You Can Lead a Horse to Water, But You Can’t Make it Drink
I am not sure what the Turkish translation is other than you can hike rates massively and not ensure that anyone wants to buy your currency. We can go into all the reasons that the policy isn’t working, but that isn’t the main point right now. There are two things we need to look at closely here
- What can EM Central Bankers do? We have seen devaluation and massive rate hikes. So far neither has worked. This is an important question as Emerging Markets face currency pressures and pressures on their stock markets and on their economies, what will they do?
- We are all apparently waiting for the Fed to lead us to the trough once again so that we can all comfortably buy risk assets. What if just like Turkey, they can lead us to the water, but can’t make us drink?
Emerging Markets
To Continue Reading Please Sign In I am really not sure what they can do. Some of it may be as simple as playing a waiting game and waiting for the hype to die down and then trying to slowly but surely shift policies. While doing that, I would certainly take some potshots at the U.S. and blame as much of this fiasco on QE as possible.
I expect the problem to linger, though I think the damage is getting largely priced in, at least in EM. I am far less convinced that the damage to Developed Markets will be limited (since when did people start using the term DM?).
This knock-on effect will be particularly powerful if topics like QE become highly politicized – which seems to be the likely next step.
So on EM, expect weakness, but I am leaning more towards finding opportunities to buy as short squeezes and no float should offer some support. On this so called DM, I remain bearish.
The Fed
The market is convinced that the Fed will help risk assets. Shorts are scared of the Fed and longs are quietly confident (and in some cases backslapping confident) that the Fed will provide a lift to the market.
The bulls seem to be touting the fact that “we are only down 10 points on the S&P 500″ as a reason to celebrate. These were the same people talking about how great it was last night when stocks were up 10 points. That 20 point shift is merely “a better entry” point.
Maybe, but I see several problems with that hope
- Too many people seem to have that same hope.
- Liquidity can allow people to buy what they want to buy more easily, but if they don’t want to buy it, almost no amount of liquidity will help. I think we are near that stage where the risk of loss will impact investor’s willingness to buy.
- The talk about the market correction merely pulls us back to levels we saw in the middle of December in the case of U.S. stocks and Global CDS and to early January levels for high yield bonds. Investors packed up for the year sometime in early November so there has been a big portion of the gains that have been achieved with minimal volumes and without being tested.
- So much of the return on stocks can be explained by multiple expansion that anything that hints that future growth and future fed liquidity will be reduced can easily send that metric tumbling, and every 1 multiple is roughly 100 S&P points.
So look to the Fed to try and talk up the market, yet fail.
Long the Long Bond
We have been very focused on the 10 year. We have generally liked it, though our most recent trade recommendation was to short it on Friday and cover it Monday (we should have gone long then but didn’t).
We have like the 10 year in part because the curve was so steep. The 10′s 30′s is not quite so steep. Okay, the average since 66 bps and it is currently at 94, but that is down from an almost ludicrous 150 back in 2010 and 2011 and even the more persistent 120′s that it spent much of 2013 at.
So it looks interesting on a spread to 10′s but nowhere near as compelling as the 2s 10s looks. But I love what is going on in TBT.
It is a $4.4 billion market cap ETF that does Minus 2X the Daily Return of the Barclay’s 20 year + treasury index. That is a mouthful. It is short via swaps. It only enters into treasury index swaps.
I understand how you cover bond shorts if you get squeezed. Sadly, I also understand how you cover leveraged bilateral swaps if you get squeezed – painfully.
That is the growth in the shares outstanding. It has grown 20% in size since October and over 8% just this year.
It seems that retail is confident that the long bond is mispriced because:
- Because 330 bps between 2s and 30s isn’t enough when the Fed pledges to keep rates at zero?
- Because 3.6% isn’t enough of a cushion when growth is running at ? and inflation is running at 1% and everyone in the know seems more worried about deflation?
- Because if the Fed stops buying bonds the logical outcome, if QE did anything, would be to reduce growth?
- Because one of the most active and liquid markets in the world is clearly manipulated by the Fed and supply is decreasing while pension fund demand remains somewhere between constant and growing?
I look at each of those reasons as bullish and not bearish. If there is a mispricing it is that the market has taken yields too high, far too quickly, and that was before any “flight to safety” bid arrived courtesy of EM.
I think I will wait until after the Fed, but I am looking for reasons to buy the long bond.
Muni Madness
Suddenly MUB can’t go down? We have been long term fans of muni’s for some time. They have been a staple in our Registered Investment Advisor (RIA) allocation strategies until Friday. We have thought the credit was cheap and have even recommended them to hedge funds who don’t need the tax, just because they looked so cheap.
Here, we don’t like them. MCDX might be in a constant battle with XOVER for least liquid CDS index, but it has been leaking wider every day since the 22nd. Yes, I understand that Muni’s have benefitted from the rally in treasuries, but I would be more concerned about the weakness in spreads, and this is a market that just isn’t liquid.
You could make some of the same arguments about investment grade bonds, but you can’t. While LQD is up a little this week, it hasn’t kept pace with MUB, and I do see bids for investment grade bonds. I think the bid for muni’s can happen as quickly as it came.
We will be putting a 10% short on MUB into the model portfolio here.
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