By Bryan Rich 

July 5, 2016, 4:30am EST

The Brexit unknowns continue to dominate the market focus today.  But by Friday, believe it or not, it may move down the list on the daily market narratives.  We get the jobs numbers this Friday.

Last month’s payroll number was a big negative surprise, coming in at just 38k new jobs created.  But the longer term average has been closer to 200k new jobs a month (fairly healthy).  That’s closer to where the number is expected to come in this week.

For the Fed, the negative surprise last month took a June rate hike off of the table.  And then came the Brexit.  Now rate hike expectations have been moved out as far as 2018 in the minds of market participants – and the market has even begun pricing in slim chances of a cut.

With that, global rates have continued to slide to new record lows, including the U.S. 10-year yield.  The 10-year traded as low as 1.35% today.  That’s lower than the darkest days of the global financial crisis (much lower), and the darkest days of the European Debt Crisis.

So, the last time we were down here, what turned it?  It was intervention – or at least the threat of intervention. It was the ECB stepping in and saying they would do “whatever it takes” to save the euro.

Despite all of the criticisms surrounding policymakers meddling in markets, intervention (in one shape or form) has determined many historic turning points in markets – something to keep in mind.

Still, the betting market on the timing of Fed hikes has been a wild swing of extremes for years now.  And the current bet of just a 13% chance of a hike this year looks like a heck of an opportunity to be on the other side.
Keep in mind, there was a lot of damage to investor psychology in the early days of this decade-long economic downturn.  That has created a contingent of investors that have feared another shoe to drop, hence the extremes.

That fear has also led to under participation in stocks, and it also leads to weak hands in the stock market. The “weak hands” are those that may own stocks, but have little conviction (and likely a lot of fear). This dynamic has created these episodes of market swings.

But U.S. stocks still remain not far from record highs. And as we said last week, there also remains an incredible number of stocks that trade at cheap valuations (amazingly).  But when stocks go on sale, most choose to run for the exits rather than take advantage of the opportunity.   And it’s common, in those scenarios, to find the best investors in the world taking the other side of the trade from the masses.

Warren Buffett has famously said a simple rule dictates his buying: “Be fearful when others are greedy, and be greedy when others are fearful.”  He’s amassed one of the biggest fortunes in the world, largely on that philosophy – being the right place at the right time and acting.

With the above in mind, it’s no surprise that over the past few trading days, the 13D filings have been coming in fast and furious.  A 13D filing is a public disclosure made to the SEC by investors managing $100 million or more.  If these investors buy or build a stake in a public company that exceeds 5%, they are required to disclose it to the SEC within 10 days.  These stakes generally give the investor a controlling interest in the company, and the shares are acquired with the intent of waging some influence on the company’s management. With that said, some of the best have been snapping up shares in new companies in recent weeks and/or adding to existing stakes on a dip.

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By Bryan Rich 

June 30, 2016, 3:00pm EST

Yesterday we looked at some key markets, some that have recovered nicely following the Brexit news, and others that are still down on either safe-haven demand or speculation of economic drags due to the Brexit.  One particular spot that hasn’t fared well in the past week is Japan.

Japan is three years into a bold plan to beat two decades of deflation and restore its economy to prominence.  The data shows that their efforts haven’t translated so well just yet.  Inflation is still dead, and economic growth — about the same.

Two key tools in the Bank of Japan’s QE program, which is designed to drive inflation and economic activity, is a weaker yen and a higher stock market.  Since they telegraphed their intentions of big, bold QE in late 2012, Japanese stocks have risen by as much as 140%.  And the yen has declined by as much as 38% against the dollar.  But over the past 12 months, about half of those “policy gains” have been given back.  And post-Brexit the attrition has only worsened.

Still, after three years and big moves in the yen and stocks, the inflation objective remains a distant target.  What does it mean?  The Bank of Japan has to do more.  A lot more.

We think they can, and will, ultimately destroy the value of the yen — mass devaluation.

Unlike the U.S., which is constrained by “flight to safety” global capital flows and a world reserve currency, Japan has the ingredients to make QE work, to promote demand, and to promote growth. Japan has the largest government debt problem in the world. They have an undervalued currency. They have a stagnating economy with big demographic challenges. They have are in a deflationary vortex.

They have the perfect attributes for a mass scale currency printing campaign. Not only can it work for their domestic economies, but it serves as the liquidity engine and stability preserver for the global economy.

In normal times, the rest of the world wouldn’t stand for a country outright devaluing their way to prosperity. But in a world where every country is in economic malaise, everyone can benefit – everyone needs it to work. It can be the solution for returning the global economy to sustainable growth. We wouldn’t be surprised to see USDJPY return to the levels of the mid-80s (versus the dollar)in the not too distant future. That would be 250+.  Currently, 103 yen buys a dollar.

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By Bryan Rich 

June 28, 2016, 4:00pm EST

We’ve talked about the Brexit effect the past couple of days.  And we’ll continue on that theme today, as people continue to digest the results and come to grips with potential outcomes.

The knee-jerk reaction in markets has suggested that there is considerable fear of another global financial crisis.  But as we’ve said, things today are very different than they were in 2008.  The failure of Lehman triggered a global credit freeze.  That brought global banks to their knees and, therefore, even massive Fortune 500 companies couldn’t access capital needed to operate.

Again, this time is different (typically dangerous words to say, but true).  The financial system remains well functioning.  Most importantly, central banks are pro-actively maintaining stability and confidence by offering liquidity to banks and have made it well known that they stand ready to act where ever else needed (i.e. intervention).

So now we’re seeing some projections of the economic implications of the Brexit coming in.  The ECB thinks it will shave “as much as” ½ percentage point in GDP growth in Europe.

Here’s a look at euro area GDP…

euro gdp
Source: Tradingeconomics.com

You can see the damage to the economy in the global financial crisis.  While Europe is still emerging from stagnation, lopping off ½ percentage point is far from a “Lehman moment.”  Plus, if the euro weakens, as it should, on the outlook, that economic hit will be softened dramatically.  When we think about the broad Brexit implications, Europe is probably the first place everyone should be looking, and the ECB’s projection doesn’t look so bad at all.  With that, the market volatility we’re seeing seems to be over-exaggerating the Brexit effect.

Still, the biggest risk associated with the Brexit is that it becomes contagious.  As we said on Friday, the potential Grexit (of last year) and the Brexit are most different for one simple reason.  The British vote doesn’t involve a country leaving the common currency — the euro.

The British, of course, have their own currency, and among all of the EU countries, the British have probably retained the most sovereignty.  It’s a fracturing of the euro, the second most widely held currency in the world, that would trigger a global financial and economic crisis.  That’s the big danger.  If other EU countries that are also part of the common currency (the monetary union – the EMU) took the lead of Britain, then it gets very ugly.

Perhaps the first place to look for that potential spillover, is in the sovereign debt markets of Spain and Italy — the two big EMU constituents that were close to default four years ago.  When those countries were on the brink of collapse in 2012, the 10-year government bond yields were trading north of 7% (unsustainable levels).

111spain yield
Source: Reuters, Billionaire’s Portfolio

111italy yield
Source: Reuters, Billionaire’s Portfolio

Today, Spanish and Italian 10-year debt is yielding just 1.3%.  In a post-Brexit world, where the real risk is contagion, both of these important market barometers are indicating no contagion danger.

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By Bryan Rich 

June 27, 2016, 4:15pm EST

Over the past two trading days, we’re seeing the “risk-off” flow of global capital that we saw through the early stages of the global financial crisis.

For a long time, Wall Street sold us on the idea of sector and geographic diversification for stocks. That abruptly ended in 2008-2009. It was clear that in a global crisis, the correlations of sectors, geographies and many asset classes went to 1 (i.e. almost everything went down–a few things went up).

Our table below gives some perspective on how the swings in global risk appetite have affected financial markets since the onset of the financial crisis in 2008.

In a sense, the risk trade is an easy one to understand. When the world looks like a scary place, people pull back and look for protection. They pull money out of virtually everything, including banks, and plow money into the U.S. dollar, U.S. Treasurys and gold (the safest parking place for money in the world, on a relative basis).

At the depths of the global financial and economic crisis, there was a clear shift in investor focus, away from “return ON capital” toward one of “return OF capital.” Then, as sentiment improved about the outlook, people started taking on more risk, and that capital flow reversed. But with each economic threat that has bubbled up since, we’ve seen this risk-off dynamic quickly emerge again.

Two trading days following the Brexit vote, the market behavior is clearly back in the risk-off phase. The question is: Are we back into the risk-on/risk-off seesaw in markets that we dealt with for several years coming out of the worst part of the crisis?

As we said, there are huge differences between now and 2008. When Lehman failed, global credit froze. Today financial conditions globally have tightened a bit, but nothing remotely near the post-Lehman fallout. Most importantly, as we’ve said, we had no idea how policy makers might respond and how far they might go. Now we know, they will “do whatever it takes.”

When was the last time we had a huge sentiment shock for global financial markets and for the global economy? It was only a year ago, in Greece. The Greek people voted NO against more austerity and more loss of sovereignty to their European neighbors (namely Germany). That vote too, shocked the world. But all of the draconian outcomes for Greece, which were being threatened, with such a vote, didn’t transpire. Greece and Europe compromised.

Bottom line (and something to keep in mind): A bad outcome for anyone, at this stage in the global economic recovery, is a bad outcome for everyone.

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By Bryan Rich 

June 24, 2016, 4:15pm EST

The world was stirring today over the UK decision to leave the European Union.  Here are a few things to keep in mind.  As we discussed earlier in the week, the repercussions of the Brexit are very different than those that were feared over the potential “Grexit.”  Greece was threatening to leave the euro. It would have had major and immediate financial complications, which could have quickly paralyzed the financial system.

The Brexit is more political than economic (not financial).  And any retrenchment in the banking system because of uncertainty can be immediately quelled by central bank intervention.  Not only were the central banks out in front of the potential exit outcome, promising to provide liquidity to the banking system, but they were also in last night stabilizing currencies, and likely bond yields as well.

As we said, there are also huge differences between now and 2008.  When Lehman failed and global credit froze, we had no idea how policy makers might respond and how far they might go.  Now we know, they will “do whatever it takes.”

The market volatility surrounding the Brexit may actually be a positive for the global economy.  Seven years into the global economic recovery, global central banks have thrown the kitchen sink at the crisis, and they’ve proven to be able to stabilize the financial system and the global economy, and restore confidence.  And that has all indirectly created an economic recovery, albeit a slow and sluggish one.  But they haven’t been able to directly stimulate meaningful economic growth (the kind you typically see coming out of recession) because of the nature of the crisis.

Fiscal stimulus has been the missing piece of the puzzle.

Governments have been reluctant to spend, given the scars of the debt crisis.  This may give policy makers an excuse to green light fiscal stimulus.  After all, growth (or the lack thereof) is the primary driver of the public discontent – not just in the UK, but globally. Growth has a way of solving a lot of problems.

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By Bryan Rich 

June 22, 2016, 2:20pm EST

Tomorrow is the UK vote, where UK citizens will vote on whether to ‘stay’ or to ‘leave’ the European Union.  In this post-Lehman (failure) era, we’ve had no shortage of fear and doubt.  Remember the Fiscal Cliff, Sequestration, Cyprus, several chapters of the drama in Greece, Italy and Spain were threatening default, China’s slowdown – the list could go on.

Along the way, the message in the media has always had little substance, but one very common word to promote and validate fear:  the word, “uncertainty.”

But throughout this entire post-Lehman era, the world has been a very uncertain place.  Whether times have been relatively good or not so good, given the state of the world seven years ago, and given the unprecedented policies it has taken to get us here, uncertainty is the new normal.  But what is certain, following the near apocalypse of the global economy, is how policy makers will respond.  We know, without a question, they will do ‘whatever it takes’ – their own words.  And they’ve proven that their actions can avert disasters and promote confidence and recovery.

With all of this in mind, let’s dig in a little bit and talk about the UK vote.

First, to be clear, there are a lot of comparisons made to the Greek vote last year (the “Grexit”).  The UK vote (the “Brexit”) is very different.

The notion of Grexit threatened the existence of the second most widely held currency in the world, the euro.  That was a much, much bigger deal.  The UK, of course, is part of the European Union, but not part of the currency union.  They did not adopt the euro.  They have their own currency and their own monetary policy.  The UK vote is about trade, immigration, ability to work and live in other EU countries – perhaps mostly about control and politics.

The polls have been broadly building the story for an exit, though they are also broadly deemed unreliable.  Meanwhile the bookmakers have had the chances of an exit, along much of the way, as slim (at about 70/30 favoring the ‘stay’ camp).  Still, at the peak of the frenzy last week, that number had narrowed to 56/44 favoring ‘stay.’  But when the pendulum of sentiment swung, so did the bookmakers odds of a ‘leave’ vote winning.  They are putting the chances of an exit at just 25% as we head into tomorrow’s vote.

As we said, we’ve seen a number of events over the course of the past several years that have introduced fear and doubt into the minds of investors (and especially the media).  Something to keep in mind:  Any and all of the dips in markets associated with those flare-ups have proven to be extremely valuable buying opportunities.  As we noted yesterday, some of the best spots to buy the dip this time around will likely be German and Japanese stocks.

Have a great night.

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By Bryan Rich 

June 20, 2016, 2:45pm EST

On Friday we looked at four key market charts that suggested the worst of the Brexit storm may be behind us.

As of Friday afternoon, the bookmakers had the odds of the UK staying in the Eurozone at 64%, versus 36% leaving.  And as we looked across the prices of gold, oil and stocks, all were suggesting, at least technically, that the peak of fear, regarding a Brexit, had passed.

Gold was rising sharply early last week.  Oil began to slide. These are two very important barometers of global risk appetite, and those moves were clearly demonstrating fear and uncertainty in markets.

But on Thursday, gold put in a key reversal signal. So did oil, on Friday.  Those reversals continued today.  Additionally, a very key bond market in Germany (the German 10 year bund yield), which traded into negative yield territory at one point last week, has been clawing back into positive territory since Friday (trading above 5 basis points today – positive 5 basis points).

Why?  Because of this chart…

1aa odsmaker

Above is an update of the bookmaker odds on a Brexit.  The chances of a leave have now dropped from 44% to 25%, since Thursday.

That’s why global markets are aggressively taking back the hedging and selling from last week.

The UK vote is this Thursday.  We’ve said months ago, that despite the speculation of a UK exit, it was not going to happen, given where the oddsmakers were pricing the risk (at about 70/30 in favor of staying for much of the way), and given the scale of the “fear of the unknown” in the voter’s eyes.  Adding to that, we expected that the warnings from big public figures would come in hot and heavy as the date approached.  Type in the words “Brexit” and “warning” into Google and you get almost 7 million results.

Already, everyone has weighed in with draconian warnings in an attempt to influence the decision: from the UK Prime Minister, the head of the Bank of England, the head of the IMF, to the ECB, to the Fed and the U.S. President.  Now UK employers have been latest, directly writing their employees to warn of the business damage from a ‘leave’ vote.

If the Brexit risk continues to abate, and the referendum comes and goes on Thursday, with a ‘stay’ vote, that should clear the way for broad global stock market rallies and a sharp bounce back in yields, as the focus will quickly turn to a July Fed rate hike.

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By Bryan Rich 

June 15, 2016, 4:30pm EST

The Fed held rates steady today.  As we’ve talked about, this was a decision they laid the ground work for over the past two weeks.  We want to talk about a few takeaways from the Fed event, and then continue our discussion from yesterday on the Bank of Japan decision tonight (where the big news may come).

First, the Fed did indeed consider the global stability risk that comes with the decision in the UK on whether or not to leave the European Union.  The polls in recent weeks have continued to show that it could go either way.  Meanwhile, the bookmakers have had this vote clearly in favor of “staying” in the European Union all along — as much as 70/30 ‘stay’ much of the way.  But those odds have been narrowing in the past week.

Still, as we discussed yesterday, holding pat on rates today was a “no risk” decision, especially because they had an event (the weak jobs data) and the platform (through a prepared speech by Yellen just days after the weak jobs data) to manage away expectations for a hike.

With that, stocks remained steady on the decision.  And markets in general remained tame.

So now the Fed is in position to see the outcome in the UK.  There was some two way talk about the jobs and inflation data, but it looks like the Fed is most concerned with what’s going on in the global economy.  That’s clear in their reaction to the oil price bust, when they responded back in March by taking two rate hike projections off the table.  And it’s clear in their reaction now to the Brexit risk.

But their new projections on the future path of interest rates have been ratcheted down in the coming years, and in the long run.  For perspective, a year ago the Fed thought the benchmark rate would be 2.75%.  Now they think it will be 1.5.  Why?  What’s been acknowledged more and more in recent meetings is the impact of the weakness and threats in global economies on the U.S. economic outlook.  The U.S. economy has been relied upon to drive global economic recovery, but it’s being dragged down now by the weight of global economic weakness.

This all puts pressure on Europe and Japan to follow through on their promise to do “whatever it takes” to restore their economies.
As we’ve said, the most important spots in the world, right now, are Japan and Europe.  The Fed only began its campaign of removing its emergency level policies because Europe and Japan took the QE baton handoff from the Fed – picking up where the Fed left off.  And unlike the U.S., which is constrained by “flight to safety” global capital flows and a world reserve currency, they have the ingredients (primarily Japan) to make QE work, to promote demand, to promote growth.  Japan has the largest government debt problem in the world. They have an undervalued currency.  They have a stagnating economy with big demographic challenges. They have are in a deflationary vortex.

They have the perfect attributes for a mass scale currency printing campaign. Not only can it work for their domestic economies, but it serves as the liquidity engine and stability preserver for the global economy.

In normal times, the rest of the world wouldn’t stand for a country outright devaluing their way to prosperity.  But in a world where every country is in economic malaise, everyone can benefit – everyone needs it to work. It can be the solution for returning the global economy to sustainable growth.

With that, and given the position of the yen and Japanese stocks (see our chart yesterday), along with the underperforming economy in Japan, even after three years of QE, now is the time to throw the kitchen sink at it (i.e. they should act tonight, and in a ‘shock and awe’ fashion).

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By Bryan Rich 

June 13, 2016, 5:00pm EST

Last week we talked a lot about the German bund yield, the most important market in the world right now.  Today we want to talk about how to trade it.

The best investors in the world love asymmetric bets (limited downside and virtually, if not literally, unlimited upside).  That’s the true recipe to building huge wealth.  And there is no better asymmetric bet in the world right now than the German 10-year bund.

With that in mind, in recent weeks, we’ve revisited Bill Gross’ statement last year, when the 10-year government bond yields in Germany were flirting with zero the first time.  He called it the “short of a lifetime” to be short the price of German bunds - looking for yields to bounce back.  It happened.  And it happened aggressively.  Within two months the German 10 year yield rocketed from 6 basis points to over 100 basis points (over 1%).  But even Gross himself wasn’t on board to the extent he wanted to be.  The bounce was so fast, it left a lot of the visionaries of this trade behind.

But over the past year, it’s all come back.

Is it a second chance?  German yields are hovering just a touch above zero – threatening to break into negative yield territory for one of the world’s most important government bond markets.

As we said on Friday, the zero line on the German 10-year government bond yield is huge psychological marker for perceived value and credibility of the ECB’s QE efforts. And that has huge consequences, not just for Europe, but for the global economy.

Given the importance of this level (regarding ECB credibility), it’s no surprise that the zero line isn’t giving way easily.  This is precisely why Bill Gross called it the “short of a lifetime.” With that, let’s take a look at the incredible risk/reward this represents, and a simple way that one might trade it.

There is a euro bund future (symbol GBL) that tracks the price of the German 10-year bund.  Right now, you can trade 1 contract of the German bund future at a value of 164,770 euros by putting up margin of 3,800 euros (the overnight margin at a leading retail broker).  If you went short the bund future, here are some potential scenarios:

If you break the zero line in yield, the euro bund future would trade up to about 165.50 (it currently trade 164.77).  If you stopped out on a break of zero in yield, you lose 730 euros (about $820 per contract).  If the zero line doesn’t breach, and yields do indeed bounce from here, you make about 1,500 euros for every 10 basis point move higher in the German 10-year bund yield.

For example, on a bounce back to 32 basis points, where we stood on March 15th, the profit on your short position would be about 4,600 euros (or about $5,200).  If German bund yields don’t breach zero and bounce back to 1%, where it traded just a year ago, you would make about 15,000 euros ($16,900) per contract on your initial risk of $820 – a 20 to 1 winner.  Of course, there are margin costs to consider, given the holding period of the trade, but in a zero rate world, it’s relatively small.

If you’re wrong, and the German 10-year yield breaches zero, you’ll know it soon.

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By Bryan Rich 

June 10, 2016, 4:00pm EST

On Wednesday we talked about the most important market in the world, right now.  It’s German bunds.

The yield on the 10-year German bund had traded to new record lows, getting just basis points away from the zero line, and thus from crossing into negative yield territory for the 10-year German government bond.  That has inched even closer over the past two days, touching as low as 1 basis point today.

Not surprisingly, stocks sold off today.  Volatility rose.  Commodities backed off.  And the broader mood about global economic stability heads into the weekend on the back foot.  For perspective, though, U.S. stocks ran to new 2016 highs this week, and are sniffing very close to record highs again.  Oil and commodities have been strong, and the broad outlook for the economy and markets look good (absent an economic shock).

What’s happening?  Of course, the vote that is coming later this month in the UK, on whether or not UK citizens will vote to ‘Stay’ in the European Union or ‘Leave’ continues to bubble up speculation on the outcome.  That creates uncertainty.  But the real reason rates are sliding is that the European Central Bank is in buying, not just government bonds, but now corporate bonds too.  The QE tool box has been expanded.  That naturally drives bond prices higher and yields lower.  But the question is, will it translate into a bullish economic impact (i.e. the money the ECB is pumping into the economy resulting in investing, spending, hiring, borrowing). As we discussed on Wednesday, it’s the anticipation of that result that sent rates higher in the U.S. when the Fed was in, outright buying assets, in its three rounds of QE.

With that, the most important marker in the world for financial markets (and economies) in the coming days, remains, the zero line on the German 10-year government bond yield.  Draghi has already told us, outright, that they will not take benchmark rates negative (as Japan did).  That makes this zero line a huge psychological marker for perceived value of the ECB’s QE efforts.

With this in mind, we head into a Fed meeting next week.  The Fed has done its job in managing down expectations of a hike next week.  With that, they have no risk in holding off until next month so that they can see the outcome of the stay/leave vote in the UK.  And, as we’ve discussed, the Bank of Japan follows the Fed on Wednesday night with a decision on monetary policy.  They are in the sweet spot to act, not only to reinvigorate the weak yen trend and strong stock trend in Japan, but to add further stimulus and perception of stability to the global economy.  We think we will see that happen.

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