"The Leaders Are Crashing" - It"s Not Just Junk Bonds That Have Given Up

We have been warning about significant divergences between equity prices and other asset classes for a few weeks (most notably the decoupling from equity risk and credit risk, junk bonds), but as BofA notes its not just these assets that are breaking away from soaring Nasdaq levels, in fact many of the rally"s leaders are crashing... in a way we have not seen recently.

High yield risk has suddenly decoupled from equity markets...

And Jeffrey Gundlach has been warning something"s got to give. Based on the past two days, looks like we have our answer.

Stocks fell around the world a second day and high-yield bonds headed for a fourth straight loss, resuming a historic correlation that the hedge fund manager on Wednesday had warned was alarmingly out of whack.

“JNK ETF down six days in a row, closing near its seven month low,” the DoubleLine Capital LP co-founder wrote on Twitter Wednesday. “SPX up five of last six days, closing at an all time high. Which is right?”

In fact the correlation between these two leaders has crashed...

In the past decade, there were only three other instances where the relationship between JNK and mega-cap tech broke down to this degree. Each time, the two assets began to resume their positive correlation within four to 12 days, data compiled by Bloomberg show.

But given the last few days in equities and credit... High Yield Bond prices (HYG) are at 8 month lows...

On record dollar volumes of trading...

Gundlach is calling a win...

“A material pullback would be something we need to watch for, as a deteriorating credit market has led each of the largest equity pullbacks since 2014,” said Frank Cappelleri, a senior equity trader and market technician at Instinet LLC.

 

“With divergences once again apparent now, the bulls face their latest test.”

It"s not just credit risk, but equity risk has decoupled from equity prices too...

VIX has started to creep higher but has further to go to fit with credit risk...

But it"s not just high yield bonds, price leadership has been stung in recent days: Oct 26th/27th ECB announced "tapering", Brent broke $60/b…concerns of "peak policy" stimulus & "peak profits"caused toppling of credit, bank, tech "leadership"; sell-off sequence past few weeks = 1st EMD, 2nd HYG, 3rd SX7E, 4th BKX, and #5 SOX...

As BofA"s Michael Hartnett notes, watch EMD & HYG in particular...needs to stabilize... but the recent pullback also follows insane gains...

FAANG+BAT market cap up $1.5tn YTD, a sum larger than entire market cap of DAX ($1.4tn); and Aug saw all-time low yields in US HY tech bonds (4.3% H0TY) & EU HY corp bond yields hit low in Oct (2.1% HE00, i.e. lower than yield on US Treasuries).

Finally, in case you think this is all much ado about nothing. The last time we saw such a divergence between credit and equities was in Aug 2015...

Just two weeks before the huge ETF  flash crash.

BMO Finds An A New Source Of Systemic Risk

In a time of suffocating, crushing market complacency (which has made the lives of financial analysts so boring, they have even quantified what complacency is), a pet hobby that has emerged within the financial community is to find new possible sources of underappreciated systemic risk. One such attempt comes from BMO"s Mark Steele today, who notes that aside from the pressure that the short to medium end of the curve is dishing out as Central Banks turn hawkish, "the market dishes out some of its own early signals of a more important nature."

Steele says he created a basket of Chinese Bank CDS to look for systemic risk there, and yesterday it notably broke above a narrowing trend – Exhibit 1.

Breaking the basket down, BMO highlights China Construction Bank as the key member that shows the greatest, albeit liquidity induced, "breaking bad" spike – Exhibit 2

Here, Steele will stop readers before they go asking about BofA, or SocGen, credit risk, to say that the bank"s systemic risk basket sleeps like a baby. His spin would be to tell you that it seems an opportune time to buy protection – Exhibit 3.

So is a Chinese bank the potential source of the next systemic risk? His answer: "The systemic risk problem this time round won’t come directly from a Chinese bank. The potential Lehman will come indirectly. We update that basket from I Never Kissed a Bear with the overnight breakdown below – Exhibit 4"

For those asking, the basket in question is charted below: it represents what Steele believes are China"s Systematic Risk Entities - aka China"s chronic acquirors profiled here at the end of June - that got a call from the Chinese Bank regulator at the end of June. He then adds "If we had to break down the basket to have the market call out the potential Lehman, we’d say it was (Wicked?) Wanda."

World's 2nd Largest Stockpile Of Gold Leaves The United States

Submitted by Simon Black via SovereignMan blog,

About 20 years ago when I was still a cadet at West Point, my economics professor organized a class trip to the Federal Reserve Bank of New York.

The part of the trip that I remember most was touring the Fed’s high security vault, 80 feet below street level beneath the bank’s main office building downtown.

This vault houses the largest known depository of gold in the world.

None of that gold, of course, belongs to the Fed. The Federal Reserve doesn’t own a single ounce of gold.

Almost all of that gold is owned by foreign governments and central banks.

It’s been that way since the end of World War II—European governments wanted to store their wealth overseas, out of the reach of the Soviet Union.

As a kind of professional courtesy among governments and central banks, their gold has been stored for free by the Fed for the last 70+ years.

Even after the Soviet Union fell, most governments still chose to keep their gold in New York.

It was safe. America was a rich, trusted ally. Why bother moving it?

Fast forward a few decades and the world has clearly changed.

The US government is in debt up to its eyeballs. It has been caught blatantly spying on its own allies. And it’s much less predictable than ever before.

Germany was among the first out the door.

Even as early as 2013, the German government announced that they would bring back at least half of their country’s gold reserves (the second largest in the world) by the end of 2020.

They’re ahead of schedule.

Late last week the German government moved $13 billion worth of gold from New York to Frankfurt.

That shipment puts them nearly at their goal, almost four years earlier than planned.

It’s easy to understand why.

The entire global financial system requires having a great deal of trust.

If you have an online brokerage account, you may be surprised to know that you don’t actually own a single stock in your portfolio.

When you log in to your account and buy, say, Apple shares, the brokerage will typically register those shares in its own name, not your name.

Apple has no idea who you are. The shares are effectively owned by your broker. It’s their asset, not yours.

Now that’s putting a LOT of trust in a complete stranger.

It’s the same when you deposit your money in a bank. It’s no longer your money. It’s the bank’s.

The bank, in turn, uses your savings to make loans and buy bonds, thus entrusting your savings to yet another group of people.

This is how the system works; your money keeps getting passed around, which means there’s an entire daisy chain of other people, or “counterparties”, standing between you and your savings.

“Counterparty risk” is the risk that something goes wrong with one of the many, many counterparties in this daisy chain.

Imagine that you deposit money with X.

X invests the money with Y. Then Y deposits the money with Z.

If something goes wrong with Z, you’re all screwed.

This is the nature of counterparty risk. Someone far down the chain can cause consequences for everyone else.

Now, ordinarily, this isn’t a problem. When the system is functioning normally, institutional counterparty risk is low.

But counterparty risk becomes a BIG deal, and QUICKLY, when the system stops functioning normally.

We saw the effects of this during the 2008 financial crisis. As one bank went down, it dragged multiple others with it.

No one ever thinks about counterparty risk until it becomes a problem… and by then it’s too late.

The simple way to reduce this risk is to reduce the number of counterparties.

Germany used to place a lot of trust in the US government and central bank to store its gold.

But there are obvious signs that Uncle Sam is no longer the reliable, credible, trusted counterparty he once was.

Germany hasn’t quit cold turkey; they’re still going to store a minority portion of their gold in the US.

But they have taken a major step to reduce exposure to a counterparty that’s obviously bankrupt, which hence reduces the risk.

You can do the same thing; it’s why we regularly discuss holding physical cash.

Keeping some physical cash ensures that there’s no more middle men (i.e. counterparties) standing between you, and at least a portion of your savings.

When you eliminate the counterparty, you eliminate the risk.

Having some cash means that if some major crisis should ever befall the banking system, then you’ll at least have some emergency savings that’s not at risk.

But even if nothing happens… even if there’s never a single problem ever again in the banking system… you won’t be worse off holding a bit of cash.

Do you have a Plan B?