Category Archives: Fixed Income

Illinois And The Tsunami

Apparently the standoff between Governor Rauner and Speaker Madigan continues. As it should. Madigan’s willingness to dispense unfunded largesse to his supporters is largely responsible for the state’s financial woes. Today also the state was ordered by a Federal court to pay its backlog of Medicaid bills, which will be interesting as the state is already cash flow negative.

However the biggest issue is the unfunded state employee pension obligations. This article from Bloomberg contains a nice graphic ostensibly showing the funding levels of most states (no data for California? Really? just check this blog)

These reported funding levels are a cruel joke. These funds continue to assume 7-8% returns, despite the fact that they have not achieved them for years. Just look at the column showing the decline in funding ratio from 2014 to 2015. Not only are the assumptions high, but they are for long-term averages, so that they adjust future return estimates higher to compensate for below-average realized returns. John Hussman’s work shows more or less zero returns for the next 12 years, with the high likelihood that there will be a major drawdown in that period. Drawdowns are lethal to pension funds because the payment of benefits continues, sapping the capital base and making recovery to previous levels nearly impossible.

Pension funds used to invest in bonds. The trustees would meet once a quarter, review the actuarial forecast of liabilities and approve adjustment of the laddered bond portfolio’s maturities to exactly meet the liability schedule. Then there would be lunch and golf. The future returns would be locked in and the contributions needed to fund the bond portfolio would be obtained from the sponsor. Everyone got to sleep at night.

Then Wall Street decided that pension funds had a lot of money, and not enough was being siphoned off into Wall Street pockets. So the sales force went out, armed with charts showing that stocks had historically offered higher returns than bonds. Higher returns mean that less contributions would be needed, so fund sponsors bought the pitch. Yes, stocks have offered higher returns but for a reason – much higher risk. Well, we’ll just assume a long-term average return and surely it will average out. GLWT.

Unexpected Outcome

People seem to be surprised that the Fed’s rate hikes have resulted in rates declining. Really? It seems pretty clear that the Fed’s outlook is at odds with reality, and that rates are responding to the real outlook, which is that Fed rate hikes are a negative for an economy that is already tanking.

Fed Folly

Lacy Hunt from Hoisington Management.

Hubris

Janet Yellen today:

“Will I say there will never, ever be another financial crisis? No, probably that would be going too far. But I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will.”

Seriously? If nothing else, the coming pension tsunami virtually guarantees it. It is truly scary that this powerful person seems to live in an alternate universe.

GLWT.

No Joy In Mudville

Well the employment report this morning was a big miss to expectations on all fronts. The household report showed a net loss of jobs, and overall the quality of jobs declined as part-time, minimum wage jobs replaced full-time. However, the VIX sellers strode in to pump up stocks, leaving Treasuries as the main beneficiary of the report, with the 30-year yielding 2.86% as I write. TRIN at 2.03 shows that while the VIX sellers hold up the mega-caps, there’s a lot of distribution going on.

Oil is trading weak, in the low 47s. Wages disappointed as the employment mix changed unfavorably, even though shortages of skilled workers are widespread.

 

Bubble Blowers

Res ipse loquantur.

Blood In The Sand

The Atlanta Fed forecast for Q1 GDP now stands at 0.5% annualized, in other words not statistically different from zero or even small negative numbers.

Treasuries and equivalents are reacting accordingly, but in stocks it is the same old thing – any attempt to sell down is met with VIX slams and all manner of manipulation to preserve the status quo. Needless to say, this is just building up pressure as the prudent exit stage left, leaving the wild-eyed bulls snorting center stage while the matador sharpens his swords in the wings.

It is not so much that the bulls feel lucky,  but that they are being cozened into a feeling of security by the matador’s assistants.

Trumpets

Markets are all excited because Trump declared that the dollar is “too strong” and Ms Yellen is “not toast.” Not crumpet either, I would say, and Trump clearly knows his crumpet.

Short Memories

Consumer Confidence was reported this morning to have risen sharply, to the highest since December 2000. Stocks rose and bonds fell, taking this news as a sign of economic strength, one presumes. Obviously the buyers do not remember what happened in 2001. when the market fell to a loss of 27% by September.

Oh, and by the way, there is essentially no historical correlation between changes in the reported Consumer Confidence and changes in actual retail spending. Just sayin’

Inflation

There is much noise that the Fed will raise interest rates to combat “inflation.”

Over the last year to the end of February, wages are up 2.8% (nominal). The price of oil, as a metric for energy prices, is up 32%.

Guess what is driving “inflation.”

The Saudis are still pumping as hard as they can, but justifying it on the grounds that they are storing the above-quota output, not selling it internationally. It seems to me that a tank in Saudi and a tank in Oklahoma are pretty much fungible, except that we at least think we know how much is in the Oklahoma tanks.

The bottom line is that global inventories of oil are continuing to expand to new records, more or less on a daily basis. The EIA is forecasting that US shale is set to expand production by 109k barrels from March to April, rising from 4.853mmbpd to 4.962mmbpd, and offsetting OPEC’s entire February production cut.

At some point we are going to see a reaction and that will be the end of “inflation.” For a while, anyway.