Mythbusters on BLS, Treasuries, Apple & HY
Guest post by Peter Tchir.
I don’t think the BLS is nefarious or did anything wrong with last week’s numbers. I’m frankly surprised by the disbelief many have with the numbers, though it is part of what seems to be a growing trend – frustration at manipulated markets.
The household survey is flawed in its methodology. It is a survey of 60,000 households in a nation of 310,000,000 people. A very small sample size which explains why +/- 436,000 is a “statistically significant movement”. For the actual NFP, the number is +/- 90,900. So clearly the room for error in the household survey is large.
Then the household survey actually has a broader definition of “employment” than the NFP. The BLS tracks something called “Adjusted household survey employment” which attempts to make the household survey conform better to the NFP. That number was only 294,000, so good, but more in line with the NFP of 114,000.
What is more striking is that people are ignoring that in July and August, the household survey said there were job losses rather than job gains. So the three month total of NFP is 437 compared to 559 for the household survey and 507 for the much maligned ADP.
When considering how unreliable the household survey is, the three month running total seems to be a better way to look at it.
I think the jobs report, when looking at NFP was mediocre, especially since so many of the jobs were government workers. It was a better report than some feared, but no real indication that job growth took off. I would not be surprised to see the household survey underperform next month.
It seems hard to believe in this modern age that we can’t come up with better ways to calculate employment. Have companies actually file something about hiring in a timely manner? Living with garbage data means we get garbage results sometimes and for some reason, seem unwilling to change methods to catch up with the tools available that could make these reports much more accurate.
The idea that treasury prices are manipulated (which they are when 40% of longer bonds are held by an uneconomic buyer – the Fed) and that manipulation is going to come back to hurt us is an idea that keeps coming back. I’m not yet sure how it would play out, but more and more I think it is a real issue.
Personally any “study” or “report” that I see that shows how something looks cheap versus treasuries just doesn’t ring true. Comparing dividend yield versus treasury yield and reaching the conclusion that dividend stocks are cheap just doesn’t make sense when the treasury yield is artificial.
That is the problem. The front end of the curve is at 0, not because we are currently experiencing deflation, but to spur growth. So the front end, which should be “risk free” and move in line with inflation, at least in theory, is now anchored at zero. It is not safe to own, at least in terms of maintaining wealth versus inflation, but is all we have.
The bigger risk is the “unwind” risk. What happens if the Fed stops purchasing bonds? What happens if the Fed decides it wants to sell its bonds? Never before have we faced that question. For a long time the risk of owning the 10 year treasury was a battle between supply (how big a deficit), inflation, and demand (largely from other countries). These are all risks the market has been dealing with for decades. This new dynamic, this risk that the Fed would sell its holdings and what that would do to the market is something new to digest. And being totally honest, I have to laugh at the thought of the Fed ever announcing its intention to sell the treasuries.
You CANNOT announce sale of 40% of something and not expect the market to react poorly. So in all likelihood the Fed owns those bonds to maturity, but that in itself is a risk we haven’t dealt with before.
Again, this isn’t an immediate trade, but is something lurking in the background that is worth thinking about because it will be play an important role at some point.
It’s All Just a Number and Stop Loss Seeking
Now that Apple has officially joined the “it’s just a number” crowd of stocks on the downside, people are paying attention. No one seemed to care why Apple was reaching $705. Everyone seemed happy to accept that it was a great company and a great stock. No one worried that $10 billion a day of market cap was being created on no news at all. Now that we have wiped out almost $75 billion of market cap at yesterday’s lows in a little over 2 weeks, people are paying attention.
In theory stocks represent some valuation of a company. Over the longer term that is true, but in the short term it is just a number. Stop loss trading and high frequency trading accentuate that phenomenon. High frequency trading seems in many ways designed to push trends. To put pressure in a direction in an attempt to trigger stops.
Hedge fund trading often lets that strategy work. Hedge funds, particularly this time of the year, are very concerned about returns. They may have liked Apple at 700 and swore up and down that they would load up if it ever got back to $650, but they won’t. It is one thing to talk about buying the dip and another thing to do it. If you were long going into the sell-off you have just taken a pretty big hit. Someone will talk about “catching a falling knife”. Someone else will ask about selling due to potential tax changes next year. There will be real fear here. I think there is a chance that Apple is so well loved, that we can get another run up, but this situation needs close scrutiny. We could hit $600 just as easily as more funds decide they had a good run and it is prudent to get out.
In any case, the “show” that has been apple is likely to further erode investor confidence in the market. If the biggest, most followed, most frequently mentioned stock of the past month can be some random number between $585 billion and $660 billion in the course of a month, on virtually no news, then anything can be any price. That may be an extreme view, but be careful when trading companies as though they are just numbers.
High Yield is known as Junk for a Reason
It is time to get out of the mindset that high yield is safe. There is no endless chase for yield that will constantly prop up prices for these bonds. The evidence is starting to mount that high yield bonds are due for a pause, if not a minor correction.
Mutual fund and ETF flows have been negative two weeks in a row. I think this is fairly innocuous at this stage and indicates that investors are now properly allocated to high yield and are taking some profits, but in a market that is only ever liquid in one direction, it is a concern that retail support is diminishing.
After hours, there was a brief attempt to celebrate that Alcoa made 3 cents rather than breaking even. Alcoa is an investment grade company that trades at a CDS spread of about 325 bps. The fact that major companies can struggle to show a profit should be a warning sign that some weak companies out there will be losing money. QE may raise asset prices, but in the end, that is unlikely to stop some weak companies from going bankrupt. We have a strong loan market, thanks to CLO demand and BKLN broke $1 billion in assets. So while loans are strong, there is support for high yield, but earnings season may highlight a few companies that are overextended.
Then there is all the talk about how “cheap” high yield is on a “spread basis”. I find that horribly misleading in many ways. First and foremost almost no one owns high yield on a spread basis, so it is irrelevant to market positioning. If you think HCA or LYO are cheap on a spread basis, then you better be short some treasuries. At these yields, those bonds have as much rate risk as spread risk. Normally I’m not a fan of any rate hedge for high yield (in fact owning treasuries more often than not is best hedge for owning high yield) but some of these bonds don’t look or trade like traditional junk bonds.
Then there is the issue of convexity. Some very “cheap” bonds on a spread basis trade to near term calls. If the market has a spread of 500, but the effective duration is 2 rather than 5, the upside is much more limited. In fact with average prices so high, the downside is much greater than the upside. Ignoring actual price and duration is a mistake that seems to be getting made frequently when people discuss spreads for high yield bonds.
I don’t see anything particularly wrong with the market, but I could see a quick sell-off as earnings spark some fear, retail is done buying, and hedge funds have gotten too long and will likely be forced to sell to protect their year on any weakness. With no real liquidity to be provided by the street, and many funds having reduced cash to buy new issues and compete with fully invested ETF’s, there just isn’t as much cushion up here. And as bizarre as it sounds, a 3 point move in the market, nothing extreme, would now represent almost 6 months of carry. Thank you Fed.
Less Bearish than Yesterday
I reduced some shorts. I will add, but do think it is prudent not to get too bearish here with so much liquidity sloshing around. One right word from Draghi or Rajoy and we can see a pop higher.
I actually like being short IG CDS here. I wrote about that last week for some institutional clients, and continue to like that trade. So many people have moved out of the hedges that they will be the first to react to any negative news. IG went out weak yesterday and isn’t looking great yet this morning. It dovetails nicely with my view on high yield.