Intermediate Market Peaks Often Identified by Junk Bonds and European Equities
We have seen several intermediate market peaks over the last few years and most of them have been associated with negative divergence with junk bond funds and European equities that warned of a coming top.
The 2010 mid-year top and bottom are a great example of this where leading into the April/May top both the iShares High Yield Bond Fund (HYG) and the Euro Stoxx 50 Index failed to make a higher high above the January peak leading to a negative divergence prior to the market correction. As the market correction commenced the Stoxx 50 bottomed in early May while HYG bottomed in the middle of May while the S&P 500 didn’t bottom until July as both produced a bullish divergence suggesting a bottom was forming.
During the multi-month topping process in 2011, the Stoxx 50 Index gave ample warning of a coming top as it peaked in February and made a series of lower highs while HYG followed the S&P 500 more or less and didn’t provide a clear warning leading into the peak, though it did accelerate lower from May to July than the S&P 500 did. Not only was the Stoxx the better early warning indicator for the 2011 top but also the bottom as it troughed in the middle of September while both the S&P 500 and HYG didn’t bottom until two months later in November.
The HYG bond fund acted as a better early warning indicator in 2012 than it did in 2011 as both HYG and the Stoxx 50 Index showed negative divergences at each intermediate top during the year. The first significant top of 2012 came when the S&P 500 peaked near 1420 in early April, though the HYG fund peaked well before it in late February while the Stoxx 50 peaked a few weeks earlier in March. We witnessed another top in October and HYG showed the most negative divergence with the S&P 500 while the Stoxx 50 more or less traded in step with the S&P 500.
Between the two indicators, at least one of them has shown significant negative divergence with the &P 500 near intermediate tops and as seen below in the shaded red box in the far right of the chart, both are currently selling off while the S&P 500 is hitting new highs suggesting a near-term pullback may be just around the corner.
Given how strong the market’s internals are (please see Wednesday’s article) I would expect any pullback to be shallow in nature and likely see the S&P 500 pullback to the breakout point near its September 2012 highs near 1465-1475 for roughly a 3-5% pullback. After working off an overbought condition and bullish sentiment, the markets could hit new highs and continue their advance until we see more significant internal erosion in the market’s health.
This week's record outflows from high-yield bond ETFs could be a warning sign for investors in risk assets
Flows into equity funds totaled $6.6 billion in the first week of February. January's historic inflows averaged $13.5 billion a week, but this isn't really a strong signal that flows into mutual funds and ETFs investing in stocks are slowing down.
However, there are two other observations from this week's flow data that could be concerning for investors in risk assets.
This week, U.S. Treasury funds recorded their first inflows – $0.5 billion – after 10 straight weeks of outflows, totaling about $6 billion.
This week's gains in the Treasury fund space obviously don't make up for the $6 billion that have flowed out of those funds in recent weeks, but the fact that they didn't suffer outflows this week is evident of a risk reversal nonetheless, says BofA strategist Michael Hartnett.
The data on high-yield debt flows offer much more striking evidence of a risk reversal, as the chart below shows (via Zero Hedge).
This week, high-yield ETFs recorded their largest weekly outflows ever.
Zero interest rate policy has depressed yields in safer bonds, like investment grade and government debt, causing investors searching for interest income to move further out on the risk spectrum – arriving at the high-yield bond market.
As such, high-yield is one of the first places you would expect to see a breakdown in a risk rally, and that appears to have happened pretty swiftly this week.
Credit strategist Peter Tchir recently wrote an excellent, inside look at high-yield ETFs specifically, and why self-enforcing feedback loops in those funds pose so much risk in the event of a selloff (Bond ETFs Are A Massive Accident Waiting To Happen).
It will be very interesting to keep an eye on the data in the next few weeks to see whether or not the move out of high-yield reverses, and whether the negative sentiment infects the equity space.
The Wall Street consensus is that Treasury yields are headed higher in 2013. That's big news because it could mark the end of a three-decade bull market in bonds.
Strategists expect those higher yields – driven by an upturn in economic growth – to cause bond investors, who after three decades aren't used to seeing negative returns, to reallocate toward equities. Hence, a "Great Rotation."
The prospect of higher yields has the government bond market on edge, but it's also sparked some intense analysis of what could happen to corporate debt markets if rates rise. The rumblings from a few firms in notes to clients are that not everyone is going to come out a winner.
BofA credit strategist Hans Mikkelsen describes how it could unfold in what he describes as the "biggest risk" to the market in a note to clients:
In our view, a disorderly rotation out of bonds – characterized by higher interest rates and wider credit spreads – is the biggest risk for investment grade corporate bond investors this year. The key problem is that, with the rise of bond funds and ETFs, individual investors now have a means to trade illiquid corporate bonds in a much more liquid manner.
When interest rates rise and NAVs decline, we are concerned that redemptions will lead to a situation where too many illiquid underlying corporate bonds come out of funds – especially as dealers have little capacity to act as buffer in the new regulatory environment.
Forced selling – and no one to take the other side of the trade.
"But we have never seen a disorderly rotation," writes Mikkelsen. So, how that sort of scenario would pan out is uncertain.
We have seen two big moves out of bonds spurred by rising interest rates, in 1994 and in 1999, but the picture is radically different now, thanks to the rise of mutual funds in the corporate bond market.
Federal Reserve Flow of Funds, BofA Merrill Lynch Global Research
Mutual funds and ETFs, whose investors are typically going to head for the exits if they observe negative returns, have accounted for a big portion of the buying in recent years as investors across the spectrum have searched for yield. Thus, a decent share of the market is exposed to forced selling by these funds.
In comparing today's set-up to 1994 and 1999, Mikkelsen writes:
However, what is different this time is that, following continued declining interest rates and quantitative easing, bond fund assets under management have expanded significantly.
Moreover, the share of corporate bonds in mutual fund fixed income assets has increased to 42% from 24% in 1994 and 31% in 1999. Hence, mutual funds and ETFs now own 19% of the corporate bond market (high grade and high yield), up sharply from 9% and 10% in 1994 and 1999, respectively.
Thus, if we were to experience outflows from bond funds of the magnitude seen in 1994 and 1999, the impact on corporate bonds this time would be much more severe.
On top of the illiquid nature of the instruments being used to trade corporate bonds and the growing share of the market held by those instruments, there may be another massive, secular headwind for credit markets to contend with if things really pan out for the American economy.
So, here is what the "Great Rotation" looks like from the credit perspective, according to Mikkelsen:
Moreover, following the extended declines in interest rates, and associated outsized fixed income total returns, households now hold more than 13% of their financial assets in fixed income – at the upper end of the historical range and sharply above the low of 8% we saw more than 30-years ago in the early 1980s before interest rates began their secular decline.
This higher fixed income allocation to us is a direct result of the extended environment of declining interest rates – when interest rates start increasing, we look for households to reduce allocations to fixed income. This, despite the underlying bond friendly demographics.
Of course households’ percentage allocation to fixed income automatically declines when stock prices increase – but there is reason to suspect that households will play a more active role in rebalancing out of bonds, into stocks as interest rates increase.
Combine the "Great Rotation" with a corporate bond market uniquely vulnerable to rising interest rates and credit markets may have a tough go of it this year or next.
Mikkelsen thinks 10-year Treasury yields would have to keep rising past 2.5 percent and on toward 3 percent in 2013 in order for a sell-off in credit like the one described above to occur.
"Timing is obviously also important," he writes, "as the disorderly scenario requires a fairly rapid, as opposed to slow and drawn out, increase in rates."
Citi strategist Stephen Antczak, on the other hand, writes that if 10-year yields rise "anywhere near what our economists expect (again, 2.5% by year end)," that total returns in bond funds could be negative, which would create a forced selling situation
Central Banks have repressed the sovereign bond markets of the world's currency printers to extreme. This relative pricing makes stocks look extremely cheap on an equity risk premium basis (thank you Ben); however, everyone knows this and, as we have discussed many times, margin balances and net long positions are as high as they have ever been. A zealous belief in the power of the central bank has compressed the market's risk perception to near-zero - but at the same time, returns have been crushed as even junk bond yields are at record lows. In other words - there is no risk any more, and no conventional return. Or rather, the only "return" is in the wholesale herding of cattle into the "safety" of the equity beta butcher house.
Equity risk premium (relative to repressed bonds) make stocks look 'attractive'...
"Central Bankers and policymakers can’t stop themselves from interfering." To be fair on them (unusual in his case), SocGen's Albert Edwards admits the pressure to do something in the face of “bad” economic news is overwhelming. The general public or more inconveniently, the electorate, clamor for action from policymakers to counter any economic pain. Any ‘Austrian School’-type suggestion that it is best to let the cycle play out is derided as heartless and defeatist. Something can and must always be done. Whether intervention makes things worse in the medium to long run is an inconvenience that can be ignored until later. We feel Edwards pain as he "sheds tears of despair as [he] was reminded of the blundering incompetence of our overconfident policymakers, whose interventions, despite their best intentions, seem to bring about financial crises with increasing rather than decreasing regularity."
GLOBAL PUBIC POLICY
STATISM - It Takes A Compliant Society
Mail & Guardian - "Without saying so explicitly,
the government claims the authority to kill American terrorism suspects in secret."
Seldom do moral questions come into the discussions of eliminating enemies of the state.
The military has transformed warfare into a deadly computer game with drone weapons. Media programs like Weaponology or Future Weapons on the Military Channel provide detailed examples of the lethalness of autonomous technology. The use of drones as the preferred method of carnage is well established. Seldom do moral questions come into the discussions of eliminating enemies of the state. The rules of engagement vested in international law and the Geneva Convention, either ignored or rewritten for high-tech 21st Century combat, becomes the foundational tactic to maintain the killing force of the grand empire.
The video, Remote Control War, is an informative summary of the capabilities and uses of a drone air force. After viewing the range of aftermaths from GPS targeting, ponder the role of perpetual DARPA conflict. The distress from invented terrorism is used against the American public as a tool to incrementally relinquish basic rights and individual liberties. Matt K. Lewis offers up this assessment in an item published by This Week, Obama, drones, and the blissful ignorance of Americans.
"And here's the ugly truth: Obama is giving us what we want . . .
Americans, it turns out, don't really have the stomach for the unseemly business of taking prisoners, extracting information from prisoners, and then (maybe) going through the emotional, time consuming, and costly business of a trial.
American citizens want someone who will make the big, bad world disappear. Problems only exist if we have to confront them. Obama has made warfare more convenient for us — and less emotionally taxing."
Beware of the unseen predators over foreign lands for the blowback is the real source of the instability and a root cause of hatred for American hegemony. What you are witnessing is the imbalance between Legislature and the Presidency. The war powers responsibility of Congress, long surrendered to the imperial commander and chief of killing incorporated is a national tragedy.
"Since at least the 9/11 attacks, Congress has been less than confrontational with the White House over presidential powers to conduct war and anti-terrorism operations, to the dismay of civil libertarians. So we had President George W. Bush's warrantless domestic wiretaps retroactively green-lighted by Congress, torture only officially nixed by a change in presidents, and a big ramping-up of lethal drones being used to kill terrorism suspects under President Obama. But Obama's decision to kill at least two Americans working for al Qaeda in Yemen in 2011, and the legal justification that emerged in a leaked white paper (read below) this week, has caused a big, unusual outcry from both the Left and Right."
"This week, NBC News obtained an unclassified, shorter "white paper" that detailed some of the legal analysis about killing a citizen and was apparently derived from the classified Awlaki memorandum. The paper said the United States could target a citizen if he was a senior operational leader of Al Qaeda involved in plots against the country and if his capture was not feasible."
One might be accused of NYT bashing if you dare point out that their reporting resembles a briefing session from White House press secretary, Jay Carney. The use of warbots on home soil is a short step from spreading terminal sanctions of homeland security.
"Both the progressive American Civil Liberties Union and the libertarian Rutherford Institute cheer legislative efforts to place strict limits on unmanned aerial vehicles, or UAVs. And, prodded by privacy groups, state lawmakers nationwide-Republicans and Democrats alike-have launched an all-out offensive against the unmanned aerial vehicles.
The prospect of cheap, small, portable flying video surveillance machines threatens to eradicate existing practical limits on aerial monitoring and allow for pervasive surveillance, police fishing expeditions and abusive use of these tools in way that could eliminate the privacy Americans have traditionally enjoyed in their movements and activities," the bill's author, Sen. Robyn Driscoll, a Democrat from Billings, testified."
The ACLU presents a list of provisions that the Civil Liberties organization advocates. AlsoRead the ACLU's full report on domestic drones. "Congress has ordered the Federal Aviation Administration to change airspace rules to make it much easier for police nationwide to use domestic drones, but the law does not include badly needed privacy protections. The ACLU recommends the following safeguards:
USAGE LIMITS: Drones should be deployed by law enforcement only with a warrant, in an emergency, or when there are specific and articulable grounds to believe that the drone will collect evidence relating to a specific criminal act.
DATA RETENTION: Images should be retained only when there is reasonable suspicion that they contain evidence of a crime or are relevant to an ongoing investigation or trial.
POLICY: Usage policy on domestic drones should be decided by the public's representatives, not by police departments, and the policies should be clear, written, and open to the public.
ABUSE PREVENTION & ACCOUNTABILITY: Use of domestic drones should be subject to open audits and proper oversight to prevent misuse.
WEAPONS: Domestic drones should not be equipped with lethal or non-lethal weapons."
"In a 3-2 vote, members of the Charlottesville City Council adopted a resolution drafted by The Rutherford Institute which urges the Virginia General Assembly to prevent police agencies from utilizing drones outfitted with anti-personnel devices such as tasers and tear gas and prohibit the government from using data recorded via police spy drones in criminal prosecutions. In so doing, Charlottesville has become the first city in the country to limit the use of police spy drones, providing momentum and inspiration for other cities across the country to follow suit.
The passage of the resolution, which also places a two-year moratorium on the use of drones within city limits, coincides with a Department of Justice memo leaked to the media which outlines the Obama administration's rationale for assassinating U.S. citizens via drone strike. With at least 30,000 drones expected to occupy U.S. airspace by 2020, John W. Whitehead, president of The Rutherford Institute, has called on government officials at the local, state, and federal level to do their part to safeguard Americans against the use of drones by police. Rutherford Institute attorneys have drafted and made available to the public language that can be adopted at all levels of government in order to address concerns being raised about the threats posed by drones to citizens' privacy."
When was the last time that a civil liberty issue developed an alliance of purpose to oppose the despotism of the totalitarian murder regime?
Even so, some of the more perceptive state legislatures are waking up to the danger of domestic drone operations. Texas "Anti Drone" Laws Would be Toughest in USA, and "prohibit federal law enforcement or federal officials from flying drones over Texas to spy on random citizens. Only individuals who are suspected with reasonable cause could be the target of drone surveillance, and only with a warrant issued by a judge of an open and public court."
Politico details, "Virginia Gov. Bob McDonnell has not decided whether he will sign a bill barring state and local agencies from using drones for two years — the first legislation of its kind in the country that passed through the state’s General Assembly Tuesday with bipartisan support."
The National Defense Authorization Act is the latest unconstitutional measure that targets domestic citizens for punitive punishment. Due process, now reduced to "Due or Die" is the harbinger of the use of domestic drone capitulation. What will it take to awaken submissive citizens that the capability of foreign deployed drones easily can be weaponized for local operations?
The Obama administration has demonstrated an eagerness to trump up a bogus domestic terrorist threat that requires a surrender of our Bill of Rights. Reaper drones are a much greater peril than just a violation of privacy. A technology that is rapidly expanding and designed to militarize the police state into a killing field of reputed rebellious Americans - violates true national security.
"Making warfare more convenient and less emotionally taxing" is the direct opposite of the horror of battle. When a false flag surgical strike targets your location and your person, it will not be an episode in a computer simulation.
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - Feb. 10th - Feb. 16th, 2013
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