Oct 23. Boomerang
Last week I cited news reports that Vice President Joe Biden warned Russia that the US was considering cyber attacks against Russia. And on Friday the US itself was subject to a massive cyber interruption. Hey Joe, you pushed the wrong button. I guess we’re lucky he didn’t threaten someone with nuclear annihilation.
Below is an updated chart I trot out every so often, SPX divided by the Bloomberg Commodity Index, which points up the idea of financial asset inflation.
One interesting aspect of this chart is that it seems to have stalled from late 2015 until now, perhaps as a result of the slow turn in perceptions of central bank omnipotence. Of course, as energy is 31% of the BCOM index, the surge in late 2015 can be partially attributed to oil’s plunge. What brought this topic to mind was a question posed to Draghi at last week’s ECB press conference about the effect of QE on income inequality. Draghi pretty much dismissed the question, but did say that while the ECB may generate some wealth inequality in the short run, there’s scant longer term evidence. Obviously, this chart provides a clue that equity holders have outpaced the pack, but there are other factors at play as well. For example, information technology has become much more valuable than ‘things’. In addition, there’s a long running theme that new technologies have displaced bulky, commodity-dependent products, for example, a cell phone and earplugs have now replaced a turntable, shelves of vinyl, speakers, a tuner and tape deck; the accoutrements of a previous day (actually the picture below shows the audio equipment at my local coffee shop Alchemy; the vertical turntable IS pretty cool). Given that phones now hold files and mail and music, it sort of makes me wonder why every idiot on my train is lugging around a wheeled suitcase and huge backpack, but I suppose that’s a question for a later time.
In any case, the Fed has necessarily become preoccupied with the prices of financial assets. In the current environment of declining earnings and record corporate debt loads in the context of an equity market valued near a record pct of GDP (now ~120%) it all feels a bit top heavy.
The diminished importance of ‘things’ is likely disinflationary, as are the well-known factors of demographics and a stronger US dollar (China’s currency fell to a new low last week). However. as SF Fed president Williams noted, “There’s no question that US wage growth is picking up.” Government ‘fixes’ in health and education have spurred rapid price increases in medical care, insurance, and tuition. Also, M2 has accelerated from below 6% growth at the end of 2015 to 7.4% now, the fastest since early 2013. The prospect of fiscal infrastructure spending and increased budget deficits are additional factors that might make investors shun long duration, which is why I continue to favor long curve trades.
Many investors have been beaten down into central bank price distortion hell, as has been reported extensively, most recently in a Bloomberg article (linked below) with snippets like this, “…the 57-year-old manager says the past few years have been the most perplexing of his career.” It seems as if smothered volatility has been a frequent feature of this landscape, clearly on display in interest rates this week. For example, on Thursday TYZ 130.5 straddle was 1’20, it settled 1’12 on Friday. Two Fridays ago the atm USZ straddle (165 strike) was 4’54, on Friday the same strike (also atm) closed 3’40 (25% decline…about equal to the loss in days, but the relationship isn’t supposed to be linear with this much time left). There was huge selling of EDH7 9900^ last week, with a settlement of 14.5, down from 16.5 the previous Friday. Ten year vol is near multi-year lows sub 4% and the bond contract is nearing 9%! Of course, it’s not just rates. Crude oil is near a two year low (using the CBOE Oil ETF VIX). Same with stocks. A friend mentioned Friday that he had bought one week (week 4, October) 2050 puts for just 0.35. “…easily the lowest pricing of puts with a week left that I have ever seen.” These puts were 4% out of the money on Friday. Perplexing.
One last note. The euro closed below 109, near the low for the year and below the Brexit low, as the trade deal between Canada and the EU fell apart. Annus horribilis for the euro, with Brexit, ongoing problems with commercial banks, and now this. From Wikipedia, “the phrase was used in 1891 to describe 1870, the year in which the Roman Catholic church defined the dogma of papal infallibility.” Perhaps now it will refer to the failures of central banks and other over-reaching institutions. On the other hand, the Chicago Cubs are in the World Series!
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| 10/14/2016 | 10/21/2016 | chg | |
| UST 2Y | 83.5 | 82.3 | -1.2 |
| UST 5Y | 127.8 | 124.3 | -3.5 |
| UST 10Y | 178.9 | 173.8 | -5.1 |
| UST 30Y | 255.2 | 249.2 | -6.0 |
| GERM 2Y | -65.9 | -66.1 | -0.2 |
| GERM 10Y | 5.8 | 0.6 | -5.2 |
| EURO$ Z6/Z7 | 19.0 | 16.5 | -2.5 |
| EURO$ Z7/Z8 | 16.5 | 15.0 | -1.5 |
| EUR | 109.72 | 108.84 | -0.88 |
| CRUDE (1st cont) | 50.75 | 50.85 | 0.10 |
| SPX | 2132.98 | 2141.16 | 8.18 |
| VIX | 16.12 | 13.34 | -2.78 |
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