“This is a serious problem, although it is not as dramatic as sort of an epidemic.”
Author Ian Fleming created James Bond, code named 007, in 1953 and subsequently featured him in twelve novels and two short story collections. Bond was an intelligence officer in the Secret Intelligence Service and a Royal Naval Reserve Commander. Fleming based this fictional character on many of the intelligence officers and commandos he met during World War II. Interestingly, the name James Bond came from American ornithologist James Bond, a Caribbean bird expert and author of the definitive field guide Birds of the West Indies. (Don’t worry, I haven’t read it either.)
Over the course of the Fleming’s twelve novels and the twenty-two James Bond movies (the highest grossing series ever at $4.9 billion), Bond utilizes his astute intelligence gathering capabilities, combined with various gadgets, including an exploding attaché case, to save the world from a myriad of threats. If Bond were a research analyst studying today’s markets, the U.S. bond markets may be considered an emerging epidemic in his analytical purview.
Even if not an epidemic, bond issuance levels this year have been staggering. Firstly, in the municipal bond market in the United States, as of May, issuance is up 70% compared to the same period in 2011. Secondly, in the U.S. corporate bond market issuance is up 5% year-over-year, but has seen a serious acceleration in the last few months with investment grade issuance up 54% and high yield up 30% in July 2012. Finally, according to Lipper Research, bond ETFs have seen the eighteenth consecutive month of net inflows.
So, is there is a bond epidemic / bubble? Given the stance of the global central banks to keep interest rates at artificially low levels, it is likely not an epidemic that is going to end in the short term. In fact, we are actually aggressively allocated to U.S. government bonds as we think equities are at an extreme and growth is continuing to slow. Certainly though, James Bond, the research analyst, would be gathering his intelligence and watching and waiting for an opportunity to sell the high yield bond market.
As we show in the Chart of the Day below, which we have aptly named, From the Central Banks with Love, the high yield market is at a generational low in yield. Obviously when studying a corporate bond, there are a number of factors to analyze in determining whether it is overvalued or undervalued. Certainly, the overall interest rate environment is critical, but ultimately the prospects of the company are the drivers of a junk bond’s value, especially given the bond’s inferior position in the capital structure. Therefore, given that yields in the junk bond market are literally at generational lows, it implies that default risk is also close to an all-time low. Personally, I’d need a few James Bond-esque martinis before I’d believe that last point to be an accurate assessment of default risk.
Speaking of bonds, Der Spiegel reported this weekend that the ECB may set a specific threshold to cap periphery bond yields at its meeting in September. The immediate reaction in the European sovereign debt markets is, not surprisingly, positive as credit default swaps are trading tighter across the board. As well, the Spanish 10-year is back down to 6.19%. Even if positive in the short term, broad intervention in a large market speaks to another epidemic, the epidemic of government intervention in the free markets. Random intervention by governments does not build confidence in the markets. And confidence is what is sorely missing in the European debt markets.
In the latest sign that global growth is slowing, the Shanghai Composite hit a fresh three and a half year low this morning. The Chinese equity markets may not always garner headlines in the U.S. financial media, but nonetheless China remains the engine for global growth and as China goes so goes marginal global growth. Thursday will give us some important insights on Chinese and global growth as flash PMIs are reported for China, Europe and the United States.
Keith is back in Thunder Bay this week taking some time off with his family ahead of what is going to be a busy next few months at Hedgeye, so we will be highlighting some of the key calls from our broader research team this week. This will be kicked off this morning with our Financials Sector Head Josh Steiner and our Retail Sector Brian McGough leading our morning client call at 830 a.m. Email if you like to ask them any questions, or get access to the call.
Although we are currently not short it in the Virtual Portfolio, one of McGough’s favorite short ideas has been J.C. Penney. We’ve been consistently short JCP for the past fifteen months and will likely look to re-short when we see our level. McGough had the following to say after JCP’s recent earnings announcement:
“We won't bother with the full financial review. Comps down -22%, dot.com down 33% and a ($0.67) loss pretty much sums that up.
But that's the past. We invest for the future. One thing that matters in investing for the future is believing in who is running the ship. We initially figured that Johnson's Apple halo would have lasted 18-24 months. But about 5-minutes into his commentary today, his credibility stood up, ran out the door, and got hit by a bus.
Last quarter, his level of arrogance around communicating the message was bothersome. He spoke to the Street like we were toddlers, or at least retail novices. He glossed over the bad, and played up whatever positive statistic he could find. A JV mistake for a new CEO.”
As it relates to CEO Ron Johnson at J.C. Penney, or really any CEO of a large public company, perhaps Ian Fleming said it best when he wrote:
“Once is happenstance. Twice is coincidence. Three times is enemy action.”
Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1, $110.89-115.21, $82.20-82.89, $1.22-1.24, 1.72-1.87%, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on August 06, 2012 for Hedgeye subscribers.
“Your father doesn’t believe in magic.”
This weekend I took my son Jack to Pixar’s latest animation, “Brave.” The original story, set in the 10th century Scottish highlands, was called “The Bear and The Bow.” Since the McCullough Clan genuinely loves bears, we thoroughly enjoyed the movie.
Brave’s King Fergus doesn’t like bears anymore than modern day Eurocrats do. In fact, the King’s entire life is centered around fighting one demon bear in particular by the name of “Mor’du.”
I won’t ruin this European short squeeze (or the rest of the movie for you), but having gone to French Canadian school until the 5th grade, I must give you a hint – “mordu”, en Francais, is the past participle of “death.”
Back to the Global Macro Grind…
No worries, no short sellers from New Haven, CT actually died in Friday’s latest no-volume squeeze (we cut the SHORTS in the Hedgeye Portfolio to only 5 by Friday morning). Evidently, neither did as many people perish in the government’s now infamous “birth/death adjustment” for US payrolls.
In today’s Chart of the Day, Darius Dale contextualizes the July 2012 Jobs Report with a picture that nets out the effects of the NSA’s “birth/death adjustment” from the NSA Non-Farm Payroll month-over-month figure.
In addition to that picture telling you 1,000 words, here are some other quick hits on the jobs report:
- For June (last month’s report), the government revised non-farm payrolls down to 64,000 vs 80,000 prior
- For July, the “birth/death adjustment” of +52,000 jobs was the highest “adjustment” on record (since July 2000)
- For July, the actual unemployment rate ticked up +10bps (month-over-month) vs June to a very elevated 8.3%
But, but… provided that you believe in magic during an Election Year, America’s jobs crisis is over and it’s time to buy stocks with both hands at VIX 15, again. *Note, every time you’ve bought US Equities at VIX 14-15, in the last 5 years, you’ve been killed.
Killing the shorts is cool, until it isn’t. Don’t forget that short covering is one of the only ways left for these markets to go up. Inflows into US Equities remain dead. So is trust.
While it was funny to see the perma-bulls of the manic media blame Europe for the April-June US stock market declines, I don’t see too many of these cats championing Europe as the reason for a US stock market rally. #weird
Looking at the short squeezes we’ve seen off the June 2012 lows, here are some noteworthy ones:
- Oil (Brent) = +23%
- EuroStoxx50 Index = +15%
- SP500 = +8.7%
Centrally planned black magic or not, Americans of the 30th Olympiad better be thanking Europe for hosting one mother of a short squeeze in commodity and stock prices, even if the volume of fans is low.
The commodity side of this Reflation Rally to lower-highs is worth wasting a few more bullets on:
- CFTC (US Commodities Futures Trading Commission) contracts ripped another +5% wk-over-wk to 1.22 million contracts
- Agricultural bets (net long contracts) were up another +3% wk-over-wk at a new high of 884,477 contracts
- Gold bets put on their biggest wk-over-wk move (+36%) since November of 2008 (96,200 contracts)
Got Inflation Expectations? Brooksley Born, do you hear her now?
How about causality (central planning policies) and correlation (US Dollar Correlation Risk to stock and commodity prices)? Yep, Obama and Axelrod understand this full well. So did Bush and Bernanke. If you want commodity and stock market inflations to re-flate those political chances, you just need to spend like mad and debauch that US Dollar.
With the US Dollar down another -0.4% last week (down for 2 consecutive weeks), this keeps Oil (and Energy stocks) leading the latest charge. Oh, wait. The US stock market is down 8 of the last 11 days, and the Russell2000 was down another 1% last week…
So you better be either a Brave Bear when covering those shorts on Thursdays, or just get right loaded to the gills in commodity leverage and, at the same time, say there’s no inflation at the pump. Jack’s Dad tells him magical fairy tales at bedtime too.
My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Russell2000, and the SP500 are now $1591-1624, $106.05-110.84, $82.06-82.95, $1.20-1.23, 779-791, and 1368-1406, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Daily Trading Ranges
20 Proprietary Risk Ranges
Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.
Takeaway: U.S. banks and EU sovereigns were tighter last week, while EU banks were wider. Will Europe's promises be different this time?
* European sovereign swaps tightened further last week on positive commentary from Angela Merkel, while European bank swaps were generally wider (particularly Greek, German, Spanish and Italian banks). Unfortunately, there is a somewhat mixed track record of late with respect to whether it's the banks or the sovereigns that are the appropriate leading indicator.
* Large cap U.S. banks are definitely taking their cues from Europe's sovereigns and Merkel's commentary. Large-cap bank swaps were tighter again this week.
* The 2-10 spread widened another 13 bps, leaving it 20 bps higher on a MoM basis. This week's positive data gets the yield environment one step closer to being flat sequentially vs. 2Q12. While yield spreads are now effectively flat, the 3Q12-to-date sequential change is still meaningfully negative.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 6 of 12 improved / 1 out of 12 worsened / 6 of 12 unchanged
• Intermediate-term(WoW): Positive / 8 of 12 improved / 2 out of 12 worsened / 3 of 12 unchanged
• Long-term(WoW): Positive / 7 of 12 improved / 2 out of 12 worsened / 4 of 12 unchanged
1. US Financials CDS Monitor – The money center banks (JPM, BAC, C, WFC) and the large U.S brokers (GS, MS) all saw credit default swaps tighten week-over-week. The large-caps continue to tighten on perception of diminished risk across Europe. Interestingly, Euro banks were less enthusiastic last week, as most major EU banks widened.
Tightened the most WoW: MTG, RDN, AGO
Widened the most WoW: MET, TRV, CB
Tightened the most WoW: RDN, MMC, XL
Widened the most MoM: GNW, MTG, UNM
2. European Financial CDS - Unlike the sovereigns, the Euro banks were much more mixed last week. While French bank swaps tightened slightly, German, Italian and Spanish bank swaps were mostly wider. Greek bank swaps, meanwhile, widened considerably.
3. Asian Financial CDS - Chinese banks were notably tighter week-over-week with all three reference entities we track tightening by 10-20 bps. Meanwhile, Indian banks continue to move in the wrong direction. Japanese banks were generally tighter week-over-week, though just nominally.
4. Sovereign CDS – European sovereign swaps moved still tighter last week with Italy, Spain and Portugal contracting the most. In response, Germany and France tightened as well.
5. High Yield (YTM) Monitor – High yield rates rose 13 bps last week, ending the week at 7.16% versus 7.03% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 3.8 points last week, ending at 1697. This series continues to move up and to the right.
7. TED Spread Monitor – The TED spread rose 3 bps last week, ending the week at 35 bps.
8. Journal of Commerce Commodity Price Index – The JOC index fell 1.6 points, ending the week at -6.93 versus -5.4 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread tightened by 3 bps to 26 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk.
10. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system. An increase in this metric shows that banks are borrowing from the ECB. In other words, the deposit facility measures one element of the ECB response to the crisis.
11. Markit MCDX Index Monitor – Last week spreads tightened 3 bps, ending the week at 139 bps versus 142 bps the prior week. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.
12. Chinese Steel - Steel prices in China rose 0.3% last week, or 12 yuan/ton, to 3633 yuan/ton. In the last few months, Chinese construction steel prices have fallen ~10%.This index is reflecting significant weakness in China's construction market. Chinese steel rebar prices have been generally moving lower since August of last year. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
13. 2-10 Spread – The reflation in the 2-10 spread has been dramatic. Last week it tacked on another 13 bps, rising to 154 bps. Currently, the yield spread is back in line with the average for 2Q12 (151 bps), though the 3Q12-to-date average remains meaningfully down sequentially.
Margin Debt - June: +0.72 standard deviations
NYSE Margin debt rose in June to $285 billion from $279 billion in May. We like to to look at margin debt levels as a broad contrarian sentiment indicator. For reference, our approach is to look at it margin debt levels in standard deviation terms over the period 1. Our analysis shows that when margin debt gets to +1.5 standard deviations or greater, as it did in April of 2011, it has historically been a signal of extreme risk in the equity market. The preceding two instances were followed by the equity market losing roughly half its value. Overall this setup represents a long-term headwind for the market. One limitation of this series is that it is reported on a lag. The chart shows data through June.
Joshua Steiner, CFA
Having trouble viewing the charts in this email? Please click the link at the bottom of the note to view in your browser.
TODAY’S S&P 500 SET-UP – August 20, 2012
As we look at today’s set up for the S&P 500, the range is 13 points or -0.86% downside to 1406 and 0.06% upside to 1419.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: on 08/17 NYSE 706
- Decrease versus the prior day’s trading of 1327
- VOLUME: on 08/17 NYSE 675.67
- Increase versus prior day’s trading of 13.41%
- VIX: as of 08/17 was at 13.45
- Decrease versus most recent day’s trading of -5.88%
- Year-to-date decrease of -42.52%
- SPX PUT/CALL RATIO: as of 08/17 closed at 1.77
- Up from the day prior at 1.07
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: as of this morning 35
- 3-MONTH T-BILL YIELD: as of this morning 0.08%
- 10-Year: as of this morning 1.84%
- Increase from prior day’s trading of 1.81%
- YIELD CURVE: as of this morning 1.55
- Up from prior day’s trading of 1.52
MACRO DATA POINTS (Bloomberg Estimates)
- 8:30am: Chicago Fed Nat Activity Index, July (prior -0.15)
- 11am: Fed to purchase $4.25b-5b notes 8/31/2018-8/15/2020
- 11:30am: U.S. Treasury to sell $32b 3-mo., $28b 6-mo. bills
- 4pm: Weekly crop report
- House, Senate not in session
- U.S. presidential election fundraising deadline
- FERC meets on natural gas, electricity market coordination in U.S. Northeast, 9am
- AICPA holds 2012 National Governmental Accounting & Auditing Update Conference
- ITC judge hears testimony in LG’s patent case against Osram over light-emitting diodes, 9am
- ITC announces whether it will review judge’s findings that VirnetX couldn’t file a complaint against Apple because it lacked ownership control of a patent, 5pm
- Samsung Electronics asks U.S. appeals court to let it continue selling Galaxy Nexus smartphone while waiting outcome of Apple patent-infringement trial next year, 2pm
WHAT TO WATCH:
- Aetna said to have agreed to buy Coventry for $5.7b: WSJ
- Best Buy said founder Richard Schulze declined board offer to conduct due diligence; WSJ, NYT report BBY has picked Carlson CEO Hubert Joly as new CEO
- Prudential Financial said to emerge as lead bidder for Hartford’s indiv. life insurance unit, which may fetch ~$1b
- Home sales, durable-goods orders probably climbed in July
- American Airlines flight attendants’ voted yesterday to approve new contract with cost cuts
- Apple, Samsung made no progress toward narrowing dispute over smartphone, computer tablet patents, in report to court Aug. 18, increasing chances jury will decide matter starting Aug. 21
- Berkshire Hathaway unit agreed to acquire U.S. unit of Clal Insurance Enterprise Holdings for $221m
- Moody’s, S&P lost bid for dismissal of fraud claims in suit by investors
- Google’s Motorola Mobility unit said Aug. 17 filed new patent-infringement case against Apple at ITC
- EU leaders plan talks to bolster Greece, sovereign bonds
- China new-home prices rise in more cities after rate cuts
- CME said planning Europe exchange to compete w/ Eurex, Liffe
- Facebook failed to persude judge to approve $20m settlement on lawsuit over “sponsored stories”
- Netflix CEO plans to take on BSkyB’s dominance in streaming films by outbidding Sky for Hollywood studio movie rights: Sunday Telegraph
- BOK Financial said it bought Milestone; terms undisclosed
- GM recalling ~249,260 vehicles over concern fluid may enter driver’s door; Fisker Automotive plans to recall all its $103k Karma sedans to fix flawed cooling fan linked to Calif. fire
- “The Expendables 2,” distributed by Lions Gate, led U.S., Canadian box offices with sales of $28.8m
- U.S. sector previews: Energy, Finance, Industrials, Tech, Rates, Real Estate, Media/Entertainment, Health, Consumer, Transports
- Lowe’s Cos (LOW) 6am, $0.70
- Corinthian Colleges (COCO), 7:45am, $0.11
- Urban Outfitters (URBN) 4pm, $0.33
- Nordson (NDSN) 4:30pm, $0.99
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Speculators Hold Wagers at 11-Month High Amid Rally: Commodities
- Merkel’s Green Shift Forces Germany to Burn More Coal: Energy
- Oil Trades Near Three-Month High as Euro Leaders Ready for Talks
- Rubber Set to Drop 25% on Bearish Momentum: Technical Analysis
- Crop Outlook Seen Eroding as July Heat Compounded Drought Damage
- U.K. Natural Gas Surges as Demand Increases on Belgian Exports
- Copper Declines on Speculation China Will Hold Off From Easing
- Corn Gains as U.S. Rain Too Late to Boost Drought-Damaged Yields
- Rubber Drops for First Day in Four as Chinese Demand May Slow
- Gold Seen Rising on Speculation a Weaker Dollar Will Spur Demand
- Hedge Funds Slash Gas Bets as Bullish Party Ends: Energy Markets
- Lonmin Says 30% of Workers Return After Ultimatum Issued
- CME Planning Europe Exchange to Compete With Eurex, Liffe
- Swine Fever’s Spread Threatens EU, According to Russian Watchdog
- Speculators Hold Wagers at 11-Month High
- Rubber Seen Dropping as Chinese Inventories Set to Equal Record
- Sugar Rebounds on Speculation Prices Fell Too Far; Cocoa Rises
The Hedgeye Macro Team
Takeaway: We expect sequential improvement in monthly Macau trends
Macau GGR monthly projections
- We think July was the near-term bottom with only 1.5% YoY growth
- September and October should be bang up months with the opening of the 2,500 Sheraton rooms at Sands Cotai Central and the associated marketing
- Investor sentiment should improve around the market and LVS as its share should continue to rise.
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