To grasp why the bond market is on the verge of crisis, and why trillions of Dollars, Euros, Yen and Pounds are about to panic and run away, we ask you to understand how free-markets really work. For starters, all free markets have two sides competing and participating. There are natural buyers and there are natural sellers. The point at which they meet in the middle is the selling/purchase price and the entire process is called price discovery…..And this is why bond prices (or yields) have become so distorted; the true price of a bond hasn’t existed now for almost 9 years. When the 2008-09 housing crisis crippled the world, central banks decided they would help the world recover by providing stimulus.
What is most frightening, is that despite the decline in property sales, the government’s role in the housing market continues to grow according to the WSJ, and here is a stunning statistic: Of all the residential floor space sold in China last year, 18% was purchased by government entities or with state subsidies, E-House China determined from official government data. The share could reach 24% this year, the firm said. To paraphrase: Beijing is now the (covert) marginal buyer of a quarter of all Chinese real estate. That, in itself, is a mind-blowing statistic.
While all seems calm in the U.S. equity markets, with stocks continuing to hit all-time highs, an interesting trend has emerged beneath the surface. Combing through the latest Commitments of Traders report from the Commodity Futures Trading Commission (CFTC), we found that commercial traders (“smart money”) have a record number of short positions in the Dow Jones Industrial Average DJIA, +0.71% At the same time, noncommercial traders (“dumb money”) have a record number of long positions.
But financial suicide for whom? The web of interdependency between Spain and Catalonia is so tightly woven that if one goes down, the other goes with it. Catalonia accounts for 20% of Spain’s GDP, and roughly a quarter of Spanish exports and the government’s tax revenues. Without it, there’s no way the Spanish State would be able to meet its gargantuan financial obligations — not even with Mario Draghi’s help!
The last leg higher has been directly responsive to the ramp up in the political “marketing surge” surrounding “tax cuts and tax reform.” With the House having already passed their respective budget resolutions, late Thursday, the Senate passed a budget blueprint for the next fiscal year. With both of the “budget resolutions” in place, it was seen as clearing a hurdle to the goal of overhauling the tax code. This is not new, of course, as the entire rally for the markets since the election has been driven by hopes of lower taxes, despite disaster, floods, fires and Central Bank threats of liquidity extraction.
An endearing quality of a late stage bull market is that it expands the universe of what’s possible. Somehow, rising stock prices make the impossible, possible. They also push the limits of the normal into the paranormal.
Jeffrey Gundlach is known around Wall Street as the Bond King. His Los Angeles-based firm, DoubleLine Capital, manages $116 billion, most of which is invested in bonds. He is also a bit of a Renaissance man, peppering his insights about the credit markets with astute references to Nietzsche, Mondrian, Escher, and Mad magazine covers. That’s why his answer to a simple question—“Why would anyone invest in bonds?”—from someone in the audience at Vanity Fair’s New Establishment Summit, held earlier this month in Los Angeles, was at once both startling and perceptive.
The newest issue of Foreign Affairs features the theme of “America’s Forgotten Wars”, with a cover illustration that juxtaposes a carefree scene of Americans enjoying a picnic with a scene of American soldiers fighting and incurring casualties in some sandy and desolate battle space. The picture depicts truthfully the detachment between, on one hand, the daily interests and attitudes of most Americans and, on the other hand, the disturbing reality of the United States being engaged continuously in a variety of lethal military operations in multiple lands overseas.
In light of the 30-year anniversary of the Black Monday Crash in 1987 (when the Dow lost more than 20% in “one day”, we should be reminded that investor anxiety usually increases when markets get to extremes. If stock prices fall steeply, people fret about money lost, and if they move too high too fast, they worry about sudden reversals. As greed is supposed to be counterbalanced by fear, this relationship should not be surprising. But sometimes the formula breaks down and stocks become very expensive even while investors become increasingly complacent. History has shown that such periods of untethered optimism have often presaged major market corrections. Current data suggests that we are in such a period, and in the words of our current President, we may be “in the calm before the storm.”
And with so many traders short vol, Bass said investors will know the correction has begun when a 4% or 5% drop in equities snowballs into a 10% to 15% decline at the drop of a hat.