MORNING BID – The first step is a Lulu

Jun 12, 2014 13:59 UTC

It will be interesting to see if the spiral that yogawear retailer Lululemon Athletica has found itself in over the last year is one that can be arrested. Companies rise and fall often in this world, but the U.S. stock market’s history is littered with retailers that went into a tailspin after series of missteps that turn once-interesting investments into a veritable death trap for investors, and result in the kind of drop that benefits mostly short-sellers, late-night comedians and eventually restructuring lawyers.

It’s particularly rough for companies that inspire cult-like followings, be they as a stock or as a retail purchase, as markets eventually become saturated, competitors jump into the fray, and investors go forth and look for the next big thing to occupy their time. And a stock like Lululemon, which quintupled between late 2010 and early 2012, is kind of the definition of a cult stock. That’s well and good when earnings keep going, which kept the stock price in a range (albeit elevated) through December 2013, but those days are over.

Coming into the morning, investors were betting on a 9 percent move in the stock by the end of the week in one direction or another, and it turns out they may have undershot that expectation in terms of volatility, as the stock is down 14 percent after results that clearly came out disappointing and don’t point to the kind of turnaround that the bulls on the company had hoped for (not that there are a heck of a lot of those right now – as of yesterday about 80 percent of the shares that could have possibly been used for short bets were being borrowed for such a purpose, according to Markit). With the stock cut in half in the last year and more expected, the bearish bets on the company are likely to pick up.

Lululemon’s realized volatility over the last 30 days sits at about 23 percent, with expected 30-day volatility at about 53 percent according to, so investors had been anticipating more action, but even with this decline, StarMine’s intrinsic value on the stock is still lower, at about $29.95 a share, modeling 8 percent annual growth over the next 10 years, compared with growth of about 12 percent or so expected by investors for that period of time.

As investors have seen with the likes of Aeropostale, Abercrombie & Fitch, and even larger department stores like J.C. Penney, once a brand has a certain level of stink on it, it’s not something that easily washes off. Lululemon certainly has a smell to it – and not the yummy Canadian bacon kind – thanks to the Vancouver-based retailer’s founder Chip Wilson saying a year ago that “some women’s bodies just actually don’t work” for Lulu’s pants after it had to recall its yoga pants for being more-or-less see-through. Add to that supply chain issues and it’s not the happiest of pictures: coming into the day, StarMine shows its enterprise value-to-revenue ratio at about 3, compared with competitors like Gap and VF Corp, which sport better ratios on that front. Again, it still points to a lot in terms of expected growth that may be difficult.

“As we move into 2014, we are reflecting on our learnings with humility, and are entirely focused on our future,” Chief Executive Laurent Potdevin said in a statement. Investors are thinking about that future, too.

from The Great Debate:

What’s a leveraged ETF and what makes it dangerous?

Ben Walsh
May 30, 2014 20:36 UTC


Larry Fink is sounding the alarm. The chairman and CEO of $4.4 trillion asset manager BlackRock is worried about leveraged ETFs (exchange-traded funds). Fink thinks they could “blow up the industry.” His statement is a little unclear, but the industry he's referring to is probably ETFs themselves, not the global financial system.

Blackrock is itself a huge player in ETFs, but Fink says they'll never get into leveraged version of the financial instruments.

So, what’s the difference between regular and leveraged ETFs?

Regular ETFs are designed to track the price of a specific set of securities, taking the place of traditional mutual funds that focuses on particular investment sectors or classes of stock. ETFs started in stocks, particularly indexes, but now cover all types of assets. In this way they are similar to a mutual or index fund, but can be bought or sold like a stock. Regular ETFs, particularly the ones that track broad indexes like the S&P 500, are pretty vanilla financial products. Sure, an index fund might be slightly better for achieving individual investment objectives, but ETFs generally have much lower fees than actively managed mutual funds.

Leveraged ETFs take the idea a step further. They are designed to amplify, not mimic, the price changes of the assets they track. If oil goes up $1, an oil ETF should go up $1. If oil goes up $1, a three times levered oil ETF will go up $3. The way that works is that levered ETFs are based on derivatives.

Fink is worried that regular ETFs' growing good name will lure people who shouldn't own derivatives into derivatives ownership, without even realizing it. At its core, Fink’s concern is about retail investor access to derivatives products that are not suitable for them. This is a legitimate concern.

Selling investors who want long-term index-like investments a pocketful of derivatives exposure is wrong. As Breakingviews put it (paywall), "that’s akin to giving a circular saw to a toddler. These short-term, structured ETFs can make mincemeat of an unwitting buyer’s investment portfolio."

And when that happens, there are existing regulations to punish unscrupulous brokers. The open question, as with much of financial regulation, is how or if those regulations are actually enforced.

For now, levered ETFs make up just 2 percent of the $1.7 trillion global ETF market. But there are other types of ETFs that might be unsuitable for individual investors, as well. For instance, should you have a basket of concentrated tech stocks in your retirement fund? Levered or not, the answer is no. Broadly, there are about 20 percent less derivatives outstanding than there where before the financial crisis. But if markets become suddenly volatile, it is not really clear how ETFs, levered or otherwise, will behave as they move through the clearing and settlement infrastructure on the financial system. It is this uncertainty that has led the Bank for International Settlements, the Financial Security Board, and the International Monetary Fund to call ETFs a systemic risk (paywall) to the financial system.

That's a more worrying statement than anything Fink said.

MORNING BID – All bonds, all the time

May 29, 2014 14:16 UTC

There’s nothing dull these days about the bond market, which is exhibiting an unforeseen, profound level of strength that’s spread through the various asset classes on the fixed income side, and that continues to remain unexpected for the most part.

As of Wednesday the Barclays US Aggregate Index had notched a year-to-date return of 3.62 percent; the 10-year-plus index was up a crazy 9.39 percent, and the Barclays Intermediate High Yield Index was up 4.05 percent. Looking at one of their competitors, the Bank of America/Merrill Lynch Corporate Index has so far netted a 5.39 percent return year-to-date while the Merrill High Yield CCC and Lower Index is up 4.45 percent. So that’s pretty solid returns across the board – comparing favorably with the S&P 500’s total return of 4.3 percent so far this year. Explaining how it’s all happening in the bond market is the more difficult task, but let’s give it a whirl.

The Barclays US Aggregate Index had a duration of 5.62 years as of Wednesday – duration declines throughout the month as various maturities in the index slowly mature, and then the figure bounces back up again on the first of the month following the Barclays rebalancing of that index.

So at the beginning of May it was 5.70 years and at the beginning of April was 5.72 years – as long as the duration has been since 1979 and reflective of the Federal Reserve’s steady move away from its monthly bond buying and the recent decline in auction sizes for two- and three-year notes. Estimates from traders on Wednesday were that the next extension would boost that duration to about 5.75 years, still taking us back to the Carter Administration in terms of overall duration.

Taken together that’s affecting the buying in the long end of the curve in a way that some other factors, including pension fund purchases or the effects from Europe may not be (generalized fear and big, big short positions still arrayed against more gains in bonds are also contributing, however). Notably the 10-year hasn’t been able to break through what some analysts identified as resistance around 2.45 to 2.47 percent. This is the second time that’s been tested in recent days (there’s no technical strategy that abides by the ‘third time is the charm’ adage, just FYI).

Furthermore, we might also start to see some convexity-related buying out of the MBS sector in coming days: Vitaliy Liberman, portfolio manager of mortgage-backed securities at DoubleLine Capital, said on Wednesday that he sees another 20 basis point drop in the 10-year Treasury yield, telling Jennifer Ablan that “at that point, you might see some scrambling to hedge out convexity.” (When interest rates fall and homeowners refinance, investors of mortgage-backed securities get back their principal, which they have to reinvest at lower rates. To offset the resulting shortening of their portfolios, they buy non-callable Treasuries.)

Either way, though, most of the reasons offered up for bond yields sinking are undercut in some fundamental way: it’s hard to argue that the safe-haven rally is what’s keeping bond yields dropping as sharply as they are – volatility indexes, be it the VIX or the MOVE Index, are all pretty much saying that there’s no volatility right now. Valuation doesn’t quite explain it – if anything, the move in the bond yield puts it at 400 basis points less than the S&P 500’s earnings yield of about 6.45 percent right now, which is way past the usual difference of about 138 basis points.

One could point to lack of inflation, which is to say it’s possible that expected low inflation – as seen in the five-year/five-year forward rate that still only puts inflation at about 2.5 percent five years from now – as a likely enough catalyst. And rising rates and weak demand would certainly explain that combination – mortgage demand is low, wage growth is weak, overall economic growth came in at -1 percent in the first quarter (even if the weather had something to do with it – which it did).

That mélange of stuff lines up relatively smoothly with the notion that the market is discounting a weak economy in the future that market players just don’t believe right now, and volume in the last couple days has been high enough to warrant this a second look as an explanation. Where it falls apart, of course, is the possibility that the equity market is the one that’s correct here, and that economic growth is about to take off (we’ve heard this before, no?) and with that the bond market gets whipsawed into oblivion.

MORNING BID – “Omaha! Omaha!”

May 2, 2014 12:21 UTC

If the U.S. economy indeed is going to shake off the weather-related problems and push higher in coming months, one of its biggest bettors is likely to remain Warren Buffett, whose Berkshire Hathaway reports results this weekend in addition to its Omaha confab that brings in investors, fans and interested parties alike, where Warren and Charlie Munger will sip Coke, talk up their investments and reveal what else it is they’re looking at about now. Buffett famously couldn’t find a bear on Berkshire this time around (bears on Berkshire being the market’s equivalent of the Washington Generals, just looking to be a punching bag), so they’ll have other analysts asking them questions, with one of the more pertinent ones surrounding what companies Buffett might be eyeing for potential acquisitions in the coming years.

That’s not an easy one to suss out. Buffett famously hates newfangled stuff that strikes of a fad. He partnered with 3G Capital last year to buy Heinz in a $23 billion deal, and so he may not go alone if he hunts for another “elephant” as he likes to put it. He told Luciana Lopez last week that such a template could be used again, saying “If I live long enough we’ll do another one.”

Buffett’s underperformed in the last five years, and it’s not hard to see why; the S&P’s total return from 2008-2013 was 128 percent; Berkshire saw its net worth grow 91 percent during that time period. It’s the first time in nearly half a century that the Berkshire book value over five years trailed the S&P 500.

It’s hard to count him out, though (50 years is a pretty damned good track record, and it’s not like there’s a comparable group that’s been investing over a period of time to compare to, because many of them are probably dead). His acquisition strategy is laid out in a Berkshire regulatory filing this year that says, of course, that “our long-held acquisition strategy is to acquire businesses at sensible prices that have consistent earning power, good returns on equity and able and honest management.” That’s part of it, but some of it is also that he’s usually getting into businesses that are embedded like a tick in the American landscape. Heinz is the very definition of ketchup; BNSF is the largest operator of U.S. rails, Geico recently became the second-largest car insurer in America; Lubrizol, another Buffett holding, was in 2010 the top performing chemical company among Fortune 500 companies based on earnings per share and total shareholder return figures. He’s of course a big holder of Coca-Cola and IBM, which, well, y’know.

Trying to figure out who might be next on his list is a tricky one – a screen of companies with a low P/E, high return on equity and low debt-to-capital ratios (around 25 percent) yields only a handful of names, and most of them are pretty small. That’s not to say smaller companies aren’t something he’d like, but they’d better have a market leading position. Still, Buffett’s boosterism of the U.S., which he highlighted a few years back, comes at a time when capital expenditures are starting to rise and strategists have noted rising bank loans to smaller companies as well.

That’s a potential positive – it shows, as Rich Bernstein of Richard Bernstein Advisors LLC noted, that companies are ever-so-slowly expanding their time horizon to spend money on longer-term projects, such as M&A (big this week obviously) and capex. Even though the expansion has run for about five years now, Bernstein believes the slow, steady pace of growth means putting an artificial “sell-by” date is a bit premature: “Today we’re in a mid-cycle environment – there’s a tug-of-war between rising rates and fundamentals,” as the Fed ever-so-slowly starts to end stimulus, while earnings improve and data gets better. That’s generally the kind of environment Buffett still likes for shopping, if not for an elephant like Heinz or BNSF.

MORNING BID – Google, IBM cloud market rebound

Apr 17, 2014 13:21 UTC

The markets have remained interesting this week as earnings season has ramped up, but the most interesting index remains the Nasdaq Composite.

The Nazz continues its upward swing following Tuesday’s volatile, deep plunge; it has now gained more than three percent in the brief period between the lows it hit Tuesday and the Wednesday close. That’s a pretty short period of time to see such a dramatic move in the index but doesn’t necessarily point to better tidings ahead. Bespoke Investment Group pointed out that when swings like this are usually seen – there have been 18 such occurrences since 2000 – it doesn’t bode well for the tech-heavy index.

On average, the decline following all of these types of days like Tuesday – where the market opens at least 0.1 percent higher, drops as much as 1.5 percent and then finishes in positive territory – is 2.84 percent in the week that followed. That’s not encouraging, but that’s kind of the way things go when the market sees bouts of volatility like this.

Notably, most of these volatile sessions are clustered around bad market environments – it happened several times in 2000 and 2001 before abating, only to return in 2008; so rough markets are generally when this kind of thing occurs. What’s undetermined now is how well the markets overall will do in a rebound attempt and whether it’s a Sisyphean pursuit at a time when many stocks are doomed for more pain.

Goldman Sachs doesn’t entirely think so, believing some stocks have plenty of room for upside after the momentum-driven selloff took down a lot of stocks heavily. They finger Illumina, Biogen, TD Ameritrade – as among those that could see relief rallies due to the kitchen-sink approach to investing that has driven stocks up, then down, all at once of late.

That may not translate to the entire market, though. Google and IBM results were lousy, with the kind of problems that bode ill for the rest of the market and not just to company-specific issues. Google saw a steep fall in mobile ad rates, while IBM blamed weak hardware sales for its lowest quarterly revenue in five years, as Reuters’ Alexei Oreskovic and Noel Randewich wrote recently.

An 11-percent drop in emerging markets including China, Brazil, Russia and India was partially to blame and that’s worrisome for tech names dependent on enterprise-spending, such as Oracle, Cisco, EMC and Hewlett-Packard. Looking further, these reports, should they continue to disappoint, will take the market’s renewed fervor and bury it. Robert Sluymer of RBC Capital Markets believes that the current technicals suggest nothing more than a ‘technical’ rebound that fizzles within a few days time.

And Scott Fullman, senior managing director and chief strategist at Increasing Alpha, who studies options activity, notes that with options expiration coming today that there are currently about the same percentage of calls and puts that look set to expire worthless – about 28,400 calls and 28,200 puts that have no bid are expiring. That means people are still collecting premiums, Fullman said, a sign they’re not really to stop trading them even this late in the one month cycle that marks expiration; they’re worried about volatility and using this to make a bit of money and also remain prepared against sudden market moves.

It speaks to wariness of more declines, and more earnings like Google and IBM will surely bring them.


Apr 11, 2014 12:51 UTC

The question of whether the market is going into a longer, broader correction is one with a lot of wrinkles.

Whether these high-flying stocks are going to come back is the easier question to answer. Why? Because unlike stocks where most of the embedded value is in existing earnings and existing growth – things a person can cling to, like the utilities or telecom – these stocks ride based on their expected growth for years down the line.

And when the unknown is combined with optimism you get price-to-sales ratios of something like 20. So when they cheapen – that is, sell off – those price-to-sales ratios (just another way of valuing a company) they drop to 15 times sales, which when compared with the S&P 500 is still ridiculous (the whole index tends to run around the 1.7 area of late). Which tells you of course that valuation was never the name of this game to begin with.

So with the valuation not there, and investors no longer getting the gratification from seeing stocks rise as soon as they buy them, there’s a couple strikes against them. A third one is supply. Motivated sellers, knowing they bought the stock at higher prices, are therefore champing at the bit to get out of positions if the market surges to a level they’re satisfied is enough to either lock in profits (if they’ve been in a while), get out at even (if they bought recently) or get out with losses because they know they’re screwed. Because, make no mistake about it, people who bought these high-flyers this year are underwater, sometimes seriously so, and unless sentiment does a complete about-face, these “investments” suddenly don’t look like so much fun to own. Broken momentum stocks are an ugly thing – just ask those who rode shares of Crocs into oblivion.

How are we so sure of this? Using volume-weighted-average price data (and a big tip to Mike O’Rourke of JonesTrading for cluing us in on this). Using Datastream, we found that some of your momentum favorites have been on average purchased at much, much higher prices this year than they stand now.
A group of 24 big-gaining names with most of their value wrapped in future expectations, as identified by Credit Suisse, have disappointed those who jumped in this year hoping for lots of gains.

We won’t go through all 24 here, but here are five favorites, listing the VWAP, or average price investors have paid this year, along with Thursday’s closing price, and the difference between the two:

  • 3D Systems $71.90 $48.78 -32.2%
  • Twitter $56.81 $41.34 -27.2%
  • SolarCity $71.17 $55.13 -22.5%
  • Workday $94.28 $75.62 -19.7%
  • Netflix $385.91 $334.73 -13.2%

Not much to like there at all. On average, investors in Twitter in 2014 are down 27 percent from where they bought the stock, and it’s not even as if a 27 percent gain will get them to break-even - at $41.34, that stock now needs to rise by 37 percent to get back to this break-even VWAP level.
That’s a tall order, especially when sentiment is moving against the shares and hedge funds are correcting themselves from being more overweight in momentum than they were any of the other style factors that strategists measure (which include things like beta, volatility, earnings yield, dividend yield, and a few other metrics).

If there was one area that wasn’t constrained by the hedge fund managers, it was momentum – thanks to a rosy 2013 that many figured would just roll on in 2014. It’s been anything but that. Now, some strategists are warning that earnings are the next point of measurement and sure, that’s true – but that’s more for companies within a small range of where most think they’re valued. These stocks are different – the forecasts for growth over coming years vary wildly, because with names like this, things are just inexact (and even more so with biotechnology names, which are frequently all-or-nothing stocks).

Momentum works two ways – and now it’s working in the wrong direction for the bulls.

MORNING BID – Momentum stocks: A primer

Apr 7, 2014 13:25 UTC

Lots of stocks have been getting killed in the last several weeks and the declines don’t seem really like they’re set to abate headed into a week where news is again at a premium (sure, earnings, but it’s just a few names, and they’re mostly decidedly not in this category of the momentum names that fueled the rally in 2013). So the likes of Facebook, Tesla Motors, Netflix, Alexion Pharmaceuticals, and a bunch of others have seen their fortunes turn in the market. But at this time we thought it would be a good way to get into this topic again by trying to lay out just what the hell a momentum stock is in the first place, because they exhibit a number of characteristics beyond just “a stock that’s going up very high.” So here goes:

Growing Industries: Internet retail, internet security, solar, cloud computing, companies that use the cloud for providing services (think, biotechnology, and anything else where the prospects for growth are big and related to a growing sector of the economy. Utilities don’t really qualify here, naturally. The reasons are two-fold: for one, in order to jump onto a rising growth story, you’d want to be in a place where the expected future returns outpace the returns you’re getting now, something you won’t get from the telephone company, someone who sells toothpaste, or the guys hooking up the electricity.

Revenue, Revenue, Revenue: Credit Suisse’s quantitative research models shows that the big winners in 2013 were those whose price when compared to enterprise value showed most of the value in the stock wrapped up in their future growth prospects. Lots of these types are showing a big boom in the money they’re bringing in every year, even if that’s not translating yet into earnings – Tesla, for instance, saw its revenue rise by about 75 percent in 2011, which then doubled in 2012, and increased nearly four-fold in 2013. That’s growth, and that’s what feeds the expectations for more growth. The exception here is probably biotechnology, where much of the prospects are given over to expectations for a drug approval – though it’s notable that Alexion, for example, has posted revenue growth of 37 percent or better for five years running.

Rising Stock Price: This is sort of a no-brainer, but it’s a little more nuanced than just “OMFG LOOK AT THAT.” (Ok, maybe not much, but let’s unpack it anyway.) There’s a lot of talk about stocks that steadily rise and then go through a period of what people blandly call “consolidation,” but in a sense that kind of thing is important – it means that investors are seeing their stocks sit, churn for a while, and not really move, but those confident in the prospects and in the valuation of a company will buy as these dips occur, thus ensuring a “base” when the stock falls back. They’re not “value” investors, but they’re investors believing that a company’s value sits at a certain price where they’d be willing to buy, again and again. But these stocks exhibit no such pattern – they don’t really come up for a breather at all, and sort of just simply keep going and going and going. So investors who get into these names, including but not exclusively hedge funds, are doing it and finding what Mike O’Rourke of JonesTrading called “instant gratification from price appreciation.” When investors talk about stocks going “parabolic,” that’s what they’re referring to – look at Netflix last year, rising with barely a stop from around $90 to more than $450 a share.

Volume and Volatility: This is an underappreciated aspect of the stock-price move, and that when you see these stocks start to take off, often volume will bust out in a big way on the up days as more and more people jump in to take advantage. They also tend to move around a lot.

Short Interest: Not always necessary, but often an added part of this. Just as these stocks often attract hungry buyers, there are a lot of hungry sellers who jump in as well and believe – as is likely the case – that the valuations are absurd. But with momentum stocks, that doesn’t really matter, so you see lots of shorts get burned. Green Mountain Coffee Roasters, Tesla, Netflix and a few others are good examples of those that built a stubborn short base for quite a while. Eventually, they will be right, but they may not even be in the stocks anymore, having gotten run over by big big mo.

Faddish Industries: Those that buy these names can either be emotionally connected to a story – prostate cancer drug maker Dendreon had for years a fervent group of followers who lived and died on every regulatory announcement – or they come out of brands that naturally attract buyers because they have a consumer appeal as well. Netflix, Priceline, TripAdvisor, or Tesla all work in this description. Sometimes they’re even an outlier in an otherwise slow-growing industry because of “fad” appeal – Crocs was a big momentum stock for a long time too.

So what’s all this make out as? The question is when people start to find value in these names, but given that tradition valuations don’t work (Netflix is valued at 20 times sales; the S&P is 1.7 times), investors start to see the upward momentum in these names sag, and then quickly exit as fast as they got in – Morgan Stanley points out that a basket of stocks consistent with hedge-fund overweights lagged a basket of HF underweights by 7.7 percentage points from March through April 4. There’s a point where these stocks become “broken” – and it can take several attempts before it happens, as it did in the dot-com era, but once it happens, there’s little real way to stop it. The average price paid by investors in a lot of these names ends up being higher than where the stock is at a given point, and that acts as a ceiling on a rebound. A few stocks escape this, but many don’t.

MORNING BID – Puerto Rico in the spotlight

Mar 11, 2014 13:45 UTC

The market remains in a bit of a vacuum, with interesting activity focused on a few speculative investments that don’t necessarily suggest anything about the larger environment – though one could extrapolate from the interest in these myriad issues that the market is getting frothy, one way or another.

The island of Puerto Rico will sell about $3 billion in bonds to a varying group of investors on Tuesday, many of whom are likely not to be traditional municipal bond buyers. What’s interesting to see, as our muni team pointed out late Monday, is that the bonds appear set to sell at an 8-percent coupon, with yields somewhere in the mid-8s or high-8s. That’s nowhere near the 10-percent yield that some had expected. (Full Story)

What may be happening is a bit of fortuitous timing as the market had been in the midst of a half-way decent rally for a bit here and as investors clear the decks of some emerging-markets assets that have underperformed. The rest of the world has caught a bit of a cold here, it seems, so safer assets – and Puerto Rico qualifies on some bizarre level – will reap the rewards.

Some of it is also the buyers: Distressed debt funds and high-yield funds, along with hedge funds looking for fat yields and a bit less concerned about the implied risk that the junk-level sale suggests. The constant refrain one hears is that people would invest in somewhere other than the stock market but have nowhere to go. Well, there’s some nice beachfront property here.

Tuesday also promises the latest chapter in the saga of Bill Ackman vs. Herbalife HLF.N. This has so far not worked out all that well for Ackman, given the share increase in the last 12 months (admittedly, the stock has been weaker so far this year, losing about 18 percent). The hedge fund manager is expected to make a presentation that will include new allegations relating specifically to its operations in China, suggesting the company is violating laws in that country.

The Ackman thesis, essentially, is that Herbalife is a pyramid scheme, where only the first few investors are guaranteed to make money, though he has motivated opponents on the other side, including Carl Icahn, and of course, the company itself. As of Friday, about 18 percent of the company’s shares were being borrowed for short bets – a high figure – though it had been more than 20 percent a few months ago, according to Markit data.

Options action doesn’t really suggest much of a move for the rest of the week (at the money straddles put it at about 5 percent), suggesting people have, in part, grown weary of this battle, even as Ackman is reluctant to give it up.

MORNING BID – Contagion abounds, and the Super Bowl

Jan 31, 2014 13:57 UTC

On Thursday, this column suggested that a bunch of stock markets selling off in tandem did not satisfy the definition of contagion. Central banks dumping U.S. assets, weak auctions of government debt in seemingly less related countries, and big sell offs in less affected currencies? That’s getting closer to the mark.

Foreign central banks cut their holdings of U.S. debt stored at the Federal Reserve by the most in seven months in the past week, in a bid to defend weak currencies. “It makes sense,” said Scott Carmack, fixed income portfolio manager at Leader Capital, which has $1 billion under management. “It will probably continue as emerging markets try to prop up their currencies.”

So, overall foreign holdings of securities like Treasuries, mortgage-backed securities and agency debt at the Fed fell by $20.77 billion to $3.325 trillion in the week ended Wednesday, the biggest drop since June. The overall draw-down has come to about $55 billion since the Fed first said it would cut back its monthly bond buying. Debt and equity funds, meantime, continue to shift away from the emerging markets, with EPFR reporting a pullback of about $10 billion from such funds; debt funds have shed $4.6 billion so far in 2014, about one-third of 2013′s total drawdown of $14.3 billion (and that’s for a full year).

While in some ways, the most attractive solution for some of these countries to try to stem capital flight is through higher interest rates (making their debt more attractive to investors who need a bigger return over inflation, which is too hot in places like Brazil and Turkey), higher rates aren’t going to entirely solve the problem. And so you get the spectacle of Hungary cutting its 1-year Treasury bill auction and yields rising by about two-thirds of a percentage point just to garner enough interest for what they did manage to sell.

Hungary’s less in danger than some other countries. It’s got a big current account surplus rather than a deficit, but that hasn’t stopped investors from pulling back there either, driving the forint to a two-year low against the dollar.

The ongoing weakness in currencies – which many analysts say has not yet run its course – is going to pinch economic growth in tandem with higher rates. This can sometimes launch a vicious cycle that has consumers in those countries saving money rather than spending it – again, because of inflation. Combine that with a slowing in capital flows, and a weak export environment thanks to the China slowdown, and it gets a lot uglier, as Reuters’ Sujata Rao pointed out in an overnight story.

She quotes Steve O’Hanlon, a fund manager at ACPI Investments, who summarizes it well by saying: “Markets are pricing a pretty dire situation in emerging markets (but) is EM cheaper given potential future output? I wouldn’t say so but it’s getting there. When currencies stop selling off, if (governments) produce real reforms, I will be investing in those markets. If you don’t see any reforms, the rate hikes will just destroy growth, discourage investors and make the situation far worse.”

On the U.S. side of things, the stock market might see a bit of relief, however briefly. The outperformance by bonds against stocks this month might spur some reallocation trades, helping the market on its last day of the month. So it’s got that going for it, which is nice. Of course, futures are getting hit hard this morning, so maybe this is false hope.

From a more grounded (well, ridiculous) perspective, it’s the Super Bowl this weekend in the U.S.

Strategists have long made sport of the vaunted “Super Bowl Indicator,” which, for a long time, stipulated that when teams in the National Football Conference (the 49ers, Giants, Cowboys, to name a few) were victorious, the stock market was in line for a good year, but when teams in the American Football Conference (Dolphins, Raiders) won the big game, the equity market was set for a bad year.

That was modified a few years ago to include old NFL teams that had migrated to the AFC – the Steelers and the Baltimore Colts (this column does not recognize teams that move in the middle of the night.) So that puts us in a unique position this year.

First off, the AFC team is the Broncos, so a win by them should put the market on track for weakness for the rest of 2014. This is, of course, undermined by the fact that when the Broncos do win (and they won in early 1998 and early 1999), the market does pretty darned well. Furthermore, their opponent, the Seattle Seahawks, spent most of their existence in the NFC before moving to the AFC a few years back. If the Steelers and Colts can be grandfathered into the good side of the ledger, it stands to reason that the Seahawks ought to be included on the bad side of the ledger, no?

MORNING BID – Turkey, the Fed, and we all float down here

Jan 29, 2014 14:46 UTC

The messy sell-off in emerging markets was stemmed overnight after Turkey surprised everyone by raising rates to 12 percent – but it didn’t last. Major averages in Britain and Germany opened at their highs of the day but have since faded, and even though the big rate increases in Turkey, South Africa and India are meant to stem capital flight, so far the market’s shooting first and asking questions later. S&P futures were up about 20 points after the Turkey rate hike – an odd move for such a localized event – and we’re seeing the reaction now, which, to quote Tom the cat about the ‘white mouse no longer being dangerous,’ “DON’T…YOU…BELIEVE…IT.” So we’re lower, and continue to head lower, and for those of you new to the markets, this is what’s called a selloff.

The big question: Will the Federal Reserve defer its tapering campaign in recognition of emerging-markets difficulty? One could say the Fed cannot be expected to act as the underwriter for global risk-taking, but you’d be laughed out of the room, given the performance of assets around the world in the last several years as the Fed went into full-QE mode.

On the other hand, there’s a difference between providing broad support to the markets (via helicopter or not) and an actual admission that you’re changing policy to respond to specific issues worldwide, and such a move strikes us as the latter, not the former. With that in mind, it would be remiss to think the Fed does not continue at its measured pace, dipping down to $65 billion in bond purchases per month this time, as Janet Yellen takes the reins and we find out what kind of situation the new Fed head has gotten herself into while Ben Bernanke eases into what one hopes is a steady and muted retirement (think Johnny Carson, not Alan Greenspan).

For one, eventually reducing the monthly stimulus to zero at least gives the Fed room to ratchet up that stimulus again if they really need to.
Furthermore, the emerging markets, in a sense, are already gone. No, it’s not a disaster yet – but the implosion of China’s shadow banking system, the resignation of every Turkish official in Ankara, and the, well, uh, never mind, Argentina is Argentina, and isn’t going to be solved by the Fed put. The Fed might give it lip service in its statement but any more than that really ratchets up the moral hazard.

Furthermore, when one takes a look at the relative strength of emerging markets stocks with the U.S. market, it’s clear EM has been struggling for a while anyway. A comparison of relative performance between the MSCI EM index (.MSCIEF, or EEM.P if you’re into the ETF thing) is at 0.7 or so, and U.S. markets have been the steady outperformer since the beginning of 2013, and that outperformance accelerated throughout the year but particularly in the second quarter when the Fed started talking about reducing stimulus in the first place.

That doesn’t mean they can or will reverse course – it makes no sense. But less liquidity washing ashore means a bad investment can no longer be covered by smoke and mirrors. The MSCIEF’s relative performance index is still looking terrible, having fallen below the 30 level that indicates an oversold condition. It’s not quite at the nadir of the June 2013 or May 2012 selloffs, but it’s close, so if there’s a place one might expect some buying, it’s now. But it’s not happening yet – and that does raise questions about whether we’ll see more soothing words from central banks.

Back in the USA, the Treasury is readying its first-ever auction of two-year floating-rate securities, likely to see demand from various types of investors.
There are currently more than $200 billion in agency and “supra-sovereign” floating rate notes outstanding, mostly from Federal Farm Credit and Federal Home Loan Bank, per Morgan Stanley data. So, Treasuries should add nicely to the mix here, and it’ll quickly become a very big dog in a very small pond (dogs can jump in ponds, go with the analogy). So the $15 billion will add to the week’s mix of other supply.

For one thing, this gives the Treasury the chance to manage its issuance a bit more by reducing the number of short-dated auctions of bills, instead issuing this note that resets based on market rates for floating-rate notes. It will helpfully cut back on the weird dislocations that the market has seen of late in bills that are maturing just as the United States is set to run afoul of the debt limit (again) or face some kind of annoying only-in-Washington-type spectacle.

(Of course, if it was all two-year floaters, then in the month it had more floaters coming just as a budget crisis hit, those yields would go through the roof. So you can’t entirely solve the Washington problem this way, and floating-rate notes as far as we know cannot hold Congressional office).

The other advantage for the Treasury is the lack of what’s called “term premium,” which Morgan Stanley says will lead to interest-rate payment savings.
Term premium refers to how much additional interest you have to offer someone who is taking the risk of buying longer-dated securities (and therefore risking wide swings in interest rates or other unforeseen events over a five-year period vs. say, six months). But floating rate notes have no such provision (they float, after all), so that *should* save Treasury some money.

Reuters’ bond correspondent Richard Leong points out they’re expected to sell with a yield of 0.10 percentage point, almost a quarter less in the two-year fixed-rate note supply sold on Tuesday. So, that’s savings for Uncle Sam until the FRN yield rises above the fixed-rate two-year notes. Overall, the interest rate should be greater than what’s embedded in notes, though, which is good for money market funds (they hold about $276 billion of floating rate notes already).

FRNs are great in an environment where interest rates are on the rise, which has been the case for several months now (until this month that is), and therein, of course, lies the danger. If rates fall, well, not so great, as the interest rate on the notes would be chipped away.

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