Week End Blog – High Yield Shivers, Rate Conundrums and Poker Profits

It long seemed endless, the powerful rally in high yield bonds. But investors grew more cautious in recent weeks, pushing the prices of high yield bonds down. The positive correlation with equities has broken, as stock prices did manage to keep their rally going.

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Investor worries are reflected in fund flow data. The Wall Street Journal published a graph this week, showing the biggest outflow from high yield bonds in almost a year. A surge in covenant-lite bond issues and already tight spreads make investors wary. But are they willing to give up the little extra yield that is out there, yet?

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The first graph poses another interesting question; will equities follow high yield bonds? So far, the answer is ‘no’ as investors focus on the positives for now. Equities are not really expensive and the earnings season is progressing nicely. The Dow Transportation Index keeps outperforming, a traditional confirmation that the rally is intact.

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Another positive for equity markets is the strong growth in deal-making. M&A activity is at the highest in years.

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And what about government bonds? Nothing changed, as the interest rate conundrum continues. This week, initial jobless claims dropped to the lowest level since 2006(!), another sign that the labor market is improving. That said, the Department of Labor accompanied the jobs number with warnings on week-to-week volatility, indicating this week’s number could be a one-off.

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US CPI numbers came in just shy of expectations, but also showed that the period of very low inflation is behind us. Core PCE, the main inflation indicator of the Fed and at 1.5% in May, still trails a little, however.

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With fresh inflation data available, I updated our fair value bond model, which, again, confirmed the rate conundrum. Moreover, in recent months, the gap between the fair value yield and the actual bond yield has increased quite dramatically. Based on the model, the bond yield should be something like 3.70%, 1.2% higher than the current yield of 2.50%. Even if I would add in some QE effect, 2.50% seems pretty low. But I’ll be the first to admit this has been going on for quite some time now. Still, I would expect rates to go up, not down.

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Let’s move over to Europe. Did I already mention that France is looking pretty ‘terrible’? Well, the latest PMI number, 47.6, is no exception. Interestingly, the German Ifo index also came in lower than expected. The economic and political effects of all that is going on in the Ukraine have their impact on German business sentiment.

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Meanwhile, the euro looks like it is (finally) giving in. Earlier this week it already broke 1.3460 briefly, and after the lower than expected Ifo index, the euro weakened further.

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Only one graph on China makes the week end blog, but it is an important one. The HSBC/Markit Manufacturing PMI came in at 52.0, the highest in 18 months, and well above expectations. I will not comment on the quality of Chinese growth this week, instead I will just enjoy the number.

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To round up this week end blog, I have chosen a very nice graph from The Economist. Not very good at sports? Don’t worry; you can still make a fortune playing ‘e-sports’. The Economist came up with this cool table containing the lucrative prize pools for video-game competitions. Poker is by far the most profitable online game, which might provoke a career change. To quote The Economist; ‘Gentlemen (and Gentlewomen) start your computers.’

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Until next week, have a nice weekend (blog).

3 responses to “Week End Blog – High Yield Shivers, Rate Conundrums and Poker Profits

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