Category Archives: Bonds

As market risk has been trading on the low over the last few months I thought that I would post a few charts of mine. First looking at the VIX as a measure of  financial market risk we are indeed trading at relatively low level, though we are still a few points away from the  9.31 the lowest ever close that printed on the 22nd of December 1993 .  The  two states Markov regime switching remains  clearly on risk seeking mode.

Contributing to this low volatility has been the massive inflows that we have seen on equity markets.  However I would not call this level abnormal, the chart above  start from January 1990 and show that we have indeed experience long period of low volatility in the past. The chart below shows the significance of  inflows/outflows in US mutual funds tracked by the ICI . The chart on the left shows the T-stat of the inflows for the main asset classes over various time horizons. It is clear that the preference has been for  equities, and this with good reasons as discussed in my previous posts. So far in the US alone we have seen close to USD 120 billions of new inflows in US mutual funds.

Out of this, as shown by the right hand chart,  close to 40% went into Foreign equities , only 5% into US equities and   21% in hybrids. if we assume a 60/40 benchmark this means an extra 8% into equities. Therefore  potentially 53% of the 120bn invested went into equities.  This is somehow in decline in respect of what we have seen in the first half of 2013 where 162bn went into US mutual funds, with an estimated 62%allocated to equities.  However this is without any doubt a contributing factor to the low level observed in the VIX. Clearly central banks monetary policy  and also the implication for the bond market of an exit scenario on the back of better economic fundamentals has somehow  been behind the great rotation that started now a couple of years ago. The last chart showing the cumulative inflows in the main asset classes indicates that  there is still some way to go….I ll stick to equities as usual….

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. 

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.

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.

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.