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Michael Gayed: The Wrong Rates Are Rising

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If junk bonds continue to weaken, equity markets could get hurt very badly.

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What's right is what's left if you do everything else wrong.
-Robin Williams

The stock equivalent of betting on bonds is to position into Utilities, given that sector's interest rate sensitivity to growth and inflation expectations. I discussed this in the summary version of the 2014 Dow Award winning paper I co-authored

The bond equivalent of betting on stocks is to go long junk debt. 

Characteristically, and from a capital structure standpoint, junk debt has historically behaved like equities in bull markets, and has tended to fall sharply during corrections.

If junk debt goes down hard, stocks will likely follow.

Junk debt has a higher claim on assets than stocks in the event of default, so their movement gives investors a sense of how others perceive the riskiness of a company, both fundamentally and technically. 

In a bull market, you tend to see junk debt perform well relative to Treasuries, as the market perceives default risk as trending lower relative to the US government which by the power of its money printing press can't technically go bankrupt (from a purely theoretical and mechanical perspective of course).

One of the big fears that's out there is that we will enter a "rising rate environment."  When people say this, they are referencing interest rates and the yield on government bonds.

That meme has been wrong for several years, and shockingly wrong in 2014 into the end of Quantitative Easing. The rates that are rising are not in Treasuries, which our alternative ATAC Inflation Rotation Fund (ATACX) rotated fully into on a recent risk trigger. They're rising in in junk debt and that is a major problem for the Federal Reserve and high-beta bulls who continue to disregard the reality of where we are in the economic cycle, in which nearly every other part of the investable landscape is negative.

Take a look at this chart showing the price ratio of the SPDR Barclays High Yield Bond ETF (JNK) relative to the PIMCO 7-15 Year U.S. Treasury Index (TENZ). As a reminder, a rising price ratio means the numerator/JNK is outperforming (up more/down less) relative to the denominator/TENZ. A falling ratio means the opposite, and can be interpreted as credit spreads widening.


Click to enlarge

Looks like an early downtrend, doesn't it?

This could become a big problem. 

I have gone on record in several media appearances that in my travels across the country presenting on our award winning papers, no one seems to be bearish on credit. People are more worried about selling stocks than selling junk debt, yet the source of risk for stocks IS junk debt. The liquidity characteristics of junk debt are vastly different than equities. 

If panic selling occurs there, stocks could break down sharply, and no amount of central bank intervention may be able to do anything about it. 

The Fall Epiphany continues...

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The fund as of 10/12/2014 does not invest in any of the following investments: JNK, and TENZ.  Fund holdings are subject to change and are not recommendations to buy or sell any security.  Current and future holdings are subject to risk.

The 2014 Charles H. Dow Award was open to anyone with an interest in technical analysis who submitted a paper prior to the deadline. The Papers were judged on the following standards; the paper is based upon the concepts of technical analysis, the topic is substantive, the research is thorough, include the results of applying the technique to a sufficient quantity of data that covers at least one full market cycle and preferably longer, shows the application of accepted standards of testing (including but not limited to, statistical significance, Chi Square, Monte Carlo simulations, and statistical correlation), the writing meets generally accepted standards of style for publications and college level writing, the analysis and conclusions are useful and enhance the understanding of market action, a paper shall not have been previously published in any media made available for public dissemination, and a paper should be written for an audience of knowledgeable technical analysts. The judging panel reserves the right to not select a winner if it deems that there are no submissions that are worthy of being given the award.

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No positions in stocks mentioned.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

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