Week in Brief: January 30

January 30, 2015

So concludes another football season. Closing the door on a year the National Football League just assume forget. The Super Bowl ended with a with an eye-popping coach's call followed a sloppy post-game brawl more reminiscent of the NHL.


An apt conclusion for a season marred by domestic violence, murder allegations, cheating conspiracies, concussion controversies, and a mute, 28-year old Seahawks running back who-despite his age and lofty pay grade-found it impossible to appease fans throughout the season with an introspective comment or two.


With the first month of 2015 in the can, stocks continue to slip, with the S&P 500 down 3 percent thus far. There's an old market adage that says, "As goes January, so goes the year." Should that hold, we're in for one hell of a ride. Of course, one need not go very far back in time to disprove it, as last year saw the S&P drop more than 3.5 percent in January, only to jump markedly from February through December.


No shortage of worries. Falling oil prices. Greece's eurozone exit. The specter of rising interest rates. Recession concerns in Europe. China. Japan. Australia. And rising violence in the Middle East and Ukraine.


We believe 2015 will see a rise in volatility. Which is why we've taken positions in VIX options and U.S. Treasuries (see Eleven Reasons We're Not Late to the T Party, below). These and other ideas have been born from the idea that equity markets have soared, even as slow-growth economies sit atop rocketing equity markets propelled by central bank cash infusions and unsustainable corporate cost-cutting. The dollar is soaring against foreign currencies. Commodities are plummeting. Still, stocks continue to rise.


Given the cacophony of questions, we find it hard to believe that the Fed will raise rates mid-year. Things remain too fuzzy. So, given the recent QE actions by the Europeans, we believe the Fed will sit on its hands for some time. Especially as inflation remains at bay for the foreseeable future.


Out in the oil fields, crude oil prices rallied 20 percent of last Wednesday's low. And while $53 per barrel would have been unthinkable six months ago, today it's an amazing jump. Especially after Baker Hughes reported that U.S. oil rig counts fell the most in a single week in nearly 30 years.


Speaking of oil, The New York Times reported that Saudi Arabia is attempting to induce Russia into abandoning support for Syrian president Assad's regime. Using the Kingdom's ability to cut production and prop up prices as bait. How's that for petro politics?


On the domestic energy front, crude futures had jumped nearly 20% from their lows. Then, West Texas Intermediate crude came under pressure in a big way. The selloff was the largest since November.


Bearish inventory data received most of the blame. The U.S. Energy Information Administration, a semi-independent unit of the Department of Energy, reported that crude stockpiles rose by 6.3 million barrels last week. Nearly double the consensus estimate. The buildup left stockpiles at their highest monthly level of the last 80 years.


So, the recent oil price decimation is strictly about economics? Too much oil; not enough demand. Proving that there are no free lunches. Yes, the U.S. is moving towards energy independence. Away from Middle East energy autocrats. But, all that supply inevitably leads to lower prices. Unless global demand ramps up. Yin and yang, people.


Greecian Formula

Greece held an election. When the smoke cleared, a nuvo Marxist party had won the election. And they refused to continue the harsh austerity measures as laid out by their northern European creditors. New Prime Minister Alex Tsipras is betting that the eurozone won't let the euro blow up. Not over what amounts to a fairly small amount of money. Especially after the money already committed to keeping it together. All of which would shatter the illusion that the eurozone can hold together despite the fact that its periphery is as profligate as teenagers on allowance day.


In essence, Tsipras is the first eurozone leader refusing to play by the harsh rules of bankers who made a terrible series of loans and now want their money back. Call it a popular revolt.


What should happen is some type of debt relief. The loans need to be restructured and made more humane. Especially as Europe faces the same problem in Italy and Spain.


All this amounts to a lot more drama in the eurozone this year. After two years of relative peace.  Making global markets grumpy. Though, given the new QE program, this doesn't mean eurozone stocks can't go higher. They'll simply do so amid more volatility.


Eleven Reasons to Like Treasurys

1. Safe haven investment. Like the U.S. dollar, Treasurys are a safe haven in times of turmoil and uncertainty. Of which there is plenty today.

2. Deflation, currently in many countries and looming in others including the eurozone, makes current Treasury note and bond yields attractive.

3. Quantitative Easing, currently in Japan and in the eurozone, provides money to invest in U.S. Treasurys.

4. Treasury yields are attractive relative to yields abroad. With the new round of QE in Japan and in the eurozone, the BOJ and ECB will be buying more government securities, sending yields even lower. The U.S. government obligation is probably at least as high quality as any of these others, and the rising dollar against the euro and yen enhances the appeal to foreign investors.

5. Foreigners are buying Treasurys. The December Treasury sale indicated as much as 50% was purchased by foreigners. While the Fed is no longer buying, foreigners and domestic investors are more than replacing Fed purchases. Half of Treasurys are owned abroad.

6. U.S. banks are buying Treasurys as they move away from lower-quality assets in compliance with new rules requiring more liquidity. Further, 60% of these assets must be backed by the federal government.

7. Long Treasurys are attractive to pension funds and life insurance firms that want to match their long-maturity liabilities with similar duration assets.

8. Junk and corporate bonds are losing favor, which helps Treasurys. The spreads between junk vs. Treasurys are widening as Treasurys rally while junk bonds sell off due to investor worries about defaults on weak energy issues.

9. The odds of a near-term Fed rate hike are receding. Early last year, the futures markets assigned a high probability to a year-end increase. Now these markets indicate that the odds are receding, and investors--and the Fed--realize that foreign central bank stimuli amounts to Fed tightening, relatively.

10. Postwar babies are aging and this favors Treasurys as older people reduce riskiness of their portfolios and favor high-quality bonds.

11. Speculators are increasingly short the benchmark 10-year Treasury note in the futures market. If the rally in Treasury prices persists, sooner or later they will be forced to buy back their shorts, adding to demand.


We believe the rally in Treasurys may continue, as the 30-year yield drops from the current 2.75% to 2.0%, perhaps by the end of 2015. If so, long bonds would provide a total return of 18.8% and the 30-year zero coupon bond, 24.6%. If the 10-year note yield drops from the current 2.17% to 1.0%, as many forecast, the total return would be 12.4%. These may seem like big gains for yield declines of only about one percentage point, but that's what happens when yields are low. In any event, we feel this bond rally has room to run. 


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Weekly Results

Major markets finished lower last week. The DJIA fell 2.87%, the S&P 500 dropped 2.77%, and the Nasdaq declined 2.58%.  Small cap stocks fell 1.98%.  And the 10-year Treasury bond yield lost 15 basis points to 1.65%. Gold dropped $9.61 per ounce, or 0.74%.


Check out JP Morgan's weekly recap here.

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