Research Watch

This week, the debate surrounding the “great rotation” from bonds into stocks is being re-framed: Gerard Minack argues there was never a big move from equity into debt in the first place, while Ray Dalio describes an unsustainable bubble in cash. But Quartz recalls the bond bubble was forecast to burst each January since 2009, and rates are still near all-time lows. Elsewhere, the Dow theory is about to flash a “buy” signal — although Richard Russell urges caution — while a BofA Merrill Lynch metric suggests it’s time for a correction. Also, the Australian dollar is among the “sexiest” currencies in the world, Donald Trump proves his father was not an orang-utan, and, on video, sing along to Standard & Poor’s allegedly incriminating version of “Burning Down the House”.

The ‘great rotation’ isn’t a rotation at all...

“Gerard Minack … says there wasn’t an anti-rotation out of equities to unwind in the first place: ‘First, the idea of a “great rotation” from debt into equity presupposes that there has been a massive rotation from equity to debt. It’s not clear that that has happened. The great rotation of the past few years appears to have been from cash-like assets into debt, not from equity to debt. Exhibit 1 shows US mutual fund flows. The big trend from early 2009 has been out of money market mutual funds into debt funds (and bank deposits).

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Moreover, he says if one looks at equity fund flows, there are no signs of a mass exit — though there is a big shift towards ETFs:

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… Also, he points out that if one were to place faith in big shifts by, say, pension fund managers into a particular asset class as supporting said asset class, history does not bear this out:

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(FT Alphaville, February 5)

But there may be a cash bubble that is close to bursting…

“What’s happened now is that because of all the money that has been added to the system, there is a great deal of liquidity in the world. So there is money in corporations, in households. Liquidity is all over the place, a lot of it. And it has gone there because of monetary policy and it has also gone there seeking safety. That is changing on the margin. The returns of cash are terrible. So as a result of that, what we have is a lot of money … that is getting a very bad return. That, in this particular year, in my opinion, will shift. And the complexion of the world will change as that money goes from cash into other things. Now each region is very different, each set of circumstances. But the landscape will change I think particularly later in the year and beyond as those people who put their money there are receiving this bad return and feel an environment of safety [now] because the imbalances of Europe have largely been rectified. … The most fundamental laws of economics are you can’t have debt rise faster than income. You can’t have income rise faster than productivity and the long term growth will be dependent on productivity. And we have these cycles around productivity growth because of debt cycles. We don’t have a credit bubble because of the production of too much credit, but we do have a bubble in liquidity. There is too much liquidity and so bonds are a poor investment, they will have a poor return. Cash will have an even worse return, that’s assured. And that’s a bubble. Too much money in there. So the cash bubble exists, but we are reaching an equilibrium in terms of the debt growth.” (Ray Dalio of Bridgewater, via The Reformed Broker, February 2)

Although we’ve heard that before...

“For the fifth consecutive January, the financial markets are greeting the new year with a decent rise in interest rates.

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… And with every uptick in interest rates, you got a spurt of fear-mongering about the imminent popping of the bond market bubble:

2009: The bond bubble is an accident waiting to happen

2010: The bond market is wrong

2011: Are bonds the next bubble?

2012: Is the bond bubble about to pop?

2013: Central bank hot air pumps up bond bubble

And yet the long-awaited spike in interest rates hasn’t materialised. In fact, US interest rates remain near all-time lows.” (Quartz, January 30).

The Dow theory is about to flash ‘buy’...

“Dow theory says that when the Dow Jones Industrial Average and the Dow Jones Transportation Average move in tandem, up or down, the rest of the market will move with it. … But [legendary Dow theorist Richard Russell] warns that Dow theory doesn’t operate in a bubble. There’s another element to consider: the Relative Strength Index (RSI): ‘It seems so easy -- all the Dow has to do is climb another 174 points, and eureka, it’s at a new record high, and at the same time it has confirmed the new record highs in the Transportation Average. Wait, note that RSI is at its severe overbought zone for the first time in almost two years.” (Money Game, February 5)

But global flows suggest it might be time to sell...

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“In a note to clients this morning titled ‘Sell-Signal Triggered,’ BofA Merrill Lynch strategist Michael Hartnett says equity fund inflow signals are now pointing to a decent-sized sell-off. According to Hartnett, last time this signal was triggered, in January 2011, an 8% correction in global stocks followed over the course of February and March. Hartnett writes, ‘On average, a “sell” signal precedes a 5% correction in global stocks over the subsequent 4-5 weeks." (Money Game, February 1)

Too sexy for currency shorts?…

“In a note out to clients today, [SocGen’s currency strategist Kit Juckes] explains what makes a currency sexy: ‘”Sexy" currencies are ones with attractive fundamentals - healthy balance of payments, high rates, and strong growth.’ All of those things, high interest rates, a strong trade balance, and strong growth are what typically make a currency attractive to traders. On this chart, you can see that the currencies that are far to the right on the sexy index include the Norwegian Krone, the Aussie Dollar, the Kiwi, the Swiss Franc, the Swedish Krona:

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On the left side is Purchasing Power Parity, which is a measure of how expensive a currency is. Almost all of the sexy currencies are also expensive, with the exception of Norway.” (Business Insider, January 31)

Make the most of China’s final soft landing...

“Premier Wen Jiabao addressed this possibility nearly six years ago, arguing in March 2007 that the seemingly spectacular Chinese economy had become ‘unstable, unbalanced, uncoordinated, and ultimately unsustainable.’ Since then, many of China’s inherent strengths have been sapped by all-too-frequent external shocks. The banking sector is still digging out from the bad loans extended in the aftermath of the global meltdown in 2008. Finding affordable housing has become an increasingly serious problem for those relocating to cities for the first time. And corruption scandals and the related risks of political turmoil were unsettling... In other words, the vulnerability implied by Wen’s ‘Four Uns’ has increased significantly. China’s economy has certainly become more unstable, with major slowdowns in real GDP growth in 2009 and again in 2012. Its imbalances have gotten worse as well, with the investment share of GDP approaching 50% and private consumption falling below 35% of GDP. … In short, China’s growth model has been stretched as never before. And, like a piece of fabric, the longer it remains stretched, the longer it will take to return to its former resilient state – and the greater the possibility that it will not spring back the next time something goes wrong.” (Stephen Roach, former chief economist at Morgan Stanley, via Project Syndicate, January 29)

Although demographics could ultimately save the day...

“We’ve recently heard an interesting suggestion that China’s ageing population — generally a bad thing for growth — might also have the positive side-effect of inducing a transition away from the country’s unusually high ratio of investment to consumption. This would happen, argues CH Kwan of the Nomura Institute for Capital Research, because ageing Chinese will draw down on their savings. Those savings — themselves a result of the lack of a safety net for many Chinese — are a key source for funding of China’s capital boom aided by financial repression via policies such as artificially low interest rates, which keep capital cheap. It’s an appealing idea because it’s kind of like one of China’s problems (ageing population) is solving another one of its problems (overinvestment). And a rebalancing of the investment/consumption mix plus a big improvement in China’s capital productivity looks, very simplistically, like it could be a way for China to transition towards a more balanced economy. Not an easy way, but there are none of those anyway.” (FT Alphaville, February 6)

Do you see a resemblance?...

“Donald Trump filed a lawsuit Monday in California against comic Bill Maher, suing him for $5 million after Trump says Maher did not follow through on a $5 million public bet he made on ‘The Tonight Show.’ … Last month, Maher said on NBC to Jay Leno that he would pay $5 million to Trump’s charity of choice if he provided a birth certificate proving that he’s not ‘spawn of his mother having s-x with orang-utan.’ It was similar to an offer Trump made to President Barack Obama during the presidential campaign season, in which Trump wanted Obama to release his college records. … ‘He promised me $5 million for charity if I provided certain information,’ Trump said Monday on Fox News. ‘Well I provided the information. He didn’t pay. So today I sue Bill Maher for $5 million for charity.’” (Politico, February 4)

Video of the Week: S&P singalong...

Click here to view the video.

“By March 2007, the [US Justice Department alleges] S&P knew that certain mortgage securities were doing poorly and might have to have their ratings revised. That month, an analyst who had taken a close look at 2006-vintage securities sent an e-mail to some colleagues with the subject line ‘Burning down the house — Talking Heads,’ according to the complaint. The e-mail reproduced in the complaint read:

Watch out

Housing market went softer

Cooling down

Strong market is now much weaker

Subprime is boi-ling o-ver

Bringing down the house

Hold tight

CDO biz — has a bother

Hold tight

Leveraged CDOs they were after

Going — all the way down, with

Subprime mortgages

Own it

Hey you need a downgrade now

Free-mont

Huge delinquencies hit it now

Two-thousand-and-six-vintage

Bringing down the house

… An analyst who received the lyrics ... subsequently gave a high rating to a security that defaulted the following year, according to the complaint.” (Dealbook, February 5)