Tag Archives: Bonds

Hard Core Doom Porn, by Robert Gore

It will be a crash like we’ve never seen before.

SLL has been accused of trafficking in “doom porn.” Guilty as charged. If you don’t like doom porn, don’t read this article, it’s hard core. If you prefer feel good and heartwarming, there are plenty of Wall Street research reports and mainstream media stories about the economy available. Enjoy!

In 1971, President Nixon closed the “gold window,” which allowed foreign governments to exchange their dollars for gold. This severed the last link between any government and central bank-created debt and the real economy. Debt could be conjured at whim, and governments and central banks have done so for the last 46 years.

Not surprisingly, credit creation without restraint has papered the globe with the greatest pile of debt mankind has ever amassed, measured in nominal terms or relative to the underlying economy. A measure of how extraordinary this situation is: most people regard it as normal, if they think of it all. Debt is a first mover, a financial constant. Any exigency small or large can be met from an unlimited credit pool that will always be with us. How to rebuild Houston, Florida, and Puerto Rico? No problem, borrow.

Although fiat credit creation by governments and central banks is unconnected to the real economy, its effects are not. Their debt becomes an asset within the financial system. Through fractional reserve banking, securitization, and derivatives it become the basis for a multiplication of the original debt. That multiplication is many times the multiplier (the reciprocal of the reserve requirement) taught in introductory macroeconomics classes whereby the debt is contained within the banking system.

Nominal global debt is reckoned at between $225 and $250 trillion, or about three times global GDP. Financial, debt-supported derivatives (financial instruments whose prices are derived from the prices of other financial instruments) are estimated at anywhere from $500 trillion to $1 quadrillion notational, or six to twelve times global GDP.

Overpriced houses did not cause the last financial crisis and almost bring down the world’s financial system, securitized packages of mortgages and their associated derivatives did. The Panglossian view of derivatives is that most of them can be netted out against offsetting derivatives, thus actual exposures are far less that notational amounts. The real world view is they can only be netted out as long as all counterparties remain solvent. As we learned in 2009, that is not always a correct assumption.

Globally, unfunded old age pension and medical liabilities, not counted as debt but still promises made that often have the force of law, sum to another $400 trillion. In the US, they are about $210 trillion, or about 11 times US GDP. Demographics amplify the liability: across the developed world, declining birth rates and extensions in life expectancies mean a shrinking pool of workers supports an expanding pool of beneficiaries. In the last month, SLL has posted four excellent articles by John Mauldin for those who want all the gruesome details. (Just enter John Mauldin in SLL’s search box and they’ll pop right up.)

This doom porn, the skeptics will say, is almost as old as Deep Throat (released in 1972). Markets crash from time to time, but they always bounce back. Central banks and governments come to the rescue with fiscal stimulus (increased government debt) and unlimited fiat debt. Why should we worry now?

There are a number of reasons. When the world was less indebted, a fiat currency unit’s worth of debt produced more than a fiat currency unit’s worth of expanded output of goods and services. Sometime within the last year or two, the marginal economic effectiveness of all that government and central bank debt reached zero, and is negative after debt service.

With the world saturated in debt, another fiat currency unit of debt produces no increase in output. Kick in the costs of servicing and repaying that debt, and increasing debt is actually retarding economic growth. It accounts for the long-term slowing growth trend, flat incomes, and “secular stagnation” that puzzle so many economists.

It also accounts for the lack of inflation that puzzles so many central bankers, at least in the price indexes they look at. They are looking at the wrong indexes. The relevant indicia are stock, high-grade bond, real estate, and cryptocurrency prices, still at or close to record highs, and corporate and securitized-debt credit spreads to treasury benchmarks at record lows (indicating massive complacency about corporate credit risk). Here inflation—the speculative kind that blows bubbles—is alive and thriving.

With the Federal Reserve now taking steps to shrink its balance sheet and other central banks making noises about doing the same, global fiat debt creation may go into reverse for the first time in many years. Brandon Smith at Alt-Market.com argues that this is part of plan leading to a crash and global, centralized monetary control.

He may or may not be on to something, however, valuation extremes and sentiment indicators point to the same conclusion concerning a crash. SLL maintains financial markets are exercises in crowd psychology, impervious to government and central bank efforts to control them, designed to separate the maximum number of speculators from a maximum amount of their money.

Robert Prechter, of Elliott Wave International, has written the chapter and the verse on markets and psychology. (SLL reviewed his groundbreaking tome, The Socionomic Theory of Finance.) Consider the following from Elliot Wave International’s October “Financial Forecast.”

Every month another sentiment indicator seems to pop to a frothy new extreme. Last month it was the percentage of cash that members of the American Association of Individual Investors harbored in their investment portfolios. At 14.5%, it was the smallest allocation to this safe alternative since January 2000, the same month that the Dow Industrials began a 38% decline that lasted through October 2002. Last month, we also showed a new bullish extreme for the five-day average of Market Vane’s Bullish Consensus survey of advisors. On September 15, the average pushed to 71%, a new ten-year extreme.

The most recent Commitment of Traders Report shows that Large Speculators in futures on the CBOE Volatility Index (VIX) have amassed a record net- short position of 172,395 contracts.

This record bet on subdued volatility sets the stage perfectly for the period of “high volatility” that EWFF called for in August.

…Large Speculators in the E-mini DJIA futures have pushed their net-long position to 95,976 contracts, more than four times the number of contracts they held in January 2008, shortly after the Dow started its largest percentage decline since 1929. So, investors are betting to a record degree that the stock market will continue to rise and volatility will continue to remain subdued. Paradoxically, these measures indicate that exact opposite.

Various media accounts confirm that a rare complacency now dominates the stock market.

One doesn’t have to buy in to socionomics to realize that virtually everyone is now on the same side of the boat, a condition generally followed by the boat capsizing. Using conventional valuation measures, the only time stocks have been more highly valued is just before the tech wreck in 2000.

If one does buy into socionomics, the last few upward squiggles in the stock market will put the finishing touches on intermediate, primary, cycle, supercycle, and grand supercycle Elliot Waves dating back to 2016, 2009, 1974, 1932, and the 1780s, respectively. In other words, this is going to be a crash for the ages.

Given the unprecedented level of global debt, that appears to be the most likely scenario. Every financial asset in the world is either a debt claim or an even less secure equity claim—a claim on what’s left after debt is paid. Much of the world’s real, tangible assets are mortgaged.

When the debt bubble implodes, a global margin call will prompt forced selling, driving down all asset prices precipitously. Most of what is currently regarded as wealth will vanish. Opening up the world’s fiat debt spigots full force won’t stop this one. The notions that governments and central banks have speculators’ backs, that problems caused by excessive debt can be solved with more debt, will be revealed as monumental follies. And markets will not come back, at least in our lifetimes.

Long-time readers will point out that SLL has been issuing warnings for years. Again, guilty as charged. However, we’ll join Mr. Prechter and company in their prediction that US equity markets top out before the end of this year. (They called last year’s top in the government bond market, adding to an impressive list of correct calls.) If we’re wrong, it won’t be the first or last time. If we’re right, given the magnitude of what’s coming, being a few years early won’t matter at all. Our concluding clichés: fear is stronger than greed and markets go down much quicker than they go up.

Alt-Historical Fiction!

AMAZON

KINDLE

NOOK

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It’s Really Crazy What This ECB Has Wrought, by Wolf Richter

Europe is a borrower’s paradise and a saver’s hell. From Wolf Richter at wolfstreet.com:

In the land of NIRP refugees and “Reverse Yankees,” who will get crushed?

At the end of the week, something special happened, something totally absurd but part of the new normal: the average yield of euro-denominated junk bonds – the riskiest, non-investment-grade corporate bonds – dropped to the lowest level ever: 2.77%.

April 26 had marked another propitious date in the annals of the ECB’s negative yield absurdity: the average euro-denominated junk bond yield had dropped below 3% for the first time ever.

By comparison, what is considered the most liquid and save debt, the 10-year US Treasury, carries a yield of 2.33%; the 30-year Treasury yield hovers at 3%.

This chart of the BofA Merrill Lynch Euro High Yield Index (data via FRED, St. Louis Fed), shows just how crazy this has gotten in the Eurozone:

It’s not like there’s deflation in the Eurozone, despite rampant scaremongering about it. The official inflation rate in April was 1.9% for the 12-month period. As this chart shows, it’s not likely to go away any time soon (via Trading Economics):

In other words, the average “real” junk bond yield (after inflation) according to the above two indices is now 0.87%. That’s the return bond-buyers get as compensation for handing their money for years to come to non-investment grade corporations – as per an average of the ratings by Moody’s, S&P, and Fitch – with an appreciable risks of default looming on the horizon.

Issuing junk bonds in euros is not just the prerogative of European companies. It includes issuance of junk-rated US companies that seek out this cheap money. “Reverse Yankees,” as these bonds are called, have become a large factor in euro-bond issuance.

And investors that accept a “real” compensation of only 0.87% per year to deal with these risks – have they gone nuts? You bet.

To continue reading: It’s Really Crazy What This ECB Has Wrought

Biggest EU Banks Embark on the Mother of All Debt Binges, by Don Quijones

European banks need to raise capital, so they are issuing a brand new type of debt: senior non-preferred bonds. They are considered capital, have “senior” in the name so they pay a lower interest, but can be “bailed in.” In other words, if the bank runs into trouble, this class of creditors will have made an involuntary and probably unrecoverable contribution to the bank. This will not end well. From Don Quijones at wolfstreet.com:

Spain’s three biggest banks, Banco Santander, BBVA and Caixa Bank, have got off to a flying start this year having issued €8.6 billion in new debt, seven times the amount they sold during the same period of last year. The last time they rolled out so much debt so quickly was in 2007, the year that Spain’s spectacular real estate bubble reached its climactic peak.

Santander accounts for well over half of the new debt issued, with €5.12 billion of senior bonds, subordinate bonds, and a newfangled class of bail-in-able debt with the name of “senior non-preferred bonds” (A.K.A. senior junior, senior subordinated or Tier 3) that we covered in some detail just before Christmas.

Investors beware…

This newfangled class of bail-in-able debt was cooked up last year by French-based financial engineers in order to help France’s four global systemically important banks (BNP Paribas, Crédit Agricole, Groupe BPCE and Société Générale) out of a serious quandary: how to satisfy pending European and global regulations demanding much larger capital and debt buffers without having to pay investors costly returns on the billions of euros of funds they lend them to do so.

That’s what makes senior non-preferred debt so ingenious: it pretends to be simultaneously one thing (senior), in order to keep the yield (and the cost for the bank) down, and another (junior) in order to qualify as bail-in-able. What it amounts to is a perfect scam for big banks to bamboozle bondholders – usually institutional investors like our beaten-down pension funds – into buying something with other people’s money that doesn’t yield nearly enough to compensate them for the risks they’re taking.

To continue reading: Biggest EU Banks Embark on the Mother of All Debt Binges

 

Markets Smell a Rat as Central Banks Dither, by Wolf Richter

There are a lot of good reasons not to allocate much money to bonds as an asset class right now. For one, as Wolf Richter points out, central banks are probably not going to be as strong a bid for them as they have been. From Richter at wolfstreet.com:

Markets are suspecting that central banks are in the process of exiting this fabulous multi-year party quietly, and that on the way out they won’t refill the booze and dope, leaving the besotted revelers to their own devices. That thought isn’t sitting very well with these revelers.

In markets where central banks have pushed government bond prices into the stratosphere and yields, even 10-year yields, below zero, there has been a sea change.

The 10-year yield of the Japanese Government Bond (JGB) jumped 2.5 basis points to 0.115% on Thursday, the highest since January 2016, after an auction for ¥2.4 trillion of 10-year JGBs flopped, as investors were losing interest in this paper at this yield, and as the Bank of Japan, rather than gobbling up every JGB in sight to help the auction along, sat on its hands and let it happen.

And on Friday morning, the 10-year yield jumped another 3 basis points to 0.145%!

In September last year, the BOJ started the now apparently troubled experiment of trying to control not just short-term interest rates but also the entire yield curve. It targeted a 10-year yield of about 0% (it was negative at the time). Analysts believed that this would mean a range between -0.1% and +0.1%, and that if the yield rose to +0.1%, the BOJ would throw its weight around and buy.

But the fact that the BOJ allowed the yield to go above that imaginary line signaled to the markets that it no longer has the intention of capping the yield at +0.1%, that in fact the BOJ has stepped back.

To continue reading; Markets Smell a Rat as Central Banks Dither

 

Doug Casey: “Sell All Your Bonds”

The bond market is oversold so you might want to wait for a rally before you sell your bonds. That being said, selling bonds is a good long-term strategy, because interest rates have probably seen their generational lows (interest rates and bond prices move inversely to each other). From Doug Casey at caseyresearch.com:

So, Trump has won the election. Of course anything can happen between now and his presumed inauguration on January 20. Maybe the Swamp Creatures will succeed in causing a recount in so-called Purple States that could change the number of electors in Hillary’s favor. Maybe they’ll somehow influence Trump electors to vote for Hillary. None of this would have been an issue if Baby Bush II, Jeb, had been the Republican nominee, as was supposed to have happened. It all just shows what a transparent (a word these people love to use) fraud “democracy” has become.

Let the hoi polloi cast a meaningless vote, so they have the illusion of being in control. Instead of seeing themselves as subjects, they’ll think they’re “we the people,” who actually have some say in what happens. That way they’ll pay their taxes willingly, enthusiastically sign on to aggressive wars on the other side of the world against people they know nothing about, and generally do as they’re told. Because it’s supposed to be patriotic. “Democracy” is a much more effective scam for controlling the plebs than kingship or dictatorship.

That said, the Establishment, the Deep State, was genuinely shocked and appalled by Trump’s victory. As Baby Bush the First would have said, they misunderestimated how angry the average voter was. That’s because the Coastal Democratic Elite are totally out of touch with the common man. But they needn’t fret too much. They’ll be re-installed, with a vengeance, in four years.

To continue reading: Doug Casey: “Sell All Your Bonds”

Surging Bond Yields Signalling Pain Not Growth Ahead For US Economy, by Guy Manno

Surging bond yields reflect the prospect of surging bond supply, and perhaps a notching up of the market’s estimation of US default risk. From Guy Manno at crushthemarket.com:

The US election results are in and the US stock market is enjoying a sharp rally over the shock news of Donald Trump winning the election and becoming the new President elect.

On the back of the big rally in US stocks there has also been another big shift occurring in another very important asset class, US Government bonds.

US Government Bond Yields Surging

Since the news of the results of the US election were released US Government bonds have experienced a huge sell off in prices causing the yields to surge on Government bonds ranging from the 2 year bond all the way to the long end with 30 year Government bonds. (Note: Bond yields move inversely to bond prices.)

Specifically the US 10 yr Govt bond has seen the yield jump from around 1.80% before the election results to the current price of around 2.13%. (See chart below)

In the chart below you can see the magnitude of the rise in US 10 yr bond yield reaching the same level of the S&P 500 dividend yield.

Traditionally bond yields help to price the relative value of stocks. If bond yields rise the dividend yield on stocks would also have to rise. Usually stock dividend yields are above bond yields to entice investors to own riskier stocks over more conservative bonds. For the yield to rise on stocks either dividends would need to rise and or stocks would have to fall in price to lift the dividend yields.

So the fact that the 10 year bond yield has reached the same level of the S&P 500 dividend yield means that a bond investor can receive the same yield as stocks without the perceived risk.

Normally when Government bond yields rises considerably it indicates that either inflation is also rising and / or the economy is accelerating it’s growth prospects. When the economy start to accelerate its growth prospects investors traditionally buy stocks in anticipation of higher profits and dividends from a stronger economy and sell bonds which are considered defensive assets.

Many analysts and financial commenters have already come out and suggested that growth is now back on the agenda for the US economy since the electing of Trump as the new president. Because of the Trump factor these commentators have suggested this is the reason why bond yields are rising and suggest it’s a positive.

Why Surging Bond Yields Signals Pain Ahead

However we are not in normal times and there is a very big reason why the FED has spend the majority its balance sheet trying to keep US Government bond yields low, by buying them through the various QE programs and artificially forcing the bond prices higher lowering the yield.

It’s also the same reason why the FED has only increased the interest rates once back in December 2015 and has been terrified to rise them further since then. The reason is because the US has a major debt problem from a Government , corporate America and consumer level.

So if the FED has tried all this time to keep rates lows, how is it all of a sudden a good thing for the Government, corporate America, the consumer and the economy that interest rates are now rising. Especially when the debt levels in the US are higher now than before the 2008 GFC event that shook the US and Global economy.

To continue reading: Surging Bond Yields Signalling Pain Not Growth Ahead For US Economy

 

Will the “Rout” in Government Bonds Turn into Carnage? by Wolf Richter

For all the conniptions in the stock market this week, the real story has been in the much bigger, much more important, and much less publicized, bond market. From Wolf Richter at wolfstreet.com:

“Inflation Trade” Heats Up, “Greater-Fool” Trade Falls Apart

The Government “bond rout” didn’t start with Trump’s election victory. It started in July. And it didn’t just hit US Treasuries. It hit government bonds around the world. It’s predicated on the idea that inflation was raising its ugly head again. That idea has now become further entrenched.

The threat of inflation puts holders of low-yielding or zero-yielding long-term bonds in a very foul mood because the purchasing power of their capital gets destroyed without compensation.

It hit US Treasuries particularly hard. Central banks can push down long-term rates by buying bonds. The ECB and the Bank of Japan are doing that. But the Fed has been flip-flopping about raising rates. There is a good chance it will raise them another notch in December, from nearly nothing, by almost nothing, to next to nothing. So it isn’t going to revolutionize short-term rates. But it does point out that long-term rates in the US are on their own.

Then Trump won. He’d campaigned on a big deficit-funded stimulus program that includes a military buildup and – by golly, much needed – infrastructure work, funded, so to speak, by corporate and individual tax cuts….

The US bond markets reacted with a vengeance. They figured that these plans, once they sail through the Republican Congress, would create much larger deficits which would have to be funded by an onslaught of new bonds that somebody would have to buy, and that somebody wouldn’t be the Fed.

Dreading this supply, bond traders went out and cut great-big holes into the most magnificent bond bubble in history, and what we’ve been hearing since this act of Fed-defying vandalism is the deafening sound of hot air hissing out of it.

Today, Veterans Day, the US bond markets are closed, which may be a good thing. It gives them an extra day to take a breath. Because over the last three trading days, the US 10-year yield has skyrocketed 35 basis points, from 1.8% to 2.15%. That’s a huge move (chart via StockCharts.com):

Since early July, the 10-year yield has jumped by 77 basis points. So what does this mean for bondholders, in dollars and cents? Bond prices fall when yields rise. This chart (via StockCharts.com) shows the CBOT Price Index for the 10-year note. It’s down 4.5% since July.

It gets outright ugly with 30-year Treasury bonds. Over the last three trading days, the 30-year yield has soared by 38 basis points and since early July by 83 basis points (via StockCharts.com):

To continue reading: Will the “Rout” in Government Bonds Turn into Carnage?