Today’s title is a play off the great George Gershwin tune, “Summertime,” made famous by the “First Lady of Song,” Ella Fitzgerald. Although the lyrics seem sunny and bright when read, they have a very dark sense of foreboding when sung by Ms. Fitzgerald. I think that feeling captures our markets perfectly this summer. The S&P 500 recorded new all-time highs five out of the last nine trading sessions. However, the mood in the market is far from jubilant. Instead, market participants resemble terrified riders on the “Iron Rattler” roller-coaster at Six Flags Fiesta Texas (here in beautiful San Antonio) as it goes to the tippy-top.
As I wrote last week, risk markets have been pumped up by the promise of massive monetary and fiscal stimulus from Japan. The most extreme form of stimulus is the Frankenstein-like merging of fiscal and monetary stimulus, also known as printing money out of thin air or “Helicopter Money.” I said in last week’s piece that the mere hint from someone, like Bank of Japan’s (BOJ) Governor Kuroda, who would say “NO” to Helicopter Money would send the Yen skyrocketing, and the risk rally would reverse itself. On Wednesday night, an interview with Mr. Kuroda surfaced where the Governor said no to Helicopter Money. Sure enough, the Yen skyrocketed and the Nikkei plunged. Later that night, it was revealed that the interview in question was from June 17!
The dramatic move in currency and equities quickly reversed themselves. However, this violent move from an interview that took place mid-June shows just how edgy the risk markets are. The Bank of Japan meets this week on July 29, and if the BOJ says no to Helicopter Money, it is going to get ugly. However, as I said last week, a “yes” to Helicopter Money will be far uglier down the road.
Unfortunately, I am starting to think that whether or not the Bank of Japan explicitly states on July 29 that it is printing Yen out of thin air, for all intents and purposes, they already are. My sentiment appears to be plausible given some great commentaries I’ve been reading, like Mark Gilbert’s Bloomberg article, “The Hidden Risk to Sovereign Bonds.” Consider this, Japan has a debt-to-Gross Domestic Product (GDP) ratio of approximately 230%. Furthermore, the Japanese government is talking of a stimulus package between 10 and 30 trillion Yen.
The possibility of Japan ever paying off this debt, especially given their terrible demographics, is more negative than the yield on their bonds! Japan would have to be magically turned into 1990’s China to have a chance at generating enough economic growth to overcome that debt.
Therefore, since the BOJ now owns half the debt, and is increasing its percentage of ownership every month, there’s a good chance that the debt the BOJ holds just gets “forgiven.” David Zervos (Jefferies) has a great term for this—a “bondfire!” If the BOJ has a bondfire, then Helicopter Money stands ready to be unleashed as soon as the banks who sold the BOJ the bonds take out their money. After all, once the bondfire happens, the BOJ does not have an asset to sell to raise the Yen to pay the banks back, so they essentially print it. Viola! This won’t end well.
Meanwhile, earnings season has been pretty poor. Bank earnings, aside from windfall trading gains the last week of June with the turmoil caused by BREXIT, are pretty weak. Banks need to make net interest margin (NIM) their bread and butter. Most of the large banks factored at least two Fed hikes into 2016 when they drafted their budgets. Now that it appears those hikes are not coming, budgets are off, and probably the only way they can get anywhere near their budgeted earnings for 2016 is through more cost cutting. United States banks are in far better shape than their European and Asian counterparts. Nevertheless, as banks go, so does the rest of the market in the long term, and bank stocks are looking weak, in my opinion.
Commodities have been taking it on the chin as the Commodity Research Bureau Commodity Index (CRB) has fallen to 182. That is the lowest since this past May, when crude made its big run to $50. The crude rally has stalled out with supply still a problem and demand tepid. For the moment, the S&P remains decoupled from oil after moving lock-step from late 2015 until mid-June. However, I feel that lock-step relationship will return, and since oil is trending down, there’s a good chance it takes stocks down with it.
The 10-year Treasury has been bouncing back and forth between 1.60% and 1.55%. I think we can stay in this tight range for a bit more. However, we can find ourselves in the 1.40s% sooner rather than later. I like owning duration at these levels, adding on dips. Longer-dated municipal spreads have widened about 21 basis points the last couple of weeks. I would be adding there as well.
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