Stocks slide as bond yields jump

Friday 14:00 BST. US and European equities are under pressure as disappointment over the European Central Bank’s decision to stand pat on monetary policy and uncertainty over the Federal Reserve’s interest rate trajectory force up borrowing costs.

Risk appetite also is being damped by news North Korea conducted a nuclear test, though meagre demand for traditional haven assets — such as gold and the yen — suggests these jitters are contained.

The yields on 10-year US and German government bonds, which move inversely to bond prices, are climbing to multi-week highs, up 3 basis points to 1.65 per cent and adding 5bp to minus 0.01 per cent, respectively.

Benchmark Bund yields hit a record low of minus 0.20 per cent in July, but have risen sharply in the last few sessions in the wake of the ECB’s decision on Thursday not to beef up its €80bn-a-month asset purchase stimulus programme, or QE.

Equivalent maturity Italian and Spanish paper, where yields have been greatly suppressed by ECB buying, are jumping 6bp to 1.21 per cent and up 6bp to 1.04 per cent respectively.

Ian Williams, economist at Peel Hunt, said investors appear “rather underwhelmed by the ECB announcement, both the absence of further policy action and the lack of guidance offered by Mr Draghi at his press conference about what may come next”.

Fixed income analysts at Citi said the ECB had introduced volatility by failing to even discuss QE. “The decision not to extend the timetable of QE from Mar-17 weakens forward guidance and is bearish.”

The rise in benchmark Treasury’s takes them 33bp above the record trough touched in July, and comes after Eric Rosengren, the head of the Boston Federal Reserve, and a voting member of the Fed’s policy-setting board warned that the US economy could overheat if rates were kept too low.

The comments add to a sense among investors that despite the market pricing in a just a 36 per cent chance the Fed will raise rates in less than two weeks time, the central bank seems more minded to make a move.

Jeffrey Gundlach, chief executive officer at DoubleLine Capital and a closely watched fixed income commentator, said on Thursday that the Fed appeared determined to show they are independent from the market and may confound investors by hiking borrowing costs on September 21.

Equity markets have been underpinned in recent years by the meagre alternative income on offer from bonds, and so the sight of implied interest rates moving higher is rattling investors.

Futures suggest the S&P 500 on Wall Street will slip 14 points to 2,167 as the pan-European Stoxx 600 falls 0.7 per cent, not helped by data showing a sharp slide in German exports during July. Losses are only held in check by banking stocks welcoming the sight of interest rates moving up, because it may improve their lending margins.

London’s FTSE 100 is off 0.8 per cent with energy stocks struggling for momentum as oil prices dip. Brent crude, the international benchmark which jumped 4.2 per cent in the previous session on news US oil inventories fell more than expected, is off 2.3 per cent to $48.82 a barrel.

Such dollar-denominated commodities are also being pressured by greenback strength. The dollar index is up 0.2 per cent to 95.20 as the euro gives up a slice of its post-ECB gains, easing 0.2 per cent to $1.1231.

US benchmark yields had been lower earlier in the global session as traders sought traditional safety plays at a time of geopolitical stress.

South Korea’s Kospi equity index fell 1.3 per cent after Pyongyang confirmed it had conducted a nuclear test, sparking worldwide condemnation and rattling sentiment across the Asia-Pacific region, where the mood had already been soured by the ECB’s inaction.

Australia’s S&P/ASX 200 shed 0.9 per cent and Japan’s Nikkei 225 was flat, the latter also pressured by the yen strengthening — though the unit subsequently has reversed to trade 0.4 per cent weaker at ¥102.93 per dollar.

China’s Shanghai Composite eased 0.55 per cent on Friday as data showed the country’s producer prices contracted in August by the smallest rate since 2012, while consumer price inflation softened a touch.

“While some will likely argue that the fall in headline CPI increases the likelihood of further monetary easing by the People’s Bank, we doubt it will make a great deal of difference,” said Julian Evans-Pritchard at Capital Economics. “It is concern over credit risks, not inflation risks, that is keeping the PBoC on hold.”

Still, some major Asian stock markets were chipper, with Hong Kong the best performer. The Hang Seng was up 0.8 per cent on Friday, securing a 3.6 per cent bounce over the past five days.

The territory’s bourse is enjoying fund inflows from the mainland as Beijing allows Chinese insurers to use the Shanghai-Hong Kong Stock Connect facility, according to Reuters.

Gold is not displaying its tendency to rally at times of geopolitical tension, the bullion easing $3 to $1,335 an ounce as investors are more worried about the “opportunity cost” of holding the precious metal as bond yields move up.

 

 Additional reporting by Peter Wells in Hong Kong

Article and media originally published by Jamie Chisholm at ft.com

 


Why markets have gone insane this year

There is something unprecedented going on with the markets, not with just the yen right now, but with all assets, as discussed by John Thomas, one of the founding fathers of the modern hedge fund industry.

A market where both fundamental research and technical analysis are utterly useless and everything goes the opposite of where it should is no place for me. Despite having negative interest rates and the world’s worst fundamentals, the Japanese yen has been skyrocketing since the beginning of February.

The last time the yen (NYSEARCA:FXY), (NYSEARCA:YCS) moved this sharply was when President Richard Nixon took the US off the gold standard in 1972, and currencies floated for the first time. The yen immediately shot up 10%.

I remember it like it was yesterday. There is something unprecedented going on, not with just the yen right now, but with all assets. So I am getting out of the way. If I don't understand what is happening with a position, I drop it like a hot potato.

This could be occurring because Japan's oil bill has been cut in half over the past year, shaving some $125 billion off its annual imports. That means less dollar buying and yen selling to settle the trade. However, in looking for reasons to explain the madness about us I could be too logical and analytical here.

In my travels around the US two weeks ago, I discovered what might be a more pressing reason to cause all asset classes to go haywire. I heard on the grapevine that there are at least a half-dozen large hedge funds with tens of billions of dollars in assets each that are going out of business.

Poor performance has led investors to demand redemptions en masse. That means unwinding possibly $100 billion worth of positions. And every one of these positions was financed by short sales in the Japanese yen. The only way for them to get out of these positions and raise cash is to buy yen, a lot of them, to close those shorts.

 If this is the case, it would explain a lot of what is going on in the markets this year. The worst performing asset classes of 2016 have been those where hedge funds were major owners. Those would include US banks, short positions in ten-year Treasury bonds (NYSEARCA:TLT), shorts in the Euro (NYSEARCA:FXE), and special situations like Variant Pharmaceutical (NYSE:VRX).

It provides the logic behind the atrocious performance by the big tech FANG stocks in recent weeks. And yes, it gives the backdrop for the enormous overreaction in Apple (NASDAQ:AAPL) shares after the Q1 earnings report.

It gets worse. When markets sniff out that big positions have to be shifted, they suddenly go illiquid. That leads to small amounts of capital triggering exaggerated moves in the underlying prices. That has given us the enormous volatility in all asset classes we have seen this year. Look at oil, stocks, gold, gold miners, silver, and the yen and they are all delivering the most extreme moves in a half century.

This all makes markets impossible to trade. Markets aren't breathing. We are seeing one straight line move after another. Prices aren't trading within defined channels that traders make their living from. Instead, they are going ballistic. In other words, the price action of 2016 can be described as liquidity events.

And this is the good news. All liquidity events burn out. Eventually, the positions get liquidated, the investors get their money back, and markets return to normal. You could blame all this on negative interest rates, which have never occurred before in history. I have never seen the strategist community so clueless before.

You might also ascribe it to the demise of the hedge fund. It seems that whenever industry assets approach $3 trillion in assets, it implodes. The market can accommodate only so much "smart" money. Almost all hedge funds accumulated their stellar track records when they were small. Get above $20 billion and they can only generate slightly better than utility-type returns. Only a select few friends of mine have been able to keep the numbers coming.

 My strategy has always been to break even when it is tough, and coin it when it is easy. This is one of those break-even times.

This is why my performance has been flat-lining just short of an all-time high for months. This too shall pass. When it does, it will be back to racking up double-digit returns, as I have done with this service for the past eight years.

Personally, I have great hopes for the second half of the year, when the presidential election gets out of the way. (Original article at Seeking Alpha with some charts by the author)

Disclosure by author: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.  I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Originally published by John Thomas at Wealth Management through Seeking Alpha.

 


Why Popular Investments Are Usually Wrong

Why popular investments are usually wrong

(Wealth Management) Oscar Wilde, the 19th century poet and playwright, once said: "Everything popular is wrong."  The Irish wordsmith wasn't referring to the financial markets, but he may as well have been. That's because investors should be very wary of the popular stocks, sectors, and exchange-traded funds (ETFs) du jour.

While it's true that momentum can persist, more often than not, popularity is the kiss of death.

In finance, the degree of popularity is typically referred to as sentiment.  Fundamentals matter in the long term, but sentiment is what really drives short- and intermediate-term moves in the financial markets.  Caution is, therefore, essential when sentiment reaches a bullish extreme.

The Texas Hedge

It was a no-brainer, can't-lose trade.  Pundits on CNBC and Bloomberg TV were supremely confident in the outcome.  Fund flows poured in to take advantage of its inevitability.  This was a "layup" - a sure thing.  The Bank of Japan (BOJ) was going to depress the value of the Japanese yen, and Japanese equities would rise due to exporters benefiting from a cheap currency.

Naturally, everyone wanted to be long Japanese stocks, but short the yen, and the WisdomTree Japan Hedged Equity ETF (NYSEARCA:DXJ) provided an easy way to do just that.

Except now investors are realizing that they aren't hedged at all.  Ironically, the yen has gone through the roof ever since the BOJ implemented a quasi-negative interest rate scheme.  The U.S. dollar/Japanese yen exchange rate (USD/JPY) recently hit its lowest level since October 2014 (a decline in USD/JPY represents dollar weakness, yen strength).

Thus, anyone betting on a decline in the yen is getting bludgeoned in the market.  Not only that, Japanese equities are, unsurprisingly, falling in tandem with USD/JPY.  This is a lose/lose situation for DXJ holders.

Since April 2015, when I warned that investors in currency "hedged" ETFs were essentially speculating on currency movements, DXJ has lost 26% of its value (including distributions).  Going back even further to early 2014, DXJ has produced a total return ofnegative 6%.

Alas, it was so popular!  Over the same time frame, the S&P 500 has returned a positive 16%.

Shifting Sentiment

To be sure, DXJ now offers a far better risk-reward proposition than it did a year ago.  Basically, the fund may excel because the trade is not nearly as popular.  We're even seeing currency futures speculators, in aggregate, bet on yenappreciation.

The last time this group had a net long position in the yen was 2012, right before the yen plummeted as "Abenomics" was introduced. In other words, the sentiment of this crowd is a contrarian indicator.  Sentiment notwithstanding, the fundamentals for Japan, in general, remain poor.  Japan has a shortage of the most precious natural resource on the planet: children.

Do the central planners really think that burning their currency at the stake is going to solve anything? Well, they certainly shouldn't.  Nonetheless, the short-term swings will continue, as prices are determined - at the margin - by human behavior and emotions.

This is why serially buying the most popular investments is a great way to destroy wealth.

Meanwhile, the fundamentals for U.S. Treasuries remain strong. The real trick, however, will be knowing when they, too, have become overly popular.

Originally published by Alan Gula on WealthManagement.com.