biggest, most important issues to consider if you want to maintain your wealth when the next round of systemic risk hits!" Graham Summers - Phoenix Capital

TWO PROBLEMS

1- CUSTODIANS OFTEN DON'T KNOW WHERE YOUR ASSETS ARE HELD

The SEC recently performed a study of some 400 investment advisor firms. As the SEC itself stated in its report - approximately one-third (140) failed to meet custody rule requirements. What this says is custodians don't know where their clients funds are! Many didn't even know they themselves were legal custodians of their clients funds!

2- YOUR ASSETS WILL LIEKLY BE FROZEN WHEN YOU NEED THEM MOST

Even if an appropriate legal framework is in place to eliminate the risk of loss of value of the securities held by the custodian in the event of its failure, it can take weeks or even months to transfer the securities to new custodians. During that time, you cannot close out open positions .. they are effectively frozen.

In the case of MF Global, some investors were locked out of their accounts and couldn't trade their positions for weeks. As a result many of them incurred massive losses.