When "Whatever It Takes" Ends

Via Global Macro Monitor,

On Tuesday,  June 27th,  Super Mario said this,

“Deflationary forces have been replaced by reflationary ones.”  – Mario Draghi

And here is how global 10-year bond yields reacted,

The German 10-year Bund yield increased 77 percent — OK, from a low base —  and bonds across the world from Canada to Australia to the United States were tattooed.

Change In Fundamentals?

Absolutely not!

Bond yields haven’t been trading on economic fundamentals for several years due to central bank financial represssion via quantitative easing (QE), ZIRP and NIRP.   We have been pounding the table on this point,

Lot’s of hand wringing these days about the flattening yield curve.  We still maintain our position that the signal from the bond market is significantly distorted due to the global central bank intervention (QE) into the bond markets.   See here and here. 

Most of what is happening with the U.S. yield curve is technical. – Global Macro Monitor,  June 22, 2017

Beach Ball Effect

The major central banks have repressed interest rates throughout the world by engineering a structural shortage of high grade sovereign bonds with their quantitative easing (QE) programs.   For example,  as we posted last week, the combined market cap of just two stocks in the U.S. — Apple and Amazon — exceeds the entire stock of U.S. Treasury notes and bonds maturing in 2027-2047 when holdings of the Federal Reserve are excluded.

This is tantamount to holding a beach ball underwater.  You know what happens when when the ball is released.  Such as when a prominent central banker unexpectedly speaks out that the days of holding that ball underwater may be coming to an end.  We just had a little taste of that this week.

Conclusion

The European Central Bank tried to walk back or dilute Draghi’s comments, but bond markets are not having it.   The train has left the station and the path toward monetary normalization is, at least in rheotric, been entered into the GPS.    The next few months shall be interesting.

Though we think the “correct” or equiblrium price for interest rates on bonds is serveral hundred basis points higher — 2-3 percent real yield plus inflation —  we don’t think they get there “by way the crow flies” or in a straight line.

Several months ago,  we cited a 2012 Federal Reserve paper estimating that yields on the 5-year note should be several hundred basis points higher if not for the recycling of reserves into U.S. Treasuries by the PBOC.   The paper didn’t even take into account the impact of QE on bond and note yields,

A paper published by the Federal Reserve Board (FRB) in 2012 estimated the impact on interest rates of the capital flow recycling into the U.S. bond market,

We find that a $100 billion increase in foreign official inflows into U.S. Treasury notes and bonds lowers the 5-year yield by roughly 40 to 60 basis points in the short run. However, our VAR analysis shows that in the long-run, when we allow foreign private investors to react to the effects induced by a shock to foreign official holdings, the estimated effect is roughly -20 basis points per $100 billion. Putting these results into context, between 1995 and 2010 China acquired roughly $1.1 trillion in U.S. Treasury notes and bonds. A literal interpretation of our long-run estimates suggests that if China had not accumulated any foreign exchange reserves during this period, and therefore not acquired these $1.1 trillion in Treasuries, all else equal, the 5-year Treasury yield would have been roughly 2 percentage points higher by 2010. This effect is large enough to have implications for the effectiveness of monetary policy. – FRB

Extrapolating the above analysis to the current stock of foreign official Treasury holdings of around $4 trillion leads to nonsensical results, such as the 5-year yield should be 800 basis points higher than it is today.   Obviously, the analysis should truncate the dependent variable – 5-year note yield — and ceteris paribus (other things being equal) does not hold in the real world.  –   GMM, March 18, 2017

Deflation is an urban myth, at least it has been in the U.S., as central banks have revealed their hand to do “whatever it takes” to fight it.  Let us not conflate relative price moves with generalized deflation.

The end game will thus be an episode of ugly monetary/debt induced inflation,  in our opinion.   Not yet, however.   Timing,  my friends.

Maybe it’s time to start looking at debt fundamentals again.

And The Best-Performing Asset Since The Fed Started Hiking Rates Is...

...Gold!

After all the concerns about interest-rate hikes curbing gold’s appeal, the metal has managed to retain its luster.

Since Dec. 15, 2015, a day before the Federal Reserve began its current cycle of U.S. rate increases, bullion has climbed 18%. The barbarous relic has outperformed the broadest measure of US stocks (NYSE composite) as the long-bond is unchanged since Dec 2015 and commodities plunging back after inflation hope fades.

As Bloomberg notes, non-interest-bearing gold is getting an added boost from speculation that the Fed will be slow to raise rates further, with 10-year Treasury yields near the lowest since November (below where they were at the start of the rate-hike campaign in 2015) and the yield curve has collapsed each time The Fed hiked rates...

Perhaps the yield curve is reflecting the post-China-Credit-Impulse collapse in US macro data (no matter how hard and fast economists cut estimates, it"s still disappointing)...

But then again, there is a bigger divergence... between inflation and earnings expectations that could spell trouble for investors, according to a note by analysts at Strategas Research Partners.

As Bloomberg notes, while the U.S. Treasury curve has flattened, with 10-year yields falling, equity analysts are staying bullish on earnings growth.

“The factions are known to disagree from time to time, but are rarely both right supporting divergent views,” analysts led by Nicholas Bohnsack, wrote in a note to clients Thursday. “Stay tuned.”

Japan's Bond Market Grinds To A Halt: "We'll Go Days When No Bonds Trade Hands

The Bank of Japan may or may not be tapering, but that may soon be moot because by the time Kuroda decides whether he will buy less bonds, the bond market may no longer work.

As the Nikkei reports, while the Japanese central bank ponders its next step, the Japanese rates market has been getting "Ice-9ed" and increasingly paralyzed, as yields on newly issued 10-year Japanese government bonds remained flat for seven straight sessions through Friday while the BOJ continued its efforts to keep long-term interest rates around zero. 

The 10-year JGB yield again closed at 0.055%, where it has been stuck since June 15m and according to data from Nikkei affiliate QUICK, this marks the longest period of stagnation since 1994,

Because what comes after record low volatility? Simple: market paralysis. And that"s what Japan appears to be experiencing right now as private bondholders no longer dare to even breathe without instructions from the central bank.  Meanwhile, the implied volatility of JGBs tumbled to the lowest level since January 2008 for the same reason we recently speculated may be the primary driver behind the global collapse in volatility: nobody is trading. This means that trading in newly issued 10-year debt has become so infrequent that broker Japan Bond Trading has seen days when no bonds trade hands.

It"s not just cash bonds that find themselves in trading limbo: trading in short-term interest rate futures has also thinned and on Tuesday of last week the Nikkei reports that there were no transactions in three-month Tibor futures - the first time that has happened since such trading began in 1989.

The three-month Tibor, or Tokyo interbank offered rate, has not moved in the nine months since the end of September 2016. There were just a few trades last Friday, and it was only a matter of time until the number hit zero. The absence of volatility makes it hard to profit from bets on the direction of interest rates. Alternatively, the death of trading means volatility has crashed to all time lows.

Trading in even shorter-term contracts is also ebbing. The Tokyo Financial Exchange announced on Thursday that starting at the end of July it will suspend trading of futures based on Japan"s uncollateralized overnight call rate, the interest that financial institutions charge each other for loans with a one-day maturity. The exchange will consider restarting trading if it can confirm demand.

As more market participants throw in the towel on a rigged, centrally planned market, the result will - no could - be a further loss of market function, and a guaranteed crash once the BOJ and other central banks pull out (which is why they can"t). As the Nikkei politely concludes, "if the bond and money markets lose their ability to price credit based on future interest rate expectations and supply and demand, the risk of sudden rate volatility from external shocks like a global financial crisis will rise."

Translation: in a world where only central banks trade, everyone else is destined to forget forget what trading, and certainly selling, means.

Meanwhile, the "grinding halt" in the market is not just a Japanese phenomenon. As we showed a month ago, quarterly portfolio turnover among hedge funds just dropped to the lowest ever.

And yet, in a world which no longer wants, or even remembers how to trade, central banks jawbone with threats that they are soon pulling the training wheels off the market. Somehow we very much doubt it.

The Incredible Shrinking Relative Float Of Treasury Bonds

Via Global Macro Monitor blog,

Lots of hand wringing these days about the flattening yield curve.  We still maintain our position that the signal from the bond market is significantly distorted due to the global central bank intervention (QE) into the bond markets.   See here and here.

Most of what is happening with the U.S. yield curve is technical.  Sure, traders can get a wild hair up their arse,  believing the economy is slowing and try and game duration by punting in the cash or futures markets.  Given the small relative float of the U.S. Treasury bond market, however,  it doesn’t take much buying to move yields.  In the words of economists,  the supply curve of outstanding Treasuries is very inelastic.

This is illustrated in the following chart. The combined market cap of just Apple and Amazon at today’s close is larger than the entire the float of outstanding Treasury notes and bonds that mature from 2027-2027.  We define float (US$1.16 trillion)  as total Treasury securities (2027-2047) outstanding (US$1.73 trillion) less Fed holdings (US$575 billion).

Now consider you started the year with, say, a hypothetical $3 billion portfolio of Amazon, Apple, and Treasury notes and bonds, each with a 33.3 percent weighting.

Given the rise of Apple and Amazon stock prices just this year, the current under weight in your Treasury position relative to the start of year would force an additional purchase of US$226 million of bonds to get back to the 33.33 percent weighting.  

The allocation effect of a stock bull market or bubble on the bond markets can be a powerful source of demand.

This is a classic case of a positive feedback loop between two markets.  The allocation effect and the increased demand for bonds lowers the interest rate making stocks fundamentally more attractive as the rate to discount corporate cash flows declines.  This drives up stock prices ergo another allocation effect on bonds.

Here’s to hoping that in the next decade we, and the policy makers, don’t look back at this period with regret realizing we got the signal from the yield curve entirely wrong.  

In hindsight, it is always so obvious.

China 'Rescues' Bond Market In Symbolic Move But Yield Curve Remains Inverted

For the 10th day in a row, China"s bond yield curve remains inverted (the longest in history).

With yields at 3-year highs, corporate bond issuance is evaporating, and has now emerged as the latest major, and most imminent, threat facing China"s financial sector and $10 trillion corporate debt market.

However, it appears Chinese authorities have reached their max pain point.

In a very symbolic move overnight, China"s Ministry of Finance bought 1.26 billion yuan of 1-year bonds for the first time in history via the secondary market. As Bloomberg reports,

The operation is part of a broader initiative to generate a reliable yield curve for risk-free government debt that can serve as a benchmark for borrowing costs across the economy.

While China has more than 22.9 trillion yuan ($3.4 trillion) of government securities outstanding -- one of the world’s largest -- it has less liquidity than many developed nations.

Under a system unveiled last November, China’s Ministry of Finance confers with market participants and, after any agreement that government bonds have insufficient or excess demand, issues additional securities or purchases existing ones from the secondary market.

While yields tumbled on the rescue attempt, the curve remains inverted...

As Christophe Barraud, Chief Economist & Strategist at Market Securities, explains, while the amount is not huge, it"s much more about the signal.

They really want to show that they are ready to buy bonds to contain short term yields, in line with recent injections of liquidity via OMOs.

Once again, in a year of political transition, they will do what is necessary to avoid any tensions.

So, despite the need to curb credit growth and the housing bubble, they should remain active on the money market.

In the meantime, public spending more precisely infrastructure spending will be a key tool to avoid a hard landing.

Finally, the reason why all of the above matters for not only the Chinese, but global, economy is because as we showed last week, China"s credit impulse is already crashing and has suffered its biggest drop since the financial crisis. As UBS calculated, "from peak to trough the deceleration in global credit growth is now approaching that during the global financial crisis (-6% of global GDP), even if the dispersion of the decline is much narrower."

If one adds tens, if not hundreds of billions in Chinese corporate bond defaults to the China, and thus global credit drain next, the global credit impulse, and global deflationary tsunami, may surpass that observed during the financial crisis. And ironically, this "credit crunch" will come at a time when the Fed, unlike back in 2009 when Bernanke had just launched QE1, is hiking rates and preparing to do what it has never done before: reduce its balance sheet without crashing the market. 

Reflexivity And Why The Fed Must Sell The Long End

Via Global Macro Monitor,

The yield curve is flattening like a pancake.  

Tightening cycles tend to do that.

Furthermore, the effective float of 10-year and longer U.S. notes and bonds is relatively small and greatly distorts the bond market signal.   We have written about this several times.

…how small the actual float of longer-term marketable U.S. Treasury securities is available to traders and investors. The data show the Fed owns about 35 percent of Treasury securities with maturities 10-years or longer. Note the data only include notes and bonds and excludes T-Bills.

The Fed’s holdings combined with foreign ownership of longer maturities — more than 1-year — exceeds 80 percent of marketable Treasuries outstanding. The Fed combined with just foreign official holdings, mainly, foreign central banks, is 65 percent of maturities longer than 1-year. Thus, almost 2/3rds of tradeable Treasuries longer than 1-year are held by entities with no sensitivity to market forces.  –  GMM, March 2017

Given the small float of tradeable Treasury notes and bonds,  the market is subject to massive short squeezes if it gets too offside and rapid ramps if traders algos try and game duration.

Information Positive Feedback Loop

Many in the market,  we fear, are being hoodwinked by the flattening yield curve, however.  It’s purely the result of technicals and not economic fundamentals.

Nevertheless,  some still look to the badly distorted bond market as a signal of the health of the economy and act accordingly.   Such as delaying capital spending;  becoming more risk averse;  and cutting back on consumption, for example.

A flatter yeld curve also makes bank lending less profitable.

This could thus lead to what George Soros calls “reflexivity” where the negative, but false, signal from the bond market actually causes an economic slowdown or leads to a recession.   So much for efficient markets.

Recall the famous line of one prominent market strategist during the dark days of the great recession,

“ We’re in a depression. That is what the bond market is telling us.”

Or the ubiquitous,  “what is the bond market telling us?”    Come on, man!

The Fed Needs To Start Selling Longer Dated Securities

It would, therefore,  behoove the Fed to sell some of its longer dated Treasury holdings to steepen the yield curve.

The follwing table shows the Federal Reserve’s holdings of U.S. Treasury securites and the total Treasury outstandings for each year.  This table does not include T-Bills.

If the Fed were to just let its balance sheet “run off” — that is not rollover maturing notes and bonds — it would cause additional pressure on short-term interest rates even as policy rates are rising.  It could also  potentially invert or further disort the front-end of the yield curve and destablize the money markets.

Looking at the data in 2018 and 2019  large maturities are coming due.   Rolling a portion of these maturities and selling longer-dated securities would probably cause less disruption in the market and be a more optimal strategy of reducing the Fed balance sheet.

Announcement Effect

Just announcing the fact the Fed was contemplating such a strategy of unloading longer dated Treasuries first would cause the yield curve to steepen.   The market would  begin to front run the Fed.  Bill Gross & Co. would kick into action and “sell what the Fed wants to sell.”

And because there are so relatively few Treasuries outstanding with maturities longer than 10-years,  it is unlikely it would cause a bond market debacle, which many believe is coming.  The total stock of Treasury securities with maturities longer than 10-years is smaller than the combined market capitalization of just Apple, Google, and Amazon, for example.

If bonds become too oversold, the Fed could easily engineer a short squeeze to bring the yield curve back to where it desires.

Recall, the Fed losing control of the yield curve prior to the financial crisis to foreign central banks recyling capital flows back into the U.S. is what Alan Greenspan singles out as the major cause of the housing bubble.   The Fed moved the funds rate up 425 bps and the 10-year and mortgage rates barely budged.

During the 2004-07 tightening cycle, the era of the Greenspan bond market conundrum, for example, the 10-year yield managed to rise only a maximum of 64 bps during the entire cycle from a beginning yield of 4.62 percent to a cycle high yield of 5.26 percent. This as Greenspan raised the fed funds rate by 4.25 percent, from 1.0 percent to 5.25 percent.  – GMM, March 2017

Risks

The risk is that foreigners begin to sell.  But where will they go?

Spanish 10-years at 1.43 percent?  German 10-year bunds at 0.266 percent?  How about a 10-year Japanese JGB at 0.067 percent?    In fact,  low foreign yields and the ensuing portfolio effect is keeping the U.S. 10-year note well anchored below 2.60 percent and another factor distorting the yield curve.

Credit and Equity Markets

That is where there we could have some short-term problems and overshooting.   But our sense, many are waiting to pounce on a sell-off in the spread and equity markets.   Too many pensions are underfunded and too many seniors are yield strarved.

Having some dry powder makes sense.    It’s coming and you will have to act fast.

Conclusion

A sustained spike in inflation?

Tilt!  Game over, comrades.

10-Year Treasuries Break Key Trendline As Yield Curve Collapses

10-year US Treasury yields just broke to 2.10% for the first time since November 10th, and more importantly tumbling through a key trendline support from a year ago...

h/t @RaoulGMI

Sending the yield curve near cycle flats...

The entire post-Trump-Election reflation trade is collapsing...

This does not look like the plan Janet!!

"Fire" in the Bond Market - Fed Raising Rates and US Issuing Ultra Long Bonds - by Michael Carino

The bond market is on fire and you are about to get
burned!!!  Bond yields are lower and interest
spreads as tight or tighter than that of the bond market crisis of 2008.  This will lead to a catastrophic financial
train wreck that can happen at any moment. 
Why do I feel like I’m the only one sounding the alarms?  Where is the media to help warn and prepare
the marketplace?  Why are investors going
along and playing in what seems to be a rigged and tragically destructive game?
 It reminds me of the story of a frog
jumping into a boiling pot of water. Once the frog hits the hot water, it jumps
right out.  But the frogs that is in the
pot when the water starts out cold slowly gets cooked.  The Fed has excessively accommodated financial
markets for almost a decade. This has been such a long, accommodative cycle,
investors can’t tell how close they are to getting cooked.

Some of the world’s largest and most sophisticated investors
who pride themselves on being some of the smartest individuals are taking some
of the most expensive risks with the worst payoff profiles of all time.  Obviously, most investors have short term
memories.  Longer-term government bonds
typically trade above the level of inflation by 2-3%. That should put the long
bond around 5-6%. However, when there is an asymmetric skew in the economic
data, like there is today, where growth and inflation has a higher probability
to surprise to the upside, the premium should be even higher.  Longer-term US Treasuries now yield 2-2.8%.  If the longest US Treasuries normalize, the market
losses could be as high as 50%!

Over the last couple of weeks, long dated US Treasuries
rallied 40 basis points. That may not seem like much, but this is days before
the Fed is going to raise rates another 25 bps.  What makes this move absurd is that the rally
happened not when rates are normal, but still priced for a recession or a
depression.  When factoring this 25 bp
hike in short term rates, that is a 65 bp compression in spreads – a huge move!
Why?  Was there a natural disaster?  Was there a financial catastrophe?  Both of these might be justification for a 25
or 30 bp spread tightening. But 65 bps? 65 bps is over 20% of the US Treasury long
bond yield!

What has come out over the last couple of weeks is that GDP
is running around 3%, CPI and PPI – core and headline inflation are running 2%,
the unemployment is at a cycle low of 4.3% and the Fed is hiking rates and going
to reduce their balance sheet.  This is
an environment where overpriced bonds should be getting decimated because current
yield levels are so low.  It is clear
that fundamentals have nothing to do with setting yields in the bond
market.  What has been setting yields is a
consortium of Treasury market investors that have been high volume trading
Treasuries aggressively during typically low volume periods and making the
market believe – through price action – that there is great demand for bonds.
This is nothing more than squeezing the bond market and giving it misinformation
in hopes of bluffing bond investors to not pull the ripcord and cash out of the
bond market. 

This is not a unique strategy.  This is the same strategy employed during 2006
and 2007 to coax longer term bonds into a low volatility state.  This flattened the yield curve with declining
long term yields as the Fed raised Fed Funds from the historically low 1% last
cycle.  And what did that lead to?  This high volume, volatility diminishing
trading of long term rates led to mispricing of all risks embedded in the bond
markets.  And when those risks eventually
were realized (when Fed Funds raised high enough to be a substitute for
overvalued bonds), the normalization process was rapid.  This market move confused investors that were
clueless as to what was setting yield levels before, during and after the
crisis.  The financial crisis of 2008 was
only a crisis because yields were mispriced too low due to the manipulation in
the Treasury market.  If rates were
normalized in 2008, there would have never been a crisis.  Yields and spreads would have only moved a
little bit higher instead of having to adjust so drastically that anyone with
leverage or a low risk tolerance was forced to sell.  This led to a lack of liquidity in the bond
market and the Fed having to step in to provide liquidity.  The Feds mistake is they provided the
liquidity then and still are today.  This
encourages reckless risk taking in the bond market and the insanity continues
today. 

To make this last paragraph a little clearer, monetary
policy in the last cycle was over accommodative. These conditions led to the
2008 financial crisis.  The Fed’s
response was to be even more accommodative for an even longer period of time.
They expect different results this time? (Definition of insanity!)  I fear with this next crisis congress will
place the blame squarely on the Fed.  The
result, most likely, will be a different mandate for the Fed – if the Fed
continues to exist at all.  But I
digress.

The Fed will raise interest rates in two days.  The US Treasury Secretary Mnuchin just repeated
he is looking into issuing ultra-long bonds (great timing).  The job market is tight and global economy
roaring.  In the US, you can’t find a
parking spot and homes are selling over asking price again.  This is not the recessionary or depressionary
conditions reflected in the bond market.

Congratulations to the Fed.  They saved us from the last financial crisis
by sowing the seeds of the next, never to be out done, even more spectacular
financial crisis.  The Fed has
manipulated the markets by buying 5 Trillion of bonds and a consortium of bond
investors are manipulating the markets, trading 1 trillion of government bonds in
the cash and futures markets daily.  If
you think fundamentals are setting prices in the bond market, your wrong.  Let’s be clear: when fundamentals matter in
the market place, yields and yield spreads will be double to triple of what
they are today.  So get ready to hop out
of the financial pot before the water gets too hot.  With the Fed hiking rates and reducing their
balance sheet and the bond market grossly overvalued, the pot may start to boil
faster than most expect.

 

by Michael Carino, 6/13/17

Michael Carino is the CEO of Greenwich Endeavors, a
financial service firm, and has been a fund manager and owner for more than 20
years.  He has positions that benefit
from a normalized bond market and higher yields.  Do you?

    

Recession Watch - Fall 2017

Authored by EconomicPrism"s MN Gordon, via Acting-Man.com,

One Ear to the Ground, One Eye to the Future

Treasury yields are attempting to say something.  But what it is exactly is open to interpretation.  What’s more, only the most curious care to ponder it. Like Southern California’s obligatory June Gloom, what Treasury yields may appear to be foreshadowing can be somewhat misleading.

Behold, the risk-free tide…

 

Are investors anticipating deflation or inflation?  Are yields adjusting to some other market or external phenomenon, perhaps central bank intervention?

So far this year, and in the face of the much-ballyhooed prospect of Trumpflation, the yield on the 10-Year note has gone down.  Not up.  On January 1st, the 10-Year note yielded 2.44 percent.  As of market close Thursday, the yield was 2.22 percent.

At first glance, it appears there’s nary a care in the world about inflation.  Conjecture, says there’s an expectation that Trump will be unsuccessful at getting his spending bill through Congress.  Without Trump’s fiscal stimulus, goes the thinking, the potential for inflation becomes muted.

10-year treasury note yield and 30 year t-bond yield – going the non-flationary way. In case you are wondering what the “but” is about: it’s current net speculative positioning in t-note futures, which has gone from record net short to record net long in a heartbeat – click to enlarge.

In reality, does this have anything to do with anything?  What are Treasury yields really trying to say?

To be clear, contemplating Treasury yields is like a baker contemplating the microbiology of bread yeast.  The proper technique is imprecise, and best garnered over time through learned experience.

We’ve found the best results for drawing an inkling from Treasury yields are obtained by putting one ear to the ground and one eye to the future.  Here’s what we mean…

A Flattening Yield Curve

If you plot the interest rates of Treasuries with different maturity dates you get a graph showing something that economist and banker types call a ‘yield curve.’

For example, if you plotted three-month, two-year, five-year, and 30-year Treasury debt you’d have a yield curve that is often used as a benchmark for establishing various lending rates.  More importantly, you can use the shape of the yield curve to forecast changes in economic growth.

Bad curve behavior returns – there isn’t much left of the “reflation” party – click to enlarge.

When everything’s just great with the economy, a normal yield curve, showing longer maturity Treasuries with a higher yield than shorter-term Treasuries, will appear.  This reflects the potential for greater market risk, and inflation, further out into the future.

However, prior to a recession the yield curve often becomes inverted, with shorter-term yields higher than longer-term yields. Presently, the Treasury yield curve is flattening.  Could it be transitioning to an inverted curve?  Here we turn to FXSTREET for instruction:

“Five years ago, long-term interest rates were just about where they are now, and short-term rates were nearly as low as the overnight federal funds rate (that is to say, at zero).

“At the end of 2014, when the Fed ended QE, short-term rates didn’t move much. But the middle of the yield curve moved higher.  Again, long-term yields are nearly the same today as they were in 2014.

“Finally, the current yield curve looks much flatter.  Short-term yields moved higher, mirroring the Fed’s rate hikes, and the middle of the curve has drifted higher.  But long-term rates are about where they were five years ago!

“That’s not encouraging.  Markets don’t believe there’s much risk of inflation or economic growth.”

We have shown this chart of 3 month and 10 year Japanese govt. debt previously, and is a bit of a warning: since 1989, there were five recessions in Japan that were not preceded by an inversion of the yield curve. The final stage of the big bubble in the Nikkei in 1989 was the last time the curve inverted in Japan. In a ZIRP regime a flattening of the curve is apparently all it takes sometimes – click to enlarge.

Recession Watch Fall 2017

Hence, according to the Treasury market, economic growth may be stalling out.  The Great Recession officially ended in June 2009.  Yet the recovery has not been equally great.  In fact, the recovery has been greatly feeble; it has hardly been discernible to the broad population.

The unemployment rate may have come down.  GDP may have inched up.  Incomes may have even returned to where they were at the turn of the new millennium.  But the wealth has generally concentrated with a small few, while everyone else has been left to fight over bread crumbs.

 

When your stagnating income makes you feel blue, always remember that some species have a particularly complicated relationship with bread crumbs…

Moreover, unemployment, GDP, and incomes have all been blown about by the Fed’s odorous monetary gas.  Specifically, this is the same monetary gas that huffed and puffed up stock market and real estate prices, and suppressed interest rates.  So, too, this is the same monetary gas that the Fed has been incapable of weaning the economy from.

Could it be that we’re facing the prospects of another recession prior to the completion of Fed ‘normalization’ policies?  From our one ear to the ground one eye to the future vantage point you can already count on it.

Of course, many of the conditions that presaged the last recession – high levels of public and private debt, and asset bubbles – still exist today.  Only in many instances they’re even larger.  Naturally, the foolish attempt to solve a debt problem with more debt has now set us up for a much larger crisis and recession.

At the moment, this forthcoming recession is popping up like dark storm clouds just above the horizon.  By fall, it may be bearing down upon us in full force.

Fink Fears Bond Curve Signals, Cooperman Warn Stocks Ahead Of Fundamentals

US equity markets pushed back into the green this morning just as two heavyweight investors suggested all is not well in the land of exuberance. Blackrocks" Larry Fink warned the equity market is not appreciating the message from the Treasury yield curve (and sees lower growth than Trump hopes for), while Omega"s Cooperman warned that markets are fully priced, and ahead of fundamentals.

Fink headlines from his comments at a Deutches Bank conference:

• *BLACKROCK"S FINK SAYS SEEN VERY LITTLE ON REFORM FROM TRUMP


• *FINK: EQUITY MARKETS REMAINER OF YR DEPENDS ON TRUMP


• *FINK: SAYS U.S. GROWTH IN MID-2S IS NOT HAPPENING


• *FINK: WE"RE STARTING TO SEE EXCESSES IN CREDIT MARKETS AGAIN


• *FINK: CREDIT MARKETS ARE RICH


• *FINK: MARKET ISN"T APPRECIATING THE YIELD CURVE

And Omega"s Cooperman was on CNBC:

• *COOPERMAN: MARKET IS FULLY PRICED, AHEAD OF FUNDAMENTALS


• *COOPERMAN: WOULDN"T OWN BONDS, VERY FULLY VALUED

But then added...

• *COOPERMAN: CONDITIONS THAT SPUR MARKET DECLINES NOT PRESENT

As BofA wrote just this morning, it appears equities are the last man standing...

With the Treasury curve below Trump lows, Hard data below Trump lows, and even Soft data now collapsing back to reality, stocks seem to know only one thing - the $100 billion a month of buying from central banks better not go away anytime soon!

Muni-Bond Market To Trump: "Your Tax Cuts Are Dead"

Authored by Lance Roberts via RealInvestmentAdvice.com,

Since the election, much of the reasoning behind the surge higher in asset prices has been the expected tax cut/reform from the Trump administration which, as the theory goes, would lead to a surge in economic growth, higher inflation, and subsequently higher bond yields.

Unfortunately, given the lack of progress on the ACA replacement/repeal, the harsh pushback and criticism of Trump’s proposed budget, and the ongoing investigations and inner turmoil of the Trump Administration, the likelihood of tax cuts is becoming a much more distant reality. As such, the municipal bond market (and the Treasury market) have begun to aggressively discount the probability of significant tax reform any time soon.

Furthermore, the whole “reflation” trade also seems to come down to a similar agreement about the possibility of the Trump Administration to achieve any of its policy goals.

As shown below, the Dollar/Interest Rate trend is clearly negative.

As RBC macro strategist Mark Orsley wrote Friday:

“I am finding it increasingly difficult to see a near-term catalyst for UST’s to sell off.  In fact, almost all indicators I watch are flashing a warning that a breakdown in yields (longer end) is increasingly probable.” 

I have long been discussing that a move to 2% or below is quite likely (see here) but as Orsley points out:

“Technicals -> two head and shoulder formations point to lower yields. Target of 2.05% on the Feb/March formation, and if 2.17% gives way, the H&S from April/May targets 1.95%. Notice the MACD starting to trend lower…”

He is correct. A breakdown in yields will likely come with the realization that current earnings projections are far too optimistic to support current market valuations which will likely be coupled with concerns of a recessionary onset from further Fed rate hikes.  Any rallies in rates back to 2.4% should likely be used to add additional exposure to bonds for a trade in the weeks ahead.

As Orsley concludes:

“It may seem like a no-brainer to short at these levels into a Fed hike (at least this time the market isn’t going in at the yield highs), but all the above indicators should serve as a warning to bond bears. Despite cleaner short positioning, the pain trade still remains lower yields.“

I agree.

Stronger Than Expected 2 Year Auction, Thanks To Highest Yield Since October 2008

After today"s very ugly 4-Week Bill auction, moments ago the bond market redeemed itself somewhat when it sold $29.1BN (including $3.1BN in SOMA) in 2 Year paper. The high yield of 1.316% stopped through the 1.322% When Issued by 0.6 bps, which was the biggest "stop through" since last August. Perhaps the yield was a factor: at just below 1.32%, this was the highest auction stop on 2Y paper since October 2008.

The internals also came in strong, with the Bid to Cover rising from 2.853 to 2.904, the highest since May 2016, with total bids of $78.6BN for $29.1BN in notes sold.

Indirects took down 57.15%, below the 58.9% in April, but above the 46.6% average of the last six auction. Directs took down 12.4%, in line with recent history, leaving 30.45% to Dealers, below the 41% 6MMA.

In summary, a strong auction which the bond market was desperately in need of following some very disappointing Bill and Coupon auctions over the past few weeks.

China Suspends Bond Market After "Abnormal Fluctuations"

China has suspended trading in its bond market for at least one Ministry of Finance-issued bond suffered "abnormal fluctuations" in the last two trading days.

The MOF 2021s dumped and pumped by almost 10 points in the last two days (and at the same time 5Y China bond futures rallied and fell notably...

The Shanghai Stock Exchange has suspended trading of the bond (Number 019535):

[The bond] is trading this morning with abnormal fluctuations. According to the relevant provisions of the "Shanghai Stock Exchange Trading Rules" and the "Shanghai Stock Exchange Securities Exception Trading Real-time Monitoring Rules", the firm decided to suspend treasury bonds from 11:00 on May 16, 2017 (019535).

From 20:17 on May 16, 2017 to resume trading.

We remind investors to pay attention to transaction risk, rational investment.

After the resumption of trading, if the bond transaction again abnormal fluctuations, the implementation of the second interim suspension of trading, suspension time lasted to 14:55 today.

One wonders if the delveraging is killing liquidity in the Treasury market now (as we have already seen the impact in the corporate bond market)

Is A Chinese Recession Imminent? Yield Curve Inverts For First Time Ever

While China growth has been slowing, and monetary conditions tightening, few (if any) have predicted any prolonged deflation (let alone a recession), yet overnight - for the first time ever - the $1.7 trillion Chinese bond market inverted, flashing a warning signal to the world that something is wrong.

Early on Thursday, the five-year yield rose to 3.71%, breaking above the 10-year yield for the first time since records began - even though the latter, at 3.68%, was near a 25-month high.

Some of the overnight weakness in the 10Y yield was eased by reports that PBOC would offer some Medium-Term Loans.

Of course it"s not just bonds that are getting dumped...

But, as The Wall Street Journal writes, such a “yield-curve inversion” defies normal market logic that bonds requiring a longer commitment should compensate investors with a higher return. It usually reflects investor pessimism about a country’s long-term growth and inflation prospects.

Perplexed traders and analysts offered up many excuses...

“Many of us are scratching our heads for an explanation because this kind of curve inversion is absolutely not normal,” said Wang Ming, a partner at Shanghai Yaozhi Asset Management Co., a bond fund that manages 2 billion yuan ($289.66 million) in assets.

“The inversion is a form of mispricing in the bond market,” said Liu Dongliang, senior analyst at China Merchants Bank . “The fact that no one is taking the bargain despite the higher yield on the five-year bond just shows how depressed investors’ mood is.”

“It’s really difficult to predict when the selloff or such anomalies will end because China’s bond market is reacting to the regulatory crackdown only and is no longer reflecting economic fundamentals,” said China Merchants Bank’s Mr. Liu.

But of course, the reality is - without massive and contonued credit creation, there are very large questions about just how "dynamic" Chinese growth could be and while technical flows are certainly part of the reasoning for 5Y yields rising, the question is, why wouldn"t the rest of the world pile in to "reach for yield"... unless the fundamentals really did have them worried?

6-Month Window & A Fiscal Fumble? Things That Don't Matter Could Matter Again...

Authored by Jason Leach via FusionPointCapital.com,

The first six to nine months of a presidential term are arguably the most important thanks in large part to staggered elections put in place by our forefathers. The Bush tax cuts, Clinton"s tax hikes, and the serious groundwork for Obamacare were accomplished during this time frame. President Trump and a balkanized Republican party have taken on ACA repeal/replace during this critical six month window, aiming to use fiscal year 2017 reconciliation (simple Senate majority but “nuclear” to cooperation) to get something passed before the Fall (the current House bill is dead on arrival in the Senate). Then, after this self-immolation, they aim to use the same reconciliation process to get something done on tax reform in fiscal year 2018 (they have a one-pager to work off as of now), and hope to tack on infrastructure and ongoing deregulation going into the 2018 midterm campaign season.

In the last four years, perhaps the least cohesive congress in history has passed the least legislation in over 200 years. After Obamacare passed (via reconciliation) and the subsequent killing of the use of earmark horse trading to corral votes (remember Nebraska?), the 2010 Tea Party insurgence became the “All Pros of No”, or the shutdown defense against anything serious getting done during Obama"s remaining years. Now, the six month window will probably close without real structural change to healthcare, tax reform will then likely be pushed into 2018/2019 (and be “tax relief” not reform), and infrastructure could well fall prey to pre-midterm stasis (Democrats not throwing a lifeline to “Reconciliation Republicans”).

Meanwhile, with a string of solid jobs numbers (despite anemic sub 3% growth in average hourly earnings instead of hoped for 3-5% to outpace inflation), the Fed is intent on making the “fiscal hand off”, with two rate hikes in the last six months (and unless rumors of Fed nervousness about the deteriorating credit situation are true) another hike in June (market is pricing in ~70%). Remember “Three Steps and a Stumble” from Pulling Awesome Forward? And, after seven years of feeding another asset pricing cycle (stocks, real estate) instead of productive “virtuous” cap ex cycle (outside the oil patch discussed in Crude Compression), the Fed plans to start reducing the size of the bloated $4.5 trillion balance sheet starting at the end of the year. Ben Bernanke expressed this past week that he is “calm about unwinding part of the balance sheet”, but he neglected to mention that no country has ever exited QE, so it may get rocky (if it happens at all as many view QE as a permanent part of central bank policy at this point).

After the election, consumer sentiment ("soft data") reached 17-year highs, and small business sentiment surged to 2004 levels, recording the biggest one month surge since 1980 in January. These “animal spirits” propelled markets to new highs just this past week, despite the Atlanta Fed"s GDPNow first quarter 2017 GDP forecast (that is, “hard data”, not sentiment) coming in at a severely revised down 0.2%. Consumer spending continues to lag sentiment with consumption at its lowest level in seven quarters. Business and consumers are sentimental but the virtuous cycle is not in gear. It"s just the annual first quarter blip right…

Let"s Talk About Credit…

It"s curious that the rise in LIBOR, affecting everyone with a credit card and an adjustable rate loan, is being overlooked by so many. The credit canary in the coal mine is wheezing a bit and with delinquencies on all loan bases rising - subprime mortgage, autos, and Capital One confirmed subprime credit cards are starting feel the pain (remember the Capital One turn in "06?).

That said, financial conditions and the overall market cycle has been a big focus at Fusion Point Capital. Chief Market Technician Arun S. Chopra CFA CMT has been keeping members in front of the cyclical process through a variety of longer term indicators. This is paramount at this stage of the cycle.

Some of the things Arun and I have been watching related to the overall macro story.

• Libor and the dollar started rising in 2014, the end of QE expansion, the start of tightening conditions that crashed commodities (i.e., oil), led to a string of Yuan devaluations and roiled markets (LIBOR is up 5X from bottom and double from one year ago, and is the effective borrowing cost for dollars worldwide).


• The dollar is now sitting on its rising 50 week moving average, an important overall trend level and signal (the Trump team has been talking down the greenback of late, we will see, but a move back up in the Indomintable Dollar is deflationary and oil could get hit again along with high yield, multi-national earnings, Emerging Market debt, etc.)


• At the same time in 2014, we saw the yield curve peak (i.e., potential peak in economic expansion as flattening yield curve presages economic downturns)


• There is still a 1% spread between the short and long end of the yield curve (before inversion), which can change quick depending on macro trends. 

Markets, Valuations, and Sentiment

Forward Street earnings are resurgent on “rebounding” oil (not so much anymore), anticipated tax cuts, infrastructure and deregulation – the reflationary “fiscal hand off” – all of which are looking like they are not occurring in 2017, and increasingly unlikely in anticipated form in the first half of 2018. Full year S&P 500 earnings for 2016 came in at $106. Current full year earnings estimates are $130 for 2017 and $147 for 2018, implying 23% earnings growth in 2017 and another 13% in 2018.

Citi estimated recently that every 1% of tax rate reduction adds roughly $1.75 of full year EPS to S&P 500. A significant amount of the 23% earnings growth anticipated above is based on the Trumponomics “reflation” and tax reform. Again, it does not look like it is coming soon, if at all in substantive form so take a hair cut to that S&P 2017 and 2018 earnings estimates of $130 and $147?

The much maligned non-timing tool of PE10 stands near its second highest level ever at ~30x and trailing P/E is ~25X. Remember, higher P/Es are justified by low rates and NPV (the TV says so). Additionally, and this is a point of emphasis, fully 96% of companies are now reporting non-GAAP earnings (removing “one-time” items), up from 70% in 2014, and less than 50% in 2009. That is, the one-time items boosted GAAP earnings for 2016 by 12%, to $106 from $95 – which is about the same level as 2013 when the S&P 500 traded 30% lower.

Right now, the market is easy peasie. It"s invincible - ostensibly due to overcoming every brief elevator down blip over the past 8 years of Fed asset price control. What happens when it becomes apparent there is a fiscal fumble? Things that don"t matter could possibly matter again…

Seven Charts For Bullish Investors To Ignore

Wall Street still exudes widespread optimism that 2017 will provide another year of solid gains for stocks amid stable albeit unspectacular economic growth and only gentle interest rate rises. However, as The FT details, all is not well in reality, and the following seven charts will hearten investors of a more bearish persuasion...

After climbing to its highest in 3 years earlier in 2017, Citi’s Economic Surprise index — which gauges how well data come in better than expected — has sagged badly lately. In fact, this week saw the biggest drop in US Macro data in 6 years (after poor readings on job creation, inflation, housing starts and car sales)...

US corporate lending has also been unexpectedly weak, raising eyebrows among economists. Here is a chart from Goldman Sachs showing the growth of commercial and industrial loans has fallen sharply recently, while corporate debt servicing costs have been climbing to more normal levels reflecting rising indebtedness and the Federal Reserve’s interest rate increases. Goldman Sachs’s economists point out that debt servicing costs are likely to continue to rise, given the central bank’s plans to tighten monetary policy further.

Source: The FT

The consumer lending side is also looking less than ideal, with many households and individuals struggling with big student loans, credit card debt and car loans, after a period of anaemic wage growth. Signs of some stresses can be seen in the uptick in S&P/Experian’s bank card default rate.

Source: The FT

Even the default rate on high-quality “prime” loans edged up in the last quarter of 2016, according to the Mortgage Bankers Association.

Source: The FT

Meanwhile, one of the most accurate measures of looming recession risk is the bond market “yield curve” shaped by bonds of various maturities flattening or even inverting. The US yield curve is far from inverting, but it has flattened sharply again this year, after steepening following the US election in November. The difference between two and 10-year US Treasuries this week compressed below 100 basis points for the first time since November, and many analysts expect it to flatten further as the Fed keeps raising interest rates. As is clear from the chart below, bonds are tracking "real" economic data and stocks are tracking "soft" survey hope...

 

And focusing on equities, fading analyst optimism over US “small-caps” - smaller listed companies beyond blue-chip gauges like the S&P 500 - is another warning sign. Small-caps are the bedrock of corporate America, and were at the epicentre of the post-election “Trump trade”, because of their mainly domestic businesses that would be shielded from a stronger dollar, and high tax rates that the new president promised to slash. But the Russell 2000 small-caps index has been treading for most of 2017, and analysts have taken a chainsaw to their small-caps earnings forecasts.

Source: The FT

Lastly, the rancorous US political climate shows no signs of abating. Here is a chart of the Philadelphia Fed’s “partisan conflict” index, which tracks the degree of political disagreement among federal-level politicians by measuring the frequency of newspaper articles that report disagreements in any given month.

With the market priced for Trump policy perfection, one might want to look away from this chart before faith is entirely erased.

Just some things to ignore before you BTFD after today"s French Election.

Warning Signs

Authored by Lance Roberts via RealInvestmentAdvice.com,

Bull Market Still Intact…For Now

This past Wednesday, on the Real Investment Hour, I spoke with Greg Morris about the technical backdrop of the market. During that interview, he discussed that from a technical perspective the bullish trend of the market is still in place, and despite fundamental underpinnings being stretched, investors should remain allocated to the market.

This is shown in the chart below.

For now, portfolios remain allocated to the market currently. However, as I stated two weeks ago, we did lift profits and rebalance current holdings. Furthermore, we are not adding any “new” positions currently until some of the extreme overbought conditions are resolved. 

This is what the “technicals” dictate, at least for now.

As noted in the chart above, the market is very close to a short-term “sell signal,” lower part of the chart, from a very high level. Sell signals instigated from high levels tend to lead to more substantive corrective actions over the short-term. I have denoted the potential Fibonacci retracement levels which suggest a pullback levels of 2267, 2230, and 2193. To put this into “percent terms,” such corrections would equate to a decline of -4.7%, -6.2% or -7.8% from Friday’s close.

To garner a 10% decline, stocks would currently have to fall 237.8 points on the S&P 500 to 2140.20.  Given there is little technical support at that level, the market would likely seek the next most viable support levels at the pre-election lows of 2075 or a decline of -12.7%. Such a decline, of course, would not only wipe out the entirety of the “Trump Bump,” but would also “feel” much worse than it actually is given the exceedingly long period of an extremely low volatility environment. 

Speaking of low volatility, the market has now gone 108-trading days without a drop of 1% for both the Dow and the S&P 500. This is the longest stretch since September of 1993 for the Dow and December of 1995 for the S&P 500.

This is a pretty impressive feat given the rise in policy uncertainty since the election, geopolitical tensions on the rise, and economic data remaining weak.

In other words, there is a whole lot more downside risk than upside potential in the current environment.

This is particularly the case following the FOMC’s decision on Wednesday to hike rates further.

An Unlikely Outcome

On Wednesday, as the Fed hiked rates for the second time in the last three months, and a third time since December of 2015, the Atlanta Federal Reserve released their latest GDP NowCast which reduced estimates for first quarter growth to just 0.9% from nearly 3% in January. 

Interestingly, following the Fed’s announcement of a rate increase, stocks, bonds and gold all surged.

The reason I say “interestingly,” is that higher interest rates increase borrowing costs which slow economic growth and quells inflationary pressures. Therefore, since the primary argument to support the second highest valuation levels in history is an economic and earnings recovery story, higher rates slow both of those supports. 

Of course, the wisdom of hiking interest rates, thereby removing monetary accommodation, at the lowest average level of economic growth on record is also questionable.

Furthermore, there is also some doubt as to the veracity of the following justification from Ms. Yellen regarding the policy change:

“The simple message is the economy is doing well. We have confidence in the robustness of the economy and its resilience to shocks.” – Janet Yellen, March 15, 2017.

First, I guess we have to quantify what we mean by the “economy is doing well.” In 2016, the economy grew at 1.60% which is well below the expected average of 2.0%. But more importantly, take a look at the chart below of annual “real” economic growth rates.

There are three things of importance to note:

1. The economy did well prior to the last two crisis as well. In 2000, the annual growth rate was 4.09% and 1.78% in 2007. It was a “Goldilocks” economy. 


2. While there was a recession in 2001, the economy averaged a real return that year of 0.98%.


3. The current “real economy” is currently growing, as of 2016, at a rate lower than that prior to the last two recessions and “crisis” in the market and only slightly above that of the recession based 2001 average. 

At a 1.6% growth rate, there is very little wiggle room between Fed rate hikes and a negative growth rate in the economy. The chart below adds the Fed Funds (effective rate) to the chart above.

Two important points:

1. As soon as the Fed has started hiking rates previously, economic growth began slowing.


2. While it is often stated the economy remained buoyant following rate hikes, it was ONLY a function of the time for starting economic growth rates of 4.09% and 3.79% to fall below ZERO.

The table and chart below show the historical time frames for the economy to fall into recession following the start of a rate hiking campaign. At 1.6%, historically, the economy has found a “crisis” withing 1-3 quarters. 

IMPORTANTLY: The number of times the Fed has started a rate hiking campaign and NOT pushed the economy into either a recession, crisis, or both equals ZERO.

So, as to Ms. Yellen’s second point of a resiliency to shocks, there is actually no historical evidence of that being the case. The only question is what “shock” eventually ignites the “gasoline” of excessive complacency, exuberance and leverage into a “panic fueled” explosion of liquidation.

Unfortunately, I do not know the answer to the “what” or the “when” of when such will occur. I am certain that it “will.”

But, if you need more evidence, here is this tidbit from Nautilus Research’s Tom Leveroni:

“Many are familiar with the Wall Street adage ‘3 Steps and a Stumble,’ popularized by Marty Zweig, for the tendency of stocks to sell off after the 3rd Fed rate hike in the cycle.

The S&P 500 has endured significantly below average results from 1 to 12 months after 3rd rate hikes in 11 events back to 1955. Six (more than half) of those hikes occurred within a year of a major cyclical top for stocks (1955, 1965, 1968, 1973, 1980, 1999).

The only exception was in 2004, when stocks rallied for another three years before the Great Recession.

Hikes are generally bad for stocks, somewhat bad for the US dollar, and bullish for 10-year yields and commodities. Will rate hikes derail stocks this time around? In a general sense, yes. Is there a deterministic formula or trigger for precisely when? Probably not.”

Warning Signs

So…let’s add this all up.

The bullish trend is intact which keeps portfolios on the long-side of the ledger for now. However, such does not mean one should become complacent and ignore the rising number of warning signs.

Valuations are stretched by most measures. While valuations are not reliable “timing” indicators, they are useful in predicting forward rates of returns.

Leverage is extended. Margin debt, or the dollar volume of stocks bought with borrowed money, surged just before the US election to a record high.

Retail investors are suddenly rushing to buy. Following eight years of net outflows, they poured nearly $80 billion into mutual funds and exchange-traded funds in the post-election rally. This year, however, corporate insiders have been selling at the fastest pace in nearly 30 years.

The technicals are showing vulnerability. From Monday through Thursday last week, the number of stocks making 52-week lows surpassed new highs. It was the longest streak since November 4 and was a sign of a toppy market, Rosenberg said. Also, the S&P 500 has traded as much as 10% above its 200-day moving average.

Investors are complacent, and it seems like the calm before the storm. The Chicago Board Options Exchange volatility index, or VIX, remains unusually low. The S&P 500 has not swung 1% intraday for almost 60 days, the longest streak in at least 35 years.

The Fed is raising rates. The rise in short-term yields could invert the yield curve before the Fed Funds rate is at 3%. An inverted curve — which reflects investors’ expectations for slower future growth — is seen as a precursor of recession.

Inflation is picking up. The core personal consumption expenditures index is at a 30-month high. Though it is likely not sustainable, it is a “classic late-game signpost.”

The gap between economic growth and sentiment is large. The pace of policy change in Washington could disappoint investors.

Households have over-ownership. Their exposure to the stock market is 42% above the norm.

Credit markets are frothy. The compensation investors demand for choosing risky US high-yield bonds over risk-free assets — the risk premium — is widening.

Like gasoline, all of these warnings are “inert” and, other than smelling really bad, are harmless.

Well, that is until your cousin “Randy” shows up and decides to have a quick smoke.