The Stocks-Bonds Interplay

By Steve Saville

It’s normal for the stock market to ignore a rising interest-rate trend for a long time. The reason is that while the interest rate is a major determinant of the value of most corporations, the interest rate that matters for equity valuation isn’t the current one. What matters is the level of interest rates for a great many years to come. Therefore, a rise in interest rates only affects the stock market to the extent that it affects the general perception of where interest rates will be over the next decade or longer.

To further explain, the value of a company is the sum of the present values of all its future cash flows, with the present value of each future cash flow determined via the application of a discount rate (interest rate). Nobody knows what these cash flows will be or what the appropriate discount rate should be, but guesses, also known as forecasts, are made. Clearly, when discounting a set of cash flows spanning, say, the next 30 years, it won’t make sense to simply use the current interest rate. Instead, the analyst doing the calculation will have to make a stab at what will happen to interest rates in the future.

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Bond Bull Bull

By Jeffrey Snider

On February 12, 1999, the Bank of Japan announced that it was going full zero. Japan’s central bank would from that day forward push the overnight uncollateralized lending (interbank) rate to the zero lower bound. Further, it pledged to keep it there until Japan’s economy recovered.

The economic slump in the nineties had been by 1999 almost a decade in length. As the Japanese economy ground to a halt, unmovable and completely resistant to being restarted by any of the orthodox techniques tried up to that point, there came to be an institutional bid for government paper. It was the perfect illustration of Milton Friedman’s interest rate fallacy – low interest rates signal tight money in the real economy. The bid was pure liquidity risk, having nothing to do with the “fundamentals” of bonds.

ZIRP was intended to try and change that condition. The mere rumors about it all the way back in 1998 had kicked off a BOND ROUT!!! From September 1998 through February 1999, it seemed as if the so-called bond bull market had finally been broken. Central bankers would ride to the economy’s rescue with non-standard “accommodation.”

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Bond Market Losing Confidence In Federal Reserve

By Anthony B. Sanders

S&P Valuation Near “Cheapest” Since 2016 (Inflation Expectations Cooling)

(Bloomberg) — The bond market is losing confidence in the Federal Reserve’s policy tightening projections after a punishing stretch for U.S. stocks.

Traders pared wagers on 2019 rate hikes last week as disappointing corporate earnings helped drag the S&P 500 Index down 10 percent from its record high at one point Friday. Markets are now factoring in fewer than two quarter-point hikes for next year, compared with the three increases that policy makers project. Tanking inflation expectations suggest some investors already deem Fed policy too restrictive.

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Meanwhile, back on the equity farm, S&P500 valuation is near the “cheapest” since 2016.

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Economic Bears Throw in the Towel

By Kevin Muir

Don’t you love it how, now – after the biggest sell-off in fixed income in decades – suddenly everyone is bearish?

Long-time readers will know how I am a Kodiak Brown when it comes to fixed-income, but even I can’t bring myself to sell into this hole. I mean, c’mon – do you really think that waiting for your guru to announce on CNBC that two closes above 3.25% for the 30-year bond constitutes a trading strategy?

The always insightful Trevor Noren from 13D Global Research recently tweeted a chart from the WSJ’s Daily Shot that demonstrated the true extent of the bond market’s oversold nature:

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Extremes in Bond Market Sentiment

By Callum Thomas

3 Quickfire charts on US bond market sentiment… some of these sentiment charts are clearly at an extreme – and that’s usually when you go looking for contrarian signals.  But then I look at a lot of charts on the bond market and it’s quite easy to make a case for a major trend change.

1. Speculative futures positioning:  The standout here is speculative futures positioning in the 30 year… gone from around neutral to extreme short.  Total capitulation.

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The “Big Bond Short” Illusion

By Kevin Muir

Before we even start, I want to point out I deserve zero credit for this next idea. All of the following insightful observations are brought to you by Adam Collins of Movement Capital. Adam’s work on COT data is second-to-none and he is a must-follow.

Over the past few months I have struggled with a glaring inconsistency.

The CFTC’s Committment of Trader’s (COT) data for the 10-year US treasury note has displayed a large increase in the size of the net speculative short position, yet this is at odds with what I observed in terms of market sentiment amongst traders and portfolio managers.

This increase in speculative net shorts has pushed it to a record position.

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Bond Market Volatility

By Callum Thomas

Following on from yesterday’s post on Cross Asset Volatility, the chart of today is a focus on bond volatility.  Specifically what we’ve got here is a look at the rolling annual sum of daily changes in the US 10 year treasury bond yield which exceeded varying hurdles (the smallest hurdle being 5 basis points).  What the chart shows is a collapse in bond volatility.  What’s interesting about this is that the smallest hurdle indicator is starting to turn up, and typically when these types of indicators turn up from such low levels it can mark a major turning point.  The issue is that a rise in volatility can come in a falling yield environment as well as a rising yield environment.

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Extreme Positioning in Stocks vs. Bonds

By Callum Thomas

As I was updating my various charts and models, something weird caught my eye.  This peculiar chart shows speculative futures positioning in equities (aggregated across all US index futures) and bonds (US 10 year treasury futures)… and most notably, the spread between them.  With bond traders the most crowded short in recent history, the spread between bonds vs equities positioning is at an extreme.

So what?  Let’s break it down: if traders are short bonds they expect yields to rise (which usually happens as a result of higher growth and inflation outcomes), and if traders are long equities they expect stocks to go up (which similarly hangs on a supportive growth backdrop).  So basically what we’ve got here is traders doubling down on a view that growth and inflation heats up even further from here.  They may be right.  But if they’re wrong, there will be a lot of scrambling to cover positions (aka the long awaited return of market volatility).  So if you’re looking for latent pressure building up in the markets, you’ve found it in this chart.

 

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Midsummer Walkabout

By Tim Knight

I actually like it when we get past June 20. Knowing that each day has less sun is like a gift to me. I can’t say why. It just feels like a sense of relief.

Let’s look at some ETFs together. It would make a better narrative for me to order these differently, but I’m going to be lazy and leave them alphabetical.

First is commodities, which I think will roll over beneath the red horizontal I’ve drawn. Crude oil, in particular, I believe will drag this lower.

The diamonds remain in a long-term and intermediate-term uptrend. Short-term, it’s starting to gently turn lower, but as you can see from the moving averages, it’s going to take a LOT of damage to break this bull run.

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Inversion Alert! Treasury Slope Plummeting Towards 0 BPS

By Anthony B. Sanders

Corporate Debt To GDP May Be At Credit Cycle High

One of the effects of The Federal Reserve’s zero interest policy (ZIRP) was the massive expansion of both consumer and corporate debt. The US may be at a credit cycle peak (Corporate Debt-to-GDP).

corporate debt to gdp 2

Which brings me to the UST 10Y-2Y slope, plummeting towards inversion (now at 24.5 BPS). The last time we saw the 10Y-2Y slope so flat was in early August 2007, 4 months before The Great Recession began.

Continue reading Inversion Alert! Treasury Slope Plummeting Towards 0 BPS

The Next 7 Years

By Charlie Bilello

What returns are you expecting from stocks and bonds over the next 7 years?

This is a question that GMO (one of the largest and most respected asset managers) attempts to answer on a quarterly basis.

Their most recent forecast was downright depressing: -2.2% per year from large cap U.S. stocks and +1.9% per year from U.S. bonds. If correct, it would mean a 60/40 portfolio of U.S. stocks and bonds would generate a return of -0.6% per year over the next 7 years.

By comparison, GMO is expecting +3% per year from cash, implying that there is little to be gained today from taking risk.

Source: GMO.com. Note: Nominal Total Return derived from GMO’s real return and adding their inflation assumption of 2.2% per year.

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The Current Message From the Most Useful Sentiment Indicator

By Steve Saville

As I’ve noted in the past, the Commitments of Traders (COT) information is nothing other than a sentiment indicator. Moreover, for some markets, including gold, silver, copper, the major currencies and Treasury bonds, the COT reports are by far the best indicators of sentiment. This is because they reflect how the broad category known as speculators is betting. Sentiment surveys, on the other hand, focus on a relatively small sample and are, by definition, based on what people say rather than what they are doing. That’s why for some markets, including the ones mentioned above, I put far more emphasis on the COT data than on sentiment surveys.

In this post I’ll summarise the COT situations for five markets with the help of charts from “Gold Charts ‘R’ Us“. I’ll be focusing on the net positioning of speculators in the futures markets, although useful information can also be gleaned from gross positioning and open interest.

Note that what I refer to as the total speculative net position takes into account the net positions of large speculators (non-commercials) and small traders (the ‘non-reportables’) and is the inverse of the commercial net position. The blue bars in the middle sections of the charts that follow indicate the commercial net position, so the inverse of each of these bars is considered to be the total speculative net position.

I’ll start with gold.

Continue reading The Current Message From the Most Useful Sentiment Indicator