Doug Noland: “Money” on the Move


When markets turn highly speculative – and especially when in “melt-up mode” – underlying fundamentals are not all that relevant to securities prices. News and analysis will invariably focus on the positive, while surging markets create their own liquidity and self-reinforcing bullish psychology (“greed”). It’s also true that markets can enjoy speculative blow-offs even in the face of underlying fundamental deterioration. The years 1999 and 2007 are not yet ancient history.



It’s been awhile since I’ve used this terminology. But global markets this week recalled the old “Bubble in Search of a Pin.” It’s too early of course to call an end to the great global financial Bubble. But suddenly, right when everything looked so wonderful, there are indication of “Money” on the Move. And the issues appears to go beyond delays in implementing U.S. corporate tax cuts.

The S&P500 declined only 0.2%, ending eight consecutive weekly gains. But the more dramatic moves were elsewhere. Big European equities rallies reversed abruptly. Germany’s DAX index traded up to an all-time high 13,526 in early Tuesday trading before reversing course and sinking 2.9% to end the week at 13,127. France’s CAC40 index opened Tuesday at the high since January 2008, only to reverse and close the week down 2.5%. Italy’s MIB Index traded as high as 23,133 Tuesday before sinking 2.5% to end the week at 22,561. Similarly, Spain’s IBEX index rose to 10,376 and then dropped 2.7% to close Friday’s session at 10,093.

Having risen better than 20% since early September, Japanese equities have been in speculative blow-off mode. After trading to a 26-year high of 23,382 inter-day on Thursday, Japan’s Nikkei 225 index sank as much as 859 points, or 3.6%, in afternoon trading. The dollar/yen rose to an eight-month high 114.73 Monday and then ended the week lower at 113.53.  From Tokyo to New York, banks were hammered this week.

Perhaps the more important developments of the week unfolded in fixed-income. Despite the selloff in the region’s equities markets, European sovereign debt experienced no safe haven bid. German bund yields traded at 0.31% on Wednesday, before a backup in rates saw yields close the week at 0.41%. Italian bond yields traded as low as 1.69% on Wednesday before closing the week at 1.84%. Spain’s yields ended the week up 10 bps to 1.56%.

November 9 – Bloomberg (Molly Smith): “The run-up in junk bonds is showing signs of returning to earth. After a spate of bad news triggered sell-offs of a few big speculative-grade borrowers, the pain has spread and even led NRG Energy Inc. to pull a $870 million bond offering on Thursday. Exchange-traded funds that buy high-yield debt have plunged the most since August, with $563 million of retail outflows since the start of this week alone. Three of the biggest junk-rated borrowers, IHeartMedia Inc., CenturyLink Inc. and Community Health Systems Inc., posted disappointing earnings that sent their bonds plunging.”

November 10 – Wall Street Journal (Ben Eisen and Sam Goldfarb): “A red-hot bond market is turning more frosty toward junk-rated issuers. Investors demanded a 3.79 percentage point premium, or spread, over going rates to own junk bonds, the highest in nearly two months on Thursday… That’s up from 3.38 percentage point on Oct. 24, near its lowest since the financial crisis. The market gyrations suggest a shift away from particularly easy conditions that were on full display just a few months ago.”

November 9 – Bloomberg (Dani Burger): “As U.S. markets swim in sea of red, trading in the largest high-yield exchange-traded funds has skyrocketed to dizzying levels. The iShares iBoxx High Yield Corporate Bond ETF, Blackrock Inc.’s $18.7 billion fund, saw volume spike over five times higher than its average level… At more than 23.8 million shares, trading in the largest junk-bond fund has already surpassed its one-day average of 11 million for the past year — outpacing volume notched in August amid saber-rattling between the U.S. and North Korea.”

NRG’s large refinancing was the first junk deal pulled since June. Friday then saw Canyon Consolidated Resources cancel its junk bond sale. Interestingly, Tesla’s $1.8 billion junk bond issue sold back in August now trades near 94, with yields up 50 bps in two weeks to 6.26%. Netflix’s 2018 bond saw yields jump 27 bps this week to 5.18%.

This week’s junk selloff was most pronounced in the telecom and healthcare sectors, buffeted by earnings disappointments and the failed Sprint/T-Mobile merger. Sprint CDS surged 120 bps this week to an 11-month high 342 bps. It’s worth noting that the telecommunications sector – making up about 20% of most junk indices – has suffered a flurry of earnings disappointments this quarter. CenturyLink (2039) bond yields surged 42 bps this week to 9.46%.

There were notable jumps in (high-yield) communication-related company CDS prices this week. CDS prices spiked 542 bps for Windstream, 223 bps for Frontier Communications, 175 bps for CenturyLink, 163 bps for Qwest, 88 bps for Level 3 Communications and 25 bps for Dish Corp. In the investment-grade communications arena, CBS, Viacom, Expedia and Bell South all saw CDS prices rise to near six-month highs.

Monitoring U.S. junk spreads by sector, Tech, Consumer Discretionary, Telecommunications and Healthcare all traded to three-month wides this week. One could argue that the strong performance of Energy over recent months has helped mask deteriorating performance in key high-yield sectors.

Especially late in Bubble periods, the marginal (“junk”) borrower plays an increasingly instrumental role in both Financial and Real Economy booms. Loose financial conditions and intense speculation ensure abundant cheap finance. And so long as cheap “money” remains readily available, it will be borrowed (irrespective of the trend in fundamental factors).

A tech-heavy Nasdaq surged to record highs during the first quarter of 2000, seemingly oblivious to the rout that was unfolding in telecom debt. In all the exuberance, it’s easy to forget that “tech” Bubbles are fueled by infrastructure spending by scores of negative cash flow enterprises dependent on junk bonds, leveraged lending, speculative sector flows and loose finance more generally. Especially after securities prices have succumbed to speculative blow-off dynamics, few are prepared for how rapidly liquidity abundance can disappear.

Over the past year, enormous worldwide issuance of high-yield debt has been integral to the global Bubble. From Bloomberg Intelligence: “Emerging market primary market activity remains red-hot, with benchmark-eligible hard-currency debt issuance surpassing $500 billion this year for the first time on record.” China is currently enveloped in a (higher-yielding) corporate debt issuance boom. Europe has been enjoying a spectacular boom, with junk yields sinking all the way to a ridiculous 2%.

At this point, junk bond weakness is relatively confined. And in the recent past we’ve witnessed pullbacks that refreshed. Speculators were emboldened, as financial conditions loosened only further. Yet could sector concerns prove a harbinger of asset class issues and a problematic Risk Off backdrop?

When markets turn highly speculative – and especially when in “melt-up mode” – underlying fundamentals are not all that relevant to securities prices. News and analysis will invariably focus on the positive, while surging markets create their own liquidity and self-reinforcing bullish psychology (“greed”). It’s also true that markets can enjoy speculative blow-offs even in the face of underlying fundamental deterioration. The years 1999 and 2007 are not yet ancient history.

I’m beginning to think it might not take all that much to wake folks up to risk. And by the looks of Japanese and European equities (along with junk ETFs) this week, there may be some big players with fingers hovering over sell buttons. The Fed will likely raise rates next month, and I’ve already read some analysis that chairman Powell may not be the dovish pushover he’s been portrayed. There was also news out this week shedding further light on the growing split at the ECB. Meanwhile, the esteemed head of the People’s Bank of China was publicly warning of ‘hidden, complex, sudden, contagious and hazardous’ risks within the Chinese financial system.

General financial conditions seemed to tighten marginally this week. And, curiously, as global risk markets were indicating some vulnerability, sovereign yields did something anomalous: they rose. A jump in yields concurrent with widening Credit spreads puts pressure on leveraged trades. It’s worth noting as well that the yen, euro and swissy all posted modest gains this week, perhaps putting pressure on global leveraged “carry trades.”

Recent highflyer EM equities markets fell under some pressure. Stocks were down 2.4% in Brazil and 2.1% in Turkey. Stocks retreated about 1% in India and Mexico. Geopolitical issues hammered markets in the Middle East. In general, Latin American equities were under notable selling pressure. There was also upward pressure on local currency EM bond markets. Yields were up 65 bps in Lebanon, 55 bps in Argentina and 19 bps in Brazil. Many EM yields traded to six-month highs this week. Most dollar-denominated EM yields moved to three-month highs.

From Bloomberg: “Mysterious Gold Trades of 4 Million Ounces Spur Price Plunge.” I haven’t a clue who might want to dump gold. But it was a week that saw losses in stocks, Treasuries and corporate debt. I would venture that it was not a particularly good performance week for the so-called “risk parity” crowd. Few groups have benefitted more from the float-all-boats, massive monetary stimulus of the past (going on) nine years. There are scores of investment models that have worked brilliantly during the most prolonged of bull markets. A tightening of financial conditions would expose a lot of genius swimming naked.

So how might we get from the recent “Risk On” to a problematic “Risk Off”?

Imagine a flurry of outflows from junk ETFs spurring illiquidity in the underlying securities holdings. This begins to spook some players leveraged in investment-grade corporate Credit. The more sophisticated players begin to take some risk off the table, as financial conditions tighten. Fears of outflows from the – now massive – passive investment-grade funds complex spur incipient risk aversion in equities. De-risking/de-leveraging dynamics begin to take hold – at home and abroad (spike in the yen pressuring global “carry”?). And with everyone now Crowded so nice and tight into the big tech names, an abrupt reversal of the leadership technology stocks would further rattle the leveraged lending market that has been operating in overdrive. Fears of a bursting “tech” Bubble overwhelm greed. Sinking tech would take down the indices, unleashing a bit of harsh reality upon the tsunami of “money” that has disregarded risk to participate in the passive index mania. The short volatility Crowd gets crushed.


Original Post: 11 November 2017

Categories: Doug Noland, Perspectives