Wednesday, August 14, 2013

Is tapering panic over?

I recently saw a Bloomberg story indicating that the risk-off trade that occurred in the wake of the Fed taper panic was getting unwound in the fixed income markets:
Bonds rated CCC and lower lost 2.4 percent between May 22, when Bernanke said the central bank was considering reducing or ending the asset purchases, and June 19, when he reiterated those comments.

Since then, the debt has gained 3.5 percent as yields fell to an average of 9.79 percent on Aug. 7 from a seven-month high of 10.6 percent on June 25, Bank of America Merrill Lynch bond indexes show.

Most risk assets “have probably retraced a good 75 percent on average of the widening that occurred in the late May and June period,” Michael Materasso, co-chairman of the fixed-income policy committee at Franklin Templeton Investments in New York, said in an Aug. 5 telephone interview.
Indeed, junk bond prices have rebounded smartly since the whispers of Fed tapering surfaced on May 22. However, I remain nervous about other risk trades getting unwound. In my previous post It's the risk premium, stupid!, I wrote that the end of QE signaled a shift in how the Fed wanted to communicate about risk. As QE was meant to push down risk premiums, the end of QE is likely to push up risk premiums:
With this shift in tone, don't expect the Fed to push yields down anymore. The Fed won't be pushing you to take as much risk. Consider what this means for stocks. If the economy does truly take off and earnings grow, then stock prices can rise. However, don't expect stock prices to rise because P/Es are going to go up because the Fed is pushing the market to take more risk. In fact, P/Es are more likely to fall and it will be up the the E component of that ratio, namely earnings, to do the heavy lifting.
While some credit spreads have narrowed, other carry trades appear to continue to get unwound. Consider DBV, which is an ETF as a measure of the currency carry trade. DBV tanked since May 22 and it has struggled with a key technical resistance level. Does this look like that risk is getting bought again?

As well, I had been watching the relative performance of EMB, the emerging market bond ETF, against HYG, the junk bond ETF. The EMB/HYG ratio fell through a key relative support level and has had trouble regaining relative strength.

These conditions suggest to me that while the risk-on trade may be returning in the US, it is not necessarily coming back globally. The market hasn't totally "healed" since the news of tapering hit the tape on May 22.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

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 blog 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 I may hold or control long or short positions in the securities or instruments mentioned.

1 comment:

keithpiccirillo said...

I have a question for you.
Earlier this year, Ken Heebner chose to short treasuries (duration was not mentioned) so how could I "back test", or at least try to gauge whether or not he could still have such a position on. I have been monitoring the TYX (30 year bond) and TBF (20 year bond) as rough proxies but paradoxically they have been rising the past couple of months.
His end of close NAV today did quite well, losing only 0.37%, although his home builders could have also helped account for his performance today.