The ECB Is Buying BMWs; But You Probably Shouldn't

| About: iShares 20+ (TLT)

Summary

Once again the question emerges: what's more ridiculously overvalued, stocks or bonds?

The answer: both (and yes, that's an attempt at humor because 'both' isn't an answer to that question).

Let's look at Treasuries ahead of this week's 'main event.'.

I love Deutsche Bank's Aleksandar Kocic.

He writes the derivatives section of the bank's US fixed income weekly note and is personally responsible for some of the most bizarre, metaphysical market commentary you'll get from the Street (see here, for instance).

Kocic is one of those guys that's just flat out smarter than you. And I don't mean that as an insult because I'm including "me" in "you." I invariably lose him about halfway through his weekly missives, a fact I humbly chalk up to my relative stupidity.

But the upside is, I generally understand the first few paragraphs, and they're great - in a weird kind of way. Here are the sections of his latest commentary that you and I, united in our shared idiocy, can understand (my emphasis):

Despair fatigue or how hopelessness grew boring...

As the markets show signs of normalization after Brexit, a clearer picture of fragmentation of horizons is beginning to emerge. In the near term, we see ironing out of post-referendum dislocations as the main driver. In particular, the debates will be centered on repositioning, reversal of correlations and volatility decline. As echoes of the UK referendum fade, the debates would return back to policy response problems, in particular inadequacy of the monetary policy and additional policy tools. With the existing political, economic and event risk in place, central banks are likely to stay out of the way, but short of deeper crisis, we see explicit relent as unlikely.

In terms of available policy tools, fiscal stimulus and helicopter money is receiving increasingly more attention. Both of these maneuvers, if proven successful, would be bear steepeners. In general, fiscal spending is seen as a politically risky theme and is likely to be avoided during the presidential campaign. Thus, we do not expect to see steepeners before 2017. In the meantime, long rates could be under (downward) pressure with a possibility of bull flattening around the elections in the face of additional political non- linearities and event risk.

Ok, got it. Long, long rates (NYSEARCA:TLT), - for now (and yes, there are two "longs" there). That seems to be the general consensus and frankly, it's nuts, even if it's the right call. You can't fight the Fed but you damn sure call the whole thing crazy.

See that's the thing that a lot of people fail to understand. You can be right and wrong at the same time. Think about Michael Burry of "The Big Short" fame. Those subprime MBS swap premium payments seemed really stupid in the short-term. But they didn't look so stupid later on, did they?

In that same vein, US Treasuries are insanely overvalued. I mean, it's ridiculous. Here, look:

(Chart: Goldman)

This isn't the first time I've noted this. But far be it for me to rely one bank's fair value model. Let's ask my friends over at Citi what they think (emphasis mine):

Although long-term US rates initially defied a strong rebound in June NFP last Friday, rates sold off this week with the 10y currently close to our year-end target at 1.6%. Having said that, we believe any tactical selloff is likely to be short-lived and would be looking to take our tactical bearish trades off next week. A large part of the recent risk-on can be attributed to expectations of further monetary stimulus, including ECB and BOJ QE expansion, as well as BOE cuts. This is evident from the fact that stocks and rates have remarkably decoupled recently, with S&P up by 3% since May and 10y rate down by 25bp over the same time period. When evaluated by a simple 1y rolling regression, the 10y is almost two sigmas rich to stocks, a divergence not far from historical extremes.

Ok, so we'll parse that step by step (I'm getting a fair amount of requests for granular breakdowns). Here's what Citi means by "long-term US rates initially defied a strong rebound in June NFP last Friday, rates sold off this week with the 10y currently close to our year-end target at 1.6%":

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And next, here's what Citi means by "...this is evident from the fact that stocks and rates have remarkably decoupled recently, with S&P up by 3% since May and 10y rate down by 25bp over the same time period."

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That makes no sense. It's not intuitive. S&P soars, Treasuries rally. It's an aberration I discussed here.

Note that the above looks like further evidence of something else I've discussed lately: the fact that central banks might have rendered the equity-risk premium completely useless as a measure of stock/bond relative richness/cheapness.

To Citi's point about expectations for further easing fueling risk-on sentiment, on Thursday we'll get this week's "main event," as it were - the first ECB meeting since the Brexit vote. You can find the full Heisenberg preview here, but suffice to say expectations are for jawboning to be the only policy "tool" deployed aggressively between now and September. Here's Deutsche Bank (emphasis mine):

The pressures on European banks make for a more complex environment for monetary policy setting. We believe the ECB will try to ease the policy stance further, but on balance will wait until September before doing so. The ECB appears to have a smaller Brexit shock in mind than we do, is confident about getting more benefits from policies like TLTRO2 and CSPP and in September will have the in-depth analysis accompanying the new staff forecasts.

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As a reminder, CSPP is the ECB's lunatic plunge into corporate bond monetization, an effort which has driven rates below zero for some corporate borrowers. I want to close with an excerpt from a truly epic Deutsche Bank note out on Tuesday morning followed by a punchline and a graph. Enjoy.

From Deutsche:

[There's] nothing else to buy

This seems to be a serious issue, as many investors have told us that our sector doesn't screen as having any value but that other sectors screen as having even less.

BMW, for example, might be a great car, but that doesn't mean you should pay 2x the sticker price just because there other car buyers that have lots of cash in their pockets or there is a lot shortage.

Oh yeah? Well someone forgot to tell the ECB:

(Chart: BofAML)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.