Behold The Fed’s Takeover Of The Bond Market

Friday, August 17th, 2012

The must see time lapse video below courtesy of Stone McCarthy shows the distribution across the entire curve of the US marketable debt, as it was held by either the Fed, or the private sector over the past three unconventional monetary policy programs: starting in 2003 and concluding yesterday. In one short minute, this clip demonstrates very vividly how the Fed effectively took over the US bond market.

Some things to note:

• The reason why the Fed no longer holds any debt with a maturity under ~3 years is because of the “ZIRP through late-2014″ language which means there is no point for the Fed to hold that debt. For all intents and purposes it is the equivalent of cash. Debt maturing between now and 2014 amounts to just under $5 trillion.  Which means the Fed only has about $5.5 trillion in marketable debt with a maturity over 3 years to work with, and already owns about a third of it. It also means that as all the Fed’s holdings in the under 3 year category are sold, Twist will have to be extended, and with it the ZIRP language to beyond 3 years – most likely 5 or so.
• What is very visible is how the Fed had no choice but to expand its SOMA limit holdings per CUSIP from 35% to 70%. Soon, once the Fed owns 70% of every longer-dated Cusip, it will have no choice but to again extend the maximum permitted holdings, this time to 100% as it gradually become theentire market.

If after watching this clip anyone still believes that the biggest bond market in the world resembles anything even close to fair and efficient or which would have clearing prices anywhere near to where they transact now, they may want to double down on the FaceBook IPO allocation now.

Initial marketable debt distribution by holders starting back in2003 when the first Fed monetary policy started:

And most recent.

Tags: 3 Years, Cusip, Debt Distribution, Distribution Curve, First Fed, Intents And Purposes, Ipo, Marketable Debt, Maturity, Maximum, Mccarthy, Monetary Policy, Private Sector, Reason, Soma, Takeover, Time Lapse Video, Trillion, Us Bond Market, Zirp
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One Indicator Showing an Extreme Reading

Wednesday, July 4th, 2012

Here is one of the indicators I spoke of this morning – it was 85 coming into the day (the chart does not update intraday) which is a very rare level over the past 3 years.  If today’s ramp holds into the close it would not be surprising to see a reading near 100.  That has only happened once in 3 years, late July 2010.  It happened a few times in late 08, early 09 as well – once even well over 100.  But it’s rare.

Looks like everyone is anticipating not only a 25 basis point ECB cut but some goodies now that they have said they wanted the fiscal authorities to act first.  Again we need not see a big selloff, but usually when you reach these sort of levels you digest for a few sessions.

Tags: 3 Years, Basis Point, Fiscal Authorities, Goodies, Intraday, Nbsp, Ramp, Selloff, Sessions
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Jim Grant on Bernanke’s Continuing “Grand Manipulation”

Thursday, June 7th, 2012

In preparation for what we are about to receive from the Charmain of the Fed, may we be truly grateful, Jim Grant offered CNBC’s Maria B the forthright advice last night “prepare for platitudes but watch what they are doing not what they are saying”. The ever outspoken Grant notes that the Fed’s balance sheet has been contracting (unlike Maria’s mainstream perspective); for the past three months the Fed’s balance sheet has contracted at an annualized rate of 10% – even as Fed-head after Fed-head talk up QE and so on. So unless they continue buying securities – since the short-dated positions will continue to roll off – the Fed’s balance sheet will continue to contract and therefore the stimulative effect will fall. Grant does expect QE3 since it is the fun-drug that we have been using for 4 or 5 years and that Bernanke will need little pushing to continue the Grand Manipulation. He ends on a rather interesting note that the Wisconsin win and the potential for an Obama loss in November may be more of a positive driver for stocks since markets begin to revert to a free market once again – we suspect this is not the case given the donors/beneficiaries under Romney’s wing. But rest assured – the bespectacled bear ends on the chilling note that ‘the long-term implications are bad’ for the ongoing manipulation that is now the status quo.

and from Goldman, if there was any doubt of Grant’s comments on the implicit tightening – or inverse flow – as they present the embedded tightening opportunity cost for the Fed it does nothing.

The bottom line here is that if the Fed does nothing then there is an implicit 5-10bps of rate-hike tightening per quarter implicit in the balance sheet roll-down (50bps in next 3 years) – so when considering the Fed’s actions, discount the effect of this automatic tightening before buying the S&P at 2000…

Tags: 3 Years, Amp, Balance Sheet, Beneficiaries, Bernanke, Bottom Line, Charmain, Cnbc, Donors, ETF, ETFs, Fed Head, Gold, Goldman, Jim Grant, Mainstream, Manipulation, Opportunity Cost, Platitudes, Qe, Rate Hike, Term Implications, Three Months
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Another Week Passes, Retail Investors Ignore “Generational” Opportunity To Buy Stocks

Thursday, April 19th, 2012

The week ended April 11th is when equities finally rolled over. Which is why those curious how retail fund flows did in the past week will not be very surprised: if individual investors avoided stocks like Bernie Madoff Asset Management on the way up, there is no reason why they should change their mind on the way down.

Sure enough, in the past week, $1.5 billion was withdrawn from domestic equities. Instead, cash, solely with the aim of capital preservation enter taxable bond funds, as it has for the past 3 years now. With the latest redemption, total 2012 flows to date are over $25 billion, or more than double the comparable amount in 2011. It appears that retail has seen right through the once in a lifetime opportunity, and is withdrawing money from stocks at the fastest pace ever, irrelevant of what the myth formerly known as the “market” actually does.

And something a tad odd: the orange arrows are of identical length, and are inclined at exactly the same angle.

Tags: 3 Years, Aim, Asset Management, Bernie Madoff, Buy Stocks, Capital Preservation, Domestic Equities, Fund Flows, Individual Investors, Lifetime Opportunity, Money, Myth, Orange Arrows, Pace, Redemption, Retail Investors, Taxable Bond Funds, Week 1
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Scott Minerd: “A Wide Range of Assets Are About to Make Large Gains”

Thursday, March 1st, 2012

Scott Minerd, Guggenheim Partners CIO, discusses his long-term strategy, investing for an asset bubble, the risk-on trade, and shorting Treasuries. Also, how best to implement and apply the trend, with the Fast Money traders.

From CNBC:

“The world is being flooded with liquidity,” says Minerd in a live interview on CNBC’s Fast Money. “Money is coming out of central banks around the world.” And he adds that the Federal Reserve is committed to keeping rates low for an extended period of time.

With so much liquidity chasing return, Minerd thinks a wide range of assets are about to make large gains. “Over the next 2-3 years, it’s risk on,” he says. And he’s planning to position as follows:

- Long High-Beta Equities
- Long gold and silver
- Long junk bonds
- Buy art & collectibles
- Short Treasurys

In the near term, that sounds good for your equity portfolio –but if you have a longer time horizon, Minerd also makes some troubling comments.

Tags: 3 Years, Art Collectibles, Assets, Central Banks, Cio, Cnbc, Federal Reserve, Guggenheim Partners, Junk Bonds, liquidity, Live Interview, Money Money, Period Of Time, risk, Term Strategy, Time Horizon, Treasuries, Treasurys
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Markets’ Performance Year to Date

Thursday, March 1st, 2012

The WSJ details:

Treasury and gold investors were rocked out of their recent torpor on Wednesday as a series of large trades in the futures markets sent prices tumbling.

At the Chicago Mercantile Exchange, an unusually big sale of more than 100,000 futures on U.S. government debt cascaded across traders’ screens shortly after 10 a.m.

The selling spread to the cash markets where 10-year Treasury yields, which rise as prices fall, spiked to 1.99% from 1.93% in minutes.

The trades came just after the release of congressional testimony from Federal Reserve Chairman Ben Bernanke. Some traders said Mr. Bernanke appeared less focused on the prospect for a third round of asset purchases, known as QE3, than the market expected.

Not a good day for gold bugs.

Despite the huge sell-off in gold shown above (the largest in 3 years), gold (and other asset classes) are doing just fine. The only asset down year to date that EconomPic regularly reports on is long Treasuries (which were up more than 30% in 2011).

Source: Yahoo Finance

Tags: 10 Year Treasury, 3 Years, Asset Classes, Asset Purchases, Cash Markets, Chicago Mercantile Exchange, Congressional Testimony, Federal Reserve, Federal Reserve Chairman, Futures Markets, Futures Prices, Gold Bugs, Gold Investors, Government Debt, Qe3, Screens, Torpor, Trades, Treasuries, Wsj
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European Nash Equilibrium Collapses – Bank Bailout Stigma Is Back At The Worst Possible Time

Tuesday, February 7th, 2012

In all the excitement over the December 21 LTRO, Europe forgot one small thing: since it is the functional equivalent of banks using the Discount Window (and at 3 years at that, not overnight), it implies that a recipient bank is in a near-death condition. As such, the incentive for good banks to dump on bad ones is huge, which means that everyone must agree to be stigmatized equally, or else a split occurs whereby the market praises the “good banks” and punishes the “bad ones” (think Lehman). As a reminder, this is what Hank Paulson did back in 2008 when he forced all recently converted Bank Holding Companies to accept bail outs, whether they needed them or not, something that Jamie Dimon takes every opportunity to remind us of nowadays saying he never needed the money but that it was shoved down his throat. Be that as it may, the reason why there has been no borrowings on the Fed’s discount window in years, in addition to the $1.6 trillion in excess fungible reserves floating in the system, is that banks know that even the faintest hint they are resorting to Fed largesse is equivalent to signing one’s death sentence, and in many ways is the reason why the Fed keeps pumping cash into the system via QE instead of overnight borrowings. Yet what happened in Europe, when a few hundred banks borrowed just shy of €500 billion is in no way different than a mass bailout via a discount window. Still, over the past month, Europe which was on the edge equally and ratably, and in which every bank was known to be insolvent, has managed to stage a modest recovery, and now we are back to that most precarious of states – where there is explicit stigma associated with bailout fund usage. And unfortunately, it could not have come at a worse time for the struggling continent: with a new “firewall” LTRO on deck in three weeks, one which may be trillions of euros in size, ostensibly merely to shore up bank capital ahead of a Greek default, suddenly the question of who is solvent and who is insolvent is back with a vengeance, as the precarious Nash equilibrium of the past month collapses, and suddenly a two-tier banking system forms – the banks which the market will not short, and those which it will go after with a vengeance.

The WSJ has more on this very subtle but so very critical shift in the European bailout game theory equilibrium:

A group of top European banks is disclosing that they didn’t borrow money under the European Central Bank’s bank-lending program, fearful of being perceived as bailout recipients.

The broad participation in the program, known as the Long-Term Refinancing Operation, fueled a sense of euphoria among many bank executives and investors that the worst of the Continent’s two-year banking crisis was over. In a second batch of loans in late February, analysts expect the ECB to distribute as much as €1 trillion in additional funds, partly because the central bank is making it easier for banks to borrow.

But some bankers and observers are starting to warn about unexpected fallout from the ECB’s loan program. A top concern among banks is that the receipt of central-bank lifelines could subject them to potential political or regulatory interference and sully their ability to declare themselves free of any outside help. That sentiment has the potential to damp demand for future ECB loans, at least among the Continent’s strongest banks.

In other words, the market is finally waking up that the LTRO, more than merely carrying the upside of a mechanism preserving the status quo for a brief period of time, also has the downside of implicit stigma associated with any and every bank that is found to use it. And the punchline here is that the second a European “Jamie Dimon” emerges and starts touting their lack of need to use LTRO cash, the whole plan collapses. It appears that Deutsche Bank, the bank whose assets are 80% of German GDP, is just that equilibrium collapse factor.

It isn’t yet clear how many banks declined to borrow but the list includes Deutsche Bank AG and Barclays PLC. While the ECB doesn’t divulge which banks borrowed, most companies are expected to disclose the information as they release annual results this month.

“The fact that we have never taken any money from the government has made us, from a reputation point of view, so attractive with so many clients in the world that we would be very reluctant to give that up,” said Josef Ackermann, Deutsche Bank’s chief executive, explaining to analysts last week why the German lender didn’t borrow from the ECB.

Mr. Ackermann said Deutsche Bank still is scarred from its experience borrowing from the Federal Reserve in the first phase of the financial crisis in 2008. U.S. regulators encouraged banks to borrow under the cloak of promised confidentiality, but when the banks’ identities were subsequently disclosed by the Fed, the recipients were dubbed bailout recipients. “We learned a lesson,” Mr. Ackermann said.

Other bank executives privately have voiced similar opinions. Some of that sentiment is likely to surface publicly in coming weeks as banks report annual results and executives face questions from investors about whether they borrowed from the ECB.

English banks are also suddenly scrambling to portray themselves as healthy:

In the U.K., the Financial Services Authority informally encouraged the banks to tap the ECB loan program, although the regulator also made clear that the decision was up to the individual banks, according to executives with several British banks. The goal of the FSA, shared by other European regulators, was to promote broad use of the facility and reduce any stigma associated with borrowing, said people familiar with the matter.

A number of top British banks, including Barclays, Standard Chartered PLC and Lloyds Banking Group PLC, opted not to borrow from the ECB, according to people familiar with the matter.

Beyond the implicit, there are explicit risks associated with being bailed out:

“Those heavily reliant on ECB funding run risks of interference as a price for continued support. This may come to be seen as a form of nationalization,” said Simon Samuels, a European banking analyst at Barclays Capital. He said bank executives are likely to worry that regulators will view their dependence on ECB funds as a sign of a broken business model and will pressure them to restructure operations.

Such concerns are peripheral for banks that potentially were going to have trouble refinancing maturing debt at nonpunitive prices. Virtually every major French, Spanish and Italian bank borrowed billions of euros from the ECB, according to bank disclosures and people familiar with the matter. Among those was Banco Bilbao Vizcaya Argentaria SA, Spain’s second-largest lender by assets, which borrowed €11 billion, the bank’s president told analysts last week.

Some healthy banks also pounced on the opportunity for inexpensive three-year funding. HSBC Holdings PLC was among those that borrowed even though it didn’t need the money, according to people familiar with the matter. Any profits the British bank reaps from investing the borrowed funds will be segregated from HSBC’s bonus pool, one person said.

Yet all these considerations pale before the reality that any banks that borrows even €1 on February 29 will suddenly be perceived as a lower-tier performer, when faced with banks that parade with their “fortress balance sheet.” And as everyone knows, bail outs only work when everyone agrees to be bailed out. Otherwise, it is a shortcut to collapse. Because the last thing Intesa and UniCredit and STD and a whole lot of not so healthy banks will want on March 1 and onward is to be put in the “bailout recipient” category when so many others clearly no longer need the cash…

It appears that European banks, in their vain attempts for short-term capital gains, may have just sealed the fate of the entire financial sector.

Tags: 3 Years, Bank Bailout, Bank Holding Companies, Banks, Borrowings, Capita, Continent, Death Sentence, Excitement, Functional Equivalent, Hank Paulson, Jamie Dimon, Largesse, Lehman, Nash Equilibrium, Qe, Reminder, Stigma, Trillion, Trillions
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New 52 Week Highs – Notice a Pattern?

Friday, December 30th, 2011

As I scan my traditional watch lists most of the stocks in them are doing “meh” – they take 3 steps forward and 2 steps back.  Or vice versa.  They are really doing very little other than churning.  Most of the leadership of the past 2-3 years has died – broken charts everywhere.   See Mr. Amazon.com (AMZN) for but one example.

Lately, it has been a market whose leadership is in safety and yield.  Not typically what you associate with a bull move.  Many of these stocks are very overbought (in some cases extremely so) but each day the buyers come in and buy more…. one wonders if Mr. Bernanke with his multi year (and perhaps decade long) low interest rate policy has begun fomenting the next bubble: yield.  No longer able to get yield in traditional havens, investors are pushed into equities that provide it.  Seemingly, en masse.When stock price appreciation expands in excess of earnings or cash flow – that means multiples are expanding.   Multiples are a judgement call – but generally fall within very long term historical ranges.  We are now seeing excess in the ranges but like good lemmings the crowd is being herded…

Ironically these are considered ‘safe’ stocks – but we all have seen this game before and know how the crowded trade ends.  But we never know when.

I think as you scan the 52 week high list a very obvious pattern should be apparent.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Tags: 2 Steps, 3 Years, 52 Week High List, 52 Week Highs, Amazon, Bernanke, Cash Flow, Crowd, Disclosure Notice, Earnings, Havens, Interest Rate Policy, Investors, Judgement Call, Leadership, Lemmings, Mutual Fund, New 52 Week Highs, Personal Portfolio, Portfolio Securities, Stock Price Appreciation, Stocks
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Neils Jensen: Investment Outlook (December 2011) – “The Facts They Don’t Want You To Know”

Friday, December 30th, 2011

The Absolute Return Letter December 2011

The Facts They Don’t Want You to Know

by Niels Jensen, Absolute Return Partners

What have Bill Gross, John Paulson, Anthony Bolton and Bill Miller all got in common? They are all ‘rock star’ fund managers who have fallen on hard times more recently. Life in the fund management industry is not what it used to be like. Life is tough even for the supremely skilled. Markets are changing, fund managers are struggling to adapt and clients are growing restless as a result. If I told you that the composition of an average UK equity fund changes by 90% a year, would that startle you? How would you feel if I added that the 20 funds with the highest turnover returned just 4.7% to investors in the 3 years to the end of March 2011 whereas the 20 funds with the lowest turnover returned 16.8% over the same period?¹

From the same source: Out of 1,230 funds across 12 different strategies, only 35 fund managers produced a performance consistent enough to earn their fund a place in the top quartile in each of the last three years (upper half of chart 1). In a universe of 1,230 funds, over a three year period and completely disregarding skill, the expected number of funds consistently ranked in the top quartile is 1,230*0.253=19.22.

In other words, more than half the 35 managers were there not because of skill but because, statistically, someone was always likely to ‘over-achieve’. This leaves about 15 fund managers out of a universe of 1,230 – ca. 1% – who could with some right claim that they have consistently been in the top quartile.

The problem is we don’t know who they are. All we know is that none of them are managing Asian equities, North American equities or Global fixed income funds as those three strategies didn’t produce a single top quartile performer between them. And when you look at the second, and slightly less demanding, part of the study – those who have been in the top half in each of the past 3 years – the picture is broadly the same (lower half of chart 1). 177 fund managers achieved the required consistency but 154 of the 177 are likely to have done so because of luck, not skill.

I have never come across a fund manager who openly admits that his (or her) outperformance is down to luck. On the other hand, I often come across fund managers who suggest their underperformance is down to bad luck. I suppose no manager ever skilfully underperforms, but to put it down to bad luck is an insult when we all know that human error is the most common cause of underperformance.

If a fund manager’s outperformance is based on skill rather than luck, wouldn’t one expect the majority of the outperformance to come from those stocks with the highest weights in the portfolio? This seems a reasonable assumption given that one would expect any rational fund manager to allocate the most capital to his/her highest conviction ideas.

However, in a study conducted by UK consulting firm Inalytics (see here), 39 of 42 Australian funds managers who outperformed their benchmark owed their outperformance to the ‘underweights’ in the portfolios – suggesting that human error is not only the source of underperformance but perhaps also of some of the outperformance.

Bestinvest produces an annual survey called Spot the Dog (see here for the latest survey) which has gained considerable attention in the UK fund management industry, although it is not a league table you will be proud to be mentioned in. According to the 2011 survey published back in August, over £23 billion is currently managed in so-called dog funds², an increase of no less than 74% since the previous report.

You don’t become a dog just because you have a bad quarter or two. The members of that exclusive club have a history of serial underperformance, yet they will generate in the region of £350 million of fees to their firms this year despite the obvious value destruction.

And the story gets worse – much worse in fact. According to an unpublished report conducted by IBM, our industry destroys $1,300 billion of value annually – a staggering 2% of global GDP (see here for details). This includes about $300 billion in fees on actively managed long-only funds which fail to outperform their benchmarks, $250 billion spent on wealth management fees for services which do not meet their benchmarks and $50 billion in fees on hedge funds which underperform. Do I need to say any more?

Why are fund managers finding it harder than ever to outperform and what are the long term implications of those miserable performance statistics? Let’s deal with the ‘why’ first. There is no question that managing money – in particular equity mandates – has been a delicate affair over the past decade.

Through the 1980s and 1990s global equity markets benefitted from a strong undercurrent of bullishness. As a result, fund managers went into the bear market of 2000-01 on a wave of optimism (who doesn’t recall the repeated calls in the late 1990s of a new investment paradigm?) epitomised by the record high P/E levels in 1998-1999 just before it all went pear shaped in 2000.

Tags: 3 Years, Absolute Return, Asian Equities, Bill Gross, Bill Miller, Equity Fund, Fixed Income, Fund Changes, Fund Management Industry, Fund Managers, Investment Outlook, John Paulson, Neils, Niels Jensen, Period 1, Quartile, Rock Star, Star Fund, Tho, Turnover, Uk Equity
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Ten Year Italian Bonds Sold at 6.98% – Strangely, Market Yawns

Thursday, December 29th, 2011

Riddle me this.  Yesterday, Italy had a ‘successful’ short term bond auctions but the market took a gash to the chest as the euro broke down to a yearly low – which of course meant the dollar rallied, which of course meant every risk asset on Earth had to be sold by the computers.   Of course those sub 3 year bond auctions were affected by the LTRO situation.  Today, we saw an Italian 10 year bond auction, which was relatively putrid at a nearly 7% yield, the euro falls again and…. no one cares.  Futures are up.  Boggling.  Just boggling.

On a side note – it looks like the ECB (which of course is not allowed to bid directly in an auction from a government) stepped in directly after the auction to buy buy buy.

Based on the difference in action in sub 3 year versus over 3 years we clearly see that yes the LTRO has had an impact….this was something I was very curious to see.  One wonders when the ECB will begin offering nearly free money at 7 years (or heck 10 years) rather than 3 years to “fix” the eurozone.

Via Reuters:

• Italy’s borrowing costs fell from recent record highs at a bond auction on Thursday but cautious investors still demanded a near 7 percent yield to buy 10-year debt, a level seen unsustainable over time for the euro zone’s third-largest economy.  Traders said the European Central Bank stepped in after the auction to buy Italian bonds on the open market as investors worry about the country’s ability to sell enough long-term debt ahead of large redemptions early next year.
• Italy raised 7 billion euros ($9 billion) of debt in thin holiday markets, just above the mid-point of its target range.  It sold the top planned amount of its 10-year benchmark bond but the yield was 6.98 percent, not far from a euro lifetime record of 7.56 percent a month ago.
• “Today’s decline in the auction yield by ‘just’ about 60 basis points versus end-November in such a high-yield territory underscores that the genuine pressure on Italy is still tremendous, despite bold ECB actions that have given (short-term debt) a big boost,” said David Schnautz, a rate strategist at Commerzbank in London.

Disclosure Notice

Any securities mentioned on this page are not held by the author in his personal portfolio. Securities mentioned may or may not be held by the author in the mutual fund he manages, the Paladin Long Short Fund (PALFX). For a list of the aforementioned fund’s holdings at the end of the prior quarter, visit the Paladin Funds website at http://www.paladinfunds.com/holdings/blog

Tags: 3 Years, Basis Points, Benchmark, Bond Auction, Bond Auctions, ECB, Euro Zone, Eurozone, Free Money, Holiday Markets, Lifetime Record, Mid Point, Percent Yield, Record Highs, Redemptions, Reuters, Riddle, Target Range, Term Bond, Term Debt
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