April 14, 2019 – Weekly

Misallocation of credit is the topic of a short note of friend Keith Weiner, founder and CEO of Monetary Metals.  A link to the note is at bottom, from which I have copied a graph, below.

This chart shows that nearly 40% of Russell 2000 companies are not profitable even as earnings estimates increase.  There’s another chart which highlights Keith’s main point: the decreasing marginal utility of debt.  That is, increases in debt levels for Russell 2000 companies are generating lower growth levels in earnings.  A dollar in increased debt buys smaller and smaller amounts of increased earnings/growth.

This phenomenon is evident with China’s data released Friday.  The US equity market cheered China’s stimulus, which was reflected in a huge increase in credit.  China’s Aggregate Financing grew 80% yoy in the month of March.  On a quarterly basis (Jan/Feb/March) the yoy growth was 40%!  This data was much stronger than expected.  There comes a time when more debt simply doesn’t address structural issues.  In any case, the ten year yield in China has responded. From a low of 3.07% at the end of March, it ended the week over 3.35%, a gain of more than ¼%.  Since the start of Q3 last year, US, German and Japanese bond yields have been in downward sloping channels.  While China has broken out to the upside, downward trends are still intact in other bond markets (for now).  One other bit of news out of China concerns imports, which were much weaker than expected at -7.6% yoy, the lowest since 2016, and a sign of sluggish consumer demand. 

Another chart which circles back to the idea of misallocation of capital is displayed below from The Daily Shot, which shows that the 5 year yield in Greece has fallen below that of the US.  No further comment.

Last week I mentioned the staggering amount of new money-losing IPOs, with LYFT as the poster child. LYFT has now fallen to 59.90 from an IPO price of 72, and is down by nearly 1/3rd from the high price of 88.60.   

The question is whether high and increasing debt levels, driven in large part by government, are going to spur sustainable growth.  For now, US bond markets don’t appear to be buying into that thesis.  Sure, rates increased across the US curve by 5 to 7 bps this week and by 12 to 15 over the past two weeks, but that’s in the context of SPX and Nasdaq being with a couple percent of taking out last year’s highs.   

From Hoisington’s Q2 review, “Federal debt accelerations ultimately lead to lower, not higher, interest rates.  Debt-funded traditional fiscal stimulus is extremely fleeting when debt levels are already inordinately high.  Thus, additional and large deficits provide only transitory gains in economic activity, which are quickly followed by weaker business conditions.  With slower economic growth and inflation, long term rates inevitably fall.”

An interesting article from the NY Times was brought to my attention: (thanks BCC)  ‘What the Rest of the World Can Learn from the Australian Economic Miracle’.  28 years without a recession!  The author identifies reasons:  good luck, good policy choices and regulations, the growth of China.  “Yet, instead of giddy enthusiasm, what I found in Sydney was a pervasive sense of caution and wariness – and not just involving real estate, though housing does loom large in discussions about the economy.”   What is stunning is that nowhere in the article does the author mention the huge household debt to GDP data.  It’s a glaring omission.  According to various articles. Aussie household debt to GDP has grown to between 122-129% of GDP currently, from 105-110% in 2006.  By way of comparison, it’s about 77% in the US, having peaked around 100% just before the crisis.  Well sure, there’s a pervasive sense of caution when one is saddled with large amounts of debt.  And now housing prices have begun falling.  From January another article mentions: “Household debt [in Australia] towards the end of 2018 was equivalent to 127% of GDP, or 189% of disposable income.  Both of these ratios are near record highs and very high on any global comparison.”  (links below)

Misallocation of capital has been incentivized by governments and central banks.  It continues until it falls under its own weight.  Vice President Pence was the latest to add another couple of straws in an interview with CNBC’s Joe Kernen on Friday.  Paraphrasing, Kernan asked, “if the economy is so great then why is the administration pressuring the Fed to cut rates back to emergency levels?’  Pence responded, “Because there’s no inflation.” Great.


As TYM9 traded around 123-04 Friday, there was a (new) buyer of about 75k TYK 123c, and seller of nearly 100k 124c.  The call spread was legged for 20 to 21, and settled 19 vs 123-03.  May options expire in two weeks, 26-April.  Though it was a weak close across the curve in interest rate futures, further downside is likely limited. 

Odds of a Fed ease are being squeezed out of the market for 2019.  In late March FFF0 had settled at high as 9791.0, more than 30 bps lower in yield than the current Fed Effective, that is, more than one ease.  On Friday, FFF0 settled 9972, essentially pricing 50/50 for an ease this year.  While near term odds of an ease fell, the near one-year Eurodollar spreads still remain around -25 bps.  EDZ9/EDZ0 is the lowest, settling exactly at -25, having been -27 the previous week. 

Shortened week as US markets are closed for Good Friday.  Beware of illiquidity as the week progresses.  

4/05/2019  04/12/2019  
UST 2Y 234.1 239.3 5.2
UST 5Y 231.2 237.5 6.3
UST 10Y 250.1 255.8 5.7
UST 30Y 290.9 297.2 6.3
GERM 2Y -56.8 -55.9 0.9
GERM 10Y 0.6 5.5 4.9
JPN 30Y 54.5 51.6 -2.9
EURO$ Z9/Z0 -27.0 -25.0 2.0
EURO$ Z0/Z1 -1.0 -2.5 -1.5
EUR 112.18 113.01 0.83
CRUDE (1st cont) 63.08 63.89 0.81
SPX 2892.74 2907.41 14.67
VIX 12.82 12.01 -0.81



Posted on April 14, 2019 at 12:21 pm by alexmanzara · Permalink
In: Eurodollar Options

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