• Weekly Comments for August 29, 2016

    The focus this past Friday was on the Fed's public comments regarding interest rates. I conclude that the road ahead remains murky as everything will hang on short-term stability versus long-term stability. Since short-term stability is key to naming the presidential election winner, this indicates that next Friday's unemployment data should come a little weaker than expected. This will allow the Fed to delay raising rates.

    However, I would not put too much weight on the Fed's next move as having a great influence on US equities markets. What is really important are the two rate differentials that influence big movements of money:

    1. The differential between the discount rate and the rate paid on excess reserves. (If the differential increases, money will move out of reserves, which is equities positive.)

    2. The differentials between US and Japanese rates and, incidentally, between US and European rates.

    We know that the run since last February was due to the BOJ's NIRP policy, which forced Japanese pension funds to allocate more money to US based assets since they offer better yields.

    One issue however is that nobody expected that the BOJ Nirp would push the demand for Yen cash so high that the Yen/US$ gained 20% in the past seven months. In the past 30 years, the main buyers of Japanese debt had been the Japanese public and Japanese pension funds. Since NIRP, it made more sense to keep the cash than buy negative yielding assets.



    Buying gold was also a good option. However, we can see that gold is now pulling back.



    But this can also be detected in high yielding US assets such as XLU and VNQ.





    During the recent VNQ pullback, the Effective Volume pattern was still positive, indicating accumulation. However, last week showed a different picture: large players started selling VNQ.



    I made a connection between these pullbacks and the fact that the Japanese pension fund GPIF - which manages 1.3T$ of assets - started losing money on its foreign asset investments.

    http://wolfstreet.com/2016/08/27/jap...le-not-amused/



    There might however not be a direct causality between the two: pension funds are extremely slow moving. Their last change of fund allocation (domestic/international and bonds/equities) dates from 2015, long before NIRP. No new allocation has been announced in past weeks.

    However smaller pension funds and Japanese individuals might have started liquidating US assets simply because they could not endure the Yen's strength.

    The good point is that the Yen fell heavily on Friday against the US$. In theory, this should then be US equities positive.





    We can see that the US/Japanese rate differentials bounced on Friday, making US assets more attractive to Japanese investors.



    I want to show below the two most puzzling figures that I found: the big selling in QQQ and the buying in QID. I did not find similar patterns in SPY/IWM. This means that some very large institution is betting against the NQ100, but not against the general market.





    However, when we calculate the NQ100 money flow based on each individual stock, we can see that such selling cannot be detected.



    Conclusions:

    My interpretation is that the indiscriminate buying of US assets through the largest ETFs might be reaching an end.
    I will closely watch the LEV patterns of XLU, VNQ, QQQ and QID.
    Comments 2 Comments
    1. PeterR's Avatar
      TY Pascal,

      I wonder why Japanese Funds don't FX-hedge their overseas investments.
      Are they forced by political interests to act this way ?
      Incompetence ?
      Panicky search for yield ?
    1. Pascal's Avatar
      Quote Originally Posted by PeterR View Post
      TY Pascal,

      I wonder why Japanese Funds don't FX-hedge their overseas investments.
      Are they forced by political interests to act this way ?
      Incompetence ?
      Panicky search for yield ?
      For two reasons:

      1. They really believed that Yen printing would keep the Yen low.
      2. Hedging costs and must be compared to small rates differentials.


      Pascal