You can’t expect the Fed to spell out what it’s going to do. Why? Because it doesn’t know. - Stanley Fischer
It’s been a busy week. Which do you want first, the Good News, or the Bad News?
The US stock market made an all-time high, then backed off hard. New York’s own Joe Torre was named to the Baseball Hall of Fame. In Washington, five warring regulatory agencies reconciled for an hour to sign off on the Volcker Rule. In Butner, North Carolina, Bernie Madoff observed the fifth anniversary of the day he turned himself in to the feds, while in Ottawa, Canada’s national postal service announced the end of home mail delivery because of budgetary constraints. From Jerusalem came word that former Israeli central banker Stanley Fischer is the likely candidate to be Fed vice-chairman under Janet Yellen, and from Vatican City comes the announcement that Pope Francis has been named Time Magazine’s Person of the Year, narrowly beating Edward Snowden and Miley Cyrus. No puff of white smoke was released.
Stanley Fischer’s resume includes years as chief economist at the World Bank, and his time as a professor at MIT where he mentored European central banker Mario Draghi, as well as our very own Ben Bernanke. Lest you think this makes him unsuited to oversee US monetary policy, we offer a few items from his years as Israel’s central banker.
At the Bank of Israel, Fischer created a policy committee whose purpose was to act as a brake on the power of the chairman. Fischer, who was born in Zambia, won praise from his colleagues by taking the trouble to learn Hebrew, despite the fact that all his colleagues at the bank were comfortable in English – and despite the fact that he was the boss. His stewardship of the Israeli economy included policies requiring Israeli home buyers to make 25%-30% down payments in cash. No exceptions. Fischer may not exactly duplicate these successes here – his English is probably good enough to get by in Washington, but we suspect he will have a tough time going head to head with Mel Watt on the subject of mandatory down payments for homebuyers.
Thanks to the new radioactive Congress, Mel Watt has been put in charge of the Federal Housing Finance Agency, the body that oversees Fannie Mae and Freddie Mac. Watt replaces acting director Edward DeMarco who doggedly refused to implement reductions in mortgage principal for borrowers who are underwater on their mortgages. Observers expect Watt to move forward with a program of underwater principal reduction for GSE borrowers (loans held at Fannie and Freddie). Current stepped-up restrictions on loan servicing have already made it difficult to foreclose on delinquent borrowers. New rules coming into effect in January will add to these restrictions, raising the question: Is there still such a thing as a Secured Loan?
Aside from its impact on real estate market pricing, there’s a risk that mortgage principal reduction could become a Last Straw, convincing investors that it’s dangerous to do business with the federal government. Yellen and Fischer could be boxed into a corner and be forced to actuallyincrease the Fed’s buying in order to absorb panic selling of mortgage-backed securities that are suddenly seen as riskier than the mortgage-backed issues the Fed is currently buying. In short, turbulence in the housing market could return to center stage as a major factor in the markets next year. Shades of 2007?
As far as the Volcker Rule is concerned, there will be legal challenges. But the immediate challenge is that the regulatory agencies charged with implementing it are barely equipped to keep their bathrooms stocked with toilet paper, much less to launch a major industry surveillance initiative.
The SEC and CFTC are cash starved, and Congress does not appear disposed to help (Financial Times, 11 December, “Cash-Strapped Regulators Face Heavy Volcker Workload”). The CFTC is in such dire straits they may have to furlough employees for two weeks in 2014. They have already said they may have to outsource, or completely forego certain key inspections. The SEC is better off financially, but only just. It remains to be seen how much clout Chairman White will wield with Congress.
The one agency that appears to be sufficiently funded to take on the additional burden of Volcker Rule inspections is the Office of the Controller of the Currency. You will recall that the OCC was the agency that performed multiple routine audits of HSBC’s Mexican accounts but failed to detect the bank laundering nearly a billion dollars of Mexican drug cartel money. And as overseer of America’s banking industry, the OCC didn’t bother to dig down and figure out what JPMorgan’s “London Whale” was really doing. No wonder they have so much money; they never do anything.
And speaking of regulators doing nothing, the fifth anniversary of the Bernie Madoff story is a reminder that America’s regulators – with the apparent exception of Ms. White at the SEC – continue to be incapable of sustaining the integrity of our markets. The collective regulatory failure to catch Madoff in the act – SEC, FINRA, the various exchanges, brokers and fund managers where Madoff executed transactions (or didn’t) and managed assets (or didn’t) – is the financial regulatory equivalent of the intelligence failure in the run-up to 9/11. From where we sit, it doesn’t look any better today. Oh well… at least we got Congress to pass another 1000 pages of legislation…
Pope Francis incurred the wrath of the Right – Rush Limbaugh called him a “communist” – with his apostolic exhortation Evangelii Gaudium, the “Joy of the Gospels,” a document that opens with the words “The great danger in today’s world, pervaded as it is by consumerism, is the desolation and anguish born of a complacent yet covetous heart, the feverish pursuit of frivolous pleasures, and a blunted conscience.” Admonishing the faithful to turn their attention to the poor, Pope Francis blasts today’s “idolatry of money and the dictatorship of an impersonal economy” as a reincarnation of the Golden Calf. “One cause of this situation is found in our relationship with money,” he writes, “since we calmly accept its dominion over ourselves and our societies. The current financial crisis can make us overlook the fact that it originated in a profound human crisis: the denial of the primacy of the human person!”
Who does this guy think he is, Jesus Christ’s personal representative?
Meanwhile, the stock market has turned very suddenly and very decidedly bearish. You might have missed it if you are following market technicians looking at 200 day moving averages, but Hedgeye’s macro work uses its own unique toolkit. This week Hedgeye CEO Keith McCullough appears on Hedgeye TV explaining his warning to “Beware This Big New Market Risk Signal.”
The mechanics of the stock market tell a story – one that you can read, once you figure out the grammar. In this case, says McCullough, they’re practically screaming. Keith developed his market models over nearly a decade as a hedge fund portfolio manager. He uses a simple three-component snapshot to derive a near-term market signal. The model looks at Price, Volume, and Volatility. When Price and Volume are rising, and Volatility falling, that’s an ideal near-term bullish set-up. It means more participants are entering the market, and are confidently adding money, happily paying higher and higher prices. It signals building confidence in the immediate term which, simply put, means you will be able to find someone else to sell your stock to when it goes up.
The obverse of that coin is declining prices, increasing volume, andincreasing volatility, signaling that investors are agitated, nervous, and possibly on the verge of panic. Says McCullough, this is precisely the signal the markets are flashing now, and it’s a new one. If you have followed our Macro work you know that we have been in favor of buying this bubble. Now, says McCullough, it is signaling that it may be ready to pop.
Prices are declining, meaning more selling coming into the market. Volume is declining, signaling a mismatch between the need to sell and the appetite to buy. And volatility is rising, indicting uncertainty. Sellers want to wait until they get their price. Rising volatility gets people upset, and people who are upset make less rational decisions. You don’t want to be the last person trying to sell your stock when volatility hits a critical point.
This negative near-term signal flashed on our screens this week, the first meaningful bearish signal we’ve had in a long time. Investors sitting on profits should consider taking them, while traders looking to ride the momentum of this bubble shouldn’t be surprised if trades go against them in a big way. In a market atmosphere characterized by gloom and uncertainty, a spike in volatility could trigger a rush for the exits. Imagine a crowded dance club. Imagine four hundred people in a space designed to hold no more than 250. Imagine a single exit door just wide enough for two people to pass through. Imagine a fire. Imagine you’re at the back of the room.
Happy Friday the Thirteenth.
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Editor's note: The piece was written by Managing Director Moshe Silver in this weekend's Investing Ideas. Hedgeye's Investing Ideas is for the savvy, longer-term investor looking for excellent long-only opportunities. With your subscription, you'll know immediately when one of our award-winning analysts uncovers a new idea or changes a current one. Additionally, every Saturday morning, you'll receive our newsletter with stock updates, Trend Levels and all the important investing information of the week. Click here to subscribe.
Takeaway: Redemptions continued in bonds last week and equities had slight inflows. YTD the rotation is underway with bond outflows and equity inflows
This note was originally published December 12, 2013 at 08:25 in Financials
Editor's note: This unlocked research note was written by Director of Financials Jonathan Casteleyn. For more information on how you can subscribe to Hedgeye research click here.
Investment Company Institute Mutual Fund Data and ETF Money Flow:
Total equity mutual fund flow for the week ending December 4th was $1.9 billion, a below average weekly inflow for stock funds this year but none-the-less a slightly positive indication. Within the total equity inflow result, domestic equity mutual funds lost $1.0 billion, the second consecutive weekly outflow in U.S. stock funds with International equity funds posting a $2.9 billion inflow, on par with last week. Total equity mutual fund trends in 2013 however now tally a $3.2 billion weekly average inflow, a complete reversal from 2012's $3.0 billion weekly outflow.
Fixed income mutual funds continued persistent outflows during the most recent 5 day period with another $4.4 billion withdrawn from bond funds. This week's draw down improved slightly sequentially from the $4.7 billion outflow the week prior but ongoing redemptions have now forced the 2013 weekly average for all fixed income funds to a $1.2 billion outflow, which compares to the strong weekly inflow of $5.8 billion throughout 2012.
ETFs experienced mixed trends in the most recent 5 day period, with equity products seeing slight inflows and fixed income ETFs seeing moderate outflows week-to-week. Passive equity products gained $207 million for the 5 day period ending December 4th with bond ETFs experiencing a $331 million outflow, an acceleration from the $251 million redemption the 5 days prior. ETF products also reflect the 2013 asset allocation shift, with the weekly averages for equity products up year-over-year versus bond ETFs which are seeing weaker year-over-year results.
With year-end tallies almost complete with only 2 full work weeks left in 2013, we have compiled the annual totals from the ICI for mutual fund results and also from Bloomberg for ETF production throughout 2013. In the Hedgeye Asset Management Thought of the Week below, we outline the resurgence in stock fund inflows, the emerging outflows in bond funds, and the record years for equity ETF inflow and commodity ETF outflows.
For the week ending December 4th, the Investment Company Institute reported slight equity inflows into mutual funds with over $1.9 billion flowing into total stock funds. The breakout between domestic and world stock funds separated to a $1.0 billion outflow into domestic stock funds and a $2.9 billion inflow into international or world stock funds. These results for the most recent 5 day period within stock funds were bifurcated, with the outflow in domestic stock funds below the weekly average of a $551 million inflow and with world stock fund production slightly above the $2.6 billion weekly inflow average. The aggregate inflow for all stock funds this year now sits at a $3.2 billion inflow, an average which has been getting progressively bigger each week and a complete reversal from the $3.0 billion outflow averaged per week in 2012.
On the fixed income side, bond funds continued their weak trends for the 5 day period ended December 4th with outflows staying persistent within the asset class. The aggregate of taxable and tax-free bond funds booked a $4.4 billion outflow, a slight sequential improvement from the $4.7 billion lost in the 5 day period prior. Both categories of fixed income contributed to outflows with taxable bonds having redemptions of $3.0 billion, which joined the $1.3 billion outflow in tax-free or municipal bonds. Taxable bonds have now had outflows in 23 of the past 27 weeks and municipal bonds having had 27 consecutive weeks of outflow. While the sharp redemptions that marked most of the summer and the start of the third quarter have moderated, the appetite for bonds has hardly rebounded. The 2013 weekly average for fixed income fund flows is now a $1.2 billion weekly outflow, a sharp reversal from the $5.8 billion weekly inflow averaged last year.
Hybrid mutual funds, products which combine both equity and fixed income allocations, continue to be the most stable category within the ICI survey with another $894 million inflow in the most recent 5 day period, although the past 2 weeks have been below year-to-date averages. Hybrid funds have had inflow in 25 of the past 27 weeks with the 2013 weekly average inflow now at $1.5 billion, a strong advance versus the 2012 weekly average inflow of $911 million.
Exchange traded funds had mixed trends within the same 5 day period ending December 4th with equity ETFs posting a slight $207 million inflow, a drastic drop from the $11.4 billion subscription the week prior. The 2013 weekly average for stock ETFs however is still a $3.3 billion weekly inflow, nearly a 50% improvement from last year's $2.2 billion weekly average inflow.
Bond ETFs experienced a moderate outflow for the 5 day period ending December 4th, with a $331 million redemption a sequential acceleration from the week prior which produced a $251 million outflow for passive bond products. Taking in consideration this most recent data, 2013 averages for bond ETFs are flagging with just a $253 million average weekly inflow for bond ETFs, much lower than the $1.0 billion average weekly inflow for 2012.
Hedgeye Asset Management Thought of the Week:
Some analysts as well as media outlets are still in denial about the start of a rotation from U.S. fixed income into U.S. stocks, however the debate in our minds is a short one. With only a few weeks left in 2013, we have compiled the year-to-date flow totals from the Investment Company Institute for mutual funds and from Bloomberg for exchange traded funds. The trends from our perspective are quite clear. Within mutual funds, the $1 trillion that has come into bond funds since 2008 (or the start of the Fed's quantitative easing program) has started to unwind with the first outflow in fixed income funds within the ICI data since 2007. The fixed income outflow of $63 billion through the first 49 weeks of 2013 still pales in comparison to the $303 billion inflow that came into fixed income last year in 2012 (can you say blow off top?) and also the record year of 2009 when the Great Rotation from stocks into bonds started and $379 billion came into fixed income funds. While the over $155 billion outflow in the back half of 2013 has been the sharpest bond outflow in history (most significant 27 week ouflow sequence), the first half of 2013 experienced nearly $100 billion of inflow into fixed income to net to the fairly insignificant outflow year-to-date of $63 billion currently. Our regression model of bond performance to bond outflows continues to forecast a total outflow of $200 billion through 2014 meaning that this current rotation from bonds into equities could have quite a tail to go.
Conversely, the nascent production in stock funds (while consistently dismissed) has been historically quite impressive being double that of the $74 billion that came into equity mutual funds in 2007. While the $159 billion running inflow into stock funds thus far in 2013 has had an international fund bend ($131 billion has gone into international stock funds versus just $28 billion into domestic equity funds), there is still ample reason to think that U.S. stocks can continue this turn in redemptions that has plagued them for all 6 years of ICI data before '13 (still record amount of cash on U.S. corporate balance sheets, generally low yields can allow stocks higher multiples, and the unwinding of the commodity super cycle and U.S. bond fund outflows needing to be invested somewhere). Bloomberg's annual tally of ETF information has equally interesting thematic value with the strong mutual fund trends in equities being validated on the stock ETF side, with another record year for ETF inflow (equity ETFs for 2013 have netted $173 billion in '13, higher than the $117 billion in '12 and a new record from the prior high of $127 billion in 2008). Fixed income interest in ETFs is matching its mutual fund brethren as well with passive bond products taking in a paltry $11.3 billion in 2013, a drastic drop from the record $56.4 billion last year (even the new fast growing ETF vehicle is not summoning up new interest from investors with the potential multi-year down cycle in fixed income). Commodity ETFs have had a year to forget with the formerly exuberrant gold market having been knocked down for a 20% plus loss and incrementally higher U.S. interest rates broadly supporting a higher dollar which has sent overall commodity indices lower. Commodity specific ETFs have had a record $25.1 billion redemption this year, the first negative year since the start of our data set in 2007, and a far cry from the formerly worst year of just a $600 million inflow in 2011.
We don't estimate that a substantial change from these current trends will occur until mid 2014 (these current themes are intact with forthcoming Fed tapering to continue to hurt the demand for fixed income and that U.S. stocks can at least have a positive start to 2014). Thus our favorite long idea remains T Rowe Price (TROW), a manager with industry leading equity performance to hoover up new industry equity flows and also a strong balance sheet to seed new products and also continue its streak of 26 consecutive years of dividend increases.
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
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Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor". If you'd like to receive the work of the Financials team or request a trial please email .
European Financial CDS - European banks resumed their winning ways last week, posting another sharp improvement. Spanish and Italian bank swaps led the charge lower. On a month-over-month basis, the average EU bank is trading 17 bps tighter (9%) tighter.
Sovereign CDS – Sovereign swaps were tighter throughout much of Europe last week. Italy and Spain saw sovereign swaps tighten 17 and 15 bps, respectively. Elsewhere in the world, swaps were little changed.
Euribor-OIS Spread – The Euribor-OIS spread widened by 1 basis point to 10 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.
Macau gaming revenues were much better in the 2nd week of December than the first. Daily table revs averaged HK$1,033 million, up 33% over the comparable period last year, and 9% better than the 1st 9 days of this December. We believe both volumes and hold percentage contributed to the strength. We had already accounted for the improving results, thus our full month GGR forecast remains unchanged at YoY growth of +10-16%.
As expected, market shares have normalized from week 1 although LVS now shows the biggest delta over recent trend. Wynn and MGM are also above trend thus far in December. WYNN and LVS remain our favorite Macau stocks.
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