Tag Archives: ETFs

If Michael Burry Is Right, Here Is How To Trade The Coming Index Fund Disaster, by Tyler Durden

Michael Burry was one of the heroes of Michael Lewis’s book The Big Short. Now he’s got another big short. From Tyler Durden at zerohedge.com:

Last week, the Big Short’s Michael Burry sparked a fresh wave of outrage among the Gen-Z and algo traders (if not so much the handful of humans who have actually witnessed a bear market) on Wall Street, by calling the darling of modern capital markets – passive, or index/ETF, investing – the next CDO bubble. Echoing what many skeptics before him have said, Burry argued that record passive inflows, coupled with active fund outflows which suggest passive equity funds will surpass active by 2022 according to BofA…

… are distorting prices for stocks and bonds in much the same way that CDOs did for subprime mortgages. Eventually, the flows will reverse at some point, and when they do, “it will be ugly.”

This nascent passive bubble is also why Burry had avoided large caps and was focusing entirely on small-cap value stocks: to Burry, they tend to be underrepresented in index funds, or left out entirely, which is why they are i) cheap and also why ii) when the passive bubble bursts, they will be the few names left standing.

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As Credit Markets Crack, Gundlach Tells Investors To Get Out Of Corporate Bonds… Now, by Tyler Durden

High-yield (junk) bond yield spreads to safer bonds are widening out, and that’s generally not a good sign for financial markets. From Tyler Durden at zerohedge.com:

While credit markets ‘tightness’ had been proclaimed as a pillar of support for the bull thesis by many still clinging to hope, that is no longer the case.

While longer-term, credit spreads remain extremely compressed, in the short-term, high yield bond markets have started to crack notably wider…

Cash bonds appear to be outperforming (not widening as much) but this is due to managers, such as Aberdeen’s Luke Hickmane,preferring to use the considerably more liquid ETF and CDS markets to hedge before unwinding underlying cash positions.

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These Popular Investment Vehicles Could Crash Hard, by Bill Bonner

From Bill Bonner at bonnerandpartners.com:

RANCHO SANTANA, Nicaragua – Stocks sold off on Friday. The Dow fell 211 points.

Leading the retreat were tech stocks with the Nasdaq, where they tend to hang their hats, down more than 3%.

“Tech sector leads sharp sell-off,” said a Wall Street Journal headline.

Steps to the Moon

“Did you see what happened to professional social network company LinkedIn?” asked Exponential Tech Investor editor Jeff Brown, who was down here with us at Rancho Santana.

“It was a disaster. The company announced earnings, which were pretty much in line with what the market expected. But its forward guidance was down a little.

“Investors dropped it like a hot potato. The stock dropped by almost 50% – and investors lost about $11 billion – in 20 minutes of trading.”

Jeff is a believer in new technology: self-driving cars. Virtual reality goggles. Artificial intelligence.

“Computers are already smarter than PhDs,” he reported.

“In what discipline?” we wanted to know. “There are Cocker Spaniels that are smarter than PhDs in economics.”

“There is a huge difference between a regular company and a company that is on the cutting edge,” he went on.

“The difference is exponential. A regular company may grow 5% to 10% per year. A good tech company grows exponentially, at 100% a year or more.

“Just imagine that you are walking. You get somewhere by putting one foot in front of the other. If you are like a regular company, you grow… one step at a time.

“At a step a day, you’ve gone 30 paces in a month. But if you are able to walk exponentially – one step, then two steps, then four steps… in a month – you could have covered the distance from here to the moon.”

Many tech investments don’t go anywhere, Jeff admitted. But when you get it right, you get a moonshot.

That may be true. But it is also true that from time to time, investors feel they have gone too far. That seems to be the case now… with a broad sell-off in the entire tech sector.

Look Where No One Is Looking

There are “facts and dreams,” said Churchill. Many of those dreamy, techy satellites… launched into space in the Bubble Epoch… are beginning to fall to Earth. Look out below!

Also present here in Nicaragua is our old friend and super stock picker Chris Mayer. The occasion was the Family Wealth Forum, a meeting for our premium family wealth advisory, Bonner & Partners Family Office, in which we discuss both sides of the “family money” formula.

“There are two things you need in order to have family money,” we say gravely, “family and money.” Several people spoke to all the things that could go wrong in a family. Chris was speaking to what could go wrong with the money.

“Right now, hundreds of billions of dollars are being invested in the stock market by investors who don’t know anything about the companies they own.

“They buy exchange-traded funds [ETFs] – passively managed groups of stocks – that typically track the performance of a stock market index. These ETFs distort the market.

“Some well-known stocks are so heavily bought by ETFs that their prices are completely out of line with the real value of the company. And the ETFs are set up in such a way that there is no judgment at all involved.

“They are bought automatically, almost regardless of what is actually going on in the companies themselves.”

To continue reading: These Popular Investment Vehicles Could Crash Hard

World’s Largest Leveraged ETF Halts Orders, Citing “Liquidity Constraints”, by Tyler Durden

Yesterday it was China’s collateralized commodities, today it’s Exchange Traded Fund (ETF) liquidity: obscure corners of financial markets that most people don’t know about, but which will make their way into the mainstream in a hurry if they blow up. From Tyler Durden at zerohedge.com:

First The Bank of Japan destroyed the Japanese bond market, and then, back in May we warned that The Bank of Japan had ‘broken’ the stock market. Now, it appears the all too obvious consequences of being the sole provider of buying power in an antirely false market are coming home to roost as Nomura reports the “temporary suspension” of new orders for 3 leveraged ETFs – the largest in the world – citing “liquidity of the underlying Nikkei 225 futures market.”

Source: Nomura

As Bloomberg reported previously on Nomura’s funds,

Money is being shredded at an unprecedented rate in a souped-up exchange-traded fund tied to Japan’s most famous stock index.

Since mid-August, investors have poured a record $4.5 billion into the Next Funds Nikkei 225 Leveraged Index ETF, a security designed to rise or fall twice as fast as its namesake equity gauge. That’s too bad, considering that twice the Nikkei 225 Stock Average’s loss over that period comes out to about 21 percent.

So fast have the country’s individual investors been plowing money into the fund that even as a fifth was lopped off its price, its market value more than doubled. It’s the largest security of its kind in the world, and is now big enough to affect the whole stock market as overseers rush to buy and sell securities to meet its price target, according to BNP Paribas Investment Partners Ltd.

“They are taking up a larger proportion of the market,” said Tony Glover, head of the investment management department at BNP Paribas Investment Partners Japan in Tokyo. “Volatile markets are not great news with increasingly wider intraday swings. The funds are a big factor causing this.”

The ETF has become more popular with traders than even Toyota Motor Corp., Japan’s biggest company. Average turnover for the ETF was about 250 billion yen ($2.1 billion) a day over the past two months, triple that of Toyota.
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Who could have seen this coming? Well we did… numerous times…and here is the explanation…

Two months ago, in “ETF Issuers Quietly Prepare For Meltdown With Billions In Emergency Liquidity,” we outlined the rather disconcerting circumstances that have led some large fund managers to quietly line up emergency liquidity facilities that can be tapped in the event of a sudden retail exodus from bond funds.

“The biggest providers of exchange-traded funds, which have been funneling billions of investor dollars into some little-traded corners of the bond market, are bolstering bank credit lines for cash to tap in the event of a market meltdown. Vanguard Group, Guggenheim Investments and First Trust are among U.S. fund companies that have lined up new bank guarantees or expanded ones they already had, recent company filings show,” Reuters reported at the time, in a story we suspect did not get the attention it deserved.

At a base level, these precautionary measures are the result of the interplay between central bank policy and the unintended consequences of the post-crisis regulatory regime. ZIRP creates a hunt a for yield and simultaneously incentivizes companies (especially cash strapped companies) to tap the bond market while borrowing costs remain artificially suppressed. Clearly, this is a self-fulfilling prophecy. The longer rates on risk free assets remain near, at, or even below zero, the more demand there is for new corporate issuance (the rationale being that at least corporate credit offers some semblance of yield). More demand means rates on corporate credit are driven still lower, and once yields on high grade issues get close to the lower limit, yield-starved investors are then herded into HY.

All of this supply in the primary market comes at a time when liquidity in the secondary market for corporate credit is non-existent thanks to the shrinking dealer books that resulted from the government’s (maybe) well-meaning attempt to crack down on prop trading. The result: a crowded theatre with a tiny exit.

This situation has been exacerbated by the proliferation of bond ETFs which have allowed retail investors to pile into corners of the fixed income world where they might not belong.

To continue reading: World’s Largest Leveraged ETF Halts Orders

Mom And Pop “Will Probably Get Trampled”: Alliance Bernstein Warns On Bond ETF Armageddon, by Tyler Durden

What looks like liquidty may be a mirage, especially when Mr. and Ms. Retail Investor try to hit the bid. From Tyler Durden at zerohedge.com:

Right up until China threw the financial world into a frenzy by devaluing the yuan right smack in the middle of a stock market meltdown that Beijing was struggling to contain, bond market liquidity was all anyone wanted to talk about.

Of course we’ve been talking about it for years (literally), as have a few of the sellside’s sharper strategists, but earlier this year the mainstream financial news media caught on, followed in short order by the rest of the Wall Street penguin brigade, and before you knew it, even the likes of Jamie Dimon were shouting from the rooftops about illiquid corporate credit markets.

The problem, in short, is that the post-crisis regulatory regime has made dealers less willing to warehouse bonds, leading to lower average trade sizes, sharply lower turnover, and a generalized lack of market depth. That in turn, means that trading in size without triggering some kind of dramatic move in prices is more difficult.

But that’s not the end of the story.

Seven years of ZIRP have i) herded yield-starved investors into riskier assets, and ii) encouraged corporates to take advantage of voracious demand and low borrowing costs by issuing more debt. The rapid proliferation of ETFs and esoteric bond funds has encouraged this phenomenon by giving investors easier access to corners of the bond market where they might normally have never dared to tread. These vehicles have also given investors the illusion of liquidity.

Ultimately then, the picture that emerges is of an increasingly crowded theatre (lots of IG and HY supply and plenty of demand) with an ever smaller exit (dealers increasingly unlikely to inventory bonds in a pinch).

To continue reading: Mom and Pop “Will Probably Get Trampled”

Are These Ticking Time Bombs In Your Portfolio? by Wolf Richter and David Eifrig

Buying bonds at today’s microscopic or negative interest rates pose extraordinary risks to one’s wealth, but buying certain Exchange Traded Funds and open end funds that own bonds is even riskier. From Wolf Richter, at wolfstreet.com, and David Eifrig, at dailywealth.com:

I have on occasion warned about bond funds. Bonds themselves can be a great investment – and have largely been a great investment over the last 30 years, running up all the way to the peak of the greatest credit bubble in history.

If the bond market starts throwing up, you can always hang on to your bonds, collect the interest, and get out alive. If the company gets knocked over and it “restructures,” stockholders get wiped out, but depending on what kind of bond you hold, you could be made whole, lose part of your capital, or get wiped out too.

The yield is supposed to compensate for these and other risks, though it hasn’t in years, thanks to the Fed’s interest rate repression.

Bond funds are an entirely different animal. Not all bond funds are made of the same cloth. But anyone holding the Schwab Yield Plus Select fund (SWYSX) in 2007 and 2008 knows this. Like most bond funds, it was an “open end” fund (more on this kind of monster below). It was stuffed to the gills with highly rated mortgage-backed securities. It looked great on paper, at one point had $13 billion in assets, and paid half a percentage point more in yield than a 1-year FDIC insured CD.

When cracks appeared in the credit markets in 2007, some investors pulled their money out. So for them, the low-yield gamble – that’s what it was – worked.

After them, the deluge. Soon everyone was pulling their money out. At first, the fund sold its most liquid assets, such as Treasuries, and didn’t show any significant losses. When it ran out of them, it had to sell other bonds, but there weren’t many takers, and it had to sell them below their book value. Losses appeared. As they got worse, investors woke up, and the fund experienced an all-out run and had to dump its MBS for which liquidity had dried up – for cents on the dollar.

At the other end of every bond fund sits the “smart money,” waiting for the opportunity. And the “smart money” bought these MBS and later sold them to the Fed at a huge profit. Investors in SWYSX got cleaned out. Those who sat it out to the end, hoping for the uptick, lost well over 50% before it was eventually shut down.

Lawyers – class-action types and those representing individual investors – had a field day. Schwab paid out a chunk of money to settle these suits, and much of it went to the lawyers.

It was a little extra yield for a ton of extra risk.

That’s the theme today as well. But now bond funds are stuffed with junk bonds. They can get ugly in a hurry too.

Unlike investors who hold bonds outright, investors in “open-end” bond funds that experience a run can’t benefit from an eventual uptick in bond prices – because the fund is forced to sell them at the worst possible moment!

Few funds actually go through a real run like this, but when they do, it’s bloody for the small fry and a huge opportunity for lawyers and the “smart money.”

So here are the salient parts of an article by David Eifrig on what constitutes a “time bomb in your portfolio” – given the current climate – and what might be an acceptable risk….

By David Eifrig, Daily Wealth:

Fixed-income securities – specifically bonds – are an important part of any balanced portfolio. You put your money into a bond and lock up a certain yield. Then, you get paid year after year for loaning the bond issuer your money. That’s why bonds are considered a safer way for retirees to earn a return on their savings, rather than being exposed to the ups and downs of the stock market.

The thing is, not all bond investments are the same.

http://wolfstreet.com/2015/05/20/are-these-ticking-time-bombs-in-your-portfolio/

To continue reading: Are These Ticking Time Bombs In Your Portfolio?