European financials started to rollover last fall, before US banks followed suit. We are seeing the same pattern today (chart below). Strong sell signals in the Eurozone financials have us on alert, our Lehman systemic risk indicators are on the rise.
1 Year Chart of US Financials vs European Financials
Continue reading Happy Days Aren’t Here to Stay
Last July and again in December, as credit risk was surging globally, we strongly recommended our subscribers take down risk to equities.
“US equity markets continue their slow climb higher, pushing the S&P 500 back near the highs, while the junk bond market is selling off”. – Bear Traps July 24, 2015
The chart above is a look at European and Asian 5 year CDS’ credit risk on banks this morning. Notice the correlation among these credits are still high.
It’s still too early to tell the side effects of Negative Rates in Japan but there is no doubt, many participants are losing faith in central banks, putting a bid under gold as the “fear trade” and leading to more misallocations of capital.
As long as commodities stay at depressed levels, volatility and Credit Default Swaps on Banks will remain expensive.
In simple terms, a Credit Default Swap (CDS) is a hedge against an asset falling in price. When an investor assumes a company or security (i.e. bonds) may default, investors will buy insurance protection in the form of a Credit Default Swap to protect against loss. When the price of a CDS rises it is a sign that a default has a higher probability.
Over the last few days, 5 year Credit Default Swaps on US banks have come in substantially (less expensive meaning less risky), leading to a rally in equities globally.
However, Asian credit, especially Japanese banks are still at elevated levels. Meaning the recent surge in stocks isn’t confirming what credit is suggesting. Therefore, all rallies will remain suspect and should be sold until the price of CDS on banks (insurance protection) falls.
Continue reading What’s Japan telling us about US Equities?
Special thanks to our friend, macro maven Brian Yelvington for his contribution to this piece
On the seventh anniversary of the implosion of Lehman Brothers, an event that rocked the global economy, it’s more than ironic that the main topic of global financial discussion has been a rate hike by the Federal Reserve. Behind the scenes, more interesting is the growing list of risks which may be tying the FOMC’s hands behind their back.
The Fed should have hiked rates in 2012, but every day they put off the rate raise, Lehman-like systemic risk is lurking and rising. It’s a Colossal Failure of Common Sense all over again.
With all the debate about what exactly the Federal Reserve should do with short-term interest rates, historical perspective is something that’s being left behind.
Continue reading Stuck At Zero: Global Risks Have Tied The Fed’s Hands
“A democracy will continue to exist up until the time that voters discover they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy, which is always followed by a dictatorship.”
Alexis de Tocqueville 1835
As we head into 2014, you may be asking why we are concerned about a small island located in the Caribbean Sea, about a thousand miles southeast of Miami. Geographically, it is a mere speck on the map… practically irrelevant. In fact, 70 islands the size of Puerto Rico could fit comfortably into the state of Texas. However, the debt burden currently burying this economy may eventually send nasty tremors into the United States’ municipal bond market.
Surprisingly, of all the US muni bond funds, a staggering 75% of them are lending money to Puerto Rico, leaving millions of US investors and a large portion of US brokerage accounts exposed to this beleaguered little island. We suspect Puerto Rico will become America’s Greece. If swans could fly this far south, they would without question be the color of night.
2014 Tail Risk
Texas’s state government debt is relatively modest, near $40 billion, or $1,577 per resident. Puerto Rico’s public debt of $53 billion is nearly $15,000 per person, but when we add inter-governmental debt the mountain rises to $70 billion, or $17,500 per person. Throw in a violently under-funded pension and healthcare obligations, the noose approaches $160 billion. That’s $46,000 per person, enough to make one think about trying a swim for Miami.
Quantitative Easing: Deadly Side Effects
Puerto Rico, a mere rectangle 100 miles long by 35 miles wide, the smallest and most eastern island of the Greater Antilles, is the 3rd largest municipal bond issuer after California and New York. That is a mind-blowing statistic. But Puerto Rican bonds are free from all State, Federal and local taxes, a very attractive investment for US investors with a thirst for yield. This is one side effect of low interest rates and quantitative easing coming out of the Federal Reserve; American investors have become this island’s great enabler from the north. Similar to 2007, when investors were reaching for yield in toxic subprime mortgage CDOs, today this song is playing again. This time in Spanish. A colossal reach for yield has enabled politicians in Puerto Rico to run up a dangerous bill, and the music is about to stop.
Continue reading COULD A PUERTO RICO DEFAULT HAMMER THE $3.7 TRILLION U.S. MUNI BOND MARKET IN 2014?
