An important additional way to make 50-your_age strategy more effective is "above/below 200 days"
average strategy arbitrage. In this case you make more aggressive allocation for stock part of the
allocation (let's say 60
stocks 40 bonds) if 200 days moving average is above 200 days simple average and more defensive (40/60
allocations) in case it is below. Siegel described the extreme variant of this strategy with rations
(0:100 and 100:0) in his book "Stocks for the long run".
Enhancing this "binary" age based allocation with arbitrage-based moves ("buy low"- "sell high")
or "prepare for the crash" is tempting and decrease your 401K volatility due to rigged markets, but
in practice timing is difficult and few 401K plan provide ability to make several large reallocations
during the same year. Sill one a year selling extra returns due to excessive valuations looks pretty
safe, as we are making prediction that each large stock index will eventually return to normal valuations
sooner or later. This return to average affect is unscientific but is a good, useful heuristic. You
need to try exploiting large deviations from, say, 200 days average as the proxy for overvaluation of
stocks.
One of the first (and rather questionable) published attempts of using this kind of arbitrage in
401K portfolio in addition to buy and hold strategy (actually in the book this strategy is proposed
as the alternative to "buy-and-hold" strategy as well as cost-averaging strategies) was "Yes,
you can time the market" which is still
available
on Amazon. While technical details of authors strategy are highly questionable (they artificially select
15 years averages) the key observation about cost averaging is valid: people
who use cost -averaging buy on faith and can get crushed by the market at some point
when things get priced back on fundamentals. Make no mistake, the financial markets remains "buyer beware"
as holders of technology-loaded 401K portfolios quickly found out after year 2000....
My advice here is simple -- ignore the siren song of sophisticated investments strategies. Adhere
to KISS principle: keep it simple stupid. Don't own more then three mutual funds -- they all replicate
the same stocks and bonds, just in different proportions, so you do not diminish the risk by diversifying
into larger number of funds. It might well be that owning junk bond fund -- Tips fund combination is
as good or better then owning, say S&P500 and Tips.
One additional argument for simplicity here is that complex investment strategy in 401K (and especially
complex investment strategies which are based on mixes recommended by a particular "Financial alchemist"
are implicitly making some assumptions about socio-economic dynamics of the USA. Among the questions
which would greatly influence total return of your assets are the following
Is Fed de facto got a new dual mandate based on the trade-off between Nominal GDP growth
(or macro-economic stability), and Financial Sector Stability (preventing excessive system-wide
‘leverage’ levels).
Is the US empire in irreversible decline (as Iraq, Afghanistan military defeats and the economic
rise of China and Asian tigers suggests ) or those are temporary difficulties. Whether the USA lives
on borrowed time like the last decades of the USSR or this is business as usual. Can the country
with its standard mythology survive rise of financial oligarchy and the efforts of the three recent
administrations in redistribution of the country wealth toward the most wealthy and creating hereditary
aristocracy (abolishing of estate tax is the vital step in this direction).
Will dollar survive as the reserve currency in foreseeable future ?
Will manufacturing and finance centers move to Asia ?
What will be future price of oil?
Most of those factors are belong your control. That's why it is so fanny to read
old books with recommended allocations. See for example,
The Age of Nixon for
an example of such analysis (some comments are actually as interesting as the article itself). Contrary
from what neo-classical jerks are teaching in corrupted economics departments, economics could never
be separated from politics. It is always political economy, never economics.
Starting with the tax cuts by US president Ronald Reagan of 1981, and especially after collapse of
the USSR in 1991, the regulatory, budgetary, and especially tax policies began univocally favor the rich. This meant redistribution of wealth and greater pools
of free capital, once spread more or less evenly among the broad middle class, began to be concentrated
in fewer hands of those at the very top of the income pyramid (the top 1%). This process dramatically
accelerated after election of George W Bush in 2000, and the passage and implementation of tax cuts
heavily skewed toward the rich by his administration in 2000-01.
In opinion of Paul Craig Roberts, the last recovery was artificial and did not solve
any structural problems. It was based on extremely low interest rates orchestrated by the Federal
Reserve[Roberts2006a]. The low interest rates discouraged saving, but the low rates reduced the mortgage
cost of real estate, inflated home prices and encouraged consumers to refinance their homes and to spend
the equity. That naturally led to market dominance of hedge funds. Some pundits are even
more gloomy (Economist
Caution Prepare For 'Massive Wealth Destruction'):
Marc Faber, the noted Swiss economist and investor, has voiced his concerns for the U.S. economy
numerous times during recent media appearances, stating, “I think somewhere down the line we
will have a massive wealth destruction. I would say that well-to-do people may lose up to 50 percent
of their total wealth.”
If hedge funds were a country and the hedge-fund assets under management (AUM) represented a nation's
gross domestic product (GDP), it would rank eighth in the world, according to the World Bank, just behind
Italy and ahead of Spain. Institutional Investor reported in 2005 that the average salary for top hedge-fund
managers was $363 million; the reputed top earner, James Simons, of Renaissance Technologies Corp, is
reported to have taken home $1.5 billion in 2005. Julian Delasantellis in his alarmist
Asia Times article
noted:
On June 1 the European Central Bank (ECB) warned of the risks to market stability from what it
called the "correlation of hedge-fund returns". If all the hedge funds are doing the same thing
- such as placing huge leveraged bets on the Indian stock market, a major casualty of the post-May
11 global selloff - then all their returns will be "correlated" or, in non-economist terms, similar.
ECB vice president Lucas Papademos stated: "The increasingly similar positioning of individual hedge
funds ... is another major risk for financial stability."
It has happened before. In September 1998, one of the top hedge funds in the world was Long Term
Capital Management (LTCM), which had on its board Nobel Prize for Economics winners Robert Merton
and Myron Scholes. Unfortunately, the shining stature of Merton and Scholes apparently blinded the
funds' investors to the risks LTCM was actually taking. When the firm realized that the massive
bets it had made in the global bond markets were going horribly against it, the fund was looking
at $4.6 billion in losses, many times its capital base. The New York Federal Reserve, fearing that
an LTCM bankruptcy could initiate a cascading series of bankruptcies among the big banks that comprised
LTCM's creditors, then the creditors' creditors, etc, stepped in to arrange an emergency bailout
of LTCM.
In the eight years since the LTCM crisis, with the proportion of income in the developed capitalist
democracies remaining heavily skewed toward the upper classes, the concomitant amount of global
wealth controlled by hedge funds has grown tremendously. With all of them investing similarly, the
risks of the market turning against their positions, resulting in a tremendous destruction of global
capital liquidity, have also grown apace.
After recession of 2001-2002 we became wiser, but right now immunity to hype started to wear out.
That raise an important and rather explosive question: what percentage of 401K investors will be able
to have returns enough to get their money back ? That's why the most important is to avoid experiments
with your money inspired by some recent investment advice books. Please remember that most of those
published around year 2000 are completely forgotten or even laughed at six years later.
That includes "Intelligent investor" and "Stocks for the long run" that we mentioned before: they
just failed to pass the five year test. I can only imagine what will be their residual value of current
books in ten years.
And remember that cards are stacked against you. For example, in 2009-2013 Feb helped inflate
the biggest bond market bubble in history ... in order to mop up the damage from the biggest housing
bubble in history. As Bill
Gross put in in May 2013 (at the hight of bond bubble):
"PIMCO’s advice is to continue to participate in an obviously central-bank-generated bubble but
to gradually reduce risk positions in 2013 and perhaps beyond. While this Outlook
has indeed claimed that Treasuries are money good but not “good money,” they are better than the
alternative (cash) as long as central banks and dollar reserve countries (China, Japan) continue
to participate....a bond and equity investor can
choose to play with historically high risk to principal or quit the game and earn nothing."
"... The large Vanguard High-Yield Corporate fund (VWEHX) bested most of its peers in 2019, gaining almost 16%. The two largest ETFs are iShares iBoxx High Yield Corporate(HYG), yielding 4.3%, and SPDR Bloomberg Barclays High Yield (JNK), yielding 5%. ..."
"... Many professional investors have long sneered at electric utilities as richly valued and low growth. Yet the group, as measured by the Utilities Select Sector SPDRETF (XLU), has delivered an 11.6% annualized total return in the past decade and 10% during the past five years. ..."
In Asia, In Asia, Toyota Motor (TM), at $141, yields 2%, has a cash-rich
balance sheet, and trades for about 10 times forward earnings. Hong Kong–based conglomerate CK Hutchison Holdings (CKHUY), at about
$10, offers almost 4%. European drugmakers outpaced their U.S. peers last year, amid optimism about their product pipelines.
Novartis (NVS), at $95, yields 3%, and
GlaxoSmithKline (GSK), at $47, yields 4%. Among exchange-traded funds,
Among exchange-traded funds, Among exchange-traded funds,
iShares Core EAFE MSCI
(IEFA), at $65, yields 3.2%; iShares Core MSCI Emerging Markets
(IEMG), at $54, yields 3.3%; and Vanguard FTSE Europe (VGK)
at $58, yields 3.3%.
U.S. Dividend Stocks
There are still plenty of income pockets in a record stock market that allow investors to put together a portfolio with roughly
double the 1.8% yield on the S&P 500.
Exxon Mobil (XOM), at $70, yields 5%, and
Chevron (CVX), at $120, yield 4%.
Pfizer (PFE), at $39, yields almost 4%, and cruise industry leader
Carnival (CCL), at $50, yields 3.9%.
United Parcel Service (UPS), at $117, yields 3.3%.
Kraft Heinz (KHC), the biggest loser in the food group in 2019, has
the top yield among its peers at 5% after cutting its payout by 36% last year.
David King, manager of the Columbia Flexible Capital
Income fund (CFIAX), is partial to General Mills (GIS), which,
at $53, yields 3.7%. The company has cut debt since its 2018 purchase of Blue Buffalo Pet Products, potentially paving the way for
its first dividend increase since 2017 in its fiscal year that starts in May, he says. Oil refiners are a good source of income,
with King favoring one of the largest, Valero Energy (VLO), which
at $93, yields 3.8%.
There are plenty of dividend-focused mutual funds and ETFs, including top-performing Vanguard Dividend Growth fund (VDIGX), which
reopened to investors last year. Large ETFs include Vanguard High
Dividend Yield Index (VYM) which yields 3%, and the ProShares S&P 500 Dividend Aristocrats (NOBL), which features companies with
long histories of annual payout increases, rather than those with the highest yields. It pays 1.9%.
REITs
Wall Street warmed to real estate investment trusts, which returned 29% (including dividends) based on the broad and popular
Vanguard Real Estate ETF (VNQ). That nearly matched the S&P 500 in
2019.
J.P. Morgan 's REIT analysts recently forecast an 8% to 9% total
return for REIT stocks in 2020, based on a combination of dividends -- now averaging more than 3% -- and 4.3% growth in funds from
operations, or FFO, an important
measure of cash flow .
The negative is that REIT valuations are near record highs at about 20 times estimated 2020 FFO. The J.P. Morgan analysts wrote
that those valuations could "act as a cap on absolute upside from here."
Industrial REITs were standouts. Warehouse leader Prologis (PLD)
gained 50%, as investors sought direct plays on the e-commerce boom. Mall REITs suffered from the same trend and had the worst performance
in the group. Simon Property Group (SPG), the largest mall REIT,
lost 11%, while the smaller Taubman Centers (TCO) declined 32%. Reflecting
elevated risk in the mall sector, Simon yields 5.7% and Taubman, 9%, against Prologis at just 2.4% and the Vanguard REIT ETF at 3.4%.
Investors now favor apartment REITs, such as AvalonBay Communities
(AVB) and Equity Residential (EQR), which yield 3%. Top New York
office REITs Vornado Realty Trust (VNO) and
SL Green Realty (SLG) are contrarian plays because of concerns over
new Manhattan office supply and the high cost of upgrading older buildings. Vornado and SL Green yield 4% and trade below some analysts'
estimates of their asset values.
U.S. Telecom Stocks
The sector offers a combination of elevated yields and depressed valuations.
Verizon Communications (VZ), at about $61, was up less than 10%
in 2019 and has a secure 4% dividend. AT&T (T) was the sector standout,
rising 37%, to $39, thanks to an ultralow valuation at the start of 2019 and pressure from activist investor Elliott Management,
which took a stake during 2019. AT&T yields over 5%. Verizon trades for 12 times projected 2020 earnings of $5 a share, while AT&T
trades at 11 times earnings. Both are cheap, relative to the market's price/earnings ratio of 18.
A related play is Comcast (CMCSA), the largest U.S. cable company.
Its growth outlook is better than the telecoms, thanks to its lucrative broadband services. Comcast's stock, at $45, yields less
than 2%, but trades for a reasonable 14 times projected 2020 earnings.
Convertibles
Often overlooked, convertibles are stock-bond hybrids designed to provide the upside of stocks and the downside protection of
bonds. They did that in 2019, returning 22%, as measured by the SPDR
Bloomberg Barclays Convertible Securities ETF (CWB). There are two main types of convertibles: traditional bonds with a fixed
maturity date and so-called mandatory convertibles that are equity substitutes.
Traditional convertibles have more downside protection. Tesla
(TSLA) demonstrated that feature, as the company's 2% convertible held up well at midyear when the electric-car manufacturer's stock
cratered, and it has rallied along with the stock in recent months. Technology and biotech companies are major issuers of convertibles
because they can get low borrowing costs of 2% or less.
Mandatory convertibles from electric utilities normally have three-year maturities and provide higher yields than common shares.
But they have less upside than the stocks. DTE Energy (DTE), parent
of Detroit Edison, has a 6.25% issue due in 2022, and American Electric
Power (AEP) has a 6.125% issue due in 2022.
Junk Bonds
After a rocky 2018, the market had one of the its best years in a decade, returning 14% based on the Bloomberg Barclays U.S. Corporate
High Yield Bond Index. With the average junk bond now yielding just 5.1%, down from 8% at the start of 2019, returns may be modest
in 2020.
Marty Fridson, the chief investment officer at Lehmann Livian Fridson Advisors, says a total return around 3.5% is possible in
2020, based on an assumption of a slight rise in Treasury yields and little change in the spreads between junk bonds and Treasuries.
Investors favored better-quality junk issues in 2019, but the most speculative part of the market, bonds rated CCC, rallied in
December, helped by gains in hard-hit energy debt.
Junk-rated energy debt offers a high-yielding alternative to riskier common shares. Examples include Southwestern Energy 7.5%
bonds due in 2026, at a 8.75% yield; Range Resources 4.875% bonds due in 2025, at 8%; and
Diamond Offshore 4.875% bonds due in 2043, at nearly 10%.
Tax-Exempt Muni Bonds
The municipal market is getting treacherous in the wake of a rally that dropped yields as much as a percentage point in 2019.
Muni-bond funds had returns of 6% to 11% in 2019, but they will be hard-pressed to repeat that in 2020, given current low rates.
Absolute yields on AAA-rated 10-year munis now stand at 1.4%, about 78% of the yield on the comparable-maturity Treasury, against
an average of close to 85% in recent years. Many munis yield less than the current 2% U.S. inflation rate.
Alan Schankel, muni bond strategist at Janney Montgomery Scott, thinks that muni returns will run at 2% to 3% in 2020. One supporting
factor could be continued strong flows into mutual funds after a record 2019, when an estimated $90 billion of new money poured into
funds.
High-yield munis are popular as investors search for yield. This demand enabled Nuveen, which runs
Nuveen High-Yield Municipal Bond (NHMAX), the largest
open-end fund with a low-grade focus, to bring to market a closed-end fund with a similar strategy: Nuveen Municipal Credit Opportunities
(NMCO), which yields 5%. Muni closed-end funds are no longer bargains after 20%-plus total returns in 2019.
Taxable Muni Bonds
Tax-law changes that took effect in 2018 restricting the ability of state and local governments to refinance tax-exempt debt have
led to a boom in taxable muni bonds. Total issuance approached $70 billion in 2019 and may hit $100 billion this year, against an
annual average of $30 billion for much of the decade. Big issuers include California and the Dallas/Fort Worth airport.
One advantage of taxable munis over corporate bonds is that they are generally tax-exempt in the issuer's home state, although
they are subject to federal income taxes. With top state rates now at 10% or above in places like California, that is a nice bonus.
A group of high-quality issuers like Georgetown University and the University of Pennsylvania
have issued 100-year munis in recent years that now yield in the 3.25% to 4% range. Beware of rate risk with such ultralong maturity
dates.
Electric Utilities
Many professional investors have long sneered at electric utilities as richly valued and low growth. Yet the group, as measured
by the Utilities Select Sector SPDRETF (XLU), has delivered an 11.6% annualized total return in the past decade and 10% during the
past five years.
It is harder, however, to make a strong case now for utilities, after a 25% gain in the XLU during 2019 that lowered its dividend
yield to 3.1%. Four leading utilities, Dominion Energy (D),
Southern Co. (SO),
Duke Energy (DUK), and
American Electric Power (AEP), now trade for an average of 20 times
projected 2020 earnings -- a premium to the market.
The largest utility, renewables-rich NextEra Energy (NEE), is
valued at 27 times forward earnings. The bull case is that utilities are defensive and can produce mid-single digit profit growth
in the coming years.
Preferred Stock
Preferred stock looks less appealing after a strong run in 2019. The iShares Preferred & Income Securities ETF (PFF) returned
16%, including dividends, for the year. It now yields about 5%.
That is a nice premium above the 30-year Treasury, which yields just 2.3%. But there are risks. Preferreds are typically perpetual,
while issuers are able to redeem them at their face value in five years if rates fall.
That means a lot of downside -- some preferred stocks fell 20% in price during the late-2018 interest-rate rise -- and limited
upside. One plus is that most preferred dividends get preferential tax treatment, like those of common stocks.
"It is heads, you win a little, and tails, you lose a lot," Dan Fuss, the veteran bond manager and chief of the Loomis Sayles
Bond fund, told Barron's in the fall.
A recent JPMorgan preferred with a 4.75% dividend rate now yields 4.64%, and a Morgan Stanley 4.875% issue yields 4.80%. With
most of these securities trading at a premium to face value, investors should look at the lower "yield to call," which is based on
an assumed redemption at the call date five years after issuance, rather than the higher current yield.
The best thing about Treasuries is their defensive value. U.S. government bonds have often moved inversely with equities and thus
offer put-like qualities -- and some yield.
Treasury yields, however, are paltry, ranging from 1.5% on T-bills to 2.3% on the 30-year bond. No wonder that prominent investors
like Warren Buffett and DoubleLine Capital CEO Jeffrey Gundlach aren't enamored of them.
Treasury inflation-protected securities, or TIPs, are an alternative to U.S. Treasuries, since the inflation break-even is about
1.8% for the 10-year and 30-year -- below the current 2% inflation rate.
"The ultimate enemy of fixed-income investors is inflation," says Stephen Cianci, senior global portfolio manager at MacKay Shields.
TIPs offer protection against rising inflation at a good price, he adds.
High-yield bonds (avoid the oil patch), emerging-markets bonds and dividend-paying stocks
such as real estate investment trusts and utilities are good places to hunt for yield. Funds to
consider include Vanguard High Yield Corporate ( VWEHX ),
yielding 4.5%, and TCW Emerging Markets Bond ( TGEIX ),
yielding 5.1%. Schwab US Dividend Equity ( SCHD , $56), a
member of the Kiplinger ETF 20 list of our favorite ETFs, invests in high-quality dividend
payers and yields just over 3%. Spath, at Sierra Funds, is bullish on preferred stocks. IShares
Preferred and Income Securities ETF ( PFF , $37)
yields 5.5%. (For more ideas, see Income
Investing .)
Suppose my outlook for the bond market is either wrong, or at best, premature. Bond yields
could fall next year, or just stay relatively flat. That's why it usually makes sense to own
more than one bond fund.
Vanguard Intermediate-Term Tax-Exempt Investor ( VWITX ,
$14.41) should hold up pretty well if rates rise only a small amount in 2020, and it could
trounce the other funds in this article if rates fall.
VWITX's duration is 4.9 years. That means if bond yields rise by one percentage point, the
fund's price should decline by 4.9%. That wouldn't be fun for investors, but it would hardly be
catastrophic, especially when you factor in the yield.
Like most Vanguard bond offerings, Vanguard Intermediate-Term Tax-Exempt Investor is plain
vanilla, and that's OK. It sticks almost entirely to high-quality municipal bonds. Its weighted
average credit quality is a sterling AA.
VWITX also has been a decent performer, at an annualized 3.1% total return over the past
five years.
5 Energy ETFs to Buy for Higher Oil Prices
January 03, 2020, 01:55:35 AM EDT
By
Kiplinger
Shutterstock photo
Energy stocks and exchange-traded funds (ETFs) were a miserable bet in 2019. Indeed, the energy sector was the
worst-performing sector by a mile, gaining less than 5% - far below the S&P 500's 29% return, and
significantly lagging even the second worst sector, health care (18%).
However, despite tepid analyst outlooks for oil and gas prices in 2020, energy ETFs and individual
stocks are suddenly being thrust in the spotlight once more.
On Jan. 2, the Pentagon confirmed that the U.S. military killed Qasem Soleimani - a top Iranian
general who headed the Islamic Revolutionary Guard Corps' elite Quds Force - with a drone airstrike in
Iraq. While the Pentagon said the attack was meant to deter "future Iranian attack plans," Iran
nonetheless has vowed "severe revenge." The clear, abrupt escalation in Middle East tensions immediately
sent
oil prices
higher in response.
Whether oil continues to climb is unclear. Tensions could de-escalate. Also, American fracking has
changed the playing field. "The major potential risk - to oil markets - is mitigated by the fact that the
U.S. is now the largest producer of oil and essentially approaching Energy independence," says Brad
McMillan, Chief Investment Officer for Commonwealth Financial Network. "Our oil supplies are much less
vulnerable than they were, and the availability of oil exports from the U.S. means that other countries
have an alternative source."
However, if the conflict worsens - especially if oil tankers and infrastructure are targeted in any
violence - oil might continue to spike, regardless.
Here, we explore five energy ETFs to buy to take advantage of higher oil prices. But approach them
with caution. Just like increases in crude-oil prices should benefit each of these funds in one way or
another, declines in oil have weighed on them in the past, and likely would again.
Invesco Dynamic Energy Exploration & Production ETF
Market value: $25.6 million
Dividend yield: 1.7%
Expenses: 0.63%, or $63 annually on a $10,000 investment*
Exploration and production (E&P) companies are among the energy stocks most heavily dependent on commodity prices. These
firms seek out sources of oil and natural gas, then physically extract the hydrocarbons. They typically
make their money by selling oil and gas to refiners, who turn them into products such as gasoline, diesel
fuel and kerosene.
While costs to extract those hydrocarbons vary from company to company, in general, the more they can
sell those hydrocarbons for, the fatter their profits.
The Invesco Dynamic Energy Exploration & Production ETF (
PXE
, $16.69) is a
smaller energy ETF that allows you to buy the industry broadly, providing access to 30 U.S. stocks that
are primarily engaged in E&P. These companies include the likes of Marathon Oil (
MRO
), Devon Energy (
DVN
) and ConocoPhillips
(
COP
).
While many sector funds will simply assign weights to each stock based on their relative size (e.g.,
the largest stocks account for the largest percentages of the fund's assets), PXE does things a little
differently. For one, its underlying index evaluates companies based on various criteria, including
value, quality, earnings momentum and price momentum. It also "tiers" market capitalization groups,
ultimately giving mid- and small-cap stocks a chance to shine. Roughly half of PXE's assets are allocated
to small companies, and another 36% are in midsize firms, leaving just 14% to larger corporations.
These smaller companies sometimes react more aggressively to oil- and gas-price changes than their
larger brethren - good news for PXE when commodity prices spike, but more painful when they slump.
* Includes a one-basis-point fee waiver good through at least Aug. 31, 2021.
The Energy Select Sector SPDR Fund (
XLE
,
$60.58) is the de facto king of energy ETFs, with more than $11 billion in assets under management - No.
2, Vanguard Energy ETF (
VDE
), has just $3.2 billion. But it's also a much different creature than the aforementioned PXE - and that
affects how much it can benefit from oil-price spikes.
For one, the Energy SPDR is a collection of the 28 energy stocks within the S&P 500, so most of the
fund (83%) is large-cap stocks, with the rest invested in mid-caps. There are no small companies in the
XLE.
More importantly: While the XLE owns pure E&P plays, including some of PXE's holdings, it also invests
in other businesses that have different relationships with oil prices. For instance, refiners - who take
hydrocarbons and turn them into useful products - often improve when oil prices decline, as that lowers
their input costs. Middle East flare-ups can negatively affect some refiners that rely on crude oil
supplies from the region, too, while lifting those that don't. This fund also carries
energy-infrastructure companies such as Kinder Morgan (
KMI
), whose "toll
booth"-like business is more reliant on how much oil and gas is going through its pipelines and terminals
than on the prices for those products.
Then there's XLE's top two holdings: Exxon Mobil (
XOM
) and Chevron (
CVX
), which collectively
command 45% of assets. Exxon and Chevron integrated oil majors, meaning they're involved in almost every
aspect of the business, from E&P to refining to transportation to distribution (think: gas stations). As
a result, they can benefit from higher oil prices ... but it's a complicated relationship.
Still, XLE typically does improve when oil and gas prices do, and it holds large, well-funded
companies that are better able to withstand price slumps than smaller energy firms. It also offers up a
generous 3.7% dividend yield that will help you withstand small disruptions in energy prices.
The iShares North American Natural Resources ETF (
IGE
, $30.17) provides
broad-based energy-sector exposure similar to the XLE, but with a number of twists.
The first has to do with the name. Whereas the XLE is a collection of U.S. companies within the S&P
500, the IGE's holdings are within all of North America. U.S. companies still dominate the fund, at 77%,
but the remaining assets are spread across numerous Canadian companies, including multinational Enbridge
(
ENB
).
IGE also invests more broadly, across 100 energy-sector companies. The fund is cap-weighted, so
Chevron and Exxon are still tops, but they make up far smaller percentages at the fund - roughly 10%
each, versus about 22% each in XLE.
Another difference is found in the name: "natural resources." In addition to heavy investment in
energy industries such as integrated oil and gas companies (26%), E&P (19%) and storage and
transportation (17%), IGE also owns gold mining (7%) and even construction materials (3%) companies,
among other non-energy firms. Thus, while IGE will move on changes in oil and gas prices, its movement
can be affected by other commodities, too.
* IGE's most recent distribution included a special one-time distribution from Occidental Petroleum (
OXY
) as part of its
acquisition of Anadarko Petroleum. This has skewed the dividend yield data at providers such as
Morningstar. While Morningstar lists a trailing 12-month yield of 5.6%, iShares' listed trailing 12-month
yield of 2.8%, as of Nov. 29, 2019, is much closer to what investors can expect. XLE's stated yield of
3.7% excludes a separate special payout it made closer to the end of the year related to its exposure to
Occidental.
The iShares Global Energy ETF (
IXC
,
$31.08) takes geographical diversification another step farther, and unlike IGE, it focuses completely on
energy.
A reminder here that "global" and "international" mean different things. If a fund says it's
international, chances are it holds no U.S. stocks. A global fund, however, can and will invest in
American stocks as well as international ones ... and often, the U.S. is the largest slice of the pie.
The IXC is no exception, holding a 52% slug of American companies. It also has another 12% of its
assets invested in Canadian companies. However, the U.K. (16%) and France (6%) are significant weights in
the fund, and it also allows investors to reach energy companies in Brazil, China and Australia, among a
few other countries. International top holdings include France's Total (
TOT
) and Dutch-British
oil giant Royal Dutch Shell (
RDS.A
).
Like other energy ETFs, IXC's holdings are primarily driven by oil and gas prices. But other factors
are at play, such as the fact that some of these companies have distribution businesses that are reliant
on strong gasoline demand, which can be affected by a country's economic strength. Investing across
several countries can help reduce such risks.
* Like IGE, IXC's most recent distribution was affected by a special one-time distribution from
Occidental Petroleum. While Morningstar lists a trailing 12-month yield of 7.0%, iShares' listed trailing
12-month yield of 4.0%, as of Nov. 29, 2019, is much closer to what investors can expect.
But what if you want to invest closer to the source? That is, what if rather than buying oil companies, you wanted to
invest in crude oil itself?
The United States Oil Fund (
USO
, $12.81) is one of a
few energy ETFs that let you do that ... but be warned that it's not as straightforward as it seems.
The USO is an "exchange-traded security designed to track the daily price movements of West Texas
Intermediate ("WTI") light, sweet crude oil" - what most refer to as "U.S. crude." However, unlike some
commodity funds, such as the iShares Gold Trust (
IAU
), that actually hold
the physical commodity, USO invests in crude oil futures, as well as other financial instruments to
generate its returns.
The problem? USO holds "front-month" futures, so every month it must sell any contracts that are about
to expire and replace them with futures expiring in the next month. This can result in cases where USO is
selling contracts for less than what it's buying up new ones from - or sometimes the opposite, buying for
less than what it's selling for.
In short, this means that sometimes USO will reliably track WTI, but sometimes it won't - it might go
lower when West Texas crude goes higher, and vice versa. The fund's expenses further throw off
performance.
USO clearly is far from perfect. But it remains a more direct play on oil than publicly traded
companies, and it generally will follow WTI's direction over time.
Price of oil does have problem that will play out over next 6-8 months. Without a trade war
and Brexit hanging over markets. There isn't a whole lot of reason to be holding government
bonds which yield next to nothing or less than nothing in some cases. Fed is buying bills so
Repo market won't implode into another 2008. Only problem is they need to be buying coupons
or treasuries also. They are buying some treasuries but it's not near enough to hold interest
rates down. Yields on debt are going to rise without something like a trade war holding them
down. That is a problem if your long oil.
Keep an eye on 10 year US treasuries. If they become just a little less liquid and yields
rise as i believe they will. These OPEC cuts aren't going to mean as much as some might
think.
An unprecedented frenzy of debt sales around the world is threatening to cool this year's
hot returns on corporate bonds.
Companies have sold a record $2.43 trillion so far this year across currencies, surpassing
previous full-year records. Investors rushed to snap up all this debt because they were
desperate for yield as central banks cut rates. That has pushed up valuations.
Now, some troubling signs for the direction of those valuations are converging. Recent
data suggest that the worst may be over for the global economy, which means many central
banks could have less reason next year to guide down borrowing costs. That will all make it
harder to top the double-digit returns that some investors scored on corporate bonds this
year.
---
Wealthy made some real money betting on our government bailouts, in Europe an the US. Now the
yields are gone, where to? China, the only rational central banker left means, park your
money in China.
What this means now is that things will only get more complicated for Beijing from here on
out. Chinese President Xi Jinping bet on letting the people of Hong Kong decide, and they
did. Only it was against him.
We'll return to the political situation in Hong Kong momentarily, but before we do,
another major development, this time on the business front.
On Tuesday, Alibaba executed a slam-dunk secondary offering in Hong Kong, raising $12.9
billion. That easily surpassed Uber's $8.1 billion IPO in May, making it the biggest public
offering of 2019. For those who were predicting the death of Hong Kong -- and they've been
doing that for decades, (and Kyle Bass and others are still at it) -- that again appears to
be premature.
---
Clueless reporting. Xi came out of this looking great. He has one country three systems, he
now has a sound central banking, investment is flowing in, not out. They are immune from
sanctions, and even the trade tariffs are expanding Chinese influence in Asia, Iran, Russia
and China can look forward to a new global banking system, absent the dollar. Belt and
suspenders is moving forward.
I like it, I have no priors, I can point this fact without contradiction. Go Xi.
What's behind the
ever-increasing need for emergency repos?
A couple of correspondents have an eye on
shadow banking.
Shadow Banking
The shadow banking system consists of lenders, brokers, and other credit intermediaries who
fall outside the realm of traditional regulated banking.
It is generally unregulated and not subject to the same kinds of risk, liquidity, and
capital restrictions as traditional banks are.
The shadow banking system played a major role in the expansion of housing credit in the run
up to the 2008 financial crisis, but has grown in size and largely escaped government oversight
since then.
Let's recap before reviewing excellent comments from a couple of valued sources.
The Fed keeps increasing the size and duration of "overnight" funding. It's now up $120 billion
a day, every day, extended for weeks. That is on top of new additions.
Three Fed Statements
Emergency repos were needed for "
end-of-quarter funding
".
Balance sheet expansion is "
not QE
". Rather, it's "
organic growth
".
This is
"not monetary policy
".
Three Mish Comments
Hmm. A quick check of my calendar says the quarter ended on September 30 and today is
October 23.
Hmm. Historically "organic" growth was about $2 to $3 billion.
Hmm. Somehow it takes an emergency (but let's no longer call it that), $120 billion "
at
least
" in repetitive "
overnight
" repos to control interest rates, but that does
not constitute "monetary policy"
I made this statement:
I claim these "non-emergency", "non-QE", "non-monetary policy"
operations suggest we may already be at the effective lower bound for the Fed's current balance
sheet holding
.
Shadow Banking Suggestion by David Collum
Pater Tenebrarum at the Acting Man blog pinged me with these comments on my article, emphasis
mine.
While there is too much collateral and not enough reserves to fund it,
we don't know
anything about the distribution [or quality] of this collateral
. It could well be that some
market participants do not have sufficient high quality collateral and were told to bugger off
when they tried to repo it in the private markets.
Such market participants would become unable to fund their leveraged positions in CLOs or
whatever else they hold.
Mind, I'm not saying that's the case, but the entire shadow banking system is opaque
and
we usually only find out what's what when someone keels over or is forced to report a huge loss.
Reader Comments
Axiom7: Euro banks are starving for dollar funding and if there is a hard Brexit both UK and
German banks are in big trouble. I wonder if this implies that the EU will crack in negotiations
knowing that a DB fail is too-big-to-bail?
Cheesie: How do you do repos with a negative interest rate?
Harry-Ireland: [sarcastically], Of course, it's not QE. How can it be, it's the greatest
economy ever and there's absolutely nobody over-leveraged and the system is as healthy as can
be!
Ian: Taking bad collateral to keep banks solvent is not QE.
In regards to point number four, I commented:
This is not
TARP
2009.
[The Fed is not swapping money for dodgy collateral] Someone or someones is caught in some sort of
borrow-short lend-long scheme and the Fed is giving them reserves for nothing in return. Where's
the collateral?
Pater Tenebrarum partially agrees.
Yes, this is not "TARP" - the Fed is not taking shoddy collateral, only treasury and agency
bonds are accepted. The primary dealers hold a huge inventory of treasuries that needs to be
funded every day in order to provide them with the cash needed for day-to-day operations - they
are one of the main sources of the "collateral surplus".
Guessing Game
We are all guessing here, so I am submitting possible ideas for discussion.
Rehypothecation
I am not convinced the Fed isn't bailing out a US major bank, foreign bank, or some other
financial institution by taking
rehypothecated
,
essentially non-existent, as collateral.
Rehypothecation is the practice by banks and brokers of using, for their own purposes, assets
that have been posted as collateral by their clients.
In a typical example of rehypothecation, securities that have been posted with a prime
brokerage as collateral by a hedge fund are used by the brokerage to back its own transactions
and trades.
Current Primary Dealers
Amherst Pierpont Securities LLC
Bank of Nova Scotia, New York Agency
BMO Capital Markets Corp.
BNP Paribas Securities Corp.
Barclays Capital Inc.
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc.
Credit Suisse AG, New York Branch
Daiwa Capital Markets America Inc.
Deutsche Bank Securities Inc.
Goldman Sachs & Co. LLC
HSBC Securities (USA) Inc.
Jefferies LLC
J.P. Morgan Securities LLC
Merrill Lynch, Pierce, Fenner & Smith Incorporated
It's important to note those are not "shadow banking" institutions, while also noting that
derivative messes within those banks would be considered "shadow banking".
Tenebrarum Reply
In this case the problem is specifically that the primary dealers are holding huge
inventories of treasuries and bank reserves are apparently not sufficient to both pre-fund the
daily liquidity requirements of banks and leave them with enough leeway to lend reserves to repo
market participants.
The Fed itself does not accept anything except treasuries and agency MBS in its repo
operations, and only organizations authorized to access the federal funds market can participate
by offering collateral in exchange for Fed liquidity (mainly the primary dealers, banks, money
market funds,...).
Since most of the repo lending is overnight - i.e., is reversed within a 24 hour period
(except for term repos) - I don't think re-hypothecated securities play a big role in this.
But private repo markets are broader and have far more participants, so possibly there is a
problem elsewhere that is propagating into the slice of the market the Fed is connected with.
Note though, since the Treasury is borrowing like crazy and is at the same time rebuilding its
deposits with the Fed (which lowers bank reserves, ceteris paribus), there is a several-pronged
push underway that is making short term funding of treasury collateral more difficult at the
moment.
So I'm not sure a case can really be made that there is anything going on beyond what meets
the eye - which is already bad enough if you ask me.
Preparation for End of LIBOR
What about all the LIBOR-based derivatives with the end of LIBOR coming up?
Libor is a scandal-plagued benchmark that is used to set the price of trillions of dollars of
loans and derivatives globally. A group of banks and regulators in 2017 settled on a replacement
created by the Federal Reserve known as the secured overnight financing rate, or SOFR. Companies
must move away from Libor by the end of 2021, when banks will no longer be required to publish
rates used to calculate it.
"We don't expect that 100% of the Libor-based positions today will migrate 100% to SOFR,"
Jeff Vitali, a partner at Ernst & Young, said this week during a panel at an Association for
Financial Professionals conference in Boston. "It is going to be a scenario where entities are
going to have to prepare and be flexible and build flexibility into their systems and models and
processes that can handle multiple pricing environments in the same jurisdiction."
Repro Quake
I invite readers to consider Tenebrarum's "
Repro
Quake - A Primer
" but caution that it is complicated.
He informs me "a credit analyst at the largest bank in my neck of the woods sent me a mail to
tell me this was by far the best article on the topic he has come across".
Note: That was supposed to be a private comment to me. I placed it in as an endorsement.
Tenebrarum live in Europe. Here are his conclusions.
What Else is the Fed Missing?
Contrary to similar spikes in repo rates in 2008, it was probably not fear of counterparty
risk that led to the recent repo quake. What's more, the Federal Reserve without a doubt knew
that something like this was coming. We say this because even we knew it – it was not a secret.
A number of analysts have warned of just such a situation for months.
It is astonishing that the Fed somehow seemed unprepared and quite surprised by the extent
of the liquidity shortage.
We would submit that this fact alone is a good reason for markets
to be concerned. If the Fed is not even able to properly gauge such a "technical problem" in
advance, what else is there it does not know?
Effective Lower Bound
Finally, Tenebrarum commented: "
I agree on your effective lower bound comment, since
obviously, the 'dearth' of excess reserves was pushing up all overnight rates, including the FF
rate
."
that some of this
money is leaking out to continue to prop up the stock market.
I've been trading for 46 years and current valuations are beyond
ridiculous. for example, Tesla made a buck a share in the last
quarter. woop di do. and the stock zooms to $300++ a share with a
market cap of $58 bil. 60% more than Ford???!!! We
know
that Porsche and BMW and Mercedes and Audi are going to build a
much better EV. another one, Cintas. They rent uniforms. what
a sexy business! valued at a p/e of 32 with a $28 bil. market
cap. Book value of
$29
a share. the stock is at
$270
!!!
the list goes on and on and on Carvana, etc.
personally, I have 5% bitcoin 5% gold and have a nice chunk in
a very high quality diversified commodity mutual fund.
Commodities (relative to stocks) are at multi decade lows. a
deep value trade. very best wishes to you. Argento
On occasion, it is important to revisit issues that have been
swept under the rug or simply overlooked. For most people, the
derivatives market falls into this category, partly because they
don't understand exactly what derivatives are or why this market
is so important.
Anyone paying attention knows that the size
of the derivatives market dwarfs the global economy. Paul Wilmott
who holds a doctorate in applied mathematics from Oxford
University has written several books on derivatives. Wilmott
estimates the derivatives market at $1.2 quadrillion, to put that
in perspective it is about 20 times the size of the world economy.
That is an OLD guess... today it is estimated that derivatives
exceeds $2 quadrillion, and that just commodity derivatives
approaches the old figure. Interest rate based derivatives
still dominate, my guess is much higher.
One of the key U.S. borrowing markets saw a massive surge Monday, a sign the Federal
Reserve is having trouble controlling short-term interest rates.
Amid the settlement of Treasury coupon auctions and the influx of quarterly corporate tax
payments, the rate on overnight repurchase agreements soared by 153 basis points to 3.80%,
the largest daily increase since December, based on ICAP pricing.
---------
The would be Treasury trying to tilt the curve, deposit short borrow long. Finance, in
general, is rescaling to accommodate the next 2 trillion in debt while rolling over trillions
of 'Uncle can do it later' debt. A quick downturn, readjustment, and the 'Uncle do it later'
payments to the wealthy will continue.
This is common, our progressive tribe has moles who suddenly rush off and do a deal with
the wealthy leaving the rest of us in the dark.
Repo Squeeze Threatens to Spill Over Into Funding Markets
By Stephen Spratt
September 17, 2019, 3:19 AM PDT Updated on September 17, 2019, 5:24 AM PDT
Cross-currency basis, FX forwards, eurodollar futures shift
Sale of $78 billion in Treasuries led to sudden cash squeeze
----------------
Treasury is ahead of finance in paying for the 'Uncle do it later' trick. The short rate
has jumped 10 basis points, not much but there was a reading on the overnight market of 7%.
This may mean nothing, but more likely means higher consumer credit charges. W have to pay
for 'Uncles later'.
Sep.04 -- Sean Carney, head of municipal strategy at BlackRock, discusses the municipal bond
market posting its best returns since 2014. He speaks with Bloomberg's Taylor Riggs in this
week's "Muni Moment" on "Bloomberg Markets."
Tariff Tantrums and Recession Risks
Why trade war scares the market so much
By Paul Krugman
If the bond market is any indication, Donald Trump's escalating belligerence on trade is
creating seriously increased risks of recession. But I haven't seen many clear explanations
of why that might be so. The problem isn't just, or even mainly, that he really does seem to
be a Tariff Man. What's more important is that he's a capricious, unpredictable Tariff Man.
And that capriciousness is really bad for business investment.
First things first: why do I emphasize the bond market, not the stock market? Not because
bond investors are cooler and more rational than stock investors, although that may be true.
No, the point is that expected economic growth has a much clearer effect on bonds than on
stocks.
Suppose the market becomes pessimistic about growth over the next year, or even beyond. In
that case, it will expect the Fed to respond by cutting short-term interest rates, and these
expectations will be reflected in falling long-term rates. That's why the inversion of the
yield curve -- the spread between long-term and short-term rates -- is so troubling. In the
past, this has always signaled an imminent recession:
[That scary yield curve]
And the market seems in effect to be predicting that it will happen again.
But what about stocks? Lower growth means lower profits, which is bad for stocks. But it
also, as we've just seen, means lower interest rates, which are good for stocks. In fact,
sometimes bad news is good news: a bad economic number causes stocks to rise, because
investors think it will induce the Fed to cut. So stock prices aren't a good indicator of
growth expectations.
O.K., preliminaries out of the way. Now let's talk about tariffs and recession.
You often see assertions that protectionism causes recessions -- Smoot-Hawley caused the
Great Depression, and all that. But this is far from clear, and often represents a category
error.
Yes, Econ 101 says that protectionism hurts the economy. But it does its damage via the
supply side, making the world economy less efficient. Recessions, however, are usually caused
by inadequate demand, and it's not at all clear that protectionism necessarily has a negative
effect on demand.
Put it this way: a global trade war would induce everyone to switch spending away from
imports toward domestically produced goods and services. This will reduce everyone's exports,
causing job losses in export sectors; but it will simultaneously increase spending on and
employment in import-competing industries. It's not at all obvious which way the net effect
would go.
To give a concrete example, think about the world economy in the 1950s, before the
creation of the Common Market and long before the creation of the World Trade Organization.
There was a lot more protectionism and vastly less international trade then than there would
be later (the containerization revolution was still decades in the future.) But Western
Europe and North America generally had more or less full employment.
So why do Trump's tariff tantrums seem to be having a pronounced negative effect on
near-term economic prospects? The answer, I'd submit, is that he isn't just raising tariffs,
he's doing so in an unpredictable fashion.
People are often sloppy when they talk about the adverse effects of economic uncertainty,
frequently using "uncertainty" to mean "an increased probability of something bad happening."
That's not really about uncertainty: it means that average expectations of what's going to
happen are worse, so it's a fall in the mean, not a rise in the variance.
But uncertainty properly understood can have serious adverse effects, especially on
investment.
Let me offer a hypothetical example. Suppose there are two companies, Cronycorp and
Globalshmobal, that would be affected in opposite ways if Trump imposes a new set of tariffs.
Cronycorp would like to sell stuff we're currently importing, and would build a new factory
to make that stuff if assured that it would be protected by high tariffs. Globalshmobal has
already been considering whether to build a new factory, but it relies heavily on imported
inputs, and wouldn't build that factory if those imports will face high tariffs.
Suppose Trump went ahead and did the deed, imposing high tariffs and making them
permanent. In that case Cronycorp would go ahead, while Globalshmobal would call off its
investment. The overall effect on spending would be more or less a wash.
On the other hand, suppose that Trump were to announce that we've reached a trade deal:
all tariffs on China are called off, permanently, in return for Beijing's purchase of 100
million memberships at Mar-a-Lago. In that case Cronycorp will cancel its investment plans,
but Globalshmobal will go ahead. Again, the overall effect on spending is a wash.
But now introduce a third possibility, in which nobody knows what Trump will do --
probably not even Trump himself, since it will depend on what he sees on Fox News on any
given night. In that case both Cronycorp and Globalshmobal will put their investments on
hold: Cronycorp because it's not sure that Trump will make good on his tariff threats,
Globalshmobal because it's not sure that he won't.
Technically speaking, both companies will see an option value to delaying their
investments until the situation is clearer. That option value is basically a cost to
investment, and the more unpredictable Trump's policy, the higher that cost. And that's why
trade tantrums are exerting a depressing effect on demand.
Furthermore, it's hard to see what can reduce this uncertainty. U.S. trade law gives the
president huge discretionary authority to impose tariffs; the law was never designed to deal
with a chief executive who has poor impulse control. A couple of years ago many analysts
expected Trump to be restrained by his advisers, but he's driven many of the cooler heads
out, many of those who remain are idiots, and in any case he's reportedly paying ever less
attention to other people's advice.
None of this guarantees a recession. The U.S. economy is huge, there are a lot of other
things going on besides trade policy, and other policy areas don't offer as much scope for
presidential capriciousness. But now you understand why Trump's tariff tantrums are having
such a negative effect.
I just assume the 10Y yield is reverting to trend – the trend downward it has had
since 1982. The counter trend move upward in 2018 assumed the fiscal spigots were going to be
turned on, that the deficit was no longer a dirty word and therefore inflation was no longer
a dirty word. It's just taken til now to capitulate that none of that's going to happen.
Seems the Federal Reserve was caught by surprise by this too. Otherwise I don't think they
would have raised their Fed Funds rate to where it is. Because now that the 10Y yield has
capitulated, it's actually lower than the Fed Funds rate, creating an inverted yield curve.
Which is unusual because normally an inverted yield curve is created on purpose by the
Federal Reserve – they raise their rate above the 10Y yield rather than wait for the
10Y yield to drop below their rate. Still, every good trader knows an inverted yield curve is
bad juju. So what's the Fed Reserve to do? Sit on its hands and let the inverted yield curve
work its magic and create a recession?
Seems to me that the Federal Reserve doesn't want the market to crash on Trump's watch. At
least not until after the 2020 election. So the Fed Reserve is signaling to the traders, "we
feel your pain", they'll lower their rate to bring it back below the 10Y yield. They just
need a pretext on why they're doing so, something that doesn't simply smack of the Fed
Reserve propping up the stock market. "It's the PMI, it's the employment report, it's trade,
it's one of those, yeah that's the ticket."
Anyways, even if the fiscal spigots get turned on, I don't see the 10Y yield reversing
trend until spiraling wage inflation is a thing again. I.e. when people aren't worried about
their exposure to inflating prices as long as their wages are increasing / tracking with
inflation. Making it safe for them to take on debt at increasing interest rates – i.e.
generating inflation. And I don't see that happening anytime soon unless there's some kind of
JG program.
Until then, the trend line of the 10Y yield is downwards. Giving the Federal Reserve less
and less room for their Fed Funds rate to operate in without inverting the yield curve. Seems
like that won't be able to continue at some point. Interesting years ahead.
The fourth-quarter stock market rout that wiped out $12 trillion in shareholder value and
sparked a bout of
Christmas Eve panic may have quickly been forgotten by most Americans, but not by the
salespeople and financial engineers of Wall Street.
No, the selloff, it would appear, wound up triggering fears that time was running out on the
longest bull market in history. And so, when early 2019 delivered a miraculous rebound, they
wasted no time in peddling all sorts of deals and arrangements that test the limits of risk
tolerance: from health-food makers fast-tracked into public hands to stretched retailers wrung
for billions by private equity owners in the debt market.
Junk bonds are flying out the door once again. Deeply indebted companies are borrowing even
more to pay
equity holders . And while you can't say the megadeal IPOs got rushed to market, two that
were held up as heralding a return to IPO glory days have been flops. It's quickly turning
Uber and Lyft into poster children for Wall Street eagerness amid an equity-market bounce
that has all but banished memories of the worst fourth quarter in a decade.
"At some point, people are going to get burned," said Marshall Front, the chief investment
officer at Front Barnett Associates and 56-year Wall Street veteran. "People want to take their
companies public because they don't know what the next years hold, and there are people who
think we're close to the end of the cycle. If you're an investment banker, what do you do? You
keep dancing until the music stops."
For more than a decade, income investors have been plagued by paucity wrapped in misery. The bellwether 10-year Treasury note has
doled out an average 2.6% interest since 2008. Although the Federal Reserve has nudged its target interest rate range to 2.25% to
2.50%, it has signaled that it's done raising rates for now. Even worse, the yield on the 10-year T-note briefly sank below the yield
on the three-month T-bill -- an unusual inversion that can sometimes herald a recession and lower yields ahead. The takeaway: Locking
your money up for longer periods is rarely worth the negligible increase in yield. What could increase your yield these days? Being
a little more adventurous when it comes to credit quality. When you're a bond investor, you're also a lender, and borrowers with
questionable credit must pay higher yields. Similarly, stocks with above-average yields probably have some skeletons in their balance
sheets.
You can ameliorate credit risk -- but not eliminate it -- through diversification. Invest in a mutual fund, say, rather than a
single issue. And invest in several different types of high-yielding investments -- for example, investment-grade bonds, preferred
stocks and real estate investment trusts -- rather than just one category. Despite such caveats, income investing is not as bad as
it was in 2015, when it was hard to milk even a penny's interest out of a money market. Now you can get 3.3% or more from no-risk
certificates of deposit at a bank. We'll show you 33 ways to find the best yields for the risk you're willing to take, ranging from
2% all the way up to 12%. Just remember that the higher the payout, the greater the potential for some rough waters.
Short-term interest rates largely follow the Fed's interest rate policy. Most observers in 2018 thought that would mean higher rates
in 2019. But slowing economic growth in the fourth quarter of 2018 and the near-death experience of the bull market in stocks changed
that. The Fed's rate-hiking
campaign is likely on hold for 2019. Still, money markets are good bets for money you can't stand to lose. Money market funds
are mutual funds that invest in very-short-term, interest-bearing securities. They pay out what they earn, less expenses. A bank
money market account's yield depends on the Fed's benchmark rate and the bank's need for deposits.
The risks: Money market mutual funds aren't insured, but they have a solid track record. The funds are designed to maintain a
$1 share value; only two have allowed their shares to slip below $1 since 1994. The biggest risk with a bank money market deposit
account is that your bank won't raise rates quickly when market interest rates rise but will be quick on the draw when rates fall.
MMDAs are insured up to $250,000 by the federal government. How to invest: The best MMDA yields are from online banks, which don't
have to pay to maintain brick-and-mortar branches. Currently, a top-yielding MMDA is from Investors eAccess , which is run by Investors
Bank in New Jersey. The account has no minimum, has an annual percentage yield of 2.5% and allows six withdrawals per month. You'll
get a bump from a short-term CD, provided you can keep your money locked up for a year. Merrick Bank , in Springfield, Mo., offers
a one-year CD yielding 2.9%, with a $25,000 minimum. The early-withdrawal penalty is 2% of the account balance or seven days' interest,
whichever is larger. The top five-year CD yield was recently 3.4%, from First National Bank of America in East Lansing, Mich.
Your primary concern in a money fund should be how much it charges in expenses. Vanguard
Prime Money Market Fund (symbol
VMMXX , yield 2.5%) charges an ultralow 0.16% a year and consistently sports above-average yields. Investors in high tax brackets
might consider a tax-free money fund, whose interest is free from federal (and some state) income taxes, such as Vanguard Municipal
Money Market Fund ( VMSXX 1.6%).
To someone paying the maximum 40.8% federal tax rate, which includes the 3.8% net investment income tax, the fund has the equivalent
of a 2.7% taxable yield. (To compute a muni's taxable-equivalent yield, subtract your tax bracket from 1, and divide the muni's yield
by that. In this case, divide 1.6% by 1 minus 40.8%, or 59.2%). The fund's expense ratio is 0.15%.
Muni bonds are IOUs issued by states, municipalities and counties. At first glance, muni yields look as exciting as a month in
traction. A 10-year, AAA-rated national muni yields 2.0%, on average, compared with 2.6% for a 10-year Treasury note. But the charm
of a muni bond isn't its yield; it's that the interest is free from federal taxes -- and, if the bond is issued by the state where
you live, from state and local taxes as well. As with tax-free money funds, investors should consider a muni fund's taxable equivalent
yield; in the case above, it would be 3.4% for someone paying the top 40.8% federal rate.
Yields get better as you go down in credit quality. An A-rated 10-year muni -- two notches down from AAA but still good -- yields
2.3%, on average, or 3.9% for someone paying the top rate. The risks: Munis are remarkably safe from a credit perspective, even considering
that defaults have inched up in recent years. But like all bonds, munis are subject to interest rate risk. If rates rise, your bond's
value will drop (and vice versa), because interest rates and bond prices typically move in opposite directions. If you own an individual
bond and hold it until it matures, you'll most likely get your full principal and interest. The value of muni funds, however, will
vary every day.
How to invest: Most investors should use a mutual fund or ETF, rather than pick their own individual bonds. Look for funds with
rock-bottom expenses, such as Vanguard Limited-Term Tax-Exempt (
VMLTX , 1.8%). The fund charges
just 0.17%, and yields the equivalent of 3% for someone paying the highest federal tax rate. It's a short-term fund, which means
it's less sensitive to interest rate swings. That means its share price would fall less than longer-term funds' prices if rates were
to rise. The average credit quality of the fund's holdings is a solid AA–. Fidelity Intermediate Municipal Income (
FLTMX , 2.0%), a member of
the
Kiplinger 25 , the list of our favorite no-load funds, gains a bit of yield (a taxable equivalent of 3.4% for those at the top
rate) by investing in slightly longer-term bonds. The fund's expense ratio is 0.37%; the largest percentage of assets, 39%, is in
AA bonds. Vanguard High-Yield Tax-Exempt Fund Investor Shares (
VWAHX , 2.9%) also charges
just 0.17% in fees and yields 4.9% on a taxable-equivalent basis for someone at the highest rate. The extra yield comes from investing
in a sampling of riskier bonds. But the fund's average BBB+ credit rating is still pretty good, and its return has beaten 96% of
high-yield muni funds over the past 15 years.
You get higher yields from corporate bonds than you do from government bonds because corporations are more likely to default. But
that risk is slim. The one-year average default rate for investment-grade bonds (those rated BBB– or higher), is just 0.09%, going
back to 1981, says Standard & Poor's. And corporate bonds rated AAA and maturing in 20 or more years recently yielded 3.7%, on average,
while 20-year Treasury bonds yielded 2.8% and 30-year T-bonds, 3.0%. You can earn even more with bonds from firms with lightly dinged
credit ratings. Bonds rated BBB yield an average 4.0%. The risks: The longer-term bond market moves independently of the Fed and
could nudge yields higher (and prices lower) if inflation worries pick up. Though corporate defaults are rare, they can be devastating.
Lehman Brothers, the brokerage firm whose bankruptcy helped fuel the Great Recession, once boasted an investment-grade credit rating.
How to invest: Active managers select the bonds at Dodge & Cox Income (
DODIX , 3.5%). This fund
has beaten 84% of its peers over the past 15 years, using a value-oriented approach. It holds relatively short-term bonds, giving
its portfolio a duration of 4.4 years, which means its share price would fall roughly 4.4% if interest rates rose by one percentage
point over 12 months. The fund's average credit quality is A, and it charges 0.42% in expenses. If you prefer to own a sampling of
the corporate bond market for a super-low fee, Vanguard Intermediate-Term Corporate Bond Index Fund Admiral Shares (
VICSX , 3.6%) is a good choice.
Vanguard recently lowered the minimum investment to $3,000, and the fund charges just 0.07%. Interest-rate risk is high with Vanguard
Long-Term Bond ETF ( BLV , $91,
3.8%). The exchange-traded fund has a duration of 15, which means fund shares would fall 15% if interest rates moved up by one percentage
point in a year's time. Still, the yield on this long-term bond offering is enticing, and the fund's expense ratio is just 0.07%.
SEE ALSO:
The 7 Best Bond Funds for Retirement Savers in 2019//www.dianomi.com/smartads.epl?id=4908
Dividend stocks have one advantage that bonds don't: They can, and often do, raise their payout. For example, Procter & Gamble (
PG , $106, 2.7%), a member of
the
Kiplinger Dividend 15 , the list of our favorite dividend-paying stocks, raised its dividend from $2.53 a share in 2014 to $2.84
in 2018, a 2.3% annualized increase. Preferred stocks, like bonds, pay a fixed dividend and typically offer higher yields than common
stocks. Banks and other financial services firms are the typical issuers, and, like most high-dividend investments, they are sensitive
to changes in interest rates. Yields for preferreds are in the 6% range, and a generous crop of new issues offers plenty of choices.
The risks: Dividend stocks are still stocks, and they will fall when the stock market does. Furthermore, Wall Street clobbers
companies that cut their dividend. General Electric slashed its dividend to a penny per share on December 7, 2018, and the stock
fell 4.7% that day. How to invest: Some slower-growing industries, such as utilities or telecommunications firms, tend to pay above-average
dividends. Verizon Communications (
VZ , $58, 4.2%), a Kip 15 dividend
stock, is the largest wireless carrier in the U.S. Its investment in Fios fiber-optic cable should pay off in coming years. SPDR
Portfolio S&P 500 High Dividend ETF (
SPYD , $39, 4.3%) tracks the
highest-yielding stocks in the S&P 500 index. The fund has 80 holdings and is sufficiently diversified to handle a clunker or two.
Utility PPL Corp. ( PPL , $31,
5.3%) derives more than 50% of its earnings from the United Kingdom. Worries that the U.K.'s departure from the European Union will
pressure PPL's earnings have weighed on the stock's price, boosting its yield. Nevertheless, PPL's U.S. operations provide strong
support for the company's generous payout. Ma Bell is a
Dividend Aristocrat , meaning that AT&T (
T , $32, 6.4%) has raised its dividend
for at least 25 consecutive years (35 straight years, in AT&T's case). The company has plenty of free cash flow to keep raising its
payout. SEE ALSO:
9 High-Yield Dividend Stocks That Deserve Your Attention//www.dianomi.com/smartads.epl?id=4908
You can invest in two types of REITs: those that invest in property and those that invest in mortgages. Both types must pass on at
least 90% of their revenue to investors, which is partly why they have such excellent yields. Typically, REITs that invest in income-producing
real estate have lower yields than those that invest in mortgages. The average property REIT yields 4.1%, compared with the average
mortgage REIT yield of 10.6%, according to the National Association of Real Estate Investment Trusts. Why the big difference? Property
REITs rack up expenses when they buy and sell income properties or lease them out as landlords. Mortgage REITs either buy mortgages
or originate them, using borrowed money or money raised through selling shares as their capital.
The risks: When the economy slows down, so does the real estate market, and most REITs will take a hit in a recession. Mortgage
REITs are exceptionally sensitive to interest rate increases, which squeeze their profit margins, and to recessions, which increase
the likelihood of loan defaults. REIT dividends are not qualified dividends for tax purposes and are taxed at your ordinary income
tax rate. How to invest: Realty Income Corp. (
O , $69, 4.0%) invests in property
and rents it to large, dependable corporations, such as Walgreens, 7-Eleven and Fed-Ex. It's a
Kiplinger 15 dividend stalwart and pays dividends monthly. Fidelity Real Estate Income (
FRIFX , 4.0%) isn't a REIT,
although it invests in them (among other things). The fund puts income first. It has 43% of its assets in bonds, most of them issued
by REITs. The fund lost 0.6% in 2018, compared with a 6% loss for other real estate funds. Investors will forgive a lot in exchange
for a high yield. In the case of iShares Mortgage Real Estate Capped ETF (
REM , $44, 8.2%), they're choosing
to accept a high degree of concentration: The top four holdings account for 44% of the ETF's portfolio. Although concentration can
increase risk, in this instance the fund's huge position in mortgage REITs has helped returns. Falling interest rates late in 2018
pushed up mortgage REITs, limiting the fund's losses to just 3% in 2018. Annaly Capital Management (
NLY , $10, 12%) is a REIT that
borrows cheaply to buy government-guaranteed mortgage securities. Most of those holdings are rated AA+ or better. Annaly boosts its
yield by investing in and originating commercial real estate loans and by making loans to private equity firms. Its 2018 purchase
of MTGE Investment, a mortgage REIT that specializes in skilled nursing and senior living facilities, will help diversify the firm's
portfolio. Annaly is the largest holding of iShares Mortgage Real Estate Capped ETF.
If you think interest rates are low in the U.S., note that most developed foreign countries have even lower rates because their economies
are growing slowly and inflation is low. The U.K.'s 10-year bond pays just 1.2%; Germany's 10-year bond yields 0.1%; Japan's yields
–0.03%. There's no reason to accept those yields for a day, much less a decade. You can, by contrast, find decent yields in some
emerging countries. Emerging-markets bonds typically yield roughly four to five percentage points more than comparable U.S. Treasury
bonds, which would put yields on some 10-year EM debt at about 7%, says Pramol Dhawan, emerging-markets portfolio manager at bond
fund giant Pimco.
The risks: You need a healthy tolerance for risk to invest in emerging-markets bonds. U.S. investors tend to be leery of them
because they remember massive defaults and currency devaluations, such as those that occurred in Asia in the late 1990s. But in the
wake of such debacles, many emerging countries have learned to manage their debt and their currencies better than in the past. But
currency is still a key consideration. When the U.S. dollar rises in value, overseas gains translate into fewer greenbacks. When
the dollar falls, however, you'll get a boost in your return. A higher dollar can also put pressure on foreign debt denominated in
dollars -- because as the dollar rises, so do interest payments. How to invest: Dodge & Cox Global Bond (
DODLX , 4.5%) can invest anywhere,
but lately it has favored U.S. bonds, which were recently 48% of the portfolio. The fund's major international holdings show that
it isn't afraid to invest in dicey areas -- it has 11% of its assets in Mexican bonds and 7% in United Kingdom bonds. Fidelity New
Markets Income ( FNMIX , 5.6%),
a
Kip 25 fund, has been run by John Carlson since 1995. That makes him one of the few emerging-markets debt managers who ran a
portfolio during the currency-triggered meltdown in 1997-98. He prefers debt denominated in dollars, which accounts for 94% of the
portfolio. But he can be adventurous: About 6.5% of the fund's assets are in Turkey, which is currently struggling with a 19% inflation
rate and a 14.7% unemployment rate. IShares Emerging Markets High Yield Bond ETF (
EMHY , $46, 6.2%) tracks emerging-markets
corporate and government bonds with above-average yields. The holdings are denominated in dollars, so there's less currency risk.
But this is not a low-risk holding. It's more than twice as volatile as the U.S. bond market, although still only half as volatile
as emerging-markets stocks. SEE ALSO:
39
European Dividend Aristocrats for International Income Growth
Junk bonds -- or high-yield bonds, in Wall Street parlance -- aren't trash to income investors. Such bonds, which are rated BB+ or
below, yield, on average, about 4.7 percentage points more than the 10-year T-note, says John Lonski, managing director for Moody's
Capital Markets Research Group. What makes a junk bond junky? Typical high-yield bond issuers are companies that have fallen on hard
times, or newer companies with problematic balance sheets. In good times, these companies can often make their payments in full and
on time and can even see their credit ratings improve. The risks: You're taking an above-average risk that your bond's issuer will
default. The median annual default rate for junk bonds since 1984 is 3.8%, according to Lonksi. In a recession, you could take a
big hit. In 2008, the average junk bond fund fell 26%, even with reinvested interest.
How to invest: RiverPark Strategic Income (
RSIVX , 4.8%) is a mix of cash
and short-term high-yield and investment-grade bonds. Managers choose bonds with a very low duration, to cut interest rate risk,
and a relatively low chance of default. Vanguard High-Yield Corporate (
VWEHX , 5.5%), a
Kip 25 fund, charges just 0.23% in expenses and invests mainly in the just-below-investment-grade arena, in issues from companies
such as Sprint and Univision Communications. SPDR Bloomberg Barclays High Yield Bond ETF (
JNK , $36, 5.8%) charges 0.40%
in expenses and tracks the Barclays High Yield Very Liquid index -- meaning that it invests only in easily traded bonds. That's a
comfort in a down market because when the junk market turns down, buyers tend to dry up. The fund may lag its peers in a hot market,
however, as some of the highest-yielding issues can also be the least liquid. Investors who are bullish on the economy might consider
Northern High Yield Fixed Income Fund (
NHFIX , 7.0%). The fund owns
a significant slice of the junkier corner of the bond market, with about 23% of its holdings rated below B by Standard & Poor's.
These bonds are especially vulnerable to economic downturns but compensate investors willing to take that risk with a generous yield.
You might be surprised to learn how much income you can generate from moving hydrocarbons from one place to another. Most MLPs are
spin-offs from energy firms and typically operate gas or oil pipelines. MLPs pay out most of their income to investors and don't
pay corporate income taxes on that income. Those who buy individual MLPs will receive a K-1 tax form, which spells out the income,
losses, deductions and credits that the business earned and your share of each. Most MLP ETFs and mutual funds don't have to issue
a K-1; you'll get a 1099 form reporting the income you received from the fund.
The risks: In theory, energy MLPs should be somewhat immune to changes in oil prices; they collect fees on the amount they move,
no matter what the price. In practice, when oil gets clobbered, so do MLPs -- as investors learned in 2015, when the price of West
Texas intermediate crude fell from $53 a barrel to a low of $35 and MLPs slid an average 35%. Oil prices should be relatively stable
this year, and high production levels should mean a good year for pipeline firms. How to invest: Magellan Midstream Partners (
MMP , $62, 6.5%) has a 9,700-mile
pipeline system for refined products, such as gasoline, and 2,200 miles of oil pipelines. The MLP has a solid history of raising
its payout (called a distribution) and expects a 5% annual increase in 2019. The giant of MLP ETFs, Alerian MLP ETF (
AMLP , $10, 7.2%), boasts $9
billion in assets and delivers a high yield with reasonable expenses of 0.85% a year. Structured as a C corporation, the fund must
pay taxes on its income and gains. That can be a drag on yields compared with MLPs that operate under the traditional partnership
structure. EQM Midstream Partners (
EQM , $46, 10.1%) is active in
the Appalachian Basin and has about 950 miles of interstate pipelines. The firm paid $4.40 in distributions per unit last year and
expects to boost that to $4.58 in 2019.
Closed-end funds (CEFs) are the forebears of mutual funds and ETFs. A closed-end fund raises money through an initial stock offering
and invests that money in stocks, bonds and other types of securities, says John Cole Scott, chief investment officer, Closed-End
Fund Advisors. The fund's share price depends on investors' opinion of how its picks will fare. Typically, the fund's share price
is less than the current, per-share value of its holdings -- meaning that the fund trades at a discount. In the best outcome, investors
will drive the price up to or beyond the market value of the fund's holdings. In the worst case, the fund's discount will steepen.
The risks: Many closed-end income funds borrow to invest, which can amplify their yields but increase their price sensitivity
to changes in interest rates. Most CEFs have higher expense ratios than mutual funds or ETFs, too.
How to invest: Ares Dynamic Credit Allocation Fund (
ARDC , $15, 8.5%) invests in
a mix of senior bank loans and corporate bonds, almost all of which are rated below investment grade. Borrowed money as a percentage
of assets -- an important indicator for closed-end funds known as the leverage ratio -- is 29.6%, which is a tad lower than the average
of 33% for closed-end funds overall. The fund's discount to the value of its holdings has been narrowing of late but still stands
at 12.1%, compared with 11.2%, on average, for the past three years.
Advent Claymore Convertible Securities and Income Fund (
AVK , $15, 9.4%), run by Guggenheim
Investments, specializes in convertible bonds, which can be exchanged for common stock under some conditions. The fund also holds
some high-yield bonds. Currently, it's goosing returns with 40% leverage, which means there's above-average risk if rates rise. For
intrepid investors, the fund is a bargain, selling at a discount of 10.6%, about average for the past three years.
Clearbridge Energy Midstream Opportunity (
EMO , $9, 9.7%) invests in energy
master limited partnerships. It sells at a 12.1% discount, compared with a 6.6% average discount for the past three years. Its leverage
ratio is 33% -- about average for similar closed-end funds.
The global bond market's soaring performance has left investors queasy about the ride
ahead.
The Bloomberg Barclays Global Aggregate index has earned 2.3 percent through March 28, its
best quarter since mid-2017. But with yields sinking across major sovereign markets, investors
now face a dilemma. Buying government bonds at these levels is perilous because economic data
may improve, while taking more risk could leave investors nastily exposed to a global
downturn.
"... In the ongoing desire on their part to be transparent they have, until Wed., projected their expectations for increases to short-term rates over the next two years to be 4 increases this year and 4 next year. ..."
"... As of Wednesday, that's all gone. The new dot chart says zero increases this year and at most 1 next year. The 10-year treasury immediately cratered its yield to 2.5something percent. ..."
Re shale financing . . . Folks should go and read financial articles from Wednesday afternoon
of this week.
The Fed basically took a sledgehammer to their dot charts. In the ongoing desire on their
part to be transparent they have, until Wed., projected their expectations for increases to
short-term rates over the next two years to be 4 increases this year and 4 next year.
As of Wednesday, that's all gone. The new dot chart says zero increases this year and at
most 1 next year. The 10-year treasury immediately cratered its yield to 2.5something
percent. Still falling. Overseas we see Germany tracking, and Japan, and more and more
maturities on their yield curves return to negative. Not just real negative. Outright nominal
negative.
This is something that Financial media does not talk about. Negative nominal interest
rates from major country government bonds. How could they talk about it? It is utterly
obvious that this specific reality demonstrates that the entirety of all analyses has no
meaning. Their only defense is silence. Shale would prefer that it stay that way.
The Fed also announced an end to balance sheet normalization, which is euphemism for
trying to get rid of all of those bonds and MBS that were purchased as part of QE. They are
ending their purchases late this year. They dare not continue the move towards normal. I
believe that leaves their balance sheet still holding in excess of 3 trillion. That's not
normalization, sports fans. And it has been TEN YEARS.They havent been able to get to
"normal" in ten years, and as of Wed, they will stop trying.
The Treasury notes are the underlying basis for what shale companies have to pay to borrow
money. Thoughts by folks here that the monetary gravy train will shut off shale drilling need
rethinking. Bernanke changed everything. Forever.
These Fed actions are indistinguishable from whimsy. Imagining that Powell is Peak Oil
cognizant and is focused on shale is a tad extreme, but only a tad.
I recall a Bernanke quote during the crisis that made clear he knew what Peak would mean
-- at any price.
"Bond markets globally, along with dovish central banks, have been telling us a slowdown is
on the way," said Jeffrey Halley, senior market analyst at Oanda Corp. in Singapore. "Some
parts of the world will be better equipped than others to handle this. The U.S. can at least
cut rates and apply monetary tools, while things could be worse for Europe and Japan, where
they cannot."
It does feel like in 2017. But that does not means much as economy changed substantially and probably nor in the right
direction... Purchasing power of population probably was eroded despite growth of absolute numbers of customers because of
decimation of well paying jobs. Also the market now is dominated by HFT which serves as an amplifier of pre-existing
trend and can by itself course a crash or mini crash. Another factor is oil prices.
But the idea of disconnect if a very useful idea and many other analysts predicted negative year for S&P500. I see dot-com
bubble No.2 here, not so much subprime mortgages problem of 2008. Subprime exists now in junk bond produced by shale oil players,
but it is much less in size.
He said
the stock market, for now,
"likes the fact that they (the Fed) aren't going to give them any problems."
But things could change quickly and dramatically, he said, with his final comment, the most
ominous:
"It feels eerily like '07,"
he said.
"
The stock market is near its high and the economy is noticeably weaker
- and yet everyone is saying 'Everything is Great!
'"
And just in case you wondered how bad the underlying is - despite equity market's enthusiasm -
Citi's Economic Data Change index as its worst level since 2009...
Today at 4:15pm EDT, DoubleLine founder Jeff Gundlach is holding his latest live webcast
open to investors and casual listeners, titled enticingly 'Highway to Hell', and which we
assume will discuss either Brexit, the US-China trade deal, the long-term US debt picture or
how this, latest asset bubble finally ends.
Readers can register and follow it live at
this address
,
or clicking on the image below
As usual, we will grab and highlight the most interesting charts from Gundlach's
presentation as they come in.
* * *
Gundlach, as usual, starts with one of his favorite charts, the one showing the global
central bank balance sheet level juxtaposed to the global market, as the background for the
Fed's "180 degree turn" in the stock market's recent rebound, which is understandable since the
"S&P was and is in a bear market."
... ... ...
If that wasn't bad enough, Gundlach also said that
stocks will take out the December low
during the course of 2019 and markets will roll over earlier than they did last year.
Shifting from the market to the economy, Gundlach shows that global economic momentum is getting
worse across the globe...
Gundlach then highlights the sudden collapse in global trade, which would suggest the world is in
a global recession.
And yet at the same time, US economic data, at least in the labor market,
has never been stronger as Gundlach shows:
Of course, another big red flag is the collapse in December retail sales, and despite the sharp rebound in the January print
as we saw yesterday, Gundlach highlights the sharp drop in the 6 month average and highlights it as another potential
recessionary risk factor.
Going back to one of his favorite topics, the relentless growth of US debt, Gundlach shows the following chart of debt by
sector. Needless to say, it is troubling, and as Gundlach said.
And tied to that, the following new warning on the US interest expense: "The US interest expense is projected by the CBO to
explode higher starting yesterday"
Gundlach then went on a rant against MMT, calling it a "crackpot" theory, which is based on a "completely fallacious
argument", and adds that "People who have PhDs in economics actually are buying the complete nonsense of MMT which is used to
justify a massive socialist program."
Gundlach also discusses the US trade deficit, which recently soared, saying that "the trade deficit is not shrinking but
expanding," and the goods deficit is at "an all-time record", which according to Gundlach may hurt Trump's re-election chances.
Having predicted president Trump early, when everyone else was still mocking him, Gundlach admits that he is "not really sure
what's going to happen,'' when it comes to the next election. "If you ran on promising a lesser trade deficit'' and elimination
of national debt, and both have "exploded" higher, Gundlach thinks it's hard to say that you're winning.
And speaking of the next president, Gundlach suggests that if the economy falls into recession and Trump gets thrown out, we
might get the chance to see how MMT, i.e. helicopter money, really works with the next, socialist, president.
Perhaps this is also why to Gundlach "the next big move for the dollar is lower."
Looking ahead, Gundlach also touches on the future of monetary policy, and once again highlights the discrepancy between the
bond market, which expects half a rate cut, and the Fed's dot plot which expects three hikes in 2019-2020.
What happens? To Gundlach, "Fed expectations are likely to show capitulation to the Fed this time...the bond market is having
none of the Fed's two dots that they revealed in December." He then adds that the Fed "will absolutely drop the 2019 dot,"
suggesting it may be dropped to 1/2 a hike.
Optimism that a new trade deal will occur between America and
China has driven stock markets higher even as data continues to
emerge confirming economies across the world continue to slow. It
seems much of the current market fervor is based on optimism and
hope falls into the category of "irrational exuberance" a term
that Allen Greenspan has in the past used to describe unbridled
enthusiasm. More on the realities being ignored in the following
article.
Hmm....Kinda strange call there Jeffy Jeff on those higher
interest rates.
Especially considering just today where the 1yr
yield is higher than...get this, the 2yr, the 3yr, the 5yr
aaaaand the 7year bond. Kinda strange setup for rates exploding
higher isn't it? Or if you like to think of it as a belly that
sumbuck is getting one BIG pot gut.
Politicians are imbeciles and have no remedies. The US is the
least ugly pig of the bunch. The EU needs major structural tax
and regulatory reform; open borders with a pervasive social
welfare state has proven a recipe for disaster. The US is in
similar circumstances, but its tax and regulatory environment are
at least rational. It requires massive entitlement and spending
reforms with some minor tax hikes on the top end marginal income
and capital gains brackets.
Today at 4:15pm EDT, DoubleLine founder Jeff Gundlach is holding his latest live webcast
open to investors and casual listeners, titled enticingly 'Highway to Hell', and which we
assume will discuss either Brexit, the US-China trade deal, the long-term US debt picture or
how this, latest asset bubble finally ends.
Readers can register and follow it live at this address ,
or clicking on the image below
As usual, we will grab and highlight the most interesting charts from Gundlach's
presentation as they come in.
* * *
Gundlach, as usual, starts with one of his favorite charts, the one showing the global
central bank balance sheet level juxtaposed to the global market, as the background for the
Fed's "180 degree turn" in the stock market's recent rebound, which is understandable since the
"S&P was and is in a bear market."
"At this point in the cycle, a pickup in inflation will generally lead to corporate margin
compression, which is potentially more supportive of maintaining a long duration stance,"
Bartolini, lead portfolio manager for U.S. core bond strategies, said after the jobs figures.
He sees annual CPI remaining around this report's consensus of 1.6 percent -- the slowest since
2016 -- for a while.
Benchmark 10-year yields enter the week at 2.63 percent, close to the lowest level in two
months. In the interest-rate options market, traders have been ramping up positions that target
lower yields in five- and 10-year notes.
DougDoug,
The Fed is pretty much DONE with rate hikes, as paying the INTEREST on, 22 Trillion in
Debt will get,.. UGLIER and UGLIER ! Especially with, all the new,.. Tax and SPEND Demo'Rat
Liberals, coming into, Congress ! "We the People", will be,.. TOAST !!
I'm HOLDING, my "Floating Rate" senior secured, Bond CEF's and my Utility and Tech, CEF's,
too ! Drawing NICE Dividends,.. Monthly !
The World is NOT ending for, the USA,.. THANKS,.. to Trump !
"... The one tailwind on the flip-side of Venezuela is for crude oil. U.S. sanctions mean Venezuelan crude will not be flowing to the U.S. This is good news for crude oil. U.S. West Texas Intermediate (WTI) is sitting nicely at $53.44. This is helpful for U.S. petroleum companies ..."
"... Meanwhile, our overall up, down and midstream synthetic holding in the Energy Select SPDR ETF (XLE) has the benefit of exposing us to the profitability of the midstream pipelines and the refiners as well as the producers. I continue to see value across this industry, which is capitalizing on the improvement in natural gas particularly in the liquified natural gas (LNG) market. ..."
Famed investor Louis Navellier is our resident growth investing expert. Here's what he wrote
to subscribers in his February issue of Growth Investor :
... ... ...
Beyond the larger macro issues Louis and Neil point out, U.S. oil prices are currently
benefitting from the U.S. imposed sanctions on Petróleos de Venezuela SA that came last
Monday. Petróleos is Venezuela's state-owned oil giant. On this news, Neil writes:
The one tailwind on the flip-side of Venezuela is for crude oil. U.S. sanctions mean
Venezuelan crude will not be flowing to the U.S. This is good news for crude oil. U.S. West
Texas Intermediate (WTI) is sitting nicely at $53.44. This is helpful for U.S. petroleum
companies
One of Neil's suggested ways to play energy is XLE - the SPDR Energy Select Sector ETF. It's
one of the largest and most liquid energy ETFs in the world. Back to Neil:
Meanwhile, our overall up, down and midstream synthetic holding in the Energy Select
SPDR ETF (XLE) has the benefit of exposing us to the profitability of the midstream pipelines
and the refiners as well as the producers. I continue to see value across this industry, which
is capitalizing on the improvement in natural gas particularly in the liquified natural gas
(LNG) market.
In the chart below, you can see XLE rallying off its December lows, trading sideways for the
second half of January, then beginning to push higher over the last week (notice it breaking
through its 50-day moving average last week - the blue line).
NEW YORK, Jan 17 (Reuters) - U.S. fund investors charged into high-yield "junk" bonds during
the latest week, pouring in $3.3 billion, the most cash flowing into that market since late
2016, Lipper said on Thursday, boosted by soothing words by Federal Reserve Chairman Jerome
Powell.
Underscoring investors' appetite for some risk-taking, investors pulled $15 billion net cash
from U.S.-based money market funds, according to the Refinitiv research service. For their
part, U.S.-based equity mutual funds - which exclude exchange-traded funds - posted inflows of
$4.8 billion, Lipper data showed.
Does William Cohan's New York Times Tirade Against Low Interest Rates Make Any Sense?
By Dean Baker
It doesn't as far as I can tell. Cohan has been on a rant * for years about how high risk
corporate bonds are going to default in large numbers and then ... something. It's not clear
why most of us should care if some greedy investors get burned as a result of not properly
evaluating the risk of corporate bonds. No, there is not a plausible story of a chain of
defaults leading to a collapse of the financial system.
But even the basic proposition is largely incoherent. Cohan is upset that the Federal
Reserve has maintained relatively low, by historical standards,interest rates through the
recovery. He seems to want the Fed to raise interest rates. But then he tells readers:
"After the fifth straight quarterly rate increase, Mr. Trump, worried that the hikes might
slow growth or even tip the economy into recession, complained that Mr. Powell would 'turn me
into Hoover.' On January 3, the president of the Federal Reserve Bank of Dallas said the Fed
should assess the economic outlook before raising short-term interest rates again, a signal
that the Fed has hit pause on the rate hikes. Even Mr. Powell has signaled he may be turning
more cautious."
It's not clear whether Cohan is disagreeing with the assessment of the impact of higher
interest rates, not only by Donald Trump, but also the president of the Dallas Fed, Jerome
Powell, and dozens of other economists.
Higher interest rates will slow growth and keep people from getting jobs. The people who
would be excluded from jobs are disproportionately African American, Hispanic, and other
disadvantaged groups in the labor market. Higher unemployment will also reduce the bargaining
power of tens of millions of workers who are currently in a situation to secure real wage
increases for the first time since the recession in 2001.
If Cohan had some story of how bad things would happen to the economy if the Fed doesn't
raise rates then perhaps it would be worth the harm done by raising rates, but investors
losing money on corporate bonds doesn't fit the bill.
"Goldman cuts 10-year Treasury yield target for 2019 to 3%"
By Sunny Oh...Jan 8, 2019...10:45 a.m. ET
"Goldman Sachs has rolled back its call for much higher rates in U.S. government bonds in
the U.S., though it still expects a gradual climb from the current muted levels in the
Treasury market.
In a Tuesday note, Goldman Sachs said they expect the 10-year yield TMUBMUSD10Y, +0.06% to
hit 3% by year-end, a 50 basis point cut from their forecast of 3.5%. Since last week, the
benchmark bond yield has steadily risen to 2.710% Tuesday, after hitting an 11-month low of
2.553% last Thursday, according to Tradeweb data.
"... However, despite the signs, Goldman Sachs assumes the indicators are wrong and that "recession risk remains fairly low, in the neighborhood of 15% over the next year." The bank has predicted that the S&P 500 will finish 2019 at 3,000, up from the current value just below 2,600. ..."
Confidence in continued economic growth has been waning. A huge majority of chief financial officers
around the world say a recession will happen by the end of 2020. Most voters think one will hit by the end
of this year.
Now the Goldman
Sachs economic research team says that the
market shows a roughly 50% chance of a recession over the next year, according to
Axios.
Goldman Sachs looked at two different measures: the yield curve slope and credit spreads.
The former refers to a graph of government bond interest rates versus the years attaining
maturity requires. In a growing economy, interest rates are higher the longer the investment
because investors have confidence in the future. A frequent sign of a recession is the
inversion of the slope, when investors are uncertain about the future, so are less willing to
bet on it.
Credit spreads compare the interest paid by government bonds, which are considered the
safest. Corporate bonds, which are riskier, of the same maturity have to offer higher interest
rates. As a recession approaches, credit spreads tend to expand, as investors are more worried
about companies defaulting on their debt.
However, despite the signs, Goldman Sachs assumes the indicators are wrong and that
"recession risk remains fairly low, in the neighborhood of 15% over the next year." The bank
has predicted that the S&P 500 will finish 2019 at 3,000, up from the current value just
below 2,600.
(Bloomberg) -- Jeffrey Gundlach said yet again that the U.S. economy is gorging on debt.
Echoing many of the themes from his annual "Just Markets" webcast on Tuesday, Gundlach took
part in a round-table of 10 of Wall Street's smartest investors for Barron's. He highlighted
the dangers especially posed by the U.S. corporate bond market.
Prolific sales of junk bonds and significant growth in investment grade corporate debt,
coupled with the Federal Reserve weaning the market off quantitative easing, have resulted in
what the DoubleLine Capital LP boss called "an ocean of debt."
The investment manager countered President Donald Trump's claim that he's presiding over the
strongest economy ever. The growth is debt-based, he said.
Gundlach's forecast for real GDP expansion this year is just 0.5 percent. Citing numbers
spinning out of the USDebtClock.org website, he pointed out that the U.S.'s unfunded
liabilities are $122 trillion -- or six times GDP.
"I'm not looking for a terrible economy, but an artificially strong one, due to stimulus
spending," Gundlach told the panel. "We have floated incremental debt when we should be doing
the opposite if the economy is so strong."
Stock Bear
Gundlach is coming off another year in which his Total Return Bond Fund outperformed its
fixed-income peers. It returned 1.8 percent in 2018, the best performance among the 10 largest
actively managed U.S. bond funds, according to data compiled by Bloomberg.
Gundlach expects further declines in the U.S. stock market, which recently have steadied
after reeling for most of December since the Great Depression. Equities will be weak early in
the year and strengthen later in 2019, effectively a reversal of what happened last year, he
said.
"So now we are in a bear market, which isn't defined by me as stocks being down 20 percent.
A bear market is determined by the way stocks are acting," he said.
Rupal Bhansali, chief investment officer of International & Global Equities at Ariel
Investments, picked up on Gundlach's debt theme in the Barron's cover story. Citing General
Electric's woes, she urged investors to focus more on balance-sheet risk rather than whether a
company could beat or miss earnings. Companies with net cash are worth looking at, she
said.
"... In what is still a low-interest-rate environment globally, the perpetual search for yield has found a comparatively new and attractive source in the guise of collateralized loan obligations (CLOs) within the USEM world. According to the Securities Industry and Financial Markets Association, new issues of "conventional" high-yield corporate bonds peaked in 2017 ..."
"... These CLOs share many similarities with the mortgage-backed securities that set the stage for the subprime crisis a decade ago. During that boom, banks bundled together loans and shed risk from their balance sheets. Over time, this fueled a surge in low-quality lending, as banks did not have to live with the consequences. ..."
"... A world economy geared toward increasing the supply of financial assets has hooked us into a global game of waiting for the next bubble to emerge somewhere. ..."
A decade after the subprime bubble burst, a new one seems to be taking its
place in the market for corporate collateralized loan obligations. A world economy geared toward increasing the supply of financial
assets has hooked market participants and policymakers alike into a global game of Whac-A-Mole.
A recurrent topic in the financial press for much of 2018 has been the rising
risks in the emerging market (EM) asset class. Emerging economies are, of course, a very diverse group. But the yields on their
sovereign bonds have climbed markedly, as capital inflows to these markets have dwindled amid a general perception of
deteriorating conditions
.
1
Historically, there has been a tight positive relationship between
high-yield US corporate debt instruments and high-yield EM sovereigns. In effect, high-yield US corporate debt is the
emerging market that exists within the US economy (let's call it USEM debt). In the course of this year, however, their
paths have diverged (see Figure 1). Notably, US corporate yields have failed to rise in tandem with their EM counterparts.
What's driving this divergence? Are financial markets overestimating the
risks in EM fixed income (EM yields are "too high")? Or are they underestimating risks in lower-grade US corporates (USEM
yields are too low)?
Taking together the current trends and cycles in global factors (US
interest rates, the US dollar's strength, and world commodity prices) plus a variety of adverse country-specific economic
and political developments that have recently plagued some of the larger EMs, I am inclined to the second interpretation.
In what is still a low-interest-rate environment globally, the perpetual search for yield has found a comparatively new
and attractive source in the guise of collateralized loan obligations (CLOs) within the USEM world. According to the
Securities Industry and Financial Markets Association, new issues of "conventional" high-yield corporate bonds peaked in
2017
and are off significantly this year (about 35% through November). New issuance activity has shifted to the CLO
market, where the amounts outstanding have soared, hitting new peaks almost daily. The
S&P/LSTA US
Leveraged Loan 100 Index
shows an increase of about 70% in early December from its 2012 lows (see Figure 2), with
issuance hitting record highs in 2018. In the language of emerging markets, the USEM is attracting large capital inflows.
These CLOs share many similarities with the mortgage-backed
securities that set the stage for the subprime crisis a decade ago. During that boom, banks bundled together loans and shed
risk from their balance sheets. Over time, this fueled a surge in low-quality lending, as banks did not have to live with
the consequences.
Likewise, for those procuring corporate borrowers and bundling corporate
CLOs, volume is its own reward, even if this means lowering standards for borrowers' creditworthiness. The share of
"Weakest Links"
– corporates rated B-
or lower (with a negative outlook) – in overall activity has risen markedly since 2013-2015. Furthermore, not only are the
newer issues coming from a lower-quality borrower, the covenants on these instruments – provisions designed to ensure
compliance with their terms and thus minimize default risk – have also become lax.
Covenant-lite
issues are on the rise and
now account for about 80% of the outstanding volume.
As was the case during the heyday of mortgage-backed securities, there
is great investor demand for this debt, reminiscent of the "capital inflow problem" or the "
bonanza
"
phase of the capital flow cycle. A recurring pattern across time and place is that the seeds of financial crises are sown
during good times (when bad loans are made). These are good times, as the US economy is at or near full employment.
The record shows that capital-inflow surges often end badly. Any number
of factors can shift the cycle from boom to bust. In the case of corporates, the odds of default rise with mounting debt
levels, erosion in the value of collateral (for example, oil prices in the case of the US shale industry), and falling
equity prices. All three sources of default risk are now salient, and, lacking credible guarantees, the CLO market (like
many others) is vulnerable to runs, because the main players are lightly regulated shadow banking institutions.
And then there are the old and well-known concerns about shadow banking
in general, which stress both its growing importance and the opaqueness of its links with other parts of the financial
sector. Of course, we also hear that a virtue of financing debt through capital markets rather than banks is that the shock
of an abrupt re-pricing or write-off will not impair the credit channel to the real economy to the degree that it did in
2008-2009. Moreover, compared to mortgage-backed securities (and the housing market in general), the scale of household
balance sheets' exposure to the corporate-debt market is a different order of magnitude.
A decade after the subprime bubble burst, a new one seems to be taking
its place – a phenomenon aptly characterized by Ricardo Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas as "
Financial
'Whac-a-Mole
.'"
A world economy geared toward increasing the supply of financial assets has hooked us into a global
game of waiting for the next bubble to emerge somewhere.
Like the synchronous boom in residential housing prior to 2007 across
several advanced markets, CLOs have also gained in popularity in Europe. Higher investor appetite for European CLOs has
predictably led to a
surge in issuance
(up almost 40% in 2018). Japanese banks, desperately seeking higher yields, have swelled the ranks of
buyers. The networks for financial contagion, should things turn ugly, are already in place.
1
Carmen M. Reinhart is Professor of the International Financial System at Harvard University's Kennedy School of
Government.
Douglas
Leyendecker
Dec 23, 2018
The most important questions isn't when or why this bubble will burst but how we got here in the first place. It all
starts with BAD economic and social policies. Now we require more and more "money" to keep the wheels on. Bubble to
bubble...this is where we are in the developed world today. When the reboot finally hits there won't be any
cryptocurrency because there won't be any internet. This is what happens in a fiat currency system.
Read More
MARCO
TEAMNEURS
Dec 23, 2018
Certain deterministic outcome such as the one presented by Professor Carmen M. Reinhart fits with the Idols refereed by
Francis Bacon in Novum Organum. We will be using financialization until it will be not relevant because something else
had emerged or most of us de-merged. This time might be that we are on those moments where something relevant is moving
under our feet.
What seems to be making the difference is strength of soft/hard power the CCP (Communist Chinese Party) has to leverage
decisions over the world. What happened when in the Subprime Crises Russia called China to together attack capital
markets of USA and China refused (according to Mr. Henry Paulson) might have not the same reply this time.
Read less
Paul Daley
Dec 23, 2018
Good article. But -- do I dare say it -- this time may be different. As Reinhart points out, CLOs do not have heavily
engaged public institutions, as was the case with mortgage backed securities and sovereign debt. A collapse in CLO prices
would fall largely on private shoulders. And, after their first experiments with QE, central banks should have a better
grip on the risks and consequences of asset price support programs in encouraging and sustaining asset price bubbles, and
be prepared this time to employ income support measures to sustain real economic activity, if necessary.
nigel southway
Dec 22, 2018
The best course of action is stop the easy movement of capital across borders that way it stops the phoney wealth
transactions caused by a foolish focus on the global economy start more national centered wealth funds
Jacob Alhadeff
Dec 20, 2018
I had no idea any of this was going on. This was very informative, but I don't know yet exactly what to do with this
information. I'm cynical about our ability to avoid such bubbles, but we can prepare for them. In terms of how low/middle
income Americans can prepare what would anyone suggest? Also, I'm not looking for advice on investing decisions
Read less
nigel
southway
Dec 24, 2018
We need to come to terms with who owns capital. It's mostly the nation that created it. The capitalists should only rent
it and the traders and globalists have zero rights to it hence the justification for stricter controls
"... The 30-year U.S. yield fell to 2.91 percent on Thursday, the lowest since January 2018 ..."
"... The other interpretation is that the company chose to refinance with long-term fixed-rate debt because it sees the big drop in 30-year yields as unsustainable ..."
Berkshire, with the third-highest credit rating from both Moody's Investors Service and
S&P Global Ratings, is expected to price the debt on Thursday with a spread of 150 to 155
basis points above benchmark Treasuries. The 30-year U.S. yield fell to 2.91 percent on
Thursday, the lowest since January 2018.
The other interpretation is that the company chose to refinance with long-term fixed-rate
debt because it sees the big drop in 30-year yields as unsustainable. After all, if a borrower
expects interest rates to rise in the future, it would prefer to lock in a fixed rate now
rather than face higher payments down the road.
Contra Tim Duy, The Lack of Federal Reserve Maneuvering Room Is Very
Worrisome...
This , by the every sharp Tim Duy, strikes me as simply wrong: Contrary to what he says,
the Fed has room to combat the next crisis only if the next crisis is not really a crisis, but
only a small liquidity hiccup in the financial markets. Anything bigger, and the Federal
Reserve will be helpless, and hapless.
Look at the track of the interest rate the Federal Reserve controls -- the short safe
nominal interest rate:
In the past third of a century, by my count the Federal Reserve has decided six times that
it needs to reduce interest rates in order to raise asset prices and try to lift contractionary
pressure off of the economy -- that is, once every five and a half years. Call these: 1985,
1987, 1991, 1998, 2000, and 2007.
Three things are certain: death, taxes, and that the already thin gap between human trader
and algo is narrowing ever further.
AllianceBernstein's new virtual assistant can now suggest to fixed income portfolio managers
what the best bonds may be to purchase using parameters such as pricing, liquidity and risk,
according to
Bloomberg . The machine has numerous advantages to humans: "she" can scan millions of data
points and identify potential trades in seconds. Plus she never needs to take a cigarette or a
bathroom break.
The new virtual assistant, dubbed Skynet 2.0 "Abbie 2.0", specializes in identifying bonds
that human portfolio managers have missed. She can also help spot human errors and communicate
with similar bots like herself at other firms to arrange trades, making humans redundant. This
is the second iteration of AllianceBernstein's electronic assistant which debuted in January of
this year, but could only build orders for bonds following precise input from humans.
Sourcing bonds that are easy to trade is done by Abbie 2.0 reaching out to another AB system
called ALFA, which stands for Automated Liquidity Filtering and Analytics. The AFLA system
gathers bids and asks from dealers and electronic trading venues to work out the best possible
trades.
For now, humans are still required: Jeff Skoglund, chief operating officer of fixed income
at AB told Bloomberg that "humans and machines will need to work closer than ever to find
liquidity, trade faster and handle risks. Our hope is that we grow and use people in ways that
are more efficient and better leverage their skills."
What he really means is that his hope is to fire as many expensive traders and PMs as
possible to fatten the company's profit margins. Which is why the virtual assistant already
helps support a majority, or more than 60 percent of AllianceBernstein's fixed income trades.
The "upgrades" that are coming for the new assistant will help it include high-yielding
investment grade bonds, before expanding to other more complex markets in the coming months. AB
says that they will still rely on humans to make the final decisions on trades. For now.
Related: IBM Launchs Global Payments System With New Stablecoin
While the original version of the assistant had to be told how much a portfolio manager
wanted of a specific bond, the new version now mines data pools to be proactive, making sizing
suggestions to portfolio managers. Among other things, the assistant looks at ratings of
companies, capital structure and macro data such as social and geopolitical risks.
This is just another step in the industry becoming machine oriented in order to help cut
costs, save time and avoid errors, especially in relatively illiquid bond markets. Liquidity
could become even more of a factor if the economy slips into recession over the next couple of
years.
Electronic trading in general is becoming more pronounced in fixed income as banks act more
like exchanges instead of holding bonds on their balance sheet. All the while, regulations have
encouraged the shifting of bond trading to exchanges. More than 80 percent of investors in
high-grade bonds use electronic platforms, accounting for 20 percent of volume, according to
Bloomberg.
Skoglund concluded, "We expect to be faster to market and capture opportunities we otherwise
would not have caught by using this system. There's a liquidity problem right now that could
become significantly more challenging in a risk-off environment."
We're introducing a new active bond fund that allows you to take advantage of Vanguard's
extensive global investment management capabilities and expertise. Vanguard Global Credit Bond
Fund ( Admiral™ Shares: VGCAX ;
Investor
Shares: VGCIX ) gives you unique access to the global credit market, which includes both
U.S. and international investments. The fund will be managed by the Vanguard Fixed Income
Group, which has more than 35 years of experience managing active bond portfolios.
Key potential benefits of the fund include:
Lower volatility. The fund's global diversification reduces the impact of
country-specific risks. This can help lower volatility relative to a U.S.-only credit
fund.
Higher returns. Rather than government-guaranteed bonds, the fund will hold mostly
investment-grade credit bonds. These corporate and noncorporate obligations typically offer
higher yields than their government-guaranteed counterparts. In addition, the fund has a
global -- rather than a U.S.-only -- scope. This creates greater opportunity for value-added
investments.
Competitive value through active management. The fund will seek to deliver consistent
outperformance with a goal of beating its benchmark, the Bloomberg Barclays Global Aggregate
Credit Index (USD Hedged). It will do this at a lower cost than most competing funds, with
expense ratios of 0.25% for Admiral Shares and 0.35% for Investor Shares. For comparison, the
asset-weighted average expense ratio of its active peer funds in the world bond category is
0.65%.*
Which bond fund is right for you?
We've recently expanded our bond offerings to provide more options for diversification and
income. While more choices can help you build a better portfolio, they can also make it tricky
to decide which funds are right for you.
Here's a chart that shows, at a glance, the main differences between 3 similar bond
funds:
Investment-grade corporate and government-related entities
An actively managed bond fund that focuses on U.S., nongovernment
exposure.
Making the most of Vanguard's management resources
Vanguard Global Credit Bond Fund will complement Vanguard's existing suite of 25 actively
managed fixed income funds, not including Vanguard's actively managed money market funds.
Vanguard launched its first internally managed active fixed income fund in 1982 and the
world's first bond index fund in 1986. Vanguard is one of the world's largest fixed income fund
managers with approximately $1.3 trillion in assets under management.** Over $600 billion of
those assets are in actively managed fixed income funds (including money markets).
The Vanguard Fixed Income Group has more than 175 global fixed income professionals, 90 of
whom are part of the active taxable fixed income team, including over 30 global credit research
analysts around the world.
Vanguard
Global Credit Bond Fund is the first Vanguard fund of its kind. This globally diversified,
actively managed bond product capitalizes on Vanguard's extensive global investment
capabilities and global credit expertise.
*Source: Morningstar, Inc., as of September 30, 2018.
**Data as of September 30, 2018.
Yields to maturity on 10-year U.S. Treasury notes are now at their highest level since April
2011. The current yield to maturity is 3.21%, a significant rise from 1.387% which the market
touched on July 7, 2016 in the immediate aftermath of Brexit and a flight to quality in U.S.
dollars and U.S. Treasury notes.
The Treasury market is volatile with lots of rallies and reversals, but the overall trend
since 2016 has been higher yields and lower prices.
The consensus of opinion is that the bull market that began in 1981 is finally over and a
new bear market with higher yields and losses for bondholders has begun. Everyone from bond
guru Bill Gross to bond king Jeff Gundlach is warning that the bear has finally arrived.
I disagree.
It's true that bond yields have backed up sharply and prices have come down in recent
months. Yet, we've seen this movie before. Yields went from 2.4% to 3.6% between October 2010
and February 2011 before falling to 1.5% in June 2012.
Yields also rose from 1.67% in April 2013 to 3.0% in December 2013 before falling again to
1.67% by January 2015. In short, numerous bond market routs have been followed by major bond
market rallies in the past ten years.
To paraphrase Mark Twain, reports of the death of the bond market rally have been "greatly
exaggerated." The bull market still has legs. The key is to spot the inflection points in each
bear move and buy the bonds in time to reap huge gains in the next rally.
That's where the market is now, at an inflection point. Investors who ignore the bear market
mantra and buy bonds at these levels stand to make enormous gains in the coming rally.
The opportunity is illustrated in the chart below. This chart shows relative long and short
positions in ten major trading instruments based on futures trading data. The 10-year U.S.
Treasury note is listed as "10Y US."
As is shown, this is the most extreme short position in markets today. It is even more short
than gold and soybeans, which are heavily out of favor. It takes a brave investor to go long
when the rest of the market is so heavily short.
The Vanguard Prime Money Market Fund (NASDAQMUTFUND: VMMXX) is one of Vanguard's lowest-risk investment options. Best for
short-term savings, the fund offers competitive interest rates and a stable share price. However, for investors seeking any
acceptable level of long-term investment performance, it's generally best to look at other options.
What is the Vanguard
Prime Money Market Fund?
The Vanguard Prime Money Market Fund is designed as an alternative to keeping money in cash, or in a savings account. The
primary objective is to preserve investors' principal by maintaining a portfolio of short-term, high-quality assets. This
includes CDs, short-term U.S. Treasury Bills, and other money market assets. 100% of the fund's investments are of top credit
quality (in the top two possible credit categories), and the average maturity of the fund's assets is just 39 days.
Image source: Getty Images.
The fund maintains a share price of $1.00 at all times and makes income distributions on a monthly basis. Since the fund
invests in short-term money market instruments, it tends to pay a relatively low yield, but it can fluctuate considerably
depending on the interest rate environment.
As of this writing, the fund's distribution yield is 0.48%, but it has been as low as 0.01% in recent years. However, the
fund's average return since its 1975 inception has been 5.18%. When interest rates normalize, the fund's yield should rise to a
level closer to that historic average, and as you can see, there have been times in the past when the fund's yield was
significantly higher than the average.
The fund's current expense ratio is 0.16% and requires a minimum $3,000 initial deposit. For investors with extremely large
stockpiles of cash ($5 million or more), the fund is also available in Admiral Shares, which have a lower 0.10% expense ratio.
Investors have the ability to transfer money electronically to and from their bank account, so the fund is designed to be just
as convenient as a savings account, but with a slightly higher yield.
Advantages
There are a few advantages to investing in the fund. To name a few of the best ones:
Stability: The fund maintains a $1.00 share price. In other words, the risk of losing your investment principal is
virtually zero.
Liquidity: The shares can be readily redeemed for $1.00.
Low cost: The fund's expense ratio is just 0.16%.
Income: The Vanguard Prime Money Market Fund pays a better yield than most savings accounts, checking accounts, and
short-term CDs do. Although the fund's current annualized yield is only about 0.50%, it's far better than the sub-0.10%
returns many savings accounts are offering.
Monthly income: The fund distributes income to investors on a monthly basis. This could become a more attractive benefit
once interest rates normalize, but it's still better than having to wait for a quarterly or annual payout.
However, investors should consider the following drawbacks:
Low yield: Compared with bonds and dividend stocks, money market assets don't pay very much. Investors who want income on
a long-term basis can get significantly higher checks by investing in bonds, without taking on much more risk.
Purchasing power decline: While the fund generates some income, it's important to point out that its returns are
unlikely to keep up with inflation, especially in the near term. For example, if the inflation rate is 2% and the fund returns
only 0.5%, your investment is actually losing 1.5% in purchasing power each year.
No principal appreciation: The Prime Money Market Fund maintains a $1.00 share price, no more, no less. So, while you
won't lose money, you don't have the potential to make any either.
Who should invest in the fund?
I'd recommend the Vanguard Prime Money Market Fund as a short-term investment vehicle only. For example, if you have $10,000
that you know you'll need in two months to pay for your kid's college tuition, the fund is a good way to ensure that you won't
lose any of it, and to generate a little bit of income at the same time. Or, if you have some emergency savings and don't want
to risk losing any of it by investing, this could be a good option.
As far as a long-term investment, I suggest that virtually 100% of all investors' portfolios be in either stocks or bonds (or
funds that invest in them). Stocks provide the growth younger investors need, and bonds can provide the income retirees need
without excessive risk. If you're retired and feel more comfortable with some cash, this could be a good option for a small
percentage of your portfolio, but that's about it.
Symbol: VEIPX Expense
ratio: 0.26% One-year return: 20.8% Three-year return: 10.1% Five-year return: 13.9% Value of
$10,000 invested 10 years ago: $21,206
Top three stock holdings: Microsoft ( MSFT ),
JPMorgan Chase ( JPM ), Philip
Morris International ( PM ) Equity-Income
is a member of the
Kiplinger 25 , the list of our favorite no-load funds.
We think it's a solid choice for
investors who want a conservatively managed large-company stock fund with an above-average yield.
The fund recently yielded 2.7%, compared with 2% for the S&P 500. Wellington Management's
Michael Reckmeyer manages two-thirds of the fund's assets, investing in large firms with
above-average yields. He also looks for companies with good growth prospects and the financial
muscle to raise their payouts steadily. Vanguard's quantitative group, using computers to pick
stocks, runs the rest of the fund, homing in on large, high-quality firms with attractive yields.
Since August 2007, when Reckmeyer and the quants took over, Equity-Income has returned an
annualized 8.5%, edging the S&P 500 by an average of 0.1 percentage point per year. That
isn't impressive. But the fund has been about 5% less volatile than the market over that
period, giving investors a smoother ride.
From comments "Tough to ween an entire community off its generational addiction to financial
heroin"
Notable quotes:
"... The Feds behaviour over the last decade has demonstrated institutional capture in its' purest form. Everything for the financial sector and nothing for the "Main Street" sector. ..."
So this has become a popular recession indicator that has cropped up a lot in the
discussions of various Fed governors since last year. Today, the two-year yield closed at 2.55%
and the 10-year yield at 2.84%. The spread between them was just 29 basis points, the lowest
since before the Financial Crisis.
The chart below shows the yield curves on December 14, 2016, when the Fed got serious about
raising rates (black line); and today (red line). Note how the red line has "flattened" between
the two-year and the 10-year markers, and how the spread has narrowed to just 29 basis
points:
... ... ...
So just in the nick of time, with the spread between the two-year and the
10-year yields approaching zero, the Fed begins the process of throwing out that indicator and
replacing it with a new indicator it came up with that doesn't suffer from these distortions.
And I have to agree that the Fed's gyrations over the past 10 years have distorted the
markets, have muddled the calculations, have surgically removed "fundamentals" as a
consideration for the markets, and have brainwashed the markets into believing that the Fed
will always bail them out at the smallest dip. And the yield curve, reflecting all those
distortions to some extent, might have become worthless as an indicator of anything other than
those distortions.
Isn't the Fed theoretically independent? Why then should they take cognizance of what the
President, or, for that matter, any politician wants? The Feds behaviour over the last
decade has demonstrated institutional capture in its' purest form. Everything for the
financial sector and nothing for the "Main Street" sector.
The Fed is carrying out a grand experiment. Do these 'Quaint Quant Quotients' have a
measurable relationship to the 'Real World' or do they not? My criteria for how well this
'realignment' amongst the 'Financial Stars' works out is going to be the severity of the next
"Recession."
I guess a possibility is the Fed let's the economy get really bad (not that we haven't
seen that recently even but it could be worse) in order to punish Trump. Yea but people are
going to suffer and die in the next recession, they not only already do in recessions anyway,
but there is literally no economic slack in most people's lives anymore. Yea this whole
economic system is screwy as can be, but if they produce mass unemployment we need a
guaranteed income at that point just to keep people from dying.
"(Don't Fear) the Yield Curve" is the title of the staff paper, riffing on "(Don't Fear)
the Reaper" by Blue Oyster Cult which evidently still exerts a powerful sway on the Fed's
balding eggheads 42 years on.
What distinguishes this model is its use of an interest rate dear to the hearts of
economists but absent from bond market quotes: the forward rate . Or as the Blue
Oyster Cult fanboys explain:
The current level of the forward rate 6 quarters ahead is inferred from the yields to
maturity on Treasury notes maturing 6 quarters from now and 7 quarters from now. In
particular, it is the rate that would have to be earned on a 3-month Treasury bill
purchased six quarters from now that would equate the results from two investment
strategies: simply investing in a Treasury note that matures 7 quarters from now versus
investing in a Treasury note that matures 6 quarters from now and reinvesting proceeds in
that 3-month Treasury bill.
Not a big deal to calculate -- so voracious is Big Gov's appetite for borrowing as we
approach the promised land of "trillion dollar deficits forever" that 2-year T-notes are
auctioned monthly, meaning there's always a handy pair of notes with maturities 18 and 21
months ahead whose yields can be used to derive the 6q7q forward rate for the long end of the
spread.
The joke is likely to be on the Fed, though. As their chart shows, the 0-6q forward spread
is volatile, and could well lurch down to meet the 2y10y spread any time. Moreover, despite
the June 28th date on the staff paper, the chart is stale, showing a 0.5%-plus value for the
2y10y spread which last existed several months ago.
In other words, prepare to hoist the Fedsters on their own forward-rate petard.
And they ran to us
Then they started to fly
They looked backward and said goodbye
They had become like we are
From the WSJ's Treasury page, the yield on a note due 12/31/2019 is 2.470%, while the
3/31/2020 note yields 2.511%. Yield on the current 3mo T-bill is 1.951%.
Doing a little exponential maff, we can derive a 6q7q forward rate of 2.76%, for a spread
of 0.81% over the current 3mo T-bill. This compares to a 2y10y spread of only 0.28%.
So according to the Fed's shiny new moved goalpost, there's room for three more rate
hikes, whereas the old goalpost would've allowed just one.
It is well within the Fed's capabilities to sell Treasury and Agency bonds with maturities
concentrated in the long end of the yield curve. Were the Fed to do that, particularly
against a backdrop of deep corporate tax cuts and the resultant increased supply of Treasury
debt, what is likely to happen to mortgage rates, real estate and collateral values?
I suspect the people complaining loudest about this emergent Fed policy are those who have
benefited most from both longtime negative real interest rates and a positively sloping yield
curve. Those were lucrative monetary policy features for them over the past nine years.
I have long been annoyed by the way Fed staff / hobbyists blithely treat the yield curve
as just another "indicator", as if they were forecasting the weather from changes in
barometric pressure or temperature.
Seeking a forecasting crystal in a calculated "forward" rate, supposedly mirroring
"expectations" of (a representative?) investors reflects a world view that imagines economic
actors confidently act on expectations that they believe will be fulfilled. It is not taking
uncertainty seriously.
The yield curve has worked not thru magic, but because it reflects a fundamental mechanism
of sorts that drives credit and the transformation of maturities: that some key institutions
borrow short and lend long, to coin a phrase, in the creation of credit that typically drives
the expansion of business activity. Inverting the yield curve forces the contraction of
credit by institutions that hedge a borrow short, lend long strategy with Treasuries.
It probably is not lost on those with a memory of past cycles that speculation about
whether things will be different this time with regard to the yield curve qua indicator
emerges regularly from Fed hobbyshops near the end of very long expansions. If memory serves
the Cleveland Fed research shop circulated such speculation in the 2005-7 period.
Admittedly, I haven't had my coffee yet, but I think I may have reached a conclusion: a
country whose economic system can't be understood in an hour is doomed to failure.
"... In other words, corporate yields will rise further and faster than Treasury yields, just to catch up, thus pushing down prices with gusto. ..."
"... I disagree when Wolf says the 10Y yield will follow the Fed Funds rate. ..."
"... To your point, corporate bonds will get more expensive to roll. And to your point, tax cuts will help them finance that. What it certainly means though is the good old days of stock buy backs would be over. Oh the humanity, lol. ..."
"... By the way, the 13 week treasury yield (which the Fed Funds rate tracks) is at 1.49%. Only 3 to 6 more basis points and the Fed Reserve will be due to increase their Fed Funds rate another 25 basis points. ..."
Wage inflation,yes, but they're really worried about the rising cost of corporate debt if
the Fed hikes even faster due to wage inflation. If the interest on Corp debt isn't better
than that on safer US debt then the market for especially junk bonds will evaporate leading
to bankruptcies.
Wolff Richter has written about this, and how they misused their QE magic money tree.
This is also why they needed Corp tax cut ASAP, to stave off the inevitable stock market
rout, although they should know better.
-- The Fed will continue to raise its target
range for the federal funds rate. -- The 10-year yield will follow.
-- As the Treasury yield curve, which is still relatively flat, steepens back to some sort
of normal-ish slope, the 10-year yield will make up for lost time over the past year and will
rise faster than the Fed's target range for the federal funds rate.
-- Corporate bonds will follow, but they have even more catching up to do, and so they
will rise even faster than the 10-year yield, as yield spreads between the 10-year Treasury
and corporate bonds widen back to some sort of normal-ish range.
In other words, corporate yields will rise further and faster than Treasury yields,
just to catch up, thus pushing down prices with gusto.
Junk bonds are more volatile and will react more strongly. Junk-rated companies will find
it more difficult to raise new money to service their existing debts and fund their
money-losing operations, and there will be more defaults, which will push yields even higher
as the risks of junk bonds suddenly become apparent for all to see. This will make it even
tougher for companies to raise funds needed to service their existing debts and fund their
operations.
I agree with the overall thesis of what's driving the market swoon at the moment. But
I disagree when Wolf says the 10Y yield will follow the Fed Funds rate. E.g. see
this graph: https://fred.stlouisfed.org/graph/?g=i9XE .
If you stretch it back far enough, the 10Y yield and the Fed's fund rate are pretty
independent of each other.
About the only relationship they have to each other is when they get inverted, that that
precipitates a recession. E.g. see when the Fed Reserve did that in May 2000 and June 2006 in
that same graph. That's when the punch bowl is gone, it just seems to take a while for that
to work its way through the system.
I seem to recall that Wolf had a previous posting where he argued that the 10Y yield was
going up because of other factors: the tax cuts, Fed Reserve unwinding its balance sheet,
etc. So basically the same effect. Everyone is scared the bond vigilantes will finally have
sway. To your point, corporate bonds will get more expensive to roll. And to your point,
tax cuts will help them finance that. What it certainly means though is the good old days of
stock buy backs would be over. Oh the humanity, lol.
One question I have is whether the corporations would actually retire the debt instead of
roll it over; retiring the debt should be deflationary. But I suspect most corporations don't
have enough cash flow to actually retire debt, even with the tax cuts. As usual, Banks to US:
"all your cash flow are belong to us".
By the way, a counter thesis is that the bond vigilantes won't have sway and the 10Y yield
will revert to the path it's been on since 1982. In which case, the market is saved, yay! But
then it would still be on path to an inverted yield curve anyways, boo! I guess time will
tell.
By the way, the 13 week treasury yield (which the Fed Funds rate tracks) is at 1.49%.
Only 3 to 6 more basis points and the Fed Reserve will be due to increase their Fed Funds
rate another 25 basis points.
Imagine the optics of that happening during this market swoon or soon after. Heads are
going to implode, particularly Trump's. But to my point above, corporate debt is not exposed
to that.
It separately still begs the question on whether the 13 week treasury actually anticipates
the Fed Funds rate. Or if the Fed Reserve is actually forced to follow the 13 week treasury.
One way to get more clarity would be if the Fed Reserve actually sat on increasing their
rate, e.g. just to avoid spooking the markets more. It will be interesting to see how this
plays out.
The Vanguard Energy Fund Investor Shares (MUTF: VGENX) consists mainly of large-cap growth and
large-cap value stocks from the energy sector, with an emphasis on North America. Top holdings should
come as no surprise, with the following as the most heavily weighted positions:
• Exxon Mobil Corporation (NYSE: XOM)
• Chevron Corporation (NYSE: CVX)
• Royal Dutch Shell plc (ADR) (NYSE: RDS-A)
• Schlumberger Limited. (NYSE: SLB)
• Pioneer Natural Resources (NYSE: PXD)
The fund's expense ratio is 0.30 percent, which is low for an actively managed fund.
Citigroup analysts led by Anindya Basu point out that spreads on the
CDX HY, as the index is known, are currently pricing in an expected loss of 21.2 percent, which
translates into something like 22 defaults over the next five years if one assumes zero recovery
for investors. That is a pretty big number once you consider that a total of 41 CDX HY constituents
have defaulted since the index really began trading in 2005, equating to about 3.72 defaults per
year. A big chunk of those defaults (17) occurred in 2009 in the aftermath of the financial crisis.
What to make of it all? Actual recoveries during corporate default cycles tend to be higher than
the worst-case scenario of zero percent. In fact, they average somewhere in the 26 percent range,
which would imply 29 defaults over the next five years instead of 41.
So what? you might say. The CDX HY includes but one default cycle, and those types of
analyses tend to underestimate the peril of tail risk scenarios (hello,
subprime crisis). Citi has an answer for that, too. Using spreads from the cash bond market going
back to 1991, they forecast the default rate over the next 12 months to be something more like 5
percent to 5.5 percent. (For comparison, the rating agency Moody's is currently forecasting a 3.77
percent default rate.)
,,,,The
Vanguard Core Bond Fund, unveiled in a filing with regulators on Monday, is
being
billed as an actively managed alternative to index funds like the
Total Bond Market fund (VBMFX,
VBTLX,
BND). Its launch, slated
for the first three months of 2016, would coincide with a period of great
uncertainty in the bond markets. The Fed could mull its next interest-rate hike
as soon as March.
... ... ...
Daniel Wiener, editor of the Independent Adviser for
Vanguard Investors newsletter and a close watcher of all things Vanguard, was
quick to note that the fund could invest in bonds of "any quality." The new
fund's fine print shows leeway for Vanguard's portfolio managers to plunk up to
5% of the portfolio in junk bonds. Some 30% of the fund could fall into
"medium-quality" bonds.
Vanguard's existing offering in junk debt, the Vanguard High-Yield
Corporate Fund (VWEHX,
VWEAX), is
managed by Wellington Management Company.
Says Wiener: "Vanguard has never offered lesser-quality bond funds run by
its internal group. The junk portion of the Core Bond product will be a first."
For the last several year buying "junkest junk" was a profitable strategy. Now it came to abrupt
end.
Notable quotes:
"... The rest of the industry has been quick to say that while redemptions are elevated, particularly in high-yield bond funds, there doesn't seem to be a rush to for the exits. ..."
"... Goldman Sachs, for one, put out a note Friday warning Franklin Resources "is most at risk" given the large high-yield holdings of its funds, poor performance and large outflows. On Friday, its shares fell sharply. Meanwhile, there were unusually large declines Friday in the value of exchange-traded funds that track high-yield debt. ..."
"... The idea of a "run" on mutual funds might sound strange. Typically, runs are associated with highly leveraged banks engaged in maturity transformation, funding long-term loans with short-term debt. Nearly all the programs designed to avoid destabilizing runs-from deposit insurance to the Fed's discount window to liquidity requirements-are built for banks. But unleveraged investors, including mutual funds, can also give rise to runs. That is because there is a liquidity mismatch in mutual funds that hold relatively illiquid assets funded by investors entitled to daily redemptions. ..."
Interesting WSJ article (do a Google Search for the title, for access). Last week, the Journal
noted that Chesapeake bonds that traded at 80˘ on the dollar a few months ago were currently trading
at 30˘ to 40˘ on the dollar. I suspect that there are some huge losses on the books of a lot of
pension funds.
WSJ: The Liquidity Trap That's Spooking Bond Funds
The specter of a destabilizing run on debt is haunting markets
The debt world is haunted by a specter-of a destabilizing run on markets.
Last week, this took on more form even if there weren't concrete signs of panic. Only one
mutual fund manager, Third Avenue Management, has said it would halt redemptions to forestall
having to dispose of assets in a fire sale. The rest of the industry has been quick to say
that while redemptions are elevated, particularly in high-yield bond funds, there doesn't seem
to be a rush to for the exits.
Still, growing angst comes as the oil-price rout continues and the U.S. Federal Reserve
appears ready to raise rates. This has investors worried-and starting to ask the fearful question:
"Who's next?"
Goldman Sachs, for one, put out a note Friday warning Franklin Resources "is most at risk"
given the large high-yield holdings of its funds, poor performance and large outflows. On Friday,
its shares fell sharply. Meanwhile, there were unusually large declines Friday in the value
of exchange-traded funds that track high-yield debt.
The idea of a "run" on mutual funds might sound strange. Typically, runs are associated
with highly leveraged banks engaged in maturity transformation, funding long-term loans with
short-term debt. Nearly all the programs designed to avoid destabilizing runs-from deposit
insurance to the Fed's discount window to liquidity requirements-are built for banks. But unleveraged investors, including mutual funds, can also give rise to runs. That is because
there is a liquidity mismatch in mutual funds that hold relatively illiquid assets funded by
investors entitled to daily redemptions.
"... It cuts two ways. Junk ETFs such as JNK and HYG have badly underperformed their benchmarks, owing to buying and selling in an illiquid market to replicate an index. Whereas actively managed junk mutual funds have the flexibility to deviate from index holdings in ways that can add a couple of hundred basis points a year. ..."
"... Your apology is flawed because it assumes equal access to information among investors as well as assuming all investors have the same objective. Institutional investors have different goals than hedge funds for example. The people you refer to have been fleeced that's just ok with you. As to tea leaves the people have been steeped in recovery stories for years. ..."
"... Wait, so speculators are shorting big bond positions of distressed funds? No way, hope they aren't doing this to ETF's. Jeez, didn't see this coming. I guess having the positions of big ETF's published daily might assist the speculators. ..."
"... What I do remember (and I can't remember whether it was Spring of 2008 or earlier), was that HY spreads had gapped out at least a couple of hundred bps, and equities were still at or near all-time highs. I remember sitting in a meeting with a couple I-bankers, who chuckled ruefully "equities haven't a clue". ..."
"... The received wisdom on the Street is that the bond market is smarter than the equity market. And, at last in my career, it was true, at least as far as downturns went. ..."
Yes, junk is usually the canary in the coal mine. The HY market melted in the Summer of
2008, months before equities noticed what was going on. The question really is how much contagion
there will be: how many CDS have been written on the distressed names, who holds them, etc.
My instinct tells me that there are considerably less CDS on junk than were written on MBS,
due to the smaller market, the lower liquidity and (supposed) credit quality. But how much
has that changed since 2008? I dunno.
One thing I do know: it's like the movie "Groundhog Day". The Fed always overstimulates,
and there always follows a crash. Are there any bubbles left to blow, to 'reflate' assets next
time?
Your remark on written CDS is important. While it may be difficult to get liquidity on
distressed names, it is less so on credit tiers above that or on indices. I'm sure there
is some on junk, yes, but the real opportunity for spec CDS is (perhaps, was) on the BBB
space which is the largest category in the investment grade market and is more liquid. While
it may take awhile for distressed trading to creep up the credit ratings to the larger and
more liquid names (specifically, since the definition of liquidity seems to be important
on NC: the size of the specific issues' float, approximated with average daily volume),
they will also have larger moves because potential fallen angels are repriced aggressively
in an unstable market. The other thing about CDS is that they are most often delta-hedged
which requires dealers to sell proxy's as the CDS go deeper into the money. The one restraining
factor is that once a crisis is in motion, I think its going to be difficult for specs to
get more CDS on their books. This strategy is purely directional (this is not an ETF NAV
arb), essentially owning out of the money puts with minimal cost of carry.
'Their investing strategy – putting high-risk investments into a mutual fund – seems
like exactly what not to do.'
It cuts two ways. Junk ETFs such as JNK and HYG have badly underperformed their benchmarks,
owing to buying and selling in an illiquid market to replicate an index. Whereas actively
managed junk mutual funds have the flexibility to deviate from index holdings in ways that
can add a couple of hundred basis points a year.
That said, both junk ETFs and junk mutual funds are offering daily liquidity, while holding
underlying securities that may trade once a week, or have no bids at all. As David Dayen
observes, this sets up the risk of a bank run when investors get spooked.
Take a look at the "power dive" chart of TFCIX (Third Avenue Focused Credit Fund)
- Aiieeeeee!
Now the question is contagion. Morningstar shows that 48% of TFCIX's portfolio was below
B rating, and 41% had no bond rating. Most junk funds don't have THAT ugly a portfolio.
But when the herd starts to stampede, fine distinctions can get lost in the dust cloud from
the thundering hooves.
Over to you, J-Yel. Do you feel lucky, cherie? Well, do you?
There is no CDS. There just isn't less, there is none. The stock market has pretty much
ignored it as well except that its move from 13000 to 18000 has temporarily stalled. I suspect
by the spring, this will be old news.
I think we make errors here, not understanding this particular type of financial speculation
is "anti-growth" in general. This would probably blow most of the minds on this board.
Many years ago when Alan Greenspan first proposed using monetary policy to control economies,
the critics said this was far too broad a brush.
After the dot.com crash Alan Greenspan loosened monetary policy to get the economy going
again. The broad brush effect stoked a housing boom.
When he tightened interest rates, to cool down the economy, the broad brush effect burst
the housing bubble. The teaser rate mortgages unfortunately introduced enough of a delay so
that cause and effect were too far apart to see the consequences of interest rate rises as
they were occurring.
The end result 2008.
With this total failure of monetary policy to control an economy and a clear demonstration
of the broad brush effect behind us, everyone decided to use the same idea after 2008.
Interest rates are at rock bottom around the globe, with trillions of QE pumped into the
global economy.
The broad brush effect has blown bubbles everywhere.
"9 August 2007 – BNP Paribas freeze three of their funds, indicating that they have no way
of valuing the complex assets inside them known as collateralised debt obligations (CDOs),
or packages of sub-prime loans. It is the first major bank to acknowledge the risk of exposure
to sub-prime mortgage markets. Adam Applegarth (right), Northern Rock's chief executive, later
says that it was "the day the world changed"
10th December 2015 – "Moments ago, we learned courtesy of the head of Mutual Fund Research
at Morningstar, Russ Kinnel, that the next leg of the junk bond crisis has officially arrived,
after Third Avenue announced it has blocked investor redemptions from its high yield-heavy
Focused Credit Fund, which according to the company has entered a "Plan of Liquidation" effective
December 9." When investor's can't get their money out of funds they panic.
Central Bank low interest rate policies encourage investors to look at risky environments
to get a reasonable return
Pre-2007 – Sub-prime based complex financial instruments Now – Junk bonds
The ball is rolling and the second hedge fund has closed its doors, investors money is trapped
in a world of loss.
"Here Is "Gate" #2: $1.3 Billion Hedge Fund Founded By Ex-Bear Stearns Traders, Just Suspended
Redemptions"
We know the world is downing in debt and Greece is the best example I can think of that
shows the reluctance to admit the debt is unsustainable.
Housing booms and busts across the globe ……
Those bankers have saturated the world with their debt products.
"Those bankers have saturated the world with their debt products."
I'm no apologist for Banksters but people bought this "stuff" as the Stuffies.
whether you call it greed or desperation in the face of zero yield – at the end of the
day the horizon was short since the last debacle.
getting 2 & 20 or whatever the comp arrangement was for those who are motivated by greed
– 2% of $2 Billion yields at least $40 million a year for 5 years or $200 million – not
bad for ten guys or less – obviously not fiduciaries – bouncing from Bear to Tudor to Third
Ave with no change in the model yields predictable results
I put forth the proposition the "people" deserve their fate – the tea leaves were all
there to see
Your apology is flawed because it assumes equal access to information among investors
as well as assuming all investors have the same objective. Institutional investors have
different goals than hedge funds for example. The people you refer to have been fleeced
that's just ok with you. As to tea leaves the people have been steeped in recovery stories
for years.
Also fails to recognize the collateral damage caused towards the people that did
not directly participate. It is very hard to say that they deserve their fate in this
context, in that they were largely powerless to stop it to begin with, at a reasonable
level.
Wait, so speculators are shorting big bond positions of distressed funds? No way, hope they
aren't doing this to ETF's. Jeez, didn't see this coming. I guess having the positions of big
ETF's published daily might assist the speculators.
Yesterday HYG closed at a 0.76% discount to NAV, while JNK closed at a 0.68% discount
(values from Morningstar). These are wider discounts than ETF managers like to see.
The arbitrage mechanism of buying the discounted ETF shares, redeeming them for the underlying,
and then selling the bonds at full value for an instant 0.76% gain is supposed to kick in
now.
The misperception is that the ETF junk trade is an arb right now. Its not, its directional.
The discipline to bring NAV's in line with underlying value will only kick in at much
wider levels because traders are still long (and putting on more of) the "widener" because
they anticipate higher levels of vol going forward.
Actually have already been bracing myself as demand for labor fell off a cliff at the end
of sept., and I'm guessing it's stories such as this that makes my customers tighten their
belts....
"Some say the world will end in fire Some say in ice From what I've tasted of desire I hold with those who favor (fire) INFLATION But if it had to (perish) REFINANCE twice, I think I know enough of (hate) ZIRP RATES To say that for destruction (ice) NO BID Is also great And would suffice."
All those junk companies could just declare bankruptcy and start over. That's the
way it's supposed to work. Just ask The Donald. Then it would be like that movie where
Bruce Willis saved the earth from an asteroid strike. 'Course there was only one asteroid
in that movie. Instead, we have World War Z with zombies all over the place!
But maybe JYell will buy all the junk bonds, burn them, and then the dollar will crash
and we can all get jobs?
"The HY market melted in the Summer of 2008, months before equities noticed what was going
on."
Not really. HYG market were in a downtrend during summer of 2007, together with the stockmarket.
Also in the 2008 summer both markets were in a severe meltdown. This time around the HYG´s
started their downtrend from summer 2014 with the 1:st leg down to dec same year. 2:nd leg
is now running in which the stockmarket joined.
Your right, HYG´s seems to be the canaries
here! But, from august this year they seems to go in different directions. Or are they?
You're right, it was earlier than Summer 2008, now I think about it.
What I do remember (and I can't remember whether it was Spring of 2008 or earlier), was
that HY spreads had gapped out at least a couple of hundred bps, and equities were still
at or near all-time highs. I remember sitting in a meeting with a couple I-bankers, who
chuckled ruefully "equities haven't a clue".
The received wisdom on the Street is that the bond market is smarter than the equity
market. And, at last in my career, it was true, at least as far as downturns went.
"... By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street ..."
"... Other high-risk credits, such as those backed by subprime mortgages, will follow. And the irony? Just in the nick of time, subprime is back – but this time, it's even bigger. Read… Subprime "Alt"-Mortgages from Nonbanks Run by former Countrywide Execs Backed by PE Firms Are Booming ..."
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist,
and author, with extensive international work experience. Originally published at
Wolf Street
nvestors, lured into the $1.8-trillion US junk-bond minefield by
the Fed's siren call to be fleeced by Wall Street and Corporate America, are now getting bloodied
as these bonds are plunging.
Standard & Poor's "distress ratio" for bonds, which started rising a year ago, reached 20.1% by
the end of November, up from 19.1% in October. It was its worst level since September 2009.
It engulfed 228 companies at the end of November, with $180 billion of distressed debt, up from
225 companies in October with $166 billion of distressed debt,
S&P Capital IQ reported.
Bonds are "distressed" when prices have dropped so low that yields are 1,000 basis points (10
percentage points) above Treasury yields. The "distress ratio" is the number of non-defaulted
distressed junk-bond issues divided by the total number of junk-bond issues. Once bonds take the
next step and default, they're pulled out of the "distress ratio" and added to the "default rate."
During the Financial Crisis, the distress ratio fluctuated between 14.6% and, as the report put
it, a "staggering" 70%. So this can still get a lot worse.
The distress ratio of leveraged loans, defined as the percentage of performing loans trading below
80 cents on the dollar, has jumped to 6.6% in November, up from 5.7% in October, the highest since
the panic of the euro debt crisis in November 2011.
The distress ratio, according to S&P Capital IQ, "indicates the level of risk the market has priced
into the bonds. A rising distress ratio reflects an increased need for capital and is typically a
precursor to more defaults when accompanied by a severe, sustained market disruption."
And the default rate, which lags the distress ratio by about eight to nine months – it was 1.4%
in July, 2014 – has been rising relentlessly. It hit 2.5% in September, 2.7% in October, and 2.8%
on November 30.
This chart shows the deterioration in the S&P distress ratio for junk bonds (black line) and leveraged
loans (brown line). Note the spike during the euro debt-crisis panic in late 2011:
The oil-and-gas sector accounted for 37% of the total distressed debt and sported the second-highest
sector distress ratio of 50.4%. That is, half of the oil-and-gas junk debt trades at distressed
levels! The biggest names are Chesapeake Energy with $7.4 billion in distressed debt and Linn Energy
LLC with nearly $6 billion.
Both show how credit ratings are slow to catch up with reality. S&P
still rates Chesapeake B- and Linn B+. Only 24% of distressed issuers are in the rating category
of CCC to C. The rest are B- or higher, waiting in line for the downgrade as the noose tightens on
them.
The metals, mining, and steel sector has the second largest number of distressed issues and sports
the highest sector distress ratio (72.4%), with nearly three-quarters of the sector's junk debt trading
at distressed levels. Among the biggest names are Peabody Energy with $4.7 billion in distressed
debt and US Steel with $2.2 billion.
These top two sectors account for 53% of the total distressed debt. And now there are "spillover
effects" to the broader junk-rated spectrum, impacting more and more sectors. While some sectors
have no distressed debt yet, others are not so lucky:
Restaurants, 21 issuers, sector distress ratio of 21.4%;
Media and entertainment companies, 36 issuers, distress ratio of 17%;
High-tech companies, 22 issuers, distress ratio of 19%;
Chemicals, packaging, and environmental services companies, 14 issuers, distress ratio of
16.1%;
Consumer products companies, 16 issuers, distress ratio of 13.9%;
Financial institutions, 14 issuers, distress ratio of 12.6%.
The biggest names: truck maker Navistar; off-road tire, wheel, and assembly maker Titan International;
specialty chemical makers The Chemours Co. and Hexion along with Hexion US Finance Corp.; Avon Products;
Verso Paper; Advanced Micro Devices; business communications equipment and services provider Avaya;
BMC Software and its finance operation; LBO wunderkind iHeart Communications (Bain Capital) with
a whopping $8.9 billion in distressed debt; Scientific Games; jewelry and accessory retailer Claire
Stores; telecom services provider Windstream; or Texas mega-utility GenOn Energy (now part of NRG
Energy).
How much have investors in distressed bonds been bleeding? S&P's Distressed High-Yield Corporate
Bond Index has collapsed 40% from its peak in mid-2014:
In terms of investor bloodletting: 70% of all distressed bonds are either unsecured or subordinated,
the report notes. In a default, bondholders' claims to the company's assets are behind the claims
of more senior creditors, and thus any "recovery" during restructuring or bankruptcy is often minimal.
At the lowest end of the junk bond spectrum – rated CCC or lower – the bottom is now falling out.
Yields are spiking, having more than doubled from 8% in June 2014 to 16.6% now, the highest since
August 2009:
These companies, at these yields, have serious trouble raising new money to fund their cash-flow-negative
operations and pay their existing creditors. Their chances of ending up in default are increasing
as the yields move higher.
And more companies are getting downgraded into this club of debt sinners. In November,
S&P Ratings Services upgraded
only eight companies with total debt of $15.8 billion but downgraded 46 companies with total debt
of $113.7 billion, for a terrible "downgrade ratio" of 5.8 to 1, compared to 1 to 1 in 2014.
This is what the end of the Great Credit Bubble looks like. It is unraveling at the bottom. The
unraveling will spread from there, as it always does when the credit cycle ends. Investors who'd
been desperately chasing yield, thinking the Fed had abolished all risks, dove into risky bonds with
ludicrously low yields. Now they're getting bloodied even though the fed funds rate is still
at zero!
It is interesting that "distressed" in this article pretty much refers to pricing alone and says
little about whether it actually represents a significant change in the ability of companies to
repay/refinance their debts. The charts show a similar spike that happened in 2012 without any
real consequence to default rates. Of course we are right to not trust the rating agencies as
they are lagging indicators and there is a prima facie case for oil being a potential disaster
area, but the article give no evidence as to why the markets are right this time. They've been
wrong before.
The definition of distress is also somewhat arbitrary – 1000bps stinks of being a round number
rather than any meaningful economic measure. 900bps sounds pretty distressed to me. Or, as a bull
might put it, a bargain!
tegnost, December 3, 2015 at 1:07 pm
Question: What mechanism brought distress down after the euro crisis in late 2011, and is it possible
that mechanism, whatever it was, will work again?
susan the other. December 3, 2015 at 1:43 pm
It's kinda like the post above on German domestic banks looking for profit from any rotten
source. We are on the cusp of a new economy; keeping alive the old consumer/manufacturing economy
is a dead end. ...
"There is no doubt that the price of assets right now is a question mark... and ultimately
when Central Banks stop manipulating markets where that price goes is up for grabs... and probably
points down"
As Gross tweeted...
Gross: All global financial markets are a shell game now. Artificial prices,
artificial manipulation. Where's the real pea (price)?
"There is no doubt that the price of assets right now is a
question mark... and ultimately when Central Banks stop
manipulating markets where that price goes is up for grabs... and
probably points down"
As Gross tweeted...
Gross: All global financial markets are a shell
game now. Artificial prices, artificial manipulation. Where's the real
pea (price)?
"...It's very conceivable for short-term rates to rise but long-term yields to decline if the market
becomes convinced that Fed hikes will slow the economy. There's even a recent hint of that
possibility looking at the action in treasuries since mid-July (the yield on 5-year treasuries
has risen faster than yield on 10- and 30-year treasuries." . "...Finally, even if economic data is weak, there is a chance yields rise if inflation picks up.
Thus, one needs to keep inflation in mind, especially over longer time-frames."
Setting aside the often-heard "certificates of confiscation" phrase, treasuries are a
reasonable buy if one believes yields are going to stay steady or decline. They are to be avoided
if the expectation is for yields to rise.
Part of the question is whether or not the Fed hikes, and by how much. But it's more complicated
than the typical "yes-no when" analysis that we see in the media.
It's very conceivable for short-term rates to rise but long-term yields to decline if the market
becomes convinced that Fed hikes will slow the economy. There's even a recent hint of that
possibility looking at the action in treasuries since mid-July (the yield on 5-year treasuries
has risen faster than yield on 10- and 30-year treasuries.
I am still not convinced the Fed is going to hike this year. Much will depend on retail sales,
housing, and jobs.
A good retail sales report will send yields soaring, likely across the board.
Finally, even if economic data is weak, there is a chance yields rise if inflation picks up.
Thus, one needs to keep inflation in mind, especially over longer time-frames.
That said, the recent decline in crude, commodities in general, does not lend much credence to
the notion the CPI is going to take big leaps forward any time soon.
All things considered, the long end of the curve seems like a reasonable buy here provided one
believes as I do, that economic data is unlikely to send the Fed on a huge hiking spree, and that
if and when the Fed does react, yields on the long-end of the curve may not rise as everyone
seems to expect.
Anonymouse
Agreed ... any Fed rate hike will slow the economy, but they won't (can't) raise
rates.
We have entered the black-hole of zero-interest, squarely caused by the incestuous
relationship between the Fed and the Treasury whereby check-kiting and theft have become our
central bankers' legal and institutional 'right.'
Through debt monetization, bond speculation has been made risk-free .. an anomaly in nature
yet over 34 years in its bull cycle.
Risk-free bond speculation creates and maintains a
falling interest rate structure which destroys the capital of virtually every market player.
This is the greater danger .... which can only result in broad-based serial bankruptcies
unless the parasitic system is abandoned for one that embraces sound money.
According to Bloomberg, bonds wiped out all their gains for the year. The benchmark US
10-year treasury yield pushed higher to about 2.42% overnight, a level it hadn't touched since
October. German bund yields rose to about 0.99%.
There is chaos in global markets. Bonds sold off sharply on Thursday morning for a second day
in a row. They've reversed the decline, but stocks are still lower, after the chaos spilled over.
... ... ...
The International Monetary Fund slashed US growth forecasts, and urged the Federal Reserve to
delay its first interest rate hike until 2016, in a statement that crossed as the stock market
opened.
In a speech last month, Fed chair Janet Yellen said it would be appropriate to raise interest
rates "at some point this year" if the economy continues to improve.
In a morning note before the open, Brean Capital's Peter Tchir wrote: "It is time to reduce US
equity holdings for the near term and look for a 3% to 5% move lower. The Treasury weakness
is NOT a 'risk on' trade it is a 'risk off' trade, where low yields are viewed as a risk asset
and not a safe haven."
The sell off in global bonds started Wednesday, as European Central Bank president Mario
Draghi gave a news conference in which he said markets should get used to episodes of higher
volatility.
Draghi also emphasized that the ECB had no intention to soon end its €60 billion bond-buying
program, called quantitative easing, before its planned end date of September 2016.
Bond yields, which move in the opposite direction to their prices, spiked across Europe on
Wednesday, and on Thursday this move is continuing, with German bund yields and US Treasury
yields hitting new 2015 highs and continuing to climb overnight.
According to Bloomberg, bonds wiped out all their gains for the year.
... ... ...
The benchmark US 10-year treasury yield pushed higher to about 2.42% overnight, a level it hadn't
touched since October. German bund yields rose to about 0.99%.
The bull case is not the recovery or the economy as it exists, it is the promise
of one and the plausibility for that promise. Under that paradigm, the market doesn't
care whether orthodox economists are 'right', only that there is always next year. Other places
in the world, however, are running out of "next year." The greatest risk in investing under
these conditions is the Greater Fool problem. Anyone using mainstream economic projections and
thus expecting a bull market will be that Fool. That was what transpired in 2008 as the entire
industry moved toward overdrive to convince anyone even thinking about mitigation or risk
adjustments that it was 'no big deal'. Remember: "The risk that the economy has entered a
substantial downturn appears to have diminished over the past month or so." - Federal Reserve
Chairman Ben Bernanke, June 9, 2008.
It's the governmental equivalent of stealing from your kids' college fund to buy lap dances.
Called the Rhode Island Retirement Security Act of 2011, her plan would later be hailed as the most
comprehensive pension reform ever implemented. The rap was so convincing at first that the overwhelmed
local burghers of her little petri-dish state didn't even know how to react. "She's Yale, Harvard, Oxford
– she worked on Wall Street," says Paul Doughty, the current president of the Providence firefighters
union. "Nobody wanted to be the first to raise his hand and admit he didn't know what the fuck she was
talking about."
Soon she was being talked about as a probable candidate for Rhode Island's 2014 gubernatorial
race. By 2013, Raimondo had raised more than $2 million, a staggering sum for a still-undeclared candidate
in a thimble-size state. Donors from Wall Street firms like Goldman Sachs, Bain Capital and JPMorgan
Chase showered her with money, with more than $247,000 coming from New York contributors alone. A shadowy
organization called EngageRI, a public-advocacy group of the 501(c)4 type whose donors were shielded
from public scrutiny by the infamous Citizens United decision, spent $740,000 promoting Raimondo's ideas.
Within Rhode Island, there began to be whispers that Raimondo had her sights on the presidency. Even
former Obama right hand and Chicago mayor Rahm Emanuel pointed to Rhode Island as an example to be followed
in curing pension woes.
What few people knew at the time was that Raimondo's "tool kit" wasn't just meant for local consumption.
The dynamic young Rhodes scholar was allowing her state to be used as a test case for the rest of the
country, at the behest of powerful out-of-state financiers with dreams of pushing pension reform down
the throats of taxpayers and public workers from coast to coast. One of her key supporters was billionaire
former Enron executive John Arnold – a dickishly ubiquitous young right-wing kingmaker with clear designs
on becoming the next generation's Koch brothers, and who for years had been funding a nationwide campaign
to slash benefits for public workers.
Nor did anyone know that part of Raimondo's strategy for saving money involved handing more than
$1 billion – 14 percent of the state fund – to hedge funds, including a trio of well-known New York-based
funds: Dan Loeb's Third Point Capital was given $66 million, Ken Garschina's Mason Capital got $64 million
and $70 million went to Paul Singer's Elliott Management. The funds now stood collectively to be paid
tens of millions in fees every single year by the already overburdened taxpayers of her ostensibly flat-broke
state. Felicitously, Loeb, Garschina and Singer serve on the board of the Manhattan Institute, a prominent
conservative think tank with a history of supporting benefit-slashing reforms. The institute named Raimondo
its 2011 "Urban Innovator" of the year.
The state's workers, in other words, were being forced to subsidize their own political disenfranchisement,
coughing up at least $200 million to members of a group that had supported anti-labor laws. Later, when
Edward Siedle, a former SEC lawyer, asked Raimondo in a column for Forbes.com how much the state was
paying in fees to these hedge funds, she first claimed she didn't know. Raimondo later told the
Providence Journal she was contractually obliged to defer to hedge funds on the release of "proprietary"
information, which immediately prompted a letter in protest from a series of freaked-out interest groups.
Under pressure, the state later released some fee information, but the information was originally kept
hidden, even from the workers themselves. "When I asked, I was basically hammered," says Marcia Reback,
a former sixth-grade schoolteacher and retired Providence Teachers Union president who serves as the
lone union rep on Rhode Island's nine-member State Investment Commission. "I couldn't get any information
about the actual costs."
... ... ...
Among the worst of these offenders are Massachusetts (made just 27 percent of its payments), New
Jersey (33 percent, with the teachers' pension getting just 10 percent of required payments) and Illinois
(68 percent). In Kentucky, the state pension fund, the Kentucky Employee Retirement System (KERS), has
paid less than 50 percent of its ARCs over the past 10 years, and is now basically butt-broke – the
fund is 27 percent funded, which makes bankrupt Detroit, whose city pension is 77 percent full, look
like the sultanate of Brunei by comparison.
Here's what this game comes down to. Politicians run for office, promising to deliver law and order,
safe and clean streets, and good schools. Then they get elected, and instead of paying for the cops,
garbagemen, teachers and firefighters they only just 10 minutes ago promised voters, they intercept
taxpayer money allocated for those workers and blow it on other stuff. It's the governmental equivalent
of stealing from your kids' college fund to buy lap dances. In Rhode Island, some cities have underfunded
pensions for decades. In certain years zero required dollars were contributed to the municipal pension
fund. "We'd be fine if they had made all of their contributions," says Stephen T. Day, retired president
of the Providence firefighters union. "Instead, after they took all that money, they're saying we're
broke. Are you fucking kidding me?"
There's an arcane but highly disturbing twist to the practice of not paying required contributions
into pension funds: The states that engage in this activity may also be committing securities fraud.
Why? Because if a city or state hasn't been making its required contributions, and this hasn't been
made plain to the ratings agencies, then that same city or state is actually concealing what in effect
are massive secret loans and is actually far more broke than it is representing to investors when it
goes out into the world and borrows money by issuing bonds.
... ... ...
Even worse, placement agents are also often paid by the alternative investors. In
California, the Apollo private-equity firm paid a former CalPERS board member named Alfred
Villalobos a staggering $48 million for help in securing investments from state pensions, and
Villalobos delivered, helping Apollo receive $3 billion of CalPERS money. Villalobos got
indicted in that affair, but only because he'd lied to Apollo about disclosing his fees to
CalPERS. Otherwise, despite the fact that this is in every way basically a crude kickback
scheme, there's no law at all against a placement agent taking money from a finance firm. The
Government Accountability Office has condemned the practice, but it goes on.
"It's a huge conflict of interest," says Siedle.
So when you invest your pension money in hedge funds, you might be paying a hundred times the
cost or more, you might be underperforming the market, you may be supporting political movements
against you, and you often have to pay what effectively is a bribe just for the privilege of
hiring your crappy overpaid money manager in the first place. What's not to like about
that? Who could complain?
Once upon a time, local corruption was easy. "It was votes for jobs," Doughty says with a sigh.
A ward would turn out for a councilman, the councilman would come back with jobs from
city-budget contracts – that was the deal. What's going on with public pensions is a more
confusing modern version of that local graft. With public budgets carefully scrutinized by
everyone from the press to regulators, the black box of pension funds makes it the only public
treasure left that's easy to steal. Politicians quietly borrow millions from these funds by not
paying their ARCs, and it's that money, plus the savings from cuts made to worker benefits in
the name of "emergency" pension reform, that pays for an apparently endless regime of corporate
tax breaks and handouts.
The Fed is targeting 2% inflation. The long-term spread between 10-year Treasuries and CPI is about
2.5% (the "real rate"). That gives 4.5% as a probable target for the 10-year bond.
It is easier to predict WHERE they will go than WHEN they will go, and near impossible to predict
both. We'll stick with WHERE in this letter, except to say we doubt rates will rise to "normal"
levels very rapidly because central banks will probably take measures to moderate the rate of change.
It seems to me that the Fed in the back of its mind is expecting 10-year Treasury rates to go
to the 4.0% to 5.0% range over the next year or two or maybe three. That would correspond to 30-year
mortgages in the range of 5.75% to 6.75% compared to nearly 4% today. The estimated Treasury rate
would also correspond to Baa corporate bonds at about 8%.
How do we estimate those rates? … just using long-term averages.
The Fed is targeting 2% inflation. The long-term spread between 10-year Treasuries and CPI is
about 2.5% (the "real rate"). That gives 4.5% as a probable target for the 10-year bond.
But more to the point, very few individual investors actually own the 10-year Treasury bond itself.
Instead, when they want fixed-income exposure, they buy a bond fund, which is likely to include
a wide variety of coupons, credits, and maturities. There are quite a few stock-pickers out there,
but there are precious few bond-pickers: bond investing is hard, boring, laborious work, and just
about all individual investors outsource it to someone else.
So, how are bond funds doing, during this torrid time for the fixed-income world? The chart above
shows how various popular bond funds have performed over the past 10 years; the main line shows
the fortunes of the $110 billion Vanguard Total Bond Market fund, an index fund which gives a pretty
good impression of how bond investors as a whole are doing. Its fortunes are more or less in line
with those of the Fidelity Total Bond fund, the Fidelity Spartan US bond fund, and the Pimco Total
Return fund.
... ... ...
Now it's true that over most of the period seen in the chart, rates were going down rather than
up. But it's not strictly true that if rates are going up then the value of your bond-fund holdings
is certain to go down. And even if you hold an index fund, I can tell you with 99% certainty
that you have no idea how much it might fall in value with any given rise in rates. Individual
investors neither can nor should be expected to do complex modified-duration calculations on their
fixed-income portfolios, let alone be able to add a credit-forecast overlay to such a thing.
The fact is that rising rates are, in general, a sign of improving economic fortunes - and that
they might well coincide with tightening credit spreads and greater economic activity, including
new corporate borrowing. Yes, they might also mean a reduction in bond prices, but that kind of
cost is easy to bear if it means a return to normality and growth in the rest of the economy, including
possibly in stock portfolios.
... ... ...
Even if your rate forecast is exactly right, there's still a good chance that your decision to
dump your bond funds might turn out to be a mistake.
In this interview, Brian Scott, a senior investment analyst in Vanguard's Investment Strategy Group,
discusses concerns about the bond market and explains why Vanguard believes bonds can play a crucial
diversification role in your portfolio, even in the event of a significant downturn.
We're getting
a lot of questions about whether bonds are headed for a bear market. What is a bond bear market,
and how is it different from a stock bear market?
It's an interesting question, because there is not a commonly accepted definition for a bear
market in bonds. The answer for stocks is a rather simple one. There is a widely accepted, broadly
used definition for a bear market in stocks, and that's a decline of at least 20% from peak to trough
in stocks.
Now, if you tried to use that definition and apply it to bonds, we've never had a bear market
in bonds. In fact, the worst 12-month return we've ever realized in the bond market was back in
September of 1974, when bonds declined 13.9%. So we've never had a decline of the same magnitude
as we've had in stocks, and I think that's one of the key differences between stocks and bonds.
Back to your original question then: What is a bear market in bonds? And, judging by investor
behavior and reaction to losses in bonds, I think the answer is simply any period of time wherein
you realize a negative return in bonds.
Is a bond bear market something we should be concerned about? If so, is there anything investors
can do to prepare?
We've a great deal of sympathy for the anxiety that investors feel about the bond market right
now. Typically, an investor that has an allocation to bonds-particularly those that have a large
allocation to bonds-tend to be more risk-averse and become more unsettled when they see negative
returns in any piece of their portfolio, let alone their total portfolio.
So we understand how unsettling this environment can be-and, in fact, we have actually realized
a negative return in bonds. If you're looking at the 12-month return through the end of June 2013,
bonds are now down about 0.7%-and when I say bonds, I'm referring to the Barclays U.S. Aggregate
[Bond] Index. So, by that definition, and if you use the definition of a bear market I applied earlier,
you could say-and some people have argued-that we are actually in a bear market in bonds.
And so it's unsettling; but, in times like these, what we encourage investors and their advisors
to do is to look at the total return of their portfolio. And I think they'll feel much more comfortable
when you take that perspective. As an example, an investor in
Vanguard's
Balanced Index Fund that has a mix of 60% U.S. stocks and 40% U.S. bonds realized a rate of
return of 12% through June 30, 2013. So a total return perspective is especially valuable in times
like this.
You recently co-wrote a research paper in which you note that in 2010, like today, investors
also believed rising interest rates would cause bond losses, but that didn't happen. Does the experience
of the last three years suggest anything about what investors should do now?
I think the last three years are very instructive and really impart a lot of lessons that investors
can find very valuable in times like this. So for a little bit of historical perspective, back in
about April/May of 2010, the yield on a
10-year Treasury note
was about 3.3%. That was a level that was probably lower than almost all investors have ever seen
in their investment lifetime. And you have to go back to August of 1957 to see yields as low as
they were back in May of 2010.
And I think that perspective alone caused many people to assume that interest rates had to rise.
And I think an important lesson from that environment and how the market actually reacted is that
the current level of interest rates tells us absolutely nothing about their future direction. Just
because yields are low doesn't mean that they can't go lower or that they must go higher. But at
any point, in May of 2010, if you looked at what the market was pricing in and looking at forward
yield curves, the market's expectation were that yields were going to rise, and the 10-year Treasury
yield was going to rise to a level slightly over 4%.
In fact, what actually happened is that yields fell to just over 1.4%-again, I'm referring to
the 10-year Treasury note. And if you had shortened the duration of your portfolio or moved your
bond portfolio entirely into cash, you lost a tremendous amount of income.
I think another important lesson is that making knee-jerk reactions in your portfolio can be
damaging over time and potentially even incur tax losses as well as higher transaction costs.
Do you have any thoughts about how to make the case that the smartest course of action is probably
no action, assuming a portfolio is already well constructed?
That's a hard thing to do, because in the face of what you think is an impending loss in your
portfolio, it's a very natural and even human reaction to feel like you have to do something. But
we would argue, very strongly, that investors are best served by not changing their asset allocation
unless some strategic element of their asset allocation has changed.
And, by that, I mean if your investment time horizon has changed, your investment objective has
changed, if you really have an enduring change in your risk tolerance, then perhaps it's worth altering
your strategic asset allocation. However, if those circumstances have not changed, you're probably
best served by maintaining the strategic asset allocation that you set.
What are some indicators that your risk tolerance may be changing?
If you have extreme anxiety-let's face it, if you can't sleep at night, perhaps it's worth asking
yourself whether your risk tolerance has changed. What we found-and we're not unique in this-is
that investors tend to have a high level of risk tolerance when times are good and then when capital
markets are delivering strong, positive returns. That changes sometimes over time. Now, we're not
suggesting that you should frequently change your portfolio, but if you're really having a high
level of anxiety over losses, perhaps it's worth becoming more conservative.
I think another way to react to the current environment is just to recognize the role that each
asset class has in your portfolio. Stocks are designed to deliver strong capital gains-ideally,
over the long term, above the rate of inflation so that you can grow your spending power over time.
The role of bonds-at least the primary role of bonds, in our minds-is to act as a cushion or balance
to stocks. Stocks tend to be much more volatile, much more prone to significant losses in bear markets
in excess of 20%, and, when that happens, bonds tend to be an ideal cushion against equity market
volatility.
It's very paradoxical. But perhaps, if you are feeling a higher level of anxiety because of the
volatility in the fixed income markets in particular, the right answer for you might actually be
a higher allocation to bonds. Because we actually think that because bonds are a good cushion to
equity market volatility, over the long term, a higher allocation to bonds will reduce the total
downside risk in your portfolio.
Investing can provoke strong emotions. In the face of market turmoil, some investors find themselves
making impulsive decisions or, conversely, becoming paralyzed, unable to implement an investment
strategy or to rebalance a portfolio as needed.
Discipline and perspective are qualities that
can help you remain committed to your long-term investment programs through periods of market uncertainty.
Well, that's certainly counterintuitive. Despite what you just said, your paper does ask the
question of whether investors should consider moving away from bonds.
Yeah, that's the most common question we're getting right now. There's a lot of interest in other
instruments that we're calling bond substitutes. Now, there's not necessarily anything wrong with
them. So I think the term might impose kind of a negative connotation on some of these bond substitutes,
but people are viewing other higher-yielding investments as a potential substitute for the high-quality
bonds in your portfolio.
Some of those substitutes that I'm referring to are things like dividend-paying stocks, some
high-yield bonds, floating-rate bonds, etc. And one of the things that we're really encouraging
investors to recognize is that, while these instruments have higher yields than high-quality bonds
like you get with the Barclays U.S. Aggregate [Bond] Index or certainly with Treasury bonds, they
do have a very different risk profile, particularly when equities are declining. When equities are
doing very poorly, many of these bond substitutes actually act a lot more like equities than bonds.
So it sounds like attempts to reach for income could end up depressing your overall returns.
Is that right?
Over the long term, we think the answer is absolutely yes, and we've done some work around this,
and we've modeled what we think will be forward-looking returns of portfolios over the long term
for balanced investors. And what we found is the higher your allocation is to equities, the larger
the downside risk in your portfolio is over time. And that's also true if you move away from high-quality
bonds and Treasury bonds, in particular, and invest your bond allocation in some of these bond substitutes
we've been talking about.
Older investors may be worried about generating income in a low interest rate environment.
Do you have any advice?
This may be the hardest question you've asked of all, because we have a tremendous amount of
sympathy for investors in this situation, those who are older-or, really, frankly, anyone who's
really dependent on their portfolio to produce income for them, to meet their current spending needs,
because you're absolutely right. The traditional answers to providing income-high-quality bonds-are
not providing the level of income that investors have grown accustomed to. We've actually referred
to these investors-and, really, maybe more appropriately call them savers-as a sacrificial lamb
of current monetary policy. The very low interest rate environment we're faced with has really imposed
a severe penalty on these savers.
And our answer is that if you choose to move away from the high-quality bonds into instruments
that will generate more income in your portfolio, you'll likely get more income over time, but you'll
also very likely experience a much higher level of volatility in that income stream. Of course,
the only other alternative is to reduce your spending, which perhaps is even harder to do than to
stomach lower levels of income for your portfolio. So there really is no easy answer.
Vanguard really emphasizes the idea of total return. Could you talk a little bit more about
that and what that means in light of what's happening in the bond market?
I think it goes back to not looking at each piece of your portfolio and the returns that they're
currently generating, but the return of your total portfolio overall. It's very rare that all assets
in your portfolio are delivering very strong returns at any point in time. In fact, you don't want
that if you're a balanced investor, because if you do have assets that are that highly correlated
in good times, chances are they'll be very highly correlated in bad times as well, and you'll realize
very sharp losses in declining equity markets. But ideally, if you have a balanced, diversified
approach to investing, you'll realize healthy rates of total return over time.
Taking short positions in US government bonds helped boost net assets in the
first half of the year at
RIT
Capital, Jacob Rothschild's listed investment trust.
"Recognising that US authorities would face difficulties in suppressing bond yields in the face
of an improving economy, we held short positions in government bonds during the period," said Lord
Rothschild, chairman.
"Bond markets tend to benefit from ageing populations relative to equity markets," says
Douglas Renwick, director at Fitch Ratings.
And the population in the industrialised world is ageing dramatically. While those over 65 accounted
for 12 per cent of the population in 1982, this has risen to 16 per cent now and is projected to
reach 25 per cent by 2042.
"We are at an inflection point," says Jonathan Willcocks, managing director at M&G Investments.
"Two thirds of investable assets in the western world are now owned by those over 50."
There are a lot of assets to shift. Around 70 per cent of all world equities are owned by mutual
funds and wealthy individuals, according to a white paper by the Network for Sustainable Financial
Markets, all of whom can shift their allocation.
Lutz has one key "tell" for investors trying to gauge the potential impact of the inevitable
mess created by our elected officials: Housing. The iShares US Home Construction ETF (ITB)
is down more than 16% in three months and nearing official bear market territory. If housing isn't
a black swan (it wouldn't be a shocking event), it's a canary in the coalmine. If housing fails
the whole economy could die in mortal peril.
"As Alan Greenspan said years ago, 'it begins and ends with housing,'" Lutz concludes. "If we
start losing control of rates all of the sudden what we're going to have is a collapse in the housing
market, GDP is going to start falling apart, employment, and then the collateral damage of consumer
spending because rates are going higher."
Buckle up, America. We could be in for yet another bumpy ride.
This is all sound and fury signifying NOTHING -- It is like baseball fans talking up their teams
chances---at the beginning of the season. There are a lot of teams competing at the beginning.
Then the field narrows until you get the playoffs, then the 'pennants' (league championships)
and final, only one is left standing after the World Series. It is the same with stocks and
bonds. Make sure that you put your money on the right ones.
First off, Gross manages a "Total return" fund. That means he Buy Bonds, or he can also buy
the TBT. He can buy TBT options. He can write TBT options. It is going to be THE place to be,
when the Fed starts unwinding 4 Trillion off their balance sheets.
Anyone who dismisses Bill
Gross, ought have their heads examined.
Rates can't go up for a long time if you don't have Wage Inflation. US Wages are declining.
The 10 Year might go above 3, but you will have the a huge recession again. Bonds are not
moving until US Government has borrowed every dime on the planet.
Two things. Fight the Fed and you will lose. guaranteed and why listen to a guy that has so
much bias. Wall Street was telling the investor to buy subprime tranche while shorting them
on the other side. Common sense prevail. Don't listen to this guy
As soon as someone comes along with as good of a track record as Bill Gross, then I'll pay attention
to their opinion, until then, I don't even care if Gross has a bad year or two.
The Fed has created this recovery based on printing money and it dare not stop. The national
debt is so huge that any return to the average interest rates on the past would bring another
great depression. The Fed has grasp the wolf by it's ears and dare not let go !
It isn't a matter of a bad year or two. Gross is a expert BOND FUND manager, who, like
the retired Bill Miller of the now totally mediocre (and interestingly re-named) Legg Mason
Value Trust, was in the right place at the right time. Gross had great, and unexpected success
riding one of the longest bond cycles in recorded history. Bully for him!
But like all excesses, there is a reversion to the mean, which appears to be increasingly the
case with bond yields. The point is, if you "stick" with a bond cycle that is going against
you, and take away the artificially-manipulated interest rate environment which the planet's
central banks have orchestrated in order to create breathing room for a nascent, and increasingly
obvious credit recovery, you can be stuck for a long, long time (how about 30 years, with hiccups,
in the opposite direction?) in a fund that is now resting on increasingly brittle laurels.
Throw in some additional leverage and positions in derivatives to make it appear that the reported
investment returns are simply the result of just buying and selling and holding fixed-income
investments, and you may have an explosive and implosive mix of unforeseen interest rate, credit
quality, duration, geopolitical and currency risk in your portfolio.
General take away: don't assume that the Federal Reserve will not remove the punch bowl because
conventional, popular media sycophants say it can't. Interestingly, while bond funds generally
have done "ok" at preserving principal over the last 5 years (except for the last 6 months),
if you had had the gumption and understanding of business trends and market psychology to move
strongly into equities in the early spring of 2009, your returns in equities would exceed 130%
from then. In the final analysis, Gross, like his counterparts and predecessors, can't publicly
say "don't buy my fund - rates are going higher" - even he, I suspect, would be fired - or at
least muzzled. Anyway it's not a war, it's a open-ended game.
In financial markets one person's loss is another's gain. Pimco's losses have created
bullish market for individual bond holders. As Pimco has to sell to meet redemptions, I've been
able to purchase high quality bonds at a steep discount. Keep it up Bill!
The bond market will be a bumpy ride for a couple of years before it settles out and becomes
a attractive again. In the long run I would have a hard time betting against Bill Gross.
It was the Federal Reserve (who Gross despises) who lowered real interest rates to artificially
low levels that made Gross look smart. As the artificially low interest rates drove bond prices
higher he looked brilliant. My money is against Gross and in equities.
"There's an age-old cycle that happens, where you have periods of easy money, and certain
sectors of our economy gorge on the easy credit, and then invariably, when rates start to rise and
the economy slows, whoever has been gorging on that easy credit gets into trouble, the economy falters
and markets go down," Hochberg says in the attached video.
Of particular concern to him are emerging markets, sovereign debt, municipal bonds and student
loans, the latter of which is increasingly in the spotlight as recent college graduates face huge
debt and weak jobs prospects.
I frame the debate as fantasy vs reality. The bull arguments are all based on fantasy, backed
up by accounting that would land any private citizen in jail.
You can either be a bull living in la la land, or a bear living in reality. Reality isn't
very fun, but it is REALITY.
Or are we really to believe that a company that loses millions on billions in revenue is
a sound investment.
Try paying bills with that type of a system. Call your bank and tell them that you made $60k
but you can't make your mortgage payment because you spent all your money. But instead of cash
they can accept shares of yourself. Which are better than money because if your value goes up,
the value of their shares will go up. Which will actually be worth more than your original mortgage
payment.
The entire stock market system is bullshit. A system engineered to transfer wealth from
people of worth to people of no worth.
Why do you buy stock?
Does the company offer a dividend, no.
Is the company buying back shares, no.
So why are the shares worth something?
Answer: Because you believe someone else will pay more for the shares sometime in the future.
But why are the shares worth more? If the company has no profit, how can the company be worth
more money?
starman
Myth: U.S. stocks will grow into their earnings expectations as the U.S. economies
recover
Im hoping the same for my dick for years.
NOTaREALmerican
Stocks will go up until something TBTF (or nearly so) actually does (nearly) fail.
Until that event, the optimistic speculators will keep winning by buying stocks (or houses).
While they won't say it I'd bet the Fed is also looking a combination of Federal revenue
and revenue from income. One of the reasons for buying treasuries is to keep the cost of debt
and deficits low. If those look to rise again on weak revenue the Fed will have little choice
but to continue sopping up the excess.
arthur_dent
using some kind of reasoned argument for justifying Fed monetary policy is humorous at best.
Tommy Vu
adornosghost:
Actually I'm in awe of what Ben has pulled off.
Lit the fuse for the Arab Spring and all that has followed. Cheney's proud
Tommy Vu wrote on Sun, 8/4/2013 - 8:19 am (in reply to...)
Tommy Vu wrote:
Lit the fuse for the Arab Spring and all that has followed.
"What has happened in Tunisia, is happening right now in Egypt, but also riots in Morocco,
Algeria and Pakistan, are related not only to high unemployment rates and to income and
wealth inequality, but also to this very sharp rise in food and commodity prices," Roubini
said.
The mortgage markets seem to agree as spreads over the 10y are starting to close.
1 currency now -yogi
arthur_dent wrote:
using some kind of reasoned argument for justifying Fed monetary policy is humorous at best.
but disgusting and immoral at worst.
obj
Rob Dawg wrote:
Looks like the Fed has for now decided 10y 2.75, 30y 3.375 is as much as the economy
can stand.
Daily Treasury Yield Curve Rates
The mortgage markets seem to agree as spreads over the 10y are starting to close.
I think the hoopla over yields rising, the crushing of bond owners by yields rising, and
hyper-inflation is over for a little while.
arthur_dent
traderwalt:
Or would you rather have the economy crash again
although a free market is an ideal, something close to it is likely better than the alternative.
That means taking the good with the bad. Whenever we place very powerful economic controls in
the hands of a few they get abused, it is just human nature to favor ones own class or group.
It is understandable that one wants their own assets to be protected on the downside but left
to run on the upside, a very utopian view of life, and maybe just a bit reptilian in the sense
of sheer greed.
So if we are to have a "crash" (caused in large part by the very forces you seem to credit
with saving you) then I say let the chips fall where thy may. If a person so manages their own
affairs to avoid leverage and speculation, preserving capital, then if they are in a position
to "pick up the pieces" as you say, then I say more power to them. It seems the very essence
of capitalism that the more sober parts stand ready to add balance on the downside when it does
occur.
1 currency now -yogi:
traderwalt wrote:
the economy crash
You mean the stock markets, not the economy. You're a trader, remember?
robj
arthur_dent wrote:
So if we are to have a "crash"(caused in large part by the very forces you seem to credit
with saving you) then I say let the chips fall where thy may. If a person so manages their
own affairs to avoid leverage and speculation, preserving capital, then if they are in a
position to "pick up the pieces" as you say, then I say more power to them. It seems the
very essence of capitalism that the more sober parts stand ready to add balance on the downside
when it does occur.
I'm more concerned about the impact to the bottom 50%, given that we keep gnawing off the
wheels of the "support" unicycle. Not ass-ets.
Tommy Vu
"Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many
households and businesses, and it adds to household wealth by keeping asset prices higher
than they otherwise would be."
Where he got it: Obamacare Full Frontal: Of 953,000 Jobs Created In 2013, 77%, Or 731,000
Are Part-Time Submitted by Tyler Durden on 08/02/2013 09:04 -0400
Quantitative easing is nothing but "competitive devaluation," Kyle Bass begins this
brief but wide-ranging interview; and while no central bank can explicitly expose the 'beggar thy
neighbor' policy, they are well aware (and 'banking on') the fact that secondary or tertiary effects
will lead to devaluing their currency. The bottom line, Bass warns, is "when the globe is
at 360% credit market debt-to-GDP, there is no real way out." Furthermore, the winds of
austerity have already blown (simply put no nation engaged in austerity prospectively - for the
nation's betterment - they were forced by the bond markets) and with central bankers now dominant
- the Krugman-esque mentality of "let's just keep going," is very much in the driver's
seat since politicians now see "no consequence for fiscal profligacy." The average
investor, Bass adds, "is at the mercy of the central bank puppeteers," as the Fed's policies are
forcing mom-and-pop to "put their money in the wrong place at the wrong time." There will be consequences
for that... there is only one way this will end... "and investors should be really careful
doing what the central bankers want them to do."
Rob Dawg wrote on Sun, 7/14/2013 - 7:39 pm (in reply to...)
josap wrote:
Growth in spending on machinery and investment by the world's 2,000 biggest companies
has begun to contract for the first time since the Lehman crisis, led by sharp falls in
China and a near collapse in Latin America.
Everyone is hoarding cash in anticipation of picking up future assets for pennies on the
dollar.
robj wrote on Sun, 7/14/2013 - 7:40 pm (in reply to...)
josap wrote:
Growth in spending on machinery and investment by the world's 2,000 biggest companies
has begun to contract for the first time since the Lehman crisis, led by sharp falls in
China and a near collapse in Latin America.
The collapse in LA has been registered in the Fidelity fund over the last year. China and
the US are the keys for the world economy, which is why I think the austerians are FOS.
This is still like the GD1 and Fortress America, in my view. We should be spending on infrastructure,
but I'm speaking to the converted, mostly. I'm going to be pissed when we do necessary infrastructure
spending at rates 2x higher than now.
Rob Dawg wrote on Sun, 7/14/2013 - 7:54 pm (in reply to...)
robj wrote:
We should be spending on infrastructure, but I'm speaking to the converted, mostly.
I'm going to be pissed when we do necessary infrastructure spending at rates 2x higher than
now.
Sadly by the time we wise up delayed repairs will eat up far more than 2x and we we still
be losing ground.
Don't Get Sucked In in the most important strategy during the bubble. And it is the most difficult
to implement. Bond squeeze already started. It come to crescendo on June 20
There can be no doubt that the global growth, earnings, incomes and fundamental story remains
very subdued. But at the same time financial markets, hooked on central bank 'heroin', have
created an enormous and – in the long run – untenable gap between themselves and the
real economy's fundamentals. This gap is getting to dangerous levels,
with positioning, sentiment, speculation, margin and leverage running at levels unseen since
2006/2007. 'Tapering' is going to happen. It will be gentle, it will be well
telegraphed, and the key will be to avoid a major shock to the real economy. But the Fed
is NOT going to taper because the economy is too strong or because we have sustained core (wage)
inflation, or because we have full employment - none of these conditions will be seen for some
years to come. Rather, we feel that the Fed is going to taper because it is getting very fearful
that it is creating a number of significant and dangerous leverage driven speculative bubbles
that could threaten the financial stability of the US. In central bank speak, the
Fed has likely come to the point where it feels the costs now outweigh the benefits of more
policy.
A – At best I give myself 5 out of 10 in terms of the accuracy of my main tactical
call detailed in the above note. The S&P rallied to 1597 in early April, and then sold off 63
points (4%) to 1534 in Q2 before recovering. I was looking for a 5% to 10% sell-off from 1575
to around 1450/1475.
B – I score myself more highly for the 2nd key call I made back in March, which was that
once we cleared a consecutive weekly close above 1575 in the S&P, we'd see new nominal all-time
highs with the S&P trading in the high 1600s. I had thought we'd get there in Q3, but as it
happens we have seen a (to date) Q2 high print of 1687 (22nd May). So maybe that deserves 7
out of 10? My sense that positioning and sentiment was set-up to get to extremes and chase/buy
any dip seems to have played out pretty well.
C – The 3rd and last main call I made was that – based on (poor) fundamentals, (in my view)
dangerously loose global central bank policy settings, increasing complacency towards risk and
blind faith in central bank 'puts' amongst investors, and the sense that positioning and sentiment
can and needs to be at (even more) absolute extremes as a pre-condition to any major market
move – it would not be until late 2013 or early 2014 before we see the onset of the next major
(-25% to -50%) bear market. Time will reveal all on this call, but for now I continue to hold
this view.
D – To clarify further, I feel that the current dip that began with
the S&P at 1687 in late-May, sparked by moves in rates and rates volatility in Japan and by
the Fed 'taper' talk, is not the big one. Risk became way overbought from late 2012
and through the first 5 months of 2013, so a 5% to 10% correction (see A above) in, for
example, the S&P (from 1687) should and will, I think, be considered normal and healthy – and
will be a dip that is also bought (into C above)
Of course things change all the time and I would have to be an (even bigger than usual) idiot
to ignore all the Fed 'taper' and Japan talk.
Here is what I think matters:
1 – There can be no doubt in my view that the global growth, earnings, incomes
and fundamental story remains very subdued. But at the same time financial markets, hooked on central
bank 'heroin', have created an enormous and – in the long run – untenable gap between themselves
and the real economy's fundamentals. This gap is getting to dangerous levels, with positioning,
sentiment, speculation, margin and leverage running at levels unseen since 2006/2007.
2 – The Fed knows all this. The Fed also knows that it was held at least partially responsible
for creating and blowing up the bubble that burst spectacularly upon us all in 2007/2008. But
very importantly, the Fed now has explicit and pretty much full responsibility for regulation
of the banking and financial sector.
3 – As such, and as discussed by Jeremy Stein in February (remember, Mr. Stein is a Member of
the Board of Governors of the Fed), the Fed now de facto has a new duel mandate based on
(the trade-off between) what I'd call Nominal GDP (or macro-economic stability), and Financial Sector
Stability (or what I'd simply label as system-wide 'leverage' levels).
4 – This means first and foremost that while growth, inflation and unemployment all matter
a great deal, the Fed cannot now either allow, or be perceived to allow, the creation of any kind
of excessive leverage driven speculative (asset) bubbles which, if they collapse, go on to threaten
the financial stability of the US. Imagine if this Fed were to allow a major asset bubble
to blow up and then burst anytime soon (say within the next two or three years). This time round
Congress and the people of the US would be able to place the entire blame on the Fed – probably
with some justification – and, if the fallout approached anything like that seen in 2008, then it
would mean, in my view, the end of the Fed as we currently know it.
5 – Turkey's do not vote for Christmas, nor is Chairman Bernanke or any other member of the Fed
willing, in my view, to take such a risk. Back in Greenspan's day he could always blame asset bubbles
on someone else – even though leverage either in and/or facilitated by the banking/finance sector
is always at the heart of every asset bubble. But this get-out has now explicitly been removed from
the list of options open to the Fed going forward.
6 – So for me, 'tapering' is going to happen. It will be gentle, it will be well telegraphed,
and the key will be to avoid a major shock to the real economy. But the Fed is NOT going to taper
because the economy is too strong or because we have sustained core (wage) inflation, or because
we have full employment - none of these conditions will be seen for some years to come.
Rather, I feel that the Fed is going to taper because it is getting very fearful that it is
creating a number of significant and dangerous leverage driven speculative bubbles that could threaten
the financial stability of the US. In central bank speak, the Fed has likely come to
the point where it feels the costs now outweigh the benefits of more policy.
7 - As part of this, the lack of sustainable growth in the US (much above the weak trend growth
of 1% to 2% pa in real GDP which has been the case for some years now) is very telling. And, while
I can't be 100% certain, at least some members of the Fed and other central bankers must
be looking with concern at recent developments in Japan whereby the BoJ's independence has, for
all practical purposes, been consigned to history, and which has a two decade head start with respect
to QE. At least some members of the Fed may be worrying about the future of the Fed and the US if
they persist with treating emergency and highly experimental policy settings as the new normal.
8 – The Fed will hope that markets heed its message and that we gradually, through the
normalization of yields (in the belly of the curve) and rates volatility (higher!), move aggressively
over optimistic financial market asset valuations somewhat closer to what is justified by rational
and sustainable real economic fundamental metrics. Rather than being based on some circular
and self-serving 'risk premium' delusion, which is almost completely predicated on the bogus time-inconsistent
assumption of a continuous and never to be removed Fed/central bank put on yields and rates volatility.
9 – The sad likelihood is that markets – which are suffering from an acute form of Stockholm
Syndrome - will listen and react too little too late. This could give us the large 25%
to 50% bear market I expect to see beginning in late 2013 or early 2014, rather than a more gradual
correction. In part, this is because markets will not believe – until it is too late – that the
Fed is actually taking away its goodies. Further, it's because positioning and sentiment among investors
just always seems to go to extremes, way beyond most rational expectations, before they correct
in spectacular style. Think Chuck Prince and his dancing shoes.
10 - Crucially I suspect that the Fed will be so conflicted/whip-sawed by, and suitably
vague in its response to data that it ends up watering down its tapering message a little too often
and a little too much, thus encouraging one or two more rounds of 'buying the dip'. This
would reflect the new dual FED mandate and because we are living through an enormous and never seen
before global policy 'experiment'. Furthermore, we are probably going to see Bernanke be replaced
come January 2014. I don't actually think it matters who will replace him – anyone different is
a risk and a new uncertainty for the market. In the unlikely event that Bernanke signs up for another
term, I don't think that the coming shifts and changes will be reversed, but I tend to feel that
the transition phase would be a little less fraught with risk and volatility, as Chairman Bernanke
has credibility and the confidence of the market.
11 – So, going back to C & D above, we can certainly see a dip or two between now and
the final top/the final turn. But it may take until 2014 (Q1?) before we get the true onset of a
major -25% to -50% bear market in stocks. We also need to be cognizant of the Abe/BoJ developments.
Along with the Fed, 'Japan' is one of the two major global risk reward drivers. The ECB response
to (core) deflation and the German elections, and weakening Chinese & EM growth and the indebtedness
of China & EM, will also matter a great deal.
As of today, my best guess is at least one major dip around Q2/Q3 (we may be in the middle
of it now) as we seek more clarity around all of these drivers. My initial line in the sand for
this dip is around S&P at 1530 and my major line is at S&P at 1450. A weekly close below 1450 S&P,
in particular, would be extremely bearish. But I expect at least one more major buying of the dip
come (late) Q3/Q4.I would not be surprised if we saw the S&P not just back up in the high 1600s,
but perhaps even a 100 points higher (close to 1800!) before the next major bear market begins.
It depends on who says what, and on the levels of extreme speculation and leverage. In other words,
did we collectively learn our lesson from the events leading up to and including the global 07/08
crash? My 25+ years in financial markets lead me to believe, sadly, that the answer is almost certainly
NO.
What I do know is that the longer we wait and the longer we put our faith in a set of
time-inconsistent policies the greater the fallout will be from the forced unwind of the resulting
speculative leverage extreme. This would come once the cost and availability of capital
(i.e., rates volatility) 'normalizes'. It would follow current policies that seek to force a mis-allocation
of capital by mis-pricing the cost and availability of capital. I am confident that view is a correct
read of the current state of affairs . And I think the Fed is telling us that they know this too.
Ignoring this seemingly transparent signal from the Fed – by, for example, believing that the Fed
will not have the courage to taper, or that the BoJ and/or ECB can replace or even out do the Fed
over the next year or so - could prove to be extremely dangerous for investors.
We are (I think) in a new volatility paradigm
now. Cash will increasingly become King over the next year, even if I do still expect another
round or two of dips that get bought during this period. Not getting too sucked in and/or too long
illiquidity and/or overly invested in high-beta risks should all be avoided. Nimble tactical trading
of risk should be the rule. An increasing focus on de-risking core balance sheet/portfolio should,
over the next 12/18 months, hopefully set one up to take advantage of what I think will be another
savage bear market in global risk assets over most of 2014.
If cash is too safe, then safety should be sought in the strongest balance sheets,
whether one is investing in bonds, in credit, in currencies and/or in stocks. And, as a rule of
thumb, (and excluding real house prices in the US) those things that have 'gone up the most'
over the past few years are likely to be the things that 'go down' the most – so as well as equities,
EM investors also need to be very careful.
If there is no housing recovery, there is no recovery, as old structural problems were not solved
and there is no any technical breakthrough that could propel the economy and improve employment picture
in the absence of structural reforms. There is no political force that can attack financial oligarchy.
Let's start with the oldest economics joke in the book: "assume there is a housing recovery."
Ok, let's assume that.
So, applying logic, wouldn't consumers be actively buying furniture for their brand new homes,
instead of furniture sales
not only declining for the past year but posting the first negative print since January 2011,
and the Great Financial Crisis before that?
... Because we are confused.
And here are some additional thoughts on the issue of the housing recovery via Doug Kass:
I expect last week's "rally" in applications will be short lived relative to history.
Here is why:
Home affordability is overstated today when compared to the last cycle.
The bubble from 2003-2007 was all about "leverage-in-finance", I.e.: popular, exotic loan
products of each period, terms, allowable DTI, documentation type, start/qualifying interest
rates etc. For example, from 2003 to '05 a 5/1 interest only loan allowed 50% DTI qualifying
at interest only payments. From 2006 to '07 Pay Option ARMs allowed 55% DTI at a 1.25% start
rate.
This made the "cost" of buying a house HALF of what it is today.
Then when the leverage-in-finance all went away during a short period of time from late-2007
to mid-2008 house prices quickly "reset" to what people could afford to pay on a fundamental
basis...30-year fixed mortgages, fully documented, 45% DTI, at a 6% interest rate.
Because 70%+ of homebuyers use mortgage loans -- and the monthly payment trumps the "purchase
price" of the house with respect to purchase ability and decisioning -- then it stands to reason
that the monthly payment rate of popular loan types of each period relative to house prices
would determine whether or not house prices are once again bubbly.
Bottom Line: the popular loan programs during the bubble years -- which allowed for
rapid and large house price appreciation -- were not 30-year fixed loans like today. Rather,
exotic interest only loans, negative amortizing Pay Option ARMs and high CLTV HELOCs. Thus,
comparing the "affordability" of houses using today's 30-year rates and program guidelines vs
30-year rates and guidelines from 2003 to 2007 is apples to oranges.
Based on "cost of ownership" for the 70% who need a mortgage loan to buy, CA houses are more
expensive today than from 2003 to 2007. This is why first-timer buyer volume has plunged
to 4-year lows recently. And if not for the incremental buyer & price pusher -- the institutional
"buy and rent or flip "investor" that routinely pays 10% to 20% over the purchase price / appraised
value treating a house like a high-yield bond -- present house prices cannot be supported.
On this basis, back in 2006 a $555k house "cost" as much as a $325k house does today.
Economy remain sluggish. 1% for Q2. Bernanke will wait to taper. Clearly we see that markets are
moving just by speculation of what FED will do. There is a lot of active players who will go out for
the summers. Market is driven by short time traders. It is just reaction to expectation not by the actions
by FED. China is an uncertainty now. Production data, manufacturing data are soft. That is about hedge
funds getting out. A lot of dislocation in market as a result. That might be the worst year as for fiscal
cuts.
Michelle Meyer, senior U.S. economist at Bank of America, and Robert Sinche, global strategist
at Pierpont Securities Holdings LLC, talk about the outlook for the U.S. economy, markets and Federal
Reserve policy. They speak with Scarlet Fu, Tom Keene and Alix Steel on Bloomberg Television's "Surveillance."
Current drop might be a test run. Bonds will return in Q3. FED want to do it very slowly. By slowing
the rate of purchaces (tapering). They want to do it very slowly starting in 2014. We see massive swings,
especially in emerging markets. Nobody knows what will happen but FED does not want to increase amplitude
of those moves. FED managed to rally the market despite absence of growth. There obviously
will be adjustment in bonds as interest rate might change.
June 13 | Bloomberg
Bank of Israel Governor Stanley Fischer discusses the U.S. economy, Federal Reserve and Bank
of Japan monetary policy, and the shekel.
He talks with Francine Lacqua and Elliott Gotkine on Bloomberg Television's "The Pulse." (Source:
Bloomberg)
Yield for 30 bond will remain low as economy remains weak. People were living in a dream work. They
went for yield. They will be world. If people look at the reality they will see disconnect. Emerging
market and junk might disappoint. People are ignoring default risk.
Gary Shilling, president of A. Gary Shilling & Co. and a Bloomberg View columnist, talks about
Federal Reserve policy, the U.S. economy and bond market. He talks with Tom Keene and Sara Eisen
on Bloomberg Television's "Surveillance." (Shilling is a Bloomberg View columnist. The opinions
expressed are his own. Source: Bloomberg)
Yield for 30 bond will remain low as economy remains weak. People were living in a dream work.
They went for yield. They will be world. If people look at the reality they will see disconnect.
Emerging market and junk might disappoint.
Shilling believes that we have a decade or more of continued deleveraging in front of us, and with
it a period of lower than expected growth and deflation. "you have to adopt a tactical approach
to investing. Take advantage of rallies when you see them, but be prepared to take profits.
In a period of deleveraging, you win by not losing."
Given the strong rebound in the equity markets since March 2009, "most investors believe
that 2008 was simply a bad dream from which they've now awoken," starts Gary Shilling in his
newly-released tome on deflation, The Age of Deleveraging. "But the optimists don't seem to
realize that the good life and rapid growth that started in the early 1980s was fueled by massive
financial leveraging and excessive debt, first in the global financial sector, starting in the
1970s, and later among U.S. consumers. That leverage propelled the dot-come stock bubble in
the late 1990s and then the housing bubble."
Dr. Shilling has had a long and wildly successful career as an economic forecaster. Shilling
was one of the few voices of reason that foresaw the busting of the Japanese bubble of the late
1980s, and he also correctly forecasted the bursting of the 1990s Internet bubble and the mid-2000s
housing and financial sector bubble. I am delighted to find him on "our" side of the inflation/deflation
debate.
It can be a bit lonely here in the deflation camp. Despite the fact that official CPI inflation
has been tepid at best for the past three years and that retailers still have practically no
pricing power, there is widespread belief that high or even hyper inflation is just around the
corner due to the Federal Reserve's aggressive quantitative easing.
Essentially, the inflationist camp is making the mistake of believing that the pre-WWII Weimar
German Republic is an accurate representation of our own conditions today. Why? Because it is
example that is often cited in popular economics books and it is thus fresh on their minds.
But a better understanding of history would tell you that 1990s Japan is a far better representation
than 1920s Germany. Japan, like America, had a massive real estate and consumer spending bubble
fueled by easy credit. Weimar Germany's inflationary spiral was a result of unplayable war reparations.
Which would seem a closer parallel to you?
Similarly, the inflationists see confirmation that inflation is "everywhere" when they see
prices for fuel and agricultural commodities rising--yet they ignore the fact that food prices
have risen primarily due to supply-shock factors (i.e. exceptionally bad harvests in Russia
and elsewhere due to extreme weather) and that energy prices are manipulated by both speculators
and the OPEC cartel.
They simultaneously ignore the fact that retail prices of services and manufactured goods
continue to fall, as do housing prices. Furthermore, the bursting of asset bubbles is virtually
always followed by a long period of deflation. Gary Shilling understands this.
Shilling believes that as a result, we have a decade or more of continued deleveraging
in front of us, and with it a period of lower than expected growth and deflation.
All About Deflation
On the federal deficit and its implications, Shilling writes,
"With the prospect of huge federal deficits for the next several years, why won't significant
inflation follow? After all, excessive government spending is the root of inflation.
Still, it's excessive only if the economy is already fully employed, as in wartime.
And that's not the case now, nor is it likely in the slow economic growth years ahead. The
continuing $1 trillion deficits result from a sluggish economy, which retards revenues and
hypes government spending."
Ditto, Gary. Dr. Shilling, though not a demographic expert by any stretch, does understand
what demographic trends imply. On the Boomers he writes,
"A saving spree in the next decade will also be encouraged by [Baby Boomer] saving. Those
79 million born between 1946 and 1964 haven't saved much, like most other Americans, and
they accounted for about half the total U.S. consumer spending in the 1990s. But they need
to save as they look retirement in the teeth... Postwar babies need to save not only
to finance retirement but to repay debt.
The Fed's 2007 Survey of Consumer Finance found that 55 percent of households with
members aged 55-64 had mortgages on their abodes and 45 percent carried credit card balances."
Yet while he sees the importance of demographics, he also misunderstands them. Shilling
falls into the trap that so many others--Dr. Jeremy Siegel and Fed Chairman Ben Bernanke among
them--fall into. There is this persistent belief that the retirement of the Boomers will cause
a labor shortage that will lead to severe inflation. As Shilling writes,
"When [the Boomers] stop working, the supply of goods and services would fall. In retirement,
they might spend less on themselves and on supporting their kids, and they might have lots
of greenbacks... Nevertheless, there would not be enough goods and services to go around."
While this argument might make intuitive sense at first, it is fundamentally flawed. Outside
of medical care and select few other industries, spending falls on virtually all other consumer
items in retirement. Yes, the elderly still have to eat. But they buy little else that contributes
meaningfully to inflation.
This is not purely an academic argument. Japan has been struggling with an aging and
even declining population for years now. And Japan would love to have an inflation problem.
Instead, deflation persists.
You see, supply is not the problem. In the post-industrial information and high-tech economy,
supply takes care of itself. Is it expensive to hire a housekeeper? No problem, buy an iRobot
Rhoomba to vacuum the carpet while you're at work. Is your tax accountant expensive? No problem,
fire him and buy TurboTax.
In the modern economy, automation and technology can make a good deal of human labor
obsolete. We bring in migrant labor to harvest crops because migrant labor is cheap. But
if the price of migrant labor got high enough, rest assured that California farmers would use
robots to pick strawberries. This is not idle conjecture; their counterparts in Japan already
do.
Demand will determine if we have inflation or deflation, not supply.
Concluding Remarks
In The Age of Deleveraging, Dr. Shilling has published a very good and very convincing body
of work. A world economy dominated by deleveraging is a very different animal than a world economy
dominated by an accumulation of debts.
As investors, you have to position your portfolios accordingly and -- I want to be firm on
this point -- you have to adopt a tactical approach to investing. Take advantage
of rallies when you see them, but be prepared to take profits. In a period of deleveraging,
you win by not losing.
I have mixed feelings about this book. I suspect that you will either love it or hate it if
you have strong predictions of deflation or inflation, respectively. For the rest of us who
aren't sure and are reading around, this is a good read but isn't entirely convincing.
Let
me just start by saying that Shilling points out in a number of places in the book that he is
a top-down economist, predicting first the macroeconomic environment with interest rates, and
then moving down to their effects on individual sectors. My trouble with this approach is that
top-down theories are interesting to read about, as they lay out a framework for thinking about
the economy and "what-if" scenarios... but they're known to be unreliable at predicting what
will happen. This is probably why Shilling spends so much time at the beginning of the book
tooting his own horn about his past predictions. Nonetheless, I hear that he has made a number
of gravely inaccurate predictions as well - see for example his book on deflation from the late
90s, I believe. Anyway, past performance, even if perfect, is no guarantee of future results.
(As an aside, the top-down, as opposed to the fundamental bottom-up, approach introduces many
data points that can significantly skew the end result by compounding small errors along the
way.
Consider that many good investors - people who actually intend to make money, as opposed
to economists and academics -, like the Buffet clan, continually reiterate that no one can predict
the markets, even with perfect economic information.)
Which brings me to my point: it seems to me that the case Shilling lays out isn't as
strong as it may seem, even if there is a lot of supporting "evidence. ..."
I feel much of this evidence is circumstantial;
it's all good in isolation, but taken together it doesn't really give strong proof that the
world is in a deflationary mode. Here's how he lays out the book. In general, he devotes much
of the book to a history of the market and various economic environments. Now I admit it's
a truly fascinating read for economic history buffs. He then launches into a very good conversation
about P/E ratio compression.
He makes the common argument, which I entirely
buy, that bear markets are often bear because P/Es continually compress more than earnings
can grow, putting pressure on the market. Fair enough. He incorporates various comments
about interest rate regimes, the earnings yield on bonds vs stocks over the last 30 yrs, and
a broad conversation about what that means. He also talks about foreign countries and their
economic policies, notably China and the Chinese growth myth. His conclusion, then, due
to compressing P/Es and various macroeconomic factors, including low interest rates, is that
deflation will rein supreme over the next 10 yrs. He then makes some investment recommendations.
All this data and analysis makes for very interesting reading, but the sum does not necessarily
add up to deflation. Possibly, it adds up to a bunch of stagflation, maybe some low growth,
and some p/e compression. But he somehow continually ends up with a number of 2-3% deflation
per annum over 10 years that seems unjustifed by the large amount of "evidence." Along these
lines, he is obsessed with the long bond and is predicting much further appreciation in bonds,
stating for example that the 3.x% yield can still go down to 2.x%, for an almost 20% appreciation.
However, just recently, and shortly after publication of the book, the yields on the long bond
rose substantially after QE2, and there is great argument in the community about what this rise
means. He ends the book by issuing some investment recommendations that seem very reasonable
given his deflation hypothesis.
As someone who is on the fence and looking for more info with an open mind, this book did
not convince me about the future of deflation - not even whether deflation exists now or not.
I think I would have liked to have seen some more specific analysis of how QE is working (or
not working) and why it's doing what it's doing compared to other inflationary or deflationary
periods. But providing me with general scenarios of history and a jump to a conclusion of deflation
is, while highly interesting from an academic perspective, not good enough for me to put money
on, which is ultimately the point of the book.
All in all, this was an interesting read, a good history, and good theory; but an amalgam
of lots of data does not necessarily end in a cogent, well-constructed argument, and it left
me questioning his argument.
All this data and analysis makes for very interesting
reading, but the sum does not necessarily add up to deflation. Possibly, it adds up to a
bunch of stagflation, maybe some low growth, and some p/e compression. But he somehow continually
ends up with a number of 2-3% deflation per annum over 10 years that seems unjustified by the
large amount of "evidence." Along these lines, he is obsessed with the long bond and is predicting
much further appreciation in bonds, stating for example that the 3.x% yield can still go down
to 2.x%, for an almost 20% appreciation. However, just recently, and shortly after publication
of the book, the yields on the long bond rose substantially after QE2, and there is great argument
in the community about what this rise means. He ends the book by issuing some investment recommendations
that seem very reasonable given his deflation hypothesis.
As someone who is on the fence and looking
for more info with an open mind, this book did not convince me about the future of deflation
- not even whether deflation exists now or not. I think I would have liked to have seen
some more specific analysis of how QE is working (or not working) and why it's doing what it's
doing compared to other inflationary or deflationary periods. But providing me with general
scenarios of history and a jump to a conclusion of deflation is, while highly interesting from
an academic perspective, not good enough for me to put money on, which is ultimately the point
of the book.
All in all, this was an interesting read, a good
history, and good theory; but an amalgam of lots of data does not necessarily end in a cogent,
well-constructed argument, and it left me questioning his argument.
I am not familiar
with Schilling but he manages money and writes a newsletter from a quick perusal of his website.
However, the book states that he does not yet manage money (but he is already a bit old). The
book is really in three parts:
The first third of the books deals with recommendations the author made to his clients
roughly from 1988 to 2008. Clearly the author is a bit full of himself here. That is allowed
because he seems to have made some good calls. I suppose the author needs to establish his
track record somehow. However, most people wouldn't find this section terribly interesting.
At least the author has made a decent job editing the text, which presumably originates
from his newsletter. However, the section might be interesting for life-long students that
want to understand the author's thought process in more detail. For those a key problem
is that he only discusses his successful predictions. Maybe he has loads of predictions
that didn't pan out. So while there is value in history, this section is problematic.
The second third deals with themes that currently preoccupies the author. We are
not going to see anything like the bull market which lasted from 1982 to 2000. Instead we'll
get deflation. This discussion is quite interesting. However, this is a contrarian
viewpoint so I would really have liked more depth and crispness in the arguments. He
should also address the contents of his 1998 book called "Deflation", because if he has
called "deflation" for over a decade her will lose credibility.
The final third deals with investment recommendations for the next decade. I'm not terribly
impressed by this section. Some of these recommendations are a bit naive, like don't buy
antiques because they're illiquid.... Other
ideas are clearly more serious, like buy consumer staples stocks. The nagging question
is that I don't know if the author still keeps his best ideas exclusive to his newsletter
subscribers. I would have liked the author to raise this issue himself.
The language is not very technical at all. I
think most people who end up reading my review can easily read the book. Personally I find the
book very verbose. He is kind of writing to a not-so-knowledgeable wealthy person. If you have
some basic economics courses under your belt, some of the book will feel quite tedious.
Judging the quality of non-fiction is different
from judging a novel. I really don't like the verbose style of writing, so style is equivalent
to two stars. However, it is really the insights and quality of recommendations that is the
important. For problems listed above that is three or four stars. So in conclusion three stars
(i.e. useful if you read many books, but certainly not your first choice on the topic).
Oregonian
Old wine in new bottle August 19, 2011
Gary Shilling has been predicting deflation for the better part of two DECADES now. In the
1990s he wrote books predicting that deflation was just round the corner. A dozen inflationary
years later, he is still singing the same tune. As they say, even a stopped clock will be right
twice a day. He lists out his great calls over the decades. How about listing the not-so-great
calls also?
Gary is most likely wrong on his recommendation for investing in Treasurys and bonds, because
with interest rates at historic lows, bond prices have nowhere to go but down in the next 10
years. And he is most likely wrong on the US dollar also. Except for short-lived bear-market
rallies, the US Treasurys and US Dollar will remain on a long term down trend, as will US stocks
until the end of this decade.
That being said, there is some great information in the book, and some great numbers. I do
agree with his recommendation to invest in rental properties. Below I quote some of his statements
from the "Rent versus Buy" section in Chapter 12.
Over time, houses have sold for about 15 times (annual) rental costs. But that was in the
post-World War II years when owners of rental properties expected inflation to enhance their
6.7% return - before the cost of income tax-deductible maintenance and property taxes. When
house price appreciation was not expected in the aftermath of the 1930s, the norm for (annual)
rentals was 10% of the house's value. In the coming deflationary years, houses and apartments
may sell for closer to 10 times (annual) rentals than the 15 times norm, much less than the
20 times in the housing boom days.
Gary's analysis has shown that even with tax deductibility of mortgage interest, renting
a single-family house or apartment is cheaper than home ownership, absent price appreciation.
One can only imagine how things will be if the mortgage interest deduction is removed (seriously
being advocated by politicians in Washington DC).
Here are some of the investments he suggests to avoid in this decade: - Commodities. - Big
ticket consumer purchases. - Banks and similar financial institutions. - Credit card and other
consumer lenders. - Conventional home builders and suppliers. - Commercial real estate. - Developing
country stocks and bonds. - Japan.
Here are some of the investments he suggests to buy in this decade: - Treasurys and other
high-quality bonds. - US dollar. - North American energy. - Health care. - Rental apartments.
- Income producing securities.
12 of 12 people found the following review helpful 5.0 out of 5 stars Thought-provoking look
at where the economy is likely heading April 14, 2011 By SCJ Format:Hardcover|Amazon Verified PurchaseDr.
Shilling quotes Mark Twain in Chapter 1: "History doesn't repeat itself, but it does rhyme." He
explains that he believes human nature changes slowly, if at all, over time which leads him to be
able to make great economic calls. (Some reviewers have been troubled by his description, "great
calls." I viewed them as I would a hallway of accolades leading me to a conversation with a wise
economic thinker). As Sir John Templeton noted, "The four most dangerous words in investing are,
"this time it's different."
So while the majority believe that an increase in the money supply will lend itself to an inflationary
challenge, Dr. Shilling believes that money velocity will continue to be muted and the supply of
goods, not money, will dictate the direction of prices. He espoused this belief in two of his previous
books in the nineties and believes that the global recession of 2007/2008 is the tipping point.
To those who disagree, he presents a strong case.
His research indicates that, in general, war is a precursor for inflation because it saps up
the excess productive capacity. When the nation(s) are at peace, deflation reigns. While acknowledging
that the United States has been in a war of sorts, the War on Terror, he believes that it may wind
down before reaching Cold War proportions. If that happens and no other wars rise up in its place,
he is confident that capacity will dictate our economic path. Too much of a good thing with too
few buyers putting them (the buyers) in command.
And these buyers are not buying like they once were. The savings rate in the US is climbing again
for the first time since it began its steady decline in the early eighties. He believes that over
the next decade we will again see the savings rate reach double digits here.... That implies a steady
increase in the savings rate of about 1 percent per year (it had fallen to 1 percent from 12 percent
before it began to reverse course). Incidentally, he notes that we have a long way to go to get
back to the debt to after-tax income ratio we had in the early 1980s. We were at 122 percent in
2010 -- almost double where it was back then!
In addition to foretelling a significant rise in the savings rate, he also notes that credit
will be much tighter in the years ahead. His logic for this is that the bankers of yesterday's excess
will become the bankers of tomorrow's thoughtfulness. There will be no more "no-doc" (liar) loans.
Only the best credit risks will be extended the courtesy of borrowing and they will graciously decline
since they are reeling from setbacks in the values of their homes and the uncertainty surrounding
their investment portfolios. We will become a nation of risk managers!
How important will this turnabout of the American buyer of first and last resort be for the rest
of the world? Dr. Shilling points out that just a 1 percent decline in US consumer spending whacks
nearly three times that much off of our imports, their exports. With US moms and pops a full one-sixth
of global GDP, the rest of the world will feel the change in thinking and spending.
So with exports from around the globe adversely affected, will that open an opportunity for the
US to ride the back of a weak dollar and become a stronger exporter? Not according to the good doctor.
He actually sees a strong dollar (the best of a bad lot and still no other option for a global reserve
currency) and a very limited link between the value of the buck and real imports/exports. On the
other hand, his statistical evidence points to a very strong correlation between GDP and imports/exports.
For those that believe deflation is impossible in a fiat currency system, he points to Japan
as an outstanding example. Their economic output has been among the top two or three for decades
and yet they have experienced a domestic demand problem tied to the deleveraging that began there
in 1989. So while we fret about the threat of rising prices, Dr. Shilling believes that we will
start to see falling prices in the years ahead. Little by little, the reality of deflation will
set in and people will start to expect to pay less in the future and not view today's purchase as
a store of value. He points to the likes of Wal-Mart lowering the prices on thousands of items in
April 2010 as a US example and Ireland, Spain, and Portugal price declines in 2009 as an international
one.
So while the monetarists under the spell of Milton Friedman continue to wax poetically on the
dangers of a pumped up money supply, Dr. Shilling continues to croon his tune of money in the vaults
doesn't matter. Show me the M2 to reserves (was 70 to 1 in early 2007 but less than 1 to 1 for the
$1 trillion in new reserves as of March 2010) and I'll show you a picture of a bunch of fat-cat
bankers sitting around the table smoking their stogies and counting their Bennies (Franklins, that
is). There's no business like show business as bankers have learned the hard way. Their exotic Italian
and British cars have been replaced with Volvos and SUVs as they have gotten back to the business
of banking. They now actually read the crash tests before they buy (or loan) now. The next wreck
they get into may find Uncle Sam's body shop closed. That's a chance they would rather not take
-- especially since Uncle Sam bought into the businesses and will now be lending a hand in deciding
what cars little Johnnie and Susie should be driving on the dangerous highways and by-ways of an
international economy teetering on the brink of failure.
So with the US consumer pulling back, the banks pulling back, and Uncle Sam pulling back, how
are prices going to push ahead? Dr. Shilling concludes that they won't. After reading his book carefully
you may not agree but I wouldn't bet on it. Read more › Comment | Was this review helpful to you?Yes
No 11 of 11 people found the following review helpful 4.0 out of 5 stars Has a really interesting
chapter on the elements of deflation / inflation August 20, 2012 By Gwendally Format:PaperbackI
heard Gary Shilling speak at a conference last month and his discussion of demographics was interesting
and insightful so I sought out his most recent book: "The Age of Deleveraging: Investment Strategies
for a Decade of Slow Growth and Deflation". This book was 500 pages long. Five hundred. I told B.
I felt like I was taking a graduate level course in economic forecasting. I'm not even sure how
to integrate this book into my body of knowledge, but here's my attempt.
The first 125 pages or so are on the subject of why we should listen to him. Each chapter is
about triumphs in prognostication he had over the years, his "Seven Great Calls" when he predicted
major economic changes. I found the history to be occasionally interesting and skimmed the chapters
looking for what he considered the markers of change. The main thing he appears to do is to really
dive down into the STORY that the economic indicators are telling. Look at the big picture: where
are the demographics? What is the existing inventory level? What makes SENSE to happen next? I found
his methods to be plausible and in line with the way I look at the world, too. Each of the many
threads emerges into a tapestry if you stand back and look at the big picture. This is why I read
so many threads and go for long walks to let it gel. I'm not Gary Shilling, but I don't have to
be if I can listen to people who see the big picture.
The central premise of this book is that Gary Shilling sees slow growth ahead. Period. He stands
with Mish Shedlock in the deflation camp (although he never mentioned Mish Shedlock.) Instead, he
takes on more esteemed heroes of mine. He pooh poohs Peak Oil (we'll switch to natural gas, he says,
and doesn't sound cornucopian when HE says it....) He dismisses Milton Friedman's definition of
inflation "as always and everywhere a result of [excess money.]" What is money, asks Shilling? If
you have a $10,000 credit line on a credit card - whether you use it or not - isn't that money?
American Express cards have no limits on them... what does THAT mean to the money supply? Instead
he talks about there being seven varieties of inflation/deflation:
1. Commodity 2. Wage-price 3. Financial asset 4. Tangible asset 5. Currency 6. Inflation by fiat
7. Goods and services.
I have to admit, I really liked having seven dimensions to this issue. It is far more satisfying
that Friedman/Martenson/Austrian versions. It fits reality better. It's hard to hold them all in
my head at once, and they often move in tandem, but they actually are NOT identical and our current
world situation has allowed the effects of different parts to be teased out better. If I ever re-read
this book it'll be for Chapter 8: "Chronic Worldwide Deflation". This is where he makes the case
that he isn't just some cranky old man moaning about how things were better when he was young (and
get off my lawn, kid!)
Chapter 9 talks a bit about what help we can expect from the Fed, IMF and Congress. It's a short
chapter. (Synopsis: none.)
Chapter 10 is about the outlook for stocks. The short version there is that he expects very low
earnings going forward. He pretty much stayed away from the question of whether to buy index funds
or managed portfolios in a confusing way, by saying managed portfolios will do better, except most
of the time they don't. He is not a fan of long-term buy and hold and hates asset reallocation strategies,
too, thinking it's foolish to sell your winners to buy your losers. Far better to just buy winners
low and sell them high. (D'oh, why didn't *I* think of that?) So, all in all, this chapter was pretty
worthless to me. (Because every book that says, "first, start by buying a high quality stock cheap
right before it goes up" is similarly worthless, although is certainly fine advice.)
Chapter 11 was his explanation of twelve investments to sell or avoid. This is worth elaborating
on:
1. Big Ticket consumer purchases (because people will be more austere and expect prices to fall
so they'll wait to buy.) 2. Consumer lenders (who are about to find out that "deleveraging" means
that they don't get paid back) 3. Conventional home builders (demographics suck) 4. Collectibles
(there's a distinct shortage of greater fools) 5. Banks (see #2) 6. Junk securities (did you notice
how the lenders fared in #2 and #5) 7. Flailing companies (uh, when WERE those a good idea?) 8.
Low tech equipment producers (becoming obsolete and fungible at the same time) 9. Commercial real
estate (low growth = high vacancies) 10. Commodities (they're being played by speculators) 11. Chinese
and other developing country stock and bonds and 12. Japanese securities.
Japanese securities were because Japan is a stagnant aging population with a serious debt problem
whose heroes all die in kabuki plays (or something like that.) But the Chinese and other developing
country stocks and bonds was because of currency risk and because the economy is still too dependent
on exports to the First World. Until a country develops a sizable middle class that can purchase
its own GDP the economy is too tied to ours, he claims, and so you just end up with the currency
risk that will eat up any growth. He also thinks that China has been stimulating itself into creating
too much capacity that they aren't yet using. In other words, he's expecting deflation there, too.
Instead, he suggests you buy:
Treasuries and other high-quality bonds. (This guy loves him some long bonds. He had a unique
voice on that subject and I should probably reread this section because I find myself really
confused how the Long Bond could be a good investment in a 0% world. He appears to be expecting
the interest rate to go still lower!)
Income-producing securities (sort of the opposite to #7 above, I mean, duh.)
Food and other consumer staples (because they won't be subject to people putting off buying
them.)
Small luxuries (fluffy toilet paper? Watches? Cosmetics?)
The U.S. dollar (he made the case that no one else has anything better.)
Investment advisers and financial planners (Wuhoo! He makes a case that we're worth our
keep.)
Factory-built housing and rental apartments (so, buy those REITS but make sure they aren't
commercial, merely residential housing. Uh, good luck with that.)
Health care. (Demographics, government unicorn funding, the thing people want above all
else) 9. Productivity enhancers (because everyone wants to run their business without actual
people)
North American energy (because we're massive hogs who care not one whit about climate
change and want our air conditioning RIGHT THIS MINUTE without having to negotiate with Iran
for oil. Sounds like a solid bet to me.)
The pieces I find myself thinking about in new ways are 30 year treasury bonds (it comes as a
surprise to me that someone LIKES those) and that emerging country growth won't be as solid a play
as I was thinking. He also gave me some instruction on how to think about the Big Picture, and my
brain may be ready for more on that subject after I rest up from reading this book. It was tough
going at times, and he occasionally veered into stories about his days meeting with captains of
industry or highly placed officials. I guess he's allowed. He's pretty proud of the job he did replumbing
the house he bought in 1968 and still lives in. I found myself liking the man, much the way I like
Jack Bogle and Bud Hebeler. Overall, recommended, but be prepared to skim some parts.
Gary Shilling is one of the bears December 12, 2010 By Y JIN Format:HardcoverGary Shilling called
the 2008 bear market. Like most other bears he just kept calling it, in 2001, 2002, 2003, 2004,
2005, 2006, 2007, and 2008. Boom! They got it. All bears declared victory. But all bears missed
the big run up. Now they all missed it again. Reading this book will not make anyone a penny.
Following the 3 and 10 year auctions in the last two days, today's
30 Year $13 billion reopening completed the trifecta of ugliness, pricing at a surprisingly
wide 3.355%, or three whole basis points above the When Issued, which traded at 3.324% at 1pm -
the biggest tail in a long time. It was also the highest yield for a 30 Year since March 2012.
The internals were not pretty either - the Bid To Cover coming at 2.47, well below the TTM average
of 2.59 but hardly the massive BTC collapse that we saw in yesterday's 10 Year.
And just like yesterday, the Directs ran for the hills taking down just 8.5%, compared to 15.2%
in the past year average, Indirects taking 40.2% and 51.3% or so left for the Dealers who will be
happy to stock up on some more collateral.
In the process of reaching and stooping, prices on financial assets have soared and central banks
have temporarily averted a debt deflation reminiscent of the Great Depression. Their near-zero-based
interest rates and QEs that have lowered carry and risk premiums have stabilized real economies,
but not returned them to old normal growth rates. History will likely record that these policies
were necessary oxygen generators. But the misunderstood after effects of this chemotherapy
may also one day find their way into economic annals or even accepted economic theory.
Central banks – including today's superquant, Kuroda, leading the Bank of Japan – seem
to believe that higher and higher asset prices produced necessarily by more and more QE check writing
will inevitably stimulate real economic growth via the spillover wealth effect into consumption
and real investment. That theory requires challenge if only because it doesn't seem to be working
very well.
...Granted, some investors may switch from fixed income assets to higher "yielding" stocks, or
from domestic to global alternatives, but much of the investment universe is segmented by accounting,
demographic or personal risk preferences and only marginal amounts of money appear to shift
into what seem to most are slam dunk comparisons, such as Apple stock with a 3% dividend vs.
Apple bonds at 1-2% yield levels.
Because of historical and demographic asset market segmentation, then, the Fed and other
central banks operative model is highly inefficient. Blood is being transfused into the system,
but it lacks necessary oxygen.
In addition, there are several other important coagulants that seem to block the financial system's
arteries at zero-bound interest rates and unacceptably narrow "carry" spreads:
Zero-bound yields deprive savers of their ability to generate income which in turn limits
consumption and economic growth.
Reduced carry via duration extension or spread actually destroys business models and real
economic growth. If banks, insurance and investment management companies can no longer generate
sufficient "carry" to support employment infrastructures, then personnel layoffs quickly follow.
With banks, net interest margins (NIM) are lowered because of "carry" compression, and then
nationwide retail branches previously serving as depository magnets are closed one by one.
In the U.K. for instance, Britain's four biggest banks will have eliminated 189,000 jobs by
the end of this year compared to peak staffing levels, reports Bloomberg News. Investment banking,
insurance, indeed the entire financial industry is now similarly threatened, which is leading
to layoffs and the obsolescence of real estate office structures as well which housed a surfeit
of employees.
Zombie corporations are allowed to survive. Reminiscent of the zero-bound carry-less
Japanese economy over the past few decades, low interest rates, compressed risk spreads, historically
low volatility and ultra-liquidity allow marginal corporations to keep on living. Schumpeter
would be shocked at this perversion of capitalism, which is allowing profits to be more than
"temporary" at zombie institutions. Real growth is stunted in the process.
When ROIs or carry in the real economy are too low, corporations resort to financial
engineering as opposed to R&D and productive investment. This idea is far too complicated
for an Investment Outlook footnote – it deserves expansion in future editions – but
in the meantime, look at it this way: Apple has hundreds of billions of cash that is not being
invested in future production, but returned via dividends and stock buybacks. Apple is
not unique as shown in Chart 1. Western corporations seem focused more on returning capital
as opposed to investing it. Low ROIs fostered by central bank policies in financial markets
seem to have increasingly negative influences on investment and real growth.
Credit expansion in the private economy is restricted by an expanding Fed balance sheet
and the limits on Treasury "repo." Again, too complicated for a sidebar Investment Outlook discussion,
but the ability of private credit markets to deliver oxygen to the real economy is being hampered
because most new Treasuries wind up in the dungeon of the Fed's balance sheet where they cannot
be expanded, lent out and rehypothecated to foster private credit growth. I have previously
suggested that the Fed (and other central banks) are where bad bonds go to die. Low yielding
Treasuries fit that description and once there, they expire, being no longer available for credit
expansion in the private economy.
Well, there is my still incomplete thesis which when summed up would be this: Low yields,
low carry, future low expected returns have increasingly negative effects on the real economy.
Granted, Chairman Bernanke has frequently admitted as much but cites the hopeful conclusion that
once real growth has been restored to "old normal", then the financial markets can return to those
historical levels of yields, carry, volatility and liquidity premiums that investors yearn for.
Sacrifice now, he lectures investors, in order to prosper later.
Well it's been five years Mr. Chairman and the real economy has not once over a 12-month period
of time grown faster than 2.5%. Perhaps, in addition to a fiscally confused Washington,
it's your policies that may be now part of the problem rather than the solution. Perhaps the beating
heart is pumping anemic, even destructively leukemic blood through the system. Perhaps zero-bound
interest rates and quantitative easing programs are becoming as much of the problem as the solution.
Perhaps when yields, carry and expected returns on financial and real assets become so
low, then risk-taking investors turn inward and more conservative as opposed to outward and more
risk seeking. Perhaps financial markets and real economic growth are more at risk than your
calm demeanor would convey.
Wounded heart you cannot save … you from yourself. More and more debt cannot
cure a debt crisis unless it generates real growth. Your beating heart is now arrhythmic and pumping
deoxygenated blood. Investors should look for a pacemaker to follow a less risky, lower returning,
but more life sustaining path.
The Wounded Heart Speed Read
Financial markets require "carry" to pump oxygen to the real economy.
Carry is compressed – yields, spreads and volatility are near or at historical lows.
The Fed's QE plan assumes higher asset prices will revigorate growth.
Traders at some of the world's biggest banks manipulated benchmark foreign-exchange rates
used to set the value of trillions of dollars of investments, according to five dealers with
knowledge of the practice.
Employees have been front-running client orders and rigging
WM/Reuters rates by pushing through trades before and during the 60-second windows when
the benchmarks are set, said the current and former traders, who requested anonymity because
the practice is controversial. Dealers colluded with counterparts to boost chances of moving
the rates, said two of the people, who worked in the industry for a total of more than 20 years.
The behavior occurred daily in the spot foreign-exchange market and has been going on for
at least a decade, affecting the value of funds and derivatives, the two traders said.
***
The
$4.7-trillion-a-day
currency market, the biggest in the financial system, is one of the least regulated.
The inherent conflict banks face between executing client orders and profiting from their own
trades is exacerbated because most currency trading takes place away from exchanges.
***
While the rates aren't followed by most investors, even small movements can affect the value
of what Morningstar
Inc. (MORN) estimates is $3.6 trillion in funds including pension and savings accounts that
track global indexes.
***
As market-makers, banks execute orders to buy and sell for clients as well as trade on their
own accounts.
***
By concentrating orders in the moments before and during the 60-second window, traders can
push the rate up or down, a process known as "banging the close," four dealers said.
Three said that when they received a large order they would adjust their own positions knowing
that their client's trade could move the market. If they didn't do so, they said, they risked
losing money for their banks.
One trader with more than a decade of experience said that if he received an order at 3:30
p.m. to sell 1 billion euros ($1.3 billion) in exchange for Swiss francs at the 4 p.m. fix,
he would have two objectives: to sell his own euros at the highest price and also to move the
rate lower so that at 4 p.m. he could buy the currency from his client at a lower price.
He would profit from the difference between the
reference rate and the higher price at which he sold his own euros, he said. A move in the
benchmark of 2 basis points, or 0.02 percent, would be worth 200,000 francs ($216,000), he said.
***
To maximize profit, dealers would buy or sell client orders in installments during the 60-second
window to exert the most pressure possible on the published rate, three traders said. Because
the benchmark is based on the median of transactions during the period, placing a number of
smaller trades could have a greater impact than one big deal, one dealer said.
Traders would share details of orders with brokers and counterparts at banks through instant
messages to align their strategies, two of them said. They also would seek to glean information
about impending trades to improve their chances of getting the desired move in the benchmark,
they said.
Interest Rates Are Manipulated
Unless you live under a rock, you know about the Libor scandal.
For those just now emerging from a coma, here's a recap:
Engaging in mafia-style big-rigging fraud against local governments. See
this,
this and
this
Shaving money off of virtually every pension transaction they handled over the course of
decades, stealing collectively billions of dollars from pensions worldwide. Details
here,
here,
here,
here,
here,
here,
here,
here,
here,
here,
here and here
Pledging the same mortgage multiple
times to different buyers. See
this,
this,
this,
this and
this. This would be like selling your car, and collecting money from 10 different buyers
for the same car
Cheating homeowners by gaming laws meant to protect people from unfair foreclosure
Pushing investments which they knew were terrible, and then betting against the same investments
to make money for themselves. See
this,
this,
this,
this
and
this
The CFMA allows any derivative or future to be purchased in limitless quantity with absolutely
no public disclosure, this entire blog topic completely true.
Bernie Sanders put a spotlight on it in 2010 by leaking CFTC records of oil futures from
the Summer of 2008 that showed Morgan Stanley and Goldman Sachs were responsible for oil @ $145
despite lower demand & higher supply, which in turn constricted over-extended consumers and
initiated the onslaught sub-prime defaults so they could benefit from short CDO counter positions
("Shitty deals")
The CFMA makes this possible for TBTF's with any metal, material, commodity, grain or energy
valuation – making them omnipotent over input costs for any sector.
Dodd-Frank was set to require position limits, but not anymore, the banking lobby is shredding
it.
Whats weird about the whole thing is that Egan Jones doesn't charge investor-clients for
sovereign ratings - no revenue, no profits, no change in business - because of the SEC's ban.
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Willy2
1. Isn't their core business to rate companies ? And rating countries is then simply a teaser
to attract customers. To attract attention ?
2. The simple fact, the Treasury (Geithner & co.) + SEC retaliated against Egan Jones speaks
volumes. Seems the Treasury "doesn't like" bad publicity.
3. Remember the case of Eliot Spitzer ? The District Attorneys of the states wanted to take
action against the fraudulous mortgages lending practices. But they were blocked by the Treasury
(OCC). When Spitzer complained in an article in the Washington Post
It's 'news' only in as much as it's published in a public nwespaper with specifics. I think
more of these crimes are getting made public because the people involved slowly realize that
very little if anything will be done by enforcement agencies to prosecute them on a direct basis,
so its less risky to leak info.
The realization is that we exist in a financial kleptocracy where the middle class muppets
only serve to be a giant sponge to wring dry by the banks. It is made all the more shocking
by how we, as a slow boiled frog society, continue to react with nothing but apathy at a conga
line of malfeance, fraud, and F-Us by the bankers. This is followed on by a silent non-responsive
F-U by our governement which refuses and abeits these crimes and protects their interest over
ours.
I drive by a shiny HSBC branch on the way to work. I have often fantasized about spry painting
'drug pimps' in red spray paint on the side and chucking a molotov through the window. Of course
the same government that criminally prosecuted exactly no one at this foreign bank for their
habitual money laundering of drug money in the US, would certainly without a doubt prosectute
me to fullest extent of the law possible and throw me in jail for that act of criminal protest.
"If your stock is in the news because of two big dudes getting in the big grass and trying to fight,
you should leave the stock," Munson concludes. But the key question in: what stocks are not manipulated
by the top 1%
Shares of Herbalife (HLF)
are up 20% in early trading after it was revealed late yesterday that billionaire investor Carl
Icahn filed a 13D disclosing that he'd taken a 13% stake in the company.
Those familiar with the story of Herbalife understand that Icahn's move was likely driven by
his ongoing and very public spat with fellow billionaire, hedge fund manager Bill Ackman.
Ackman has a large short position in Herbalife, leaving him vulnerable
to a short squeeze. In an instant classic on-air argument last month on CNBC, Ichan
suggested that HLF could become "the
mother of all short squeezes."
The Icahn-Ackman brawl is the most public instance of what has become a recurring market theme:
Hedge funds taking big positions then touting them on financial television. It makes for great theater
but Lee Munson of
Portfolio LLC and author of
Rigged Money, says it's all part of a strange
new world.
"Hedge funds back in the '80s and '90s used to be private, we used to be secretive. Nobody
told anyone about their positions," Munson explains in the attached clip. "Nowadays you go on
TV and you jack with the system."
Jacking with the system is trader-speak for causing wild swings in
stock prices. He may think Icahn bought such a huge chunk of Herbalife just to artificially
inflate the stock price, but Ackman's in no position to complain. Back in December it was Ackman
himself who caused a sell-off in shares of HLF when he called the company a "pyramid scheme" on
national television, causing the shares to drop more than 10% in a single day.
This came after he disclosed a $1 billion short position on the stock.
Munson wants to know where the SEC is in all of this. They may not be profiting from their public
jaw-boning (for his part Ackman says he hasn't booked any profits on HLF yet) but these titans are
undeniably causing massive swings in share prices. The spats might make for good theater but individual
investors are getting whipsawed at the whims of the super rich.
Enforcement officials may or may not decide to put a stop to these shenanigans, but waiting for
it to happen is a sucker's game. Munson says the only way for individuals to really protect themselves
from getting trampled is to get out of the way.
"If your stock is in the news because of two big dudes getting in the big grass and trying to
fight, you should leave the stock," Munson concludes.
This is probably the only reasonable way to buy annuity; otherwise you can emulate annuity by putting
the savings in Roth account and investing in mixture of Tips and junks bonds portfolio.
The Center for Retirement Research at Boston College has just released a new study that shows
that the best way for people to turn their 401(k) balances into a stream of income is to "buy" an
annuity from Social Security. Many people don't recognize that Social Security is in the annuity
business, but it is and it has the cheapest product in town.
As more people approach retirement with 401(k) plans as their only supplement to Social Security,
they face the challenge of how best to use their accumulated 401(k) assets to support themselves
once they stop working. They could invest in safe assets and try to live off the interest, but the
value of the assets would erode as prices rise and interest income would fluctuate as nominal interest
rates rise and fall. They could invest in a portfolio of stocks and bonds and draw out some percent
each month, but to avoid outliving their assets that draw is now about 3 percent. They could take
some of their money to an insurance company and buy an annuity, but commercial annuities tend to
be expensive because they are designed for people with above-average life expectancy and involve
considerable marketing costs.
A much better alternative is for the household to "buy" an annuity from Social Security. They
can make this "purchase" by using their savings to pay current expenses and delaying claiming to
get a higher monthly benefit at an older age. The savings used is the "price" and the increase in
monthly benefits is the annuity it "buys."
For example, consider a retiree who could claim $12,000 a year at age 65 and $12,860 at age 66
– $860 more. If he delays claiming for a year and uses $12,860 from savings to pay the bills that
year, $12,860 is the price of the extra $860 annuity income.[1] The annuity rate – the additional
annuity income as a percent of the purchase price – would be 6.7 percent ($860/$12,860). Remember
that Social Security benefits are indexed for inflation, so the retiree is buying a real annuity.
Vanguard – a wonderful company – also sells real annuities but it pays much lower rates.
The reason that Social Security annuities are a better deal than those in the private market
is that Social Security can offer a product that is actuarially fair – they are based on the life
expectancy of the average person (not those people whose parents lived into their 90s) and Social
Security doesn't have to worry about marketing costs or profits. Moreover, in this period of very
low rates, Social Security is an especially good deal because the increase in benefits is not based
on current rates but rather is a basic feature of the system. So buying an annuity from Social Security,
especially in today's low interest rate environment, is the best deal in town.
So read the
study and tell your friends with some 401(k) assets to use them to delay claiming their Social
Security benefit.
Alicia Munnell, the director of the Center for Retirement Research at Boston College, is
a weekly contributor to "Encore.
Bank stocks continue to be depressed because legitimate financial fears still linger. With economists
on average estimating growth in U.S. gross domestic product at 3.3% this year, the recovery remains
anemic in comparison with past upturns.
Despite predictions that the real estate market will soon turn up, housing sales continue to
languish. The Dodd-Frank financial reform bill "has spawned a number of new regulations that are
already taking a big bite out of banks' noninterest revenues," writes Theresa Brophy in the Value
Line Investment Survey. And there are continuing doubts about whether banks have enough capital
to weather another downturn.
...That's the trouble with banks. For investors, a bank is a black
box. Because you can't examine its loans -- in most cases, a bank's most critical assets -- you
really have no idea how sound it is or how its profits will be affected by loans that go sour.
Diversification offers some protection, but if another financial crisis comes along, the stocks
of just about every bank will be affected. Even Morgan, the best of the big banks, fell more than
70% between its 2007 high and its 2009 low. PNC Financial Services Group (PNC), another bank with
a strong reputation, dropped nearly 80%.
...Frankly, I am not enamored of either alternative. Banks today are the kinds of stocks Warren
Buffett has in mind when he says that stock picking is a game in which you stand with the bat on
your shoulder until you get a pitch you really like.
A recent publication of the staid New York Society of Security Analysts declared that "public confidence
in the integrity of equity trading markets appears to be at a once-in-a-generation low."
This is a trend measured in the nearly $300 billion retail investors have
yanked from traditional equity mutual funds since 2009.
In 2012, investors' long-harbored suspicion that the stock market was a rigged game became something
of a majority opinion.
This year, exasperation over the predominantly electronic mechanics of trading stocks, in which
hyper-fast computer algorithms maneuver against one another for fractions of pennies collected over
microseconds, boiled over. The level of disgust has gotten broad enough, in fact, that authorities
might be prepared to rethink some of the basic rules and processes driving the system.
The opaque and complex structure for trading stocks electronically across dozens of exchanges
and alternative networks has long been justified by industry leaders and regulators as the messy
but logical result of investor-friendly reforms. Technology has enabled mind-melting speed, unfathomable
communications capacity and brutal competition for order flow – all of which have made trading cheaper
and faster than ever.
Yet by squeezing out traditional market makers who once collected low-risk, protected profits
by mediating among buyers and sellers, rules and technology have tilted the power toward "high-frequency
traders." And in 2012, the fragility produced by so much layered complexity became too obvious,
and produced too many market-jarring failures, to be considered merely the price of progress.
A List of Failures
In March of 2012, BATS Trading, an upstart exchange that sees a large percentage of its volume
from HFT firms, botched its own initial public offering. First unable to process the initial trades,
BATS ultimately canceled the IPO.
In May, the Facebook (FB)
initial public offering was mishandled by Nasdaq, whose systems couldn't keep up with the flood
of electric orders. Many small investors just mustering the will to wade back into the market to
own a piece of FB were turned off by the fiasco.
Only months later, Knight Capital Group (KCG),
a premier electronic stockbroker and market maker, nearly went under when a trading-software upgrade
went rogue and spewed orders without human intention or limit. Knight is now being acquired by HFT
powerhouse Getco.
A process that began in 2000, when regulators and exchanges moved to quote stocks in pennies
-- making it easier for automated scalpers to "improve" a quote by one cent to legally front-run
real orders while reducing the amount of stock behind each bid or offer -- has now agglomerated
to a point that almost no one is satisfied. A recent publication of the staid New York Society of
Security Analysts declared that "public confidence in the integrity of equity trading markets appears
to be at a once-in-a-generation low." This is a trend measured in the
nearly $300 billion retail investors have yanked from traditional equity mutual funds since 2009.
Do Robots Really Run the Market?
But do the hyper-fast, disembodied trading robots really run the
market for their own profit?
There is some irony in the fact that the public is so embittered about what they believe to be
a market rigged against them, when, for most, stock trading has never been easier or less costly.
For a flat $8 commission, a stay-at-home investor can instantly execute a trade in almost any stock
with little noticeable friction. If, at times, an opportunistic algorithm steps ahead of that order
by, say, bidding a penny more and driving the price up a couple of cents, that charge is vastly
less than the 25-cent spread Nasdaq market makers used to take on almost every trade. If anything,
the small investor is better served by the current trading arrangements than are large institutional
investors, whose need to execute large, sensitive orders is compromised by the software spies' efforts
to step in front of their trading flows.
Indeed, even the dominance of high-frequency trading, once said to participate in a sizable majority
of stock orders, has passed its peak, thanks to competition and lower market volatility reducing
their opportunities.
Still, somehow the opacity and bloodlessness of the automated quasi market-makers rankles more,
especially when investors are less confident of unending stock market appreciation than they were
in the late 1990s and early 2000s.
Perception Becomes Reality
The measure of disaffection with today's market structure by both professionals and individuals
means that, even if the financial impact to the typical trader isn't onerous, the sour perception
in itself diminishes market quality and vitality.
And sentiment isn't helped by the ongoing round-up of alleged insider-trading conspirators among
employees of major investment firms, which has made headlines that prove the authorities are paying
attention while also hinting to the little guy that investing profits are often ill-gotten.
The good news in all the frustration with our tangled trading system is a renewed focus on rationalizing
it. At a Senate Banking Committee hearing on electronic trading in late December, a rough consensus
among exchange officials showed a desire for Congress to lay out clearer order-handling rules. The
recently announced merger of electronic derivatives exchange ICE with NYSE Euronext could provide
further impetus for a fresh look at the trading landscape.
Several years ago, Jim Maguire -- a NYSE floor veteran and longtime specialist for Warren Buffett's
Berkshire Hathaway Inc. (BRKA,
BRKB) shares -- began promoting
a small but potentially helpful reform: quoting stocks in minimum increments of nickels rather than
pennies. The idea was to create greater incentive for middlemen to provide a deep and fair market
for public orders. Dubbed "Mr. Nickel" by Barron's, Maguire was viewed as a charming little
anachronism. Yet on Feb. 5, the SEC is
holding a panel discussion to discuss
"the impact of tick sizes on securities markets." There is also now a more open discussion over
charging high-speed traders for the massive system capacity they use.
The now deeply ingrained sense that stock trading is a game rigged by privileged sharpies with
their omnipotent machines will not dissipate soon or easily. But as we enter 2013, it appears at
last that those able to take action to foster greater faith in the integrity of the markets are
at least focused on the issue.
At least for today (perhaps because I'm a little under the weather), when it comes to the Federal
Reserve I'm about all ranted out. So this isn't supposed to be a rant, but more an effort to tie
together some loose analytical ends. Key facets of my macro credit theory analysis seem to be converging:
the myth of deleveraging, "liquidationist" historical revisionism, rules versus discretion monetary
management, and "Keynesian"/inflationist dogma.
The Ben Bernanke Fed last week increased its quantitative easing program to monthly purchases
of US$85 billion starting in January. "Operation Twist" - the Fed's clever strategy of purchasing
$667 billion of bonds while selling a like amount of T-bills - is due to expire at the end of the
month. The Fed will now continue buying Treasury bonds ($45 billion/month). It just won't be selling
any bills, while continuing with $40 billion mortgage-backed security (MBS) purchases each month.
The end result will be an unprecedented non-crisis expansion of our
central bank's balance sheet (monetization). It's Professor Bernanke's "government
printing press" and "helicopter money" running at full tilt.
During his Wednesday press conference, chairman Bernanke downplayed the significance of the change
from "twist" to outright balance sheet inflation. Wall Street analysts have generally downplayed
this as well. Truth be told, no one has a clear view of the consequences
of taking the Fed's balance sheet from about $3 trillion to perhaps $4 trillion over the coming
year or so. It's worth noting that in previous periods of rapid balance sheet expansion,
the Fed was essentially accommodating de-leveraging by players (hedge funds, banks, proprietary
trading desks, real estate investment trusts, etc) caught on the wrong side of a market crisis.
Does the Fed's next trillion's worth of liquidity injections spur more speculation in bonds,
stocks and global risk assets? Or, instead, will our central bank again provide liquidity for leveraged
players looking to sell (many increased holdings with the intention of eventually offloading to
the Fed)? It's impossible to know today the ramifications of the Fed's latest tack into uncharted
policy territory. It will stoke some inflationary consequence no doubt,
although the impact on myriad credit bubbles around the globe is anything but certain.
Clearer is that the Fed has again crossed an important line. There has been previous talk of
Fed "exit strategies". I'll side with Richard Fisher, president of the Federal Reserve Bank of Dallas,
who on Friday warned of "Hotel California" risk ("... Going back to the Eagles song which is, 'you
can check out any time you want but you can never leave... '"). There has also been this notion
that the US economy is progressing through a ("beautiful") deleveraging process.
Yet there should be little doubt that the Fed has now resorted to
blatantly orchestrating a further leveraging of the US economy. It will now become only that much
more difficult (think impossible) for the Federal Reserve to extricate itself from this inflationary
process.
I've read quite sound contemporaneous analysis written during the "Roaring Twenties". There was
keen appreciation at the time for the risks associated with rampant credit growth and speculative
excesses throughout the markets and economy. The "old codgers" argued that a massive credit inflation
that commenced during the Great War (World War I) was being precariously accommodated by loose Federal
Reserve policies. Chairman Bernanke has throughout his career disparaged these "bubble poppers".
To this day the "liquidationists" are pilloried for their view that there was no viable alternative
than to wring financial excess and economic maladjustment out of the system through wrenching adjustment
periods. Through their empirical studies, quantitative models, and sophisticated theories, contemporary
academics - led by Bernanke - have proven (without a doubt!) that the misguided "bubble poppers"
and "liquidationists" were flat out wrong. Our central bankers are now
determined to prove them (along with their contemporary critics) wrong in the real world. Yet there
remains one rather insurmountable dilemma: The contemporaneous credit bubble antagonists were right.
The Dallas Fed's Fisher stated Friday that the rate-setting Federal Open Market Committee "is
probably the most academically driven in history". Well, I'll say that a world of unconstrained
market-based finance "regulated" by inventive and activist academics has proved one explosive monetary
concoction. The Wall Street Journal's Jon Hilsenrath (with Brian Blackstone) had two insightful
pieces this week, "MIT Forged Activist Views of Central Bank Role and Cinched Central Banker Ties",
and "World Central Bankers United by Secret Basel Talks and MIT Connections".
Inflationary cycles always create powerful constituencies.
After all, credit booms and the government printing press provide incredible wealth-accumulating
opportunities for certain segments of the economy. Moreover, it is the
nature of things that late in the cycle the pace of wealth redistribution accelerates as the monetary
inflation turns more unwieldy. Throw in the reality that asset inflation (financial
and real) has been a prevailing inflationary manifestation throughout this extraordinary credit
boom, and you've guaranteed extraordinarily powerful constituencies.
By now, "activist" central banking doctrine - with pegged rates, aggressive market intervention/manipulation
and blatant monetization - should already have been discredited. Instead, policy mistakes lead to
only bigger policy mistakes, just as was anticipated generations ago in the central banking "Rules
vs Discretion" debate.
Today, a small group of global central bank chiefs can meet in private
and wield unprecedented power over global markets, economies and wealth distribution more generally.
They are said to somehow be held accountable by politicians that have proven even less respectful
of sound money and credit. In the US, Europe, the UK, Japan and elsewhere, central bankers have
become intricately linked to fiscal management. As such, disciplined and independent central banking,
a cornerstone to any hope for sound money and credit, has been relegated to the dustbin of history.
Considering the global monetary policy backdrop, it's not difficult to side with the view of
an unfolding inflation issue. At the same time, the "liquidationist" perspective - that to attempt
sustaining highly inflated market price and economic structures risks financial and economic catastrophe
- has always resonated.
The markets' response to Wednesday's dramatic Fed announcement was notably underwhelming. This
could be because it was already discounted. Perhaps "fiscal cliff" worries are restraining animal
spirits. Then again, perhaps the more sophisticated market operators have been waiting for this
opportunity to reduce their exposures. After all, the Fed moving to $85 billion monthly of quantitative
easing five years into an aggressive fiscal and monetary reflationary cycle is pretty much an admission
of defeat.
I've argued that, primarily due to unrelenting fiscal and monetary stimulus, the US economy has
been avoiding a necessary deleveraging process. Some highly intelligent and sophisticated market
operators have argued the opposite. They point to growth in incomes and gross domestic product,
while total (non-financial and financial) system credit has contracted marginally. I can point specifically
to total non-financial debt that closed out 2008 at $34.441 trillion and ended September 30, 2012,
at a record $39.284 trillion. But the deleveraging debate will not be resolved with data.
The old "liquidationists" (and "Austrians") would have strong views about contemporary "deleveraging".
They would shout "inflated price levels", "non-productive debt", "unsupportable debt loads", "excess
consumption", "distorted spending patterns and associated malinvestment", "deep economic structural
imbalances" and "intractable current account deficits!" They would argue that to truly "deleverage"
one's economy would require a tough weaning from system credit profligacy.
Only by consuming less and producing more can our economy reduce its debt dependency and get
back on a course toward financial and economic stability. The "bubble poppers" would profess that
in order to commence a sustainable cycle of sound credit and productive investment first requires
a cleansing ("liquidation") of unproductive ventures and unserviceable debts. It's painful and,
regrettably, shortcuts only short-circuit the process. I'm convinced that they would hold today's
so-called "deleveraging" - replete with massive deficits, central bank monetization and ongoing
huge US trade deficits - in complete and utter disdain.
In a CNBC interview on Wednesday evening, the Wall Street Journal's Jon Hilsenrath called Bernanke
a "gunslinger". Our Fed chairman is highly intelligent, thoughtful, polite, soft-spoken, seemingly
earnest and a huge, huge gambler. And he's not about to fold a bad hand. Almost four years ago,
I wrote that Fed reflationary measures were essentially "betting the ranch". This week they again
doubled down.
With his perspective and theories, Bernanke has pushed the envelope his entire academic career.
He is now surrounded by a group of likeminded "Keynesian" academics, and they together perpetuate
groupthink in epic proportions. These issues will be debated for decades to come - and who knows
how that will all play out.
But as a contemporary analyst and keen observer, there's no doubt these unchecked "academics"
are operating with dangerously flawed theories and doctrine. It's not the way central banking was
supposed to work. Ditto capitalism and democracies. Whatever happened to sound money and credit?
Prior to last week's 3.6% bounce in the market
(S&P 500), it had been down -8.9% from the highs on 9/14/12 to the
lows on 11/16/12.
The S&P, along with the other major indexes, and countless numbers
of stocks rebounded sharply after falling below their 50-day and
200-day moving averages.
If you're bullish on the market, you likely see this as a sign
that the selling is over.
If you're bearish on the market however, you probably see this
as a short-covering rally before the market heads lower again.
Only time will tell which camp is right. And quite frankly, as
it relates to individual stocks, it might turn out that both are
correct.
For some stocks, the recent bounce is providing another opportunity
to sell stocks at a higher price -- whether that's to establish
new shorts or to finish up the end-of-year tax selling to ensure
one can take advantage of what could be the last time capital gains
taxes are this low for a while.
And for others, it was the correction they've been waiting for
to get in on some of their favorite stocks.
Retracements and Moving Averages
In general, stocks that drop below their 50-day and 200-day moving
averages are looked at as potentially bearish, while stocks that
breakout above them are considered potentially bullish. Traders
and investors will often key in on these levels as places to buy
and sell stocks.
Another often used indicator for buying and selling are retracements.
Common retracement levels, as defined by Fibonacci, come in at 38.2%,
50% and 61.8%. These levels are looked at strategically, like the
moving averages, as places to either get long or short.
With this screen (2 screens actually) we're going to combine
both of these indicators to find stocks that look like bearish retracements
and others that look like bullish set ups.
Bearish Screen
For the bearish set up, I'm looking for stocks that have:
retraced less than 61.8% of the drop that preceded it
and that are trading just under their 200-day moving average
with a Zacks Rank of greater than or equal to 3 (Hold, Sell,
or Strong Sell)
Bullish Screen
For the bullish set up, I'm looking for stocks that have:
retraced more than 61.8% of the drop that preceded it
and that are trading above their 200-day moving average
(and preferably their 50-day as well)
with a Zacks Rank of less than or equal to 3 (Strong Buy,
Buy, or Hold)
Of course, nobody should use just the retracement levels and
moving averages as their only reason for getting long or short;
the Zacks Rank aside.
But these are two popularly watched indicators, and they can
help you identify key points as to when a stock is ready to turn
around or keep on going in the same direction.
Power corrupts, and financial market power has completely corrupted financial markets. ...
Simon Johnson:
The Market Has Spoken, and It Is Rigged, by Simon Johnson, Commentary, NY Times: In the
aftermath of the Barclays rate-fixing scandal, the most surprising reaction has been from people
in the financial sector who fully understand the awfulness of what has happened. Rather than
seeing this as an issue of law and order, some well-informed people have been drawn toward arguments
that excuse or justify the behavior of the Barclays employees.
This is a big mistake.. The
behavior at Barclays has all the hallmarks
of fraud... Anyone who takes personal responsibility seriously should want all those involved
to be held accountable – to the full extent of the law in all jurisdictions. Anything that lets
individuals escape consequences will further undermine the legitimacy that underpins all markets.
...
Nevertheless, five arguments put forward in the last 10 days ... attempt to provide some
sort of cover for what happened at Barclays. None of these arguments have any merit.
First, it is argued that this kind of cheating around Libor has been going on for a long
time. This may be true, but it is a sad and lame excuse... Second, it is also asserted that
"everyone does it." This is not any kind of defense – try it next time you are accused of fraud.
...
Third, Libor-rigging is defended as a "victimless crime." This is untrue. Traders at Barclays
and other banks gained from this series of manipulations, so someone else lost. ...
Fourth, some contend that it is the regulators' responsibility and fault that there was cheating
on Libor. It is certainly the case that there was regulatory capture at work... But who does
the capturing in regulatory capture? Big banks work long and hard and lobby at many levels to
push regulators toward paying less attention.
Fifth, the weakest argument is, "It was only a few basis points, here and there"... Either
the Libor reporting process and, consequently, the pricing of derivatives has been corrupted
by a criminal conspiracy, or it has not. There is no "just a little" in this context for the
enormous global securities market. ...
How will this play in American politics? There is still time for politicians on the right
and on the left of the political spectrum to get ahead of the issue. Digging in around specious
arguments in favor of price-fixing cartels is not the way to go.
Power corrupts, and financial market power has completely corrupted
financial markets. ...
There's also the argument that regulating the industry will harm economic growth, but look at
the growth rates we currently have -- thanks in large part to an out of control financial sector
-- to see the folly of that claim. Deregulation of the financial industry did not bring us the robust
economy that we were promised, it brought disaster, fraud, and who knows what else, and more oversight
is clearly needed.
Just as I was considering another attempt at hastening my journey to wealth via some form of
speculation on stocks, a wise old sage came along and told me not to.
"The game is rigged," says Jack Bogle, the octogenarian founder of The Vanguard Group. "It is
too convoluted. It is too complex. You shouldn't be playing the game. You don't need to play the
game."
With his paternal loyalty intact, the man who created the first index fund 35 years ago is unbending
in his belief that
speculators lose, and owning the broader market for the long haul is the best path to wealth
appreciation. Not surprisingly, the enormous popularity and diversity of offerings within the fast
growing universe of exchange traded funds or ETFs, has failed to convert him.
"The index investor doesn't need to be touched by any of the lunacy that is going on in the ETF
market,"says Bogle. "The ETF industry, which has got to be the greatest marketing idea of this age,
is not the greatest investment idea of this age, I can assure you."
It's not so much products with triple leverage that irk him about ETFs, it's more the velocity
that they represent. Bogle abhors the notion of trading and timing, and the long odds that go with
it. He insists no one is smart enough to do that for the long haul.
"If you own the stock market for a lifetime, you get those returns. Playing games in the stock
market, over every day of that time, is playing the stock market. The stock market game is rigged,
the business of investing is not rigged," says Bogle.
His reasoning is simple. The use of capital by companies to "develop new products, efficiencies,
innovations, productivity, the improvement of consumer goods and services at lower and lower prices"
is all very real and ultimately validated through earnings. It's a proven process that delivers
long-term growth that mirrors the pace of economic growth, plus a pinch of dividends to round up
the results.
The problem is that investors want more than 6 or 7 percent gains and they want it fast. Unfortunately
it's been a wild ride over the past 11 years. We've made great highs and painful lows, until to
finally landing at the same place we started from, a.k.a. "the lost decade."
It's the eternal rift that marks the difference between investing and trading. The intended outcomes
are the same, but the paths to prosperity are wildly different.
Do you agree with Bogle? Are investors better off than traders? Let us know in the comment section
below.
Many are wondering if the crisis is now over. Are happy days here again? And is it too late to
get on board?
I wish shareholders the best. And maybe this rally in banking stocks will keep going. I have
no idea - I never try to foretell short-term moves in the market.
But I wouldn't touch banking stocks with a 10-foot pole. If I had any shares I'd be looking to
sell.
Why? Here are 10 reasons.
1. These stocks are gambles. They are highly leveraged bets on an economic rebound. They
will be most vulnerable if the recovery runs out of steam. And the market rally has already run
well ahead of any upturn in economic news.
2. And you're betting blind. Your cards are all face down. At least with, say, a retailer
you have a pretty good idea what the assets actually are and what they might fetch if they had to
be sold quickly. With the banks: Good luck. Nobody really understands what they own - least of all
the people in charge.
3. The "stress tests" that the government is running on banks may not be stressful enough.
As others have already pointed out many forecasters already expect the economy to do worse than
the tests' supposed "worst case scenario".
4. Recent earnings reports, while often not as bad as many had feared, should raise more eyebrows.
Write-offs are certainly rising. And analysts at SG Securities say, for example, that up to one
third of Wells Fargo's first -quarter profits may have come from an accounting change.
5. The stock market rarely comes out of a crash the way it went in. Financials and emerging
markets owned the last boom, 2003-07. They're probably not the place to be in the next one.
6. Financials aren't even quite as depressed as they may seem. They just look that way
because they got so high before. Right now they make up about 15% of the US stock market by market
value. Sure, a few years ago they were nearly a quarter of the market. But 25 years ago they were
only about 12%.
7. For the retail banks: It's hard to have much faith in - or respect for - their business model.
Too many rely on nickel and diming customers - on everything from overdraft fees, credit card gotchas
and low interest paid on deposits. Bankrate says average fees hit a new high last year. This leaves
banks wide open to more regulation, better competition, or simple customer revulsion.
8. As for the Wall Street banks: They aren't run for the benefit of the stockholders anyway.
They are run for the staff. The threat of a crackdown on pay is going to cause a stampede to new
firms. These banks will happily issue new shares, diluting existing stockholders, just to pay off
the TARP money so they can get back to handing out fat bonuses.
9. Why bother? Banking isn't the only industry on the stock market. And investors have lots of
choices these days. There are plenty of good quality businesses in other industries whose stocks
are looking reasonably valued. Why gamble with your savings?
10. Finally, and most importantly: Even if, by some magic, the economy, the stock market and
the banks recovered back to 2006 levels I still wouldn't want to own banking stocks. The bankers
would just find another way to blow all the money.
The Last but not LeastTechnology is dominated by
two types of people: those who understand what they do not manage and those who manage what they do not understand ~Archibald Putt.
Ph.D
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