Some day you will find me
Caught beneath the landslide
In a champagne supernova in the sky
Last night while sitting on set of CNBC’s Fast Money I got the following text from my main man and co-panelist Brian Kelly, who was sitting 5 feet away from me at the time:
To be fair, it was not one of my best “performances”. The problem is at this moment I have little to add (that I have not already screamed at you) about financial markets or current economic environment. I feel there is massive investor complacency given the rare but growing problem facing the global economy and that’s the death spiral of sovereign debt yields globally. Eventually it will take its toll on risk assets. Its all making me feel a tad melancholy 🙁
I’ll spare you the rants, I’ll just link to some recent ones with some choice quotes:
the U.S. Fed does nothing and remains vague about the course of monetary policy. This would cause increased uncertainty and Treasury yields make new lows, causing investor panic that the U.S. Fed lacks ammo if in fact we and the globe do in fact have a recession. In this scenario I think investors will focus on the countries and regions like Japan and Europe which make up the majority of sovereign debt in negative yields and consider just how their equity markets have fared over the last year as negatively yielding sovereign debt has exploded from $1 trillion to $10.5 trillion. Spoiler Alert: the Nikkei is down 20% from its 52 week year ago highs, as is the Euro Stoxx 50 (SX5E).
It’s been my view for a while now that the Federal Reserve has no real intent of normalizing interest rate policy anytime soon (given the state of the global economy) and the fragility of financial markets
Friday’s knee-jerk reaction lower in stocks after the weak jobs data suggests that bad news for our, and the global economy may start being taken as bad news for risk assets.
bad economic news, for now being viewed as bad for risk assets, which in my mind makes perfect sense as a continuation of this trend in the U.S. would very likely be coupled with increasingly dour data in Europe and emerging markets which would then start to increase the odds of a recession here at a time where corporate profits are already in a recession. And the big risk is that a global recession would come at a time when the the U.S. Federal Reserve had exhausted all traditional means of monetary stimulus at a time when more than $10 trillion of sovereign debt around the global is already below the zero interest bound. I’ll also remind you that in the last two instances when the S&P 500 (SPX) topped out prior to a recession in 2000 and 2007, the Fed Funds rate was at 5%, well above the current 25 bps today.
Remembering that in the height of the volatility in February, the U.S. Fed supposedly asked large financial institutions to consider the possibility of negative interest rates and their effects on their capital positions. This at a time when the ECB and the BOJ’s move to negative interest rates have had the exact opposite of the intended effect on their currencies (causing them to rise) and their stock market (causing them to decline). Some believe that the U.S. Fed will actually move towards yields below the zero interest bound in the event of a growth shock. Remember, for the most part they have exhausted most traditional means of stimulus and as the WSJ’s John Hilsenrath suggested on August 17th, 2015:
OK. I’LL STOP.
That doesn’t mean there aren’t tons of trading opportunities in the meantime, even from the long side. But all trading and investing in this environment should keep in mind that the basis for news highs for U.S. stocks is weak and who knows what lies beneath.
I’ll leave you with this from Bill Gross, who used to run the biggest bond fund in the Universe (and now runs a fairly small one so he may merely be looking to get some headlines). The manager of the Janus Global Unconstrained Bond Fund Tweeted the following yesterday:
Gross: Global yields lowest in 500 years of recorded history. $10 trillion of neg. rate bonds. This is a supernova that will explode one day
— Janus Capital (@JanusCapital) June 9, 2016
The key point there is one day. Negatively yielding sovereign bonds have gone from $1 trillion a year ago, to over $10 trillion, and rising. That sure does seem like the last years of an expanding star. But we know little about supernovae. No one knows the size it gets to before it explodes. Or when.
The rise of NIRP has not been good for stocks in their respective countries/regions of late with Japan’s Nikkei down 20% from its year ago 52 week highs, as is the case in Europe, with the German DAX down 17%, and European banks trading below their financial crisis lows, with the SX7E (Euro Bank Index) down 40% from its year ago highs.
While U.S. investors have gotten accustomed to stocks rising with bonds, it may be different this time. Just look at the following chart. It’s the 30 year of the Nikkei 225 in Japan vs their sovereign debt yield (10yr JBG). It looks like their Supernova exploded two decades ago and it’s been mostly darkness since: