Sevens Report 7.22.13

Sevens Report 7.22.13

Boring But Important: ECB Relaxes Collateral Rules

This news hit wires pretty quietly Thursday, but the ECB took action to help solve a major issue that is impeding the recovery in Europe.

One of the problems I and others have been discussing for some time in Europe is the inability for very cheap money (low interest rates) to get into the hands of so- called “SMEs,” or small to medium enterprises.  The idea was supposed to work like this:  The ECB lends money to banks at virtually 0%, and banks provide current loans (mortgages, inventory loans, etc.) as collateral for the funds.  The banks are paying virtually 0% for the money, and they can then turn and lend it to the SMEs (or the real economy) at a higher rate, and everyone wins:  The SMEs get fresh capital to invest and expand, the banks make a spread on the loans, and the ECB helps revive the EU economy.

Here’s what’s been happening instead: Cheap funds from the ECB have been staying on bank balance sheets. It’s not because of the “evil bankers”; it’s because a lot of the ECB’s new rules require greater capital ratios, and the ECB won’t accept certain types of loans as collateral for cash, which smaller commercial banks can then lend out to “SMEs,” which will hopefully stimulate the economy.  So, like most things fiscally speaking in Europe, it was a “one foot in, one foot out” approach, and that’s why it hasn’t worked.

Well, yesterday the ECB took two steps to help change that.  First, they relaxed some of the ratings requirements on certain loans that could be pledged as collateral for cash loans to these central banks.  Second, the ECB realized “haircuts” on asset-backed securities pledged as collateral for loans from the ECB to these commercial banks.

Previously, because asset-backed securities are deemed riskier, if I were a commercial bank and had a 100-million-euro loan from a car dealer secured by the inventory, I could pledge that to the ECB to get fresh capital to lend. But I wouldn’t get 100 million; I’d only get 75 million or 80 million, because the ECB imposed a “haircut” in the loan to insulate it from losses.  (I’m making up the numbers, but it illustrates the point.) Well, that “haircut” made it not worth it to me economically, so I didn’t do it.  Now, with haircuts on asset-backed securities reduced, this is a viable option, and it is one of the better ways to help get all this cheap money in the hands of SMEs (or the “real” economy) and break the capital logjam at the banks.

So, yesterday’s news was positive for two reasons:  First, it’ll help the EU economy.  Second, it implies the ECB is still working on ways to stimulate economic growth in the EU, and it will boost expectations that more plans may be announced at the ECB meeting in August.

Bottom line, though, this is a positive for, first, European banks and, second, the European economy.  And, it’s more of a tailwind on my “long” UK idea (ETF symbol EWU, the iShares MSCI United Kingdom Index).  While it doesn’t really affect the UK, it’s peripherally positive.

Sevens Report 7.19.13

Sevens Report 7.19.13

Sevens Report 7.18.13

Sevens Report 7.18.13

Money is Rotating out of Bonds, Here’s One Group of Stocks that Should Benefit.

Riding The “Great Rotation”

The “Great Rotation” is a clever name given to the expected move by investors out of fixed-income investments and into equity investments over the next few years as the bond market continues to decline.

But, like most major trends in the markets, this rotation has been slow to materialize (people have been looking for it since January/February).  But, after bond yields spiked higher in June, talk of the “Great Rotation” is back on—especially following the highly publicized $9.6 billion outflow from the PIMCO Total Return Bond Fund in June.  But, while that grabbed all the headlines, PIMCO wasn’t the only company seeing investors move out of flagship bond funds.

Outflows from fixed-income firms in June were widespread:  $14.2 billion from PIMCO, $9.8 billion from Vanguard, $6.4 billion from BlackRock and $5.3 billion from Fidelity (data according to Morningstar).

I have no idea whether this rotation out of bonds and into equities is going to be “Great.” (I don’t presume to be that smart—there are many nuances to consider in people’s asset allocations, not the least of which is a retiring baby boomer generation).  But, whether the rotation is “Great” or not, I do think we will see some rotation, and there may be an opportunity to make money off of that over the coming quarters in the asset-management space.

Keep this in mind:  Since 2009, fixed-income fund flows have been approximately $1.25 trillion, or five times the amount of the preceding five-year period (2004—’09). Conversely, equity fund inflows since ’09 were just $250 billion, which is one-third the amount of money taken in by equity funds during the ’04-’09 period.  So, if we just assume a simple reversion to the mean, you can make the case for equity asset-management shops to outperform over the coming months and quarters.

As a result of this, we should then expect potential underperformance of “bond-heavy” asset managers, and outperformance of “equity-heavy” asset managers, as over time money continues to move out of bond funds and into equity funds.

We’ve already started to see this divergence occur.  Equity-heavy managers like Affiliated Managers Group (AMG), T. Rowe Price (TROW) and Waddell & Reed (WDR)—which have the heaviest mix of equity Assets Under Management compared to debt—are at or near 52-week highs. Meanwhile bond-heavy managers like Franklin Resources (BEN), Legg Mason (LM) and, to a lesser extent, BlackRock (BLK) have underperformed.

But—I am not really a single-stock guy and it’s somewhat simplistic analysis, so I would strongly suggest doing some more homework on these names before doing anything. But, I do think these names are at least a starting point to craft a strategy (either getting long the “equity-exposed” AMs, short the “debt-exposed” AMs, or a pair trade of both).

Finally, the “equity”-focused names are all at or near 52-week highs, so in the short term they are overbought. You may want to wait for a correction (which we might get on a bounce in yields).  But, I don’t think we’ve missed the boat on this trade, seeing as the actual “rotation” hasn’t even really started yet.

Sevens Report

Sevens Report 7.17.13

Sevens Report 7.16.13

Sevens Report 7.16.13

Sevens Report 7.15.13

Sevens Report 7.15.13

Missed Profiting from the Bond Market Selloff? Here’s Your Chance to Get In.

The key here remains that the equity market continues to get more comfortable with the reality of “tapering.”  Keep in mind that the market broke from its highs almost two months ago on the Hilsenrath WSJ article that said the Fed was game planning its exit, so markets have been adjusting to this new Fed reality, sometimes violently, for 2 plus months.

So, as long as current expectations are generally met:  “Tapering” starting in September, QE ending in mid/early ‘14, then what will decide if this market moves to new highs or not is boring old economic data and earnings.  As long as rallies in bond yields and stocks are no longer mutually exclusive, as they have been since May, and emerging market bonds continue to stabilize (they don’t have to rally, they just have to not implode) then the path of least resistance for the market is higher, as long as the data is “ok”.

1650 is a key level in the S&P 500 and we’re going to open well above it this morning.  A strong close today and tomorrow could bring in momentum buyers off the sidelines and accelerate the rally into the end of the week, so that’s an important level to watch.

The analysis of the Fed minutes yesterday caused a bit of whiplash. Initially, the takeaway from the minutes was that they were “dovish,” and we saw stocks move higher and Treasuries rally/yields fall.

But, that interpretation was incorrect (as is often the case with initial interpretations of anything Fed-related). That’s why there is a popular trading axiom that states “the first move of the market after a Fed event is usually the wrong one.”

What the speed-reading programs and analysts didn’t see—in their “dovish” interpretation—was that, buried in the appendix, was this passage:

“Given their respective economic outlooks, all participants but one judged that it would be appropriate to continue purchasing both agency mortgage-backed securities and longer-term Treasury securities.

“About half of these participants indicated that it likely would be appropriate to end asset purchases late this year. Many other participants anticipated that it likely would be appropriate to continue purchases into 2014.” (Emphasis added).

Remember back to Ben Bernanke’s press conference after the Federal Open Market Committee statement.  What surprised the market was that Bernanke said the broad consensus of the Fed was that QE should end in mid-2014, which was earlier than the consensus thinking at that time. (Consensus was for QE to end in late ’14.)

Well, the “end date” of QE may be closer than “mid” 2014, depending on data, which is trending better since the last Fed meeting.

Of the 19 participants at the meeting, at least one leans toward QE ending immediately.  Of the remaining 18, “about half” thought QE should end later this year, presumably at the December meeting.

That’s another “hawkish” surprise, and we did see the effects of it when Treasuries sold off into the close and the Dollar Index pared some losses.  Now, does that mean QE will end in December?  Probably not, as Bernanke/Yellen and Dudley still dominate the Fed and they are doves.

But,  for all the gaming of the Fed, the takeaway here is that “tapering” remains very much on schedule, and it would appear that the risk is for QE ending sooner than current expectations, rather than later.

So, with regard to the market, the minutes only further reinforced the fact that interest rates are going higher as is the U.S. Dollar, unless economic data turns decidedly worse.  So, in my opinion, today’s Dollar Index decline and Treasury rally is doing nothing other than providing a great entry point to get exposure to the most powerful trends in the market:  Higher rates, which strengthens the bullish case for “short bond” plays like TBF, TBT, SJB, banks, etc.

Sevens Report 7.12.13

Sevens Report 7.12.13