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Contents Bulletin Scripting in shell and Perl Network troubleshooting History Humor

Bond funds and ETFs

News Retirement funds problem Recommended Links Vanguard Junk Bonds Fund Vanguard TIPs  
Raw Notes on 401K planning, Financial Groupthink and 401K Investors Delusions Protecting your 401K from yourself Protecting your 401K from Wall Street Protecting your 401K from government: Number racket and Fiat currency Trojan horse 401K Investing Webliography 100-your age investment strategy
Investments Scams   Casino Capitalism Financial Humor Humor Etc
  1. Introduction
  2. Popular 401K investors delusions
  3. Fashionable mutual funds mix
  4. Follow the leader
  5. Naive Siegelism
  6. "Financial alchemist" strategy
  7. Stable value only or "Depression might start tomorrow" strategy.
  8. Bonds-based strategy
  9. "Gold always shines bright"  and "Commodities rulez" strategies
  10. Lifecycle strategies
  11. Economic cycle based market timing
  12. Combination of lifetime strategies with market timing.
  13. Conclusions
  14. Webliography
  15. Old News

Introduction


"Gentlemen prefer bonds."

- Andrew Mellon.

Holding individual T-Notes or high quality bonds is never a bad idea. As long as they're held to maturity, they can't "fall in value." You'll get 100% of your investment back.

But Holding T-Note mutual funds is another matter entirely, since whenever you need that money it could be worth less than what you paid in, much less. For example, the value of Vanguard TIPs fund fluctuates 30% or more. With yield around 3%. So unless you keep your investment to ten years you will lose money (and even for ten years holding period you will lose a lot of money as inflation is not compensated in this case).

Bond interest can be separated into two part.

Actually there are bonds called TIPS which are structured exactly as described. As of 2013 The Fed is targeting 2% inflation. The long-term spread between 10-year Treasuries and CPI is about 2.5% (the "real rate"). That gives 4.5% as a probable target for the 10-year bond.

But with the exception of TIPs and other Treasuries, typically 401K investor can't invest in individual bonds. Moreover in 401K, which are designed to enrigh Wall Street, not an individual investor, you typically has access to a very limited number of bond funds (sometimes just one or two). All the rest in a typical 401K plan are stock funds.

The main advantage of bond funds is that they provide steady return despite (sometimes wild, like in September-October 2008) fluctuations of bonds fund share values. But it is important to understand that bond funds create what can be called "indefinite maturity bond with limited duration". So they behave quite differently then individual bonds:

There are several major lessons of this discussion for individual investor:

Still bond fund provide usually provide more or less uniform average duration of the bonds and quality of the issuers.

Those two variable help to predicts possible fluctuations. And if you keep bond fund long enough to exceed average maturity usually you you principal plus interest paid is at least equal the amount you invested in most (but not all) cases. One important exception are junk bonds which behave more like stocks.

According to Vanguard approximately 13% of participants in 401K plan had their entire accounts in fixed-income securities. That 's probably the most reasonable part of 401K crowd. Most knowledgeable part of this "bond oriented" crowd use stable value and TIPS for major ("safe") part of 401K portfolio.

A typical bond investor usually do not believe in investment advisor hype and take the investment risk extremely seriously as they should. The game of 401K investing is first of all about preserving capital, not so much about meaningful return.

Who cares about 10% annual returns of your portfolio in 2004-2007 if you lost 40-50% in 2008 and in desperation sold part of your holdings close to lower point. That's a typical story of "stocks for a long run" 401K investor, probably the most fleeced part of 401K crowd (although compulsive flippers -- speculators who trade their assets too often might come close)

Most investors fail to understand the importance of preserving capital. It might be the only achievable goal 401K investor can have. For that you need to beat inflation. If you could consistently beat inflation just by 1-2%, you would do far better than most. If we assume inflation of 3% then 5% return is enough to get you far ahead of the regular pack of "401K donors" in 10 years or so.

The most important advice here: do not play with your retirement money by increasing the risk.

The most important advice here: do not play with your retirement money by increasing the risk.

"High risk tolerance" is just another, more politically correct, definition of greed and it is usually punishable... If economics grows 3% a year or less, any return in excess of that carry level of additional risk that might not justify the difference.

There are nominal returns lower which bonds became way too risky. For 10 years such return is around 4%. If return falls below then you generally should think about shortening the duration of your bond portfolio.

The key idea here is to understand that a safer strategy might be to use type of allocations: stable value or short term TIPS for part of your portfolio that you will need before reaching the age of 70 (the time when people with substantial 401K holding should tap their SS benefits, as they are maximum at this age) and the other part which can be corporate bonds.

TIPS suffer from the fact that the inflation measurement are highly political and as such are crooked but still return around 3% per year even in deflationary environment of 2008-2013. Inflation is being measured and reported by the US government, which has an very strong incentive to underreport inflation. That why Boskin Commission changes in CPI, probably were the most intellectually dishonest analysis of Inflation as has ever been penned. The goal of fraud perpetrated by Boskin Commission was to reduce Social Security payments and avoid bankrupting the US Treasury -- not measure inflation accurately. Since then, the spread between the core and headline data have only grown further apart (The Big Picture)

Whenever I hear the phrase "excluding volatile food and energy" I just laugh. Can a pricing group be considered volatile if it merely goes up each month in an orderly fashion -- for years and years?

That's not volatility, thats a trend.

One way to actually measure how absurd the US core inflation measure is to look at what has happened to the spread between headline CPI and Core CPI. If Core CPI is understating inflation, than the spread should be widening. If it is accurate, the overall ratio between the two should be relatively steady.

What does the data show? The spread has increased substantially since the US adopted an ultra low rate/easy money policy under Greenspan (now affiliated with bond giant PIMCO). Since the easy money policy of the 1990s, and the rate slashing of the 2000s, it is no coincidence that the spread between the headline number and the core has grown dramatically.

If you want to trace this widening spread back to its origins, it coincides with implementation of Boskin Commission changes in CPI. (About as intellectually dishonest analysis of Inflation as has ever been penned -- its goal was to reduce Social Security payments and avoid bankrupting the US Treasury -- not measure inflation accurately). Since then, the spread between the core and headline data have only grown further apart.

This simply reflects the government's BLS inflation data diverging from reality.

Core CPI flatlined over the past 8 years because that is how it was constructed -- to not show inflation. However, the absurdity of the adjustments in inflation measures is revealed in the widening spread between Core and Headline

As one of the key crooks in Bush administration (Greg Mankiw, chairman of George W. Bush's Council of Economic Advisers from 2001-2003) openly stated "The debate about the CPI was really a political debate about how, and by how much, to cut real entitlements."

So TIPS are screwed and should be used in moderation and can and should be traded. Still government has the lowest default risk. And the only realistic alternative to TIPS is gold which is also manipulated by massive scale and might cost you pretty penny if you buy it in a bubble. That does not mean that you should not buy gold, jus that you need to understand that it also carry implicit mispricing risk.

TIPS suffer from the fact that the CPI is being measured and reported by the US government, which has an very strong incentive to underreport inflation by a significant margin.

Moreover, if you are a baby-boomer you already was ripped off royally by forced switching from defined benefit plans to defined contribution plans. To a certain extend you already lost significant part of nest egg: it was confiscated by Greenspan-Rubin-Gramm gang of "free market" for middle class, socialism for rich. In blog entry The Secret to Investment Longevity? Yyves Smith noted:

The Wall Street Journal's daily human interest story featured a holiday season tale of the Fuggerei, a Roman Catholic housing compound for the poor in Germany. The price of admission for those lucky enough to get in is yearly rent of one Rhein guilder, which equals 88 euro cents or $1.23, plus daily prayers for the founder, Jakob Fugger and his descendants.

How does such a marvel exist? The settlement is funded by a charitable trust, and the rent remains unchanged since the trust was established...in 1520.

Think about that. Can you think of another pool of capital that has lasted that long, let alone a commercial enterprise? The Fugger family is still well off, but nowhere near as rich as in Jakob Fugger's day.

The story does not give much detail about how the trust survived (a few nasty events like the German hyperinflation and World War II intervened), and gives a few tidbits about the last 200 or so years.

The core holding is forestry properties, which is both a renewable resource and inflation-hedged (admittedly with some volatility) and also owns some local real estate. The article does not indicate whether it holds securities.

Annual returns have been 0.5% to 2.0% over inflation

A fund manager who has quite a successful track record and manages money for families once told me that most investors fail to understand the importance of preserving capital and the value of keeping inflation. He said if you could consistently beat inflation by 2 or 3 percent, you would do far better than most understand. But too many investors chase greater returns, take on undue risk and in the long haul wind up worse off than if they had set more modest and attainable objectives (and note that this manager does seek and generally achieves higher returns because that is what customers want).

There is a second, behavioral issue with seeking higher returns and accepting the attendant risks. Let's say you do have a good year, or perhaps even a run of good years. You come to perceive this level of returns as sustainable, when it may be luck or an unusual set of investment conditions that will not persist. But human nature being what it is, most people would increase their expenditures in line with their new level of wealth, and are ill prepared for a reversal of fortune, as the last year has shown.

Unless you are very well-to-do there is no such things as safe investing in stocks, especially this absurd idea of "stocks for a long run" (Naive Siegelism). In no way risks of stocks go away with the long run. That's a fallacy. While this is promoted in most so called investor education materials, this is a typical hogwash promoted by financial industry. If you buy stock you never should not be a static investor (as in "stocks for a long run"). You need to become a trader (you time horizon can be much larger then regular trader but still you need to became a trader). Again, repeat after me, the idea that investing in stock as safe investment for 401K portfolio is a hogwash. You might be better off buying gold because it contradicts the fundamental of economics and first of all the notion of risk premium. The notion of risk premium discredit any muttering by people like Jeremy Siegel that you can avoid risk by taking longer time horizon. You can only diminish it by selling stocks at higher then average valuations e.g. trading (if, and only if, such a period occurs during the period you are holding them). So getting oversize returns from stock means successful trading. That's it. That means that on any fixed target date there in no certainty as for what your value of your stocks portfolio. And never will.

The current situation is a convincing proof that you should not rely on stocks in 'safe" part of your 401K portfolio. Hedging of risk is more important then diversification for most 401K investors. And the simplest way to decrease your risk is to invest larger part of your portfolio in safe assets. The fundamental idea of risk reward is how much you should allocate to safe assets not those stupid games with various stock funds allocation that are promoted in literature. You need to think about the entity that guarantee you against default risk. Right now this is money market funds (government will seldom allow them to go down, at least this was proved in 2008) and Treasuries. And anybody who try to persuade you that this is not true is either a shill of some investment company (Siegel's of the world, see Naive Siegelism ) or complete idiots (rarely it can be both ;-).

In retirement, if you have enough savings and can live simply on interest in tough times fluctuations of bond prices don't matter. What matters is the risk of default. So here you can also use 100-your age formula and diminish percentage of corporate bonds and increase percentage of TIPS with the age. But you need to be careful what you wish for. During normal periods TIPS are competitive with corporate bonds. When they are not competitive (for example in November 2008), the risk for corporate defaults is very high and most of S&P500 companies bonds are essentially junk as it is unclear which company will survive another year or two. Instead you might create in years close to retirement a stable value (cash) portion of your principal enough for, say, one or two years as TIPS can fluctuate wildly as we saw in 2008. This way you can avoid selling TIPS when their face value fall too low.

Another important augment in favor of TIPS is that according to Grantham model long term stock returns are inflation plus 2%. That means that they are equal to average return of 10 year treasures with a fraction of risk.

Please note that the price at which you buy matters. It is actually matter most. Medium and long term bonds including TIPS bought with yields below 5% can be as risky as stocks and single point ("all-in") purchases in such circumstances would better be avoided. In such cases money market funds or shot term corporate bonds are preferable to bonds as yields are lower but the risk is completely different as recent event had shown us quite well. In any case it is wise to buy bonds only on dips. You can then cost average them during as long period as you wish buying some amount each two weeks a month or even a quarter.

Medium and long term investment-grade company bonds and bond funds bought with yields below 5% are too risky and "all-in" type of purchases in such circumstances should better be avoided

Junk bonds is entirely different category as they behave more like stocks not like bonds. In small dozes (let's say 5% - 10%) they can increase 10 years returns with only minimal increase of risk. But question remains open whether one can use them in (100-your age, see Lifecycle strategies) strategy as a substitution for stocks. It depends whether those companies die like fly on the frost; 2009 was lucky year for junk, but 2027 or whenever the next financial crisis strikes might be less so... .

The problem with diversified bond fund like PIMCO Total return or Vanguard intermediate fund is that they can drop dramatically in case of real crisis when bonds and stock sink synchronously while in normal circumstances decline n stock usually lead to rally in bonds. That is a sad fact that many people, including myself discovered in 2008. But for 10 years or longer holding periods they still might be OK and provide slightly higher return then stable value. At the same time you need to understand that bonds funds are very different from bonds and can be very risky during crisis period. For example LQD dropped from $105 to $80 in 2008. With such drop you can recover the value on your investment approximately in 5 years. So some caution is appropriate:

Stable value fund is a necessary compliment of all-bond portfolio, as it can diminish the downside risk. As is evident in September-October of 2008 this is not a bad thing. For those people who like me are overly concerned with the downside risk changing percentage from offensive to defensive (for example from high yield/stable value ration of 40:60 to 20:80) might be a better strategy. For example in late 2007, a number of institutional investors are boosting their cash allocations and many investment advisors increase cash/stable value portion of the portfolio. You can probably use the level of noise in this direction as a reallocation signal. As Emil Lee wrote in his article Protect Your Portfolio! August 16, 2007

According to The New York Times, Baupost Group's Seth Klarman, regarded as one of the world's savviest investment managers, last year allocated a whopping 49.8% of the group's portfolio to cash, up from 45.8% a year earlier.

FPA Capital Fund, run by the legendary Robert Rodriguez, currently has a 40% allocation to cash and cash equivalents, and Fairholme Fund, my personal favorite mutual fund, allocates about 20% to cash. If those heavy-hitters like cash, it might be a good idea to give this patient approach a long, hard look.

At any point of time you can find pretty convincing arguments that crash is just around the corner (next month, next quarter, the next year) but the fact that they are convincing does not mean that this is a right forecast. Seldom such convincing predictions happen in the promised timeframe. In a way it might be safer to be perma-bull of Siegel variety as you might be more often right then wrong; but if you are wrong 30% of investment can be wiped out in a year of two and it is unclear whether you have enough discipline not to move you holdings into cash in the middle of the turmoil.

At the same time it is not that easy to dismiss this strategy:

There are some tricks that can be played while staying within the limits of this strategy to increase returns. John Waggoner mentioned several of them in his recent column. Most of them are not applicable to 401K accounts but the are worth consideration for other savings, if any:

Yields on money market mutual funds also fall when the Fed cuts rates. The average money fund now yields 4.08%, down from 4.76% in August.

If you count on investment income for part of your living expenses, you'll have to tighten your already-tight belt. A $100,000 CD at 3.54% will give you $295 a month in income, which might be enough if you live in a cave atop Mount Crumpit. If you don't, you'll want to look for investments that generate more income.

Normally, you can receive higher rates by investing in a longer-term CD. But these aren't normal times. The average five-year CD yields 3.76%. On a $100,000 investment, a 3.76% yield would earn you an additional $18 a month, or about enough for a can of Who-hash.

Also, you don't want to lock in a lousy 3.76% for the next five years. Rates are more likely to rise than fall in the coming years, because of the very real threat of inflation. Inflation, at 4.3% in November, will gobble up all your interest if prices continue to rise at their current clip.

Look for banks that really want to borrow your money. Countrywide Bank, for example, will pay you 5.5% on a six-month CD.

The trade-off: Many banks that offer high deposit yields have been in the news lately, and the news hasn't been good. Countrywide, once a leading subprime lender, has been plagued by lower lending volume and rising defaults.

These banks' troubles shouldn't haunt you if you stay within the federal deposit insurance limits. (You're insured for up to $100,000 of your deposits.) The insurance is quite generous: You also enjoy separate $250,000 insurance for your individual retirement accounts, for example. For a complete rundown, go to www.fdic.gov.

If you want higher yields, though, you'll have to take more risk - including that your principal might fall. One suggestion: closed-end bond funds. Unlike most mutual funds, closed-end funds issue a set number of shares that trade on the stock exchanges, just like stocks. The twist: Many times, the market price of closed-end funds falls below the value of the fund's holdings.

Thanks to the meltdown in the credit markets, many closed-end bond funds have been clobbered. That's bad news for people who had bought the funds. But it's good news if you're now looking for high yields at bargain prices. Thomas Herzfeld, a closed-end specialist, says closed-end bond funds now offer some of the best buys he's seen in nearly 40 years.

Consider, for example, Putnam Premier Income Trust (PPT). Wednesday, the fund's shares sold for $6.14. But the fund held securities worth $7.11 a share. In other words, you'd be buying the fund's shares for a 13.6% discount to their real value.

More important, the fund's yield is a generous 5.8%, according to the Closed-End Fund Association (www.closed-endfunds.com). Other closed-end bond funds that Herzfeld likes are in the chart.

All-in-all simple binary allocations like static 50-50 (or close to it in a range approximately 60:40 to 40:60 ) split between "safe" and "risky" bonds as well as recursive application of of lifecycle strategy (100 - your age and similar), but now to a bond portfolio.

Based on just simulations that I performed it looks like static 50:50 split between TIPS and corporate junk bonds provides not bad returns and a reasonable level of risk in comparison with the 100% in stable value portfolio. But again I a computer expert, not financial expert.

But there are really bad periods for this combination and junk funds in October 2008 look really bad (or suicidal, if you wish) with drops approaching declines of S&P500. At the same time 50/50 portfolio is extremely easy to rebalance. See also Life cycle fund investors Doing it wrong - Personal Finance - MSNBC.com.

All-in-all keeping all your money in money market fund or mixture of bond funds without any stock component might be an overly defensive strategy. I suspect that there is a minimum amount of stocks in portfolio below which the risk increases. Such a minimum might be in the range 10-30% depending on your personality (abrupt moves due to discomfort usually damage return greatly in a long run) and stocks can utility stocks that carry some dividend.

And with good selection of bond fund and stock index the risk probably stays within bounds similar to all bond portfolio till probably 30-40%. Then it rises but until probably 60% this rise is rather slow. That means that defensive lifecycle strategies (and lifecycle funds, see below) might be able to provide better returns then "cash only/bonds only" 401K portfolios with only minimally higher risk.

Bond funds are radically different from holding actual bonds

Here is an apt quote that describes the main problem with bond funds in 401K portfolio, the fact that your principal is at risk:

MANY INVESTORS, wary about buying bonds directly, often opt instead for bond funds, thinking, perhaps, that there is safety in numbers. Big mistake. Bond funds can be even trickier than bonds themselves because -- unlike the implication in their name -- they are not really fixed-income investments. Even when a mutual fund's portfolio is composed entirely of bonds, the fund itself has neither a fixed yield nor a contractual obligation to give investors back their principal at some later maturity date -- the two key fixed characteristics of individual bonds. [Bond vs. Bond Funds (One Bond Strategy) SmartMoney.com]

Bond funds are not panacea in comparison with stock funds, even taking into account all machination with stock prices. As we discussed TIPs are less volatile then most is should be a art of bond portfolio. You might benefit from replacing some part of stock holding with junk bond fund as they behave similarly (they are highly correlated) but have lesser volatility (interest also helps to diminish volatility during severe downturns; for example 30% drop of junk bond price with 10% interest means approximately 20% drop in your investment value).

LIBOR, the London Interbank Offered Rate, is the most active interest rate market in the world. It is determined by rates that banks participating in the London money market offer each other for short-term deposits. LIBOR is used in determining the price of many other financial derivatives, including interest rate futures, swaps and Eurodollars. Due to London's importance as a global financial center, LIBOR applies not only to the Pound Sterling, but also to major currencies such as the US Dollar, Swiss Franc, Japanese Yen and Canadian Dollar. http://www.bankrate.com/brm/ratewatch/other-indices.asp

But with junk funds like with stocks timing is everything: they are not suitable target for cost averaging. As PIMCO Gross notes by simply researching historical annual high yield default rates (5%), multiplying that by loss of principal in bankruptcy (60%), and coming up with an expected loss of 3% over the life of future loans. So fair return for junk bonds is LIBOR + 300 or more. In other words as Gross stresses "for LIBOR+250 high yield lenders are giving away money!"

It is important to understand that in current circumstances stable value funds can be a blessing as they are the only reliable hedge available to 401K investors. And if somebody is concerned about returns it's relevant to remind that average returns for 401K investors are negative after inflation. So you have nothing to lose and get peace of mind which is also very important. Money market accounts (stable value funds in 401K terminology) are the most liquid and less dangerous of bond funds and they should probably be integral part of any 401K portfolio, especially in cases where you cannot buy a bond fund that has return above 5%.

Bond funds are much complex financial instrument than bonds themselves because -- unlike the implication in their name -- they are not really fixed-income investments. Bond funds do not guarantee the return on your principal after certain number of years and for intermediate term and long term bond funds in fact can endanger your principal even if you hold them for a number of years less then maturity. Also returns can fluctuate year to year.

One of the reason is that bonds in bond fund portfolio constantly rotate. If you try to withdraw money from the bond fund during the period of Fed tightening you can lose part of your principal. That's why intermediate with return below 3.5% and long term bond funds with returns below 5% (including inflation-protected securities funds -- TIPS) are very risky to hold and are not safe financial instruments at all.

Inflation rate plus 2% rule for 10 year bonds

If we assume that stable value fund has zero effective return and compensates just for inflation, to sacrifices stability of the principal for just 1% of extra return for 10 year bonds is risky. You need at least 2% premium.

For the same reason buying bond indexes with low interest rate are much more questionable idea then buying stock indexes. Long term high quality bond funds seldom worth either the added risk or the added cost. Treasury Direct might be a simpler and better way to manage your high quality bond port of the portfolio during the retirement as government bonds are tax free.

Investment fees associated with managing bond funds investments (mutual funds fees) are assessed as a percentage of assets invested, but for bond funds this is a completely inaccurate method. Bond fund can be considered partnership between you and bond fund advisors were you provide all the capital and they provide management. That means that results should be calculated as a percentage of return after inflation. For example Pimco with its eloquent manager Bill Gross are taking approximately 0.5% in fees and has after fees return of approximately 4.5%. That means that they are taking 11% of net returns for the management of funds without even considering inflation. If we are taking about returns after inflation and assuming inflation to be around 3% a year, they are taking 0.5/1.5=33% of return on your capital and at the same time spending a lot of your money trying to persuade you that this an extremely good deal.

That's why long term bonds funds that has returns below 5% (or Libor rate if you need to be more exact) are generally a bad deal and you should consider using shorter duration funds instead. I think it is prudent to avoid buying long term bonds funds with below 5% returns in 401K portfolio. Please note that bonds funds fees are not specifically identified on statements, but can be found in fund prospects and on Yahoo finance. See A Look At 401(k) Plan Fees for Employees for details.

Bonds are especially vulnerable during "credit crunch" when even A and AA bonds can be affected (even AAA were affected during Great Depression). Cutting interest rates during such a crisis (a typical government reaction) increases inflation that has the effect of transferring wealth from creditors to debtors. That means transferring wealth away from bond investors.

From other point of view interest rates are just to consider them to be the price of money. And low interest rates suggest devalued money and high monetary supply growth. That is yet another way to explain why bond funds with returns below 5% are risky to hold. In such cases stable value funds are blessing. Gold might be blessing too.

And the last but not least: while bond funds fees usually are stated as the percentage of assets they in reality should be stated as the percentage of interest earned. That helps to see more realistic picture about who is the prime beneficiary of the money you put in the fund and how big the second largest beneficiary share is. See above calculation for PIMCO Total Return fund.


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NEWS CONTENTS

Old News ;-)

[Dec 27, 2015] This Junk Bond Derivative Index Is Saying Something Scary About Defaults

Bloomberg Business

Citigroup analysts led by Anindya Basu point out that spreads on the CDX HY, as the index is known, are currently pricing in an expected loss of 21.2 percent, which translates into something like 22 defaults over the next five years if one assumes zero recovery for investors. That is a pretty big number once you consider that a total of 41 CDX HY constituents have defaulted since the index really began trading in 2005, equating to about 3.72 defaults per year. A big chunk of those defaults (17) occurred in 2009 in the aftermath of the financial crisis.

What to make of it all? Actual recoveries during corporate default cycles tend to be higher than the worst-case scenario of zero percent. In fact, they average somewhere in the 26 percent range, which would imply 29 defaults over the next five years instead of 41.

So what? you might say. The CDX HY includes but one default cycle, and those types of analyses tend to underestimate the peril of tail risk scenarios (hello, subprime crisis). Citi has an answer for that, too. Using spreads from the cash bond market going back to 1991, they forecast the default rate over the next 12 months to be something more like 5 percent to 5.5 percent. (For comparison, the rating agency Moody's is currently forecasting a 3.77 percent default rate.)

[Dec 22, 2015] A Milestone For Vanguard: New Fund Could Include Junk Bonds

blogs.barrons.com

,,,,The Vanguard Core Bond Fund, unveiled in a filing with regulators on Monday, is being billed as an actively managed alternative to index funds like the Total Bond Market fund (VBMFX, VBTLX, BND). Its launch, slated for the first three months of 2016, would coincide with a period of great uncertainty in the bond markets. The Fed could mull its next interest-rate hike as soon as March.

... ... ...

Daniel Wiener, editor of the Independent Adviser for Vanguard Investors newsletter and a close watcher of all things Vanguard, was quick to note that the fund could invest in bonds of "any quality." The new fund's fine print shows leeway for Vanguard's portfolio managers to plunk up to 5% of the portfolio in junk bonds. Some 30% of the fund could fall into "medium-quality" bonds.

Vanguard's existing offering in junk debt, the Vanguard High-Yield Corporate Fund (VWEHX, VWEAX), is managed by Wellington Management Company.

Says Wiener: "Vanguard has never offered lesser-quality bond funds run by its internal group. The junk portion of the Core Bond product will be a first."

[Dec 13, 2015] While redemptions are elevated, particularly in high-yield bond funds, there doesn't seem to be a rush to for the exits

For the last several year buying "junkest junk" was a profitable strategy. Now it came to abrupt end.
Notable quotes:
"... The rest of the industry has been quick to say that while redemptions are elevated, particularly in high-yield bond funds, there doesn't seem to be a rush to for the exits. ..."
"... Goldman Sachs, for one, put out a note Friday warning Franklin Resources "is most at risk" given the large high-yield holdings of its funds, poor performance and large outflows. On Friday, its shares fell sharply. Meanwhile, there were unusually large declines Friday in the value of exchange-traded funds that track high-yield debt. ..."
"... The idea of a "run" on mutual funds might sound strange. Typically, runs are associated with highly leveraged banks engaged in maturity transformation, funding long-term loans with short-term debt. Nearly all the programs designed to avoid destabilizing runs-from deposit insurance to the Fed's discount window to liquidity requirements-are built for banks. But unleveraged investors, including mutual funds, can also give rise to runs. That is because there is a liquidity mismatch in mutual funds that hold relatively illiquid assets funded by investors entitled to daily redemptions. ..."
peakoilbarrel.com
Jeffrey J. Brown, 12/13/2015 at 4:06 pm
Interesting WSJ article (do a Google Search for the title, for access). Last week, the Journal noted that Chesapeake bonds that traded at 80˘ on the dollar a few months ago were currently trading at 30˘ to 40˘ on the dollar. I suspect that there are some huge losses on the books of a lot of pension funds.

WSJ: The Liquidity Trap That's Spooking Bond Funds
The specter of a destabilizing run on debt is haunting markets

The debt world is haunted by a specter-of a destabilizing run on markets.

Last week, this took on more form even if there weren't concrete signs of panic. Only one mutual fund manager, Third Avenue Management, has said it would halt redemptions to forestall having to dispose of assets in a fire sale. The rest of the industry has been quick to say that while redemptions are elevated, particularly in high-yield bond funds, there doesn't seem to be a rush to for the exits.

Still, growing angst comes as the oil-price rout continues and the U.S. Federal Reserve appears ready to raise rates. This has investors worried-and starting to ask the fearful question: "Who's next?"

Goldman Sachs, for one, put out a note Friday warning Franklin Resources "is most at risk" given the large high-yield holdings of its funds, poor performance and large outflows. On Friday, its shares fell sharply. Meanwhile, there were unusually large declines Friday in the value of exchange-traded funds that track high-yield debt.

The idea of a "run" on mutual funds might sound strange. Typically, runs are associated with highly leveraged banks engaged in maturity transformation, funding long-term loans with short-term debt. Nearly all the programs designed to avoid destabilizing runs-from deposit insurance to the Fed's discount window to liquidity requirements-are built for banks. But unleveraged investors, including mutual funds, can also give rise to runs. That is because there is a liquidity mismatch in mutual funds that hold relatively illiquid assets funded by investors entitled to daily redemptions.

[Dec 12, 2015] David Dayen Is This The Beginning of the Crackup in High-Yield Corporate Debt

Notable quotes:
"... It cuts two ways. Junk ETFs such as JNK and HYG have badly underperformed their benchmarks, owing to buying and selling in an illiquid market to replicate an index. Whereas actively managed junk mutual funds have the flexibility to deviate from index holdings in ways that can add a couple of hundred basis points a year. ..."
"... Your apology is flawed because it assumes equal access to information among investors as well as assuming all investors have the same objective. Institutional investors have different goals than hedge funds for example. The people you refer to have been fleeced that's just ok with you. As to tea leaves the people have been steeped in recovery stories for years. ..."
"... Wait, so speculators are shorting big bond positions of distressed funds? No way, hope they aren't doing this to ETF's. Jeez, didn't see this coming. I guess having the positions of big ETF's published daily might assist the speculators. ..."
"... What I do remember (and I can't remember whether it was Spring of 2008 or earlier), was that HY spreads had gapped out at least a couple of hundred bps, and equities were still at or near all-time highs. I remember sitting in a meeting with a couple I-bankers, who chuckled ruefully "equities haven't a clue". ..."
"... The received wisdom on the Street is that the bond market is smarter than the equity market. And, at last in my career, it was true, at least as far as downturns went. ..."
naked capitalism
MikeNY December 12, 2015 at 6:41 am

Yes, junk is usually the canary in the coal mine. The HY market melted in the Summer of 2008, months before equities noticed what was going on. The question really is how much contagion there will be: how many CDS have been written on the distressed names, who holds them, etc. My instinct tells me that there are considerably less CDS on junk than were written on MBS, due to the smaller market, the lower liquidity and (supposed) credit quality. But how much has that changed since 2008? I dunno.

One thing I do know: it's like the movie "Groundhog Day". The Fed always overstimulates, and there always follows a crash. Are there any bubbles left to blow, to 'reflate' assets next time?

timmy December 12, 2015 at 9:39 am

Your remark on written CDS is important. While it may be difficult to get liquidity on distressed names, it is less so on credit tiers above that or on indices. I'm sure there is some on junk, yes, but the real opportunity for spec CDS is (perhaps, was) on the BBB space which is the largest category in the investment grade market and is more liquid. While it may take awhile for distressed trading to creep up the credit ratings to the larger and more liquid names (specifically, since the definition of liquidity seems to be important on NC: the size of the specific issues' float, approximated with average daily volume), they will also have larger moves because potential fallen angels are repriced aggressively in an unstable market. The other thing about CDS is that they are most often delta-hedged which requires dealers to sell proxy's as the CDS go deeper into the money. The one restraining factor is that once a crisis is in motion, I think its going to be difficult for specs to get more CDS on their books. This strategy is purely directional (this is not an ETF NAV arb), essentially owning out of the money puts with minimal cost of carry.

Jim Haygood December 12, 2015 at 1:39 pm

'Their investing strategy – putting high-risk investments into a mutual fund – seems like exactly what not to do.'

It cuts two ways. Junk ETFs such as JNK and HYG have badly underperformed their benchmarks, owing to buying and selling in an illiquid market to replicate an index. Whereas actively managed junk mutual funds have the flexibility to deviate from index holdings in ways that can add a couple of hundred basis points a year.

That said, both junk ETFs and junk mutual funds are offering daily liquidity, while holding underlying securities that may trade once a week, or have no bids at all. As David Dayen observes, this sets up the risk of a bank run when investors get spooked.

Take a look at the "power dive" chart of TFCIX (Third Avenue Focused Credit Fund) - Aiieeeeee!

http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=tfcix&insttype=&freq=&show=

Now the question is contagion. Morningstar shows that 48% of TFCIX's portfolio was below B rating, and 41% had no bond rating. Most junk funds don't have THAT ugly a portfolio. But when the herd starts to stampede, fine distinctions can get lost in the dust cloud from the thundering hooves.

Over to you, J-Yel. Do you feel lucky, cherie? Well, do you?

Mike Sparrow December 12, 2015 at 3:48 pm

There is no CDS. There just isn't less, there is none. The stock market has pretty much ignored it as well except that its move from 13000 to 18000 has temporarily stalled. I suspect by the spring, this will be old news.

I think we make errors here, not understanding this particular type of financial speculation is "anti-growth" in general. This would probably blow most of the minds on this board.

Keith December 12, 2015 at 7:27 am

Many years ago when Alan Greenspan first proposed using monetary policy to control economies, the critics said this was far too broad a brush.

After the dot.com crash Alan Greenspan loosened monetary policy to get the economy going again. The broad brush effect stoked a housing boom.

When he tightened interest rates, to cool down the economy, the broad brush effect burst the housing bubble. The teaser rate mortgages unfortunately introduced enough of a delay so that cause and effect were too far apart to see the consequences of interest rate rises as they were occurring.

The end result 2008.

With this total failure of monetary policy to control an economy and a clear demonstration of the broad brush effect behind us, everyone decided to use the same idea after 2008.

Interest rates are at rock bottom around the globe, with trillions of QE pumped into the global economy.

The broad brush effect has blown bubbles everywhere.

"9 August 2007 – BNP Paribas freeze three of their funds, indicating that they have no way of valuing the complex assets inside them known as collateralised debt obligations (CDOs), or packages of sub-prime loans. It is the first major bank to acknowledge the risk of exposure to sub-prime mortgage markets. Adam Applegarth (right), Northern Rock's chief executive, later says that it was "the day the world changed"

10th December 2015 – "Moments ago, we learned courtesy of the head of Mutual Fund Research at Morningstar, Russ Kinnel, that the next leg of the junk bond crisis has officially arrived, after Third Avenue announced it has blocked investor redemptions from its high yield-heavy Focused Credit Fund, which according to the company has entered a "Plan of Liquidation" effective December 9."
When investor's can't get their money out of funds they panic.

Central Bank low interest rate policies encourage investors to look at risky environments to get a reasonable return

Pre-2007 – Sub-prime based complex financial instruments
Now – Junk bonds

The ball is rolling and the second hedge fund has closed its doors, investors money is trapped in a world of loss.

"Here Is "Gate" #2: $1.3 Billion Hedge Fund Founded By Ex-Bear Stearns Traders, Just Suspended Redemptions"

We know the world is downing in debt and Greece is the best example I can think of that shows the reluctance to admit the debt is unsustainable.

Housing booms and busts across the globe ……

Those bankers have saturated the world with their debt products.

Keith December 12, 2015 at 7:29 am

Links (which will probably require moderation)

Skippy December 12, 2015 at 7:41 am

Quality of instruments impaired by corruption has a more deleterious effect than quantities of could ever imagine…

David December 12, 2015 at 10:33 am

"Those bankers have saturated the world with their debt products."

I'm no apologist for Banksters but people bought this "stuff" as the Stuffies.

whether you call it greed or desperation in the face of zero yield – at the end of the day the horizon was short since the last debacle.

getting 2 & 20 or whatever the comp arrangement was for those who are motivated by greed – 2% of $2 Billion yields at least $40 million a year for 5 years or $200 million – not bad for ten guys or less – obviously not fiduciaries – bouncing from Bear to Tudor to Third Ave with no change in the model yields predictable results

I put forth the proposition the "people" deserve their fate – the tea leaves were all there to see

tegnost December 12, 2015 at 10:52 am

Your apology is flawed because it assumes equal access to information among investors as well as assuming all investors have the same objective. Institutional investors have different goals than hedge funds for example. The people you refer to have been fleeced that's just ok with you. As to tea leaves the people have been steeped in recovery stories for years.

Ian December 12, 2015 at 2:24 pm

Also fails to recognize the collateral damage caused towards the people that did not directly participate. It is very hard to say that they deserve their fate in this context, in that they were largely powerless to stop it to begin with, at a reasonable level.

Ian December 12, 2015 at 2:29 pm

I guess you qualified that with focusing solely on the people who bought it. Did not read fully.

Timmy December 12, 2015 at 8:34 am

Wait, so speculators are shorting big bond positions of distressed funds? No way, hope they aren't doing this to ETF's. Jeez, didn't see this coming. I guess having the positions of big ETF's published daily might assist the speculators.

Jim Haygood December 12, 2015 at 4:25 pm

Yesterday HYG closed at a 0.76% discount to NAV, while JNK closed at a 0.68% discount (values from Morningstar). These are wider discounts than ETF managers like to see.

The arbitrage mechanism of buying the discounted ETF shares, redeeming them for the underlying, and then selling the bonds at full value for an instant 0.76% gain is supposed to kick in now.

But sell … to whom?

Timmy December 12, 2015 at 4:51 pm

The misperception is that the ETF junk trade is an arb right now. Its not, its directional. The discipline to bring NAV's in line with underlying value will only kick in at much wider levels because traders are still long (and putting on more of) the "widener" because they anticipate higher levels of vol going forward.

tegnost December 12, 2015 at 9:15 am

Actually have already been bracing myself as demand for labor fell off a cliff at the end of sept., and I'm guessing it's stories such as this that makes my customers tighten their belts....

nat scientist December 12, 2015 at 9:55 am

"Some say the world will end in fire
Some say in ice
From what I've tasted of desire
I hold with those who favor (fire) INFLATION
But if it had to (perish) REFINANCE twice,
I think I know enough of (hate) ZIRP RATES
To say that for destruction (ice) NO BID
Is also great
And would suffice."

Marty Whitman now gets Robert Frost.

craazyboy December 12, 2015 at 4:26 pm

All those junk companies could just declare bankruptcy and start over. That's the way it's supposed to work. Just ask The Donald. Then it would be like that movie where Bruce Willis saved the earth from an asteroid strike. 'Course there was only one asteroid in that movie. Instead, we have World War Z with zombies all over the place!

But maybe JYell will buy all the junk bonds, burn them, and then the dollar will crash and we can all get jobs?

Christer Kamb December 12, 2015 at 1:44 pm

MikeNY said;

"The HY market melted in the Summer of 2008, months before equities noticed what was going on."

Not really. HYG market were in a downtrend during summer of 2007, together with the stockmarket. Also in the 2008 summer both markets were in a severe meltdown. This time around the HYG´s started their downtrend from summer 2014 with the 1:st leg down to dec same year. 2:nd leg is now running in which the stockmarket joined.

Your right, HYG´s seems to be the canaries here! But, from august this year they seems to go in different directions. Or are they?

MikeNY December 12, 2015 at 4:25 pm

You're right, it was earlier than Summer 2008, now I think about it.

What I do remember (and I can't remember whether it was Spring of 2008 or earlier), was that HY spreads had gapped out at least a couple of hundred bps, and equities were still at or near all-time highs. I remember sitting in a meeting with a couple I-bankers, who chuckled ruefully "equities haven't a clue".

The received wisdom on the Street is that the bond market is smarter than the equity market. And, at last in my career, it was true, at least as far as downturns went.

[Dec 04, 2015] Wolf Richter "Distress" in US Corporate Debt Spikes to 2009 Level

Notable quotes:
"... By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street ..."
"... Other high-risk credits, such as those backed by subprime mortgages, will follow. And the irony? Just in the nick of time, subprime is back – but this time, it's even bigger. Read… Subprime "Alt"-Mortgages from Nonbanks Run by former Countrywide Execs Backed by PE Firms Are Booming ..."
www.nakedcapitalism.com

December 3, 2015 | naked capitalism

By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street

nvestors, lured into the $1.8-trillion US junk-bond minefield by the Fed's siren call to be fleeced by Wall Street and Corporate America, are now getting bloodied as these bonds are plunging.

Standard & Poor's "distress ratio" for bonds, which started rising a year ago, reached 20.1% by the end of November, up from 19.1% in October. It was its worst level since September 2009.

It engulfed 228 companies at the end of November, with $180 billion of distressed debt, up from 225 companies in October with $166 billion of distressed debt, S&P Capital IQ reported.

Bonds are "distressed" when prices have dropped so low that yields are 1,000 basis points (10 percentage points) above Treasury yields. The "distress ratio" is the number of non-defaulted distressed junk-bond issues divided by the total number of junk-bond issues. Once bonds take the next step and default, they're pulled out of the "distress ratio" and added to the "default rate."

During the Financial Crisis, the distress ratio fluctuated between 14.6% and, as the report put it, a "staggering" 70%. So this can still get a lot worse.

The distress ratio of leveraged loans, defined as the percentage of performing loans trading below 80 cents on the dollar, has jumped to 6.6% in November, up from 5.7% in October, the highest since the panic of the euro debt crisis in November 2011.

The distress ratio, according to S&P Capital IQ, "indicates the level of risk the market has priced into the bonds. A rising distress ratio reflects an increased need for capital and is typically a precursor to more defaults when accompanied by a severe, sustained market disruption."

And the default rate, which lags the distress ratio by about eight to nine months – it was 1.4% in July, 2014 – has been rising relentlessly. It hit 2.5% in September, 2.7% in October, and 2.8% on November 30.

This chart shows the deterioration in the S&P distress ratio for junk bonds (black line) and leveraged loans (brown line). Note the spike during the euro debt-crisis panic in late 2011:

The oil-and-gas sector accounted for 37% of the total distressed debt and sported the second-highest sector distress ratio of 50.4%. That is, half of the oil-and-gas junk debt trades at distressed levels! The biggest names are Chesapeake Energy with $7.4 billion in distressed debt and Linn Energy LLC with nearly $6 billion.

Both show how credit ratings are slow to catch up with reality. S&P still rates Chesapeake B- and Linn B+. Only 24% of distressed issuers are in the rating category of CCC to C. The rest are B- or higher, waiting in line for the downgrade as the noose tightens on them.

The metals, mining, and steel sector has the second largest number of distressed issues and sports the highest sector distress ratio (72.4%), with nearly three-quarters of the sector's junk debt trading at distressed levels. Among the biggest names are Peabody Energy with $4.7 billion in distressed debt and US Steel with $2.2 billion.

These top two sectors account for 53% of the total distressed debt. And now there are "spillover effects" to the broader junk-rated spectrum, impacting more and more sectors. While some sectors have no distressed debt yet, others are not so lucky:

The biggest names: truck maker Navistar; off-road tire, wheel, and assembly maker Titan International; specialty chemical makers The Chemours Co. and Hexion along with Hexion US Finance Corp.; Avon Products; Verso Paper; Advanced Micro Devices; business communications equipment and services provider Avaya; BMC Software and its finance operation; LBO wunderkind iHeart Communications (Bain Capital) with a whopping $8.9 billion in distressed debt; Scientific Games; jewelry and accessory retailer Claire Stores; telecom services provider Windstream; or Texas mega-utility GenOn Energy (now part of NRG Energy).

How much have investors in distressed bonds been bleeding? S&P's Distressed High-Yield Corporate Bond Index has collapsed 40% from its peak in mid-2014:

US-SP-distressed-high-yield-corp-bond-index

In terms of investor bloodletting: 70% of all distressed bonds are either unsecured or subordinated, the report notes. In a default, bondholders' claims to the company's assets are behind the claims of more senior creditors, and thus any "recovery" during restructuring or bankruptcy is often minimal.

At the lowest end of the junk bond spectrum – rated CCC or lower – the bottom is now falling out. Yields are spiking, having more than doubled from 8% in June 2014 to 16.6% now, the highest since August 2009:

US-CCC-or-below-rated-yields-2011_2015-12-01

These companies, at these yields, have serious trouble raising new money to fund their cash-flow-negative operations and pay their existing creditors. Their chances of ending up in default are increasing as the yields move higher.

And more companies are getting downgraded into this club of debt sinners. In November, S&P Ratings Services upgraded only eight companies with total debt of $15.8 billion but downgraded 46 companies with total debt of $113.7 billion, for a terrible "downgrade ratio" of 5.8 to 1, compared to 1 to 1 in 2014.

This is what the end of the Great Credit Bubble looks like. It is unraveling at the bottom. The unraveling will spread from there, as it always does when the credit cycle ends. Investors who'd been desperately chasing yield, thinking the Fed had abolished all risks, dove into risky bonds with ludicrously low yields. Now they're getting bloodied even though the fed funds rate is still at zero!

Other high-risk credits, such as those backed by subprime mortgages, will follow. And the irony? Just in the nick of time, subprime is back – but this time, it's even bigger. Read… Subprime "Alt"-Mortgages from Nonbanks Run by former Countrywide Execs Backed by PE Firms Are Booming

BrianM, December 3, 2015 at 11:09 am
It is interesting that "distressed" in this article pretty much refers to pricing alone and says little about whether it actually represents a significant change in the ability of companies to repay/refinance their debts. The charts show a similar spike that happened in 2012 without any real consequence to default rates. Of course we are right to not trust the rating agencies as they are lagging indicators and there is a prima facie case for oil being a potential disaster area, but the article give no evidence as to why the markets are right this time. They've been wrong before.

The definition of distress is also somewhat arbitrary – 1000bps stinks of being a round number rather than any meaningful economic measure. 900bps sounds pretty distressed to me. Or, as a bull might put it, a bargain!

tegnost, December 3, 2015 at 1:07 pm
Question: What mechanism brought distress down after the euro crisis in late 2011, and is it possible that mechanism, whatever it was, will work again?
susan the other. December 3, 2015 at 1:43 pm

It's kinda like the post above on German domestic banks looking for profit from any rotten source. We are on the cusp of a new economy; keeping alive the old consumer/manufacturing economy is a dead end. ...

[Nov 22, 2015] Pimco Total Return Fund Redemptions Reach 30 Consecutive Months

finance.yahoo.com

Redemptions at the Pimco Total Return Fund reached 30 straight months in October as the former world's largest mutual fund fell to $93.7 billion in assets.

The Pimco Income Fund continues to head in the other direction, surpassing $50 billion in assets for the first time as group Chief Investment Officer Daniel Ivascyn's pool has attracted $11.5 billion in net new cash this year, according to Newport Beach, California-based Pacific Investment Management Co.

"The Income Fund benefited from defensive positioning in the energy sectors and the recovery in the higher quality segments of the emerging markets," Ivascyn said.

Total Return is less than a third of its peak size as investors pulled $1.6 billion from the fund in October, the smallest monthly outflow since July 2014, two months before Pimco's ouster of co-founder Bill Gross prompted a rush to the exits. The fund peaked at about $293 billion in April 2013, shortly before Federal Reserve policy makers sparked the so-called taper tantrum by threatening to reduce their investments in Treasuries and mortgage-backed securities, prompting investors to flee bonds.

The Total Return Fund returned 1 percent this year through Nov. 2, outperforming 74 percent of its peers, according to data compiled by Bloomberg.

'Extreme Worry'

"We took advantage of market pricing that reflected extreme worry about spillovers from China and global deflation in September," said Scott Mather, a manager on Total Return and Pimco's CIO for core strategies. "As markets calmed and reassessed the probabilities with new data in October, our positions in corporate credit, mortgages and Treasuries benefited."

The $51 billion Pimco Income Fund has returned 3.6 percent in 2015, beating 98 percent of peers. It ranks in the 99th percentile for the three- and five-year periods.

While Pimco Total Return has lost assets, investors have added money to competitors such as TCW's Metropolitan West Total Return Bond Fund and the DoubleLine Total Return Bond Fund. DoubleLine's fund has returned 2.6 percent this year, outperforming 93 percent of peers, while the MetWest fund is up 0.6 percent, besting 45 percent of peers.

[Jul 29, 2015] Bill Gross Explains (In 90 Seconds) How Its All A Big Shell Game

07/29/2015 | zerohedge.com

"There is no doubt that the price of assets right now is a question mark... and ultimately when Central Banks stop manipulating markets where that price goes is up for grabs... and probably points down"

As Gross tweeted...

Gross: All global financial markets are a shell game now. Artificial prices, artificial manipulation. Where's the real pea (price)?

- Janus Capital (@JanusCapital) July 29, 2015

This clip carries a public wealth warning...

Jim Shoesesta

He is short, he is a loser, shell game or not.

ebworthen

Very rich loser.

And the markets are a .gov sanctioned and supported three card monti scamming folks all day, every day.

[Jul 29, 2015] Bill Gross Explains (In 90 Seconds) How It's All A Big Shell Game

07/29/2015 | zerohedge.com

"There is no doubt that the price of assets right now is a question mark... and ultimately when Central Banks stop manipulating markets where that price goes is up for grabs... and probably points down"

As Gross tweeted...

Gross: All global financial markets are a shell game now. Artificial prices, artificial manipulation. Where's the real pea (price)?

- Janus Capital (@JanusCapital) July 29, 2015

This clip carries a public wealth warning...

Jim Shoesesta

He is short, he is a loser, shell game or not.

ebworthen

Very rich loser.

And the markets are a .gov sanctioned and supported three card monti scamming folks all day, every day.

[Jul 27, 2015]Watching Yields Rise Are Treasuries a Buy

"...It's very conceivable for short-term rates to rise but long-term yields to decline if the market becomes convinced that Fed hikes will slow the economy. There's even a recent hint of that possibility looking at the action in treasuries since mid-July (the yield on 5-year treasuries has risen faster than yield on 10- and 30-year treasuries."
.
"...Finally, even if economic data is weak, there is a chance yields rise if inflation picks up. Thus, one needs to keep inflation in mind, especially over longer time-frames."
Jul 22, 2015 | Safehaven.com

Setting aside the often-heard "certificates of confiscation" phrase, treasuries are a reasonable buy if one believes yields are going to stay steady or decline. They are to be avoided if the expectation is for yields to rise.

Part of the question is whether or not the Fed hikes, and by how much. But it's more complicated than the typical "yes-no when" analysis that we see in the media.

It's very conceivable for short-term rates to rise but long-term yields to decline if the market becomes convinced that Fed hikes will slow the economy. There's even a recent hint of that possibility looking at the action in treasuries since mid-July (the yield on 5-year treasuries has risen faster than yield on 10- and 30-year treasuries.

I am still not convinced the Fed is going to hike this year. Much will depend on retail sales, housing, and jobs.

A good retail sales report will send yields soaring, likely across the board.

Finally, even if economic data is weak, there is a chance yields rise if inflation picks up. Thus, one needs to keep inflation in mind, especially over longer time-frames.

That said, the recent decline in crude, commodities in general, does not lend much credence to the notion the CPI is going to take big leaps forward any time soon.

All things considered, the long end of the curve seems like a reasonable buy here provided one believes as I do, that economic data is unlikely to send the Fed on a huge hiking spree, and that if and when the Fed does react, yields on the long-end of the curve may not rise as everyone seems to expect.

Anonymouse

Agreed ... any Fed rate hike will slow the economy, but they won't (can't) raise rates.

We have entered the black-hole of zero-interest, squarely caused by the incestuous relationship between the Fed and the Treasury whereby check-kiting and theft have become our central bankers' legal and institutional 'right.'

Through debt monetization, bond speculation has been made risk-free .. an anomaly in nature yet over 34 years in its bull cycle.

Risk-free bond speculation creates and maintains a falling interest rate structure which destroys the capital of virtually every market player. This is the greater danger .... which can only result in broad-based serial bankruptcies unless the parasitic system is abandoned for one that embraces sound money.

[Jul 20, 2015] The Complete Guide To ETF Phantom Liquidity

Jul 20, 2015 | Zero Hedge
Two months ago, in "ETF Issuers Quietly Prepare For Meltdown With Billions In Emergency Liquidity," we outlined the rather disconcerting circumstances that have led some large fund managers to quietly line up emergency liquidity facilities that can be tapped in the event of a sudden retail exodus from bond funds.

"The biggest providers of exchange-traded funds, which have been funneling billions of investor dollars into some little-traded corners of the bond market, are bolstering bank credit lines for cash to tap in the event of a market meltdown. Vanguard Group, Guggenheim Investments and First Trust are among U.S. fund companies that have lined up new bank guarantees or expanded ones they already had, recent company filings show," Reuters reported at the time, in a story we suspect did not get the attention it deserved.

At a base level, these precautionary measures are the result of the interplay between central bank policy and the unintended consequences of the post-crisis regulatory regime. ZIRP creates a hunt a for yield and simultaneously incentivizes companies (especially cash strapped companies) to tap the bond market while borrowing costs remain artificially suppressed. Clearly, this is a self-fulfilling prophecy. The longer rates on risk free assets remain near, at, or even below zero, the more demand there is for new corporate issuance (the rationale being that at least corporate credit offers some semblance of yield). More demand means rates on corporate credit are driven still lower, and once yields on high grade issues get close to the lower limit, yield-starved investors are then herded into HY.

All of this supply in the primary market comes at a time when liquidity in the secondary market for corporate credit is non-existent thanks to the shrinking dealer books that resulted from the government's (maybe) well-meaning attempt to crack down on prop trading. The result: a crowded theatre with a tiny exit.

This situation has been exacerbated by the proliferation of bond ETFs which have allowed retail investors to pile into corners of the fixed income world where they might not belong.

All of the above can be summarized as follows.

"MF assets too large versus dealer inventories" (via Citi)...

... clear evidence of "structural damage in corporate bond trading liquidity" (via JP Morgan)...

... and the rapid growth of bond funds in the post-crisis world (via BIS)...

So given the above, the question is this: if something were to spook the market - a rate hike cycle for instance, or an October revolver raid on HY energy names, or an exogenous geopolitical shock - causing an exodus from these funds, what would happen to prices if fund managers were suddenly forced to transact in size in an illiquid secondary market in order to meet redemptions?

"Nothing good", is the answer.

The solution is to avoid selling the underlying bonds - even when investors are selling their shares in the funds.

But how is this possible?

To a certain extent, outflows in one fund can be offset by inflows to another. These "diversifiable flows" are one happy byproduct of the great ETF proliferation. Here's a refresher on how this works courtesy of Barclays.

* * *

Portfolio Products Replace Dealer Inventory

While diversifiable flows limit the risks to portfolio managers in principle, the reality of the high yield market is more complicated. Managers have specific views on tenor, callability, sectors, covenants, and, most importantly, individual credits, such that actually finding buyers for specific bonds can be quite difficult. In the pre-crisis period, dealers ran large inventories that effectively facilitated the netting of flows across funds (Figure 1). A fund with an outflow would sell bonds into the dealer community, and funds with outflows would buy bonds out of the dealer inventory. When inventory is large, the fact that the specific bonds bought and sold did not match was largely irrelevant. Funds with outflows could sell the bonds of their choice, and the funds with inflows could pick investments from the large variety of inventory held by dealers.

The matching problem has become more acute as dealer inventories have declined. Even funds can net flows in principle, dealers are much less willing to warehouse bonds, and are much more likely to buy only when they believe they can quickly offload the risk. Under this scenario, the fact that flows can theoretically be netted is of little practical use to fund managers – actually netting individual bonds is extremely difficult, particularly in the short time frame required by funds offering daily liquidity to end investors.

This is where portfolio products come in. Investors can use portfolio products to fund outflows/invest inflows immediately and execute the necessary single-name bond trades over time as liquidity in the underlying bond market allows (Figure 2). In this scenario, funds with inflows and outflows simply exchange portfolio products, sidestepping the immediate need to trade single-name corporate bonds.

* * *

Ok great, so ETFs provide a kind of "phantom" liquidity if you will. There are two problems with this:

Here's how we put it last month in "How Fund Managers Use ETF Phantom Liquidity To Avert A Meltdown":

In other words, if I'm a fund manager, the idea that ETFs provide liquidity rests on the assumption that when I experience outflows, someone else will be experiencing inflows and thus I can sell ETFs and avoid offloading my bonds into an illiquid corporate credit market. Put another way: I am depending on new money coming into the market to fund redemptions from previous investors who are exiting the market, all so that I can avoid liquidating assets that are declining in value and that I believe will be difficult to sell. There's a term for that kind of business. It's called a ponzi scheme and just like all other ponzi schemes, when the new money dries up (so, for example, when HY bond ETF flows are all headed in the wrong direction), the only way to meet redemptions is to get what I can for the assets I have and when the market for those assets is thin (as the secondary market for corporate credit most certainly is), I may incur substantial losses.

Note also that the more often ETFs are used as a way of avoiding the underlying bond market, the more illiquid that market becomes, making the situation still more precarious in the event of a panic.

So what is a fund manager to do?

This is where we come full circle to the emergency liquidity lines mentioned at the outset. In order to avoid tapping the underlying illiquid bond market in a situation where flows are unidirectional, fund managers may instead pay out redemptions in borrowed cash.

This is, to quote Citi's Matt King, "creative destruction destroyed."

Only worse.

That is, this represents the willful delay of a long overdue episode of creative destruction layered atop another delay of the much needed Schumpeterian endgame. Stripping out the metaphysics and philosophy references, that can be translated as follows: this strategy is yet another example of delaying the inevitable. If fund managers are forced to tap these liquidity lines it likely means investors have found a reason to sell en masse and if that reason turns out to be something that permanently impairs the value of the underlying bonds (as opposed to a transitory, irrational panic) then all the funds are doing by borrowing to meet redemptions is employing leverage to stave off the recognition of losses, which is ironically the same thing (in principle anyway) that the companies whose bonds they're holding have done to stay in business. It's a delay-and-pray scheme designed to avoid selling the debt of companies whose similar delay-and-pray schemes have run their course.

In closing, it's important to note that no fund manager in the world will be able to line up enough emergency liquidity protection to avoid tapping the corporate credit market in the event of panic selling in the increasingly crowded market for bond funds.

In other words, when the exodus comes, the illiquidity that's been chasing markets for the better part of seven years will finally catch up, and at that point, all bets are officially off.

[Jun 05, 2015] BONDS: U.S. government bond prices rose, pushing yields down. The yield on the 10-year Treasury note dropped to 2.30 percent from 2.36 percent late Wednesday.

[Jun 04, 2015] There is 'sheer panic' in the bond market

According to Bloomberg, bonds wiped out all their gains for the year. The benchmark US 10-year treasury yield pushed higher to about 2.42% overnight, a level it hadn't touched since October. German bund yields rose to about 0.99%.

There is chaos in global markets. Bonds sold off sharply on Thursday morning for a second day in a row. They've reversed the decline, but stocks are still lower, after the chaos spilled over.

... ... ...

The International Monetary Fund slashed US growth forecasts, and urged the Federal Reserve to delay its first interest rate hike until 2016, in a statement that crossed as the stock market opened.

In a speech last month, Fed chair Janet Yellen said it would be appropriate to raise interest rates "at some point this year" if the economy continues to improve.

In a morning note before the open, Brean Capital's Peter Tchir wrote: "It is time to reduce US equity holdings for the near term and look for a 3% to 5% move lower. The Treasury weakness is NOT a 'risk on' trade it is a 'risk off' trade, where low yields are viewed as a risk asset and not a safe haven."

The sell off in global bonds started Wednesday, as European Central Bank president Mario Draghi gave a news conference in which he said markets should get used to episodes of higher volatility.

Draghi also emphasized that the ECB had no intention to soon end its €60 billion bond-buying program, called quantitative easing, before its planned end date of September 2016.

Bond yields, which move in the opposite direction to their prices, spiked across Europe on Wednesday, and on Thursday this move is continuing, with German bund yields and US Treasury yields hitting new 2015 highs and continuing to climb overnight.

According to Bloomberg, bonds wiped out all their gains for the year.

... ... ...

The benchmark US 10-year treasury yield pushed higher to about 2.42% overnight, a level it hadn't touched since October. German bund yields rose to about 0.99%.



Etc

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