Cracks In The Dam

Includes: EMB, MUB
by: Acting Man

Submerging Markets

A friend just pointed out to us that it may be worth our while to take a look at emerging market bonds, and so we did. Luckily there is an emerging markets bond ETF, so one can get an immediate overview of the sector as a whole. It turns out there is now quite a rout under way, going hand in hand with the panic in EM currencies we have recently written about (and which has since then continued).

In fact, the action in EMB indicates to us that there is now a full-scale flight from the most risky types of paper promises – typically this 'fraying at the edges' happens not too long before the center is gripped by panic as well. It is one of the loudest alarm bells yet, and there are more than a few alarm bells clanging by now.

EMB gets kicked in the teeth. This is a daily chart encompassing the past two years. Not what holders of EMB were hoping to see – click to enlarge.

Looking at a five-year weekly chart of EEM, an ETF that generically represents emerging market stocks, we cannot say that it is particularly confidence-inspiring either. In fact, it looks like it could soon break down badly, given that it is declining from a lower high and has violated trend line support. We discussed its notable short-term divergence with the SPX recently, and we continue to believe that it is a bad sign.

EEM, weekly. This looks bad – click to enlarge.

Delayed Meredith Withney Gratification?

In recent months Meredith Withney has been mainly conspicuous by changing her tune on U.S. banks, which she previously gave such a timely and at the time slightly controversial sell signal on as the 2008 crisis got under way. So timely in fact, that she felt confident enough to parlay her newly earned popularity into founding her own research firm.

Unfortunately for her, she then tried to follow up on that spectacular call by making yet another spectacular call – this time about the imminent serial bankruptcy of various municipalities. Several municipalities have in fact gotten into severe financial trouble since then, but overall, the numbers of bankruptcies have remained small. As a result, the idea to sell municipal bonds didn't exactly work out. Admittedly at the time she made that call, it sounded not totally unreasonable. She may only have gotten the timing wrong by a few years. We say that because the major problem that municipalities face in our opinion are pension costs – and that is a millstone that weighs heavier year after year.

While we don't think that this is necessarily what's behind the recent heaviness in municipal bonds, it is noteworthy that this favored vehicle of the 'yield chasers' is following the junk bond and emerging market bond universes into the nether regions where much wailing and gnashing of teeth will likely obtain.

Muni bonds have their own ETF as well (what doesn't?), so we can also get a quick scan of their health. Clearly they are on the skids, so to speak on the ramus descendens, and in crying need of help. Who will bail their holders out?

MUB looks like it will soon need to be carted off to the emergency ward – click to enlarge.


We recently quipped that if a 50 billion ton asteroid were to hit the earth, Wall Street would probably interpret that as an especially loud buy signal. However, the long list of much discussed warning signs that have popped up in recent weeks and months keeps getting longer and longer lately. Maybe it's all just a perfectly normal 'rolling correction,' but then again, maybe it isn't, and it is anyway rarely a good idea to over think such things too much. Warning signals are what they are. We would recommend watching for mainstream comment (if any is even forthcoming) on these recent moves in the riskier market segments. If it is all played down as irrelevant, then chances are good that it is very relevant indeed. Recall our little write-up about the frenzy in frontier market bonds that reached its peak just before emerging market paper decided to head South with such vigor. We think we can now confidently state that Rwanda won't get $3.5 billion in bids anymore if it tries to sell $500 million in bonds. The buyers of the last issue are probably well on the way to becoming something between 'long-term investors' and 'grizzled veterans that have seen everything'.

Charts by: BigCharts