Da Basics

By Tim Knight

We’re four days into the trading week. For me, Monday was a “2”, Tuesday was a “3”, Wednesday was a “6”, and Thursday was a “7”. So……….progress. A week that started off vomit-inducing is getting better. I’d appreciate Friday being a 10, thank you very much.

The charts don’t necessarily point to that, however. The ES only needs to slip above that red line to give the already power-mad bulls another shot of elixir to create another phalanx of lifetime highs.

0427-es

Even more fearful is the NASDAQ, whose NQ is shown below. AMZN and GOOGL are absolutely blowing the doors off in after-hours tonight. Interestingly, fellow tech giants MSFT and INTC are stinking up the place. As I mentioned in my tweet, it seems the newer web-based tech is practically printing money, whereas the kingpins of the 1980s and 1990s are lagging.

0427-nq

For me, just about the most important chart remains the USD/JPY. If the triangle pattern below does what it’s supposed to do, the dollar will tumble away, dragging equities down with it.

0427-yen

For myself, I am mildly-aggressively positioned on the short side, with 43 positions in all. I was crazy-short last Friday, which caused my balls to get kicked it Monday morning, so I’m still nursing my wounds.

Incidentally, I’m getting more and more inquiries about ProphetCharts lately. I’ll have some very important news on this front in the near future. Indeed, I have a lot to say. All will be revealed.

High-Yield Bond A-D Line

By Tom McClellan

High-Yield Bond A-D Line
April 27, 2017

Junk bonds are the canaries in the stock market’s coal mine.

If you want to know ahead of time that trouble is coming for the stock market, then one of the best places to look is the high-yield (or junk) bond market.  The movements of prices among these bonds correlates much more closely to the stock market than to T-Bonds.  More importantly, when liquidity gets tight, the junk bonds are the first to be sold by traders wanting to lessen their portfolio risk.

We can see the importance of this message in this week’s chart, which features A-D data from FINRA TRACE.  For those who like the full spelling of acronyms, that means “Financial INdustry Regulatory Authority Trade Reporting and Compliance Engine”.  FINRA tracks the price changes on a total of 7876 individual bonds, and breaks down the Advance-Decline statistics into categories of Investment Grade, High Yield, and Convertible bonds.  The chart above features the A-D data for the High Yield bonds.

This A-D Line arguably does a better job than the composite NYSE A-D Line at doing what we want an A-D Line to do, which is to show us divergences at important times.  That is the whole reason behind ever looking at breadth data of any type.  We want it to give us an answer which is different from what prices are saying, but only at the right moments.

A lot of analysts mistakenly assert that if one is interested in the stock market, then one should only look at A-D data from the stock market.  And to take that point further, they assert that one should filter out all of the contaminants such as preferred stocks, rights, warrants, bond closed end funds, and other detritus which together are making the stock market less pure.  I debunked that point in a March 24, 2017 article.

Just recently, the overall NYSE A-D Line moved to a new all-time high, saying that liquidity is plentiful and it should lift the overall stock market.  The same message comes from this High Yield Bond A-D Line, which has also pushed ahead to a new all-time high.  The message is that liquidity is so plentiful that even junk bonds can go higher.  And history shows that such plentiful liquidity is also beneficial for the overall stock market.

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Related Charts

Sep 14, 2016

McClellan Oscillator for High Yield Bond A-D Data
Mar 24, 2017

Why Don’t We Use Just Common-Only A-D Numbers?
Dec 01, 2016

McClellan Oscillator for Corporate Bonds

Chart In Focus Archive

This is What Behavioral Finance is All About

By Jared Dillian

I live for this.

Check out this poll I ran on Twitter:

Le Pen is about a 10-to-1 dog. But that doesn’t necessarily mean that thinking she is going to win is contrarian.

Chaser:

So the markets are pricing in a 10% (or less) chance of a Le Pen win, and yet everyone thinks she is going to win.

How the hell do you explain that?

Recency Bias

Late in the third quarter of the Super Bowl, the New England Patriots had an infinitesimal chance of winning. 99-to-1 against, at least. Would you have taken that bet? Probably not.

I think if you ran that simulation again the next day, people would have taken 4-to-1 odds on the Patriots winning.

This is what we call recency bias. Short-term memories are more powerful than long-term memories, so we tend to extrapolate what just happened out into the future.  In financial terms, if a crash just happened, people will then think that crashes happen all the time, and bid up the price of crash protection.

In terms of the French Election—right-wing populists rode to surprise victories with Brexit and Trump, so everyone thinks right-wing populists are going to ride to victory again, ignoring what seems to be overwhelming odds against that happening.

Continue reading This is What Behavioral Finance is All About

Europe Will Climb That Same Wall of Worry

By Kevin Muir of The Macro Tourist

https://i2.wp.com/themacrotourist.com/images/2017/04/PorscheApr2617.png?resize=424%2C488

Although sentiment towards European equities has improved since I wrote about it last Fall (Pretty sure I am alone in this trade), this opportunity is not something that will be quickly arbitraged away. Not only that, but deep down, investors are still skeptical about the long term prospects for European equities. Sure, they are willing to surf European equities for a wave or two, but ask them where they are willing to invest for the long haul, and Europe is rarely in the running as a top pick.

I understand their pessimism. Europe has a lot of problems. Poor demographics, an unstable political union, layers of bureaucracy, the list goes on and on. It’s tough to imagine Europe being a great place to park your money.

Yet too many investors mistakenly believe good old fashioned fundamentals still drive financial asset markets. Nothing could be further from the truth. Since the 2008 credit crisis, Central Bank flows have made a mockery of financial pricing theory.

How do you determine the fair value of assets, when the risk free rate which most other assets are priced off, is negative?

https://i1.wp.com/themacrotourist.com/images/2017/04/FedModelApr2617.jpg?resize=600%2C220

Try putting negative yields (or even just tiny yields) into the Fed equation model and figure out the price for a stock index.

The current situation in Europe is remarkably similar to the U.S. period of 2010 to 2014. At that time, most investors were extremely negative about America’s prospects. Many investors called it a “sugar high” induced by the Fed’s continual balance sheet expansion. There were all sorts of forecasts of doom. Yet stocks kept climbing… and climbing.

https://i2.wp.com/themacrotourist.com/images/2017/04/SPXApr2717.png?resize=660%2C405

The same thing will most likely happen in Europe. The ECB is aggressively expanding their balance sheet, and they have even pushed short term rates to absurdly negative levels. Their monetary policy is just bat shit crazy.

Continue reading Europe Will Climb That Same Wall of Worry

More Small Things

By Jeffrey Snider of Alhambra

On April 23, 2015, the US Treasury auctioned off $18 billion in inflation-indexed bonds maturing in April 2020. These 5-year TIPS stopped out at the lowest yield for that particular security class in almost a year before then. Coming as it did during the spring of 2015, it was met with the usual textbook applied commentary, where bond investors were supposedly pricing Janet Yellen’s “transitory” scenario. The oil and commodity crash of late 2014 was by convention nothing more than an aberration, and the auction results appeared to confirm as much.

The sharp bidding for inflation protection particularly without a similar move in the 5-year UST security (not TIPS) meant that inflation breakevens, a measure of market inflation expectations, jumped 10 bps after the auction. At 170 bps, the 5-year breakeven was about 65 bps off the low and at that moment more than half retracing the considerable pessimism that had been provoked by during the (initial) oil crash. Positivity was dominant again.

“The market likes TIPS,” said Edward Acton, a U.S. government-bond strategist in Stamford, Connecticut, for Royal Bank of Scotland’s RBS Securities unit, one of 22 primary dealers obligated to bid at U.S. auctions. “This disinflationary pressure has eased off, and we’re just waiting to see how strong and how quickly inflation pressures can surprise to the upside.”

That, of course, never happened. Inflation instead sunk much lower as did the global economy. Was it merely confirmation bias, that “everyone” simple saw what they wanted? The thing about auctions is that pricing is never strictly about fundamentals, in the case of TIPS meaning inflation expectations. Demand for TIPS (or any) OTR paper may be robust for reasons that have nothing to do with inflation or credit.

Almost exactly one year before, on April 17, 2014, the Treasury had auctioned, as it typically does, the previous year’s 5-year TIPS. The demand for that security (912828C99) was even further off the charts. The yield on the day before, admittedly in late stage OFR status, was -6 bps. The market was anticipating heavy demand, but the settled yield after the auction was -21.3 bps. That drop in TIPS yield coupled with a selloff in the 5-year UST left inflation breakevens for the 5-year maturity spiking higher by more than 22 bps in a single day.

The commentary produced that day was almost exactly the same as it would be one year after.

“The stats were off the charts,” said Stanley Sun, a New York-based strategist at Nomura Holdings Inc., a primary dealer, said in a telephone interview…
“Break-evens had been very depressed ever since the March FOMC meeting,” Sun said. “Given how beat up they were, with consumer price index surprising to the upside this week, and after the strong auction investors are starting to catch up to the fundamentals.”

And once again, convention got it all wrong. Fundamentals were weakening and it was the bond market that showed as much (long, long before economists would realize it). What was going on in TIPS? I wrote a week after that particular auction coming from the opposite perspective:

That is what makes the move in 5-year TIPS so very eccentric; the typical move in inflation breakevens coincident to such tightening bias is in the opposite direction. Normally I wouldn’t even comment on such a brief change over only several days as this all may turn out to be absolutely nothing, but since the 5-year is the most active place right now, and TIPS aren’t the most vibrant and noteworthy pieces of credit, it seems worth watching.

What was truly unusual about that auction was who it was that did all the buying. The largest proportion was awarded to Indirect Bidders, a class of auction participants noteworthy for including foreign central banks (and other private banks acting on their behalf), far more than at any other auction for 5-year TIPS (to that point). They took nearly 60% of the allotment, compared to an average of 40% over the prior 10 years.

There was, however, no spill over into other areas of inflation trading and expectations. The 10-year TIPS and 10-year breakevens moved a little on April 17, 2014, but remained steadfast in the sideways action that had developed going all the way back to July 2013. That was an important clue, for a rise in the 5-year breakeven without one in the 10-year meant, fundamentally, the market was actually pricing increasing risk.

Continue reading More Small Things

The ECB is Getting Really Good at Leaking Shit to Reuters

By Heisenberg

As we learned in March, the ECB is getting pretty adept at leaking market-moving information about possible policy turns to Reuters.

You’ll recall that late last month, Reuters reported – citing unnamed sources – the following:

  • ECB policy makers wary of changing their message before June, Reuters reports citing unnamed officials.
  • One ECB person said to say message of March 9 press conference was over-interpreted

So that was really convenient because, when combined with Fed messaging designed to walk back the dovish nature of the March hike, it created a return to the policy divergence theme that had underpinned the dollar prior to March 15.

On Tuesday, Reuters is back, this time with 3 unnamed sources delivering this message:

European Central Bank policymakers are breathing a sigh of relief after the first round of France’s presidential vote put a pro-euro centrist in pole position, but they are not likely to change their policy stance until June.

Three sources on and close to the bank’s Governing Council told Reuters that with the threat of a run-off between two eurosceptic candidates in France averted, and with the economy on its best run in years, many ratesetters see scope for sending a small signal in June towards reducing monetary stimulus.

There is, however, little appetite to change at this Thursday’s meeting the pledge to buy bonds at least until the end of the year and to keep rates at rock bottom until well after that.

A move in June, however, might mean changing the wording of the ECB’s opening statement to reflect improved prospects for the economy.

Some or all the references to prevailing downside risks to the outlook, to the possibility of further rate cuts or to larger asset purchases may be taken out, the sources said.

“The discussion will be on removing some of the easing biases,” one of the sources said. “I can’t say how quickly it will happen because that depends on the data.”

You can probably guess what happened next. Here’s Bloomberg:

  • EUR/USD rose to a fresh high at 1.0925 while gaining to a one-month high versus the yen as model-driven demand for the cross continues to push through markets ahead of Thursday’s ECB meeting.
  • EUR gains accelerated after a Reuters report that French election result may prompt a change in the ECB’s language in June
  • Market continues to speculate on whether ECB will use more upbeat language to describe the economic outlook; to be sure, Draghi on Friday reiterated that the inflation pick-up remains unconvincing and risks for euro-area growth “remain tilted to the downside”
    • At same time, EUR and JPY continue to see unwind of haven trades set before French vote, muddying the FX picture
    • EUR filled offers at 1.0900/05, faces further supply around the Monday high at 1.0937, traders said

EURUSD2

EURUSD

This is particularly amusing because now, instead of anonymous Reuters leakers trying to walk back a perceived hawkish message, you’ve got unnamed Reuters leakers apparently attempting to telegraph a hawkish shift in June. Last month, policy meeting preceded Reuters leak. This month, Reuters leak precedes policy meeting. All kinds of fucked up forward and backward (mis)guidance.

Continue reading The ECB is Getting Really Good at Leaking Shit to Reuters

Volatility Crash

By Tim Knight

Everywhere you look – – green, green, green, lifetime highs, soaring charts, with one notable exception. Volatility, of course! The fear index $VIX has, in just 1.5 years, collapsed from 53.29 to almost the single digits. Indeed, there is only ONE time in the past decade it’s been even a little bit lower, and that was back on January 27th. This is about as low as it goes, folks.

0425-vix

Long-Term Price Targets Are Meaningless

By Steve Saville

Many commentators like to speculate on where the dollar-denominated gold price is ultimately headed. Some claim that it is destined to reach $3,000/oz, others claim that it won’t top until it hits at least $5,000/oz, and some even forecast an eventual rise to as high as $50,000/oz. All of these forecasts are meaningless.

Long-term dollar-denominated price targets are meaningless because a) they fail to account for — and cannot possibly account for, since it is unknowable — the future change in the dollar’s purchasing power, and b) the only reason a rational person invests is to preserve or increase purchasing power. To further explain by way of a hypothetical example, assume that five years from now a US dollar buys only 20% of the everyday goods and services that it buys today. In this case, the US$ gold price will have to be around $6,500/oz just to maintain its current value in purchasing power terms. To put it another way, in my example a person who buys gold at around $1300/oz today and holds it will suffer a loss, in real terms (the only terms that matter), unless the gold price is above $6,000/oz in April-2022. Considering a non-hypothetical example to make the same point, in 2007-2009 a resident of Zimbabwe who owned a small amount of gold and not much else would have become a trillionaire in Zimbabwe dollars and would also have remained poor.

The purchasing power issue is why the only long-term forecasts of gold’s value that I ever make are expressed in non-monetary terms. For example, throughout the first decade of this century I maintained that gold’s long-term bull market would continue until the Dow/gold ratio had fallen to at least 5 and would potentially continue until Dow/gold fell to 1.

The 2011 low of 5.7 in the Dow/gold ratio wasn’t far from the top of my expected bottoming range, although I doubt that the long-term downward trend is over. In any case, none of the buying/selling I do this year will be based on the realistic possibility that the Dow/gold ratio will eventually drop to 1. Such long-term forecasts are of academic interest only, or at least they should be.

If I were forced to state a very long-term target for the US$ gold price, it would be infinity. The US$ will eventually become worthless, at which point gold will have infinite value in US$ terms. But then, so will everything else that people want to own.

Mind the “Le Spread” Eurphoria

By Heisenberg

Earlier today we noted the “big league” compression in the all-important OAT-bund spread, the market’s preferred gauge of French political risk and thus, a go-to measure of EMU breakup risk.

Here’s the 10Y spread:

OatBund

And the 2Y spread:

France

Finally, here’s Bloomberg’s technical analyst Sejul Gokal on why this matters:

OAT Futures and ‘Le Spread’ Euphoria May Risk Fading at 200-DMA

Notable moves in OAT market have sent futures and France-Germany 10-year yield spread near key equilibrium levels that may drive tactical reversal in post-French vote reaction, Bloomberg technical analyst Sejul Gokal writes.

  • OAT1 topside gap and high at 149.90 close to the YTD high and 200-DMA at 150.08-12; levels could still come into play in a last gasp move before potential accumulation of overbought reversal sessions
    • 9-day RSI tests multi-mo. highs at ~81
  • OAT-Bund spread narrowed to 48bps vs. 64bps Fri. close
    • 200-DMA at 45bps could limit further spread compression as oversold conditions warrant corrective unwind
  • As a risk factor, watch out for any consecutive daily breaks of the longer-term average line which should indicate strong behavioral change in OATs; such development should override current overbought market warnings

To Frexit or Not to Frexit?

By Keith Weiner of Monetary Metals

This was also a holiday-shortened week.

As we write this, the big news comes from the election in France. The leading candidate is a banker named Emmanuel Macron, with about 24% of the vote in a 4-candidate race. The anti-euro Marine Le Pen came in second with just over 21%. From the sharp rally in the euro, which was up about 2% at one point, we assume that observers believe the odds of France leaving the euro have just gone down.

Of course, France (and the other European countries) faces a false alternative (well they ought to consider Keith’s gold bonds proposal, but that is not on the table). Staying with the euro means ongoing wealth destruction, and a downward slope that leads to nowhere good. However, that raises the question. What would happen if they were to try to leave?

We believe that no matter which theory prevails, and what measures are taken by les dirigistes (central planners), all roads lead to an accelerated default of trillions in bad credit. To understand why, consider the balance sheets of the banks and other financial intermediaries in France.

Suppose the new French franc goes down relative to the euro (we won’t address here whether it is likely to go up or down). This means that any French entity who had borrowed from a bank in Germany or Italy or Spain now sees its liabilities spike up relative to its assets which are now redenominated in francs. It would not take that much leverage or a very large decline in the franc to cause some major bankruptcies. The initial round of bankruptcies could cascade causing yet other bankruptcies in a highly interconnected financial system.

On the other hand, suppose the franc rises. Then the French banks get hit the other way. Their euro-denominated assets outside France are going down, but their domestic liabilities to depositors and bondholders are firm.

A regime of floating currencies sounds good in Milton Friedman’s argument about being an easy way to adjust wages downwards which are otherwise sticky. However, an actual currency revaluation means a wealth transfer from parties A, B, and C to parties X, Y, and Z. That may seem to be good for the latter, until you realize that they are creditors of the former. And the former were already leveraged, and already surviving on thin margins compressed after decades of falling interest rates. There is scant capital to absorb such a shock.

Then there is the question of who will buy French government or corporate bonds? No matter how you slice it, inserting a new currency into a block that currently has one adds friction, which means trade and production will further slow. The market will shrink (and this could in itself push some marginal corporations under).

And there are other serious problems. One is the intra-euro balances. Will these be redenominated? Another is the political response by the European Central Bank and the members of the European Union. What will they do? Will they try to shut off funds flowing to and from France? It would be naïve to assume there will be no response, and France will get away with it consequences-free.

The euro patient may have cancer, and the cancer may be terminal. But that does not mean blowing up the patient with dynamite is going to help.

Of course, traders want to know how this will affect gold and silver. As we write this, we see that silver went down 30 cents before rallying back up to where it closed on Friday. Gold went down about $20, and then half way back up.

At this point, we are not sure if the metals are supposed to go up because more printing. Or go down because the euro constrains France from printing. Or silver at least should go up because the economy is going to be better with France remaining in the Eurozone. Or go down because the ongoing malaise will only progress as it has been. Or some other logic… and the price gyrations this evening show that traders don’t agree either.

Continue reading To Frexit or Not to Frexit?