Thursday 26 December 2013

Merry Christmas and a happy new year to all!

This year Macronomics is celebrating its fourth year of existence. The blog started early December 2009.

On that special occasion, we would like to extend our thanks for the support of many and to our growing number of our readers (thanks for your praise in 2013). 

We would also like to thanks our good friends from Rcube Global Macro Asset Management for their numerous qualitative and quantitative contributions throughout 2013.

We also would like to extend our thanks to our good cross-asset friend for providing us with his great insights on the subject of volatility and his regular comments, providing us with interesting exchanges of ideas during the course of 2013. We are looking forward to hearing more of him in 2014 with a potential for more volatility to come in 2014 in that respect.

While as of late we haven't been posting, it was due to the necessity of taking a necessary "sunshine break".

We generally avoid making advertising, but, we will make an exception. For our readers who enjoy windsurfing / surfing and kyte surfing, here is the link to the location of our recent "board meeting" which explains our recent lack of posting: Windy Reef - St Martin.

Jean-Sebastien Lavocat, a great windsurfer and surfer, is running the place. Throughout the years his club has generated numerous young surfing champions and continues to do so. On top of being a great location for windsurfing and surfing, food in St Martin, in particular at Grand Case, is top notch. It is also hard to find another place in the world where 1$ = 1€. So, go check it out if you want to ride other waves than market waves...

2013 saw our arrival on Twitter, so don't hesitate to add us and to comment on our posts in 2014.

Thank you all for following us and wishing you all a happy new year in advance.

Stay tuned in 2014 for more of our ramblings!

Wednesday 11 December 2013

Guest post - When is "good news" "bad news"?

"Bad news sells because the amygdala is always looking for something to fear." - Peter Diamandis 

Please find below a great guest post from our good friends at Rcube Global Macro Asset Management. In this post our friends go through a quick and easy method to identify time periods during which "good news is bad news.

Since last May and the sudden addition of the word “tapering” to the financial lexicon, we have observed quite a few better‐than‐expected US economic releases resulting in short‐term market corrections, and vice versa.

The underlying reason for this market behavior is quite obvious: nowadays, when an economic release indicates a strong US economy, investors fear that this will incite the Fed to prematurely reduce the dosage of morphine it injects into the economy through QEs and ultra‐low rates.

In this paper, we will present a quick and easy method to identify time periods during which “good news is bad news”. We won’t use the vast mathematical toolbox aimed at this kind of task (regime‐switching models such as HMM). Instead, we’ll keep things simple, visual and intuitive.

We’ll use Citigroup’s US Economic Surprise Index (CESIUSD Index) as an indicator of economic momentum. CESI indicators reflect how recent economic releases have fared compared to expectations. As far as we know, they are never revised (unlike the vast majority of economic indicators) and as a result, they reflect the surprise factor in real‐time. Their main shortcoming resides in their rather short history (around 11 years). For stocks, we’ll simply use the S&P 500.

A casual look at both time series’ levels doesn’t yield many interesting insights:

Even when we attempt to “stationarize” the S&P 500 by applying a momentum transform, it is still
quite difficult to visually distinguish between periods where economic momentum and equities move
in opposite directions from periods where they move together.

One popular solution to identify regime switches is to perform a rolling regression between time series differentials. What follows is a 6‐month exponentially‐weighted regression* between daily changes in economic momentum and daily equity returns:

*By using an exponentially‐weighted regression, we avoid the “cut‐off” effect that is inherent to rolling windows (in which the disappearance of past observations from the rolling window arbitrarily changes our assessment of the current correlation level).

Due to outliers, the regression time series is very noisy and difficult to interpret. Moreover, the regression level is an inherently lagging indicator of regime switches.

As an alternative to rolling regressions, we therefore propose the following time series, which we will call the “Cumulative Surprise Impact” (on the S&P 500, in our case):
Cumulative Surprise Impact: 
Cumulative Sum of [ (CESI daily differential) x sign (S&P daily Change) ]

The Cumulative Surprise Impact increases (by the amount of the CESI daily differential) when the CESI daily differential and the S&P go in the same direction, and decreases when they go in opposite
directions. The goal is not to predict anything, but to analyze the S&P’s short‐term response to positive (or negative) surprises.

The level of the Cumulative Surprise Impact is not directly interpretable (CESI daily differentials represent the intensity of surprises released during each day, but their value do not represent anything). What matters is the direction of the Cumulative Surprise Impact:

‐ The slope is positive when equity investors yearn for positive economic news (“good news is good news”).
‐ The slope is negative when investors fear that the Fed’s proverbial “punch bowl” is going to be removed (“good news is bad news”).

As illustrated by the following graph, there is a clear relationship between the Cumulative Surprise
Impact and the Fed’s monetary policy:

‐ Before mid‐2004, as long as the Greenspan Fed stubbornly kept its rates at 1%, good news was generally good news.
‐ From mid‐2004 to mid‐2007, a period which started with the Fed hiking rates by 25bp at every meeting, good news became bad news.
‐ From mid‐2007 until mid‐2013, as we entered the “Great Recession,” rates were eased and we switched back to a “good news is good news” mode. Although we reached the zero‐bound for
rates in late 2008, the massive QE programs that followed acted as a substitute for rate decreases (the rate equivalent of 1 additional Tn$ in the Fed’s balance sheet is anyone’s guess, here we arbitrarily displayed 1 Tn$ as 1%).
‐ Last May, as soon as Bernanke hinted that the Fed might contemplate reducing the amount of monthly bond purchases (under the right set of circumstances), good news became bad news again.

At the risk of stating what might be obvious, we can formulate the following rule:

‐ When the Fed is in easing mode, good news is generally good news.
‐ When the Fed is in tightening mode, good news is generally bad news.

We now seem to be at the onset of a new “good news is bad news” period. As we have seen, these periods can last for several years. We therefore believe that bulls should be careful what they wish for regarding future US economic releases.

"He who laughs has not yet heard the bad news." - Bertolt Brecht 

Stay tuned!

Sunday 8 December 2013

Credit - 2014: the Carry Canary

"That's what the cat said to the canary when he swallowed him - 'You'll be all right.'" - Alvah Bessie, American novelist.

Looking at the continuous rally in the credit space, one has to wonder whether 2014 will indeed be the year of the credit carry trade which, as we posited last week, would be supported by a return of M&A, LBOs, as well as structured credit in similar fashion the year 2007.

Reading through the latest BIS Quarterly report published on the 8th of December, we do indeed share the same concern for the return of riskier credit instruments induced by the generosity of our "Generous Gamblers". As indicated by the BIS and reported by Bloomberg by Kate Linsell in her article "BIS Sounds Alarm Over Record Sales of Payment-in-Kind Junk Bonds", the return of these leverage structure is indicative of the similar pattern taken by the credit markets towards 2007 we think, hence our chosen title:
"Record sales of high-yield payment-in-kind bonds is triggering uneasiness among international regulators who are concerned investors may suffer losses when central banks tighten monetary policy.
Issuance of the notes, which give borrowers the option to repay interest with more debt, more than doubled this year to $16.5 billion from $6.5 billion in 2012, according to data compiled by Bloomberg. About 30 percent of issuers before the 2008 financial crisis have since defaulted, the Bank for International Settlements said in its quarterly review.
Companies are taking advantage of investor demand for riskier debt as central bank stimulus measures suppress interest rates and defaults approach historic lows. The average yield on junk-rated corporate bonds fell to a record 5.94 percent worldwide in May, Bank of America Merrill Lynch index data show, while global default rates dropped to 2.8 percent in October from 3.2 percent a year earlier, according to a Moody’s Investors Service report.
“Low interest rates on benchmark bonds have driven investors to search for yield by extending credit on progressively looser terms to firms in the riskier part of the spectrum,” according to the report from the Basel-based BIS. “This can facilitate refinancing and keep troubled borrowers afloat. Its sustainability will no doubt be tested by the eventual normalisation of the monetary policy stance.”

The BIS was formed in 1930 and acts as a central bank for the world’s monetary authorities.

Biggest PIK
Sales of payment-in-kind bonds last peaked in 2007 when companies issued $11.1 billion of the securities, Bloomberg data show. Offerings fell to $5.4 billion in 2008 and tumbled to $2.7 billion in 2010, the data show." - source Bloomberg.

We also agree with the BIS take that the ongoing "hunt" for yield and the instability it will create down the line:
"In addition to reflecting perceptions of credit risk, spreads may also drive default rates. A low interest rate environment naturally fosters cheap and ample credit. Coupled with the reluctance of crisis-scarred creditors to recognise losses, this can facilitate refinancing and keep troubled borrowers afloat. If such a process is indeed at work, its sustainability will no doubt be tested by the eventual normalisation of the monetary policy stance.
The ongoing search for yield has coincided with the breakdown in certain regions of a previously stable relationship between credit market and macroeconomic conditions. Over the 15 years ending in 2011, low or negative real growth had gone hand in hand with high default rates and credit spreads (Graph 4).
This pattern prevailed also more recently in the United States. By contrast, default rates in the euro area actually fell from 2012 onwards, even as the region entered a two-year downturn and the share of banks’ non-performing loans trended upwards (see below). 
Similarly, credit spreads in emerging markets dropped between late 2011 and mid-2013, just when local economic growth showed clear signs of weakness. This suggests that investors’ high risk appetite may have been boosting credit valuations in capital markets, keeping a lid on default rates." - source BIS Quarterly report published on the 8th of December.

Of course we would argue that the breakdown between in the relationship between credit market and macroeconomic conditions is due to "financial repression" and massive liquidity injections which have had the desired effect in repressing volatility.

This is clearly illustrated we think with the evolution of the Itraxx Crossover 5 year CDS index (European High Yield risk gauge based on 50 European entities) and Eurostoxx volatility (1 year 100% Moneyness Implied Volatility) - graph source Bloomberg:
"The greatest trick European politicians ever pulled was to convince the world that default risk didn't exist" - Macronomics.

On volatility being repressed and the level reached we agree with JP Morgan's recent Cross-Asset volatility snapshot:
"Vol continued its downward trend for the fifth year in a row. YTD, short vol strategies produced a profit even in the case of US rates. The biggest gain was produced by short equity vol strategies, e.g. selling variance swaps on the S&P500 index, and is not only up 11% YTD but it has also recaptured the level it held in early September 2008, just before the Lehman crisis erupted. The very low levels of vol and vol risk premia suggest that there is more upside than downside, and justify a long vol bias currently." - source JP Morgan.

The evolution of the US Vix index and its European counterpart the V2X tells as well a similar story of volatility being contained by the see of liquidity. Evolution of VIX versus its European counterpart V2X since 18th of April 2011 - graph source Bloomberg:

One space though where volatility has not been contained has been of course in the bond space, as depicted by the significant evolution of the MOVE index as well as for Emerging Markets currencies as indicated by the surge of the EM VYX index, following the Fed's tapering stance in the second quarter of 2013:
MOVE index = ML Yield curve weighted index of the normalized implied volatility on 1 month Treasury options.
CVIX index = DB currency implied volatility index: 3 month implied volatility of 9 major currency pairs.
EM VYX index = JP Morgan EM-VXY tracks volatility in emerging market currencies. The index is based on three-month at-the-money forward options, weighted by market turnover.

The significant pain inflicted to Emerging Markets in the process has been described in our post "Osmotic pressure" back in August this year:
"Since 2009, the effect of ZIRP has led to a "lower concentration of interest rates levels" in developed markets (negative interest rates). In an attempt to achieve higher yields, hot money rushed into Emerging Markets causing "swelling of returns" as the yield famine led investors seeking higher return, benefiting to that effect the nice high carry trade involved thanks to low bond volatility." - source Macronomics

The effect of the "reverse osmosis" we did put forward can be seen in the outflows which the EM funds have suffered from this rapid flows as depicted in the below graph from Societe Generale Cross Asset 2014 Outlook:
"EM funds suffered net outflows of USD 39bn (equity) and 33bn (bond) since May 22"
- Cumulative net inflows into Equity and Bond funds (ETFs & Mutual funds) since 2007, monthly data
Source: EPFR, SG Cross Asset Research/Global Asset Allocation/ Mutual Fund & ETF Watch

So moving back to our title and as we already posited in last week's conversation, 2014 will indeed be the year of the "Carry Canary" in particular in the convertibles space given M&A and buyback activity are always a catalyst for issuance as posited by Bank of America Merrill Lynch in the Global Convertibles Outlook for 2014:
"In the year ahead, we anticipate firm M&A and buyback activity. Our High Yield Strategy team’s view regarding M&A activity is that in spite of earnings and economic growth, corporations will continue to find the need to expand through acquisitions rather than rely solely on organic growth. With ever growing balance sheets, we anticipate consolidation in many industries, as smaller, less levered companies are bought by larger firms looking to boost earnings without substantially increasing debt. On buybacks, our High Grade Strategy team expects releveraging event risk activity to pick up in the form of both M&A and buyback activity. Their contention is that rising rates, besides serving as a trigger (due to the urgency for locking in financing while costs are still low), changes the landscape of event risk. Yields will likely continue to be low relative to history, suggesting that the risk of re-levering corporate actions, such as share buybacks and debt financed M&A, should remain high next year, particularly as the expected pick-up in economic growth next year will likely lead to rising M&A volumes. Share buybacks were particularly effective to enhancing shareholder value in 2013, and companies that perceive themselves to be undervalued will continue to partake in such activity (Chart 6)."
- source Bank of America Merrill Lynch

As far as our title is concerned, we believe the "Japanification" of the European credit market will lead to further spread compression. To that extent we agree with Morgan Stanley's take in their recent 2014 outlook namely that in the European Investment Grade space, "carry dominates returns" in a base case scenario, but the deflationary risks weighting on Europe makes credit counter-intuitively a good candidate for "Japanification":
"No Longer the Favored Region
-We downgrade European credit to Equal-weight as a supportive technical backdrop is offset by challenging fundamentals and middling valuations.
-IG and HY spreads tightened 20-30% in the last year despite leverage rising. Fundamental improvements are already priced in, we believe.
-Supportive technicals remain intact. In contrast to the consensus, we think demand will be stronger if rates rise, and lower if they fall.
-Europe's valuation discount to the US has been closing rapidly. EUR IG cash now trades at the tightest levels to US IG since 2009 (maturity, ratings, and FX-hedging adjusted)." - source Morgan Stanley

To illustrate further the convergence between Europe and US for investment grade, it clear the gap has been closing since 2011 as per the below graph displaying the Itraxx Europe Main (Investment Grade) CDS index versus its US counterpart CDX IG - graph source Bloomberg:

Whereas trading volumes in the CDS space have gone up, the issue with bank deleveraging has indeed been on the cash side and one of our top concerns when it comes to dwindling liquidity in the credit space with the return of riskier products as the hunt for yields gathers steam, namely our "carry canary" in 2007 fashion.

When it comes to trading volumes CITI in a recent report published on the 5th of December entitled "2013 Trading Volumes in Europe Credit" clearly indicates the trend of the "Carry Canary":
"European IG investors trade more CDS indices (Main) and fewer bonds. The 13% increase in iTraxx Main (on-the-run) trading volumes in 2013 (vs. 2012) together with the 15% decrease in cash bond volumes (€ iBoxx IG universe) is a reflection of this year’s high uncertainty and low conviction among European investors.
– More hedging via index products: The usage of both indices and especially index options as hedging tools increased this year; at the same time as investors were less keen on trading around their bond positions.
Fears of outflows and lower liquidity in bonds have pushed many investors to (i) maintain higher than usual cash balances and (ii) use CDS index longs to make up the lost carry." - source  CITI

The reduction in trading volumes in Investment Grade bonds is indicated in more details in CITI's report:
"Trading volumes during 2013 in the € iBoxx bond universe have declined both in terms of the total volumes traded (15.0%) and the average amount traded per bond (21%), relative to the equivalent period in 2012. The lower decline in the total volumes traded (vs. the average amount traded per bond) is due to a slight (3.7%) increase in the average outstanding volume of bonds in the index versus the equivalent period last year ."
"€ iBoxx
The € iBoxx index captures all large (> €500mm) fixed rate investment grade corporate bonds with a residual maturity of greater than one year. This is a representative sample of the fixed rate IG European bond market, with short-dated bonds tending to be less liquid (and with no comparable data for FRN trading volumes)." - CITI

Of course 2014 will see a continuation of lower liquidity on dealers' balance sheets, which is a cause for concern as investors dip their toes further higher in the risk spectrum. 

Not only credit will be impacted by dwindling liquidity but the rates markets will also be impacted with increasing regulatory pressure on banks as indicated by Bank of America Merrill Lynch in a report published on the 2nd of December entitled "Will the leverage ratio impact the rates markets? Yes":
"Leverage ratio: the new binding constraint
US fixed income markets face major structural headwinds as regulators shift the focus of bank capital regulations away from risk-based capital in favor of blunt, riskneutral measures such as the Supplementary Leverage Ratio (SLR). Market participants and regulators have expressed divergent views about the potential implications for the rates market since the US SLR proposal was released in July. 

Lower demand for Treasuries and lower liquidity
We expect the leverage ratio to have a significant negative impact on the rates market. This stems from the balance sheet intensive nature of fixed income trading and the effective elimination of the favorable risk-based capital treatment of repo and banks' holdings of Treasuries and agencies under the risk-based capital rules.

The main market impact will occur via two channels: 1) lower demand for Treasuries and agencies and 2) adverse effects on liquidity, transaction costs and trading volumes in these markets. We estimate that price elastic demand for Treasuries and agencies that could be negatively impacted by the SLR could be as high as $850bn.
-Lower demand for Treasuries and agencies, as well as a higher liquidity premium, should result in higher rates, all else equal.
-Treasuries should cheapen to OIS, short dated swap spreads should tighten and coupon strips should cheapen to whole bonds.
-The constraints on dealer balance sheet should increase volatility around events such as Treasury auctions, even as the risk of tail events should decline due to lower systemic risk.
-The higher cost of providing unfunded bank commitments such as corporate revolvers, standby letters of credit and liquidity backstops may result in a sharp decline in corporate CP issuance.

There could be some potential offsets, including carve-outs for certain assets such as cash in the SLR exposure definition, new entrants in the repo market, and a slower pace of Fed tapering. We are skeptical that these offsets will be sufficient to fully neutralize the market impact." - source Bank of America Merrill Lynch

"If you think liquidity is coming back in the credit space, then you are indeed suffering from Anterograde amnesia" - Macronomics - May 2013 - "What - We Worry?"

Therefore dealers inventories will continue their downward trajectory, increasing the "instability" in the system as indicated in Bank of America Merrill Lynch note:
"Dealers: inventories to decline as capital requirements rise
Dealers will face higher costs of holding inventory and providing liquidity to clients as capital requirements increase. In our view, this will likely lead to a reduction in demand for duration as dealers scale back inventories. We estimate that Credit Suisse’s rates balance sheet, for example, is 10 times bigger under the SLR than it is under RWA. Under a 3% leverage ratio, this implies a 67% reduction in ROE relative to the risk-based capital framework. Credit Suisse and UBS have already been under pressure from Swiss regulators to reduce leverage, and thus are further along in the process of reducing fixed income trading assets. We expect other SLR-constrained dealers to also reduce their rates balance sheets as ROEs decline, though some level of inventories is required for normal market making." - source Bank of America Merrill Lynch.

Obviously the deleveraging in the US banking system has indeed been much more dramatic than in Europe:
- source Bank of America Merrill Lynch

So if banks are indeed less incline in purchasing US treasuries in 2014, can the Fed simply reduce its QE program? Here is Bank of America Merrill Lynch take on the subject:
"Can the Fed offset the impact though monetary policy?
As we discussed before, the price elastic demand for Treasuries and agencies that could be negatively impacted by the SLR could amount to as much as 60% of the Fed’s asset purchase program per year in duration terms. Thus, it is conceivable that if the Fed increases its program size, it could offset the market impact of lower demand due to the SLR. However, monetary policy is driven by progress toward the Fed’s dual mandate objectives (full employment and inflation) and our economics team is looking for the Fed to begin tapering their asset purchases in March 2014. Nevertheless, if financial conditions were to tighten meaningfully the Fed could slow its exit from QE3." - source Bank of America Merrill Lynch

Hence our doubts on the "tapering" stance from the Fed. 

As we posited in our conversation "Misstra Know-it-all":
"By suppressing interest rates through ZIRP, the Fed has allowed risks to be "mis-priced" leading to global aggressive "mis-allocation" of capital in the search for returns."

On a final note the dollar and the US treasury are now moving hand in hand as displayed by Bloomberg:
"The dollar and Treasury yields are moving together more than at any time on record as Federal Reserve officials say they may cut debt purchases in coming months, drawing funds to the U.S.
The CHART OF THE DAY shows the 120-day correlation between 10-year yields and the U.S. Dollar Index climbed to 0.65, after reaching 0.68 earlier this week. That’s the highest level in data compiled by Bloomberg that goes back to 1971. A figure of 1 would mean they move in tandem. The bottom panel shows overseas holdings of Treasuries rising as the extra yield U.S. notes offer over their Group of Seven counterparts increased.
“I’m buying dollars and Treasuries,” said Will Tseng, a bond trader in Taipei at Mirae Asset Global Investments Co., which oversees $50 billion. “The Fed is going to slow the pace of pumping money into the economy. That removes the downside risk for the dollar. It’s also going to keep the benchmark rate low, making yields attractive.” Fed officials said they may reduce their $85 billion in monthly bond purchases as the economy improves, minutes of their last meeting issued Nov. 20 show. Chairman Ben S. Bernanke said last month the central bank will probably hold its benchmark interest rate near zero long after the asset purchases end.
China added to its holdings of Treasuries in September as benchmark U.S. 10-year yields climbed to 3.01 percent, the highest level since 2011. The largest foreign lender to America increased its stake by 2 percent, the most since February, to $1.29 trillion, Treasury Department data show. Holdings by Japanese money managers, the second-biggest, rose to a record $1.18 trillion.
Ten-year notes yielded 2.87 percent as of yesterday. The yield rose to 47 basis points more than bonds in an index of G-7 peers in November, the most since 2010, data compiled by Bloomberg show." - source Bloomberg.

"Great Rotation"? We are not there yet, same goes with "tapering", we think...

"I Tawt I Taw A Puddy Tat" - Tweety

Stay tuned!

Tuesday 3 December 2013

Credit - Chart of the Day - Dwindling EUR Credit Assets Yields

"We live in a moment of history where change is so speeded up that we begin to see the present only when it is already disappearing." - R. D. Laing, Scottish psychologist

While we touched in April 2013 on the epic hunt for yield in our conversation "The Night of the Yield Hunter", we thought this graph coming from Morgan Stanley's 2014 Credit Outlook entitled "A Market of Many" would illustrate yet another year of epic "hunt" for yield witnessed in 2013, namely the volume of EUR Credit Assets Yielding over 10%:
- source Morgan Stanley

We have played the game back in September 2011, such as buying some Financial Subordinated bonds retail Tier 1 paying 12.5% coupon for a cash price of around 94.5, to see them pass 130 in cash price recently. 2013 has truly been another year of "grab a yield" in the European market.

It is not really a surprise in the current process of "Japanification" in the credit markets. After all as we wrote back in 2012 in our post "Deleveraging - Bad for equities but good for credit assets", while 2013 has been a great year for equities, high beta in the credit space has also seen some very good returns thanks to convexity and the correlation with equities. The issue of course has pointed out by Morgan Stanley in their 2014 outlook is for callable High Yield / High beta bonds given negative convexity and that 71% of high yield is callable today in the US at an average call price of $103.90. In Europe its 54% of the High Yield universe bond market now trades to call creating negative convexity but to a lesser extent than the US, so switching to bullet bonds and playing High Yield via CDS for better upside makes sense, but that's another story.

"Insanity - a perfectly rational adjustment to an insane world."- R. D. Laing,  Scottish psychologist.

Stay tuned! 

Sunday 1 December 2013

Credit - All that glitters ain't gold

"Ah, lives of men! When prosperous they glitter - Like a fair picture; when misfortune comes - A wet sponge at one blow has blurred the painting." - Aeschylus

Hearing recently Alan Greenspan in the footsteps of Janet Yellen talking about the surge in equity markets not being a manifestation of "Cantillon Effects",  namely bubbles, we reminded ourselves of our post "Cold Turkey", which in retrospect should have been called "three wise monkeys" given, including Ben Bernanke, these three "wise" central bankers cannot see, hear or speak no evil. By that point, you are probably wondering therefore why this week's chosen title. 

Like many investors we have been "Singin' in the Rain", blessed by the Fed's liquidity "rain" for the last couple of years.
We have no doubt reaped some of the benefits of our "Generous Gambler", such as buying Junior Financial Subordinated bonds paying 12.5% coupon at 94.5 in cash price in 2011, seeing them soar past the 130 mark in cash price recently or buying Nikkei exposure hedged in Euro in 2013, and as we mused in our conversation the "Coffin Corner" we 've been indeed "singing":
"Like our credit friends, we keep dancing, but close to the door, knowing well enough, at some point the music will stop, and given the poor liquidity in the secondary space, the feeding frenzy on any new issues coming to the market, even with a miserable yield (Nestlé 7 year bond at mid-swaps +25 bps), when it will, it will no doubt be messy, like a NF104 Lockheed Starfighter falling from the sky."

So this week's chosen title is a musical reference to 1995 hit song "Gold" by Prince. When ones looks at some of the deals being thrown in the market, for instance in the convertible space, no wonder we think that some parts of Prince's lyrics are appropriate as our chosen title:
"Everybody wants to sell what's already been sold
Everybody wants to tell what's already been told
What's the use of money if you ain't gonna break the mold?
Even at the center of fire there is cold
All that glitters ain't gold" - Prince - Gold Lyrics

When we mention the convertible space there is a good reason. There is a surge in demand for bonds that converts into equities with zero interest, as reported in the Financial Times by Arash Massoudi in his article "Clamour for stocks sets "no-no" debt deal loose":
"A clamour for fresh opportunities to jump on board the equity market rally is providing some companies with cheap financing alternatives in the $200bn US convertible bond market. The most coveted of these are known  as “no-no” bonds. Convertible bonds allow issuers to offer debt that pays investors a low monthly coupon and gives them the option to convert the security into the issuer’s stock if it climbs to a preset premium over the bond’s tenure. But as new issuance of the hybrid securities roars back to life after a multi-year slowdown, a number of companies are taking advantage of pent-up demand to pull off no-no deals that offer no monthly interest payments or discount to face value. 

For investors, however, the return of these aggressively priced hybrid securities are the latest sign that issuers are exploiting a corner of the US capital markets for favourable terms. This month Yahoo and ServiceNow raised $1.25bn and $575m respectively by issuing no-nos, the first such deals since a $1.25bn Microsoft convertible bond in 2010. In the case of Yahoo, a conversion premium of 50 per cent means that investors need its stock to climb to above $53 a share to exercise the option of converting debt into equity. 

David Puritz, who runs the convertible bond trading desk at BlueMountain, a $13bn hedge fund, says the recent deals leave investors with little margin for error. He says: “A no-no bond may look perfectly fine in a convertible model with interest rates and credit spreads at current levels . . . but given their longer duration, low or zero coupon securities are by definition more vulnerable to a move in rates or spreads.” Still, investors say the fact the deals were able to price with such favourable terms is a reflection of optimism over the state of the US equity markets and the attractiveness of indirect equity ownership. The conversion feature of the bond means that its value increases as the issuer’s share price goes higher, making deals for companies that have more volatile share prices such as technology stocks more attractive. 

The Barclays US Composite Convertible index is up 21.6 per cent so far this year, not too far off the 26.4 per cent gains for the S&P 500. That compares with the Barclays High-Yield index, which is up 6.5 per cent, and a 2 per cent decline in the Barclays US Investment Grade index. But the resurgence of no-no bonds reflects just how distorted supply and demand in the convertible bond market has become, as the Federal Reserve’s stimulus efforts since the financial crisis have driven down interest rates. Lawrence McDonald, senior director at Newedge, says: “We see these types of deals when chief financial officers have more control over the capital markets and can dictate deal terms. That’s a trend across capital markets all year and it can be a very early indicator of an overheated market. It was in 2007 and it was in the dotcom bubble.” 

The central bank’s efforts have allowed companies to borrow from traditional bond markets at historically low rates, leaving the overall size of the US convertible bond market to contract as new issuance has failed to keep pace with maturing securities over the past five years. Analysts at Barclays say the face value of outstanding US convertible bonds has shrunk by $120bn to $175bn since 2009, as some bonds matured and others were redeemed. But companies are once again turning to convertible bonds as investors and issuers brace for a possible rise in interest rates next year as the Fed looks to wind down its stimulus. This year companies are issuing convertible bonds at their fastest clip since 2009 and the pace has continued into November, which is set to be the most active for new issues this year. Companies have raised $42.75bn from offering 158 convertible bonds this year, according to Ipreo. 

Joseph Hall, partner at Davis Polk, says: “When stock prices are as high as they are, the convertible bonds become a lot more attractive instruments for issuers. Companies are taking advantage of the opportunity to lock in financing in some cases at zero per cent.” Some warn, however, that the new deals could carry substantial risk if interest rates rise, especially for no-no bonds. Venu Krishna, head of equity-linked origination at Barclays, says: “Investors need to be cautious, especially if interest rates start rising, since these securities will be negatively impacted by heightened duration risk from having no coupon. “On the other hand, assuming no change in credit risk, if interest rates rise 100 basis points but the stock goes up say 30 per cent, investors will participate in the upside.” " - source - Arash Massoudi 

Of course many will argue that until the music stops 'in true Chuck Prince fashion as an investor, you have to keep dancing: "As long as the music is playing, you've got to get up and dance" - Chuck Prince, CITI ex CEO.

So in this week's conversation we will look at these "glitters" we are seeing which definitely ain't gold and warrant caution as we move into 2014 which could mark the final innings of the long rally initiated in 2009 courtesy of central banks generosity.

The "Cantillon Effects" at play, the rise of the Fed's Balance sheet, the rise of the S&P 500, the rise of buybacks and of course the fall in the US labor participation rate (inversely plotted) - source Bloomberg:
In red: the Fed's balance sheet
In dark blue: the S&P 500
In light blue: S&P 500 buybacks
In purple: NYSE Margin debt
In green: inverse US labor participation rate.
“This does not have the characteristics, as far as I’m concerned, of a stock market bubble” - Alan Greenspan

A recent good illustration of the issuance of convertibles for buy-back purchases was NVIDIA's announcement on the 25th of November of an offering of $1.3 billion convertible senior notes to use the proceeds of the offering to fund capital return to shareholders via the repurchase of shares of the Company's common stock and for quarterly dividend payments pursuant to the Company's recently announced $1 billion fiscal 2015 capital return program.

Multiple expansion through share buybacks have been driving indeed the stock market higher greater than earnings have. The S&P 500 has risen 26.7% YTD versus 16% for the trailing PE from 16.4x to 19.1x. Buybacks rose by 18% QoQ to $118 billion in 2013, up 11% YoY to $218 billion in 1H13. The S&P 500 trades at 25x cyclically adjusted PE ratio (CAPE), exceeding the highs reached in 1901 and 1966. In 129 CAPE reached 33x and in 2000 44x. The growing divergence between the S&P 500 and trailing PE since January 2012 - graph source Bloomberg:
All that glitters ain't gold...

And it cannot be truer if either one looks into the rise of the S&P500 between High and Low Quality Stocks - graph source Bloomberg:

Or if one looks into the outperformance of the Small-Cap ratio versus the underperformance of the S&P 500 Utilities index - graph source Bloomberg:

Another sign of the real "Great Rotation" has been the continuous selling from Institutional clients while private clients have been stepping in as reported by Bank of America Merrill Lynch in their recent equity client flow trends report from the 26th of November entitled - "Little confidence in equities' new high":
"Institutional clients lead selling; retail clients return to buying
Last week, during which the S&P 500 climbed 0.4% to reach another new all-time high above 1800, BofAML clients were net sellers of US stocks for the fifth consecutive week, in the amount of $2.3bn. Net sales were led by institutional clients, who returned to net selling following a week of muted buying. Institutional clients remain the biggest net sellers year-to-date (Chart 1),  with cumulative net sales of over $23bn—larger than in either 2008 or 2010
As we noted last week, while much of institutional clients’ net sales post-crisis were likely due to redemptions, some outflows year-to-date could suggest a rotation out of US stocks and into global equities. Hedge funds were also net sellers for the second consecutive week, while private clients returned to net buying after a week of selling. This group has been a net buyer for 23 of the past 26 weeks. Large, mid and small caps all saw net selling last week." - source Bank of America Merrill Lynch

Another illustration of this "Great Rotation" comes from the same Bank of America Merrill Lynch report which displays BofAML institutional client cumulative net buys of US equities: pension funds and institutional ex. pension funds since 2008:

Of course, the credit markets have been also indicative of  not only investors dipping their toes outside of their comfort zone but most of all the on-going "japonification" such as in the loan market as indicated by Christine Idzelis in her Bloomberg article from the 21st of November entitled "Loan Faults Seen in $250 Billion of Refinancings":
"The demand has helped companies issue $581 billion of loans to non-bank lenders such as hedge funds and collateralized loan obligations, up from $366.4 billion in all of 2012, Bloomberg data show. At the current rate, the record of $581.5 billion in 2007 may be broken as soon as today.
I don’t think there’s much of a resemblance between now and 2007 other than it’s a borrower’s market,” A.J. Murphy, global co-head of leveraged finance at Bank of America Corp., the largest underwriter of leveraged-loans in the U.S., said in a telephone interview. Leveraged buyouts are smaller than they were six years ago, she said.
The top five LBOs this year averaged about $12 billion, compared with $30 billion in 2007, Bloomberg data show." - source Bloomberg.

We must say we have been quite amused by the above quote, we all know "this time it's different. One thing for sure, 2013 has been the biggest year since 2007 for CLOs as indicated by Kristen Haunss from Bloomberg in her article from the 26th of November entitled "Wall Street Props CLO Boom as Rules Lift Costs":
"The biggest year for collateralized loan obligations since 2007 is being propped by deals managed by Blackstone Group LP and Carlyle Group LP, which started funds that pledge to boost interest rates on the debt.
While $87 billion of CLOs have been issued globally this year based on JPMorgan Chase & Co. data, coupons on the highest-rated portions have risen to as much as 1.5 percentage points over the benchmark from at least a three-year low of 1.1 percentage points in May. Yields rose as GSO Capital Partners LP, the credit arm of Blackstone, Carlyle and other money managers sold at least $4.5 billion of CLOs with the promise of higher interest payments, typically after 18 months.
Money managers and banks are finding new ways to ensure investors keep buying CLOs -- which bundle junk-rated loans used to back buyouts -- after the Federal Deposit Insurance Corp. asked lenders in April to designate AAA rated portions of the notes as “higher-risk” assets. Regulators are now considering more rules targeting the funds, which helped push issuance of leveraged loans this year to a record $277.1 billion, according to data compiled by Bloomberg.
“AAAs continue to be the hardest to sell and banks have become creative in order to distribute the debt,” Ken Kroszner, a Stamford, Connecticut-based CLO analyst at Royal Bank of Scotland Group Plc, said in a telephone interview. At least 10 CLOs sold since June offered a so-called step-up coupon, where rates increase over the life of the deal, according to Kroszner." - source Bloomberg

If you think 2013 was a record year, wait for 2014. 2014 for us points towards the last inning of the game being played thanks to "easy money". Why so? You might rightly ask.

2014 will see the return of big LBOs so as a credit investor, you should switch on your LBO screeners we think. Anne-Sylvaine Chassany from the Financial Times in her article entitled "Private equity's dry powder' raises overcapacity concerns":
"Private equity groups are holding more cash for acquisitions than they had at the height of the leveraged buyout boom, in spite of a fall in the volume of deals being done – raising concerns about overcapacity in the industry.  Data compiled by Preqin, the research group, show that the value of unspent commitments to private equity funds, known as dry powder, has surged to $789bn this year – an increase of 12 per cent since December 2012, after four years of decline. This compares with $769bn of unspent cash in 2007 – when the volume of private equity deals reached a peak – and the $829bn that went unspent in 2008, when deal volumes plunged 70 per cent as the financial crisis unfolded. 

In 2007, private-equity houses led $776bn of deals, but the comparable figure stands at just $310bn in 2013, according to Thomson Reuters. Research by Hamilton Lane, a private equity investor that tracks 2,000 funds, says this combination of increased fundraising and decreased deals could lead to a record level of dry powder by the year end. 

Buyout groups’ rising cash piles reflect the fact that they have taken longer to invest their funds since the crisis, as they have found fewer good opportunities. But the increase in the capital overhang has been largely fuelled by a renewed appetite for private funds from yield-starved investors.

After a steep contraction in the aftermath of the crash, buyout groups have been able to raise more money from investors, partly because they have found ways to return cash from previous vehicles – mostly through refinancings and initial public offerings. This has helped Advent International, Warburg Pincus, CVC Capital Partners, Carlyle and Silver Lake raise more than $10bn each for new funds. 

According to Mario Giannini, Hamilton Lane’s chief executive, 2013 is on course to become “the fourth biggest fundraising year” of all time for the private equity industry, as investors are lured by its higher returns. 

Private equity funds have attracted $279bn this year, more than the whole of last year, Preqin has found. Some industry participants warn that the cash overhang will drive asset prices up as groups feel the pressure to invest the money before the commitments expire, typically after five years." - source Financial Times - Anne-Sylvaine Chassany

What we found very amusing is that part of this "dry powder" is finding its way into shipping. There is a wave of private equity money flowing into shipping, which for us is yet another manifestation of "mis-allocation" and "Cantillon Effects".
We have long argued that "Shipping is a leading credit indicator", as well as a "leading deflationary indicator". We have also discussed at length the link between consumer spending, housing, credit and shipping back in August 2012.

The latest manifestation of the consequences of "cheap credit" and record cash is leading outside players such as private equity investors to dip into the structured finance shipping business as reported by Mark Odell and Aja Makan in the Financial Times on the 27th of October in their article "Wave of private equity money flows into shipping":
"Private equity has been drawn to the sector as asset valuations for both new-build and second-hand ships have hit rock-bottom.
As a highly-fragmented industry with few large players, the need for capital could hardly have been greater. Traditional lenders such as Germany’s Commerzbank and HSH Nordbank and the UK’s Lloyds and Royal Bank of Scotland are either exiting the market or looking to reduce exposure, stung by heavy losses on loans made before the downturn.
Ship owners looking for fresh funds have found private equity groups willing to listen as they struggle to allocate capital in their more traditional markets.
Oaktree Capital Management, for example, last year took a large stake in Floatel, which owns and operates offshore construction support vessels, and injected equity into General Maritime, a crude and petroleum product tanker company.
Other groups are investing directly in ships. This summer Carlyle committed more than $100m to InterLink Maritime, allowing it to order ten bulk carrier ships, while in September Apollo Global Management committed to a joint venture with German freight line Rickmers Group to invest up to $500m initially in second hand ships.
Before that York Capital linked up with New York-listed Costamare, a container ship owner, in another $500m joint venture. “The reason they are here is high expectations about returns as they are entering at the low-part of the cycle,” says Greg Zikos, chief financial officer of Costamare.
These expectations have so far this year attracted more than $2.7bn, a quarter of the total investment in ships led by private equity since 2008, according to data compiled by Marine Money, a US-based consultancy.
Bankers and analysts say the money has targeted specific “hot” sectors of the market, especially product tankers, which carry refined products, and vessels to carry liquefied petroleum gas and liquefied natural gas. There has also been a renewal of orders for dry bulk carriers. 
On top of the $11.2bn invested in ships and indirectly in shipowners since the start of 2008, private equity groups have also been investing in terminals, ship charterers and shipping containers. In August, KKR led $580m in funding for a specialist shipping bank." - source Financial Times, 27th of October - "Wave of private equity money flows into shipping"

Of course the investor profile in the shipping business has indeed changed with the arrival of dry powder and the buccaneers from the Private Equity business as indicated in the same article from the FT:
"But the presence of the “new” money has been noted. At a shipping industry conference in New York this summer a Greek shipowner, whose family had been in the industry for generations, took one look at the audience dotted with private equity executives, before asking the organiser: “Where are all the shipowners?” 
His question was only part in jest, says Jim Lawrence, chairman of Marine Money, who organised the conference. Private equity executives not only look different – the Greek shipowner was shocked by the number of dark suits facing him – they act differently. 
Whereas traditional shipowners tend to hold vessels for at least 20 years, private equity groups hope to turn a quick profit by listing companies or selling their vessels once charter rates and ship valuations recover." - source Financial Times, 27th of October - "Wave of private equity money flows into shipping"

The issue of course for our private equity friends that they will soon discover is that if quick profits depend on valuations, they also depend on "recovery". We think they are bound for some disappointment as overcapacity is still plaguing the industry.

The surge in the Baltic Dry Index before the start of the financial crisis was a clear indicator of cheap credit fuelling a bubble, which, like housing, eventually burst. In the chart below, you can notice the parabolic surge of the index in 2006 leading to the index peaking in May 2008  at 11,440;  with the index touching a low point of 680 in January 2012  -  Evolution of Baltic Dry Index from 1990 until today - source Bloomberg:

Shipping has been our favorite deflationary indicator, so we give you the latest reading of the Drewry-Hong-Los Angeles container rate benchmark. The container rate has been increased by $400 USD on the 15th of November on all US destinations with no impact so far for the "recovery" desired by Private Equity - graph source Bloomberg:
"The Drewry Hong Kong-Los Angeles container rate benchmark fell 5% to $1,886 in the week ended Nov. 27, declining after last week's $400 general rate increase on containers from Asia to all U.S. destinations, which had boosted rates 14.4%. This marks the 20th week this year that rates are below $2,000. Even with seven increases in 2013, rates are 13.4% lower yoy and down 14.8% ytd, as slack capacity continues to pressure pricing."  - source Bloomberg

While Private Equity's dry powder has indeed led the order book higher for shipping no doubt - source Bloomberg:

Creative destruction in the shipping industry is still slowly digesting the past excesses as illustrated by the number of bulk carrier scrapped vessels still rising - graph source Bloomberg:
Excess capacity and depressed charter rates have increased the number of container ships sent to be scrapped by around 550% since June 2005.

The overcapacity is still heavily weighting on Asia-Originated Rates lower - graph source Bloomberg:
"The Shanghai Export Containerized Freight Index (SCFI) fell 4% yoy in the week ending Nov. 15. The SCFI is 27% below its May 2012 peak as excess capacity pressures rates, yet has risen 24% from its mid-October low. Similarly, the China Export Containerized Freight Index is 9.5% lower yoy and 22% below its peak, also in May 2012. Containerized traffic is driven by consumers, with changes in spending having a direct effect on global traffic volumes." - source Bloomberg

So we are sorry for Private Equity investors in the shipping space because the deflationary forces at play are alive and kicking as indicated by the 20% drop in Asia-to-Europe FEU Rates after three weekly declines - table source Bloomberg:
"Shipping rates for 40-foot containers (FEU) fell 7.6% sequentially to $1,765 for the week ending Nov. 28, the third straight decline, according to World Container Index data. Asia-Europe trade lanes continue to be the weakest. Rates between Shanghai-to-Genoa fell 14.7% sequentially, driven by a 12% decline in Shanghai-to-Rotterdam trade lanes. Asia-Europe rates have fallen 20.1% since carriers implemented a rates increase the week ending Nov. 7."  - source Bloomberg.

Finally on shipping, deflationary forces and lack of shipping "velocity" in similar fashion to the impact QEs have had on velocity, higher costs have prompted shipping lines to slow vessels 18% over the past three years to an average speed of around 10.4 knots. Reducing the speed of container ships by 10 percent can pare fuel consumption by as much as 30 percent - graph source Bloomberg:
In similar fashion, companies have not invested in CAPEX due to ZIRP and weakening demand, preferring using "cheap credit" for buy backs purposes and shareholder friendly endeavors. Another manifestation of "japonification" in container shipping velocity? We wonder.

All that glitters in shipping ain't gold...

Apart from rising LBOs and increasing investment in shipping in 2014, you can expect another wave of M&A given companies in Europe have amassed almost $1 trillion through earnings, bond sales and by refinancing credit lines as reported by Stephen Morris in Bloomberg on the 28th of November in his article entitled "Record $1 Trillion Cash Haul to Spur Euro Growth":
"Companies in Europe have amassed almost $1 trillion through earnings, bond sales and by refinancing credit lines, foreshadowing a potential surge in acquisitions and investment.
Glencore Xstrata Plc, Siemens AG and Daimler AG are among at least 50 companies in the region that refinanced 143 billion euros ($194 billion) of credit facilities this year paying an average interest margin of 0.59 percentage point, the lowest since 2007, according to data compiled by Bloomberg. Lower debt costs have helped Stoxx Europe 600 Index members accumulate more than 600 billion euros in cash, adding an extra 200 billion euros since 2008, as companies hoarded profits and shied away from takeovers during the region’s longest recession.
Europe’s biggest firms now have ammunition for growth after almost five years of central bank stimulus measures and suppressed borrowing costs. Almost 70 percent of executives expect company mergers and acquisitions to increase in the next 12 months and more than half said growth is their primary focus, according to an October survey of 1,600 decision makers by EY, formerly known as Ernst & Young." - source Bloomberg.

Unfortunately consolidation does not amount to "job creation". It might be equity friendly but definitely not credit friendly if it means releveraging, so probably credit negative overall. While takeovers announced by western European companies have risen by 6 percent to $716 billion this year compared with 2012, according to Bloomberg data, it is still less than half the record $1.5 trillion of deals completed in 2007. It looks like credit wise, 2013 is more like 2006 and 2014 might end up looking a lot like 2007 we think. As noted by Matt Levine in his column from the 27th of October entitled "Welcome Back, Leveraged Super Senior Synthetic CDOs", the "fun" products from the past in this game of yield hunting are staging a come-back:
"You can tell that leveraged super senior synthetic collateralized debt obligation tranches are fun because they are called leveraged super senior synthetic collateralized debt obligation tranches, and anything with that many words in its name is up to something. And in fact LSS CDOs were popular prior to the financial crisis, got various people in various kinds of trouble, and more or less vanished.
But now Euromoney is reporting that Citigroup is trying to market them again, with a slight modification that might get people into less or at least different kinds of trouble, though it is far from clear that anyone will be interested." - source Bloomberg.

We believe 2014 will set another stage for the "japonification" of the credit markets as illustrated in the below chart from BNP Paribas, next year might indeed be "The big easy" as 2007:

We also agree with Peter Tchir from TF Market Advisors, namely that the spread between the 5 year CDS index Itraxx Main Europe (Investment Grade risk gauge based on 125 European entities) and the 5 year Itraxx Financial Senior index is moving towards zero - graph source Bloomberg:

2014 will also see Europe still facing the pressure from two tectonic deflationary plaques, which have been the US QE but more importantly in 2013 the outpacing of the Fed led by "Abenomics" which is indeed sending a tremendous deflationary force around the world which means that even the US is not immune to, hence our repeated doubts in seeing a "tapering" in 2014. 

Make no mistakes the Bank of Japan's actions are highly deflationary. On that sense we agree with the recent note from Russell Napier - Solid Ground - entitled "An ill wind":
"The collapse of the yen from ¥115 to ¥143 to the US dollar from 1997 to 1998 played a key role in the Asian economic crisis as Japanese competitiveness surged. The YoY percentage change in the yen-dollar rate currently outstrips the peak decline of 1998 which cause so much pain for Japan’s competitors." - source CLSA - Russell Napier - "An ill wind".

You should focus on Japan and the pain which is already being inflicted to some Emerging Markets due to the Japanese deflationary "tsunami".

On the subject of the power of this Japanese "tsunami" we agree with the following comments from a head of derivatives trading at Bank of America Merrill Lynch:
"One lesson of Japanese culture: we are always hesitant to be the first one to take action but if one does, everyone will follow in the same direction. 
DO NOT underestimate when all domestic are acting together! 
As far as I know, there "was" only one big domestic winner in this year's equity market until Q3. 
-What if the rally over last two weeks was mainly caused by domestics? 
-What if Nochu is buying equities? 
-What if other mega banks are buying? 
-What if regional banks have started buying equities? 
-What if Japan Post bank (Yucho) has been buying equities? 
-What if Japan Post bank somehow shows up as "foreigner investor" on TSE's "Investment Trends by Investor Category" statistic?
-What if GPIF starts buying from next year? 
-What if retail starts buying through NISA next year? 
-What if lifers start considering "unwinding currency hedge" or "buying foreign asset without currency hedge"? 
-What if US real money will start buying? 
-Do you know how big Nochu is? 
-What if Okinawa situation is settled soon? 
-What if PM Abe leverages Okinawa settlement to settle TPP? 
I heard that BoJ governor held a meeting on Tuesday to invite 25 investors. I heard the content was just repeating what he said before, but what was the subcontent of the meeting? Why did he hold the meeting in front of investors, though I don't think previous BoJ governor has ever done so?" - source Bank of America Merrill Lynch

Because we do not underestimate the Japanese "tsunami", we have been adding to our existing long Nikkei exposure hedged in Euro as well as our short Japanese yen stance.

In addition to Bank of America's comments, you should take into account the following article from Mayumi Otsuma and Keiko Ujikane from the 28th of November entitled "Japan's Tax-Free Granny Gifts Unlocking Retiree Savings":
"Shoko Iwasaki looked for years for a tax-free way to pass down a lifetime of savings to her grandson. Prime Minister Shinzo Abe has offered the 71-year-old an answer with a program now helping unlock pensioners’ hoarded wealth.
“I’m so grateful for this tax measure, which enables me to hand over my money all at once,” said Iwasaki, who lives alone in Ashiya, about 300 miles west of Tokyo. She plans to endow 15 million yen ($147,000) for the education of her grandson under an initiative introduced this year exempting tax on lump-sum gifts to children for schooling expenses.
Potential transferable assets to the younger generation under the program that lasts through 2015 amount to 117 trillion yen, according to estimates by Goldman Sachs Group Inc. Gifts of just 10 percent of the total could see 4 trillion yen a year trickling down -- an amount equivalent to 1.7 percent of annual consumer spending in the world’s third-largest economy.
With a shrinking and aging population leaving Japan’s companies reluctant to invest at home, added impetus to consumption would help Abe’s campaign to strengthen domestic demand. Any bump in spending resulting from the act also could diminish the blow from sales-tax increases that start in April.
This tax exemption is a significant idea in terms of tapping seniors’ money -- which is mostly in a dormant state,”said Yuichi Kodama, chief economist at Meiji Yasuda Life Insurance Co. in Tokyo. “This is one policy that will support the success of Abenomics.” "- source Bloomberg

So forget the US "tapering" and focus on Japanese "tapping". There is a Japanese "tsunami" coming your way and it represents $8.5 trillion in savings as indicated by Masaki Kondo and Hiroko Komiya in Bloomberg on the 19th of November in their article entitled "Yen Bears Return as Japan Taps $8.5 Trillion Savings":
"The Nippon Individual Savings Account program will allow individuals to invest in stocks and mutual funds starting Jan. 1 without facing taxes on profits, freeing up savings that exceed China’s gross domestic product and complementing the Bank of Japan’s $70 billion of monthly bond purchases. Strategists say low domestic interest rates may force part of the new money offshore, helping weaken the yen and end deflation.
“The NISA will spice up yen-bear sentiment,” Daisaku Ueno, the chief currency strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo, a unit of Japan’s biggest financial group by market value, said by phone Nov. 15" - source Bloomberg.

As we said back in our conversation "Cold Turkey" regarding Japan on the 17th of November:
"While some recent "trade fatigue" did materialized in recent months on the Japan rocket "lift-off", we think that we are in an early second stage for the Multistage Japan rocket"

We also added:
"As we posited in the "Coffin Corner" back in Europe, the aggressiveness of the Japanese reflationary stance spells indeed more deflation for Europe and we think the US will as well withhold its tapering stance, spelling more trouble ahead".

On a final note, the link between Japan's stocks and yen is the strongest on record as displayed in Bloomberg's Chart of the Day from the 27th of November:
"The link between Japan’s stocks and yen is the strongest on record as its central bank stands ready to ease monetary policy while the U.S. Federal Reserve prepares to pare stimulus, according to SMBC Nikko Capital Markets Ltd.
The CHART OF THE DAY shows that the correlation between the U.S. dollar's strength against the Japanese currency and the Nikkei 225 Stock Average rose on Nov. 26 to the highest on  record, based on data compiled by Bloomberg since January 1978. 
This indicates a growing tendency for equities to rise when the  yen weakens, and vice versa. The Japanese currency fell 1.1 percent against the dollar last week, while the Nikkei 225 
gained 1.4 percent.
“Japan’s monetary base is expanding and the expansion in the U.S. monetary base is slowing, which would tend to suggest, all things being equal, that the dollar will strengthen against the yen,” Jonathan Allum, London-based strategist at SMBC Nikko said in a telephone interview. “That’s a reason to think the stock market in Japan will go up.” Prime Minister Shinzo Abe and the Bank of Japan have signaled they’re willing to add to unprecedented easing measures to reach a 2 percent inflation target, while the U.S. Federal Reserve is contemplating reducing its record $85 billion in monthly asset purchases as the world’s largest economy rebounds.
The policy divergence helped the yen lose 15 percent against the greenback this year as the Nikkei 225 surged 49 percent to rank first among major developed markets.
The 130-day correlation coefficient between the yen and Nikkei 225 rose to 0.49 on Nov. 26, from as low as 0.28 on March 21. A weaker local currency boosts earnings for Japanese exporters such as Toyota Motor Corp. and Panasonic Corp., while increasing the cost of imported goods, adding to price pressures.
“The other possibility why the correlation is suddenly so strong is because there is a correlation between a weak yen and inflation,” Allum said. “If Japan gets into a more self-sustaining inflationary mode and people expect it to continue to rise, then perhaps you won’t need the currency to stimulate stocks.”" - source Bloomberg

Houston, we have lift-off...

"Fortune is like glass - the brighter the glitter, the more easily broken." - Publilius Syrus 

Stay tuned!

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