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Invesco’s AT1 CoCo bond ETF passes $1 billion AUM milestone

The Invesco AT1 Capital Bond UCITS ETF has surpassed $1 billion in assets under management as investors have continued to seek out income and diversification opportunities for their portfolios. Paul Syms, Head of EMEA ETF Fixed Income Product Management..

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The Invesco AT1 Capital Bond UCITS ETF has surpassed $1 billion in assets under management as investors have continued to seek out income and diversification opportunities for their portfolios.

Invesco’s AT1 CoCo bond ETF passes $1 billion AUM milestone

Paul Syms, Head of EMEA ETF Fixed Income Product Management at Invesco.

Around $500 million of net new assets have been invested in the ETF since the height of the pandemic volatility in March 2020, with AUM now representing an 85% share of the AT1 ETF market in Europe, according to data from Invesco.

Competing products in the contingent convertible (CoCo) bond space include the UC Axiom Global CoCo Bonds UCITS ETF (CCNV GY), a collaboration of UniCredit and Axiom Alternative Investments, and the WisdomTree AT1 CoCo Bond UCITS ETF (CCBO LN) from WisdomTree. A China Post Global ETF providing exposure to the asset class was closed down in 2019.

Invesco notes that AT1s are a specific type of debt instrument issued by European banks and other financial institutions. Their yields are not driven by the riskiness of the issuer, as with other high-yield bonds, but by a contingency element that triggers a conversion into cash or common equity if the issuer’s capital drops below a pre-set level. AT1s are intended to act as a buffer in extreme conditions and will have a lower credit rating, and in turn higher coupon, than the senior debt issued by the same issuer.

The Invesco AT1 Capital Bond UCITS ETF aims to follow the performance of the iBoxx USD Contingent Convertible Liquid Developed Market AT1 (8/5% Issuer Cap) Index, calculated by IHS Markit. The index focuses exclusively on the USD-denominated AT1 bond market, the deepest and most liquid in which European banks issue AT1 bonds. Through the ETF, investors get exposure to over 80% of European banks by market cap, including all the largest issuers.

The fund trades on the London Stock Exchange in USD (AT1 LN) and sterling (AT1P LN), on Borsa Italiana in euros (AT1 IM), and on SIX Swiss Exchange in USD (IAT1 SW). It comes with an annual ongoing charges figure of 0.39%.

Commenting on the milestone, Paul Syms, Head of EMEA ETF Fixed Income Product Management at Invesco, said: “Our ETF has grown to such scale that it has opened the door to larger investors who may have holding limits and require a vehicle that can accommodate bigger trade sizes.”

He added: “The first AT1 bonds were launched in 2013 and for the first few years, when the market was relatively small and largely unknown, there were more opportunities to add value through security selection. However, the market has matured since then. More is known about AT1s and the market is more liquid, especially for the $140bn worth of issues denominated in dollars. The market has all the ingredients you need to develop a passive strategy. And although we have the largest AT1 ETF in Europe, its AUM is less than 1% of the value of the USD-denominated AT1 market. That means there is still huge growth potential.”

A recent report published by Invesco entitled ‘AT1 bonds: Better as beta?’ underscored the increasing difficulties to deliver real outperformance through an actively managed approach given the maturity of the AT1 market. The report concluded that the correlation between the bonds in the sector is so high that it dramatically reduces the opportunities for portfolio managers to generate excess returns through security selection.

The analysis showed that between June 2018 and the market sell-off in March 2020, the median pairwise correlation across a sample of 20 of the largest and most liquid USD AT1 bonds over six-month rolling periods was 78%. During the sell-off, the correlations spiked to nearly 100%. A likely reason for this high correlation, the report found, was that financial sector credit is an unusually narrow and homogenous investment universe.

Gary Buxton, Head of EMEA ETFs and Indexed Strategies at Invesco, commented: “We aim to provide investors the tools they need to construct better portfolios, which often involves a combination of passive and active strategies. The key is knowing where and when to use one or the other. AT1s are an interesting example, as they have transitioned from being purely an active play to now being arguably more suited to a passive approach. The recent flows into our ETF are testament to investors recognising and taking advantage of these developments.”

The post Invesco’s AT1 CoCo bond ETF passes $1 billion AUM milestone first appeared on ETF Strategy.

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Futures Slide After Dismal Target Earnings, Plunging Mortgage Apps

Futures Slide After Dismal Target Earnings, Plunging Mortgage Apps

The brief bear market rally in US stocks was set to end with a whimper…

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Futures Slide After Dismal Target Earnings, Plunging Mortgage Apps

The brief bear market rally in US stocks was set to end with a whimper following Tuesday’s strong dead cat bounce, after Fed Chair Jerome Powell gave his most hawkish remarks to date. Hope that China lockdowns would soon end turned to skepticism, as the yuan slumped after its biggest gain since October, while dismal guidance from Target - which warned that inflation was crushing margins - confirmed what Walmart said yesterday, namely that the US consumer is running on fumes. An 11% plunge in the latest weekly mortgage applications only reaffirmed that a hard-landing is inevitable and just a matter of time. Nasdaq 100 futures dropped 1%, while S&P 500 futures slipped 0.7% after US stocks surged on Tuesday. Treasury yields hit session highs, rising back to 3.0%, and the dollar snapped a three-day losing streak. Bitcoin got hammered again, sliding back under $30k.

Among the biggest premarket movers, Target crashed 22% with Vital Knowledge calling its margin shortfall “more dramatic” than what Walmart posted on Tuesday, citing industry-wide macro problems. The retailer reduced its full-year forecast on operating income margin to about 6% of sales this year. It also reported first-quarter adjusted earnings per share that came in below expectations. Food and gas inflation is drawing money away from discretionary and general merchandise spending, forcing “aggressive” discounting to clear out product in the latter category, Vital’s Adam Crisafulli said in a note.

Elsewhere in US premarket trading, Tesla slipped 1% after its price target was cut at Piper Sandler. Meanwhile, Twitter Inc. also traded slightly lower even as the social media platform’s board said it plans to enforce its $44 billion agreement to be bought by Elon Musk. Here are some other notable premarket movers:

  • US tech hardware stocks may be in focus as Jefferies Group LLC strategists have turned bullish on the likes of IBM (IBM US), Cisco Systems (CSCO US) and Microchip Technology (MCHP US) after this year’s steep declines for US information technology shares
  • National CineMedia (NCMI US) shares jump as much as 33% in US premarket trading after AMC Entertainment (AMC US) reported a 6.8% stake in the cinema advertising company. AMC shares gain 1.2% in premarket trading.
  • DLocal Ltd. (DLO US) shares gain as much as 15% in US premarket trading after the Uruguay-based payment platform posted 1Q revenue that doubled from the year-earlier period and topped expectations.
  • Doximity (DOCS US) shares fall as much as 19% in US premarket trading, after the online healthcare platform provider’s forecast for 1Q revenue missed the average analyst estimate, prompting analysts to slash their price targets on the stock.
  • Penn National (PENN US) may be active on Wednesday as Jefferies raised the recommendation to buy from hold. The company’s shares rose 4% in premarket trading.

On Tuesday, Powell said the Fed will keep raising interest rates until there is “clear and convincing” evidence that inflation is in retreat, which initially pushed stocks lower but then was faded as risk closed near session highs as nothing Powell said was actually new. The S&P 500 is emerging from the longest weekly slump since 2011 as investors have been gripped by fears of hawkish monetary policy and surging inflation driving the economy into a recession. As also discussed yesterday, Bank of America’s survey published yesterday showed that fund managers are the most underweight equities since May 2020 and are piling into cash.

“This is one of the most challenging markets I have been in in my career,” Henry Peabody, fixed income portfolio manager at MFS Investment Management, said on Bloomberg Television. “I suspect at a certain point of time we’re going to have the liquidity of the markets challenged. They really haven’t been thus far.”

As the Fed embarks on interest-rate hikes, frothy growth shares, including the tech sector, have suffered in particular as higher rates mean a bigger discount for the present value of future profits. This marks a major shift in investor outlook after tech stocks had been some of the market’s best performers for years.

“Investor sentiment and confidence remain shaky, and as a result, we are likely to see volatile and choppy markets until we get further clarity on the 3Rs — rates, recession, and risk,” Mark Haefele, chief investment officer at UBS Global Wealth Management, wrote in a note.

Rebounds in risk sentiment are proving fragile amid tightening monetary settings, Russia’s war in Ukraine and China’s Covid lockdowns. In what’s seen as his most hawkish remarks to date, Powell said that the US central bank will raise interest rates until there is “clear and convincing” evidence that inflation is in retreat.

“We’ll have this kind of volatility as people jump in and look at opportunities to buy as markets decline,” Shana Sissel, director of investments at Cope Corrales, said on Bloomberg Television, referring to the Wall Street bounce. The Fed is going to struggle to achieve a soft economic landing, she added.

In Europe, the Stoxx 600 Index was little changed, with energy stocks outperforming. Spain's IBEX outperformed, adding 0.5%. ABN Amro slumped almost 10% after the Dutch lender reported first-quarter results burdened by rising costs.  The Stoxx Europe 600 Basic Resources sub-index drops, underperforming other sectors in the broader regional benchmark on Wednesday as base metals ended a three-day rebound and as iron ore declined. Base metals paused a recovery from this year’s lows, with copper and aluminum stalling after hawkish remarks from Federal Reserve Chair Jerome Powell. Iron ore futures declined as investors weighed China’s faltering economy and the prospect of support measures amid a mixed outlook for steel demand. Basic resources index -0.6%, halting three days of gains; broader benchmark little changed. Siemens Gamesa jumped as much as 15% as Siemens Energy weighs a bid for the shares of the troubled Spanish wind-turbine maker it doesn’t already own. Here are the most notable movers:

  • European oil and gas stocks rise amid higher crude prices and broker upgrades, while renewables rallied after Siemens Energy confirmed it was considering a buyout offer for Siemens Gamesa. Shell gains as much as 1.8%, BP +1.8%, Equinor +3.4%, Gamesa +15%, Vestas +7.7%
  • Air France-KLM shares rise as much as 7.5% in Paris on news that container line CMA CGM intends to take a stake of up to 9% in the French carrier following the signing of a long-term strategic partnership in the air cargo market.
  • Rockwool shares gain as much as 8.3%, most since Feb. 15, as the company boosts its sales in local currencies forecast for the full year.
  • British Land shares rise as much as 4.2%, as the company’s results show a strong recovery and a good performance in the UK landlord’s portfolio, analysts say.
  • Vistry shares climb as much as 8% with analysts saying the UK homebuilder’s trading update looks positive, particularly the robust momentum in its sales rate.
  • The Stoxx Europe 600 Basic Resources sub-index drops, underperforming other sectors in the broader regional benchmark on Wednesday as base metals ended a three-day rebound and as iron ore declined. Rio Tinto slips as much as 1.5%, Antofagasta -2.7%, Anglo American -1.5%
  • Prosus shares fall as much as 4.2% and Naspers sinks as much as 6.7% after Tencent reported first- quarter revenue and net income that both missed analyst expectations.
  • TUI shares drop as much as 13% in London after the firm announced an equity raise in order to repay a chunk of government aid that helped see it through the coronavirus crisis.
  • ABN Amro shares declined as much as 11% after the lender reported 1Q earnings that showed higher costs related to money laundering.
  • Experian shares fall as much as 5.1% after the consumer-credit reporting company reported full-year results, with Citi saying organic growth missed consensus.

Meanwhile, UK inflation rose to its highest level since Margaret Thatcher was prime minister 40 years ago, adding to pressure for action from the government and central bank. The pound weakened and gilt yields fell as traders speculated that the Bank of England will struggle to rein in inflation and avoid a recession.

Elsewhere, the Biden administration is poised to fully block Russia’s ability to pay US bondholders after a deadline expires next week, a move that could bring Moscow closer to a default. Sri Lanka, meantime, is on the brink of reneging on $12.6 billion of overseas bonds, a warning sign to investors in other developing nations that surging inflation is set to take a painful toll.

Earlier in the session, Asian stocks advanced for a fourth session as strong US economic data allayed worries about the global growth outlook, while Chinese equities slipped. The MSCI Asia-Pacific Index rose as much as 1%, extending its rebound from an almost two-year low reached last Thursday. Materials shares led the gains, with Australia’s BHP Group climbing 3.2%. Benchmarks in most markets were in the black, with Indonesia, Taiwan and Singapore chalking up gains of at least 1%.  Upbeat retail sales and industrial production data from the US underpinned sentiment, so much so that investors barely reacted to hawkish comments from Federal Reserve Chair Jerome Powell. He indicated that policy makers won’t hesitate to raise interest rates beyond neutral levels to contain inflation.

Equities in China bucked the trend. Property shares paced the drop after data showed the decline in China’s new home prices accelerated in April, while tech shares also lost steam ahead of Tencent’s earnings which missed expectations and slumped. Local investors may be underwhelmed by a lack of details from Chinese Vice Premier Liu He’s fresh vow to support tech firms. Liu said the government will support the development of digital economy companies and their public listings, in remarks reported by state media after a symposium with the heads of some the nation’s largest private firms.

Lee Chiwoong, chief economist at Mitsubishi UFJ Morgan Stanley Securities, said Liu’s comments point to an easing of the crackdown on internet firms. “The Chinese government is stepping up measures to support the economy following the slowdown,” Lee said.  “As bottlenecks stemming from lockdowns in Shanghai ease, that impact will gradually show up in the economy,” Lee added. “We should be able to clearly see an economic recovery in the second half of this year.”

Japanese equities gained as investors assessed strong US economic data and comments by Federal Reserve Chair Jerome Powell on the outlook for interest rate hikes.  The Topix Index rose 1% to close at 1,884.69. Tokyo time, while the Nikkei advanced 0.9% to 26,911.20. Sony Group Corp. contributed the most to the Topix gain, increasing 2.9%. Out of 2,172 shares in the index, 1,345 rose and 749 fell, while 78 were unchanged. Chinese stocks erased losses intraday after earlier disappointment over a much-anticipated meeting between Vice Premier Liu He and some of the nation’s tech giants. Overnight, data showed US retail sales grew at a solid pace in April, while factory production rose at a solid pace for a third month.

Australia's stocks also gained, with the S&P/ASX 200 index rising 1% to close at 7,182.70, extending its winning streak to a fourth day. Miners contributed the most to its advance. All sectors gained, except for consumer staples and financials. Eagers slumped after saying that its 1H profit will be lower than it was a year ago and flagged reduced new vehicle deliveries. Wage data was also in focus. Australian wages advanced at less than half the pace of consumer-price gains in the first three months of the year, reinforcing the RBA’s signal that it will stick to quarter-point hikes.  In New Zealand, the S&P/NZX 50 index rose 1.1% to 11,258.28

India’s benchmark equities index fell, snapping two sessions of gains, weighed by declines in engineering company Larsen & Toubro Ltd.    The S&P BSE Sensex dropped 0.2% to close at 54,208.53 in Mumbai, after rising as much as 0.9% earlier in the session. The NSE Nifty 50 Index fell 0.1% to 16,240.30.  Larsen & Toubro slipped 2% and was the biggest drag on the Sensex, which saw 17 of its 30 member stocks decline. Sixteen of 19 sectoral sub-indexes compiled by BSE Ltd. dropped, led by a gauge of realty shares.   State-run Life Insurance Corporation, which debuted Tuesday, rose 0.1% to 876 rupees, still below the issue price of 949 rupees. In earnings, of the 34 Nifty 50 firms that have announced results so far, 20 have either met or exceeded analyst estimates, while 14 have missed. Consumer goods company ITC Ltd. is scheduled to announce results on Wednesday.

In FX, the Bloomberg Dollar Spot Index reversed an early loss and the greenback advanced versus all of its Group-of-10 peers apart from the yen. The pound was the worst G-10 performer, tracking Gilt yields lower and paring the previous day’s gains. A widely expected jump in UK inflation prompted investors to pare back bets on BOE rate hikes. Money markets are pricing around 120bps of BOE rate hikes by December, down from 130bps from the previous day. UK inflation rose to its highest level since Margaret Thatcher was prime minister 40 years ago, adding to pressure for action from the government and central bank. Consumer prices surged 9% in the year through April. The euro fell for the first day in four and weakened beyond $1.05. The Bund curve has twist flattened as traders bet on a faster pace of ECB tightening after Bank of Finland Governor Olli Rehn said there’s broad agreement among members of the Governing Council that policy rates should exit sub-zero terrain “relatively quickly.” That’s to prevent inflation expectations from becoming de- anchored, he said. The Aussie swung between gains and losses while Australia’s bonds trimmed earlier declines after a report showed wage growth last quarter was less than economists forecast. The wage price index climbed an annual 2.4% last quarter, trailing economists’ expectations and coming in well below headline inflation of 5.1%. The yen rose as US yields declined amid fragile risk sentiment. Japanese government bonds were mixed, with a decent five-year auction lending support while an overnight rise in global yields weighed on super-long maturities.

In rates, Treasuries were under pressure, though most benchmark yields remained within 1bp of Tuesday’s closing levels. 10-year yields rose just shy of 3.00%, higher by less than 1bp with comparable bund yield +3.3bp and UK 10-year flat. TSY futures erased gains amid a series of block trades in 5- and 10-year note contracts starting at 5:20am ET, apparently selling flow. According to Bloomberg, six 5-year block trades and two 10-year block trades -- all 5,000 lots -- have printed since 5:20am, apparently seller-initiated as cash yields concurrently rebounded from near session lows. Wednesday’s $17b 20-year new-issue auction at 1pm ET may also weigh on the market. 20-year bond auction is this week’s only nominal coupon sale; WI yield ~3.37% exceeds all 20-year auction stops since then tenor was reintroduced in 2020, is ~27.5bp cheaper than last month’s result. Elsewhere, the UK yield curve bull-steepened with the short end richening ~5bps, while pound falls after inflation surged to a four-decade high. Money markets pare BOE rate-hike wagers. Bund curve bear-flattens while money markets bet on a faster pace of ECB tightening after ECB’s Rehn said the central bank needs to move quickly from negative rates.

In commodities, WTI trades within Tuesday’s range, adding 1.6% to around $114. Most base metals are in the red; LME tin falls 1.5%, underperforming peers, LME aluminum outperforms, adding 1%. Spot gold is little changed at $1,815/oz.

Looking to the day ahead now, and data releases include the UK and Canadian CPI readings for April, along with US data on housing starts and building permits for the same month. Central bank speakers include the Fed’s Harker and the ECB’s Muller. Earnings releases include Cisco, Lowe’s, Target and TJX. Finally, G7 finance ministers and central bank governors will be meeting in Germany.

Market Snapshot

  • S&P 500 futures down 0.5% to 4,065.50
  • STOXX Europe 600 down 0.2% to 438.11
  • MXAP up 0.8% to 164.43
  • MXAPJ up 0.7% to 539.81
  • Nikkei up 0.9% to 26,911.20
  • Topix up 1.0% to 1,884.69
  • Hang Seng Index up 0.2% to 20,644.28
  • Shanghai Composite down 0.2% to 3,085.98
  • Sensex up 0.3% to 54,469.39
  • Australia S&P/ASX 200 up 1.0% to 7,182.66
  • Kospi up 0.2% to 2,625.98
  • German 10Y yield little changed at 1.03%
  • Euro down 0.4% to $1.0505
  • Brent Futures up 1.5% to $113.66/bbl
  • Gold spot down 0.0% to $1,815.04
  • U.S. Dollar Index up 0.33% to 103.70

Top Overnight News from Bloomberg

  • Sweden’s biggest pension company has begun buying government bonds amid a “paradigm shift” in the market that pushed yields to their highest level since 2018. The CIO views Treasuries as “quite attractive” after a prolonged period of razor-thin yields that forced the company into alternative and riskier asset classes to preserve returns across its $117 billion portfolio
  • While outright China bulls may be hard to find, shifts in positioning at least point to improving sentiment. Bearish bets on stocks are being abandoned in Hong Kong, expectations for yuan volatility are falling, domestic equity traders have stopped unwinding leverage and foreigners have slowed their once-record exit from government bonds
  • The EU is set to unveil a raft of measures ranging from boosting renewables and LNG imports to lowering energy demand in its quest to cut dependence on Russian supplies. The 195 billion-euro ($205 billion) plan due Wednesday will center on cutting red tape for wind and solar farms, paving the way for renewables to make up an increased target of 45% of its energy needs by 2030, according to draft documents seen by Bloomberg that are still subject to change

A more detailed look at global markets courtesy of Newsquawk

Asia-Pac stocks traded mixed as the regional bourses only partially sustained the momentum from global peers. ASX 200 was led higher by outperformance in the mining and materials related sectors, while softer than expected wage price data reduced the prospects of a more aggressive RBA rate hike next month. Nikkei 225 briefly reclaimed the 27,000 level but retreated off its highs as participants digested GDP data which printed in negative territory, albeit at a narrower than feared contraction. Hang Seng and Shanghai Comp were subdued with large-cap tech stocks pressured in Hong Kong including JD.com despite beating earnings expectations and with Tencent bracing for the expected slowest revenue growth since its listing, while the mainland was hampered by the mixed COVID-19 situation as Shanghai registered a 4th consecutive day of zero transmissions outside of quarantine, although Beijing was said to lockdown some areas in its Fengtai district for 7 days.

Top Asian News

  • Shanghai authorities issued a new white list containing 864 financial institutions permitted to resume work, according to sources cited by Reuters.
  • China, on May 20th, is to remove some COVID test requirements on travellers to China from the US, according to embassy.
  • China's Foreign Ministry says the BRICS foreign ministers are to meet on May 19th.
  • Goldman Sachs downgrades its 2022 China GDP growth forecast to 4.0% from 4.5%.

European bourses are rangebound and relatively directionless, Euro Stoxx 50 U/C, taking impetus from a mixed APAC session which failed to sustain US upside. Stateside, futures are modestly softer and a firmer Wall St. close; ES -0.2%. Limited Fed speak due and near-term focus on retail earnings. Tencent (0700 HK) Q1 2022 (CNY): adj. net profit 25.5bln (exp. 26.4bln), Revenue 135.5bln (exp. 141bln). Lowe's Companies Inc (LOW) Q1 2023 (USD): EPS 3.61 (exp. 3.22/3.23 GAAP), Revenue 23.70bln (exp. 23.76bln). SSS: Lowe's Companies: -4.0% (exp. -2.5%); Lowe's Companies (US): -3.8% (exp. -3.7%). -0.2% in the pre-market

Top European News

  • UK Chancellor Sunak is reportedly mulling bringing forward the 1p income tax cut to the basic rate by one year, according to iNews citing Treasury insiders. Other reports suggest that Sunak is putting plans together to raise the warm home discount by hundreds of GBP in July ahead of lowering taxes in autumn to assist with the cost of living crisis, according to The Times.
  • EU is to offer the UK new concessions on the Northern Ireland protocol but has threatened a trade war if UK PM Johnson refuses to agree to a compromise, according to The Telegraph.

In FX

  • Sterling slides to the bottom of the major ranks as fractionally sub-forecast UK CPI dampens BoE rate hike expectations; Cable reverses from just over 1.2500 to sub-1.2400, EUR/GBP nearer 0.8500 after dip below 0.8400 only yesterday.
  • Hawkish Fed chair Powell helps Buck bounce ahead of US housing data, DXY towards the upper end of 103.770-180 range.
  • Aussie hampered by softer than expected wage metrics that might convince the RBA to refrain from 40bp hike in June, AUD/USD heavy on the 0.7000 handle.
  • Yen relatively resilient in wake of Japanese GDP showing less contraction in Q1 than feared, USD/JPY closer to 129.00 than 129.50.
  • Euro loses momentum irrespective of comments from ECB’s Rehn echoing Summer rate hike guidance as final Eurozone HICP is tweaked down, EUR/USD fades from 1.0550+ to test support around 1.0500.
  • Loonie treads cautiously before Canadian inflation metrics as oil prices come off the boil, USD/CAD back above 1.2800 within 1.2795-1.2852 range.

In Fixed Income

  • Gilts sharply outperform as UK CPI falls just shy pf consensus and dampens BoE tightening expectations.
  • 10 year UK bond rebounds towards 119.50 from sub-119.00 lows, while Bunds lag below 152.50 and T-note under 119-00.
  • Record high cover for 2052 German auction and low retention sets high bar for upcoming 20 year US offering.

Central Banks

  • ECB's Rehn says June forecasts are seen near the adverse scenario from March, first rate increase will likely take place in the summer. Many colleagues back stance for quick moves.
  • ECB's de Cos says the end of APP should be finalised early in Q3, first hike shortly afterwards. Further rises could be made in subsequent quarters of medium-term outlook remains around target; the build-up of price pressures in EZ in recent months raises the likelihood of second-round effects, which have not strongly materialised.

In commodities

  • WTI and Brent are modestly supported after yesterday's lower settlement; currently, firmer by just over USD 1.00/bbl.
  • Focus has been on the narrowing WTI/Brent spread, particularly going into US driving season; see link below for ING's views.
  • US Energy Inventory Data (bbls): Crude -2.4mln (exp. +1.4mln), Cushing -3.1mln, Gasoline -5.1mln (exp. -1.3mln), Distillates +1.1mln (exp. unchanged).
  • Spot gold and silver are modestly firmer but capped by a firmer USD, yellow metal just shy of USD 1820/oz.

US Event Calendar

  • 07:00: May MBA Mortgage Applications, prior 2.0%
  • 08:30: April Building Permits MoM, est. -3.0%, prior 0.4%, revised 0.3%
  • 08:30: April Housing Starts MoM, est. -2.1%, prior 0.3%
  • 08:30: April Building Permits, est. 1.81m, prior 1.87m, revised 1.87m
  • 08:30: April Housing Starts, est. 1.76m, prior 1.79m

DB's Jim Reid concludes the overnight wrap

Another reminder of my webinar replay from last week discussing our recession call for 2023 and an update on credit spreads. In it I said that while we have high conviction that HY spreads would be +850bp in H2 2023, the outlook over the next few weeks and months may actually be positive from this starting point. I would say I am nervous of that view but I still don't think that the real economic pain comes until deeper into 2023 when the lagged impact of an aggressive Fed starts to bite. Click here to view the webinar and to download the presentation.

Good luck to Glasgow Rangers and Eintracht Frankfurt in tonight's Europa League final. These are not teams that any would have expected to reach this final and I will watch with stress free divided loyalties. My father's family were all from the former and supported Rangers while the latter play at the fabulously named Deutsche Bank Park. So good luck to both. I suspect I'll be less stress free in 11 days' time when Liverpool are out for revenge against Real Madrid in the Champions League Final. At the moment I’m feeling nervously optimistic.

Talking of which, investor optimism has returned to markets over the last 24 hours as more positive data releases raised hopes that the US economy might be more resilient in the near-term than many have feared. The economic concerns won't go away, but stronger-than-expected numbers on retail sales and industrial production helped the S&P 500 (+2.02%) close at its highest level in over a week. Remember monetary policy acts with a lag and it would be very unusual historically if the data rolled over imminently. By this time next year it will likely be a very different story.

The higher yield momentum was reinforced by a Powell speech after Europe went home but there was a steady march of slightly hawkish central bank speakers through the day. Before we review things keep an eye out for UK CPI just after this goes to press. The headline rate is expected to be a huge 9.1%. Expect a lot of headlines reporting of 40 year highs.

With regards to Powell, most in focus was his claim that policy rates would rise above neutral if that was required to tame inflation. While the sentiment was not necessarily new, his explicit comment that neutral rates are “not a stopping point” garnered focus, noting that the Fed was looking for “clear and convincing evidence” that inflation was subsiding. The rates market have already priced terminal policy rates above the Fed’s estimate of neutral, but a combination of the risk on, and stronger data meant that equities could go up alongside yields.

Earlier in the day we got a smattering of communications from Fed regional Presidents, none of which registered as materially but it reinforced the direction of travel after a month to date where markets have repriced the Fed lower. Indeed, even resident hawk, St Louis Fed President Bullard, reiterated Powell’s message in that the Fed was on course for 50bp hikes at the upcoming meetings and said that “I think we have a good plan for now”.

Sovereign bonds had already sold off significantly ahead of all that Fedspeak, aided by the broader risk-on tone yesterday, but continued drifting higher through the US session. Yields on 10yr Treasuries closed +10.4bps to a one-week high of 2.99%, driven by a +7.9bps rise in real yields to 0.24%. The moves were more pronounced at the front-end however, and the 2yr yield rose by a larger +13.1bps as investors priced in a more aggressive path of hikes over the next 12 months after data showed the economy was performing stronger than the consensus had anticipated. In terms of the headlines, retail sales were up by +0.9% in April (vs. +1.0% expected), but the growth in March was revised up to +1.4% (vs. +0.5% previously). Retail sales excluding autos and gas were up by +1.0% as well (vs. +0.7% expected), whilst the industrial production number was another that came in above expectations at +1.1% (vs. +0.5% expected).

Europe also had a large move in yields, which followed comments by Dutch central bank Governor Knot who became the first member of the Governing Council to openly float the idea of a 50bp hike. Although he said that “my preference would be to raise our policy rate by a quarter of a percentage point”, he said that “bigger increases must not be excluded” if data were to show inflation “broadening further or accumulating”. So even though he’s one of the more hawkish members of the council, that’s still a significant milestone in that larger moves are being openly discussed, and echoes what we saw with the Fed at the turn of the year when the policy trajectory became increasingly aggressive.

Market pricing reflected that shift yesterday, and for the first time overnight index swaps were pricing in that the ECB would hike by more than 100bps by their December meeting and thus catching up with the DB House View. That growing belief behind additional hikes led to a fresh selloff in sovereign bonds, with those on 10yr bunds (+10.9bps), OATs (+10.5bps) and BTPs (+11.7bps) all moving higher. The biggest moves were seen from gilts (+15.0bps) however, which followed data that pointed to an increasingly tight labour market in the UK, and overnight index swaps nearly doubled the probability of a 50bp rate hike from the BoE in June, with the odds moving from 17% on Monday to 33% yesterday.

Over in equities, stronger risk appetite led to a significant rebound yesterday, with the S&P 500 (+2.02%) hitting a one-week high, whilst the NASDAQ (+2.76%) saw an even larger rebound in spite of the simultaneous rise in yields. Walmart (-11.38%) was by far the worst performer in the S&P, which came as it cut its earnings per share forecast, which it now expected to decrease by 1%, relative to previous guidance that expected it to rise by the mid single-digits. But that was the exception, and every sector except consumer staples moved higher on the day, with the more cyclical areas leading the advance. Over in Europe the STOXX 600 (+1.22%) posted a strong performance of its own, bringing its advance to more than +5% since its recent closing low just over a week ago.

Overnight in Asia, performance in regional stock indices is diverging partly on the back of economic data. Japan’s Q1 GDP (-1.0%) contracted less than expected (-1.8%), lifting the Nikkei (+0.50%) this morning. In China, though, rising covid cases and waning optimism about government’s support of tech companies weighed on the Shanghai composite (-0.37%) and the Hang Seng (-0.66%). New home prices (-0.30%) in the country also slid for an eighth month in a row. This slight souring of sentiment has extended to S&P 500 futures (-0.23%) with the US 10y yield edging back lower by -2.2bps.

Elsewhere, tensions over Brexit ratcheted up again yesterday after UK Foreign Secretary Truss announced plans to introduce legislation that would override parts of the Northern Ireland Protocol. Truss said that the UK’s preference “remains a negotiated solution with the EU” and that the bill would contain an “explicit power to give effect to a new, revised Protocol if we can reach an accommodation”, but that “the urgency of the situation means we can’t afford to delay any longer.” Unsurprisingly the EU did not react happily, and Commission Vice President Šefčovič said in a statement that if the UK moved ahead with the bill, then “the EU will need to respond with all measures at its disposal.”

Staying on the UK, the latest employment data out yesterday pointed to an increasingly tight labour market, with the unemployment rate falling to 3.7% in the three months to March (vs. 3.8% expected), which is the lowest it’s been since 1974. Furthermore, the number of vacancies was larger than the total number of unemployed for the first time, and the more up-to-date estimate of payrolled employees in April saw an increase of +121k (vs. +51k expected). Elsewhere in Europe, the latest estimate of Euro Area GDP growth in Q1 showed a bigger than expected expansion of +0.3% (vs. +0.2% previously).

Elsewhere the chances of a Russian sovereign debt default increased, following the Treasury department confirming a temporary waiver that allowed Russia to pay US creditors would expire on May 25. Meanwhile, the US is reportedly considering a tariff on Russian oil in conjunction with European allies, as the saga about banning imports to Europe drags on.

To the day ahead now, and data releases include the UK and Canadian CPI readings for April, along with US data on housing starts and building permits for the same month. Central bank speakers include the Fed’s Harker and the ECB’s Muller. Earnings releases include Cisco, Lowe’s, Target and TJX. Finally, G7 finance ministers and central bank governors will be meeting in Germany.

Tyler Durden Wed, 05/18/2022 - 07:51

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Six Natural Gas Investments to Buy as Energy Prices Soar Amid War

Six natural gas investments to buy as energy prices soar during Russia’s war against neighboring Ukraine give investors a chance to profit as other stocks…

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Six natural gas investments to buy as energy prices soar during Russia’s war against neighboring Ukraine give investors a chance to profit as other stocks slide.

The six natural gas investments to buy as energy prices climb offer opportunities to tap into growing demand for alternatives to energy sources that previously had been provided by Russia before it incurred economic sanctions for its invasion of Ukraine. The United States is among many countries that have chosen to stop importing Russia’s oil and natural gas, while Germany and other nations that lack immediate access to substitute sources of energy are seeking to scale back those imports that are funding the war against Ukraine initiated by Russia’s President Vladimir Putin.

U.S. natural gas prices have rocketed higher since mid-March by rising more than $4/MMBtu to $8.80/MMBtu. The latter level of production is the highest since 2008, according to a recent report by BofA Global Research. MMBtu, a standard unit of measurement for natural gas financial contracts, equals one million British Thermal Units.

U.S. Drilling Restrictions Lift Existing U.S. Providers by Curbing Supply

President Joe Biden “aggravated the energy shortage” last week by canceling three oil & gas leasing sales in the Gulf of Mexico and off the coast of Alaska, removing millions of acres from possible drilling amid record-high gas prices, wrote Mark Skousen, PhD, to subscribers of his Forecasts & Strategies investment newsletter.

Not surprisingly, crude oil recovered after that move and is now back to $110 a barrel, boosting the share price for Houston-based pipeline and energy storage company Enterprise Products Partners (NYSE: EPD) to 52-week highs, wrote Skousen, a descendant of Benjamin Franklin. Aside from leading the Forecasts & Strategies newsletter, he also heads the Five Star Trader, Home Run Trader, TNT Trader and Fast Money Alert services.

EPD, offering a dividend yield of more than 7%, has been a stellar stock recommendation for Skousen during 2022 by rising more than 24% through Monday, May 16. In contrast, the S&P 500 has plunged 15.91% during that time. 

Mark Skousen, head of Forecasts & Strategies, meets with Paul Dykewicz.

EPD Is One of Six Natural Gas Investments to Buy Amid War

Enterprise Products Partners is one of the largest publicly traded partnerships and a key North American provider of midstream energy services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil, refined products and petrochemicals. The company’s services include natural gas gathering, treating, processing, transportation and storage.

Plus, Enterprise Products Partners provides NGL transportation, fractionation, storage and import and export terminals. It further offers crude oil gathering, transportation, storage and terminals, along with petrochemical and refined products transportation, storage and terminals, as well as a marine transportation business.

I personally have owned Enterprise Products Partners since shortly after the 2020 stock market crash when I bought the stock as it began to rebound. At the market’s close on May 16, the stock had gained 1.46% for the past week, 0.69% for the last month, 12.23% for the past three months, 24.73% so far in 2022 and 18.42% for the last year.

Chart courtesy of www.stockcharts.com

XOM Is Another of the Six Natural Gas Investments to Buy

Irving, Texas-based Exxon Mobil Corp. (NYSE: XOM) jumped during its time as a recommendation in the Cash Machine newsletter between July 2021 and May 17, 2022, providing investors with exposure to liquefied natural gas (LNG) and strong returns. The company ranks as the world’s second-largest supplier of natural gas and jumped about 55% since its addition to the newsletter’s Safe Haven Portfolio. 

Perry, head of the Cash Machine investment newsletter, also leads the Premium Income, Quick Income Trader, Hi-Tech Trader and Breakout Options Alert advisory services, and explained he recommended its sale when the company’s dividend yield dipped below his 4% limit. With limited energy supply, Perry predicted XOM’s share price would remain well fueled by investors seeking an alternative to the sagging stock market so far in 2022, even if the stock no longer fits his requirement for a high-dividend stock.

Paul Dykewicz interviews Bryan Perry, whose services include Quick Income Trader.

Exxon Mobil reported strong first-quarter adjusted earnings of $8.8 billion, up from $2.8 billion for the same period a year ago. Adjusted earnings excluded a $3.4 billion after-tax impairment charge stemming from ExxonMobil’s Russia Sakhalin-1 operation, which the company intends to exit. Its earnings just missed meeting analysts’ consensus estimates.

XOM has continued to shine amid the market’s retreat. The company’s share price has soared 8.73% during the past week, 4.55% in the last month, 17.20% in the past three months, 51.51% thus far in 2022 and 55.44% for the last year.

Chart courtesy of www.stockcharts.com

Pension Fund Leader Picks Two of the Six Natural Gas Investments to Buy

Bob Carlson, a pension fund chairman who also leads the Retirement Watch investment newsletter, added Cohen & Steers MLP & Energy Opportunity Fund (MLOAX) to all the portfolios in his latest issue. 

“Natural gas should continue to be a good investment, as long as Europe is looking for ways to reduce dependence on Russia,” Carlson told me. “In addition, the natural gas drillers in the U.S. are focused on increasing cash flow and earnings. They’re not inclined to maximize drilling expenses in the short run to increase output.”

Bob Carlson, who leads Retirement Watch, meets with Paul Dykewicz.

Good investment opportunities can be found with companies that provide the pipelines, storage facilities and other infrastructure needed to supply the world with natural gas and other energy sources, Carlson told me. 

“One of the attractive qualities of these investments is that their revenues are independent of the prices of the commodities,” Carlson counseled. “The firms charge fees for their services, and the fees often are adjusted for inflation. Their revenues and earnings depend on the volume of commodities passing through their facilities, not the price of the commodity.”

“Leading” energy service companies provide total returns, aided by current income and price appreciation, through investments in energy-related master limited partnerships (MLPs) and securities of industry companies, Carlson said. Those businesses are expected to derive at least 50% of their revenues or operating income from exploration, production, gathering, transportation, processing, storage, refining, distribution or marketing of natural gas, crude oil and other energy resources.

Chart courtesy of www.stockcharts.com

Cohen & Steers Fund Makes List of Six Natural Gas Investments to Buy

The Cohen & Steers MLP & Energy Opportunity Fund recently held 53 positions and had 50% of the fund in the 10 largest positions. Top holdings of the fund were Enbridge (NYSE: ENB), Cheniere Energy (NYSEAMERICAN: LNG), Williams Companies (NYSE: WMB), TC Energy (NYSE: TRP) and Energy Transfer (NYSE: ET).

The fund has notched strong returns since April 2020. It is up 3.70% in the last week after dipping 1.09% in the past month. It also rose 12.88% in the last three months, 21.78% so far in 2022 and 29.20% in the last year.

UNG Makes List of Six Natural Gas Investments to Buy

Carlson’s second LNG recommendation is the ETF United States Natural Gas (UNG). The fund invests in natural gas futures contracts and related contracts on natural gas prices. The contracts are collaterized with cash and treasury securities.

The fund has zoomed 12.71% in the past week, 7.03% in the last month, 73.20% during the previous three months, 119.38% for the year to date and 157.52% over the last year.

Chart courtesy of www.stockcharts.com

Connell Chooses Two of Six Natural Gas Investments Worth Buying

U.S. LNG inventory is currently below its five-year average for this time of year by double-digit percentages, said Michelle Connell, CFA, president and owner of Portia Capital Management, of Dallas, Texas. A key issue for the U.S. LNG industry is that production of the energy source has never been profitable on its own, but it is as a byproduct of oil production, she added.

“There isn’t enough oil being produced,” Connell said. “Currently, only 11.6 million barrels/day are being produced. Pre-pandemic, we produced 13 million barrels/day.”

Instead of investing to expand capacity, oil companies have been focusing on hiking their dividends, Connell continued. If they pivot, these companies face a backlash from investors who could sell their shares, Connell added.

“Their market value could get crushed,” Connell said.

Former portfolio manager Michelle Connell, CEO, Portia Capital Management

EOG Resources Lands on List of Six Natural Gas Investments to Buy

LNG companies cannot ramp up production quickly, Connell cautioned. It takes oil companies a minimum of six to eight months to increase their oil and LNG production, Connell counseled. 

Production of oil via shale recently created the largest share of the America’s natural gas reserves, Connell continued. Unfortunately for proponents of increasing output to meet soaring demand, shale production has “decreased exponentially” since the pandemic began and the buildup of LNG reserves has declined, Connell explained.

However, Houston-based EOG Resources Inc. (NYSE: EOG) is producing substantial amounts of oil via shale, and thus considerable LNG. The company’s Chief Executive Officer Ezra Yacob called its recent financial results “outstanding” and said 2021 was a “tremendous year” for EOG with record earnings, record free cash flow and return of cash that places it among industry leaders.

Income investors will appreciate that the company’s long-standing focus on free cash flow led to payment of another $1.00 per share special dividend while also strengthening its balance sheet.

Chart courtesy of www.stockcharts.com

Reasons why Connell likes EOG include: 

-Wall Street analysts from investment firms such as Wells Fargo and Raymond James continue to increase its future earnings estimates and target prices, despite its strong performance of rising more than 40% so far in 2022;

-Based on its fundamentals, the stock may have another 25% of 12-month upside;

-Its relatively new gas resource in the Gulf Coast could provide additional potential and cash flow for the company;

-Strong cash flow growth is expected to continue for the foreseeable future, powering annualized cash flow growth in excess of 25% per year.

EPD is up 7.14% in the past week, 2.78% in the last month, 14.62% during the past three months, 45.06% so far in 2022 and 60.64% in the past year.

Pioneer Natural Resources May Be Worth Watching for a Price Pullback 

Pioneer Natural Resources Co. (NYSE: PXD), a hydrocarbon exploration company headquartered in Irving, Texas, has zoomed in recent weeks as Connell has reconsidered her recommendation of the stock due to its increased share price. The company has a market capitalization of $61.72 billion, offers a dividend and has never missed paying a dividend, she added.

In addition, Pioneer Natural Resources has produced an earnings yield of 3.25%, an adjusted cash earnings yield of 7.48% and a five-year average return on equity of 6.61%, Connell said. At the end of 2021, Pioneer Natural Resources had compiled 2.22 billion barrels of oil equivalent, with 44% of its proved reserves from petroleum, 30% natural gas liquid and 16% natural gas. 

At PXD’s current share price, Connell is not advocating its purchase, but she still spoke positively about the company. The stock has jumped 10.27% in the past week alone, 54.12% so far this year and 77.97 in the past 12 months.

Chart courtesy of www.stockcharts.com

Supply Chains May Improve as China Starts to Lower COVID Curbs

China has begun to ease its COVID-19 restrictions during the past week, and that could indicate that goods produced in that country may start to flow normally again in the weeks ahead to smooth out supply chain snags. Lockdowns in China have affected at least 373 million people, including roughly 40% of the country’s gross domestic product (GDP). Disruption of the world’s supply chain has affected products such as rice, oil and natural gas.

Shanghai, home to the world’s largest port and 25 million residents, has strained to unload cargo due to strict regulations that have caused shipping containers to stack up. Some Shanghai residents posted videos online to complain about needing food, despite government officials attempting to block dissemination of such expressions of frustration.

Chinese authorities also drew public criticism for forcibly separating young children with COVID-19 from their parents. Chinese leaders prioritized stopping the spread of a new, contagious subvariant of Omicron, BA.2. The variant also has been causing new infections in European nations such as Germany, the Netherlands and Switzerland.

U.S. COVID Deaths Top 1-Million Milestone

U.S. COVID-19 deaths topped 1 million, with the number of lives claimed by the virus reaching 1,000,167 as of May 17, according to Johns Hopkins University. Cases in the United States, as of May 17, hit 82,720,354. America retains the dubious distinction as the nation with the most COVID-19 deaths and cases.

COVID-19 deaths worldwide totaled 6,280,921 on May 17, according to Johns Hopkins. Cases across the globe now number 524,539,523.

Roughly 77.7% of the U.S. population, or 257,942,199, have obtained at least one dose of a COVID-19 vaccine, as of May 17, the CDC reported. Fully vaccinated people total 220,682,023 or 66.5% of the U.S. population, according to the CDC. America also has given at least one COVID-19 booster vaccine to 102.4 million people.

In another development on May 17, the Biden administration opened CovidTests.gov for a third round of orders. White House officials continue to call for Congress to approve additional Covid-response funding.

American households now can order an additional eight “free” COVID testing kits to use at home. COVIDTests.gov has increased the total number of free tests available to each household to 16 since the start of the program, White House officials reported.

The six natural gas investments to buy offer an opportunity to profit from rising energy prices. Investors need to pay attention to valuations before initiating new positions but the growing risks of inflation, the Fed’s plan for further interest rate hikes to curb rising prices and increased federal deficit spending are reasons to seek portfolio protection in the form of natural gas.

Paul Dykewicz, www.pauldykewicz.com, is an accomplished, award-winning journalist who has written for Dow Jones, the Wall Street Journal, Investor’s Business Daily, USA Today, the Journal of Commerce, Seeking Alpha, Guru Focus and other publications and websites. Paul, who can be followed on Twitter @PaulDykewicz, is the editor of StockInvestor.com and DividendInvestor.com, a writer for both websites and a columnist. He further is editorial director of Eagle Financial Publications in Washington, D.C., where he edits monthly investment newsletters, time-sensitive trading alerts, free e-letters and other investment reports. Paul previously served as business editor of Baltimore’s Daily Record newspaper. Paul also is the author of an inspirational book, “Holy Smokes! Golden Guidance from Notre Dame’s Championship Chaplain,” with a foreword by former national championship-winning football coach Lou Holtz. The book is great as a gift and is endorsed by Joe Montana, Joe Theismann, Ara Parseghian, “Rocket” Ismail, Reggie Brooks, Dick Vitale and many others. Call 202-677-4457 for multiple-book pricing.

 

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Nowhere To Hide

Nowhere To Hide

Authored by James Rickards via DailyReckoning.com,

Investors don’t need to be told about the recent stock market crashes….

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Nowhere To Hide

Authored by James Rickards via DailyReckoning.com,

Investors don’t need to be told about the recent stock market crashes. The Dow Jones index is down 12.5% since early January. The S&P 500 is down 16.1% in the same period. The Nasdaq Composite is down an even more spectacular 26.5% this year. It lost more ground today.

This puts the Nasdaq solidly into a bear market (down 20% or more from an interim peak) while the Dow and S&P 500 are both in correction territory (down 10% or more from an interim peak).

This collapse coming so soon after the market crash of March 2020 may surprise some investors, although this outcome was predicted in my last book The New Great Depression, published last year.

We could get into the reasons for the recent market swoon, like the Fed’s taking away the punch bowl, but the reasons almost don’t matter at this point.

What truly is surprising is that the stock market is not alone in its recent dismal performance.

The Great Crypto Crash

U.S. Treasury bonds, foreign currencies, gold and other commodities have all declined sharply side by side with stocks. There are good reasons for this, including the prospect of a recession that could cause stocks, gold and commodities to fall in sync.

Still, the market carnage doesn’t end there. The biggest collapse among major asset classes is in Bitcoin and other cryptocurrencies.

The price of Bitcoin has fallen over 55% since last November, when Bitcoin peaked at around $69,000. As I write this article, Bitcoin is trading at $29,647.

As is so often the case, gullible investors jumped in when Bitcoin was riding high. Now, 40% of all Bitcoin investors are underwater on their holdings. Like the saying goes, nobody blows a whistle at the top.

So much for Bitcoin being the new inflation hedge!

And the damage is by no means limited to Bitcoin. Huge losses have arisen in other popular crypto currencies such as Ethereum (down 57% over the same period), XRP (known as Ripple) and Solana.

Still, neither of those crypto collapses was the most spectacular. A crypto currency called Luna fell from $116.84 on April 5, 2022, to $0.0062 on May 16, an incredible 99.9% crash in less than six weeks.

That’s not just a crash, it’s a complete wipe-out. It just shows you how crazy speculative manias can become, completely unhinged from reality.

Contagion

The danger in these types of collapses goes beyond the losses to individual investors who happen to hold the coins. Such losses are indicative of a wider global liquidity crisis emerging. It’s a reminder of how deeply interconnected today’s markets are.

It comes back to contagion.

Unfortunately, over the past couple of years, the world has learned a painful lesson in biological contagions. A similar dynamic applies in financial panics.

It can begin with one bank or broker going bankrupt as the result of a market collapse (a “financial patient zero”).

But the financial distress quickly spreads to banks that did business with the failed entity and then to stockholders and depositors of those other banks and so on until the entire world is in the grip of a financial panic as happened in 2008.

Disease contagion and financial contagion both work the same way. The nonlinear mathematics and system dynamics are identical in the two cases even though the “virus” is financial distress rather than a biological virus.

As one market crashes, investors in other markets sell assets to raise cash and the collapse virus quickly spreads to those other markets. In a full-scale market panic of the kind we saw in 1998 and again in 2008, no asset class is safe.

Investors sell stocks, bonds, gold, cryptos, commodities and more in a mad scramble for cash.

Each Crash Is Bigger Than the Last

And unfortunately, each crisis is bigger than the one before and requires more intervention by the central banks.

The reason has to do with the system scale. In complex dynamic systems such as capital markets, risk is an exponential function of system scale. Increasing market scale correlates with exponentially larger market collapses.

Today, systemic risk is more dangerous than ever because the entire system is larger than before. This means that the larger size of the system implies a future global liquidity crisis and market panic far larger than the Panic of 2008.

Too-big-to-fail banks are bigger than ever, have a larger percentage of the total assets of the banking system and have much larger derivatives books.

To understand the risk of contagion, you can think of the marlin in Hemingway’s The Old Man and the Sea. The marlin started out as a prize catch lashed to the side of the fisherman Santiago’s boat.

But once there was blood in the water, every shark within miles descended on the marlin and devoured it. By the time Santiago got to shore, there was nothing left of the marlin but the bill, the tail and some bones.

The point, again, is that today systemic risk is more dangerous than ever, and each crisis is bigger than the one before. Remember, too-big-to-fail banks are bigger than ever, have a larger percentage of the total assets of the banking system and have much larger derivatives books.

The Fed Has No Answers

The ability of central banks to deal with a new crisis is highly constrained by low interest rates and bloated balance sheets, which exploded even higher in response to the pandemic. You see how much damage the Fed’s recent rate hikes and end of quantitative easing have caused.

The Fed’s balance sheet is currently about $9 trillion, which it’s just beginning to reduce. In September 2008, it was under $1 trillion, so that just shows you how bloated the Fed’s balance sheet has become since the Great Financial Crisis.

How much the Fed can drain from the balance sheet without triggering another serious crisis is an open question, but we’ll likely get the answer at some point.

The threat of contagion is a scary reminder of the hidden linkages in modern capital markets.

The conditions are in place.

But you can’t wait for the shock to occur because by then it will be too late. You won’t be able to get your money out of the market in time because it’ll be a mad rush to the exits.

The best description I’ve ever heard of the dynamic of a financial panic is, “Everybody wants his money back.”

We seem to be headed to that state of affairs at a rapid rate.

The solution for investors is to have some assets outside the traditional markets and outside the banking system.

Tyler Durden Tue, 05/17/2022 - 17:05

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