MORNING BID — Breaking it down, Fed style

Sep 17, 2014 14:58 UTC

It’s all over but the dissection of the Fed statement, due later today, which will follow with a Janet Yellen press conference after the U.S. markets get word of whether the Fed did or did not eliminate the “considerable time” bit from its statement that saw markets go into a tizzy all of Tuesday. At this point the market believes that phrase now may *not* be eliminated, which marks the second reversal in about a week on this point. No matter what, somebody is going to be caught leaning in the wrong direction, but if the latest intelligence is that the Fed’s statement won’t change materially until the October meeting, then the freshest bets are probably in the direction of those betting on that much. So if the statement does cut out that language or modifies it in any way, you could see a selloff in equities, the dollar and bonds.

The meeting also brings with it the update on the Fed’s “central tendencies,” that is, its sure-to-be-incorrect projections on where the economy is going. Given the rebound in the second quarter that seems to have at least been somewhat sustained in the third quarter, it wouldn’t be surprising to see the Fed outlook for GDP bumped up for 2014 (currently 2.1 to 2.3 pct) and 2015 (at 3.0 to 3.2 pct – the Fed will predict 3 percent growth for the year-out period until we’re all Morlocks), and the unemployment rate expectations are projected to drop to maybe 5.7 to 5.8 percent from the current 6 to 6.1 percent expected at year-end. Which is all well and good, but it doesn’t give us a good sense, really, of what’s to happen going past the meeting.

What we may be looking for over a longer time frame is an elevation in volatility. Richard Leong, in a story last week, pointed out that the market is starting to see more options-related buying that suggest rising rates in the federal funds and eurodollar markets. In a Tuesday story he noted that various measures of volatility – including the Merrill Lynch MOVE Index, a measure of fixed-income volatility, is at levels not seen since mid-summer. The dollar is showing similar activity, with volatility in the currency markets finally picking up after being stagnant (ok, about as exciting as watching grass grow) for a good long period of months now. Nomura strategists are anticipating a further pickup in volatility post-Fed meeting among currencies, judging by options positioning.

The equity market isn’t quite there yet – the VIX still remains low, trading below 13, but volatility would be expected to pick up in other risk markets if the interest-rate arena begins to exhibit more gyrations. That’s because the moves in that market make it more difficult to fund carry trades to buy other assets – the dollar remains a cheap source of funds right now, but the cost of carrying such bets increases as rates rise and more importantly as the market gets more volatile. Where that leaves investors is unclear – Bank of America/Merrill Lynch notes that credit investors are going with shorter durations (which adjust more quickly as rates rise) and leveraged loans as the best choices over the next 12 months, and are a bit less sunny on high yield, which has the potential for some ups and downs in coming months.

MORNING BID – Climbing the Wall

Jun 26, 2014 12:56 UTC

Eventually, lack of volatility, rock-bottom rates and this accommodating monetary policy will realize the build-up of excesses that causes some kind of market crack that devastates people – particularly in areas where many do not expect it. But it won’t be today, and investors should continue to ride that so-called Wall of Worry through the 2,000 mark on the S&P 500 before long.

Goldman Sachs strategists note in a piece overnight that volatility is likely to remain lower for longer, but the slowness of the economic expansion and the additional regulations as a result of the financial market crisis of 2008 mean that the buildup of those speculative excesses is happening at a much slower rate. That’s not to say they aren’t out there – Brian Reynolds of Rosenblatt Securities is adamant that we are now in a “runaway bull market,” which of course usually ends in tears for someone, but again, not today.

But back to Goldman: their head of credit strategy, Charlie Himmelberg, notes that bank regulation and other issues have reduced that so-called accelerator, where activity in the economy amplifies risk-taking in credit markets and use of leverage, and vice versa. So that’s adding some drag to the system, which can be seen through, well, the fact that the economy plods along – contracting by a ridiculous 2.9 percent in the first quarter – without any real sign of taking off. Again, there’s merit to this in that it means a recession is far off because we’re so far only about midway through the business cycle, at best.

The emerging signs of additional spending on capex are there, and investors, per Bank of America/Merrill Lynch, are practically begging for more capex – the long-term spending that follows lots of buyback and dividend activity and then after the M&A activity that we’ve seen a lot of in 2014. The company’s global fund manager survey currently shows a net 60% plus that want more capex — and the last 12 months capex growth rate is up to 5.6 percent from 2.2 percent in the previous quarter, so investors are getting what they want.

What that portends, though, is an eventual shift in volatility. That hasn’t happened yet, and some measures, like Credit Suisse’s measure of fear, where they look at the cost of put options versus call options, show a lot of fear – but that’s because the price of calls has collapsed, meaning investors just don’t see a reason to bet on higher markets. They’re not really increasing bets on lower markets – so that’s the ultimate signal of boredom. Which is a merit of sorts.

MORNING BID – The “Everything Is Awesome” Rally

May 30, 2014 12:50 UTC

Sometimes the biggest pain trade is not being in the market at all, and that’s certainly the case in 2014. We’re in something of a Goldilocks environment when it comes to major markets: Bank of America-Merrill Lynch laid this out pretty well in a note yesterday, noting that global equities, US stocks, emerging markets, government bonds, gold, high yield bonds and investment grade corporate are all up between 3.9 and 5.2 percent so far this year.

One way or another now, there are a lot of people waiting for something to go wrong in the market and as a result it’s more or less caused people to freeze in place. Recent investor surveys in the stock market have more people neutral than has been seen in a long time, because while they don’t see equities falling dramatically any time soon, they also are confounded as to how the equity market can keep rallying.

YTD asset performance

A similar affliction infects the bond market as well: long-dated Treasuries are rallying hard and may continue to do so, and that’s just got people perplexed – there are good reasons for bond yields to be higher, but equally valid ones for bond yields to continue to grind lower as well. Eventually, the thinking goes, one of these markets is going to break, and a lot of positions are going to get run over in an effort to get back to a better place.

The knee-jerk thinking, however, is that stocks are of course the ones in the wrong, because stocks tend to be the more immature crowd here (like Emmett in the Lego Movie), but that’s far too easy a way out on this. Similarly, saying the falling bond yields is indicative that the “bond market knows something we don’t know,” also ascribes a level of clairvoyance to the fixed income crowd that also doesn’t really jibe with reality. Sure, the bond market, as Bob Doll of Nuveen Asset Management told Reuters yesterday, could be saying they’re from Missouri right now, unconvinced of the expectations for better than expected economic growth going forward (Goldman now sees Q2 GDP at 3.9 percent), and so they’re pushing yields lower.

That’s not the same as saying there’s some sort of systemic freak-out on the way, not with the Merrill 6-month MOVE Index (a measure of fixed income volatility) still tracking not far from its lowest levels in more than a year), not with options on the VIX costing next to nothing and overall implied and historic volatility at rock-bottom levels.

Want more? Credit Suisse points out that S&P calls are at their cheapest in a year – SPX 25-delta call implied volatilities are at one-year lows, and to unpack that a bit, that’s looking at out of the money calls with a 25% delta. Since a delta of 1, or 100% refers to an option that moves right in line with the underlying index, the 25% ones are way out of the money and therefore ones you’d be buying that would factor in substantial moves one way or another. So that’s putting in very little risk of a big “tail” event, which near as we can tell, is something like getting hit with a stegosaurus’s tail.

The question of how long a condition like this can persist, then, is “quite a while,” and it’s a topic we’ll visit on several levels over coming days. Heavy buying out of European institutions, expectations for a big monetary policy bomb from the ECB next week, pension fund buying and allocations from other institutions should keep a lid on bond yields.

Short positions probably still need to be worked off as well: the net short position in 10-year bonds is still more than 97,000 – down from about 165,000 in mid-April, but still a fairly substantial position. Sure, some may be new positions, but it’s still something that would get squeezed should yields slip a little lower and mortgage convexity buyers are pressured into the market. So add that to the mix. BofA/Merrill added its name to those who see a summer rally coming through, based on overall low value-at-risk from investors, combined with poor performance, low volatility and heavy liquidity, all things that cause people to start chasing.

With all of that, you end up getting more support for equities, which look by comparison to be a bit cheap when compared to bonds. With yields so cheap, the temptation to do more borrowing to flush that money into emerging markets, high yield, stocks and other riskier assets remains high. The Fed is backing off, sure, but they’re not doing it quickly.

MORNING BID – Shorting a dull market, and other cliches

May 28, 2014 13:43 UTC

There are a million cliches people lean on to explain some aspect of the market that’s otherwise baffling, and the key one this week – the cliche du semaine – is something along the lines of, “You don’t want to short a dull market.”

And indeed this has been a bit of a dull one lately. The S&P 500 grinds to new highs, accompanied by the Dow transports, with the industrials not that far off.

Even the much-maligned Russell has outperformed the S&P on a relative basis for the last four days, so some of the divergence between the small-caps and the big caps has been worked off to bring valuations a bit more in line (even if the Russell’s weakness stands as one big counterpoint to all the kumbaya talk we’ve been having lately).

Recent volumes have been really weak – trading last week was 22 percent less than the average week, per Mike O’Rourke of JonesTrading.
So there’s some concern that a breakout in the stock market – which we’re seeing now – accompanied by lackluster volume somehow means it’s not “real” in a sense. But try telling that to anyone who bought into the market two or three years ago and has watched it do almost nothing but ride higher since. At this pace, corrections become much less frightening and the worrying only increases when things get truly hairy.

Which brings us to another cliche – the one about too much complacency. A look at volatility right now does underscore the way in which the market is in full Hakuna Matata mode, with one-month VIX implied volatility falling to 38.9 percent, the lowest ever, according to Credit Suisse. VIX options, therefore, are near their cheapest levels ever, and the cash VIX is hanging around the 11 range, so it’s not even ready for its Bar Mitzvah.

(And three-month implied volatility of about 12.5 percent is actually a bit rich, given realized volatility has been a bit more than 10 percent in the last three months – traders are betting on a somnambulant market and getting a market that’s the functional equivalent of rotting tree bark.)

The constructive part of all of this is that the market continues to rotate through various sectors. Old technology like Microsoft had a turn leading the way, which followed good gains for utilities, and the financials were stronger on Tuesday.

Dennis Dick of Bright Trading LLC in Las Vegas pointed out some of the cliches that keep him a bit worried – the lack of worry in total and no real catalysts to keep these things moving – but said, once again, that it’s a difficult environment to make the short selling work.

Which, of course, is only an issue if you’re a die-hard short.

MORNING BID – Of bubbles and evaporating weather troubles

Apr 1, 2014 12:55 UTC

There seems to be a battle in the market between those who believe stocks are in, or are nearly in, a bubble (that should remind investors of 2007, 2000, or another time when the market was significantly overvalued), and those who believe all is well, things may be a bit frothy but hang in there – that kind of thing.

This could be the result of who is driving news flow.

People with boring diversified portfolios (and good on ya for that) probably see this as less of a big deal, given steady appreciation in stocks. Those with big positions in the momentum names that were hammered in the last week – one of the worst in terms of performance for hedge funds relative to the S&P since 2001, according to Goldman – might see it differently.

Really, what’s happened is that the more speculative areas of the market have been the focal point for some serious gains, and now, a good deal of selling. Sure, the biotechnology stocks aren’t at the point experienced by homebuilders and financial stocks in 2007, but who would want that anyway?

Citigroup is still down about 90 percent from its peak all those years ago. And financials are the only sector since October 2007 that still boast a negative total return (it’s not a close call, either – it’s still like negative 30 percent).

Bank of America/Merrill Lynch said in a note that the average biotech stock trades at 24 times sales, the highest since the tech bubble. Still, BofA/ML is sticking to its premise: “While we continue to recommend that investors fade secular growth stocks (and bond proxies) in favor of inexpensive cyclicals, overall market fundamentals remain favorable, and the frothy spots appear well contained. Equity bubbles rarely happen when everybody is talking about bubbles, and equity sentiment remains subdued, unlike the bullish levels of 2000.”

Whole load of assumptions in that sentence – equity bubbles rarely happen when everybody is talking about them? Sure didn’t feel that way in 2000 and 2007. And frothy spots are pretty contained when the baseline is still that it hasn’t engulfed the majority of the market the way it did in 2000.

This isn’t to say BofA is wrong on this front. The market doesn’t, as a whole, feel as overwhelmingly overpriced as it did in the 2007 period or in 2000. Indeed, even the IPO market, which has been chock-a-block with unprofitable companies, including a lot of biotech names, has not extended its gains to levels comparable to the 2000 tech bubble.

So, a bit more of a correction is certainly possible, and those who believed the market would churn its way through the year are pretty much on target for now. The S&P gained 1.3 percent in the first quarter, and a repeat of that for three more quarters for a 5.5 percent or so price change in the year wouldn’t seem out of line with expectations.

Investors should get a reasonable clue of the path of consumer spending as the nation’s automakers release data on their sales in March. GM, Ford and Toyota are expected to see smaller sales gains than Chrysler, but the hope is for slightly better sales as payback for recent weather-linked sogginess, right when the market is hoping to see such encouraging news.

Morgan Stanley sees this as the case, noting that one of its proprietary indicators of consumer activity is seeing a rebound in housing, auto sales and other consumer areas, while Goldman Sachs last week wrote that “we believe that dealer traffic experienced an inflection point mid-month,” anticipating a seasonally adjusted annual rate of car sales to come in at 16 million.