Doug Nolan

Saturday, July 11, 2015

The Shanghai Composite rallied 10% this week, enjoying the “biggest two-day rebound since 2008.” Friday saw Germany’s DAX surge 2.9%. French, Spanish and Italian equities rallied about 3%. European periphery bond yields dropped (some). The S&P500 advanced 1.2%. It was, however, another rocky week for commodities.

Global markets this week approached the edge – then recoiled, as they tend to do. Over recent years it’s become the typical pattern. Wait long enough and market stress is met with whatever desperate policy response it takes at that moment. Officials in China moved aggressively to adopt their belligerent brand of “whatever it makes” central market control. Crazy stuff. And as market participants expected, the Game of Chicken saw the Greeks and Europeans eventually cave to market pressure. Markets win again. Long live the king.

So has this been just another blip presenting buying opportunities - or something much more serious? To be sure, the situations in China and Greece continue to fascinate. We’re living history real time 24/7.

My view is that China and Greece are both Broken. But that certainly won’t stop the manic markets from their short-term focus and speculative impulses. Rewards have been too reliable for too long. There’s nothing like a bout of hedging and shorting to get market operators salivating at the prospect of an abrupt reversal of hedges and short squeeze. Still, we can’t take our focus off what is unfolding in the intermediate- and longer-term.

No doubt about it: markets will do what the markets will do. The optimists – who have accumulated great financial power over the past six years – are programmed to trust that policymakers have things well under control. The possibility that this is all one historic Bubble that could now blow up at any time is wacko.

On a weekly basis, I attempt to place developments into context. I see the global government finance Bubble as the grand finale of a historic period of serial Bubbles spanning several decades. This is an extraordinarily dangerous period – financially, economically, socially and geopolitically. The Bubble has made it to the heart of the global monetary system, to the very foundation of “money” and Credit: to central bank “money” and government debt. Virtually unlimited demand for this “money” has ensured unprecedented over-issuance. Governments everywhere are desperate to contain monetary disorder that is now escalating out of control.

Massive monetary inflation has inflated precarious securities and asset Bubbles on a global basis. It has spurred unmatched wealth redistribution and inequality. And the more folks come to appreciate the permanence of this “New Normal,” the deeper the acrimony, discontent and geopolitical risk. And the bigger and more vulnerable Bubbles inflate, the greater the impetus for additional monetary inflation and only greater government control. China has built on lessons learned from the West.

I am convinced that the global government finance Bubble has been pierced. This helps explain why Greece and China (as well as Puerto Rico) have erupted simultaneously. In Europe, ECB QE has inflated bond Bubbles including those in Portugal, Spain, Italy and France, only to bypass a desperate Greece. In China, massive fiscal and monetary stimulus worked chiefly to inflate a historic stock market Bubble. In Europe, Asia and the Americas, efforts to sustain financial Bubbles only exacerbate the divergence between inflating securities markets and deteriorating fundamental prospects. At this point, a crisis of confidence in government finance and policymaking is unavoidable.

Meanwhile, markets rejoice at the notion of the Chinese resorting to blatant inflationism. The ECB will surely pick up the pace of QE. The Japanese now have an excuse to extend their reckless QE program that chiefly inflates speculation. At the Fed, a tightening of policies (not a meaningless little 25bps rate bump) is pushed out so far as to be invisible. Many global equities markets remain not far off record levels. So why are commodities so depressed?

It will be an interesting weekend in Athens, Brussels and Europe more generally. The press is alive with articles and analysis detailing the dual capitulation of nemeses Tsipras and Merkel. There may be an agreement this weekend. There will, however, be no resolution to the “Greek” crisis anytime soon.

Greece is Broken. Confidence has been shattered. The banking system is bust. So there will simply be no way to quickly bounce back from capital controls and having the banking system shuttered for a couple weeks. Importantly, the very real possibility of the return of the drachma cannot be erased from memory. “Money” wants out – out of Greek banks, out of Greek investment, out of the Greek economy and out of Greece generally. Devoid of confidence and a functioning banking system, the Greek economy is in a death spiral. It will now take a tremendous amount of new finance to keep Greece afloat. Going forward, the lurking specter of the drachma will severely hamstring recovery.

The IMF appreciates that Greece today needs a huge new assistance program. But they also have rules. Greece has already defaulted to the IMF, so new “money” will not be forthcoming from the International Monetary Fund. The ECB also (supposedly) has rules. And I suspect Mario Draghi would even agree with Bundesbank President Jens Weidmann and others: At this point Greece is hopelessly bust. Sitting on tens of billions of suspect Greece obligations already, the ECB will tread carefully here as well. OK, so who’s the sucker at the table?

I’ve always envisioned there’d come a point when the Germans had been pushed to far. Backlash would inevitably ensue. Festering anger would erupt, in unGerman-like fashion. Thus far, the “mad as hell…” Greek people have spoken. As for Germany, they have been blanketed with vitriol and unfair criticism. Far too ofter they have become the convenient scapegoat. Will German citizens now ensure that their voices be heard?

German politics is entering a period of uncharacteristic uncertainty. It appears that Chancellor Merkel, finance minister Schaeuble and other key officials now believe Grexit is necessary and inevitable. But under what circumstances will they finally bite the bullet? Seemingly the entire world is now pressuring the continuation of a course German leadership views as destined for complete failure.

Of course, the Germans don’t trust that the Greeks will suddenly start living by agreements, especially after the public referendum and with an economy in collapse. They’re appalled at the contempt Greek politicians and citizens have toward their lenders. The Germans also see political risks erupting throughout Europe. To be sure, this euro currency experiment has become a colossal problem.

The Greek people have shouted out their utter disdain for the status quo – a backdrop that today ensures a period of only greater hardship and social upheaval. It’s difficult for me to disagree with what I believe is the current view of German leadership: at this point, additional assistance should be marshaled to assist the transition of Greece outside of the euro.

This primary issue is not so-called “austerity.” It’s wrong and unproductive to scapegoat the Germans. The critical issue is disregarded: by now it’s clear that the dysfunctional Greek economy is not sustainable inside the euro zone. The harsh reality is that as part of the euro monetary regime both the Greek economy and banking system are financial black holes. It’s the wrong currency for that economic structure: throw “money” in and it leaks right out. Who is willing to keep writing these checks? Who can afford to?

Greek dislocation will continue to foster various major risks. Yet the bursting Chinese Bubble foments more dangerous global financial, economic, market and geopolitical risks.

July 8 – Wall Street Journal (Andrew Brown): “Far more than simply a market crisis, the turmoil on the Shanghai Stock Exchange is viewed by China’s leadership as a potential security threat to the regime. That helps explain the barrage of measures unleashed by financial authorities to counter a sudden market downturn that threatened to shake public confidence in the government. In that sense, the unprecedented rescue moves, including a multibillion-dollar fund set up by Chinese brokerages at the government’s behest to buy blue chips, is a preview of what’s to come following the passage last week of a national-security law that massively expands the definition of threats to the state to cover almost every aspect of domestic life, including ‘financial risk,’ as well as international affairs. The law explicitly states that economic security is the foundation of national security.”
July 10 – Financial Times (James Kynge): “On Sunday, the new graduates of Tsinghua University are set to gather in their smartest attire to celebrate degrees from one of China’s most prestigious institutions, a place that has fostered generations of political leaders. Just after the ceremony starts — according to a written agenda — the graduates must ‘follow the instruction and shout loudly the slogan, ‘revive the A shares, benefit the people; revive the A shares, benefit the people’.’ To outsiders, this may seem a curious sentiment with which to send China’s best and brightest forward into their careers. More commonly, the tropes of patriotic education are concerned with issues such as national unity and strength, socialist ideology, the recapturing of China’s past glories and washing away a century of shame inflicted by imperialist Japan and western powers. But the elevation of A shares into this rarefied pantheon of national priorities hints at the centrality of the battle that Beijing has joined to restore calm to its slumping stock markets and, in the process, revive its own credibility. This is because the A-share rout risks something much bigger than lost investments; the Communist party’s basic definition of how power and the people are supposed to interact is also in jeopardy.”
I’ve expected the bursting of the Chinese Bubble to be “frightening.” It’s commenced. I never really contemplated things would quickly turn so bizarre. “Revive the A shares, benefit the people.” Investigating “malicious short selling.” The banning of selling by large holders and company insiders. Forcing institutions to buy. Blaming rumor-mongering and foreign meddling. Media gag orders against negative reporting. Widespread trading halts and illiquidity. And the bear market is barely underway… So much in China is Broken.

“The bloom is off the rose,” as they say. Perhaps Beijing can restore some semblance of domestic confidence in Chinese equities. Tall order. But I fully expect foreigners will be looking to get out. As a foreign shareholder, would I trust Chinese communist officials to protect my rights and financial interests? Going forward, should we expect a focus on the interests of shareholders or the leadership’s political interests and fixation on global power? While the crowd ponders buying the dip, I increasingly question whether China at this point is even “investable”?’’

Some of the reporting is reminiscent of the initial subprime eruption. The general expectation is that stock market losses won’t have a significant impact on consumer spending or the overall Chinese economy. Only a small part of the population will be impacted. The government will protect against broader economic effects.

From my perspective, the key issue is the impact the stock market dislocation will have on the broader Chinese Credit Bubble. While very few appreciated it at the time, subprime amounted to the initial piercing of the mortgage finance Bubble. It represented the catalyst for a mortgage Credit tightening, escalating risk aversion, de-leveraging and a self-reinforcing general tightening of Financial Conditions. There was ebb and flow, repeated policy responses and bouts of wild volatility. Confidence proved resilient longer than I expected, with everyone somehow remaining oblivious to the ramifications of the bursting of a major financial Bubble.

Prior to recent tumult, there were already serious cracks in Chinese Credit. Housing Credit had slowed sharply, while commodities related Credit issues were also likely taking a toll. The government’s reflationary stock market gambit has been instrumental in sustaining rapid system Credit growth – massive ongoing Credit expansion required to keep a highly maladjusted and unbalanced economy levitated. With equities market Credit contracting, I expect a forthcoming huge issuance of government debt in the name of “system stability.”

I’ve seen a couple analysts question what China’s response to its faltering stock market Bubble means in terms of the ascendancy of the renminbi to an international “reserve currency.” This is an extremely important issue, although I’ll come at it from a somewhat different perspective: What do cracks in the Chinese Credit Bubble, the bursting of China’s stock Bubble and their heavy-handed and bizarre responses mean to the general stability of the Chinese currency?

I do not believe one can overstate the vital importance of the stable renminbi link to the U.S. dollar. I have posited that this “peg on steroids” has incentivized an enormous flood of “hot money” into China and, more specifically, into high-yield Chinese debt instruments. It is this massive speculative “carry trade” that has Chinese officials so jittery. It was this “hot money” Bubble that had officials backtracking from their 2014 managed currency devaluation. And it was the combination of faltering apartment and “hot money” Bubbles that was behind policymakers rolling the dice on the reflationary wonders of the stock market (they saw it work in the U.S.!) It could all come crashing down.

The renminbi began the week at 6.2055 to the U.S. dollar, right where it ended 2014. China’s currency ended the week down a meager 0.06% to 6.2094. In spite of all the market tumult and uncertainty, the renminbi peg to the dollar has been solid as a big boulder. So are we to believe that Chinese officials can control the stock market, control their Credit system, control the economy, control the media and “foreign meddling”, control financial flows, control speculation and, as well, control the currency peg to the dollar? I know, I know: they have control over $3.7 TN of international currency reserves. I’ve always believed this reserve position was much more vulnerable to disorderly “hot money” flight than commonly perceived. We may yet find out.

Throughout their historic boom, the Chinese have bent all kind of “rules” – economic, financial and otherwise. Can they continue to flout the fundamental rule that economic, financial and market instability spurs currency volatility and vulnerability?

I have posited that a proliferation of global currency “carry trades” (borrowing/leveraging in devaluing currencies to speculate in higher-yielding instruments in other currencies) is the unappreciated key source of speculative finance helping to fuel the global government finance Bubble. And for the most part, to this point currency markets have remained extraordinarily orderly and predictable. Draghi has orchestrated an orderly devaluation in the euro, essentially granting free “money” for those borrowing/shorting the euro to finance securities purchases elsewhere. Kuroda is going on three years of QE Fest, devaluing the yen and fomenting what I believe is one of history’s great speculative plays (“yen carry trade”). The Chinese have certainly done their part, with their currency peg to the dollar ensuring easy speculative profits to anyone willing to short the dollar, yen or euro and use the proceeds to leverage in high-yielding Chinese Credit instruments and securities.

The euro is vulnerable to Grexit. The crowded euro short has as well shown susceptibility to squeezes. The yen this week again indicated potentially robust demand in the event of a bout of de-risking/de-leveraging. The yen gained a quick 1.5% against the dollar during Wednesday’s nervous trading. At this point, no one is questioning China’s commitment to its currency peg. But they sure have their fingers in a number of leaky dikes.

I question whether currency markets are about to enter a period of acute volatility. Could they crack? It’s been awhile since the last episode of serious currency market tumult. I suspect a tremendous amount of “carry trade” leverage has accumulated since then.


The debt trap

The developed world has not found an answer to its debt problema

Jul 11th 2015

ALMOST eight years have elapsed since the financial crisis took hold in August 2007 and still the same issues are being fought over. Who should suffer the most pain—creditors or debtors?

Is the best way to achieve growth short-term fiscal stimulus or long-term structural reform?

And, in Europe in particular, how does one reconcile local democracy with international obligations?

Debt is a claim on future wealth: lenders expect to be paid back. The stock of debt accordingly tends to expand at moments of economic optimism. Borrowers hope that their incomes are set to rise, or that the assets they are buying with borrowed money will increase in price; lenders share that enthusiasm.

But if wealth does not rise sufficiently to justify the optimism, lenders will be disappointed.

Debtors will default. This causes creditors to cut back on further lending, creating a liquidity problem even for solvent borrowers. Governments then step in, as they did in 2008 and 2009.

The best way of coping with too much debt is to spur growth. But developed countries, even America, have struggled to reproduce their pre-crisis growth rates. So the choice has come down to three options: inflate, default or stagnate.

The inflation option means that nominal GDP rises rapidly, reducing the ratio of debt to GDP.

The main constraint on this strategy is the speed with which creditors react by forcing up interest rates on newly-issued debt. The longer the maturity of their existing debt, the easier it is for governments to use this option.

In practice, there has been very little inflation in the developed world. (Countries in the euro zone do not control their own currencies so have no power to inflate the debt away in any case.)

The debt burden has been controlled by “financial repression”: holding real rates at very low, or negative, levels. By making it easier for borrowers to service their debts, this has staved off a repayment crisis in many countries, but it has not made much of a dent in the overall debt burden.

The Greeks did manage to default on private-sector debt in 2012, but this wasn’t enough help given the collapse in their GDP in recent years. And the problem with default, when debt is so widespread, is that it simply shifts the liability somewhere else. If a country’s banks hold a large amount of government debt, and the government defaults, then the banks will need to be rescued by the government, making the problem circular. Countries have been defaulting to foreign creditors for centuries, of course, and they tend to be forgiven by investors after a few years. But economic conditions get pretty scary in the interim, as the Greeks may find out.

So if inflation has been hard to achieve and default looks like a risky option, then stagnation (or near-stagnation) ends up being the outcome. That has been the case in Japan, where sluggish economic growth has been the norm since its asset bubble burst in the early 1990s. But stagnation only postpones the problem. Japan has faced less pressure than most, since it owes money mainly to its own citizens—it does not have to worry about foreign creditors. Yet even Japan has tired of the situation: Abenomics was designed to get the country out of the trap by generating more growth and inflation.

The EU has been heading down the Japanese route. Both places face demographic problems that will sap their growth indefinitely. That increases the need for offsetting improvements in productivity, but reforms to that end face fierce political resistance.

Like Japan, the euro zone has an internal, not an external, debt problem. However, the current crisis has shown that there is not enough political solidarity to support outright burden-sharing. Intra-European transfers are seen as a zero-sum game, in which any aid to Greece is a loss to other nations in the bloc.

This has been a flaw in the euro project from the start. The only answer is political union with a central fiscal authority. But that would require voters in the 19 euro-zone member states to give up sovereignty—something the Greeks are not alone in resisting. And the EU’s sluggish growth is adding to the disillusionment with Brussels among European electorates.

So what does all this mean?At the very least, an endless series of crises and European summits.

It also means that Syriza will not be the last insurgent party to gain power, that central banks will have to keep interest rates low in order to keep the system going and that, given current high valuations, portfolio returns for investors are going to be mediocre for the foreseeable future.

Barron's Cover

A New Approach to Bonds

Bond funds tend to hold their value—unless rates are rising. Is it time to dump yours?

By Sarah Max

July 11, 2015

Robert Johnson has spent most of his career studying and teaching modern portfolio theory. So it may come as a surprise to some that Johnson, 57, has not a penny of his portfolio in bonds.
“The absolute best-case scenario for bond investors is that rates remain low in the near future, which means your best hope is the status quo with no upside,” says Johnson, president and CEO of the American College of Financial Services. “If you lock in bonds at these levels, you’re locking in a purchasing-power loss.”
Not long ago, the notion of a no-bond portfolio would have seemed crazy. But what’s really crazy, says Johnson and many of his peers, is clinging to the conventional wisdom. “What are bonds supposed to do?
They’re supposed to preserve wealth, provide periodic cash flow, and hopefully some price appreciation,” he says. At the moment, however, they aren’t offering much in the way of income, and there is a real possibility that investors could lose money.

Beyond Bonds: Finding Income of 4%-5%

Portfolio manager Anne Lester of JP Morgan is scouring the globe for interest-bearing investments. Here’s where she’s getting them.

Although the bond market is anything but simple, the math is. The bull market for bonds began in September 1981, when the yield on the 10-year Treasury peaked at 15.84%. Over the past three decades, yields across the board have steadily fallen, with the bellwether 10-year dipping as low as 1.63% in May 2013. Recently it has hovered around 2.3%. As yields have fallen, bond prices have gone up, and up, and up.

That worries Johnson, and it’s the reason that Warren Buffett declared, in 2012, that bonds should come with a warning label. When interest rates do finally swing the other direction, investors will most likely flock to newer, higher-yielding bonds, and the prices of today’s bonds will decline, perhaps precipitously.

Investors who own individual bonds and hold them to maturity are insulated, of course; barring a default, they’ll still get their principal and interest.

Bond mutual funds and exchange-traded funds are a different story. These funds, by and large, don’t aim to hold bonds to maturity, and even if they did, the strategy works only if investors stay put. If fund investors run for the exit, managers have no choice but to sell into a declining market.

That exit may be already starting. In the first five months of the year, investors put more than $75 billion into taxable and municipal-bond funds, according to Lipper. But in June, the trend turned, with investors withdrawing a net $17 billion. If that presages a bigger exit, bond funds could fall sharply.
Bond funds tend to hold their value -- unless rates are rising. Is it time to dump your bond fund? Illustration: Gary Hovland for Barron's
“This might be blasphemy, but if you’re worried about rising rates, you’re almost better sitting on cash than going into a bond fund,” says Shari Burns, managing director of United Capital Financial Advisors in Seattle.

Further complicating matters are growing concerns about liquidity in the bond market. Broker-dealers are no longer willing to buy bonds unless they have a buyer already lined up. Meanwhile, the proliferation of ETFs has paired ultra-liquid vehicles with not-so-liquid assets. “If you have a bond fund or an ETF, you don’t have any maturity. That’s not a bond; that’s a stock,” says Ron Weiner, CEO of RDM Financial Group, a wealth-advisory firm with offices in Connecticut and Florida. “There is a real, real risk in bond funds.”

THAT RISK DOESN’T get talked about very often, and most investors approach retirement with a big stake in bond funds. “A lot of individual investors don’t understand that they could actually lose money in their bond funds,” says Raj Sharma, a managing director of Merrill Lynch Private Banking and Investment Group in Boston. Though he hasn’t abandoned bonds altogether, he does think investors could stand to lighten up on fixed income. “What you’re doing is rebalancing and moving away from an extremely overvalued asset class,” he explains. “You wouldn’t buy a stock with a price/earnings of 100, so why would you buy a bond that is overvalued?”

The answer in the near term may be to shift money from bonds into cash. A longer-term solution is more problematic. “It’s hard to figure out how to balance the need for yield against the risk of assets falling,” says Hersh Cohen, co-chief investment officer for Legg Mason’s ClearBridge Investments group.

Mathematically, a higher allocation to stocks makes sense, says Cohen, who is manager of the ClearBridge Dividend Strategy fund (ticker: SOPAX). “But most people don’t have the temperament to have all their money in stocks,” he says.

NO DOUBT, ONE OF THE BIG arguments for sticking with bonds is that they are still the best insurance policy against stock market declines. “People have a short-term memory of the role fixed-income plays,” says Jay Sommariva, a senior portfolio manager at Fort Pitt Capital Group in Pittsburgh. Case in point, he says, is 2008, when “once the dust settled, the bonds that didn’t have credit problems bounced back before stocks.”

Even so, investors could be in for a rude awakening. The bond market has, for the past three decades, been exceptionally generous to investors. “Because rates have been falling, every time an investor wanted to get more conservative, there was very little to give up [in return],” says David Lafferty, chief market strategist of Natixis Global Asset Management in Boston. “Bonds do still play a role, but investors need to reset their expectations.”

There was a time when bonds could do it all—provide stability, income, and capital appreciation.

Those days are over. Now, investors need to pick their focus. And that focus should be determined by an investor’s need, rather than a hackneyed asset-allocation plan that decrees 55-year-olds dump 55% of their assets into bonds.

But even if the conventional wisdom no longer holds true, the advice is very much the same as it ever was: Know thyself as an investor, and construct a plan that suits your timeline and temperament. That is how Johnson arrived at his no-bond portfolio. “There is a willingness and an ability to take on risk, and I have both,” says Johnson. “I’m gainfully employed and have no plans to retire any time soon. But there are people in the same exact situation who couldn’t sleep at night if the stock market fell 20%.”

MOST INVESTORS NEED some form of stability, but that can mean many different things. For some it’s psychological: When the stock market hits the skids, it’s what keeps them from making short-sighted decisions. For others, stability has practical implications: They need a certain amount of money at the ready, whether for an impending expense, or in the case of retirees, to cover living expenses.

If you fall into the first camp—you want to minimize the emotional stress of a stock market correction—a small allocation to an intermediate-term bond fund will still offer ballast against big stock market losses. “If rates [for the Barclays U.S. Aggregate index] were to go up one percentage point, that represents a 5% decline in price,” says Ken Leech, chief investment officer for Western Asset Management. “But a 5% decline is, by an order of magnitude, different from the losses you could see in stock [selloffs].” Last week’s Greek debt drama exemplifies this—bonds rallied.

Market-neutral funds (also known as long-short and absolute return funds) are designed to offer stability in turbulent stock markets. These funds, such as Vanguard Market Neutral (VMNFX) and TFS Market Neutral (TFSMX), use short-selling strategies to smooth out market volatility. “The idea with most of them is to offer performance properties similar to bonds,” says Josh Charlson, director of manager research, alternative strategies at Morningstar. The big difference, of course, is the source of stability. With these funds, he says, it comes from total return, not yield.

If your need for stability is attached to a specific goal or need, such as a tuition bill or down payment—and you need to access those funds within the next decade—you’ll want to take a different approach. If your time horizon is short, say one-to-two years, it’s probably best to stick with cash, since even short-term bond funds could experience losses in the near term.

RETIREES LOOKING for a place to stash five or 10 years’ worth of living expenses, though, run the risk of inflation outpacing the paltry returns on cash. What about hiding out in cash until rates go up? “That would be the right strategy if rates move up quickly,” says Leech. Of course, timing the bond market is even more difficult than timing the stock market. “Plenty of people have tried to capture interest rates and failed,” Leech adds.

A ladder of individual bonds may offer the best of both: stability and a systematic approach for trading up to higher-yielding bonds as your old bonds mature. “We don’t know when rates will go up, and it doesn’t matter to our clients,” says Weiner, who started moving his clients from bond funds into individual bonds in 2013. His model portfolio now calls for 75% of his clients’ bond holdings in individual bonds with laddered maturities; the rest is in short-term strategic bond funds.

This is no small commitment. You can get away with as little as $100,000 to ladder Treasuries, though some advisors will insist on more. A typical Treasury ladder might start at two years and go out to 10, with bonds maturing in two-year increments. At the current rates—1.25%, 1.77%, 2.07%, 2.21%, and 2.33% respectively—this ladder will average 1.57% per year for the first few years.

It’s just enough to keep pace with inflation, says Burns, and, as rates rise, the money used to buy each new rung of the ladder will be invested in higher-yielding bonds. If you’re looking for the higher yields of corporate bonds or the tax advantage of municipal bonds, you’ll need several times as much to achieve the requisite diversification.

Recognizing that many investors want the predictability of a bond ladder but the diversification of a fund, some firms have launched defined-maturity ETFs. These funds, such as Guggenheim BulletShares, are designed to mimic holding bonds to maturity—but these strategies still depend on your fellow investors staying put.

FOR INCOME SEEKERS, bonds are still the go-to asset for predictable payouts. Even while rising rates are ominous, the underlying demand for bonds remains strong. This is true of institutions and individuals, in the U.S. and the rest of the world.

At the same time, rates are even lower globally, and aging investors seem to be creating constant demand for bonds. “The rich are getting richer, and they’re getting older,” says Andy Chorlton, head of U.S. multi-sector fixed income for Schroder Investment Management, the United Kingdom–based asset-management giant.

That’s particularly good for tax-free municipal bonds, which offer relatively high after-tax yields.

Investors need to be choosy about credit quality, Chorlton says, but rising rates are less of a worry since municipal bonds tend not to move to the same extent as Treasuries. When rates do fall, so-called crossover buyers, or institutional investors who normally wouldn’t own tax-free muni bonds, move in and drive prices back up. “I don’t think investors need to fear rising rates in the muni market,” says Dawn Mangerson, a managing director at McDonnell Investment Management in Chicago. “One thing that helps keep a lid on yields is the supply of new issues, which is already limited and would likely dry up if rates rose in a meaningful way.”

Given that one of the biggest boosts for munis comes from their after-tax equivalent yields, your state of residence is a driving factor. If you live in a state with high income taxes and a large muni-bond market, such as California or New York, there are more opportunities and incentives to go this route.

High-yield muni bonds are also worth considering, says Merrill’s Sharma, if you are looking for income but can withstand some volatility. “With the improving economy, there is less risk of defaults,” he says.

Meanwhile, their yields—recently about 4.5%—dampen the blow of rising rates. Given their complexity, these are best bought through a bond fund, such as the Delaware National High-Yield Municipal Bond (CXHYX) or the Nuveen High-Yield Municipal Bond (NHMAX).

FOR YOUNGER INVESTORS—and older ones, too—there is an appeal in the keep-it-simple approach of taking some bond risk off the table. Hold more cash or cash-equivalents (for example, ultrashort-term bond funds) than you would typically, and keep the rest in a diversified portfolio of stocks, including dividend payers.

“You’re getting a bit of a yield—and it’s commensurate with bonds—yet over the long term, the values of those securities will likely increase and so too should the dividends,” says Johnson. Indeed, the current dividend yield on the Standard & Poor’s 500 is 2%, and companies ranging from Johnson & Johnson (JNJ) to Wal-Mart Stores (WMT) have consistently raised their dividends for decades.

This isn’t to say that dividend-paying stocks aren’t vulnerable to rising rates. Any income-producing asset could lose value if higher-yielding alternatives come on the scene. Still, the prices and dividends of these stocks are more closely linked to their own prospects.

Jeremy Kisner, a certified financial planner with Surevest Wealth Management in Phoenix, notes that dividend growers may do better than those focusing on the absolute highest-dividend stocks. More importantly, consider the effects of rising rates on the underlying businesses, for better or worse. Rising rates bode well for most financial stocks, says Kisner.

“When rates go up, that’s good for banks, which are still trading at a discount,” he says. Utilities, conversely, could be hit with a double whammy from rising rates: At the same time that their dividends will be less appealing, they are large consumers of debt. “Some stocks that were traditionally thought of as stable could be more volatile,” he adds.

For investors who want income but don’t want to have to think through all of the many considerations, the fund industry has responded with so-called income-builder funds, such as the Franklin Income (FKINX) or the Thornburg Investment Income Builder (TIBAX). “If you don’t have time to put together your own bond proxy,” says Merrill’s Sharma, “income-builder funds will effectively do it for you.” Just keep in mind that they won’t do everything. 

Crippled Greece yields to overwhelming power as deal looms

'If it comes to the drachma, Greek resorts will have to be protected by armed guards, and that is not the sort of tourism we want,' said the country's tourist chief

By Ambrose Evans-Pritchard

5:13AM BST 11 Jul 2015
Bob cartoon, July 11

Greece's Left-wing Syriza government has agreed to draconian austerity terms rejected by the Greek people in a landslide referendum just five days ago, capping one of the most bizarre political episodes of modern times.

The surrender was confirmed by the Greek parliament by 251 votes to 32, with eight abstentions including several senior members of the ruling Syriza party.
Prime minister Alexis Tspiras sought to put the best face on a painful climbdown, recoiling from a traumatic fight that would have led to Greece's ejection from the euro as soon as Monday. He implicitly recognised that the strain of capital controls and economic collapse has been too much to bear.
“We are confronted with crucial decisions. We got a mandate to bring a better deal than the ultimatum that the Eurogroup gave us, but we weren't given a mandate to take Greece out of the eurozone,” he said.
Hopes for a breakthrough set off euphoria across Europe's stock and bond markets, though Greece still has to face an emergency meeting of Eurogroup ministers on Saturday, and probably a full-dress summit of the EU's 28 leaders on Sunday.

A top Greek banker close to the talks said there is now a "90pc chance" of clinching a deal, thanks both to intervention behind the scenes by a team from the French treasury and to aggressive diplomacy by Washington.

Inflows of tourist cash means that there is still €2.75bn of liquidity available, enough to keep ATM machines stocked until Monday night. Greeks will be able to withdraw the daily allowance of €60. Pensioners will continue to draw €120 a week. 

"We are preparing to open up branches for normal banking services next week. Capital controls will last for a while but not for as long as in Cyprus. The situation is very fluid but we don't think we will need a major recapitalisation of the banks," said the source.

An estimated €40bn of money stashed in "mattresses" should flow back into deposits as confidence returns. One or two of the weaker banks may need a capital boost of €10bn to €15bn, involving a potential "bail-in" of savings above the insured threshold of €100,000.

Any deal almost certainly means the European Central Bank will lift its freeze on emergency liquidity for the Greek financial system as soon as Monday, entirely changing the picture.

Syriza accuses the ECB of deploying "liquidity asphyxiation" to bring a rebel democracy to its knees.

The ECB freeze has been a controversial political and legal move - given the bank's treaty obligations to uphold financial stability - and is likely to be dissected by historians for years to come.

A final deal to end the long-running saga is still not certain. The outcome depends on how much debt relief the creditor powers are willing to offer, and whether it is a contractual obligation written in stone or merely a vague promise for the future.

Yet the broad outlines are taking shape after Syriza agreed to three more years of fiscal tightening, with deep pension cuts and tax rises, and a raft of "neo-liberal" reform measures that breach almost all the party's original red lines.

Panagiotis Lafazanis, head of Syriza’s Left Platform, protested bitterly, saying it would be better for Greece to restore sovereign self-government and return to the drachma. "The most humiliating and unbearable choice is an agreement that will surrender and loot our country and subjugate our people," he said.  

Party insiders did not hide their disgust, though Mr Tsipras managed to quell a full-scale mutiny. "It is a total capitulation. We never had a 'Plan B' for what to do if the European Central Banks cuts off liquidity and the creditors simply destroyed our country, which is what they are doing," said one Syriza veteran.

"We thought that when the time comes, Europe would blink, but that is not what happened. It should have been clear since April that the markets were not going to react to Grexit."
Yanis Varoufakis, the former finance minister, said he would back his successor and close friend, Euclid Tsakalotos, but only for the next two days.

Euclid Tsakalotos, Greece's finance minister

"I will reserve my judgment. I have serious doubts as to whether the creditors will really sign on the dotted line and offer substantive debt relief. My fear is that they will make all the right noises, but then fail to follow through, as in 2012," he told The Telegraph.

Mr Tsakalotos told the Greek parliament that Syriza aims to secure a swap of $27bn of Greek bonds held by the European Central Bank for longer-dated bonds at lower interest rates. "Many of Greece's debt demands are going to be accepted," he said.

The government is also pushing for an extension of maturities on €145bn of bail-out loans (EFSF) deep into the middle of the century to avoid a fresh crisis when they come due as a clump in the early 2020s.

The US, France, Italy, the International Monetary Fund and the top officials of the EU Council and Commission have all now called openly for debt relief, a crucial shift in position that clears the way for a possible accord.

Even German Chancellor Angela Merkel has opened the door to an extension of debt maturities. The difficulty is that this alone is no longer enough.

Greece has called for €53.5bn in fresh funds over the next three years. While much of this is recycled back out to cover maturing debts, the package requires a vote by the German Bundestag.

Germany alone can veto any deal since it has more than 15pc of the voting weight in the bail-out fund. An estimated 100 MPs from Mrs Merkel's Christian Democrat family have threatened to vote no.

"We have ended up with a standard bail-out package," said Costas Lapavitsas, a Syriza MP and one of five rebels calling for the nationalisation of the banks and a return to the drachma.

"What has happened shows that radical change is impossible within the constraints of monetary union," he said.

Yorgos Kaminis, the mayor of Athens, said the stand-off with creditors has brought the country to its knees. "Greece faces a national catastrophe. If there is no deal, we will be obliged to go back to the drachma immediately. Our country will be totally isolated. You can't be a member of Europe if you are blackmailing the whole world," he said.

Greek industry and the tourist sector are already preparing drastic steps to defend themselves if talks collapse and the government is forced to introduce IOUs and a parallel currency.

Alexander Kaminis, head of the Greek Tourism Confederation, said he fears a breakdown of social order. "If it comes to the drachma, we'll have to take exceptional measures. We'll be looking at a situation where Greek resorts have to be protected by armed guards, and that is not the sort of tourism we want," he said.

Greece is packed with travellers at the moment but Mr Kaminis said late bookings have dropped by 30pc. "This is going to materialize in a month or two," he said

Constantine Michalos, head of the Hellenic Chambers of Commerce and a food importer, said the economy has reached near paralysis. "There is no system in place for Greek companies to transfer money about. Our life-blood has been shut off," he said.

"People are depleting their stocks. We are going to start seeing shortages of meat by the end of the week."

The network of chambers in the Greek islands reports that the local payments system is breaking down since nobody wants to accept transfers into backing accounts that could be seized at any moment. "The ferry operators are demanding cash up front to bring in fuel and supplies," he said.

"The whole is economy shifting to cash. You can't really import anything, and 40pc of Greek GDP is based on imports," said Haris Makryniotis, who helps small businesses for Endeavor Greece.

Mr Makryniotis said his group is advising an olive processor that can't import the tin its needs to make cans, and a peach producer that can no longer obtain wooden crates for transport. "Stocks were already low because financing costs were so high. These companies are both reducing a shift this week, and they will soon be facing a complete stop," he said.

"We're going to see severe shortages of basic food in Greece in less than a month," he said.
This is the ghastly reality that Alexis Tsipras faces. He promised the Greek people that he would achieve a miracle: an end to austerity and the hated Troika Memorandum, without poisoning Greece's ties to Europe and without having to give up the euro.

This was always dangerous political gambit. It has caught up with him. His only possible redemption at this point is to bring back the prize of debt relief.

Up and Down Wall Street

The Great Fall of China and Its Stocks

Furious manipulation by Beijing helps pump up the nation’s stock markets, but how long will these maneuvers boost share prices? Also, it’s now Grimbo for Greece, and Yellen gets ready to testify.

By Randall W. Forsyth           

July 11, 2015 1:48 a.m. ET

It has been nearly three years since European Central Bank President Mario Draghi made his famous declaration to “do whatever it takes” to save the euro. Evidently, that vow has been translated into Mandarin and put fully into practice in combating a crash in China’s stock markets—even if what it takes means going against the precepts of anything resembling a free market.

Confronted with a 27% loss of market value from mid-June through last Wednesday that Citigroup research estimates totaled some $4 trillion—twice the size of India’s economy—Chinese authorities went “all in,” as Evercore ISI China watcher Donald Straszheim put it.

One might have thought they already were doing whatever it takes with a blockbuster array of measures to stem the declines. Those involved conventional monetary-easing measures, including interest-rate cuts, followed by a brokers’ fund to pump money into stocks, suspension of initial public offerings, and restrictions on short-selling. Then came rather novel moves, including the suspension of trading of about half of all stocks, halts of selling by major stockholders of big listed companies, and investigation of “malicious” short-selling.

When there were allegations a year or so ago by author Michael Lewis that the U.S. stock market was “rigged” by high-frequency traders, many investors were shocked at the assertions.

Their surprise probably would be seen as naive by Chinese investors and officials.

Some major institutional investors on this side of the Pacific spoke approvingly of the measures taken to right China’s markets, which a number likened to an adolescent going through the throes typical of that age.

These investors appear sympathetic to Beijing’s view that markets are instruments of government policies, not entities that should be permitted to operate freely on the basis of some fairy-tale notions of classical Western liberalism.

Not that U.S. authorities are averse to doing the same, as noted in this column on recently (“America and China Seek to Collar Their Markets,” April 23). And neither are European or Japanese policy makers.

Whatever the case, it appeared by week’s end that resistance to the Beijing authorities’ exertions were futile. The Shanghai Composite bounced 5.8% on Thursday and another 4.5% on Friday, winding up 5.2% on the week.

Steve Wang, chief China economist at Reorient Capital in Hong Kong, writes that short-selling collapsed by some 75% from the peak. “That demonstrates that despite the patchy, uncoordinated, and highly criticized policies being rushed out by Chinese financial regulators, the risk-reward for going against the state is not worth the effort,” he adds. As a further indication of the regulators’ firepower, a record $13 billion flowed into China equity funds in the week ended on Wednesday, concentrated in local exchange-traded funds investing in domestic A shares, Bank of America Merrill Lynch’s strategists observed.

The impact of the China stock selloff was being dismissed as affecting only 90 million retail investors out of a nation of more than one billion people (the vast majority of whom remain in rural poverty and are unlikely to use their few dollars of daily earnings to day-trade). Yet, the knock-on impact on the real world of commodities was clear.

Part of that is technical, explains Renee Haugerud, founder and chief investment officer of the Galtere hedge funds. Copper and other commodities were used as collateral for loans, including those for stock trading, which were paid off, voluntarily or otherwise, as the market tanked.

But the slide in commodities also reflects weaker fundamentals, key among them the slowdown in the previously heady economic growth in China. Indeed, prices of many key industrial commodities have fallen near the lows hit in the wake of the 2008 financial crisis.

Barron’s trusty research maven, Teresa Vozzo, reports that copper is back to its 2009 levels and is down 45% from its peak in February 2011. Iron ore also has returned to its 2009 prices and has fallen a stunning 75% from its high, reached at the same time. Silver is off 68% from its peak in April 2011, while gold is down 39% from its September 2011 high. And, of course, crude oil has slid almost exactly 50% from its $107-a-barrel peak of about a year ago.

For an economy such as China’s, which depends on imports of these raw materials, lower prices would be expected to be an elixir. But while oil’s fall reflects the expansion of U.S. supplies, the drop in other commodities to postcrisis lows speaks more to dwindling demand.

Even if China’s stock market has found a bottom, the extraordinary measures have hurt the credibility of the nation’s officials and their reforms. Long-time bear Albert Edwards at Société Générale writes (in what he emphasizes is the “alternative view” from the bank’s house opinion) that his confidence in China—born of a previous relative lack of hubris on the part of the Chinese compared with their Western counterparts—has been shaken.

It wasn’t just the latest “thrashing around with extreme measures” or that “the state-run media are blaming short sellers and foreigners for the free fall.” Those steps will prove only temporary, he maintains. The real problem was their encouragement of a bubble fueled by individual investors and touted by the state-run media as an affirmation of government policies.

In fact, the virtual doubling of the Shanghai Composite since November was an effect of an expansionary monetary policy that pumped up a bubble, while the real economy flagged. Whether the equity market’s bounce can be sustained for more than a couple of days, especially when the stocks in which trading has been halted come back into play, remains to be seen.

THE GLOBAL MARKETS ENDED the week in Grimbo—the latest acronym, describing Greece’s state of limbo ahead of Sunday’s deadline for yet another deal for the beleaguered nation’s debt.

In a nearly incomprehensible turn of events, Alexis Tsipras’ leftist Syriza government won a stunning “no” vote in the prior weekend’s referendum on austerity measures. Then his new finance minister submitted a new proposal that appears pretty austere and close to the deal that Greece’s creditors were previously offering—which lapsed before the vote. So, after two weeks of turmoil, capital controls, and the shuttering of Greek banks, a similar offer is being considered.

That’s after some major global banks had changed their base-case outlooks to Grexit—Greece’s exit from the euro and reintroduction of the drachma—perhaps through the issuance of IOUs that would circulate as money, similar to what California did during a budget impasse a few years ago.

Will Greece and its partners in their contentious marriage of convenience decide again that it’s easier to stay together? More importantly in the short term, when will Greek banks reopen and allow the flow of money and credit needed for food and pharmaceuticals, and for businesses to pay suppliers to resume?

Until there are answers, it’s Grimbo.

A KIND OF LIMBO also gripped the New York Stock Exchange Wednesday, when a software glitch halted trading for more than three hours. But notwithstanding the breathless copy from a certain pink paper, “trading all $28 trillion of stocks listed” on the Big Board wasn’t halted, but rather continued on the various exchanges that compete with the NYSE. (Unlike the Chinese bourses, U.S. exchanges haven’t figured out how to shut down only declining stocks.)

Coming just days after physical open-outcry trading of interest-rate futures ended on the Chicago Mercantile Exchange, the NYSE halt demonstrated that classic trading floors have mainly become sets for cable financial news.

The visual aspect provides a focus for TV, while the far more serious problem of the lack of liquidity in vital credit markets does not. Yet, at a recent get-together with the head of a hedge fund, the chief of trading at a major bank, and the top investment officer of a huge pension fund, the inability to do transactions because of regulatory constraints was topic A from the first pour. But that doesn’t make good video.

After rebounding in the wake of China’s recovery, the U.S. stock market this week will have to contemplate the mundane question of earnings as the reporting of second-quarter numbers begins in earnest. As Johanna Bennett wrote in Weekday Trader, results are likely to be good enough to top forecasts of the first year-on-year decline since 2012.

Viewing the flattish showing by stocks this year, David Rosenberg, chief economist and strategist at Gluskin Sheff, sees the E (earnings) having to play catch-up to the P (price) in the market’s price/earnings ratio. Stocks have enjoyed a 15% price appreciation, while earnings growth has lagged at sub-5%, so he says a pause in a 75-month bull run is justified.

The other issue for the P/E ratio is interest rates. Federal Reserve Chair Janet Yellen is slated to give her semiannual testimony to Congress on Wednesday and Thursday, but unless she departs from the script she recited again in a speech on Friday, she’ll probably say that a rate hike should be expected later this year, depending on the economic data.

More interesting will be how she parries questions from the grand inquisitors about what could bring on the rate hikes or delay them, notably because of unpredictable events abroad.

Down and Out in Athens and Brussels

Jeffrey D. Sachs

JUL 11, 2015

Greece sadness

NEW YORK – The Greek catastrophe commands the world’s attention for two reasons. First, we are deeply distressed to watch an economy collapse before our eyes, with bread lines and bank queues not seen since the Great Depression. Second, we are appalled by the failure of countless leaders and institutions – national politicians, the European Commission, the International Monetary Fund, and the European Central Bank – to avert a slow-motion train wreck that has played out over many years.

If this mismanagement continues, not only Greece but also European unity will be fatally undermined. To save both Greece and Europe, the new bailout package must include two big things not yet agreed.
First, Greece’s banks must be reopened without delay. The ECB’s decision last week to withhold credit to the country’s banking system, and thereby to shutter the banks, was both inept and catastrophic. That decision, forced by the ECB’s highly politicized Executive Board, will be studied – and scorned – by historians for years to come. By closing the Greek banks, the ECB effectively shut down the entire economy (no economy above subsistence level, after all, can survive without a payments system). The ECB must reverse its decision immediately, because otherwise the banks themselves would very soon become unsalvageable.
Second, deep debt relief must be part of the deal. The refusal of the rest of Europe, and especially Germany, to acknowledge Greece’s massive debt overhang has been the big lie of this crisis. Everyone has known the truth – that Greece can never service its current debt obligations in full – but nobody involved in the negotiations would say it. Greek officials have repeatedly tried to discuss the need to restructure the debt by slashing interest rates, extending maturities, and perhaps cutting the face value of the debt as well. Yet every attempt by Greece even to raise the issue was brutally rebuffed by its counterparties.
Of course, as soon as the negotiations collapsed two weeks ago, the truth about the Greek debt began to be stated. The IMF was the first to break the silence, acknowledging that it had been urging debt relief but to no avail. The United States then let it be known that President Barack Obama and Treasury Secretary Jack Lew had been trying to convince German Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble to offer debt relief to Greece, also without success.
Then even Schäuble himself, by far the staunchest opponent of debt relief, admitted that Greece needed it; but he also claimed that such relief would violate European Union treaty provisions barring bailouts of governments. Following Schauble’s remarkable acknowledgment (made publicly only after utter catastrophe had struck), Merkel herself opined that perhaps certain kinds of relief (such as cuts in interest rates, rather than in the debt’s face value) could do the job in a way that would be consistent with EU rules.
The fact that the Greek debt overhang was acknowledged only after negotiations had collapsed exposes the deep systemic failures that have brought Greece and Europe to this point. We see a European system of crisis management that is fraught with ineptitude, extreme politicization, gamesmanship, and unprofessionalism. I certainly do not mean to excuse Greek clientelism, corruption, and mismanagement as ultimate causes of the country’s predicament. Yet the failure of the European institutions is more alarming. Unless the EU can now save Greece, it will not be able to save itself.
The EU today operates something like the US under the Articles of Confederation, which defined the US’s ineffectual governing structure after independence from Britain in 1781 but prior to the adoption of the Constitution in 1787. Like the newly independent US, the EU today lacks an empowered and effective executive branch capable of confronting the current economic crisis.
Instead of robust executive leadership tempered by a strong democratic parliament, committees of national politicians run the show in Europe, in practice sidelining (often brazenly) the European Commission. It is precisely because national politicians attend to national politics, rather than Europe’s broader interests, that the truth about Greece’s debt went unspoken for so long.
The Eurogroup, which comprises the 19 eurozone finance ministers, embodies this destructive dynamic, meeting every few weeks (or even more frequently) to manage Europe’s crisis on the basis of national political prejudices rather than a rational approach to problem-solving.
Germany tends to call the shots, of course, but the discordant national politics of many member states has contributed to one debacle after the next. It is the Eurogroup, after all, that “solved” Cyprus’s financial crisis by partial confiscation of bank deposits, thereby undermining confidence in Europe’s banks and setting the stage for Greece’s bank panic two years later.
Amid all this dysfunction, one international institution has remained somewhat above the political fray: the IMF. Its analysis has been by far the most professional and least politicized.
Yet even the IMF allowed itself to be played by the Europeans, especially by the Germans, to the detriment of resolving the Greek crisis many years ago. Once upon a time, the US might have pushed through policy changes based on the IMF’s technical analysis. Now, however, the US, the IMF, and the European Commission have all watched from the sidelines as Germany and other national governments have run Greece into the ground.
Europe’s bizarre decision-making structure has allowed domestic German politics to prevail over all other considerations. And that has meant less interest in an honest resolution of the crisis than in avoiding the appearance of being lenient toward Greece. Germany’s leaders might rightly fear that their country will be left holding the bill for European bailouts, but the result has been to sacrifice Greece on the altar of an abstract and unworkable idea: “no bailouts.” Unless some rational compromise is agreed, insistence on that approach will lead only to massive and even more costly defaults.
We are now truly at the endgame. Greece’s banks have closed, its debt has been acknowledged as unsustainable, and yet the future of both the banks and the debt remains uncertain. The decisions taken by Europe in the next several days will determine Greece’s fate; wittingly or not, they will determine the EU’s fate as well.

Is Something Really Bad Going To Happen Soon?

by: The Fortune Teller            

  • Six years and four months into one of the most impressive rallies we have ever witnessed. Can it last?
  • Many warning signs are flashing-red around us. Can investors afford to ignore them?
  • Debt markets already seem out of steam. Will equity markets follow through?
  • While this article is by no means a "doom and gloom"prediction, I believe that the "bad wolf" will eventually show up.
Over the course of the past year I've published a few articles, including a most recent one, regarding a possible shift in the markets. When it comes to bonds, it's clear to everyone that the rally is over and that a "Buy & Hold" strategy is practically dead. Nonetheless, when it comes to equities it's quite shocking to see so many people and serious investors keep believing that the current rally, we're still in, will last forever.

Will it? Can it? I strongly doubt it.

Let me start by saying loud and clear: I have no idea when the rally in equity markets will end.

I'm not a prophet and I don't like making predictions that try pointing out both direction and timing. Nevertheless, I know that it will end and I dare say that after 6 years and four months of almost-non-stop rise - we're way closer to the end (of the rally) than to the beginning.

When it comes to the debt markets, investors are now reciting (almost?) unanimously that long durations are bad, that yields are way too low and that the reward doesn't compensate for the risk. I believe that the exact same clear-sound voice is going to be heard in regard to equities, soon enough.

It may take time and, as we all know, timing is everything! Yet, it's worthwhile hitting the gong again and you are better off to get yourself ready (in advance) for the future than adjust yourself (retroactively) to the present.

While trying to avoid being perceived as "The boy who cried wolf" - the wolf will eventually show up. My philosophy has always been: Better safe than sorry.

Sitting on the sidelines, waiting for the right moment is nothing to be ashamed of.

Nobody ever lost what he could have gained.

This article takes a closer look at the most "immediate suspects"; the five main factors that any investor should take into consideration.

But before doing so it I must make it clear: Greece isn't one of those factors. True, this tiny economy is making a lot of noise and it's the Greek-ongoing-saga that everyone tend to blame for not allowing the markets to keep marching higher. Well, I'm sorry to be the one ruining the ("blaming") party but Greece, in-spite of its gorgeous islands and ancient history, is insignificant when it comes to the capital markets. A tiny economy, accounting for not much more than 1% of the entire European economy - and this, folks, is no reason to get in or out of the markets.

I'll allow each investor to make his own interpretation to these warning signs but ignoring those signs might turn to be a big mistake. With no further delay, here are the factors that any investor should take into consideration right here, right now:

1. CHINA (FXI, MCHI, GXC). As much as the world overplays Greece, I believe that there's a huge underestimation of China. The world's second -biggest economy (officially) - and the biggest, fastest growing, force de-facto - is in trouble. It's not only the crushing of the stock exchange indices but mainly the weakening demand. Even the most recent bond auction failure is, to the very least, a good reason to raise some concerns.

With both the Shanghai Composite Index and the Shenzhen Component Index tumbling 3-5% on a daily basis over the past few weeks - this is not just "entering into a bear market territory" but a more in-depth situation that can easily get out of control.

2. BONDS (BND, AGG, LQD, HYG, JNK). Some investors tend to ignore the debt markets and solely focus on the equity markets. This is a big mistake; not only that the debt markets are much bigger (size wise) and liquid (volume wise) but they have a much better predictive powers!

Yields are, generally speaking, on the rise since the beginning of this year but one should keep in mind that this is a very tricky and sneaky tool:
  • The average yield on a 10-year US treasury note ("UST10Y") during 1912-2015 is 6.32%.
  • The highest yield on record for the UST10Y was registered in September 1981 = 15.82% (and no, this is not a typo...)
  • The lowest yield on record for the UST10Y was registered in July 2012 = 1.40% (once again, this is not a typo...)
  • Even more interesting is the movement since July 2012: After going over the 3% handle at the end of 2013, the UST10Y yield hit 1.64% at the beginning of 2015, near-by the record-low territory.
On one hand, yields are very illusive and sometimes hard to follow; on the other hand, it is worthwhile to follow the trend. As we all know, the trend is an investor's best friend - and it's not only true for stock prices direction/momentum!

3. EQUITIES (SPY, QQQ, DIA, IWF, EFA). Let's make it very simple: Six years and four months since the lows (9 March 2009) and after the S&P 500 gained circa 220% (at its peak) - I doubt there are many who believe that we're going to see another ~6.5 years with over 200% gain. It's not only against statistics but it's mostly against reality.

From a valuation point of view, there's not much room for further gains.

On 16 April 2015, Goldman Sachs - (always) one of Wall Street most bullish players - published a model that indicates a 62% probability for a (minimum) 10% correction (from peak to through) in the S&P when valuations are high. Almost three months following the presentation of this projection the probability for a 10% correction is now higher.

There are plenty more signs to take into consideration when looking at equities right now but I may publish a separate article soon to address them all. For now, it's safe to say that it's safe(r) to take profits and stay on the sidelines.

One of the most common arguments when it comes to the stock markets are that they will keep going up because "there's no alternative". Well, folks, not only that there's ALWAYS an investment alternative (to anything, anytime) but it's sufficient to say that avoiding losing money is a good enough alternative.

4. OIL (USO, OIL, UNG). After dropping to ~$44 (per barrel) in early March 2015, oil prices spiked all the way up to circa $64 in early May; that's a huge move in just two-months.

Getting back to the low $50s as I write doesn't only fall into the "entering a bear market" territory, defined as a 20% drop from any point/peak, but it's a direct result of the above-mentioned, especially the weak demand from China.

As one of the most in-use commodities, oil prices are a very good barometer to measure the world economy status.

More than the recent moves, one should ask himself what was the underlying behind for the drop from $115-120 to $40 and has this massive drop been reflected by the equity markets?

You don't need to be an orthodox in order to view the oil price fluctuations as a sign from above - or from the underneath in oil's case… - shouting-out-loud that something is not working properly inside the engine.

5. COPPER (JJC, CUPM, CPER). Similar but not identical to oil - copper prices are the best seismograph for China specifically and for the world development and construction as a whole. It's worthwhile reading the report "Copper price as an economic indicator" as well as the article "Is a global economic recession coming? Copper price say 'yes'".

Falling 50% (!) since the end of January 2015 isn't something to be ignored. Unlike oil, the decline is decisive with technical corrections along the way.

Now, don't get me wrong: I belong to the school of thought that believe that commodities, more than any other asset-class, are hard - perhaps impossible - to predict. Therefore, as much as I give no credit to "doom and gloom" predictions I do the same in regard to positive-prosperous projections. Prices of commodities are a mirror reflection of the world economy and its healthiness. One must admit that the current diagnostics don't seem very encouraging…

Joining the herd isn't necessarily a bad thing to do - and in fact, joining the LONG EQUITY herd since early 2009 proved to be one of the best-ever things an investor could have done.

Nonetheless, every party comes to an end at some point; so will the current one.

When exactly, to what extent and how will it look like - I really don't know and I dare not trying to predict. What I do know that one must always look around, pay attention to warning signs and definitely not assuming that parties last forever.

There may be several ways to interpret any warning sign but ignoring it is definitely not one of those!