August 26th, 2016 6:27 am

Via Marc Chandler at Brown Brothers Harriman:

Dollar Still Rangebound Ahead of Yellen

  • The highlight for today is Fed Chair Yellen’s Jackson Hole speech at 10 AM ET
  • During the North American session, the US reports advanced trade and wholesale inventories for July, Q2 GDP revision, and University of Michigan sentiment
  • The UK reported Q2 GDP
  • Japan reported July inflation figures
  • Local press is reporting that South African President Zuma is planning a cabinet shuffle; Mexico reports July trade

The dollar is softer against the majors in narrow ranges ahead of Yellen’s speech.  The dollar bloc is outperforming while sterling and the Norwegian krone are underperforming.  EM currencies are mixed.  ZAR, PLN, and IDR are outperforming while RUB, CNY, and TRY are underperforming.  MSCI Asia Pacific was down 0.5%, with the Nikkei falling 1.2%.  MSCI EM is up 0.1%, with Chinese markets falling 0.1%.  Euro Stoxx 600 is down 0.1% near midday, while S&P futures are pointing to a higher open.  The 10-year UST yield is down 1 bp at 1.56%.  Commodity prices are mixed, with oil down 0.5%, copper up 0.5%, and gold up 0.4%.

The highlight for today is Fed Chair Yellen’s Jackson Hole speech at 10 AM ET.  Both Dudley and Fischer have already provided their general take on the economic outlook and prospects for a Fed hike this year.  It seems unreasonable to expect Yellen to substantially deviate from their views.

Although a September hike seems unlikely, there is nothing to be gained from Yellen ruling it out.  The Fed wants investors to know that every meeting is actionable, though there is no precedent for a move in November, the month of the US national election.  According to the Fed funds futures, the market has upgraded the odds of a September hike to 32% currently from 18% on August 1 and 26% on August 5 after the US jobs data.

During the North American session, the US reports advanced trade and wholesale inventories for July, Q2 GDP revision, and University of Michigan sentiment.  It’s worth noting that the Atlanta Fed’s GDPNow model now has Q3 SAAR growth tracking at 3.4%, down from 3.6% previously.  The drop was due to weak existing home sales data reported this week.

The UK reported Q2 GDP.  Headline GDP 0.6% q/q, as expected.  Looking at the components, private consumption rose 0.9% q/q vs. 0.8% expected, GFCF (investment) rose 1.4% q/q vs. 0.4% expected, government spending fell -0.2% q/q vs. 0.3% expected, and exports rose 0.1% q/q vs. 0.7% expected.  So far, the post-Brexit economic data have shown resilience and even outright strength.  This should keep the BOE on hold next month.  

German GfK consumer confidence was reported for September.  It came in at 10.2 vs. 10.0 expected.  Yesterday, German IFO confidence came in much weaker than expected for August.  Elsewhere, France reported Q2 GDP.  Growth came in as expected, flat q/q and up 1.4% y/y.  

Japan reported July inflation figures.  The national headline CPI was steady at -0.4% y/y, as expected, while core (excluding fresh food) came in at -0.5% y/y vs. -0.4% expected.  Excluding food and energy, the inflation rate edged down to 0.3% y/y from 0.5% in June, the lowest since October 2013.  Tokyo August headline inflation came in at -0.5% y/y vs. -0.4% expected, which suggests downside risks to the national CPI next month.  Data overall have come in on the weak side recently, feeding market expectations that greater pressure will be on the BOJ for further easing.

Local press is reporting that South African President Zuma is planning a cabinet shuffle.  Potential removals reportedly include the Ministers of Higher Education, Agriculture, Public Works, and Trade and Industry, as well as the Deputy Finance Minister.  No mention of Finance.  While such a move wouldn’t be surprising in light of the recent municipal election losses, investors could still get spooked in the current environment.  Finance Minister Gordhan was not mentioned in the press report, but a recent poll by a major local bank showed that about half the respondents expect him to be eventually removed.  

Mexico reports July trade.  Exports have contracted y/y in 11 of the past 12 months, and the only exception was a 0.3% y/y gain in May.  Petroleum exports have been weak, as one would expect, but non-petroleum exports have also been weak.  Imports have also been contracting, and so deterioration in the trade and current account balances has been limited.  While the sluggish economy is likely to keep Banco de Mexico on hold for the time being, much will depend on the peso.

Some Corporate Bond Stuff

August 26th, 2016 6:00 am

Via Bloomberg:

IG CREDIT: MSFT, GE Cap Long Bonds Topped Most Active List
2016-08-26 09:54:22.153 GMT

By Robert Elson
(Bloomberg) — Secondary IG trading ended with a Trace
count of $14.6b Thursday vs $16.1b Wednesday, $15b the previous
Thursday. 10-DMA $13.4b.

* 144a trading added $1.8b of IG volume vs $2.4b Wednesday,
$1.5b last Thursday

* The most active issues:
* MSFT 3.70% 2046 was 1st with evenly weighted client
flows accounting for 83% of volume
* GE Cap 4.418% 2035 was next with client trades taking
100% of volume
* MS 4.10% 2023 was 3rd with client flows taking 100% of
volume; client buying 3x selling
* MYL 3.95% 2026 was most active 144a issue with client and
affiliate trades taking 100% of volume

* Bloomberg Barclays US IG Corporate Bond Index OAS unchanged
at 136, the low for 2016
* 2016 high/low: 215 (a new wide since Jan. 2012)/136
* 2015 high/low: 171/122
* 2014 high/low: 137/97
* All time high/low back to 1989: 555 (Dec. 2008) / 54
(March 1997)

* Current market levels vs early Thursday:
* 2Y 0.780% vs 0.758%
* 10Y 1.568% vs 1.551%
* Dow futures +7 vs -23
* Oil $47.16 vs $47.00
* ¥en 100.42 vs 100.39

* U.S. IG BONDWRAP: Light Calendar Continues With Only 1 SAS
* August volume $120.3b; YTD $1.14t

QE in Sweden Damages Market Liquidity

August 26th, 2016 5:58 am

Via Bloomberg:
August 25, 2016 — 11:24 AM EDT
Updated on August 26, 2016 — 3:48 AM EDT

The man in charge of managing Sweden’s state debt signaled the Riksbank may soon be reaching the limits of its government bond purchase program amid signs that liquidity is suffering.

“What we’re saying to the Riksbank is that the market is functioning quite well, but that there are risks, looking ahead,” Thomas Olofsson, head of debt management at the Swedish National Debt Office, told Bloomberg.

Riksbank First Deputy Governor Kerstin af Jochnick said last week the bank is probably approaching a limit for how much more in government bonds it can buy. The comments narrowed spreads in the municipal bond market, while government yields rose.

“I have no objection to Kerstin af Jochnick’s reasoning on these issues,” Olofsson said. “If I had thought her reasoning was wrong, I would say so.”

Af Jochnick said the Riksbank could “technically” buy covered bonds, corporate or municipal bonds if needed, as part of its mandate to reach a 2 percent inflation target. The bank has had a negative policy interest rate since February last year.

Monetary policy in Sweden has failed for almost half a decade to drive inflation back to target. The bank this year extended its QE program, targeting about 37 percent of nominal government debt by the end of 2016 and about 9 percent of inflation-linked state paper.

According to Olofsson, one sign that liquidity has deteriorated since the Riksbank started buying bonds two years ago is the decline in volumes for given spreads. There has also been an increase in the number of re-sellers over the summer that have had to ask the debt office for help to deliver government bonds to investors through repo transactions.

“It will be interesting to see during the autumn if we will have to continue to do repos of the present volumes, because that would possibly be an indication that the market isn’t functioning as well as before,” he said.

The Riksbank’s asset purchases have helped push Swedish yields down to historic lows. But Olofsson said he currently sees no reason to issue a 30-year bond since investors haven’t expressed an interest. He said interest rates on outstanding bonds maturing in more than 10 years would have to decline for the debt office to actively ask the market whether there’s enough demand for such bonds.

“We need to focus on maturities that create the foundations for a liquid market and in that context we must focus on ten-year bonds,” he said. “We don’t have the borrowing need required to issue bonds with a lot of different maturities.”

Credit Pipeline

August 26th, 2016 5:42 am

Via Bloomberg:

2016-08-26 09:33:10.669 GMT

By Robert Elson
(Bloomberg) — LATEST UPDATES

* Kingdom of Saudi Arabia (SAUDI), may raise more than $10b
following roadshows in late Sept.
* Said to have hired 6 banks to lead first intl bond sale
(July 14)
* Korea National Oil (KOROIL) Aa2/AA, has mandated
C/GS/HSBC/SG/KDB/UBS for investor meetings to begin Sept. 6;
144a/Reg-S deal may follow
* Pfizer (PFE) A1/AA, to buy Medivation (MDVN) for ~$14b;
expects to finance deal with existing cash
* Moody’s maintained its negative outlook on PFE, saying
low cash levels may “lead to future debt issuance for
US cash needs.”
* Couche-Tard (ATDBCN) Baa2/BBB, expects to sell USD bonds
related to ~$4.4b acquisition of CST Brands (CST) Ba3/BB
* NongHyup Bank (NACF) A1/A+, mandates C/CA/HSBC/JPM/Nom/UBS
to hold investor meetings Aug. 29-Sept. 1; 144a/Reg-S deal
may follow
* Enbridge (ENBCN) Baa2/BBB+, files $7b mixed shelf Aug.22;
$350m maturies Oct. 1
* General Electric Company’s plan to take on additional $20b
of debt could pressure ratings, Moody’s says
* Industrial Bank of Korea (INDKOR) Aa2/AA-, mandates HSBC/Nom
for roadshow from Aug. 22; 144a/Reg-S deal may follow
* Cabot Corp (CBT) Baa2/BBB, filed debt shelf; last priced a
new deal in 2012, has $300m maturing Oct. 1
* Israel Electric (ISRELE) Baa2/BBB-; said to hire C, JPM for
at least $500m bond sale in 4Q


* Sumitomo Life (SUMILF) A3/BBB+; investor mtg July 19
* Woori Bank (WOORIB) A2/A-; mtgs July 11-20


* Analog Devices (ADI) A3/BBB; ~$13.2b Linear Technology acq
* To raise nearly $7.3b debt for deal (July 26)
* Bayer (BAYNGR) A3/A-; said to review Monsanto (MON) A3/BBB+
accounts as bid weighed (Aug. 4)
* $63b financing said secured w/ $20b-$30b bonds seen
* Danone (BNFP) Baa1/BBB+; ~$12.1b WhiteWave (WWAV) Ba2/BB
* Co. Says deal 100% debt-financed, expects to keep IG
profile (July 7)
* Thermo Fisher (TMO) Baa3/BBB; ~$4.07b FEI acq
* $6.5b loans, including $2b bridge (July 4)
* Zimmer Biomet (ZBH) Baa3/BBB; ~$1b LDR acq
* Plans $750m issuance post-completion (June 7)
* Air Liquide (AIFP) A3/A-; ~$13.2b Airgas acq
* Plans to refi $12b loan backing acq via USD/EUR debt
(June 3)
* Great Plains Energy (GXP) Baa2/BBB+; ~$12.1b Westar acq
* $8b committed debt secured for deal (May 31)
* Abbott (ABT) A2/A+; ~$5.7b St. Jude buy, ~$3.1b Alere buy
* $17.2b bridge loan commitment (April 28)
* Sherwin-Williams (SHW) A2/A; ~$9.3b Valspar buy
* $8.3b debt financing expected (March 20)
* Shire (SHPLN) Baa3/BBB-; ~$35.5b Baxalta buy
* Closed $18b Baxalta acq loan (Feb 11)


* IBM (IBM) Aa3/AA-; automatic mixed shelf (July 26)
* Nike (NKE) A1/AA-; automatic debt shelf (July 21)
* Potash Corp (POT) A3/BBB+; debt shelf; last issued March
2015 (June 29)
* Tesla Motors (TSLA); automatic debt, common stk shelf (May
* Debt may convert to common stk
* Reynolds American (RAI) Baa3/BBB filed automatic debt shelf;
sold $9b last June (May 13)
* Statoil (STLNO) Aa3/A+; debt shelf; last issued USD Nov.
2014 (May 9)
* Corporate Office (OFC) Baa3/BBB-; debt shelf (April 12)
* Rogers (RCICN) Baa1/BBB+; $4b debt shelf (March 4)


* Visa (V) A1/A+; CFO says will issue $2b debt for buybacks by
yr end (July 21)
* Investment Corp of Dubai (INVCOR); weighs bond sale (July 4)
* Alcoa (AA) Ba1/BBB-; upstream entity to borrow $1b (June 29)
* GE (GE) A3/AA-; may issue despite no deals this yr (June 1)
* Discovery Communications (DISCA) Baa3/BBB-; may revisit bond
market this yr, BI says (May 18)
* American Express (AXP) A3/BBB+; plans ~$3b-$7b term debt
issuance (April)

CPI in Japan Falls for 5th Consecutive Month

August 26th, 2016 5:35 am

Via Bloomberg:

Japan’s CPI Falls for 5th Month, Raising Pressure on Kuroda
Toru Fujioka
August 25, 2016 — 7:35 PM EDT
Updated on August 26, 2016 — 1:05 AM EDT

Consumer prices in Japan fell for a fifth straight month, underscoring the central bank’s struggle to spur inflation to its 2 percent target. Friday’s figures are the last reading on this key measure before Governor Haruhiko Kuroda and his board consider a possible policy revamp at their next meeting on Sept. 20-21.

QuickTake Abenomics
Key Points

Consumer prices excluding fresh food, the Bank of Japan’s core gauge, dropped 0.5 percent in July from a year earlier (estimate -0.4 percent).
Decline was the biggest since March 2013, the same month Kuroda became BOJ governor.
Consumer prices overall slipped 0.4 percent (estimate -0.4 percent).
Consumer prices excluding food and energy rose 0.3 percent (estimate +0.4 percent).

Big Picture

After more than three years of unprecedented monetary stimulus, the BOJ is no closer to its price target and investors are asking whether the central bank is running up against the limits of its effectiveness. Kuroda has ordered a comprehensive assessment of policy that may result in further monetary easing, according to economists surveyed by Bloomberg. The yen’s gains this year, weak exports and fragile consumer spending at home are adding to the BOJ’s woes.
Economist Takeaways

“Given Kuroda has said he will act if the price target is in danger, today’s data confirms he has to take action again,” said Nobuyasu Atago, chief economist at Okasan Securities, previously head of the BOJ’s price statistics division. “The strong yen is a big factor dragging on price growth and that is expected to continue.”
“The problem for the BOJ is, the Bank of Japan has pretty much exhausted all of its monetary policy tools to reflate the economy,” said Takuji Okubo, chief economist at Japan Macro Advisors.

The Details

The BOJ released an alternative index that excludes fresh food and energy later Friday. It showed prices rose 0.5 percent in July.
The yen has gained about 20 percent in 2016 against the dollar, reducing inflationary pressures from imports while hurting export-dependent companies.
This month’s statistics reflect an adjustment in the base year for the price data to 2015, from 2010 previously.
The BOJ current forecast for when it expects to reach its 2 percent inflation target is sometime in fiscal year ending in March 2018.

UK Consumer Confidence Rebounds Post Brexit

August 26th, 2016 5:16 am

Via Bloomberg:

  • Sentiment rebounds from 3-year low in aftermath of referendum
  • Britons yet to feel tangible impact of vote: YouGov’s Harmston

U.K. consumer confidence rose the most in more than three years this month as the initial shock from Britain’s decision to leave the European Union faded.

An index of sentiment by YouGov and the Centre for Economics and Business Research jumped to 109.8 from 106.6 in July, which was a three-year low. The gauge is still below the level it was a year ago.

While the Brexit vote initially knocked sentiment, it’s not yet clear how this might ripple into economic activity. The Bank of England took pre-emptive action in early August, cutting interest rates and restarting quantitative easing to counter any slowdown. Measures of household confidence plunged in July, while retail sales actually surged that month as warm weather fueled food and clothing sales.

“For all the talk of doom and gloom — both in the months leading up to the referendum and in the days following it — most consumers have yet to feel much tangible impact of the vote,” said Stephen Harmston, head of reports at YouGov. “It’s clear that the panic that gripped the public in the immediate aftermath of the referendum has subsided as institutions like the Bank of England take decisive action and the result becomes a part of life.”

The economy could still take a real hit from Brexit. The BOE cut its 2017 growth forecast to 0.8 percent this month, just one third of the pace it previously predicted. “Everything could change once details of the deal to leave the EU emerge and the process of extracting ourselves from the Union become a reality,” Harmston said.

Healthcare Spending Takes Pound of Flesh From Middle Class

August 26th, 2016 5:08 am

Via WSJ:
By Anna Louie Sussman
Updated Aug. 25, 2016 7:22 p.m. ET

Growth in overall health-care spending is slowing, but middle-class families’ share of the tab is getting larger, squeezing households already feeling stretched financially.

Overall, health-care spending across the economy reached 18.2% of gross domestic product as of June, up from 13.3% in 2000, according to Altarum Institute, a health research group.

However, the mix of who pays has evolved. The government has taken on a larger share in recent years as more people age into Medicare, and the Affordable Care Act expanded Medicaid and provided subsidies for low-income people buying insurance on state exchanges. Middle-class households are finding more of their health-care costs are coming out of their own pockets.

David Cutler, a Harvard health-care economist, said this may be “a story of three Americas.” One group, the rich, can afford health care easily. The poor can access public assistance. But for lower middle- to middle-income Americans, “the income struggles and the health-care struggles together are a really potent issue,” he said.

A June Brookings Institution study found middle-income households now devote the largest share of their spending to health care, 8.9%, a rise of more than three percentage points from 1984 to 2014.

By 2014, middle-income households’ health-care spending was 25% higher than what they were spending before the recession that began in 2007, even as spending fell for other “basic needs” such as food, housing, clothing and transportation, according to an analysis for The Wall Street Journal by Brookings senior fellow Diane Schanzenbach. These households cut back sharply on more discretionary categories like dining out and clothing.

Workers aren’t the only ones feeling the pain of rising health-care costs. Employers still typically pay roughly 80% of individual health-insurance premiums, a share that has held fairly steady in the past five years, thanks in part to changing plan designs that shift more costs to workers, said Beth Umland, director of research on health and benefits at Mercer US Inc.

For many of the 55% of Americans under 65 covered through an employer, plans are getting stingier.

The Kaiser Family Foundation, a health-care research nonprofit, found deductibles for individual workers have soared in the past five years, rising 67% since 2010 without adjusting for inflation, roughly seven times earnings growth over the same period. A separate Kaiser analysis of tens of millions of insurance claims found patient cost-sharing rose by 77% between 2004 and 2014, driven by a 256% jump in deductible payments.

“The growth in deductibles for workers shows no sign of slowing,” said Larry Levitt, senior vice president at the foundation. “What consumers have been paying has been going up much faster than wages. Even people who are insured are having problems paying medical bills.”

Rising out-of-pocket health-care costs, combined with slow economic growth and years of tepid wage growth, pose risks for an economy in which consumer spending accounts for more than two-thirds of overall output, economists say. In 2015, 8% of Americans’ household spending went toward health care, up from 5.8% in 2007, according to the Labor Department.

Health care costs are “eating up a larger share, and it means less money for other things,” said Diane Swonk of consultancy DS Economics.

Economists say the increased burden on middle-class households may be partially responsible for a broader moderation in health spending, as they use health care more judiciously.

That is the case for Cindy Sikkema, a 47-year-old writer in Boise, Idaho. When her husband’s employer eliminated their previous health-insurance plan, they chose one of the company’s new offerings for its lower monthly premiums, despite a deductible of $6,850. After getting hit last year by a $1,500 bill for a diagnostic mammogram, they choose carefully when to see a doctor.

“Just to step into the office it’s $180 to see the doctor,” she said, instead of a $20 or $30 co-pay under the old plan. “We’re feeling the impact of every little medical decision we make, because it’s all straight out of our pocket first.”

For the Sikkema family, their higher health-care costs have meant avoiding buying anything new in favor of shopping at consignment stores and garage sales. She and her husband will skip travel overseas this year and go camping instead. They spend more time fishing and elk hunting to avoid buying meat at the supermarket.

“It’s not like we’re spending tens of thousands more, but it’s just enough that it changes everything,” said Ms. Sikkema, acknowledging the impact was as much psychological as financial.

In addition, price increases for prescription drugs have been accelerating. The average price of brand-name drugs rose 16.2% in 2015, and is up 98.2% since 2011, according to drug-benefits manager Express Scripts Holding Co.

While prescription drugs are a relatively small share of national health-care spending, roughly 10% in 2015 according to the Centers for Medicare and Medicaid Services, they’re “a very visible expense for consumers,” Mr. Levitt said.

In the 15 years since B.J. Welborn, 66, started taking the leukemia medication Gleevec, its list price has risen from under $24,000 for a year’s supply, to over $121,400, according to drugmaker Novartis. Now on Medicare, Ms. Welborn has a co-pay of $491 for a 30-day supply of Gleevec, seven times the co-pay on her old Blue Cross Blue Shield plan. She estimates she now pays between $11,000 and $12,000 a year for the drug.

“I look at my college roommates…they’re traveling, they go see their grandchildren, they go to Europe,” she said. “I did not picture retirement as a trip into anxiety and sometimes fear. I thought I was set.”

Write to Anna Louie Sussman at anna.sussman@wsj.com

Giant Japan Pension Fund Takes Hit in Q2

August 26th, 2016 5:02 am

Via Bloomberg:
World’s Biggest Pension Fund Loses $52 Billion in Stock Rout
Yuko Takeo
Shigeki Nozawa
August 26, 2016 — 2:30 AM EDT
Updated on August 26, 2016 — 3:16 AM EDT

Japan’s GPIF wipes out all gains since shift to shares
Investment losses are no reason to change strategy: Sera


The world’s biggest pension fund posted a $52 billion loss last quarter as stocks tumbled and the yen surged, wiping out all investment gains since it overhauled its strategy by boosting shares and cutting bonds.

Japan’s Government Pension Investment Fund lost 3.9 percent, or 5.2 trillion yen ($52 billion), in the three months ended June 30, reducing assets to 129.7 trillion yen, it said in Tokyo on Friday. That erases a 4.1 trillion yen investing return for the previous six quarters starting October 2014, the month it decided to put half its assets into equities.

The quarterly decline follows a 5.3 trillion yen loss in the fiscal year through March, the worst annual performance since the global financial crisis. After benefiting from a surge in Japanese equities and a weaker yen earlier in Prime Minister Shinzo Abe’s term, GPIF has posted losses as domestic stocks tumble and gains in the currency reduce the value of overseas assets. Still, for Sumitomo Mitsui Trust Bank Ltd., that’s no reason to veer from the current approach.

“Since its investments are tied to market moves, it’s natural that this would happen and there’s no point looking at it with a short-term view,” said Ayako Sera, a Tokyo-based market strategist at the bank. “GPIF is so big that its losses look huge even though the fluctuations in its investments just mirror the market.”

The fund’s Japanese shares sank 7.4 percent in the period as the benchmark Topix index lost 7.5 percent. More than 80 percent of GPIF’s local equity investments are passive. Overseas stocks lost 7.8 percent, while foreign debt fell 8 percent, as the yen surged 9.1 percent against the dollar. The only asset class to post a profit was domestic bonds, which rose in value as the Bank of Japan’s negative interest rates sent yields lower.


“We invest with a long-term view,” President Norihiro Takahashi said in a statement Friday. “Even if market prices fluctuate in the short term, it won’t damage pension beneficiaries. We are also strengthening risk management and continuing to hire experts.”


GPIF held 21 percent of investments in local stocks at the end of June, and 39 percent in domestic bonds. Overseas equities made up 21 percent of assets, while foreign debt accounted for 13 percent. Alternative investments were 0.05 percent of holdings, down from 0.06 percent at the end of March. GPIF targets allocations of 25 percent each for Japanese and overseas stocks, 35 percent for local bonds and 15 percent for foreign debt.

In a briefing about the results, GPIF official Shinichiro Mori said he was more positive about the outlook for returns this quarter. The Topix has climbed 3.4 percent since the start of July.

“The U.K.’s decision on Brexit was a surprise for the market, but it has mostly priced that in and calmed down,” Mori said. “Stocks are on the verge of rebounding. Still, the yen is continuing to trade sideways against the dollar, so we are cautiously watching

Wall of Worry Dismantled

August 25th, 2016 5:51 pm

Via Barron’s:

Hulbert on Markets

Uh Oh, the Wall of Worry Just Came Tumbling Down

Whenever market timers have been this bullish in the past, the market was headed for a fall.

Updated Aug. 25, 2016 11:36 a.m. ET

Getty Images

Bullishness on Wall Street has soared over the past two months as the stock market has climbed to all-time highs.

Some might even call the prevailing mood “irrational exuberance.”

Regardless of what you call it, it bodes ill for the stock market’s near-term future, according to contrarian analysis. It means that the “Wall of Worry” that bull markets like to climb has largely — if not completely — disappeared. In short, the theory is that if everyone is bullish, there is no one left to buy, and the sellers can take control.

Consider the average recommended exposure level among a subset of short-term market timers who focus on the Nasdaq stock market (as measured by the Hulbert Nasdaq Newsletter Sentiment Index, or HNNSI). Since that market responds especially quickly to changes in investor mood, and because those timers are themselves quick to shift their recommended exposure levels, the HNNSI is my most sensitive barometer of investor sentiment.

This average currently stands at 80.6%, having recently gotten as high as 83.3%. That reading is higher than the highest level to which the HNNSI rose at the tops of the last four bull markets. The average of those sentiment peaks was 60%, far below today’s levels.

An equally telling contrast: The HNNSI fell to minus-55.56% in the panic selling after the U.K. Brexit referendum, indicating that the average Nasdaq-focused market timer was allocating more than half his equity portfolios to going short — an aggressive bet that the market would continue falling.

Contrarians, on the contrary, forecasted a powerful rally, which of course is precisely what ensued.

But with the HNNSI nearly 140 percentage points higher today than then, contrarians have long since stopped singing a bullish tune.

To be sure, extreme levels of bullish sentiment don’t immediately doom the market. On average since I began tracking the investment newsletter industry in the 1980s, bullish sentiment reached its peak between two and three weeks prior to the market itself. This is an average, however, and in some cases the lead time was greater; the longest since the mid-1980s was nine weeks.

Recent high sentiment readings have persisted since mid-July. The HNNSI has been above 70% since July 12, in fact; far from falling, the stock market has held its own. The Dow Jones Industrial Average today is up 0.7% since then; the Nasdaq is 3.7% higher.

Note that even though the five weeks since mid-July are longer than the average lead time between sentiment peak and market top, the elapsed time is still very much within the historical range of past tops. And that means stock market risk is very much above average right now.

Consider the stock market’s returns on those past occasions when the HNNSI was also high. Since 2009, the Wilshire 5000 index has produced an average one-month return of just 0.6% whenever the HNNSI was above 70%. In contrast, whenever the sentiment index was below zero, the subsequent one-month gain averaged 3.3%. An even bigger contrast emerged at the three-month horizon.

These differences are highly significant, at the 95% confidence level that statisticians typically use to determine that a pattern is genuine.

Is there any way the stock market can wriggle out from underneath the indicator’s discouraging message? Of course. Not all measures of sentiment are showing extreme bullishness right now (though most are showing above-average optimism). And, to be sure, sentiment is not the only thing that makes the world go ‘round.

It’s also worth noting that the HNNSI’s extreme could be worked off by an extended trading range market rather than a severe decline. It would take longer in that scenario for the Wall of Worry to be rebuilt, of course, but after a long-enough period in which the market goes nowhere, the bulls would begin to throw in the towel.

A quicker resolution of today’s extreme bullishness would be for a short but severe market drop that reacquaints traders with fear rather than their current greed. If and when that happens, contrarians will return to the bullish camp.

Yellen Preview

August 25th, 2016 3:11 pm

Via Stephen Stanley at Amherst Pierpont Securities:

Fed Chair Yellen has been silent since her semi-annual Congressional testimony in June.  To put that in perspective, the last time we heard from her was just before the Brexit vote.  Clearly, a lot has happened since then, so market participants are extremely eager to get an updated assessment of the near-term monetary policy outlook from the Fed Chair when she addresses the annual Jackson Hole Economic Symposium tomorrow morning.

Unfortunately, if market participants are expecting her speech to feature a detailed blow-by-blow account of the current economic situation and near-term policy prognosis, they are likely to be sorely disappointed.  Jackson Hole is an academic seminar and after it went Hollywood a bit under Greenspan and Bernanke, Chair Yellen and KC Fed President George (the host) have sought to get back to a more scholarly approach with a lower profile with respect to the press and market participants.  Thus, it is important to put what you hear in context.  The theme for the weekend is “Designing Resilient Monetary Policy Frameworks for the Future.”  Moreover, Yellen’s speech topic is “The Federal Reserve’s Monetary Policy Toolkit.”  Obviously, this is more of a long-term topic, and I expect the sessions (and Yellen’s speech) to focus primarily on a very broad discussion of how the Fed can navigate a world where equilibrium interest rates are lower and thus the zero bound may come into play more often.  SF Fed President Williams posted an Economic Letter at the beginning of last week that spoke directly to this topic.  Market participants concluded, based on a couple of newswire headlines (most notably, Williams suggesting that the Fed should debate whether to raise its inflation target to create more distance from the zero bound), that Williams had become a raging dove.  When he gave a speech on the near-term outlook a few days later, it was discovered that the “dovish” label was woefully misapplied, as he argued for a rate hike “sooner rather than later.”

The Williams episode offers a key lesson for market participants heading into Yellen’s speech.  Just because she discusses a lower long-term equilibrium interest rate does not mean that she wants to leave the funds rate at 0.375% for the foreseeable future.  Keep in mind that the latest set of FOMC projections put the long-run neutral funds rate at 3.75%.  So, the fact that the Fed is likely to revise that figure down in the coming quarters is no reason for the bond market to rally, especially given that the markets are already pricing for what strikes me as a ridiculously dovish scenario (fed funds and Eurodollar futures are pricing in only half of a quarter-point tightening per year for as far as the eye can see).  And just because Yellen talks about the tools the FOMC might use to deal with another brush with the zero bound in the next cycle should not be interpreted as evidence that the Fed never intends to raise rates again in the current cycle.  However, I fear that may be exactly what the market reaction is at 10:01 tomorrow.

In a vacuum, that might have been the end of my preview.  However, the set-up for tomorrow simply begs for Yellen to digress from her announced topic and talk at least a little bit about the current policy landscape for two reasons.  First, she has been silent for over two months.   People desperately want to know what she thinks.  Second, several of her closest colleagues on the FOMC, Dudley, Williams, and Fischer, have spoken about the near-term outlook in the past two weeks and were all more hawkish than the markets expected.  Each of them left the distinct impression that the FOMC wants to get another rate hike in before the end of the year, though of course no one is willing to get pinned down on timing.  Yellen has been around long enough to know that if she says nothing about the current situation, market participants will likely interpret that as an implicit disagreement with the developing FOMC consensus.  Mind you, she does not have to say very much or get very specific.  A mere paragraph on the current situation that ends with “if the data are consistent with our expectations, a rate hike may be warranted before year-end.”  Certainly, if the Fed Chair had decided that she wanted to push for a September rate rise, then, of course, she would almost be compelled to send a strong signal tomorrow.  I highly doubt that Yellen is going to favor a move at next month’s FOMC meeting, though there will clearly be a number of participants pushing for one (8 out of the 12 Fed Bank Boards asked for a discount rate hike in advance of the July FOMC meeting).  I continue to believe that the Fed will go in December instead, but if Yellen fails to sustain the notion that a rate hike this year is a reasonable bet, then traders are likely to conclude that she is content to stand pat for the rest of the year, especially if her discussion of the longer-run prospects for policy has a dovish tone (low neutral rates, zero bound, etc.).  A scenario where Yellen abstains from providing any near-term policy guidance, which I think has a probability of significantly above zero, would risk creating a much larger version of the unnecessary round trip in market rates/Fed expectations that occurred last week on Williams’ two releases.