Monthly Archives: December 2013

Mark My Words: It Is Just The Beginning Of The Bloodbath For Bonds !

Quite clearly the last Fed meeting of the year was  important. We got the long awaited  announcement that the purchase of Treasuries and MBS would be reduced. The rate of 10 billions  a month at which it decided to decrease its security purchase was mild enough to demonstrate that the Fed meant to remain accommodative and that its main concerns were the relatively high unemployment rate and the stubbornly low inflation rate, as shown in the word cloud of the Fed Statement. fed cloud 18122013

To put in context  how mild this reduction of security purchase by the Fed is, it is worth bearing in mind that US mutual fund holders have been redeeming from bond funds at an average rate of 23 billions a month over the last seven months. This probably supports my contention that the Fed will accept to lag the market shift in asset allocation so as not to send those long term rate flying… but ultimately the 10 year US rate is more likely to trade close to 4% than 2% within the next year or so as private sector redemptions and government withdrawal of liquidity  will ineluctably  bear on bond valuations. So we will see further steepening in yield curves. The reason behind the price dynamic is clearly driven by growth expectations which are rationalised by the continuous decrease we have observed in US unemployment and general pick up in economic activity.  Anyhow it seems that the market took the news very well  since we have seen a small upside in equity markets and the VIX  has been holding at what once would have been deemed insanely low levels as shown in the below chart.


As of why the VIX remain so low,  my theory is that the dynamic is supported by the significant inflows we are seeing in the equity markets. selling short the VIX should indeed correlate with a long position in equity markets.  Anyhow  the last batch of data has just been released by the ICI and guess what ? It is redemption time again for those fixed income funds. Somehow the Fed meeting which acted as a beacon for the Roubinni’s of this world and black swan watchers proved to be a damp squib because of the modest decrease in security purchase announced. Not surprisingly there were a few outflows for domestic equity funds ahead of the Fed release and the outflows in bonds was as usual negative (as would be consistent with a decrease purchase by the Fed). It is worthwhile noting however that the flows toward global equity funds remained significantly positive. This  ultimately lead me to thing that this will put pressure on the US$ particularly against the EURO because of the country weighting in MSCI and other equity benchmarks.   Below are the usual map charts and cumulative charts.

flow map 201220133

As mentioned in the above the inflows into equities and outflows from bond products are taking place in a relatively low risk environment (as expressed by the VIX).  I find this interesting as it is consistent with an orderly shift in asset allocation. We are not talking about the kind of asset shift we have seen in 2007/2008. It was then clearly driven by a strong risk adversity and therefore not a long lasting proposition. The chart below illustrates well the new flow dynamic we are experiencing.

inflow outflow vix

This kind of configuration tends to occur when an equity bull markets is taking hold. So my view remain stubbornly unchanged and you are better to get used to the above charts….the bloodbath for bonds has just started it will be slow and agonising…I will stay long equity Beta.

Are Equity Markets Overbought ?

Fair question, it has been quite a  run over the last 18-months. Those moves may look atypical to some because we forgot what was a good old fashioned bull market whilst experiencing the previous bond rally who has come to term…The MAP below shows the T_Stats  for major stock markets over various time horizon… everything above or below -1.6450/-1.6450  would breach a 95% interval of confidence on a normal distribution… nothing out of the ordinary there…..


Keep on buying then !

FX Moves

Ok we have had a few moves in FX over the last weeks and as liquidity is about to dry up I though it would make sense to look at how significant the moves in the main dollar crosses were…The chart below shows what were the T-Stats  for the G10 US$ exchange rates across different time period….

fxpositioning 3m  05122013 fxpositioning 05122013

Nothing looks out of what you would expect under the 95% confidence interval of a normal distribution…. so I guess I would stay with the trend… I.e long USD-JPY & EUR-USD and sell commodity currencies…..


It Is Still Buy Equities and Sell Bonds….

Ok the latest ICI data release is out again , so here are my favourite charts. An yet again no surprise it is buy international and domestic equities and sell bonds.


Now it has been 12 months that US investors are buying equities and 6 months that they are selling bonds (and my contention is that we have the same phenomenon in the UK) . What do you need more as a signal ?  The great rotation is just starting, so there is still time to come on board….


What really fascinate me is the amount of investment in bonds remaining to be culled by the private investors…even if you think within a balanced portfolio framework we should have a 60% bonds /40 % equity as a point of reference for a neutral the asset allocation… the chart below tells me that we are quite far from this level… buy equities… as long it is not PIMCO because their revenues are likely to be dented significantly unless they can re-invent themselves as a global equity manager…..


Should I Stay or Should I Go ?

As we are nearing the end of the year and that typically we should see liquidity drying up as well as  rumors about a nasty retracement in equities abounding I thought I would have a quick look at some of my pointers. Clearly it has been a nice run so far and central banks have been very helpful in supporting the current bull market. The latest data from the ICI   demonstrates that there is no stopping American investors buying international equities and selling bonds. And my thought is that the situation is similar in many of the major economies which are on their way to recovery. I guess the risk of a major retracement in the bond markets in the next couple of years is still a significant risk  whilst upside likelihood remains limited so there is a strong rationale for a private investors to go bull on equities as the economy is picking up.  The chart below shows the significance of the inflow and outflow in US Mutual funds by asset classes and over various time horizons. The greener the more inflows the redder the more outflows….Clearly we have been in equity buying mode for a while now.

US MUTUAL FUNDS flowsDespite the significance of the flows observed the dent made to the level of investments  accumulated in bonds over the years  remains modest so far. This is good news for the current rally as therefore there  is still much adjustment to take place all being equal. Clearly  what we will experience ahead will be dependent on future economic growth. Bearing in mind the track record of accuracy of forecasts made by economists and alike my view of a significant economic growth in  the next few years based on the lagged response to the significant stimulus provided by major economies is as good as any. Over a shorter horizon  I think it is fair to say that so far governments and financial authorities have done a relatively good job and that the green shoots of recovery are well established. My view is that  central banks will be weary of adjusting their monetary policy  too fast as they will want to maximise the likelihood of  strong economic recovery and job creation. Inflation will definitively become acceptable if accompanied by strong growth. A scenario of higher nominal rates but not necessarily higher real rates should further promote  flows toward equities. Lets face it what we are seeing is structural and we probably have another few years of equity beta coming our way.

cumulative flows us mutual funds

I acknowledge that we  have had a significant upside in equity valuations this year if one takes exception of emerging markets.  Most markets have had  double digit returns  that can t remain unnoticed to the average investor . So despite my bullish view emulated in the above this  raises some issues about the market being possibly overbought.


The chart below investigates the periods were the S&P500 has had a statistically similar run and plots what has happened in the following 250 days ( I use a sample of daily data spanning from 1980 to date).   Clearly what we have seen  is pretty much average in regard of past bull markets  and from there the possibilities are broad we could retrace by close to 30% or rally by another 50%, if history is a guide at all.


Meanwhile the VIX  which should embed market expectations  about possible risks remains well below its long term median. My other metrics of market risk Volga and Shockindex are similarly close to their historical low. This may indicate a level of vunerability of the market but also reflects that the flows going into equities are somehow dampening the market volatility.

risk metrics Finally my two-state Markov regime switching model still indicates  that we are within a risk on environement (i.e long equity risk) and there are no sign of  a change there.


So  I guess I ll stick to my bullish view and will keep my broker unhappy by holding my positions…. no commissions for him in December….