Macro and Credit - White Tiger

"Earnings don't move the overall market; it's the Federal Reserve Board... focus on the central banks, and focus on the movement of liquidity... most people in the market are looking for earnings and conventional measures. It's liquidity that moves markets." - Stanley Druckenmiller

Watching with interest the trade war between the United States and China ratcheting up with Beijing cancelling its plans to send two delegations to Washington, given the season of fall is upon us, when it came to selecting our title analogy, we decided to go for "White Tiger". The White Tiger is one of the four symbols of the Chines constellations. It is sometimes called the White Tiger of the West and represents the West in terms of direction as well as the autumn season.  It has been said that the white tiger only appeared when the emperor ruled with absolute virtue, or if there was peace throughout the world. Obviously for those who remember our June conversation "Prometheus Unbound", we argued the following:

"It seems more and more probable that the United States and China cannot escape the Thucydides Trap being the theory proposed by Graham Allison former director of the Harvard Kennedy School’s Belfer Center for Science and International Affairs and a former U.S. assistant secretary of defense for policy and plans in 2015 who postulates that war between a rising power and an established power is inevitable:
- source Macronomics June 2016 

"It was the rise of Athens and the fear that this instilled in Sparta that made war inevitable." Thucydides from "The History of the Peloponnesian War" -

In similar fashion, more recently maverick hedge fund manager Ray Dalio came to a similar prognosis in his recent musing entitled "A Path to War" on the 19th of September:

"The economic/geopolitical cycle of economic conflicts leading to military conflicts both within and between emerging powerful countries and established powerful countries is obvious to anyone who studies history.  It’s been well-described by historians, though those historians typically have more of a geopolitical perspective and less of an economic/market perspective than I do.  In either case, it is well-recognized as classic by historians.  The following sentence describes it as I see it in a nutshell:

When 1) within countries there are economic conflicts between the rich/capitalist/political right and the poor/proletariat/political left that lead to conflicts that result in populist, autocratic, nationalistic, and militaristic leaders coming to power, while at the same time, 2) between countries there are conflicts arising among comparably strong economic and military powers, the relationships between economics and politics become especially intertwined—and the probabilities of disruptive conflicts (e.g., wars) become much higher than normal.

In other words economic rivalries within and between countries often lead to fighting in order to establish which entities are most powerful.  In these periods, we have war economies, and after them, markets, economies, and geopolitics all experience the hang-over effects.  What happens during wars and as a result of wars have huge effects on which currencies, which debts, which equities, and which economies are worth what, and more profoundly, on the whole social-political fabric.  At the most big-picture level, the periods of war are followed by periods of peace in which the dominant power/powers get to set the rules because no one can fight them.  That continues until the cycle begins again (because of a rival power emerging).

Appreciating this big economic/geopolitical cycle that drives the ascendancies and declines of empires and their reserve currencies requires taking a much longer (250-year) time frame, which I will touch on briefly here and in more detail in a future report.
Typically, though not always, at times of economic rivalry, emotions run high, firebrand populist leaders who prefer antagonistic paths are elected or come to power, and wars occur.  However, that is not always the case.  History has shown that through time, there are two broad types of relationships, and that what occurs depends on which type of relationship exists.  The two types of relationships are:

a) Cooperative-competitive relationships in which the parties take into consideration what’s really important to the other and try to give it to them in exchange for what they most want.  In this type of win-win relationship, there are often tough negotiations that are done with respect and consideration, like two friendly merchants in a bazaar or two friendly teams on the field.

b) Mutually threatening relationships in which the parties think about how they can harm the other and exchange painful acts in the hope of forcing the other into a position of fear so that they will give in.  In this type of lose-lose relationship, they interact through “war” rather than through “negotiation.”

Either side can force the second path (threatening war, lose-lose) onto the other side, but it takes both sides to go down the cooperative, win-win path.  Both sides will inevitably follow the same approach.

In the back of the minds of all parties, regardless of which path they choose, should be their relative powers.  In the first case, each party should realize what the other could force on them and appreciate the quality of the exchange without getting too pushy, while in the second case, the parties should realize that power will be defined by the relative abilities of the parties to endure pain as much as their relative abilities to inflict it.  When it isn’t clear exactly how much power either side has to reward and punish the other side because there are many untested ways, the first path is the safer way.  On the other hand, the second way will certainly make clear—through the hell of war—which party is dominant and which one will have to be submissive.  That is why, after wars, there are typically extended periods of peace with the dominant country setting the rules and other countries following them for the time it takes for the cycle to happen all over again." - source Ray Dalio

Because the color white of the Wu Xing theory also represents the west, the white tiger became a mythological guardian of the West on the mythological compass. The White Tiger is as well considered in China as the ruler of the Autumn and the governor of the metallic elementals (hint for you gold bugs out there...) but we ramble again. Will the age of reason disappear with the White Tiger? We wonder.

In this week's conversation, we would like to look at the gradual path towards recession in the US and how does the credit cycle will end.

Synopsis:

• Macro and Credit - Credit cycles die of "old age". 
• Final chart - Hey Fed, NAIRU this!

• Macro and Credit - Credit cycles die of "old age". 

While many pundits have been focusing on the continuation of the flattening of the yield curve, as we pointed out in our most recent conversation again, credit cycles die because too much debt has been raised. What the most recent Fed quarterly survey Senior Loan Officers Opinion Survey (SLOOs) tells us is that financial conditions remain very benign still. Yet, no one can ignore the hiking path followed by the Fed and that already some part of the economy such as housing are already feeling the heat and the gradual tightening noose of financial conditions. 

From a "White Tiger" perspective, a full-blown trade war between China and the United States would push US companies to pass on prices increases onto the US consumer. Any acceleration in inflation would lead to the Fed to be more aggressive with its hiking stance. The rhetoric of Fed members in recent week has become decisively more “hawkish”.

First question we are asking ourselves is when does the US consumer gets "maxed out"? We are already seeing credit card usage surging as well as the return of housing equity extraction thanks to the return of HELOC. On this subject we read with interest Wells Fargo Economics Group note from the 18th of September entitled "Consumer outlook in a rising rate environment":

"Executive Summary

Conventional wisdom has it that rising interest rates are bad for consumer spending because swelling financing costs put a squeeze on a household’s capacity for other outlays. What if conventional wisdom is wrong? Our analysis finds that a rising interest rate environment does not immediately snuff out consumer spending growth.

As the current expansion stretches further into its tenth year, the economy is on track to eclipse the expansion of the 1990s as the longest on record. In this report we consider the outlook for consumer spending against this backdrop of a record-setting expansion and consider how long the good times will last. Our base-case scenario, spelled out in this special report, anticipates a modest pick-up in consumer spending, at least in the near term. Eventually, like all good things, the longest economic expansion on record will come to an end and consumer spending will come back down with it. That will likely occur alongside financial conditions that warrant rate cuts by the Fed. The precise timing of these events is tough to get right, but by signaling this drop-off in activity in late 2020, we are essentially saying that while the end of the party is not imminent, no cycle lasts forever.

- Source Bloomberg LP, The Conference Board, University of Michigan and Wells Fargo Securities

As per the below Macrobond chart, the University of Michigan Consumer Confidence turning points tend to coincide with significant S&P 500 12 months return:

- source Macrobond (click to enlarge).

Before we go into more details of Wells Fargo's note, there are a couple of points we would like to make. Despite decreasing significantly from its peak prior to the Great Recession, household debt still remains quite elevated, stabilizing around 77%. Also back in March in our long conversation "Intermezzo", when it comes to consumer credit, as pointed out by famous French economist Frédéric Bastiat, there is always what you see and what you don't see. We pointed out the following from Deutsche Bank's State of the US Consumer report from the 26th of February entitled "Robust Consumer with Pro-cyclical and Seasonal Tailwinds on the Horizon":

"Items to watch

Lower income consumers are more levered than they appear: The aggregate deleveraging post-crisis has largely benefited from mortgage leverage sitting at its lowest level since 2001. However, other consumer leverage (card, student, auto, and personal) continues to grind higher into 2018 and is now at all time highs (~26%). Excluding disposable income for the Top 5% income bracket of US consumers, consumer debt levels are closer to 43% of adjusted disposable income—almost double the reported measure of ~26%. The latest triennial Fed Survey of Consumer Finances highlights this dynamic, with the bottom 40% income households running at ~50% non-mortgage DTI, which is ~10% more than LT averages.

The subprime/low income consumer is stretched: Sluggish wage growth and rising healthcare and rent expenses as a percentage of income (non-debt obligations near 25 year highs) among lower income households have stretched subprime consumers as they look to augment rising expenses with debt. 

Banks have met this increased demand by providing deeper credit access to subprime (increased participation, especially for cards), leading to higher leverage and an increased severity risk of loss as delinquencies start to diverge for lower quality consumers. Like DTI, adjusting debt payment burdens to exclude the top 10% income brackets almost doubles the reported Fed figure (9.6% PTI vs. 5.8% reported PTI by the Fed).

Socio-economic divide driving credit cycle: While aggregate consumer fundamentals remain robust, subprime consumers are seeing rising delinquencies and losses starting to normalize much faster than other credit tiers: +90-day DQs within subprime cards have rose+300bps Y/Y in 3Q17 vs. only~30bps on average for near prime/prime borrowers. ~45% of Americans would have difficulty paying a surprise medical bill of ~$500 (Kaiser Foundation), while ~50% of US consumers live paycheck to paycheck (FITB). Taken all together, a disconnect between the lower credit tier borrowers and the economic cycle is starting to emerge." - source Deutsche Bank

The issue of course for the stretched US consumer would be if Core PCE inflation continues to pick up slightly faster than core CPI if healthcare service price inflation accelerates while rent inflation gradually slows. This upside risk to healthcare prices and expected further labor market tightening, one could expect core PCE inflation to rise further, not to mention the issue with gas prices at the pump should oil prices continue as well to trend up. Remember that the acceleration of inflation is a dangerous match when it comes to lighting up/bursting asset bubbles.

But let's return to Wells Fargo's take:

"A Consumer Spending Framework in the Context of Rates

As we would at any time in the business cycle, we consider the macro drivers of consumer behavior. Consumer sentiment and confidence, by about any measure, are at or near high levels last seen around 2001; which, not coincidentally, was in the late stages of that prior long-lasting expansion (Figures 1 & 2). We also look at the purchasing power in consumers’ wallets, be it in the form of personal income, which is at last picking up (albeit in only a modest way) or in access to capital through borrowing, where measures of revolving consumer credit growth indicate a levelling off more recently. Finally, we tally the actual spending numbers reflected in the personal income and spending report and the monthly retail sales numbers, both of which have been on a roll in recent months.

In an effort to better inform a consumer outlook, it is essential to have a framework for thinking about these fundamentals and how households will manage finances at this late stage of the cycle. The trouble with considering this period in the context of what has happened in prior cycles is that for a long stretch in the current cycle, from December 2008 until December 2015, the Federal Reserve maintained a near zero interest rate policy (ZIRP), and at various points during those years was engaged in a broad expansion of the balance sheet through quantitative easing (QE), (Figures 3 & 4).

- source Federal Reserve System and Wells Fargo Securities

The Fed has historically purchased Treasury securities to expand the monetary base, although the monetary policy “medicine” applied during that era, including the purchases of mortgage-backed securities and other assets, had not been tried before, at least not in the United States.

Central bank actions, no doubt, are a factor in the remarkable duration of the current cycle, and on that basis any informed outlook for consumer spending ought to not only consider these macro drivers (like confidence, access to capital and willingness to spend) but to consider them in the context of Fed policy.

To that end, we went back to just before the 1990s expansion began in 1989 and divided the years since into four broad categories based on what the Federal Reserve was doing with monetary policy at the time: (1) lowering the fed funds rate, (2) a “stable” rate environment, (3) raising the fed funds rate and (4) ZIRP with QE.

The date ranges for each of these periods is spelled out in Table 1 below.

Most of the time periods are straightforward, although the one period that might invite critique is that we have characterized the time period from March of 1995 through January 2001 as “stable” (revisit Figure 3).

One could reasonably observe that the fed funds rate actually moved up and down during that nearly six-year stretch. Our argument for calling it “stable” is that this period was essentially from the “mid-cycle” slowdown until the end of that expansion. Admittedly, there were adjustments up and down throughout the period, but from the start of the period to the end, the funds rate finished just 50 basis points higher. Reasonable minds could disagree, but in our view, the idea of thinking of that period as four unique rate cycles would unnecessarily complicate our analysis.

With our various Fed cycle dates established, we looked at our macro drivers for consumer spending through the lens of the Fed policy that was in place at the time. For each interest rate backdrop, we calculated the average levels for various measures of consumer confidence, the average annualized growth rate of personal income, the average net monthly expansion in consumer credit and finally the average annual growth rates of both real personal consumption expenditures and of nominal retail sales.

A key takeaway from our exercise, depicted in Table 2 below, is that measures of consumer fundamentals tend to do best in periods of stable interest rates. Interestingly though, a rising rate environment is almost as good for these same consumer fundamentals.

Perhaps that is not altogether surprising, considering that the Fed is apt to raise rates when the economy is at full employment and inflation is heating up beyond the Fed’s comfort zone. Those factors tend to exist when the economy is doing particularly well or even overheating.

The inverse of that dynamic may explain why the worst rate theme for consumer spending is during periods when the Fed is lowering rates. Personal income and spending as well as nominal retail sales all performed worst during periods when the Fed was cutting rates. Interestingly, the lowering of interest rates does not compel consumers to increase their appetite for credit, at least not immediately. The average net monthly increase in consumer credit came in a distant last during periods when the Fed was actively lowering rates.

2020 Vision

So what sort of Fed policy theme should we consider looking forward? To judge from the Fed’s dot plot, a visual rendering of policymakers’ own forecasts for the fed funds rate, the FOMC is closing in on its neutral rate for fed funds. With most dots clustered around 3.00 to 3.25% and the current fed funds rate at 2.00%, there are only four or five quarter-point rate hikes left to go in the current cycle, barring some change in forward guidance from the Fed (Figure 5).

Our forecast anticipates two more hikes this year and another three next year. After that it stands to reason we would be in a stable rate environment slightly above the neutral rate until the Fed’s understanding of r* changes (favoring another hike) or until conditions warrant a cut. In a separate special report1, we explained our use of an analytical framework we recently developed to inform our view of Fed policy going forward and why we look for the FOMC to raise rates another 125 bps before it cuts rates at the end of 2020.

In forming our outlook for the consumer, we take the findings of our rate-environment study and overlay them with our expectations for Fed policy over the next couple of years. If things play out the way we anticipate, monetary policy is entering an era of transition unlike anything the economy has seen in more than a decade. For a number of factors including the longevity of the cycle, growing fiscal budget imbalances and a potential fallout from the global economy, we indicated in our initial 2020 forecast that by the end of our forecast horizon the Fed would likely begin cutting the fed funds rate.2 A rate-tightening environment is expected to prevail at least through the first part of 2019, which will be followed by a stable rate for another year or so before the Fed begins to signal eventual rate cuts.

For the consumer, this Fed forecast implies a pick-up in the pace of consumer spending in the near term before an eventual slowing the further out we go in the forecast period. Full year PCE growth was 2.5% in 2017. By the time we close the books on the current year, we expect the comparable number for 2018 to pick up to 2.6%, prior to quickening to 2.7% in 2019 and slowing to just 2.2% in 2020 (Figure 6).

- Source: Bloomberg LP, Federal Reserve Board, U.S. Department of Commerce and Wells Fargo Securities

Outlook

Consumers may be better prepared to endure a slowdown than in the past. The saving rate, currently at 6.7%, is rather elevated given the late stage of expansion, while real median household income surpassed its pre-recession peak in 2017. With the unemployment rate currently matching low levels last seen in the late 1960s, there remains little slack in the economy. The labor market is expected to grow increasingly tight, with the unemployment rate trending to as low as 3.3% by 2020. Similarly, inflationary pressures that continue to gradually build over our forecast horizon will put downward pressure on real income gains.

The length of the current expansion is expected to surpass that of the 1990s, taking the title as the longest expansion on record. While monetary policy changes act as signals to markets about the health of the economy and/or concerns about inflation expectations, we must be sensitive to policy movements and their implication for consumer spending. Our initial 2020 forecast expects the Fed to surpass its neutral rate, prior to beginning to cut policy by the end of 2020. With this signal of a slowdown in activity, we are essentially saying that this expansion will eventually draw to a close. The rate cutting environment will act as a last call announcement – and for the consumer sector it serves as a valuable indication for longevity of this expansion." - source Wells Fargo

Whereas we agree with the timing, we disagree with the perceived health of the US consumer, as per the above points illustrated in a previous Deutsche Bank research note. There is more leverage than what can be seen, not only when it comes to the US consumer but as well when it comes to the distorted balance sheets of many US corporates after years of a buy-back binge and a fall in the quality of the overall rating for the Investment Grade category much closer to "junk" than in the previous cycle.

Overall the timing for the end of the credit cycle could indeed be in the region of 2020. This is as well Ray Dalio's most recent view and also Christopher R. Cole, CFA from Artemis Capital Management as per his July  2018 letter entitled “What is water?”:

“When you are a fish swimming in a pond with less and less water, you had best pay attention to the currents. The last decade we’ve seen central banks supply liquidity, providing an artificial bid underneath markets. Now water is being drained from the pond as the Fed, ECB, and Bank of Japan shrink their balance sheets and raise interest rates.Despite this trend, U.S. equities will very likely escape 2018 without a crisis or volatility regime shift because of the one-time wave of corporate liquidity unleashed by tax reform. Expect a crisis to occur between 2019 and 2021 when a drought caused by dust storms of debt refinancing, quantitative tightening, and poor demographics causes liquidity to evaporate.” – Source Christopher R. Cole, CFA from Artemis Capital Management

The whole note written by Christopher R. Cole is worth a read particularly on the subject of passive management and liquidity. His quote from above resonates as well with our opening quote from maverick investor Stanley Druckenmiller.

 As well in his note, Christopher R. Cole indicates when he thinks we will most likely have another crisis on our hands:

“When does this all end? If or when the collective consciousness stops believing growth can be created by money and debt expansion the entire medium will fall apart, otherwise it is totally real… and will continue to be real.

A crisis-level drought in liquidity is coming between 2019 to 2022 marked by a perfect dust storm of unprecedented debt supply, quantitative tightening, and demographic outflows.

Quantitative easing has caused the natural relationship between corporate debt expansion and default rates to break down. U.S. debt is at an all-time high of $14 trillion (45% of GDP) and high yield default rates are near all-time lows at 3.3% (MarketWatch, 13d). This is not sustainable. Years of cheap money has led scores of investors to buy debt at levels that do not reflect credit risk. The poster child is the 2017 issuance of 100-year Argentina bonds (USD denominated) that were oversubscribed 3.6x with a 7.9% yield. It is hard to find a decade where Argentina has not defaulted, much less a century. That medium of bond market demand has already begun to show signs of cracking.” – Source Christopher R. Cole, CFA from Artemis Capital Management

Fiduciary duty anyone? Credit cycles tend to die of old age and too much debt. We have entered the season of the White Tiger we think. Only a few innings left. 

On the current evolution of the credit cycle we read with interest Bank of America Merrill Lynch's take in their High Yield Strategy note from the 21st of September entitled "The Evolution of the Credit Cycle:

"The Evolution of the Credit Cycle

As we continue to study the state of the current credit cycle, the accumulated evidence sides with the argument that it has more room to develop, as long as few more years. Previous cycles have lasted anywhere between 6-8 years, on average, and this observation would make it an unusual development to see the current cycle extend for much longer. However, we also note that more broadly, this economic cycle has been an unusual one in many respects, including how long it took the US GDP to return to trend growth rates, the unemployment to decline, and the inflation to recover. And if those major macroeconomic variables took an unusually long time to return to normal levels, then why should we expect the credit cycle to be an average one?

Away from this argument, we also continue to believe that the commodity episode in 2015-2016 represented a partial cycle in and of itself. Among the most conclusive pieces of evidence in support of this view, we present the charts in Figure 3 for debt growth and Figure 4 for capex.

In both cases, we highlight cyclical turns, as defined by catalyst events as the starting points and subsequent observed peaks in trailing 12mo HY issuer default rates as ending points.

Both graphs suggest that previous cyclical turns have occurred at similar points on each respective line, had similar impact on each measure, and had left them at similar levels after defaults receded. Both graphs also suggest that a cyclical turn at current levels and given their recent trends would be inconsistent with historical experiences going into previous default cycles.

And yet, inconsistent does not imply impossible, particularly in light of trade tariffs that are being threatened and imposed by the Trump Administration. It remains our view that at the end, these policies are unlikely to survive the test of time, however it is difficult to say how much time it would take to prove them wrong and how much damage they could do in the meantime.

The exact timing of cyclical turns is an inherently uncertain exercise and we do not claim to possess superior skills to do so. Instead, our approach relies on using all available data and analytical tools to help us make a judgment on a relatively short next-12mo time horizon, and continue doing so as time progresses and new data becomes available. As such, we made a call that this cycle was unlikely to turn at this point last year. With all the evidence we accumulated since then, we believe this view still holds today.

Our default model continues to suggest low likelihood of a meaningful spike in defaults over the next year, based on its latest inputs. It currently projects a 3.25% issuer weighted rate during this time period, marginally lower than the actual realized 3.41% rate as calculated by Moody’s (Figure 5). A 3.25% issuer default rate would be consistent with 2.0% par-weighted rate. 

How it ends?

In our last year’s outlook on the prospects of this credit cycle, we listed three key risks to its longevity: (1) inflation spike; (2) trade contraction; and (3) sector distress. We think all three remain valid and potent sources of known risks going forward as well. In our judgment, the spike in inflation remains a lower probability risk, followed by trade contraction, somewhat higher on our scale of likely developments, and still inside of a tail risk zone.

A contraction in one of the key industry sectors is a higher probability outcome, in our opinion, albeit not an imminent one. Previously, we published our thoughts on capital allocation trends across various sectors, and identified healthcare as the most overextended sector in terms of the amount of capital raised in recent years.

A higher capital formation could lead to higher capex, higher production capacity, higher supply, lower prices, and an eventual need to remove excess capacity. The latter stage often goes hand in hand with a need to eliminate excess debt that was used to finance excess capex.

Other sectors that we found to be overextended on this scale include autos, utilities, and food producers, although these three are relatively small compared to healthcare.

And at the end of this conversation on risks, we think it is also important to remind ourselves that previous cycles have ended with a surprise event, a “black swan” of sorts, which, by definition, was unexpected by the consensus and meaningful in its impact. We do not see any particular reasons as to why the next one would break out of this mold." - source Bank of America Merrill Lynch

From our "White Tiger" perspective, an inflation spike is something very much on our radar, hence our close attention to market gyrations in oil prices and geopolitical risk, the famous known unknowns which have been building up recently in world which has decisively moved from cooperation to noncooperation.

As we have stated above, many pundits are focusing on the flattening of the yield curve, from an employment and non-accelerating inflation rate of unemployment (NAIRU), Monetary policy conducted typically involves allowing just enough unemployment in the economy to prevent inflation rising above a given target figure, we think the Fed will once again be behind the curve as per our final chart.

• Final chart - Hey Fed, NAIRU this!

In our previous conversation we discussed the great work of American economist Irving Fisher, in relation to NAIRU,  the concept arose in the wake of the popularity of the Phillips curve which summarized the observed negative correlation between the rate of unemployment and the rate of inflation (measured as annual nominal wage growth of employees) for number of industrialised countries with more or less mixed economies. This correlation (previously seen for the U.S. by Irving Fisher) persuaded some analysts that it was impossible for governments simultaneously to target both arbitrarily low unemployment and price stability, and that, therefore, it was government's role to seek a point on the trade-off between unemployment and inflation which matched a domestic social consensus, the famous dual mandate of the Fed. We won't go into more details about our fondness of the Phillips curve, it's a subject we have discussed on this very blog on many occasions. Our final chart comes from Deutsche Bank's US Economic Perspectives note from the 20th of September entitled "How the Powell Fed can make history" and shows that the Fed has never succeeded in returning unemployment to NAIRU from below without a recession ensuing:

"With unemployment now noticeably below standard measures of its natural level of full employment and likely to tighten further and with wage and price inflation returning to desired levels and likely to continue upward, the Fed has a delicate task on its hands. It needs to begin to close the gap between growth of aggregate demand and aggregate supply in the economy — in other words, to slow and eventually reverse the tightening of the labor market before it risks pushing up inflation and inflation expectations excessively. The question is whether it can do so without pushing the economy into recession and causing unemployment to surge upward, overshooting its natural rate.

Many in the market already see the storm clouds of recession gathering in the distance, a narrative that has found an ally in the flattening yield curve. Talk of a downturn by 2020 is increasingly in vogue and for good reason: a soft landing in unemployment from below NAIRU has never been achieved before. In the modern history of US national economic statistics since the late 1940s, every time the unemployment rate has overshot to the downside, policy firming by the Fed has helped drive the economy into recession (Figure 1).

We think the Powell Fed can make history by achieving the unprecedented outcome of a soft landing from below sans recession." - source Deutsche Bank

Contrary to the elements put forward in this very interesting note, we think that once again this time isn't different. On a final note we thought we had run out of arguments against the cult of the Philipps curve as per our conversation "The Dead Parrot Sketch" back in August 2017, we did read additional arguments against the Phillips curve cult in Saad Filali's take on Seeking Alpha in his article "There Is No Inflation: Too Much Supply, Not Enough Unions", which we found of great interest.  It has been said that the white tiger only appeared when the emperor ruled with absolute virtue, it could be said that the white tiger only appeared when the BIS ruled with absolute virtue as per their very interesting most recent quarterly survey, but we digress...

"Liquidity is oxygen for a financial system." -  Ruth Porat

Stay tuned!

Charts of the Day - Why top-down Macro remains more important than ever

"Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passions, they cannot alter the state of facts and evidence." - John Adams, American president

While we recently indicated our concerns relating to the relationship between rising positive correlations thanks to central banks' markets meddling and rising +/-4 standard deviations moves or more in asset classes in our August short conversation "Charts of the Day - Positive correlations and large Standard Deviation moves", we believe that top-down Macro remains more important than ever thanks to these rising correlations.

This can be ascertained from Bank of America Merrill Lynch's "Global Focus Point note from the 7th of September entitled "3 million data points soared":

"Correlations skyrocketed in August
In August, global stock-to-stock correlations jumped to the highest level in four years. Macro concerns ranging from fear of the Fed raising rates, China slowdown, risk of Greece contagion, and falling GDP forecasts have marred equity market returns recently. Stock-to-stock correlations are signaling that stocks are performing similarly to each other. Factoring in macro issues becomes much more important than pure fundamentals during phases of rising correlations.

3 million data points
Stock-to-stock (or pair-wise) correlation is correlation between daily price returns of each stock in the MSCI ACWI index to the daily price returns of every other stock (i.e., 3 million calculations each month). Last month correlations jumped above long-term averages in all major regions and sectors of the world. Correlations are highest in Japan, followed by Europe and the US. Previous jumps in correlations have coincided with falls in global equity markets, on average.

Signals from the Global Wave critical
Rising stock-to-stock correlation coupled with weakening Tactical Indicators suggests that macro is more important than ever. The Global Wave, our macro indicator, continues to fall after signaling a peak in the global economic cycle in January. Investors should closely monitor the signals from the Global Wave for clarity on the macro environment.

What to buy?History suggests defensive styles and sectors tend to do well when the Global Wave is falling. This suggests overweighting the Bunkers which are based on styles for a downturn including earnings stability, low beta, low estimate dispersion and high dividends.

The best performing sectors when the Global Wave is falling tend to be Health Care and Consumer Staples, and the worst include Materials and Industrials." - source Bank of America Merrill Lynch

Furthermore a low beta strategy of "overweighting sectors such as "Consumer Staples" can be seen as an embedded free "partial crash" put option.

We already approached this very subject in our 3rd of April 2013 conversation "Equities, playing defense - Consumer Staples, an embedded free "partial crash" put option":

"The value of the put option offered by the Consumer Staples sector protects investors from monthly declines of 5% or more i.e. you can generate market performance and be insulated to a degree from major market shocks." - source Société Générale

As per our previous April 2013 note:
Consumer Staples are mostly a defensive play that can outperform during phases of "Risk-Off" which we have been experiencing on numerous occasions since the financial crisis of 2008:

"The low-volatility index did best in times when stocks fell, such as 2000 to 2002, and in 2008, according to S&P data. In 2008 the low-volatility index fell 21 percent compared with 37 percent for the S&P 500." - source Bloomberg.

As a reminder, another way in protecting a portfolio is investing on ETFs such as the PowerShares S&P Low Volatility Portfolio for protection from stock-market swings because Consumer Staples account for around 22%.

Some inconvenient facts: Low volatility stocks have provided the best long-term returns, one of the greatest anomalies in finance.

 "Defense is a definite part of the game, and a great part of defense is learning to play it without fouling." - John Wooden, American coach

Stay tuned!

Credit - The Coffin corner

"There are old wise central bankers (Paul Volcker) and bold bankers (Ben Bernanke now joined by Haruhiko Kuroda ); we have no old central bankers, just bold central bankers". - Macronomics.

While watching with bemusement, or disbelief the "Yield famine" central banks induced rally turning to a credit feeding frenzy, and looking at a dealer's bond run on our Bloomberg on Ford company with no offer, but bid only, we could not resist but use again an aeronautical analogy in our title in similar fashion to our previous post "Bold Banking" where we stated:

"When it comes to "reckless banking" and "reckless piloting", we found it amusing that current leaders have repeatedly failed to correct central bankers' policies, like the ones pursued by former Fed president Alan Greenspan and current Fed president Ben Bernanke, or, the ones pursued by Japan. These policies are instigating, bubbles after bubbles at an inspiring rate. When one looks at the fragile state of the "House of cards" and the "boldness" of credit investors dipping their toes, once again in very risky credit structures such as CLOs made up more and more with Cov-lite loans, we think our title, and our analogy to the crash of "Czar 52" is this time around very appropriate, but once again our thoughts keep wandering."

As we indicated at the time, the demise of "Czar 52" on the 24th of June 1994 also called the BUFF (the nickname among pilots for the B-52 meaning Big Ugly Fat Fellow) which saw the tragic crash of a Boeing B-52H "Stratofortress" assigned to 325th Bomb Squadron at Fairchild Air Force Base during practice maneuvers was due to Colonel Bud Holland's decision to push the aircraft to its absolute limits. He had an established reputation for being a "hot stick" like our bold bankers.

This week's analogy refer to what is called by pilots the "Coffin corner" also called the "Q Corner", which was responsible for the accident of Air France Flight 447 in 2009 over the Atlantic Ocean when the three experienced Airbus A330 pilots were unable to recognize they were operating at a too high angle of attack to sustain flight:

"The coffin corner (or Q corner) is the altitude at or near which a fast fixed-wing aircraft's stall speed is equal to the critical Mach number, at a given gross weight and G-force loading. At this altitude the airplane becomes nearly impossible to keep in stable flight. Since the stall speed is the minimum speed required to maintain level flight, any reduction in speed will cause the airplane to stall and lose altitude." - source Wikipedia

Consequences:

"When an aircraft slows to below its stall speed, it is unable to generate enough lift in order to cancel out the forces that act on the aircraft (such as weight and centripetal force). This will cause the aircraft to drop in altitude. The drop in altitude may cause the pilot to increase the angle of attack (the pilot pulls on the stick), because normally increasing the angle of attack (pulling up) puts the aircraft in a climb. When the wing however exceeds its critical angle of attack, an increase in angle of attack (pulling up) will lead to a loss of lift and a further loss of airspeed (the wing "stalls"). The reason why the wing "stalls" when it exceeds its critical angle of attack is that the airflow over the top of the wing separates.

When the airplane exceeds its critical Mach number (such as during stall prevention or recovery), then drag increases or Mach tuck occurs, which can cause the aircraft to upset, lose control, and lose altitude. In either case, as the airplane falls, it could gain speed and then structural failure could occur, typically due to excessive g forces during the pullout phase of the recovery.

As an airplane approaches its coffin corner, the margin between stall speed and critical Mach number becomes smaller and smaller. Small changes could put one wing or the other above or below the limits. For instance, a turn causes the inner wing to have a lower airspeed, and the outer wing, a higher airspeed. The aircraft could exceed both limits at once. Or, turbulence could cause the airspeed to change suddenly, to beyond the limits. Some aircraft, such as the Lockheed U-2, routinely operate in the "coffin corner", which demands great skill from their pilots."  - source Wikipedia

Looking at the desperate attempts by the Bank of Japan to cancel out the deflationary forces at play by increasing the "angle of monetary attack" with the "bold" central pilot banker Kuroda pulling very strongly on the stick, we wonder if Japan will indeed endure structural failure in the end. Maybe Kuroda is a gifted pilot such as pilots from the famed Lockheed U-2 spy plane, but, maybe he isn't. On another note, movie buffs like us will remember the 1983 epic movie "The Right Stuff" depicting at one point Colonel Chuck Yeager crashing his NF-104 Lockheed Starfighter on the 4th of December 1963 (also known as the Widow maker, interestingly the same nickname as the  famous short Japanese JGB trade).

So how did Chuck Yeager encountered the "Coffin Corner" in his "Widow maker"? Why did this legendary test pilot crash?

"The flight data from Chuck’s last two flights, including the accident proved there was not a single system failure on either his first flight that day or during the entire accident flight.  The data was undamaged in the accident, due to the low impact falling in a flat spin, with virtually no fuel on board and no resulting fire in the airplane.  The aircraft had performed flawlessly!

The facts are clear.  Chuck Yeager proved incapable of doing the job.  He was totally outside his element.  He was a natural pilot who had learned by experience and feel, but never really understood stability, just ‘sensed’ how airplanes would act, but aerodynamics and space dynamics are night and day.  If he was to fail, I expected it to be outside the aerodynamics region.

But not even that can excuse his accident, which was his fault, alone and was an error of bad pilot technique during normal, aerodynamic flight.  His shortcoming was inability to gain and maintain the 70 degree climb angle.  That required strict and delicate airplane control.  No more and no less.

 His failure to do that made the space flight moot.  He made the mistake, not once but on each of his four zooms, exaggerated on each until his accident was inevitable long before he departed his familiar flying region. His failing started at the moment he began a 3½ g pull up to the required 70 degree climb.  He never once made his immediate angle close to 70 degrees thus losing so much energy that he could not fly high enough to stay out of trouble.  Worse yet, he repeatedly started climb at a lower angle, then pulled the nose up later losing energy even faster and making the situation far more critical.  He needed time outside the atmosphere to use the reaction controls to nose over and he denied himself that time with poor piloting in his element of expertise, aerial flight.

In effect, what he did was climb far too shallow and then pulled up very steep in aerodynamic flight to a hammerhead stall, which in any F-104 meant an irrecoverable pitch-up and likely spin." - source NF104.com

We found most interesting that the "Coffin Corner" is also known as the "Q Corner" given that in our post "The Night of The Yield Hunter" we argued that what the great Irving Fisher told us in his book "The money illusion" was that what mattered most was the velocity of money as per the equation MV=PQ. Velocity is the real sign that your real economy is alive and well. While "Q" is the designation for dynamic pressure in our aeronautic analogy, Q in the equation is real GDP and seeing the US GDP print at 2.5% instead of 3%, we wonder if the central banks current angle of "attack" is not leading to a significant reduction in "economic" stability, as well as a decrease in control effectiveness as indicated by the lack of output from the credit transmission mechanism to the real economy.

In similar fashion to Chuck Yeager, Alan Greenspan made mistakes after mistakes, and central bankers do not understand that negative real rates always lead to a collapse in velocity and a structural decline in Q, namely economic growth rate! Maybe our central bankers like Chuck Yeager, just ‘sense’ how economies act or work.

We believe our Central Bankers are over-confident like Chuck Yeager was, leading to his December 1963 crash. Central Bankers do not understand stability and aerodynamics...

In relation to Quantitative Easing program, our "bold" pilots/central bankers should really check the "structural" soundness of their "confident" policies given that in similar fashion to QEs the F-104 "Widow maker" series all had a very high wing loading (made even higher when carrying external stores), which demanded that sufficient airspeed be maintained at all times...Even Erich Hartmann, the world's top-scoring fighter ace, who commanded one of Germany's first jet fighter-equipped squadrons deemed the F-104 to be an unsafe aircraft with poor handling characteristics for aerial combat. To the dismay of his superiors, Hartmann judged the fighter unfit for Luftwaffe use even before its introduction. 

Maybe it is the reason why the German ace bankers from the Bundesbank are reluctant to retaliate with more QE in Europe, to the dismay of Mario Draghi at the ECB. 

The Class A mishap rate (write off) of the F-104 in USAF service was 26.7 accidents per 100,000 flight hours as of June 1977, (30.63 through the end of 2007), the highest accident rate of any USAF Century Series fighter. Some international operators lost a large proportion of their aircraft through accidents, although the accident rate varied widely depending on the user and operating conditions; the German Air Force lost about 30% of aircraft in accidents over its operating career, and Canada lost over 50% of its F-104s.

Overconfident pilots? Or poor structural design? You decide, but we ramble again.

So this week we will look again at the "unintended consequences of our "bold pilots".

The recent meteoric rise in the Japanese Yen, the Nikkei index and the receding pressure on Itraxx Japan credit spreads courtesy of Abenomics is validating we think, this week's aeronautical analogy - graph source Bloomberg:

Looking at Japan's consumer price index falling 0.9% in March from a year earlier, we do think Japan is indeed pushing towards the "Coffin corner":"The relationship of stall speed to critical Mach narrows at high altitudes, to a point where any sudden increases in angle of attack or roll rate and disturbances, such as clear-air turbulence, can lead to a stall." - source AINonline - Understanding High-altitude Aerodynamics Is Critical

Moving back to our Lockheed Starfighter reference, at extremely high angles of attack the F-104 was known to "pitch-up" and enter a spin, which in most cases was impossible to recover from. We think QEs  like the F-104 are very sensitive to control input, and extremely unforgiving of pilot error. No wonder another nickname for the plane was the Flying Coffin.

When it comes to Japan, the decade-high volatility in Japanese government bond debt induced by Bank of Japan Governor Haruhiko Kuroda, similar to Chuck Yeager's flying antics in the NF-104 Starfighter may have the unwelcomed effect of weakening bond prices and therefore undermine economic-growth goals, that  famous Q, in MV=PQ. Excess volatility, or "pull-up" for a Japanese plane can be seen, we think in the rise in JGBs volatility - source Bloomberg:

"The CHART OF THE DAY shows that the pace of swings in 10- year Japanese government bonds, known as JGBs, surged to levels not seen in more than 10 years, according to a gauge known as historic volatility. The measure, which represents the annualized standard deviation of price changes for a specific time period, surged amid swings in yields that came after the central bank increased monthly bond buying to 7.5 trillion yen ($76 billion) to reach a 2 percent inflation goal." - source Bloomberg.

In the case of Japan in general and JGBs in particular, another indicator we have been closely following has been the 30 year Swiss bond yields versus the Japan 30 year bond yields throughout 2012 until the recent "Big in Japan" bang moment following the Bank of Japan "all in" move - source Bloomberg:

As one can see for the above chart, it hasn't been really "plain flying" to say the least recently with the absolute spread widening from near zero to -54 bps again.

As far as the Nikkei is concerned versus Emerging Markets (MSCI EM), our Japanese Chuck Yeagers have really been pushing the envelope - source Bloomberg:

Push the envelope meaning:
"To attempt to extend the current limits of performance. To innovate, or go beyond commonly accepted boundaries."
This phrase came into general use following the publication Tom Wolfe's book about the space programme - The Right Stuff, 1979:
"One of the phrases that kept running through the conversation was ‘pushing the outside of the envelope’... [That] seemed to be the great challenge and satisfaction of flight test."
In aviation and aeronautics the term 'flight envelope' had been in use since WWII, as here from the Journal of the Royal Aeronautical Society, 1944:
"The best known of the envelope cases is the 'flight envelope', which is in general use in this country and in the United States... The ‘flight envelope’ covers all probable conditions of symmetrical maneuvering flight."

So good luck to our Japanese pilot Kuroda. We wonder if this latest surge in QE wars does not amount to a "Kamikaze" approach in dealing with deflation.

Moving on to Europe, we are unfortunately pretty confident about our deflationary call in Europe, particularly using an analogy of tectonic plates. Europe was facing one tectonic plate, the US, now two with Japan. It spells deflation bust in Europe unless ECB steps in as well we think.

As we posited on a number of conversation, the difference in the United States PMI and Europe's PMI and the growth outlook is purely a question of credit conditions - PMI US vs Europe (top graph) and US Leverage Loans versus European Leverage Loans (bottom graph) - source Bloomberg:

Any similarities are purely fortuitous? We think not...The S&P/LSTA U.S. Leveraged Loan 100 Index was little changed at 98.49 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has gained 2.6% this year. What's the latest US GDP growth figure? 2.5%.

We hate sounding like a broken record but, no credit, no loan growth, no loan growth, no economic growth and no reduction of aforementioned budget deficits (our case for Europe...). 

And, when we look at credit growth for non financial corporates in Europe, the picture cannot be clearer than this:

The absolute level of core European government yields has been falling even more with the anticipation of a 25 bps rate cut next week in conjunction with the expectations of unconventional measures which should be taken by the ECB to restore, somewhat the credit transmission mechanism to the real economy, which has been so absent as of late - source Bloomberg:

Both Italian and Spanish government yields are closed to the level they had back in 2010.

But, the new record set up by the Spanish unemployment rate moving at 27.2% in conjunction with Spanish minister Mariano Rajoy seeking a two year extension to tackle its soaring budget deficit to cut its current 10.6% shortfall towards the European limit of 3% by 2016 instead of 2014 is interesting for us for a very simple reason which ties up nicely with this week analogy, namely the non-linearity of public deficits when growth is either absent or very weak. A violent reaction of budget deficits to a loss of economic growth, in similar fashion to a high altitude stall can be very simply explained by a sudden and continuous rise in unemployment levels.

"Past-due loans in Spain have fallen to 161 billion euros ($210 billion) from a high of more than 191 billion euros in November 2012, according to the Bank of Spain, helped by transfers to a `bad bank,' reforms, increased provisions and write-offs. March's estimate-busting surge in unemployment will likely endanger this trend by further pressuring asset quality at both a corporate and retail level." - source Bloomberg

The case for Spain is interesting, but looking at the alarming rise in unemployment levels in France, at 3.2 million, the highest level since 1997 and an 11.5% annual increase , France looks increasingly close to the "coffin corner" we can argue. In relation to France, in our conversation "A Deficit Target Too Far" from the 18th of April, we argued: "We also believe France should be seen as the new barometer of Euro Risk".

As indicated by a recent note from Natixis on France and the non-linearity of deficits, when growth falls strongly (like in 1975, 1993 and 2009), the budget deficit is important, in particular when growth has stalled for two consecutive years. They indicated that if GDP growth falls by 2 points, the budget deficit, due to its non-linearity feature, rises not by 0.88 points of GDP in the case of France but by 1.32 points of GDP. So when the French Minister of Economy and Finance Mr. Moscovici targets 3.7% of budget deficit for 2013 with 0.1% of positive growth, we think he is seriously deluded given we think GDP growth for France will be between -0.5% to -1% in 2013.

France unemployment level versus Germany - source Bloomberg:

Meanwhile in the credit space the ""spring-loaded bar mousetrap" continues to be coiled. For instance on the 23rd of April in the US credit space the market has witnessed the lowest yield ever recorded (2.21%) out of more than 3000 observations spanning 12 years of iBoxx history.

We could not agree more with Societe General recent credit comment:

"Not quite speechless, but we're out of superlatives. The iBoxx junk index yield is at a record low of 6.19%, IG at a record low of 2.21%; returns YTD at 3.38% and 1.51% respectively - and it doesn't feel overheated. 

Annoyed at the poor liquidity? Frustrated at the level of the market and the low levels of supply? Well, we're going to have to get used to it. We're resigned to going tighter, all-in yields will likely go lower while secondary market accommodation of a trade will remain the exception rather than the rule. An exaggeration perhaps, but the point is made. It's not all about throwing in the towel - well, maybe it is - but performance will come from embracing risk. We think it is also about recognising that policy is forcing us to take higher risk on further massive (potential) manipulation of yields, while new marginal buyers emerge to take assets out of the market. If it has yield attached to it, there's pretty much a bid. The more nervous February and March months seem very far away now. Into the weakening eurozone economy, risks of corporate bond downgrades will be ignored for the foreseeable future; while the addition of risk assets outside of our comfort zone will be a necessity, but hopefully a measured investment in most cases. The recent data (PMIs, for example) paint a bleak picture with downside risks to the eurozone's Q2 GDP growth story. Much more of the same (as is likely) and the ECB might cut soon enough; and while the lower interest rate might have little direct impact on valuations, the sentiment behind it will matter more. Additionally, the use of non-conventional tools could lead to a new marginal buyer of credit risk - and this would heighten investor frustrations substantially. After all, we're waiting for the Japanese to put their buying boots on as well. If these buying cares eventually materialise - well, scary. And the way equities and fixed income assets are moving - higher in tandem into the bleak economic outlook - suggests that the market is expecting its next fix from further central bank policy response. There is some room for immediate disappointment, but it will come, and not too far down the road. There's no point in fighting it; instead embrace it, make yieldier assets your friend - single name event risk permitting. There will be a pull-back at some stage, but the feared structural unwind of credit positions isn't likely to be coming any time soon." - source Societe Generale.

And, 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.

But until then enjoy the liquidity party as indicated by Bank of America Merrill Lynch in their recent note from the 25th of April entitled "Great Divergences and Yogi Berra:

"The liquidity party continues: best performing asset in the past week = Italian equities; past month = Greek government bonds; YTD = Japanese equities.

“When you come to a fork in the road, take it.”

The financial markets are currently riddled with divergences and contradictions. High debt, low growth; record high stocks, record low bond yields; a bull market in US and Japanese real estate stocks; a bear market in Chinese real estate stocks. The Great Divergences are best explained by the war between deflationary debt fundamentals and aggressive reflationary policies. Real estate and banks remain the best barometer of policy success." - source Bank of America Merrill Lynch.

Could the below picture be the picture of the "Coffin Corner? Low growth and high debt:

- Source Bank of America Merrill Lynch.

Or could that be the one when one looks at the discrepancy between record low bond yields and record high equities?

- Source Bank of America Merrill Lynch.

Or maybe this one, when one looks at the discrepancy between low commodity prices and higher stock prices?

- Source Bank of America Merrill Lynch.

Just a fact in relation to the defensive nature of the S&P rally, year to date, 2013 buyback authorizations are at around $275 billion, +102% from a year ago and +8% vs 2007.

So what's the risk for our bold pilots / central bankers you might rightly ask? Well, on that very point we agree with Citi's recent note from the 25th of April entitled "Too much money, not enough assets to buy", which for us is reminiscent of the crazy days of 2007:

"What's the risk?

While the unconventional policies and the artificial inflation of asset prices has had few discernible negative side effects to date, the exit risk is clearly extremely large.
Part and parcel of the argument that we have made above is the fact that enormous volumes of non-dedicated money has been encouraged into risk assets, not least across fixed income markets.

Sharp adjustments like the one we have recently seen in gold are likely to become more commonplace in our view. More broadly, the reaction to the mini-backups in US yields early this year also illustrates how prone markets are to withdrawal symptoms.
Credit, in particular, has benefited from being a half-way house, offering less sensitivity to the global downturn than equities and retaining the upside benefit from falling yields. Our US credit strategists calculate that two-thirds of the inflows into US IG credit since 2009 has been through mutual funds and ETFs. A large portion of that will be retail money, more sensitive to total return prospects." - source Citi

Mutual funds and ETFs have seen significant inflows and at the same time inventories in the dealer space are nowhere near the 2007 levels, hence us still "credit dancing" but close to the exit door or ready to pull the handle on the ejection seat. As Matt King from Citi recently put it in his note from April 2013 - Mind the Gap:

- source Citi

And if you think liquidity in the credit space has improved, the unintended consequences of ZIRP from our "Top Guns" means that the turnover in IG corporate bonds is still falling, in similar fashion as velocity is as we move towards the "Coffin corner":

- source Citi

As we posited in "The Unbearable Lightness of Credit":
“Liquidity is a backward-looking yardstick. If anything, it’s an indicator of potential risk, because in “liquid” markets traders forego trying to determine an asset’s underlying worth – - they trust, instead, on their supposed ability to exit.” - Roger Lowenstein, author of “When Genius Failed: The Rise and Fall of Long-Term Capital Management.” – “Corzine Forgot Lessons of Long-Term Capital“

Flying a "Central Bank" or a NF-104 Starfighter requires strict and delicate airplane/monetary control:
"Tightening policies to preserve price stability and unwind some of the trillions of dollars pumped into global economies since 2007 via quantitative easing will require interest rate hikes, and may also necessitate asset sales by central banks, according to April's IMF Stability Report. Increased credit and securities losses would be the major negative impacts for banks as rates rise. Bank funding may also be disrupted if asset sales do take place." - source Bloomberg.

So buckle up, because our Central bankers Yeagers are indeed pushing on a string we think as indicated by the "altitude records", or spread tightening levels which are being broken as indicated by the level reached by corporate bonds worldwide as described by John Glover in his Bloomberg article entitled - Record Risk Discounted as Bonds Pass 110 Cents from the 25th of April:
"Corporate bond prices worldwide are poised to set a record as easy money policies by central banks
push investors into riskier investments even with the potential for losses at about an all-time high. Bondholders are paying an average of 110.22 cents on the dollar for the right to receive 100 cents back at maturity plus the interest from coupon payments, according to Bank of America Merrill Lynch’s Global Corporate & High Yield Index. At the same time, the so-called effective duration that measures how sensitive bond prices are to changes in yield has jumped, making the securities about the riskiest to hold ever.
Central bank purchases of government bonds to contain borrowing costs and stimulate economic growth have led investors to pour money into the $10 trillion global market for corporate bonds as they search for yield. Besides betting that interest rates won’t rise anytime soon, investors also face increased risk from restructurings." - source Bloomberg

And as indicated by the same article:
"For every 50-basis-point jump in yields, prices would drop an average 2.85 percent, compared with a low of 2.36 percent in September 2008, according to the average effective duration of the Bank of America Merrill Lynch index. Bond prices rose to a record 110.28 cents on the dollar in November. In 2009, the securities were trading below par." - source Bloomberg.

On a final note, we leave you with a Bloomberg chart indicative of the limited room which stock investors could benefit from a falling US savings rate:

"As the CHART OF THE DAY shows, household savings equaled 2.2 percent of disposable income in January and 2.6 percent in February, according to data compiled by the Commerce Department. The rate for March will be released on April 29. This year’s readings are the lowest since 2007, when the rate dropped as low as 2 percent. The chart shows the trend in savings since a peak of 8.3 percent was recorded in May 2008, when the economy was in a recession. “The potential for a further drop in the savings rate is obviously more limited,” Lapointe and two colleagues wrote in a report yesterday. “The best-case scenario” for stocks would be for savings to stabilize at less than 2 percent of disposable income or to rise gradually, they wrote. Quarterly increases of more than 1 percentage point since 1950 preceded declines in the Dow Jones Industrial Average for the next three, six and 12 months, according to data cited in the report. The Dow industrials moved higher on average when rates rose less than 1 point or declined. “The risk is that the savings rate rapidly bounces back to a more ‘normal’ level of 5 percent,” the report by the Montreal-based strategist and his colleagues said. “This would put additional pressure on equities.” The rate was 6.5 percent in December, when President Barack Obama and Congress were struggling to avert automatic tax increases and spending cuts." - source Bloomberg.

We still think deflation is the name of the game, the rest is poetry, and maybe the 1600 level for the S&P is the "Coffin corner" altitude for stalling where oxygen is rare and lift is low - triple top? - source Bloomberg:

Chuck Yeager made the mistake, not once but on each of his four zooms in the NF-104 Starfighter, and exaggerated on each until his accident was inevitable long before he departed his familiar flying region....just a thought...

"A kamikaze is a surprise attack, according to our ancient war tactics. Surprise attacks will be successful the first time, maybe two or three times. But what fool would continue the same attacks for ten months? Emperor Hirohito must have realized it. He should have said 'Stop.'" 

- Saburo Sakai, IJN flying ace