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Charts Of The WeekUpdated Pictures of Current Interest
For the week of November 5, 2008
Long-Term Interest Rates - 1900 to 2007
Bianco Research L.L.C.An Arbor Research & Trading Affiliated Company
Independent · Objective · Original———————————————————————————————————————————————————————————————————————
Bianco Research, L.L.C For the week of November 5, 2008 2
What Does A “Medicated” LIBOR Measure?From Our Newsclips/Daily Commentary
The Financial Times - Dollar lending rate reflects crunch easing
The benchmark floating rate for dollar lending on Tuesday fell below the level that prior to the bankruptcy of Lehman Brothers in mid-September, providing a further sign that the credit crunch is slowly easing. The decline in the three-month dollar London Interbank Offered Rate, however lags behind the Federal Reserve’s action in cutting its overnight rate in half to 1 per cent last month. Interest rate futures price in a further cut for the Fed’s rate to at least 0.75 per cent by the end of the year…While rates are coming down, traders say money market funds are still not willing to lend to banks at this juncture. The bulk of activity is being done through money market and commercial paper programmes instituted by the Fed, reinforcing the central bank’s role as lender of sole resort. With the Fed and US Treasury fully supporting short-term lending and banks, the stress in the system has been medicated, but it remains to be seen when the market can resume working without external support, say traders.
Comment - The story above hits the nail on the head, and is something we addressed last week.
That is, both LIBOR and commercial paper are “heavily medicated” (to use the phrase above) through massive government intervention. We cannot use these measures or derivatives of these measures (such as the Ted Spread or the OIS/LIBOR spread) as indications that credit is getting better. Only when governments pull back from these markets and they show they can stand on their own can we hail their “improvement” as a sign that the credit crisis is easing. Since governments are not about to pull back, we are still left to wonder if credit is improving.
3-Month US Libor Rates And The Target Federal Funds Rate
12/12/20075.058%
12/6/20075.146%
9/7/2007, 5.725%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
5.50%
6.00%
2/9/
2007
3/9/
2007
4/6/
2007
5/4/
2007
6/1/
2007
6/29
/200
7
7/27
/200
7
8/24
/200
7
9/21
/200
7
10/2
2/20
07
11/1
9/20
07
12/1
7/20
07
1/14
/200
8
2/11
/200
8
3/10
/200
8
4/7/
2008
5/5/
2008
6/2/
2008
6/30
/200
8
7/28
/200
8
8/25
/200
8
9/22
/200
8
10/2
0/20
08
11/1
7/20
08
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
5.50%
6.00%
Target Federal Funds Rate
3-Month Libor
Bank 10/22/2008 10/23/2008 10/24/2008 10/27/2008 10/28/2008 10/29/2008 10/30/2008 10/31/2008 11/3/2008 11/4/2008 11/5/2008JPM/Chase 3.25 3.25 3.25 3.25 3.25 3.15 3.00 2.75 2.55 2.45 2.25Rabobank 3.30 3.30 3.35 3.25 3.40 3.25 3.00 2.90 2.65 2.50 2.25Citibank 3.40 3.45 3.45 3.40 3.38 3.25 3.15 3.00 2.80 2.50 2.40Lloyds 3.50 3.45 3.45 3.45 3.40 3.35 3.00 2.90 2.55 2.60 2.45Bank of America 3.25 3.25 3.30 3.30 3.35 3.25 3.00 2.80 2.60 2.50 2.50HSBC 3.45 3.45 3.45 3.45 3.40 3.40 3.15 3.00 2.80 2.65 2.50UBS 3.55 3.60 3.55 3.50 3.45 3.40 3.20 3.02 2.85 2.70 2.50RB Canada 3.53 3.55 3.50 3.50 3.46 3.39 3.24 3.04 2.85 2.70 2.50West LB 3.55 3.60 3.55 3.50 3.48 3.42 3.20 3.05 2.90 2.75 2.50HBOS 3.55 3.55 3.50 3.50 3.35 3.45 3.25 3.10 2.90 2.75 2.50CSFB 3.75 3.70 3.70 3.70 3.70 3.55 3.15 3.05 3.00 2.75 2.50Norinchukin 3.60 3.58 3.58 3.58 3.55 3.50 3.20 3.05 2.92 2.75 2.55Bank of Tokyo 3.65 3.75 3.75 3.70 3.65 3.60 3.35 3.20 3.05 2.75 2.60RB Scotland 3.70 3.75 3.75 3.75 3.68 3.60 3.30 3.00 2.93 2.83 2.65Deutsche Bank 3.60 3.50 3.55 3.58 3.58 3.45 3.25 3.05 2.85 2.75 2.75Barclays 4.00 3.85 3.95 3.90 3.95 4.00 3.40 3.20 3.00 2.90 2.75Highest 4.00 3.85 3.95 3.90 3.95 4.00 3.40 3.20 3.05 2.90 2.75Lowest 3.25 3.25 3.25 3.25 3.25 3.15 3.00 2.75 2.55 2.45 2.25Range 0.75 0.60 0.70 0.65 0.70 0.85 0.40 0.45 0.50 0.45 0.50All Average 3.54 3.54 3.54 3.52 3.50 3.44 3.18 3.01 2.83 2.68 2.51Trim Mean 3.53 3.54 3.53 3.51 3.48 3.42 3.17 3.01 2.84 2.68 2.51Posted Libor 3.54 3.54 3.52 3.51 3.47 3.42 3.19 3.03 2.86 2.71 2.51Difference -0.01 0.01 0.02 0.01 0.02 0.00 -0.02 -0.01 -0.02 -0.03 0.01Bold Rates Are The Eight In The Middle Used in Calculating The Average, Red Highlighted Banks Have Received Capital From Governments
3-Month USD Libor BreakdownA Breakdown of the 16 Reporting Banks
Bianco Research, L.L.C For the week of November 5, 2008 3
Are CDX Prices Pointing To Health In The Credit Markets?
From Our Newsclips/Daily Commentary
Markit CDX North American Investment Grade Index125 Entities
5/2/200888.42
3/10/2008, 193.67
10/24/2008, 223.67
20
40
60
80
100
120
140
160
180
200
220
240
6/24
/200
4
8/20
/200
4
10/1
8/20
04
12/1
4/20
04
2/10
/200
5
4/11
/200
5
6/7/
2005
8/3/
2005
9/29
/200
5
11/2
5/20
05
1/25
/200
6
3/30
/200
6
5/26
/200
6
7/25
/200
6
9/20
/200
6
11/1
5/20
06
1/17
/200
7
3/15
/200
7
5/11
/200
7
7/10
/200
7
9/5/
2007
11/1
/200
7
12/3
1/20
07
2/28
/200
8
4/29
/200
8
6/25
/200
8
8/21
/200
8
10/1
7/20
08
12/1
2/20
08
Basi
s Po
ints
20
40
60
80
100
120
140
160
180
200
220
240
Basi
s P
oint
s
Bloomberg.com - Libor’s Biggest Drop Fails to Match Fed, Spur Loans
Credit markets are still creaking even after the biggest decline on record in the rate banks say they charge each other to borrow dollars. The London interbank offered rate, or Libor, for three- month loans fell to 2.51 percent today, from 4.82 percent on Oct. 10. The rate is still 151 basis points more than the Federal Reserve’s target interest rate for overnight bank loans, compared with an average of 22 basis points in the five years before the global credit crisis began in August 2007. “Banks are cutting back, the economy is in a deepening recession and in that environment, I don’t think banks are going to become a lot more willing to extend credit soon,” said Jan Hatzius, chief U.S. economist in New York at Goldman Sachs Group Inc., the world’s biggest securities firm.
Comment – On the previous slide we said commercial paper and LIBOR are “too medicated” to be used as indications of credit improvement. So, what can be used? Markets that (for now?) do not have heavy government involvement. One such market is the CDX North American Investment Grade Index. We will leave it to the reader to decide if this measure is signaling the credit crisis is passing. We think it is too early to tell, as we say above.
Bianco Research, L.L.C For the week of November 5, 2008 4
Credit Spreads Are Still At Crisis LevelsFrom Our Newsclips/Daily CommentaryHigh Yield Spreads
The Option-Adjusted Spread (OAS) of the Merri ll High Yield Master Index
10/27/2008, 1,681
6/5/2007241
5/18/2005455
3/11/2005273
10/10/2002, 1,097
5/9/2002671
9/28/2001994
1/2/2001908
10/19/1998654
3/30/1998255
3/17/2008, 862
0
200
400
600
800
1,000
1,200
1,400
1,600
1,80012
/31/
1997
6/24
/199
8
12/1
6/19
98
6/11
/199
9
12/3
/199
9
5/26
/200
0
11/1
7/20
00
5/14
/200
1
11/8
/200
1
5/6/
2002
10/2
5/20
02
4/22
/200
3
10/1
0/20
03
4/6/
2004
9/28
/200
4
3/29
/200
5
9/16
/200
5
3/14
/200
6
9/1/
2006
2/28
/200
7
8/21
/200
7
2/20
/200
8
8/13
/200
8
1/30
/200
9
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
Investment Grade SpreadsThe Option-Adjusted Spread (OAS) of the Merrill Investment Grade Corporate Master Index
10/30/2008, 617
10/10/2002, 267
3/10/2005, 795/28/1998, 69
11/4/1998, 144
12/8/2000, 203
2/26/2007, 86
5/19/2005, 110
3/26/2008, 316
50
100
150
200
250
300
350
400
450
500
550
600
650
12/3
1/19
97
6/24
/199
8
12/1
6/19
98
6/11
/199
9
12/3
/199
9
5/26
/200
0
11/1
7/20
00
5/14
/200
1
11/8
/200
1
5/6/
2002
10/2
5/20
02
4/22
/200
3
10/1
0/20
03
4/6/
2004
9/28
/200
4
3/29
/200
5
9/16
/200
5
3/14
/200
6
9/1/
2006
2/28
/200
7
8/21
/200
7
2/20
/200
8
8/13
/200
8
1/30
/200
9
Basi
s Po
ints
50
100
150
200
250
300
350
400
450
500
550
600
650
Basi
s Po
ints
iTraxx CDX Europe Crossover IndexEntities in Europe Straddling The Divide Between Investment Grade and High Yield
10/27/2008, 873.02
5/2/2006224.52
2/22/2007170.81
5/17/2005452.02
3/8/2005149.66
6/26/2006308.69
7/30/2007461.30
10/11/2007269.67
3/10/2008, 636.12
5/19/2008396.02
100
200
300
400
500
600
700
800
900
6/24
/200
4
8/20
/200
4
10/1
8/20
04
12/1
4/20
04
2/10
/200
5
4/11
/200
5
6/7/
2005
8/3/
2005
9/29
/200
5
11/2
5/20
05
1/25
/200
6
3/30
/200
6
5/26
/200
6
7/25
/200
6
9/20
/200
6
11/1
5/20
06
1/17
/200
7
3/15
/200
7
5/11
/200
7
7/10
/200
7
9/5/
2007
11/1
/200
7
12/3
1/20
07
2/28
/200
8
4/29
/200
8
6/25
/200
8
8/21
/200
8
10/1
7/20
08
12/1
2/20
08
Basi
s Po
ints
100
200
300
400
500
600
700
800
900
Basis
Poi
nts
Bianco Research, L.L.C For the week of November 5, 2008 5
Distressed DebtFrom Our Newsclips/Daily Commentary
The Financial Times - Lex: LBO debt
Where leveraged buy-out debt has gone, the rest of the high-yield universe has followed, a sort of levelling upwards of the perceived riskiness of companies with lower credit ratings. The level of distress in LBO bonds, defined as bond yields trading at 1,000 basis points or more above the risk free rate, accelerated before the bulk of the credit sell-off. But now many high-yield issues, not just LBOs, are trading at distressed levels, implying default rates of about 18 per cent, according to Garman Research. That is a huge number. It would be nearly double the actual default rates of the 1990s recession, which buried LBOs from the junk-bond craze of the 1980s. It would also top the 15 per cent default rates of “speculative” debt in the Great Depression, although it is hard to compare that class of debt with today’s high-yield.
Percentage of "Distressed Bonds" In The High Yield Master 2 Index
4/25/200829.61%
7/27/20070.68%
11/29/2002, 42.36%
0%
10%
20%
30%
40%
50%
60%
70%
80%
1/3/
1997
11/3
/199
7
9/3/
1998
7/3/
1999
5/3/
2000
3/3/
2001
1/3/
2002
11/3
/200
2
9/3/
2003
7/3/
2004
5/3/
2005
3/3/
2006
1/3/
2007
11/3
/200
7
9/3/
2008
0%
10%
20%
30%
40%
50%
60%
70%
80%"Distressed Bonds" = Bonds With An Option-Adjusted Spread (OAS) In Excess of 1,000 bps
Bianco Research, L.L.C For the week of November 5, 2008 6
Munis vs. Treasuries
Municipal Excess Returns Over TreasuriesThe 12-Month Total Return Of The Merrill Municipal Master Index Less The Merrill Treasury Master Index
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
Dec
-89
Feb-
91
Apr-
92
Jun-
93
Aug-
94
Oct
-95
Dec
-96
Feb-
98
Apr-
99
Jun-
00
Aug
-01
Oct
-02
Dec
-03
Feb-
05
Apr-
06
Jun-
07
Aug
-08
12-M
onth
Tot
al R
etur
ns
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
12-M
onth
Tot
al R
etur
ns
The Wall Street Journal - Muni Yields Rise to Rare Levels
Alarmed by the stock market’s severe drop and the financial system’s fragility, investors have been fleeing to what they view as the safest investment haven on earth: U.S. Treasury bills, notes and bonds. But these moves may be an overreaction. Lately, more investors have been taking a new look at a depressed sector that some financial strategists say offers not only safety but also unusually attractive bargains: tax-exempt state and local government bonds — better known as municipal bonds, or munis.
Comment - Do not necessarily assume munis are a better investment than Treasuries simply because of their high tax-free yield. As the chart below shows, the total return of the Merrill Treasury Master Index has outperformed the Merrill Muni Master Index by 12.46% over the last year.
From Our Newsclips/Daily Commentary
Bianco Research, L.L.C For the week of November 5, 2008 7
Sovereign Credit Risks: With A Little Help From Our FriendsFrom A Recent Market Facts
As the introduction of new government programs to address the credit crunch has reached the transcendentally spastic pace of Joe Cocker’s air guitar solo during his cover of the Beatles’ classic at Woodstock, let’s take the opportunity to update an August Market Facts and see whether sovereign credit risks on both sides of the Atlantic have been affected thereby.
Five- and ten-year CDS costs on U.S. Treasury debt (thin red line, both charts) have moved to record high levels and have increased by 90.4% and 77.1%, respectively, since the mid-September bankruptcy of Lehman Brothers (green vertical line, both charts). Please note these CDS are priced in euros to avoid the circularity associated with pricing insurance on USD in USD. The euro has declined nearly 11.4% against the USD since that date, which makes the effective cost increase of insuring against the end of the United States as a functioning entity only 68.6% and 56.9% higher for the five- and ten-year CDS over this period.
A second set of CDS, on German bonds (hatched red line, both charts) is priced in USD for the same reason. They have increased by 268.2% and 165.8% for the five- and ten-year swaps, respectively, before currency adjustment and an astonishing 315.4% and 199.9%, respectively, afterwards.
Ten-Year CDS Costs On U.S. & German Bonds Vs. Normalized Yield Spread
7
10
13
16
19
22
25
28
31
34
37
40
43
2-A
pr8-
Apr
14-A
pr18
-Apr
24-A
pr30
-Apr
6-M
ay12
-May
16-M
ay22
-May
28-M
ay3-
Jun
9-Ju
n13
-Jun
19-J
un25
-Jun
1-Ju
l7-
Jul
11-J
ul17
-Jul
23-J
ul29
-Jul
4-A
ug8-
Aug
14-A
ug20
-Aug
26-A
ug1-
Sep
5-S
ep11
-Sep
17-S
ep23
-Sep
29-S
ep3-
Oct
9-O
ct15
-Oct
21-O
ct27
-Oct
31-O
ct
Ten-
Year
USD
& D
EM C
DS,
EU
R &
USD
Bas
is P
oint
s(T
hin
& H
atch
ed R
ed L
ines
)
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
[EU
R10
- U
SD10
] / U
SD10
(Thi
ck B
lue
Line
)
Ten-Year USD & DEM CDS(Left Scale)
Normalized Yield Spread(Right Scale)
Five-Year CDS Costs On U.S. & German Bonds Vs. Normalized Yield Spread
3
6
9
12
15
18
21
24
27
30
33
36
39
42
2-A
pr8-
Apr
14-A
pr18
-Apr
24-A
pr30
-Apr
6-M
ay12
-May
16-M
ay22
-May
28-M
ay3-
Jun
9-Ju
n13
-Jun
19-J
un25
-Jun
1-Ju
l7-
Jul
11-J
ul17
-Jul
23-J
ul29
-Jul
4-A
ug8-
Aug
14-A
ug20
-Aug
26-A
ug1-
Sep
5-S
ep11
-Sep
17-S
ep23
-Sep
29-S
ep3-
Oct
9-O
ct15
-Oct
21-O
ct27
-Oct
31-O
ct
Five
-Yea
r USD
& D
EM C
DS,
EU
R &
USD
Bas
is P
oint
s(T
hin
& H
atch
ed R
ed L
ines
)
22%
24%
26%
28%
30%
32%
34%
36%
38%
40%
42%
44%
46%
48%
50%
[EU
R5 -
USD
5] / U
SD5 (
Thic
k B
lue
Line
)
Five-Year USD & DEM CDS(Left Scale)
Normalized Yield Spread(Right Scale)
Bianco Research, L.L.C For the week of November 5, 2008 8
Sovereign CDS Costs’ Impact On Equities And CurrenciesFrom A Recent Commentary
National Currency Responses To Credit Default CostsJuly 11 - October 31, 2008
-60%
-55%
-50%
-45%
-40%
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
10%
100%
1000
%
Percentage Increase In 5-Year CDS Cost, Inverse Scale
Cha
nge
Vs. U
SD
National Equity Market Responses To Credit Default CostsJuly 11 - October 31, 2008
-90%-85%-80%-75%-70%-65%-60%-55%-50%-45%-40%-35%-30%-25%-20%-15%-10%-5%0%5%10%15%20%
10%
100%
1000
%
Percentage Increase In 5-Year CDS Cost, Inverse Scale
Tota
l Ret
urn
On
Sto
cks,
USD
Ter
ms
Equity And Currency Responses
We can map the total return of national stock indices in USD terms over this period against the percentage change in national CDS costs plotted on an inverse logarithmic scale (left-hand chart). The generalized trend, unsurprisingly, is poorer equity market performance arises from greater percentage changes in sovereign credit risk.
We can do the same for changes in spot currencies against the USD (right-hand chart). The Eurozone currencies are highlighted in green markers. Here the relationship is far more random; currencies can remain strong in the face of declining sovereign credit quality for any number of reasons, including higher short-term interest rates imposed in those countries to prevent capital flight. Of course, those very same higher interest rates could contribute to a poorer equity market.
Bianco Research, L.L.C For the week of November 5, 2008 9
Are E&P Stocks Calling An Energy Commodity Bottom?From A Recent Market Facts
Upstream Equities' Relative Performance Rebounding Before Crude Oil & Natural Gas
90%
110%
130%
150%
170%
190%
210%
230%
250%
270%
290%
Jun-
05
Aug
-05
Oct
-05
Dec
-05
Feb-
06
Apr
-06
Jun-
06
Aug
-06
Oct
-06
Dec
-06
Feb-
07
Apr
-07
Jun-
07
Aug
-07
Sep
-07
Nov
-07
Jan-
08
Mar
-08
May
-08
Jul-0
8
Sep
-08
Rel
ativ
e Pe
rform
ance
, EPX
To
SPXE
WJu
ne 2
8, 2
005
= 10
0% (T
hin
Red
Lin
e)
50%
75%
100%
125%
150%
175%
200%
225%
250%
CL
& N
G L
ed 1
2 an
d 1
Day
Jun
e 28
, 200
5 =
100%
(Thi
ck B
lue
& H
atch
ed G
reen
Lin
es)
Relative Performance(Left Scale)
Crude Oil Led 12 DaysNatural Gas Led 1 Day
(Right Scale)
We noted in a July Market Facts how the relative performance of SIG Exploration & Production index, an equal-weighted index of upstream companies in crude oil and natural gas to the S&P Equal-Weighted index (thin red line) led the subsequent downturn in crude oil and natural gas (thick blue and hatched green lines, respectively) by 12 days and one day, respectively.
Relative performance peaked on July 1, 2008. The subsequent declines in the commodities prices have been anything but gentle, 52.6% for crude oil and 49.2% for natural gas. Those moves are year-sized in most markets.
The relative performance of the Exploration & Production index has risen from a local minimum of 145.5% (June 28, 2005 = 100%) on October 10, 2008 to 170.2% yesterday. This rebound is far ahead of anything the commodities are doing, and as it is occurring within the context of general industrial deflation, a process confirmed in the TIPS market. As such, the relative outperformance of the Exploration & Production index may be a sign the violent slide in the two major energy commodities is drawing to a close.
Bianco Research, L.L.C For the week of November 5, 2008 10
Stock Market Capitalization as a Percentage of Nominal GDPFrom Our Recent Market Cap to GDP Update
As of September 30, 2008, stock market capitalization was 96.54% of nominal GDP ($13.93 trillion divided by $14.43 trillion).
Many have asked if we had an October update. We do not have an official update, as we need Q4 GDP which will be released in late January to calculate these figures. That said, we did estimate it to be slightly under 80%, as shown below. If this estimate pans out, this would be the lowest ratio since March 1995.
Stock Market Capitalization As A Percentage Of Nominal GDP
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
1925
1929
1933
1937
1941
1945
1949
1953
1957
1961
1965
1969
1973
1977
1981
1985
1989
1993
1997
2001
2005
2009
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
Dec-7278.1%
Nov-6877.8%
Aug-29 81.4%
Apr-4216.0%
Sep-7433.7%
Jul-8233.5%
Last (Sep 2008) 96.54%Stock Market Capitalization = $13.93 TrillionNominal GDP = $14.43 Trillion
Estimate for Oct 2008 = 79.75%Stock Market Capitalization = $11.51 TrillionNominal GDP (assume unch.) = $14.43 Trillion
Average = 55.79%
Mar-00183.0%
If estimate holds, lowest since October 1995
Bianco Research, L.L.C For the week of November 5, 2008 11
Total Return Review UpdateFrom Our Recent Total Return Review
S&P 500 Total Return IndexTrailing 10 year rate of return
0.50%9/30/74
19.49%8/31/00
-4.95%8/31/39
21.43%5/31/59
0.40%10/31/08
8.53%03/31/03
-10%
-5%
0%
5%
10%
15%
20%
25%
1935
1940
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
Com
poun
d A
nnua
l Rat
e
-10%
-5%
0%
5%
10%
15%
20%
25%
Com
poun
d A
nnua
l Rat
e
Median = 11.04%
Regular viewers of CNBC might be familiar with a new commercial in which Jim Cramer claims, “the old days of buy and hold are over.” In a poorly disguised attempt to boost his stock-picking show’s ratings, he makes the argument that investors must deftly jump from one stock to the next, timing the market rather than simply buying good companies for the long term.
While we will not attempt to rationalize this line of thinking, maybe the chart below will give us a glimpse as to what is going on in Cramer’s head. It shows the total return of the S&P 500 on a trailing 10-year basis. If you invested in stocks on October 31, 1998, you would have realized an annualized compound return of just 0.40%, underperforming even Treasury bills over the same period. The last time stocks performed this poorly over a 10-year period was March 1931 to March 1941!
While this has been a particularly brutal 10-year stretch for equities, note that the average annualized total return for the S&P 500 is still 11.04% over any 10-year period. While past results are never indicative of future returns, we would be willing to guess that those investors who are willing to buy and hold stocks over the long term will be just fine.
Bianco Research, L.L.C For the week of November 5, 2008 12
Revisiting The Stock-Treasury Relationship After The CollapseFrom A Recent Commentary
Stock/Bond Relationship Near Multi-Decade Low
-0.8
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
1941
1943
1945
1947
1949
1951
1953
1955
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
Rol
ling
Thre
e-M
onth
Cor
rela
tion
of R
etur
ns(T
hin
Red
Lin
e)
-0.8
-0.7
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
Rol
ling
One
-Yea
r Cor
rela
tion
of R
etur
ns(T
hick
Blu
e Li
ne)
Three-Month Correlation(Left Scale)
One-Year Correlation(Right Scale)
We opened a July Commentary:
The recent selloff in global equities in general and Japanese stocks in particular – the Nikkei 225 recently completed a 12-session losing streak – raises the question of whether the ongoing credit crunch is turning into something more severe.By “severe” we mean a decline in financing activity and a concomitant increase in the demand to hold cash balances. Taken in combination with declining asset prices and reduced consumer purchasing power, this is a deflationary environment, one similar to that seen globally in the 1930s and in Japan after 1990. Deflation, ironically, must be fought with the very same negative real interest rates seen as the cause of commodity prices inflation in recent months.
We were not sufficiently alarmist, nor could we have been. The Oracle at Delphi would have flubbed the forecast of what was to transpire.
Let’s update the long-term stock and bond relationships and the interest rate analogy between the U.S. and Japan. We still see an exceedingly negative correlation of returns for rolling three-month and one-year periods (thin red and thick blue lines, respectively) between U.S. stocks and ten-year Treasuries. Those correlations have turned less negative since October 6th as long-term Treasury yields have increased nearly 30 basis points.
Bianco Research, L.L.C For the week of November 5, 2008 13
Corporate Yield Curves Fifteen Months Into The Credit CrisisFrom A Recent Special Report
Corporate Yield Curve Comparison To Treasury Curve
-0.14
-0.12
-0.10
-0.08
-0.06
-0.04
-0.02
0.00
0.02
0.04
0.06
Mar
-02
Jun-
02S
ep-0
2
Dec
-02
Mar
-03
Jun-
03S
ep-0
3
Dec
-03
Mar
-04
Jun-
04
Sep
-04
Dec
-04
Mar
-05
Jun-
05
Sep
-05
Dec
-05
Mar
-06
Jun-
06
Sep
-06
Dec
-06
Mar
-07
Jun-
07A
ug-0
7
Nov
-07
Feb-
08
May
-08
Aug
-08
Nov
-08
B F
RR
- U
ST F
RR
, 2-1
0 Ye
ars
(Thi
n R
ed L
ine)
-0.14
-0.12
-0.10
-0.08
-0.06
-0.04
-0.02
0.00
0.02
0.04
0.06
BB
FR
R -
UST
FR
R, 2
-10
Year
s (T
hick
Blu
e Li
ne)
B Curve Spread(Left Scale)
BB Curve Spread(Right Scale)
Corporate Yield Curve Comparison To Treasury Curve
-0.08
-0.07
-0.06
-0.05
-0.04
-0.03
-0.02
-0.01
0.00
0.01
0.02
0.03
0.04
Apr
-91
Oct
-91
Apr
-92
Oct
-92
Apr
-93
Oct
-93
Apr
-94
Oct
-94
Apr
-95
Oct
-95
Apr
-96
Oct
-96
Apr
-97
Oct
-97
Apr
-98
Oct
-98
Apr
-99
Oct
-99
Apr
-00
Oct
-00
Apr
-01
Oct
-01
Apr
-02
Oct
-02
Apr
-03
Oct
-03
Apr
-04
Oct
-04
Apr
-05
Sep
-05
Mar
-06
Sep
-06
Mar
-07
Sep
-07
Mar
-08
Sep
-08
BB
B F
RR
- U
ST F
RR
, 2-1
0 Ye
ars
(Thi
n R
ed L
ine)
-0.05
-0.04
-0.03
-0.02
-0.01
0.00
0.01
0.02
0.03
0.04
AA
FR
R -
UST
FR
R, 2
-10
Year
s (T
hick
Blu
e Li
ne)BBB Curve Spread
(Left Scale)
AA Curve Spread(Right Scale)
Yield Curve Spreads
We can compare the relative steepness of two yield curves by comparing their forward rate ratios across a segment of the yield curve, in this case the 2-10 year segment. The FRR2,10 spreads for both BBB and especially AA-rated issues (thin red and thick blue lines, respectively, left-hand chart) have turned lower since mid-June following their rebound from the early March 2008 panic low in Treasury yields (green vertical line here and subsequently). This is confirmed for high-yield markets, as measured by BB- and B-rated markets (thick blue and thin red lines, right-hand chart).
Bianco Research, L.L.C For the week of November 5, 2008 14
Implications For Long-Term Treasury ReturnsFrom A Recent Special Report
Implications For Long-Term Treasury Returns
We can map three month-ahead percentage price returns for the constant-maturity ten-year notes and map them against the respective HLC volatilities and forward rate ratios. Positive and negative returns are marked with blue and white bubbles, respectively; the size of the bubble indicates the magnitude of the return. Green horizontal and vertical lines mark the current readings of the forward rate ratio and the HLC volatility on each chart to place the current combination in a historic context.
The present stretched values for both the forward rate ratios and HLC volatilities place the current combinations outside of theavailable sample data. We have to look at the bubbles on the northeast edges of the bubble clusters to infer the bias for threemonth-ahead returns. For the Japanese yen HLC mapped against both the FRR3M,10Y and FRR1,10 (left- and right-hand charts, respectively) the northeast edges are predominantly white.
Three-Month Ahead Percentage Returns On Ten-Year USTAs Function Of Japanese Yen Volatility And FRR1,10
0.950
0.975
1.000
1.025
1.050
1.075
1.100
0.0%
2.5%
5.0%
7.5%
10.0
%
12.5
%
15.0
%
17.5
%
20.0
%
22.5
%
25.0
%
27.5
%
30.0
%
Japanese Yen High-Low-Close Volatility
Forw
ard
Rat
e R
atio
, One
-Ten
Yea
rs
Three-Month Ahead Percentage Returns On Ten-Year USTAs Function Of Japanese Yen Volatility And FRR3mo,10yr
0.990
0.995
1.000
1.005
1.010
1.015
1.020
1.025
0.0%
2.5%
5.0%
7.5%
10.0
%
12.5
%
15.0
%
17.5
%
20.0
%
22.5
%
25.0
%
27.5
%
30.0
%
Japanese Yen High-Low-Close Volatility
Forw
ard
Rat
e R
atio
, Thr
ee M
onth
s - T
en Y
ears
Bianco Research, L.L.C For the week of November 5, 2008 15
The Baltic Dry IndexFrom Our Newsclips/Daily Commentary
The Financial Times - Lex: Never mind the BalticsCranes stop mid-swing, boats judder to a halt half-way down the slipway. No, not a montage from a disaster movie: this, or something close to it, is the world in November 2008, judging by the vertiginous decline in the Baltic Dry Index. Often seen as a proxy for global trade, the index - a composite of charter rates for dry goods vessels of various sizes - has plunged by over 93 per cent since June. But other closely-watched metrics do not evoke apocalypse…A better explanation for the plunge in the BDI is that it is not trade, but speculative traffic in commodities that is grinding to a halt. The BDI’s trajectory this year almost exactly mirrors the Reuters/Jefferies commodities index, an average of a broad basket of futures prices. While markets were swept up in a debt-fuelled frenzy, traders had good reason to keep large and growing stockpiles of nickel, copper, coffee and sugar to make big capital gains. This drove up demand for freight services.
The Baltic Dry Index
11/4/2008, 815
5/20/2008, 11,793
10/29/2007, 11,033
8/4/2005
12/6/20042/5/2004
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
5/11
/199
3
1/6/
1994
8/30
/199
4
4/25
/199
5
12/1
3/19
95
8/13
/199
6
4/11
/199
7
12/1
/199
7
7/30
/199
8
3/23
/199
9
11/1
1/19
99
7/18
/200
0
3/13
/200
1
11/9
/200
1
7/15
/200
2
3/11
/200
3
10/3
0/20
03
6/30
/200
4
2/28
/200
5
10/1
9/20
05
6/19
/200
6
2/14
/200
7
10/8
/200
7
6/5/
2008
1/20
/200
9
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
11,000
12,000
Bianco Research, L.L.C For the week of November 5, 2008 16
Gasoline, Productivity And Inflation After The DownturnFrom A Recent Commentary
Where Is The Negative Price Elasticity Of Demand?
8.70
8.75
8.80
8.85
8.90
8.95
9.00
9.05
9.10
9.15
9.20
9.25
-1.5
00
-1.3
75
-1.2
50
-1.1
25
-1.0
00
-0.8
75
-0.7
50
-0.6
25
-0.5
00
-0.3
75
-0.2
50
-0.1
25
0.00
0
0.12
5
0.25
0
0.37
5
0.50
0
0.62
5
0.75
0
0.87
5
Logarithm Of Gasoline Re-Indexed To July 1984 = 100%
Loga
rithm
Of U
.S. I
mpl
ied
Gas
olin
e D
eman
d, M
MB
/D
Where Is The Lead/Lag Relationship?
-1.500-1.375-1.250-1.125-1.000-0.875-0.750-0.625-0.500-0.375-0.250-0.1250.0000.1250.2500.3750.5000.6250.7500.875
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Loga
rithm
Of G
asol
ine
Re-
Inde
xed
To J
uly
1984
= 1
00%
(T
hin
Red
Lin
e)
8.70
8.75
8.80
8.85
8.90
8.95
9.00
9.05
9.10
9.15
9.20
9.25
Loga
rithm
Of U
.S. I
mpl
ied
Gas
olin
e D
eman
d, M
MB
/D(T
hick
Blu
e Li
ne)
Gasoline Demand(Right Scale)
Constant-Dollar Gasoline(Left Scale)
Much has changed since our May Commentary on gasoline expenditures, inflation and productivity. That document was written when crude oil was at $125, roughly twice the recent price level, and one week before global equities reached their post-Bear Stearns high. Global growth was still strong, investment banks were still walking the earth and Benjamin Bernanke was three weeks away from threatening to raise interest rates to combat still-rising inflation.
While vehicle-miles declined 5.6% in August from year-ago levels, a significant level to be sure and one consistent with declines in the 1974-1975 and 1980 recessions, it is important to remember prices are affected not by vehicle-miles but rather by total volumetric demand. We repeat from May (original boldface):
If we index constant-dollar gasoline prices to July 1984 levels and map the logarithm thereof (thin red line, left-hand chart) against the logarithm of implied gasoline demand (thick blue line), we see total gasoline demand has risen higher in an erratic fashion for almost a quarter-century independent of price.
If price elasticity of demand was operating as designed, we would see a negative trend in the scatter diagram (right-hand chart). The trend is erratically positive. The partial contribution of price to total demand may be negative, but it is being overwhelmed by income- and engineering-related factors. Both continue to support our original thesis that gasoline demand can rise independently of price so long as the economic value added by its consumption exceeds the total cost paid.
Bianco Research, L.L.C For the week of November 5, 2008 17
Metals Led Mining Equities’ Relative Performance LowerFrom A Recent Market Facts
Equity markets often are proclaimed justifiably to be discounting mechanisms. This is not always the case, however. The Journal of Commerce-Economic Cycle Research Institute’s industrial metals index (thick blue line, left-hand chart) led the performance of the MSCI World Metals & Mining index relative to the MSCI World index (thin red line). Few allege spot industrial metals to be more forward-looking than equities, but this was the case both on the upside in 2007 and early 2008 and most certainly on the downside after May 1, 2008. Neither index is showing much abatement of downward momentum at present.
If we look at the dollar index-adjusted prices of individual base metal forwards traded at the LME, we find all peaked well before miners’ relative performance did (black vertical line). The peaks for copper and aluminum (red-yellow and blue lines, respectively) were in May 2006, zinc (hatched green line) was in November 2006, nickel (black-white line) in May 2007 and lead (thin red line) in November 2007.
Dollar-Adjusted LME Forwards Peaked Long BeforeMiners' Relative Performance
50%
100%
150%
200%
250%
300%
350%
400%
450%
500%
550%
600%
650%
700%
May
-03
Aug
-03
Oct
-03
Jan-
04
Apr
-04
Jul-0
4
Oct
-04
Jan-
05
Apr
-05
Jul-0
5
Oct
-05
Dec
-05
Mar
-06
Jun-
06
Sep
-06
Dec
-06
Mar
-07
Jun-
07
Sep
-07
Dec
-07
Mar
-08
May
-08
Aug
-08
May
6, 2
003
= 10
0%
50%
100%
150%
200%
250%
300%
350%
400%
450%
500%
550%
600%
650%
700%
May
6, 2
003
= 10
0%
CopperAluminumNickelLeadZinc
Spot Metals Broke Before Miners' Relative Performance
75%
100%
125%150%
175%
200%
225%250%
275%
300%
325%350%
375%
400%
425%450%
475%
500%
Jul-0
0O
ct-0
0Ja
n-01
Apr
-01
Jul-0
1O
ct-0
1D
ec-0
1M
ar-0
2Ju
n-02
Sep
-02
Dec
-02
Mar
-03
Jun-
03S
ep-0
3D
ec-0
3M
ar-0
4M
ay-0
4A
ug-0
4N
ov-0
4Fe
b-05
May
-05
Aug
-05
Nov
-05
Feb-
06M
ay-0
6A
ug-0
6O
ct-0
6Ja
n-07
Apr
-07
Jul-0
7O
ct-0
7Ja
n-08
Apr
-08
Jul-0
8O
ct-0
8
Rel
ativ
e Pe
rform
ance
, MSC
I Wor
ld M
inin
g Vs
.W
orld
Inde
x Ju
ly 1
7, 2
000
= 10
0% (T
hin
Red
Lin
e)
75%
100%
125%
150%
175%
200%
225%
250%
275%
300%
325%
350%
375%
JOC
-EC
RI I
ndus
trial
Met
als
Inde
xJu
ly 1
7, 2
000
= 10
0% (T
hick
Blu
e Li
ne)
Relative Performance(Left Scale)
Industrial Metals Index(Right Scale)
Bianco Research, L.L.C For the week of November 5, 2008 18
Ethanol Economics, Hedging & VeraSun Energy’s BankruptcyFrom A Recent Market Facts
For those of you waiting for the government’s profits from the TARP’s management to start rolling in, we commend you to the just-announced bankruptcy of ethanol distiller VeraSun Energy. As we have railed early and often, most recently in August, corn-derived ethanol is nothing but a misconceived government subsidy program gone horribly awry. It surely would have ranked at the top of economic debacles in most administrations; here the competition was too fierce to provide for that outcome.
The irony is gross distillation margins (thick blue line, left-hand chart) are still positive, albeit declining as we move forward through the storage cycle of new-crop corn. Corn futures converted into ethanol (green line, left-hand chart) are in a strong carry, while ethanol futures (thin red line) are essentially flat.
National rack ethanol prices themselves (thin red line, right-hand chart) have been moving in lockstep with both reformulated gasoline and RBOB (thick blue and hatched green lines, respectively). The price spikes in September are artifacts of Hurricane Ike.
Ethanol And Gasoline Prices
75
100
125
150
175
200
225
250
275
300
325
350
375
400
Sep
-97
Mar
-98
Sep
-98
Feb-
99
Aug
-99
Feb-
00
Aug
-00
Jan-
01
Jul-0
1
Jan-
02
Jul-0
2
Jan-
03
Jul-0
3
Dec
-03
Jun-
04
Dec
-04
Jun-
05
Nov
-05
May
-06
Nov
-06
May
-07
Nov
-07
May
-08
Oct
-08
Nat
iona
l Eth
anol
Rac
k Pr
ice,
Cen
ts P
er G
allo
n(T
hin
Red
Lin
e)
255075100125150175200225250275300325350375400425450475500
Gul
f Coa
st R
FG A
nd R
BO
B G
asol
ine,
C/G
(Thi
ck B
lue
And
Hat
ched
Gre
en L
ines
)
Ethanol(Left Scale)
Gasoline, RFG And RBOB(Right Scale)
2008-2009 Gross Ethanol Distillation Margin Declining Through Crop Year
$1.40
$1.45
$1.50
$1.55
$1.60
$1.65
$1.70
$1.75
$1.80
Dec-08 Mar-09 May-09 Jul-09
Eth
anol
And
Con
verte
d C
orn
Futu
res
(Thi
n R
ed A
nd T
hick
Gre
en L
ines
)
$0.175
$0.200
$0.225
$0.250
$0.275
$0.300
$0.325
Gro
ss M
argi
n (T
hick
Blu
e Li
ne)
Ethanol And Converted Corn(Left Scale)
Gross Margin Oct. 31, 2008(Right Scale)
Bianco Research, L.L.C For the week of November 5, 2008 19
The Federal Reserve And Crude Oil After The CollapseFrom A Recent Market Facts
We noted in that same July Market Facts that crude oil prices had risen 50% and the dollar index had fallen 5.2% since a previous observation. As crude oil prices have declined close to 55% since mid-July and the dollar index has risen 17.6% over the same period, we should revisit the question of whether higher crude oil prices are attributable to monetary policy. This asymmetric gearing suggests those who had equated crude oil price strength with dollar weakness were guilty of small-sample misinterpretation.
The long-term comparison between crude oil expressed in either current or constant 1983 prices (thin and hatched red lines, respectively, both charts) and the dollar is statistically unstable over time. Of course, traders always have a decision whether to be profitable in their execution or to be correct in their analysis, and there is no doubt trading crude oil and the dollar/euro exchange rate as if they were linked causally was profitable after August 2007.
The same observation applies to a map against the forward rate ratio between three-month LIBOR and ten-year Treasuries (thick blue line, right-hand chart). The action in the yield curve since 2001 has included two violent steepenings, an equally pronounced flattening and now a sudden steepening. A casual observer might conclude monetary policy is being made and re-made on a daily basis, perhaps hourly. The break in crude oil prices in July occurred six weeks after the June flattening of the yield curve. The yield curve began to re-steepen three weeks ago; if all we need to trade crude oil successfully is this yield curve, we should look for higher crude oil prices by Thanksgiving.
Are Crude Oil And The Yield Curve Related?
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
May
-83
Mar
-84
Dec
-84
Oct
-85
Aug
-86
May
-87
Mar
-88
Jan-
89O
ct-8
9A
ug-9
0Ju
n-91
Mar
-92
Jan-
93N
ov-9
3A
ug-9
4Ju
n-95
Apr
-96
Jan-
97N
ov-9
7A
ug-9
8Ju
n-99
Apr
-00
Jan-
01N
ov-0
1S
ep-0
2Ju
n-03
Apr
-04
Feb-
05N
ov-0
5S
ep-0
6Ju
l-07
Apr
-08
Wes
t Tex
as In
term
edia
te, $
/ B
arre
l (Th
in R
ed L
ine)
0.990
0.992
0.994
0.996
0.998
1.000
1.002
1.004
1.006
1.008
1.010
1.012
1.014
1.016
1.018
1.020
Forw
ard
Rat
e R
atio
, 3M
-10Y
(Thi
ck B
lue
Line
)
WTI$Current And $1983
(Left Scale)Forward Rate Ratio, 3M-10Y
(Right Scale)
Are Crude Oil And The Dollar Related?
0
10
20
30
40
50
60
70
80
90
100
110
120
130
140
150
May
-83
Mar
-84
Dec
-84
Oct
-85
Aug
-86
May
-87
Mar
-88
Jan-
89O
ct-8
9A
ug-9
0Ju
n-91
Mar
-92
Jan-
93N
ov-9
3A
ug-9
4Ju
n-95
Apr
-96
Jan-
97N
ov-9
7A
ug-9
8Ju
n-99
Apr
-00
Jan-
01N
ov-0
1S
ep-0
2Ju
n-03
Apr
-04
Feb-
05N
ov-0
5S
ep-0
6Ju
l-07
Apr
-08
Wes
t Tex
as In
term
edia
te, $
/ B
arre
l (Th
in R
ed L
ine)
70
80
90
100
110
120
130
140
150
160
170
Dol
lar I
ndex
, Inv
erse
Sca
le (T
hick
Blu
e Li
ne)
WTI$Current And $1983
(Left Scale)
Dollar Index(Right Scale)
Bianco Research, L.L.C For the week of November 5, 2008 20
Crude Oil Futures: Large Specs Should Stand And Be CountedFrom Our Latest
Commitment Of Traders Update
Net Hedgers/Commercials
-160
-120
-80
-40
0
40
80
120
Net
Pos
ition
s (in
000
's)
-160
-120
-80
-40
0
40
80
120
Net
Pos
ition
s (in
000
's)
Hedgers are those that do deal in the cash market and have more than 350 contracts
Net Large Speculators
-100
-60
-20
20
60
100
140
Net
Pos
ition
s (in
000
's)
-100
-60
-20
20
60
100
140
Net
Pos
ition
s (in
000
's)
Speculators are those that do not deal in the cash market and have more than 350 contracts
Crude Oil Futures
-25
0
25
50
75
100
125
150
Wee
kly
Ran
ge
-25
0
25
50
75
100
125
150
Wee
kly
Ran
ge
"Backward Adjusted" Continuous Futures
Net Small Traders
-60
-40
-20
0
20
4012
/29/
1992
10/5
/199
3
7/12
/199
4
4/18
/199
5
1/23
/199
6
10/2
9/19
96
8/5/
1997
5/12
/199
8
2/16
/199
9
11/2
3/19
99
8/29
/200
0
6/5/
2001
3/19
/200
2
12/2
4/20
02
9/23
/200
3
6/29
/200
4
4/5/
2005
1/10
/200
6
10/1
7/20
06
7/24
/200
7
4/29
/200
8
Net
Pos
ition
s (in
000
's)
-60
-40
-20
0
20
40
Net
Pos
ition
s (in
000
's)
Small Traders have less than 350 contracts
Friday's Commitments of Traders data for Crude Oil futures showed Hedgers were net long 23,137 contracts on October 28. At the same time, Friday's report showed the Large Speculators were net short 8,406 contracts on October 28.
This market doubled in the ten months after August 2007 and fell in half thereafter. Someone must have been doing something. And yet we could not infer it from these data. The short net position of the Large Speculators is so small as to be trivial.
Bianco Research, L.L.C For the week of November 5, 2008 21
FF Rate & YoY Change in Core CPI Back to 1958From Our Collection of Long-Term Charts
Federal Funds Rate and Year-over-Year Change in Core CPI Back to 1958
0%
4%
8%
12%
16%
20%
0%
4%
8%
12%
16%
20%
Federal Funds Rate
Year-over-Year Change in "Core" CPI
Last (Sept 2008) : Y-O-Y Change in "Core" CPI = 2.28%Last (Sept 2008) : Federal Funds Rate = 2.00%
Real "Core" Federal Funds Rate Back to 1958
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
Last (Dec 2007) = -0.28%
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