RISK - Post Q2 Quadruple Witch - Institutional Money Changing Direction

OUR BIG PICTURE

DRILLING DOWN

STUDY SEQUENCE:

1. THE ILLUSION
   • Don’t Fight The Market 06-21-15 Alhambra Investemtn Partners
   • All Their Eggs in Janet's Basket 06-22-15 John Hussman
2. THE EQUITY MARKET PROBLEM - One of Them
• "Debt Gone Wild" - Debt Funded Stock Buybacks Soar 06-22-15 Lance Roberts
• The Long Expansion 06-22-15 Ed Yardeni
3. THE BOND MARKET PROBLEM
• -$140 Billion Bond Fund Goes To Cash As It -Braces For Bond-Market Collapse 06-22-15 TCW Group / JP Morgan via ZH
4. NERVOUSNESS
• The "Smart Money" Just Sold The Most Stocks In History 06-23-15 BOAML via ZH
• Pop Goes The Bubble 06-23-15 Dmitry Orlov via ClubOrlov blog,

"DON'T FIGHT THE FED" MANTRA

• Real growth expectations are flat to falling.
• Inflation expectations are rising.
• Capital is flowing away from the US and back to international markets and economies.
• Credit markets are starting to get worried.

• Europe does not appear to have changed any economic policy sufficiently to affect their long term growth arc.
• Japan is improving but only slowly.
• Most people seem to think that China has a stock market bubble that will end badly.
• Australia, Canada and most of Latin America are dependent on China.

It seems best to trust what the market is saying. So, forget the Fed. Don’t fight the market.

Investors whose strategy is to follow the Fed – in the belief that stocks will advance as long as the Fed does not raise interest rates – are free to place all their eggs in Janet’s basket. On the other hand, for investors whose strategy is historically informed by factors that have reliably distinguished market advances from collapses over a century of history, our suggestion is to consider a stronger defense. Our greatest successes have been when our investment outlook was aligned with valuations and market internals, and our greatest disappointments have been when it was not. Both factors are unfavorable at present, and our outlook is aligned accordingly.

CHANGING INSTITUTIONAL FLOWS

GLOBAL RISK - Bond Funds are Bracing for a Market Crash

$140 Billion Bond Fund Goes To Cash As It "Braces For Bond-Market Collapse" 06-22-15 ZH

Recently, it’s become readily apparent that some of the world’s top money managers are getting concerned about what might happen when a mass exodus from bond funds collides head on with a completely illiquid secondary market for corporate credit. 

Indeed, bond market illiquidity is the topic du jour and has almost become something of a cliche among pundits and mainstream financial media outlets years after we first raised the issue in these pages. But just because something has become fashionable to discuss doesn’t mean it’s not worth discussing and indeed, we’re at least pleased to see that the world is suddenly awake to the fact that a primary market supply bonanza catalyzed by rock-bottom borrowing costs and yield-starved investors could spell disaster when paired with shrinking dealer inventories. 

For illustrative purposes, here’s a look at turnover in corporate credit…

Chart: Barclays

...and a snapshot of shrinking dealer inventories and ballooning bond funds…

Chart: Citi

...and finally, here's UST market depth…

What all of these charts show is that whether you’re talking about corporate credit or “risk free” government debt, liquidity simply isn’t there and as was on full display last October, wild swings in illiquid markets will be exacerbated by the presence of parasitic HFTs. 

Meanwhile, Treasury market participants are shifting to futures and corporate bond fund managers are using ETFs to offset “diversifiable” outflows, phenomena which prove investors are actively avoiding credit markets by resorting to derivatives, a practice which only serves to make the underlying markets still more illiquid. 

Of course one way to mitigate risk is simply to move to cash (as we noted over the weekend, some managers are even moving to physical cash), a strategy TCW’s Jerry Cudzil is currently implementing in order to ensure he’s not one of the ones “looking silly” after the crash. Bloomberg has more: 

TCW Group Inc. is taking the possibility of a bond-market selloff seriously.

So seriously that the Los Angeles-based money manager, which oversees almost $140 billion of U.S. debt, has been accumulating more and more cash in its credit funds, with the proportion rising to the highest since the 2008 crisis.

“We never realize what the tipping point is until after it happens,” said Jerry Cudzil, TCW Group’s head of U.S. credit trading. “We’re as defensive as we’ve been since pre-crisis.”

TCW isn’t alone: Bond funds are holding about 8 percent of their assets as cash-like securities, the highest proportion since at least 1999, according to FTN Financial, citing Investment Company Institute data.

Cudzil’s reasoning is that the Federal Reserve is moving toward its first interest-rate increase since 2006, and the end of record monetary stimulus will rattle the herds of investors who poured cash into risky debt to try and get some yield.

Of course, U.S. central bankers are aiming to gently wean markets and companies off zero interest-rate policies. In their ideal scenario, borrowing costs would rise slowly and steadily, debt investors would calmly absorb losses and corporate America would easily adjust to debt that’s a little less cheap amid an improving economy.

That outcome seems less and less likely to Cudzil, as volatility in the bond market climbs.

“If you distort markets for long periods of time and then you remove those distortions, you’re subject to unanticipated volatility,” said Cudzil, who traded high-yield bonds at Morgan Stanley and Deutsche Bank AG before joining TCW in 2012. He declined to specify the exact amount of cash he’s holding in the funds he runs.

Price swings will also likely be magnified by investors’ inability to quickly trade bonds, he said. New regulations have made it less profitable for banks to grease the wheels of markets that are traded over the counter and, as a result, they’re devoting fewer traders and money to the operations.

To boot, record-low yields have prompted investors to pile into the same types of risky investors -- so it may be even more painful to get out with few potential buyers able to absorb mass selling.

“We think the market’s telling you to upgrade your portfolio,” Cudzil said. “Whether it happens tomorrow or in six months, do you want look silly before the market sells off or after?”

Well, preferably neither, but point taken and we would have to agree that if ever there were a time to take one's money and run — before the realities of a dealer-less corporate credit market and/or an HTF-infested, VaR shock-prone government bond market conspire to prove, once and for all, that in today's world, the idea that bonds are any safer than other asset classes is completely and utterly false — this is it.

FINANCIAL REPRESSION - Cashless Society Needed for Negative Rates

Cashless Society Needed for Negative Rates-Gordon Long