10Y Treasury-Bund Spread at Highest Levels of Last Decade

As central bank policies in the U.S. and Europe appear to be headed in very different directions, bond markets have taken note.  Not since June 2006 has the spread between 10-year government bonds in the U.S. and Germany been so extreme.  While yields have fallen in both benchmarks, the difference by which the U.S. treasury exceeds Germany's bund is now comfortably in excess of 100 basis points:

US Losing Currency War

One of things that has gotten some attention lately is the spread compression in the long end of the yield curve.  This looks to us like a classic deflationary configuration.  Consider that: 1) nominal rates have been falling for both the 10 and 30 year bonds and 2) while nominal spreads have dropped by 37bps since last April, the inflation spread (or simply the spread between 10 and 30 year inflation expectations) has dropped by 51bps.  This suggest to us that over 100% of the compression in long bond spreads is due to falling inflation expectations.  This evidence points more toward the secular stagnation hypothesis of the US rather than the growth resurgence.



What is the source of these deflationary pressures?  There are at least three we can identify: 1) despite the massive amounts of QE, the US never really experienced much of a currency devaluation and surge in inflation expectations, 2) the Fed is moving to taper without having propped inflation expectations enough and 3) the US has been getting crushed in the currency was for the last year.

A good example of the third point is Japan, who was been doing massive QE in the last year.  In the chart below, we plot the USD/Yen against the nominal spread between 30/10 year US Treasury bonds.  The drop in the 30/10 spread has largely been a function of the latest battle in the currency was.  If rising inflation expectations, rising rates and falling currency are by-products of a successful battle in the global currency war, then the US has clearly been on the losing end for over a year now.

Put/Call Ratio In Perspective

In spite of the S&P's 'triple whammy' yesterday (see our comment here), one traditional marker of a meaningful decline or correction failed to do much at all.  Indeed, the put/call ratio didn't even jump to one standard deviation above its mean over the last decade:



The average investor does not seem too eager to buy protection against a downward move-- yet.

Identifying Bears...Who Is Already In A Bear Market This Year?

A lot of the time by focusing solely on the headline indices investors can miss seeing the level of the dispersion happening among individual stocks. With the more recent pick up in volatility, the difference between the performance winners and the performance losers year-to-day is quite staggering. YTD in North America, Forest Laboratories is up an impressive 45.6% as of the close yesterday. Meanwhile, Best Buy is the worse performer YTD in the MSCI North America Index  at -34.3%. Overall, there are 13 stocks that are already in "bear market territory" (down 20% or more) with another 78 stocks down over 10%.



In Europe, the worst performer YTD is Asos which is down 25.24% while the best performer is Fiat Ord up 49.6%. There are only 5 stocks in a bear market YTD with another 32 stocks down over 10%.



Finally in Asia, the worst performer is Hokkaido Electric Power (-43.65%) while the best performer has been Newcrest Mining (47.5%). The rout in Asia-Pacific so far this year has been deeper than in North America or Europe. There are 28 stocks down over 20% YTD and another 93 down over 10%.

A Triple Whammy Day For SPX: 1840 Support Broken, Negative Outside Reversal, Down by More than 2%

Today is a day that will test the persistence of this market rally. A few events came together that to us suggest a level of distribution. They are:

1. The 1840 level on the S&P 500 that had provided pretty reliable support failed decisively.
2. The S&P 500 registered another negative outside reversal day (a day in which both the intraday high is higher than the previous day's intraday high and the close is lower than the previous day's intraday low), which brings the total number of negative outside reversal days to six over the last three months.
3. The Index finished down by more than 2%.

These are pretty rare events and their confluence is somewhat noteworthy. We haven't seen the three month running total of negative outside reversal days reach a level of six since 2006 and we haven't seen the six month running total of 2% down days reach a level of three since the beginning of 2012. The Index is currently sitting on the 100-day moving average which has provided extremely good support over the last year, so these next few sessions will be interesting to watch.  

Chinese Corporate Sector is in a Close Race for Most Levered Asian EM Balance Sheet

Yesterday we posted that Chinese Corporate Balance Sheets Are the Most Levered They Have Ever Been as we showed that the leverage kept piling up in 2013 even as profit margins fell the lowest level as far back as our records go. Showing how Chinese balance sheets have been evolving over time is nice for understanding the leverage buildup over the last decade, but how does the Chinese corporate balance sheet stack up against its Asian rivals? To answer this question we aggregated financial statement data for all non-financial, non-utility constituent stocks in the major Asian EM indices. What we find is that China and India are battling it out for the most levered corporate balance sheet. China boasts more working capital (read Chinese companies appear to be financing more sales by expanding working capital) while India has slightly higher financial leverage, net debt and liabilities relative to equity. It is clear though that Chinese and Indian corporates stand out from the pack when it comes to balance sheet leverage.

Advance/Decline Not Confirming MSCI Europe Gains

As we touched on last week (here), breadth of participation in continued market gains--as measured by the advance/decline ratio-- is at very low levels in MSCI Europe:



Some sectors are exhibiting more extreme divergences than others.  Moves in Consumer Discretionary, Financials, and Industrials (all above old highs in price) look particularly disconnected from the 200-day measure of advancing stocks versus declining stocks:

Number Of New 52-Week Lows Increased To A 17-Month High

As we are sitting here watching another potential 1% down day in the S&P 500 (we commented about  this earlier in the week here and here), we thought we would take a quick look at cumulative net new highs and lows. For the MSCI World, the 1-quarter sum of new 52-week lows has increased to the highest level since October 2012 (left axis is inverted on the first chart). Meanwhile, the 1-quarter sum of new 52-week highs has steadily been falling since the beginning of the year. This has brought the net new 52-week highs (highs minus lows) into range of breaking the low set in September 2013. As 2011 shows, this can go from a very positive number to a very negative number in just a few months so it is something to keep an eye on.

US Econ Roundup - Initial Claims Improve To Best Level Since 2007 & Trade Prices Remain Subdued

Weekly Initial Jobless Claims fell to 300K which is the lowest level in 360 weeks (May 2007). The four-week moving average is very close to making a new 7-year low as well.





Import prices rose by 0.6% month-over-month in March while export prices rose a strong  0.8%. On year-over-year basis, however, prices remained subdued as import prices are slightly negative (-0.6%) and export prices are only slightly positive (0.2%). Import prices ex-petroleum are slightly positive year-over-year but look like they may slip to slightly negative according to exchange rates. Finally, the movement in the yen is indicating that we may see a rise in import prices of autos in the near future. This wouldn't be too surprised given that the year-over-year change in auto import prices are basically at all-time lows.

Median Stock Valuations Expand Again to at Least a 15 Year High

Many market commentators have recently been claiming that stock valuations are "fair" or "average" and are basing these statements primarily on forward P/E ratios derived from market cap weighted indices like the S&P 500. At least two problems with this methodology come to mind. First, forward earnings, as we all know, are based on analyst estimates that are often (or usually, as the case has been) revised lower. Second, using market capitalization to weight the earnings biases the derived P/E towards the P/E's of the largest companies in the sample. One way to address both of these problems simultaneously is simply to measure valuation based on realized financial history of the median stock in the index. When one does this we see that valuations are mostly far from average and in the case of the Price to Sales ratio, the median stock has never been valued more richly. Below we show the valuations for the median stock in the MSCI World Index.

Chinese Corporate Balance Sheets Are the Most Levered They Have Ever Been

One of the most interesting annual activities we undertake is a top down examination of Chinese corporate balance sheets. Why is it interesting? Because every year we are surprised by their almost systematic deterioration, and 2013 was no exception. In the below table we aggregate financial statements for all non-financial, non-utility constituents of the CSI 300 index and then calculate relevant financial ratios through time to understand how they are evolving. Here are the highlights:

• Total liabilities as a % of equity remained at a record high
• Net debt as a % of equity increased by 5% to a record
• Financial leverage increased again to a record
• Non-financial working capital as a % of total capital (a measure of working capital accumulation (lower is better)) fell, but it still near the record high
• Inventories as a % of total capital fell, but remain near the record high
• Accounts receivable, accounts payable and inventories all remain near record highs (i.e. corporates are still "stuffing the channel" to finance sales)

Meanwhile, the net profit margin fell to a record low and the cash flow margin rose but is just slightly above the decade low. These measures are 1/2 to 1/3 of their level of 10 years ago. Once again we have more leverage and less margin for error.  

Show Me the R&D

As long-time readers know, we are big believers in the intangible benefits of companies' investments in items like research and development.  Among constituents of MSCI Europe, where do we find the most R&D?

Geographically, Denmark leads the pack:


On a sector basis, Information Technology and Health Care invest the most as a percent of sales:


The top ten R&D investing companies in MSCI Europe:

Even with the Rally Yesterday, the Average Stock is Still 11% From Its 1 Year High

As the the technical divergences continue to pile up according to our work, one of the stats we've been keeping an eye on is how far the average stock is from its one year high. As of yesterday's close the average stock in the MSCI World Index was 11% from its one year high even though the index is itself only 1.4% from its cycle high. This is another example of the internals of the market showing a weaker trend than the headline indices would have us believe. In the tables below we show for each MSCI regional index the average stock's current price relative to it recent high broken down by sector.

MSCI World Index:


MSCI North America:


MSCI Europe:


MSCI Pacific:

Weekly Mortgage Refinancing Apps Accounting For Lowest Share Of Total Loans Since 2009

Refi loans are accounting for about half of all mortgage applications which is the lowest amount since July 2009. On the surface this seems like a positive trend back to pre-2008 levels. However, the ABSOLUTE level of mortgage apps is currently only about half of what it was pre-2008. The overall weekly MBA mortgage application index is still just slightly above 14-year lows and the refinancing index is just barely above 5-year lows.

Copper's Decline Has Checked Up, but It's Now Back into Resistance

The dramatic decline in copper prices that took place at the beginning of March has taken a breather over the last two weeks as the metal has retraced about 37% of the decline that began on March 6th. A relief rally of sorts is common after such a large and sudden move lower, but copper now finds itself running into a key resistance level at around $3.06. It's price behavior at this critical juncture should be watched carefully since copper is seen as a leading indicator of economic growth.



Copper doesn't look soo hot in our point & figure work as the trend is still clearly down.

Japanese Groups That Work With A Stronger Yen

It seems clear that Japan is signaling its intention to stand pat with monetary policy, content to watch how the second quarter plays out.  This introduces a risk (or opportunity) that the Yen may regress from the weakening experienced over the last year.  Our models--which have done a decent job capturing the effects of US and Japan monetary policy--indicate that the opportunity exists for a stronger Yen.  We compare the relative size of each central bank balance sheet, making projections about expected central bank purchases.  In the chart below, in our low estimate, we assume Japan follows through with its 70 trillion Yen promise, that the Federal Reserve maintains its taper trajectory and that this relationship is calibrated at 100 Yen.  In our high estimate, we assume the Bank of Japan doubles its asset purchases (which after today seems not immediately forthcoming).  This approach suggests the Yen could strengthen back to 90 and still be within the boundaries of our model.



We say above that the a strengthening Yen is a potential opportunity because: 1) there are sectors and industries that outperform in a rising Yen environment and 2) these areas have underperformed since the onset of QE.  The MSCI Asia-Pacific consumer staples sector has the highest correlation to the Yen of all sectors in the MSCI Asia-Pacific index.



Within that sector, beverages, food retail and food producers have the highest correlations to the Yen.