Dr. Bernankenstein Insist the Experiment Will Continue
The Fed re-iterated its commitment to purchasing $85 billion a month of mortgages and treasuries until the job market improves. So far, all that is clear, is that the Fed is pushing investors into risky assets and is at the risk of turning investors into a bunch of zombies, in the search of risk. Here are my biggest concerns
- Mortgage rates have creeped steadily higher since September, which makes the premise that low mortgage rates will help housing which will in turn help the economy, at least somewhat dubious
- Treasury yields have backed up as well, dragging corporate bond yields with them as spread tightening can no longer offset that. So the two things the Fed is actually buying have underperformed. I can understand some of the logic, but at the same time it also looks like a lot of risk taking has been front run
- Jobs created in January were actually weak. The bright spot of the Non Farm Payroll (NFP) report on Friday was that previous months had big upward revisions. The trend is actually negative, which should be an even greater concern since avoiding the Fiscal Cliff on January 1 should have sparked more hiring, not less.
- Financial engineering is a safer and better way for companies to generate share price growth when compared to actual engineering or production. The Fed, without a doubt, has shifted the balance towards taking financial risk rather than economic risk, which I don’t think was their intention and the long lasting impact of which has yet to be felt.
The saying “don’t fight the fed” exists for a reason, but 2008 happened in the midst of what at the time was unprecedented support, and there is something that is troubling about an economy that requires low yields, but can’t keep them low, even with the Fed buying.
A Wile E Coyote Moment for Corporate Debt
There was a brief moment on Thursday morning when there was no real buyer of corporate bonds. Investors weren’t looking to sell them, but if you made a casual call to your market maker about where a bond was, they assumed:
- You weren’t calling to buy bonds, you were calling to potentially sell
- They had no interest in buying the bonds for their own account, and had already scouted around to find buyers for bonds they held in inventory, only to find there was a buyers strike
The situation reversed fairly quickly on Friday as stocks set off to new highs, but now is the time to lighten exposure to corporate bonds. A few things drove this move
- Retail is slowly but surely pulling back from corporate bonds, the shares outstanding of LQD, HYG, and JNK have all been on the decline, in spite of the Fed re-iterating its intention to purchase bonds
- Pension funds and Insurance companies are reasonably full on their allocations to fixed income and are reluctant to add more at the first sign of weakness, they can finally afford to be patient
- New issues started to struggle. THC and DNR were two junk issues from the week before that traded below issue price. That puts pressure on all the “flippers” and also causes investors to hold off on the secondary market and focus on trying to get greater concessions out of the new issue market, where the calendar remains robust
- Hedge funds, in their focus on getting 10% returns in a low yield environment, have started to use leverage. While they have plenty of room to “buy the dip” and to add, they wait for the turns because they get nervous that even a 3% drop in high yield bond prices (hardly a rare event) could damage their ability to perform for the rest of the year.
The market bounced quickly on Friday, but still didn’t finish as strong as equities and that bit of wobbliness may return.
Spain and Italy
I haven’t mentioned these countries in awhile, but ……
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