Guest post by Peter Tchir.
Chasing Yield Is Tiring Work – is the Market fit enough to keep going?
Well we got some chase for yield. High yield did well. EM did okay, as did Munis and Investment Grade. Closed end funds on the fixed income side did very well, benefitting from leverage and short memories, where once again investors want these at a premium (image of Homer Simpson repeatedly burning himself).
Treasuries actually had a good week in spite of the “risk on” mentality, but that was “confirmation” from Hilsenrath that the Fed is likely to continue to find ways to buy long dated treasuries once Operation Twist is officially over.
So it was a nice, and surprising combination for treasuries and risky bonds to do well, but this week was the first time in awhile that we saw some confusion in the broader market about corporate bond performance.
Guest post by Peter Tchir.
There was some chatter about the performance of fixed income ETF’s yesterday. They performed poorly at least relative to stocks and some had a late day sell-off fueling some speculation that credit wasn’t doing well.
That speculation was just wrong, but highlighted so,e problems with existing fixed income ETF’s.
They were trading at a premium and that premium tends to disappear when bonds become easy to source. While HY bonds remained well bid, the investment grade bond market is being flooded with new issues – primarily to enable large one time dividends. Might be worth probing into these companies a little deeper, but that is for another day.
So premium versus bond availability explains some of the noise, but to a large degree that is secondary.
Guest post by Hussman Funds.
In the day-to-day focus on the “fiscal cliff,” our own concern about a U.S. recession already in progress, and the inevitable flare-up of European banking and sovereign debt strains, it’s easy to overlook the primary reason that we are defensive here: stocks are overvalued, and market conditions have moved in a two-step sequence from overvalued, overbought, overbullish, rising yield conditions (and an army of other hostile indicator syndromes) to a breakdown in market internals and trend-following measures. Once in place, that sequence has generally produced very negative outcomes, on average. In that context, even impressive surges in advances versus declines (as we saw last week) have not mitigated those outcomes, on average, unless they occur after stocks have declined precipitously from their highs. Our estimates of prospective stock market return/risk, on a blended horizon from 2-weeks to 18-months, remains among the most negative that we’ve observed in a century of market data.
On the valuation front, Wall Street has been lulled into complacency by record profit margins born of extreme fiscal deficits and depressed savings rates. Profits as a share of GDP are presently about 70% of their historical norm, and profit margins have historically been highly sensitive to cyclical fluctuations. So the seemingly benign ratio of “price to forward operating earnings” is benign only because those forward operating earnings are far out of line with what could reasonably expected on a sustained long-term basis.
It’s helpful to examine valuations that are based on “fundamentals” that don’t fluctuate strongly in response to temporary ups and downs of the business cycle. The chart below compares historical price/dividend, price/revenue, price/book and Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) to their respective historical norms prior to the late-1990’s market bubble – a reading of 1.0 means that valuations are at their pre-bubble norm.
Guest post by Doug Short.
I’ve updated the charts below through today’s close. The S&P 500 is now 7.66% off its interim high set on September 14th, the day after QE3 was announced. We’re still above the 10% correction benchmark. The 10-year note closed today at 1.58, which is 30 basis points off its interim high of 1.88, also set the day after QE3 was announced. The historic closing low was 1.43 on July 25th. But the big news today is Freddie Mac’s Weekly Primary Mortgage Market Survey. The 30-year fixed has set an all-time low of 3.34 percent.
Are yields heading lower? If the post-election selloff in equities continues, the 10-year yield could certainly revisit the levels of late July. Japan is an example (admittedly an extreme one) of a developed nation with its own currency that has experienced a relentless demand for government bonds, as this chart illustrates. Currently Japan’s 10-year yield is around 0.75, less than half that if its US counterpart.
Here is a snapshot of selected yields and the 30-year fixed mortgage one week after the Fed announced its latest round of Quantitative Easing.
Guest post by Azizonomics.
A number of economists and economics writers have considered the possibility of allowing the Federal Reserve to drop interest rates below zero in order to make holding onto money costlier and encouraging individuals and firms to spend, spend, spend.
Miles Kimball details one such plan:
The US Federal Reserve’s new determination to keep buying mortgage-backed securities until the economy gets better, better known as quantitative easing, is controversial. Although a few commentators don’t think the economy needs any more stimulus, many others are unnerved because the Fed is using untested tools. (For example, see Michael Snyder’s collection of “10 Shocking Quotes About What QE3 Is Going To Do To America.”) Normally the Fed simply lowers short-term interest rates (and in particular the federal funds rate at which banks lend to each other overnight) by purchasing three-month Treasury bills. But it has basically hit the floor on the federal funds rate. If the Fed could lower the federal funds rate as far as chairman Ben Bernanke and his colleagues wanted, it would be much less controversial. The monetary policy cognoscenti would be comfortable with a tool they know well, and those who don’t understand monetary policy as well would be more likely to trust that the Fed knew what it was doing. By contrast, buying large quantities of long-term government bonds or mortgage-backed securities is seen as exotic and threatening by monetary policy outsiders; and it gives monetary policy insiders the uneasy feeling that they don’t know their footing and could fall into some unexpected crevasse at any time.
Guest post by Peter Tchir.
Once again, the fate of the world or at least the markets rests on the shoulder of two men. Ben and Mario hold center stage over the next few days.
I believe Ben will disappoint and rather than highlighting what can be done, will take this opportunity to preach on fiscal policy and to talk about what can’t be done with monetary policy. It won’t do much damage to the markets, but isn’t going to support the rally in the short term. I will be on Bloomberg TV today at 5 to discuss my reaction to what he actually says and does.
Draghi, on the hand, I think will come through. It will be tricky as the market has decided it wants certain things (ESM banking license, full support along the entire curve, etc.) that are outside of his “mandate” to deliver. So there may some initial disappointment, but I think he will be able to push the market along.
The immediate response of many is that he cannot do anything meaningful. That Spain and Italy are in solvency modes with deteriorating budgets, so what can monetary policy do?
With the Spanish yield curve at extreme levels, the relevant question is whether Draghi has made things worse going forward? From Bloomberg.
European Central Bank President Mario Draghi’s bid to bring down Spanish and Italian yields may spur the nations to sell more short-dated notes, swelling the debt pile that needs refinancing in the coming years.
Yields on Italian and Spanish two-year notes plunged after Draghi said on Aug. 2 the ECB may buy debt on the “short-end of the yield curve” as part of a broader crisis-fighting plan. The gap between Spain’s two-year and 10-year yields rose on Aug. 6 to the widest in at least two decades, while the spread between similar Italian securities also approached a record.
The average maturity of Spanish debt is the shortest since 2004 as Spain, like Italy, hasn’t issued 15- or 30-year bonds all year. As Prime Ministers Mario Monti and Mariano Rajoy fight to avoid bailouts that may threaten the euro’s survival, the ECB’s plan risks adding to pressure on the two nations’ treasuries.
The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of “stocks for the long run” or any run have mellowed as well. I “tweeted” last month that the souring attitude might be a generational thing: “Boomers can’t take risk. Gen X and Y believe in Facebook but not its stock. Gen Z has no money.” True enough, but my tweetering 95-character message still didn’t answer the question as to where the love or the aspen-like green went, and why it seemed to disappear so quickly. Several generations were weaned and in fact grew wealthier believing that pieces of paper representing “shares” of future profits were something more than a conditional IOU that came with risk. Hadn’t history confirmed it? Jeremy Siegel’s rather ill-timed book affirming the equity cult, published in the late 1990s, allowed for brief cyclical bear markets, but showered scorn on any heretic willing to question the inevitability of a decade-long period of upside stock market performance compared to the alternatives. Now in 2012, however, an investor can periodically compare the return of stocks for the past 10, 20 and 30 years, and find that long-term Treasury bonds have been the higher returning and obviously “safer” investment than a diversified portfolio of equities. In turn it would show that higher risk is usually, but not always, rewarded with excess return.