Friday, September 2, 2011

No help from the banks for the bulls

I have been writing about the relative performance of the KBW Bank Index (BKX) relative to the market since May. I indicated that a relative breakdown of the BKX against the market was an indication of rising systemic risk, consistent with a Russia Crisis or Lehman Crisis. Since then, the relative breakdown did take place and things have gotten worse, a lot worse.

Despite a half-hearted rally from the Berkshire/BAC deal, the banks remain in a relative downtrend against the market.

Up until recently, the performance of the Regional Banks have been relatively well behaved. While the BKX, which is heavily weighted with Too-Big-To-Fail (TBTF) banks, had broken down on a relative basis, the Regional Bank Index had held steady. Now the Regionals have broken down and they are having trouble rallying above relative resistance.

FT Alphaville has been writing extensively about the short-term funding problems of European banks because of the withdrawal of money market funds from the eurozone banking market (example here), now it appears that the French banks are having trouble because of their heavy reliance on wholesale funding.

Look at this chart of the ratio of the Euro STOXX Banks vs. the EURO STOXX Index. The Europeans banks are in a relative downtrend and they have broken a major relative support line. The relative ratio is now at all time lows - a sign of trouble.

Signs of systemic risk are rising. Take a look at this chart of funding costs of various banks. Eeek!

How many bullets can you dodge?
Putting all this together, I interpret these conditions as:
  • Systemic risk in the US banking system: The US TBTF banks are signaling rising systemic risk.
  • High risk of a US recession: The relative weakness of the US Regional Banks is signaling a high risk of a US recession.
  • Lehman/Russia Crisis warning in Europe: The combination of continuing stories of short-term funding problems at eurozone banks and the relative breakdown of that sector in Europe are signaling a very serious problem. No wonder IMF Managing Director Christine Lagarde warned at Jackson Hole that European "banks need urgent recapitalization."
Maybe the combination of the Fed, ECB, the Obama Administration, Congress and the EU can get together and kick the can down the road yet one more time.

Realistically though, how many bullets can you really dodge? With risks like these on the horizon and technical indications that the bulls are losing control, I would be inclined to stay long the US long bond.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.


Tiho said...

Hey there!

Nice blog. I do have one comment to make. Personally I think buying or holding the Long Bond is a suicidal investment. For one, the whole yield curve is now showing real negative interest rates. Second, 50% of the Dow Ones will soon be paying a higher yield than the Long Bond.

It is possible that despite US Government debt to GDP ratio being in assess of 600% if you include entitlements, you will be paid interest; however, it is totally insane to think that you will receive those interest payments - or in your case capital gains - in proper currency or unit of account.

Furthermore, after a great bull market in Bonds, which has now lasted for 30 years, since September 1981, you are now recommending to buy the Bond, while all the big players like China, Russia and Middle East are looking at ways of getting the hell out of there., without triggering of a crash Besides, wouldn't you want to buy something that has been depressed for 30 years, instead of in a bull market for 30 years? Buy low, sell high?

Please post your opinion to this matter, if you do have one. Much appreciated. Keep up the good work on the blog.


Cam Hui, CFA said...


The long bond call is a trading call based on an extremely elevated systemic risk level in the financial system.

Should the US plunge into recession or Europe experience a banking crisis, USD-denominated Treasury assets have historically soared.

onegoal said...

bonds are definitely in a bubble, however, where in the bubble are we is the crucial question. We could be 6 weeks, 6 months or 1 year from the top - and bonds could increase by 20 - 30% more before the final top. The bond bubble is too obvious at this time, i.e. too many KNOW that they are in a bubble and can only go lower. The last run up is the most violent one in every bubble. By the way, fantastic and insightful blog. A valued read.

Tiho said...

Treasuries have already soared. It is the biggest rally, second only to late 08, in the Long Bond's 20 year history. Usually the news for any asset class bull market are most favorable at the top.

Have you ever studied about the great inflation of the 70s and how strong of a belief every investor had in Gold by 1980?

Have you ever studied or maybe even traded throughout the late 90s and into 2000, when traders had an unbelievable and unshakeable belief that NASDAQ stocks will keep rising?

Today, and also since late 2007, you have amazing amount of bad news in the developed market economies. This news is very very favorable for Treasuries and a perfect excuse to buy them. I am not sure if you ever take a step back and look at things properly from a different perspective, and value the asset class properly.

Sure the noise argues that fundamentals are perfect to buy Treasuries, but if you remove the day to day noise of fear mongers, EU break up or repeat of 2008, you will realize that you are advising investors to buy Treasuries at the top of a secular move.

Sure, the tradable rally could keep going, however, it could also be possible that 2.5% yield during the great panic of 2008 will not be taken out. Especially if you believe that we aren't repeating 2008. And that seems to be the biggest fear most investors have and therefore is creating the most favorable news, close to the top, for an aging 30 year bull market.

It is only natural for investors to react like you have in this post. After all, humans are a by product of recent events. They tend to influence us more than historical ones, because they are memory which has been mixed with recent emotions. When feelings and emotions of 2008 are retrieved from our memory, the conventional wisdom leads us to turn towards investing in Treasuries.

I wish you all the best with that trade, but personally, I am a disbeliever that we will approach anywhere close to 2.5% yield on the 30 Yr Bond, let alone make new all time lows. Either way, the market will decide.

Best of luck and keep up the good work on your blog!

onegoal said...

Tiho, while I agree with your premise, my point was simply that I do not know where/when the top is or will be -(it could already be in)- I try not to predict because overbought/oversold can become more so and these one-off events can destroy a portfolio if your premise is correct, but your timing is off. That also is the toughest loss to take psychologically. Just look at Amazon at the top in 2000 bubble and its following bottom and now today. MCD, AAPL IBM and so many others. If I had to invest something and could not change my position for 10 years, 5 years or 3 years, clearly equities would be the easier/correct choice the longer out you look. I also agree that the bond bubble bursting will make the equity bubble look like a non-event so we are in a precarious spot and anyone INVESTING in bonds - especially further out on the curve to capture yield, while feelling comfortable today, will rue that day in the relatively near future (I just do not know when) You point is well made and you have an interesting blog as well. appreciate your comments as well.