My favourite data is out and guess what ? US investors are still selling bonds and buying foreign equities.
So I guess by now you must know my thoughts if you have read my previous posts. We are clearly heading for a bond crash and higher US yields is not a supportive factor for the dollar when money is going abroad…Looks to me like private investors are tapering ahead of the Fed….
It seems that the risks flagged for September are slowly vanishing and that the risk agenda is now relatively clear for the remainder of the year. Syria is still a concern but there is now a possible alternative to a direct military intervention which is somehow good news. The German elections are nearing and though some uncertainty remains as highlighted by recent surveys, Merkel remains the likely winner. Of course there is the Fed meeting on the 17th & 18th and the market eagerly speculating on the semantics of the Fed communique. Tapering or business as usual ? My thought is that all this is overblown and that we have been given a clear path of what will be the Fed monetary policy in the forthcoming cycle…so no real tradable surprise…Anyhow the equity market is taking this pretty well so far as reflected by last month performance and the low level of risk implied by the VIX. So business as usual…long those equity betas and short bonds….
FX market have been correlating fairly well with the equity market and we have seen commodity currencies recovering significantly over the last few sessions . Also the Yen carry trade still in favour with USDJPY breaking the 100 level. That being said most of the currencies have remained within statistically normal boundaries as indicated by the below charts which show the current T-Stats for major dollar crosses and also their rolling 3-month T-Stats relative to a 95% confidence interval.
The below charts shows the sensitivity of the BTOP FX to major dollar exchange rates and therefore and idea of the portfolio content of most FX managers. The USDJPY seems to be the trade favoured by the speculative community as well as dollar long generally speaking. Maybe more interesting is the second chart that shows an estimate of the leverage used by the FX managers peer group. It is derived by comparing the variance of the BTOPFX index and the Variance of the estimated sensitivities for an unleveraged portfolio.
Overall the level of positioning seems to be pretty average by historical standard. This lead me to think that there are still some good opportunities left in FX going to the end of the year. Assuming that no event comes to spoil the party I would hope to see a continuation of the recent trends…namely a sell off of the dollar as US investors focus on international opportunities and more upside in yen crosses as they re-leverage…that being said I probably would remain cautious on outright long USDJPY due to the current positioning and equity flows potentially weighting on the Greenback…
Ok the ICI has just released their latest dataset for August and there is no abating for International equities buying by US investors and conversely selling of bonds….
This may explains why the 10 years is currently trading close to a 3% handle…It looks like those payroll data may bring some further volatility to this.
As mentioned in my previous posts, I think we are still at the beginning of the spiral and that we have not as of yet seen much change in the velocity of the asset allocation shift taking place, so I believe all fundamentals being equal there are some good opportunities that remain in my scenario… I am still adding on my equity portfolio and ponder about the future effect of an unavoidable bond market crash…and yes I still think the dollar will weaken as those flows amplify and the appetite for international equities accelerate….
Ok I have to admit last month was not as rosy as the previous 9 months if you invested in equity markets, but clearly this is not a disaster unless your time horizon is that short.
The good thing is that despite the short term underperformance of stocks the appetite for global equities and the hatred for bonds is relentless as seems to indicate the latest release of the ICI data.
Bearing in mind the overall size of the US Mutual Funds market and the outstanding disproportionate bond holdings this should be comforting to the equity bulls. Even more comforting is that all my equity risk metrics and my regime switching model give a green flag for holding equities.
Of course there is Syria, the forthcoming discussion (or speculations) of tapering at the September Fed meeting as well as the German election to potentially exacerbate financial markets risk premium. However September is generally a month where liquidity comes back and this tends to dilute market risk….my bet is for a good old fashioned year end rally…sit tight !
Ok the latest ICI data on US mutual fund has just been released and guess what ? moms and pops are still selling bonds like it is going out of fashion and buying equities like there is no tomorrow. Hence the red squares on my chart that shows the T-Stats of the inflow/outflow for each asset buckets over diverse time horizons.
…and yes those 10 year bond yields are still going higher and further incentivising the laggards to come out of their bond holding….
To the risk of repeating myself we all know that there is a massive overhang in bond holdings, so my contention is that we may have entered a spiral and that somewhere on the line we are going to see a repeat of 94…..a good old fashioned bond market crash….
Meanwhile as we gathered from the Fed minutes everyone is getting very cagey about mentioning when they will start tapering (or is it tampering…) ….looks like the street is about to dictate the Fed monetary policy by jettisoning those low yielding assets for something more sexy…..
Ok I could not help the reference to Trading Places, it has been 30 years since the movie came out after all but this time it is not about commodities it is all about equities ! Let’s face equities are on fire and there is so much bond holdings to get rid off ahead of central banks taking their liquidity back that. That fuel is not about to run off….after all the move that we have seen in treasury is not that big….or at least there is still some ground for further retracement surely (Fig 1)…event when Bernanke tries to give us some re-insurance about the pace at will they will withdraw liquidity the direction is clear…the bond Pandora box is now officially open !
Meanwhile as investor the Fed gives us little choice…. Commodities ? well we have seen some retracement but if the view remain for a muted growth it may not be necessarily the best tactical bet. Bonds ? you skipped a paragraph surely…. Equities seems to be the only way unless you like cash with a very low yield…or want to go for less tangible assets. Clearly the markets have moved that way if you take a look at Fig. 2. Ok Asia and Latam did not do too well but Nikkei 67% and other countries performance says it all …..
Fig. 1: one year performance of major stock indices.
More interestingly as per the very last data from the ICI it seems that there are no abating for bond dislike and equity appetite ! I put out a set of my usual charts for your perusal….
Fig 2: Mapping of Inflow/Outflow in US mutual funds
As I put the question to a well know chief economist a few months ago: Do you think money can create money ? Think a minute…after all it is surely what the Fed must be thinking ? if somehow all that private money shift from bonds to equities those companies will have to use their new stock valuation to do something…look for new market, go into M&A mode, invest in research and development…hire a few peoples and kick start the economy ? This is what I would expect from the CEOs that manages the companies I am invested in or else give me my money back !….Now the question is: If all or greater part of this private money is shifting from bonds to equities what will be the effect on the dollar ? Clearly the current contention is that the significant retracement in bond markets will conduct an upshift in the US yield curve and that this will be beneficiary to the dollar strength….Most economists seem to have been lured by this scenario….I have to say that I am unsure about all this…The US Mutual fund is about US$ 19 trillions in size of which most of it is currently invested in US bonds (either US or global hedged) and it seems from the above that there is a justified and significant appetite for international equities who are generally invested into on an un-hedged basis…bearing this in mind and possibly companies drawing on their rising valuations to support M&A , R&D which are likely to be foreign by nature I would think that this can significantly offset the rising US yield effect and that we could see the US$ depreciating….My feel is that we are seeing a structural asset allocation shift and that old tenets will not hold whilst we are experiencing the renaissance of a true Equity bull market…. a bit like in the 80’…..Looking good Billy Ray !
It looks like American investors are still switching away from bonds in July as per the recent data of the ICI. I have put together a few of my usual charts to visualise this. The appetite for bonds is a mirror of what it is for equities.
As mentioned in my previous post on the same subject my feeling is that we could see all this impact the strength of the US$ . Many economists out there are entrenched in their scenario of rising yields and GDP for the USD over the medium term with a strengthening of the US$. Whereas I agree on the rising yields and GDP in the US, I somehow strongly disagree on the effect on the US$. Clearly the world has had a domestic bias since 2008 and this has been reflected on the risk adversity of the average US investor asset allocation which was primarily dominated by bonds and somehow local equities. If investors become a bit more adventurous , they will start to invest more significantly in international equities (as shown in the above charts) therefore they will need to sell some US$ in the process. In that scenario it may well be that the EURUSD does not present such a bad value at 1.3280……
Looks like there is no abating to for equity appetite out there. And there some are good reasons to be hungry for it…bonds won’t g bring you any decent yield whilst still bearing a massive Fed tapering tail risk. Despite the Fed floating some reinsuring words about the measured pace at which they will withdraw the liquidity it supplied, make no mistake they will. Now the big question is: Will the market front run them and dictate the monetary policy going ahead ? Clearly if the bond market inventory is to adjust drastically as your typical US and foreign household start to take more risks in equity markets and redeem their bond funds in the process this must also mean something for the short end of the yield curve……In that respect I am still pondering about the possible effects of this as clearly the outstanding bond holding in US mutual funds is very large indeed not to use the word humongous. Maybe we are not too far to discover what is the answer to this question as there seem to be clearly a general dislike for bonds and a growing appetite for equities out there. The ICI on inflow/outflow in US mutual funds illustrates well what is taking place. The chart below shows what has been the inflow / outflow for the first half of July, significant inflow in domestic and foreign equities and outflows in bond products….Pretty much a continuation of what happened in June, aside the inflows in domestic equities which were negative last month.
Meanwhile if we look at the risk environment, the VIX trades pretty much on its long term median and a 2-state Markov regime switching model tells us that we are fairly well entrenched in a “Risk on” scenario.
Bearing in mind a background of fundamentals that do not seem to be on the awful side if we are to believe Moody who changed its outlook from negative to stable for the US, I can’t help to be still in love with equities….Bond managers, tin hat on please !
Ok we know that the Australian economy is intimately tied to other Asian economies and particularly China and that growth expectations for China have been dimmed by a tighter monetary policy. However it strikes me that the Australian dollar has somehow been heavily sold over the last few month when I look at the t-stat of the daily logarithmic changes of the AUDUSD over different time windows. The first chart shows the T-stats of various exchange rates against the US$ over windows of 1 week to 6-month. The second chart shows the rolling 3-month t-stats of daily logarithmic changes of major currencies against the US$. The plotted lines are 95% interval of confidences. Clearly the AUDUSD has been significantly oversold on a statistical basis.
The Australian stock market has held well relatively to the rest of the world . The recent global surge in equities we have seen is not driven only by a rotation toward equities due to the fear of central bank rising their interest rates at some time in the not so distant future but also due to expectation economic growth.
The oz seems quite cheap at 0.9050 against the Greenback….tempting….
The answer seems to be yes as far as what took place in June. This is the start of a proper bond bear market, thank you Mr Bernanke. When one looks at the June data on outflow / inflow in US mutual funds just released by the ICI it becomes obvious that we are not dealing anymore with ordinary moves. The outflow in taxable bond funds was similar in term of intensity to what we observed in equity funds in October 2008. There is a smell of panic amongst bond investors and with good reason, the remaining inventory is massive and the gate is narrow. The guys at PIMCO would know about it as they had an estimated US$ 10bn outflows last month. What is quite exciting about all this is that we have seen some inflow in international equities over the same period. This clearly looks like the onset of the shift in asset allocation I have been so fond of over the last year and half (see my previous posts). Anyhow I thought I would display my usual charts….please look away if you are still overweight bonds…
The above charts shows the monthly inflow outflow in US mutual funds. The chart on the left plot the data relative to its long term median and 95% up/ interval of confidences. The data for bond is way out of scale. The chart on the left shows the T-stats of the inflow/outflow (i.e. how significant they have been) over various time period. Despite the recent inventory adjustments bond holdings still remain very rich which would indicate that there is further room for a significant sell off in fixed income unless the Fed shy away from its view on tapering, better watch this job data then…..
The charts above shows the outflow/inflow relative to the VIX. We have not seen much increase volatility in the equity markets, the VIX averaged 17% in June. We just had a minor outflows in US equities but also interestingly a notable inflow in both hybrids and international equities….This looks like the onset of an asset allocation shift to me. Finally it may be worth to start mulling over what would be the effect of further significant investing in foreign assets by US investors on the strength of the US$…..