Thursday 23 April 2020

The bear market rallies of 1929-1932

Wiki has a short summary of how the 1929 crash unfolded.

 Source: Wiki

After the initial selling took the Dow from around 380 down to just below 200 it then rallied from mid November 1929 to mid April 1930, about a 50% rally, recovering about half of the loss.

It then staged multiple further sell offs until 1933 as the credit cycle contracted and the recession deepened, but each one saw a rally after that revovered around half of the loss.

You can also see the equivalent of the Plunge Protection Team trying to prop the market up at the start.

Liaquat Ahamed's excellent Lords of Finance book does a great job describing the precursors to the crash - the Treaty of Versailles and the destabilisation of the gold standard that led to the roaring 20s and subsequent bust.

Yet what have we witnessed since 2008 except new Lords of Finance? Only these ones have a printing press while in 1929 the local money supply was determined by gold availability.

Tuesday 21 April 2020

Is the next leg down starting now?

If the US 10 does go negative, given the Primary Dealers have to buy, even though the Fed has rates at zero, they will be negative carry and swamped with sales/ reverse repo/ Treasury new issuance.

Two key charts: US 10yr breaking out and equities just scuffed the bottom of the retracement target box I drew up based on prior bear market rallies:

In terms of the next leg down being on us now, we had the initial liquidity crack in March leading to a 1 month sell off. We then had a 1 month relief rally driven by technicals. Historically the next leg down should start pretty much now and take out the March lows and take place over a similar 1 month time horizon.

So looking at late last week this week so far:

  • Equities starting to roll over
  • USD index starting to break out
  • Yen and Euro showing signs of capital repatriation
  • US 10yr breaking out
  • Oil imploding into delivery
  • Gold fading the rally
  • High yield looking like its starting to fade the rally

Friday 17 April 2020

Could foreign ownership of $4Tn of US Corporate debt be the $600Bn cross currency margin call of this cycle?

So I looked through the Treasury TIC data on who owns what fixed income/ credit assets in the US. 

The US has run a Current Account deficit this cycle of about $450bn a year, so around $5Tn cumulatively since 2009.  A couple of points:
  1. Someone had to fund that with their savings
  2. The Gross funding data is bigger as US investors also buy assets abroad
  3. Financials, especially banks own duration funded short term, in many cases the FX basis swap rolls every 3 months, so while in theory they can hold investment grade debt to maturity, in reality at least part of the funding needs to be rolled quarterly.
So since 2009 US GDP has gone from $14.45Tn to $21.4Tn or +$7Tn, +48%.

But to June 2018 there has been about a $10Tn increase or 47% of 2019 GDP increase in foreign holdings of US securities. Roughly 50/50 split equity and debt. The CA deficit has been running at about $450bn a year on average.

Foreigner owned corp debt looks to have grown about 70% from $2tn to $3.4tn in 2018

Net position deteriorated:

Foreign holdings of Corp debt, $1.9Tn to $3.4Tn. So a 15% price drop would be about a $510bn margin call:

Held by the obvious holders:

In Corporate debt bank and financial debt is the most common holding:

They owned 28% of corporate debt:

Using the monthly TIC data, the EU and UK/ City has been two of the big cumulative funding sources:

Japan also bought bank debt and I believe this excludes CLOs/ loans:

Using the monthly data foreign holdings of US debt rose $1Tn YoY to January and US corporate debt holdings rose to $4.2Tn by January 2020. But foreigners have been Corporate bond net sellers since last August, ie since the US curve inverted:

Cross border data is a bit harder to get but the TIC data has some and the BIS also does. 

The table below summarises what I understand is TIC data showing US bank to foreign financial firm USD repos; they have grown 200% in this cycle but collapsed 40% in 2008:

BIS reported cross-border bank lending has been growing over 10% recently, but shrank after 2008:

BIS US bank cross-border loans to non-bank financials:

US bank liabilities to Japanese entities:

So is one of the weak links US corporate debt, including US financial debt, held 3-month xccy basis currency swapped, by EU and Japanese banks and insurers, whose own balance sheets are leveraged 10-20x? 
Perhaps, the data I could find is not that granular, but we know QE leakage from Japan and EU caused xccy FX basis spreads to widen out precisely because of this imbalance.

Seems like a 15% price drop is the equivalent of a $600Bn quarter end margin call. This might help explain the scale of the sell off of US investment grade credit in March. But I don't feel like the bottom is in yet. It does not feel like there has been enough forced selling or a big enough bankruptcy yet. 
Either way foreign holders of US corporate debt have been selling since last August, and attracting a lot of net Treasury investment at near zero yields might be a struggle. The US has a $400bn pus CA deficit to finance. All of this points towards a much weaker US Dollar in Trump's likely second term. 

Thursday 16 April 2020

Are Bonds and FX pointing towards the next leg lower starting next week?

I have had the view that at least since late March markets have been trading on technicals, not really even news flow. Question is when does QE induced technicals take a back seat to economic reality?

In the last couple of days equities and junk bonds have stopped rallying and traded around their Fibonacci retracement lines. While I do think there is a chance at a bit more upside for a few more days, most of the technical rebound had been had. Yet at the same time Treasury yields have broken lower and the USD has started to try to move higher again, which if it continues, I believe is the start of the next move lower, the proper liquidation event. 

The next leg down I think is catalysed by the realisation there is no V-shaped recovery from Corona, that the lock down disruption will drag on a bit longer and that in Q2 going into Q3 we will see the peak pessimism on the outlook. 

While the Fed can magically control a large part of the fixed income markets, in the end default and earnings expectations combined with a lack of market making capacity drive credit and equity valuations with exaggerated moves in both directions now part of the market normal.

In prior posts I have looked at prior shocks and recoveries and also prior bear market rallies. In bear market rallies only a partial retracement happens and it tends to happen over a similar time horizon as the sell off, in this case about 1 month. Well we are roughly a week from the start of the current bear market rally, the 23rd, so next week might be pivotal for risk assets. 

US 10 year has broken lower from its wedge:

USD has broken higher from its short term wedge:

 And is on medium term support and breaking higher:

Equities are a little short of the 3000 level/ 200 day MA/ 62% retracement but we still have a few days yet:

JNK which is a bit closer to the direct effects of QE is hovering around the 62% retracement:

If the compression of the US yield curve restarts QE repatriation, look out below:

The Fed has magically caused a recovery in investment grade credit. But ultimately it cant buy a meaningful amount of corporate credit directly unless the Treasury massively expands the recently created Secondary Market Corporate Credit Facility (which it will):

Tuesday 14 April 2020

Some comments on Zoltan's Global Money Notes #29

Here is a link to the note: Global Money Notes #29 U.S. Dollar Libor and War Finance

I thought this Zoltan note was interesting. The Fed has basically fixed the plumbing in Treasury, Repo, OIS, FX swap markets. But that says nothing of IG corp credit or worse quality assets and we know the intermediation problems during risk off in credit. But the US has had about $5Tn in CA deficit funding this cycle and a lot of that is xccy QE leakage from EU, Jap, Asian banks and insurers who themselves are 10-20x balance sheet leveraged. I dont have data for how much corporate credit risk they hold but its not zero. I also understand that much of the FX hedges are done on a 3 month basis. So they are borrowing short and lending long and do have mark to market USD funding risk on the 3 month FX swap rolls (to my understanding). 

As such I think the case for a renewed risk off is economic expectations deteriorating for Q3 over the coming weeks, and some initial selling cascading into a stop out run from the top with IG being liquidated and that spreading out into higher risk assets.  

After that the Fed/ Treasury will be under pressure to do much more in IG credit, probably via a much bigger Treasury backstopped corporate credit vehicle. It will probably have to be $1Tn or so in promised size, the existing SMCCF has only $25bn in equity from the Treasury, so that would need to be upsized 5-10x I think. 

I would have thought the USD index and 10yr yield would get wind of this in advance. So far US 10 yr has gone sideways this month, more or less, but is developing a breakout wedge formation and USD is on a big support line and should bounce if its risk off. The Yen might also start to move if the US 10yr breaks 60bps on the downside to yields. 
Nevertheless, in the meantime equities can probably try for the 3000 mark on the S&P as Trump tries to map out a reopening of the economy and then declares total victory. 

Tuesday 7 April 2020

What's the sub-prime of this cycle?

The next leg down, which I assume starts late this month or in May... we should see what floats to the surface in terms of big, realised, end of cycle losses. 

I think the next leg down will be driven by a mix of the corp cycle and leveraged xccy carry holders of IG fixed income being stopped out. Primarily I think Japanese and EU banks and insurers. That is the real weak link, the sub-prime of this cycle; large quantities of overpriced assets held by weak holders. Some of the assets they own lost 10-12 years of carry in points loss in March before many of these areas started to rebound. But I think they will resell off again in the next sell off. 

As the market sells off and these investors start to stop out, it will force people holding BBB, HY or Equity to sell as well.
So Raoul Pal's USD wrecking ball view, while somewhat true for Emerging Markets facing a trade shock combined with USD liabilities, isn't quite that for Developed Markets. In DM it is instead the Eur and Yen rallying as QE leakage is stopped out and repatriated and the wrecking balls smashes asset markets downwards from the top. Remember the banks and insurers are typically 10-20x leveraged to their own equity.

So what QE giveth, QT taketh away and it never seemed to do all that much for the real economy anyway. 
As Chaucer said, 'now up, now down, like a bucket in the well.' 

Thursday 2 April 2020

Policy failure and the Q3 recession

The self-inflicted recession of Q3 coming up. S&P hasnt quite figured it out yet, but should sometime later this month or early next and drive the next, liquidation phase. 

If Trump can get a truce on the oil war (since writing this he tweeted a deal with Russia and Saudi) and oil up to $45 or so that would help HY credit and probably help the S&P upside bounce for a couple more weeks. But after that reality should set in. 

And per this doctor, the all societal lock down is basically unnecessary.

We have another case of supposed experts, with their claims and projections propagandised by a failing media Fourth Estate, all talking their book with an eye on research funding/ ad revenues and distorting public policy at great cost to everyone else. 

The continued and repeated failure of leadership by career politicans with little knowledge, experience or confidence outside of their narrow world is a disaster. 

The true Corona mortality rate will be a fraction of 1% once ARDS patients (young people dying of their own auto-immune response that can be treated with HCQ, zinc, anti-virals and zpack) & those already dying of chronic illness are excluded from the numbers. 

Most of those <1% fatalities will be retirees with existing health conditions. Certainly they should self isolate.

Wednesday 1 April 2020

Could the next leg down come as soon as late April or May?

The bulk of the 2008 sell off happened from early September to mid-November, so about 2 1/2 months, followed by a month and a half relief rally and a further sell off in Q1 for about 2 months until the market turned in early March.

This 2020 crash seems to be happening at least 2x as fast. We have had a major sell off and then a partial recovery all inside 5 weeks. So when might the next leg down come? This faster process might put the second sell off in May or even late April with a bit more upside consolidation/ hopium first if the Corona numbers improve as the weather warms and the shut downs work and markets look for better economic data in Q3. I had thought that the 200 day MA at about 3000 could be a target but a 50% retracement would be nearer to 2800 and is perhaps more realistic a target. A second leg down over the course of about a month would take the total fall to about 45% would put the S&P in the mid-1800s by the end of June. This is a similar level of drop to the 2000 and 2008 crises.

However as the reality of a typical corporate recession and retrenchment sets in and as markets write off chances of a Q3 recovery (which seems to be the great hope at the moment, plus Fed buying) then markets should sell off again.

The US economy was almost in recession before Corona and the oil MAD war, which Trump obviously wants to end.

If the recession drags on then there can be more than one relief rally followed by more disappointment. If you own a long term viable SME and need cash, whats the quickest way to get it? Sell investments. The Central Banks are bidding fixed income and some areas of IG credit, but there is no buyer of last resort in risky credit or equities....

The example of the late 60s to early 80s also shows that equities sell off significantly when earnings fall double digits only to rally again as the cycle turns.

Trump possibly implementing a $2Tn infra stimulus later and the cyclical recovery as Corona impact passes, I would hope would see a sustained recovery later in the year, but the Democrat controlled Congress wont want to give too much away before the election.

So to wheel out that Chaucer phrase again: now up, now down, like a bucket in a well. 

2008, One brutal sell off, one 25% or so bounce, another brutal sell off, then over:

 2020 so far: a brutal one month sell off followed by a fairly quick rally:

2000: a more drawn out slump. The big sell offs were followed by 20-25% or so bounces and the smaller rallies were about 8-10% in size: