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Bond Deflation Commences As The Euro Soars On European And World Bank Earnings

|Includes:iShares Core Total U.S. Bond Market ETF (AGG), BAB, BIS, CEW, CMF, CRED, DBV, DRR, EEM, EMB, EMFN, EPV, EUFN, FEZ, FXE, HYD, JNK, LQD, MUB, RXD, SIJ, SSG, TLT, TMV, VT, VXX

I ... Market summary for 8-2-2010

Currency traders took the Euro, FXE, higher on European and world bank earnings, continuing the rally in European Financials, EUFN,  and the European stocks, FEZ, as well as emerging market countries such as Peru, EPU and Columbia, GXG, and Thailand, THD.

HSBC, BNP Earnings Spurred A Drop in Bank Swaps To A Three-Month Low. HSBC Holdings Plc and BNP Paribas SA led a decline in the cost of insuring bank bonds to the lowest level in three months after posting profits that beat analysts’ estimates, easing concern of a global economic slowdown. The Markit iTraxx Financial Index of credit-default swaps linked to 25 banks and insurers fell 3 basis points to 112.5, near the lowest since April 21

Higher bank profits also helped fuel a rally in corporate credit, with the Markit iTraxx Europe Index of 125 companies with investment-grade ratings down 3 basis points at 102, the lowest since May 13.

HSBC, Europe’s biggest bank, and BNP Paribas are the latest companies to exceed profit forecasts in what Deutsche Bank AG strategist Jim Reid called a “blockbuster earnings season.”

Global Chip Sales Rose 7.1% in Second Quarter. Global chip sales edged up 0.5% in June from a month earlier, contributing to 7.1% growth in the second quarter from the prior quarter. Meanwhile, gains for the month and quarter from last year were 49% and 45%, respectively, reflecting growth in a broad range of markets from an industry slowdown in the first half of last year.

World stocks, VT, rose; and US, Stocks, VTI rose. The higher euro yen carry trade moved commodities higher.

II ... Currencies gained:

FXS, Swedish Krona, 1.4%, soared well above it April 26, 2010 high

FXB, British Pound Sterling, 1.3%, soared well above it April 26, 2010 high

FXE, Euro, 1.1%, closed at 131.25

BNZ, New Zealand Dollar, 1.3%

SCR, South African Rand, 0.3%

FXA, Australian Dollar, 0.2% 

FXC, Canadian Dollar, 0.4%

FXF, Swiss Franc, 0.25

BZF, Brazilian Real 0.1% rose near its April 26, 2010 high 

FXY, closed 0.1% lower at 114.50

DBV, Developed Currencies, 0.61%

CEW, Developing Currencies, 0.55

The US Dollar, $USD, fell to $80.93, just above 200 day moving average.

Here is a Finviz screener of currencies

The ratio of DBV to CEW closed at 1.052 which is above resistance at 1.050; soon developed currencies are going to have to go down in relation to developing currencies because the level of their burdensome sovereign debt and the value of their toxic banks will cause the currency traders to sell off the developed currencies more than the developing currencies.

Said another way debt deflation is coming to the developed nations like Asia, DNH, Spain, EWP, Italy, EWI. As European Financials, EUFN, fall lower, so will, the emerging markets financials, EMFN, financials, XLF, and definitely effecting the credit sensitive Russell, 2000, IWM. Note the weak doji in the chart of the Russell 2000 shares; click on chart to enlarge.

The ratio of the pure small cap growth stocks to the pure small cap value stocks, RZG:RZV, is at the prior level where there was a stock market turn in the stock market in January 2010. Sectors such as biotechnology stocks, IBB, and the semiconductors, SMH, utilities, XLU, and health care, XLV, are prime for a turn lower; click on chart of semiconductors to enlarge.

Emerging market leaders GXG, THD, TUR, and ECH. traded higher today as emerging market debt, EMB, and  emerging market currencies, CEW are both traded higher today.

World currencies, DBV rose 0.61%, and emerging market currencies, CEW, rose 0.55% …. World shares, VT, rose 2.7% and emerging market shares, EEM, rose 2.6% .. Chart of DBV, CEW, EEM and VT.

Chart of FXI, INP, EEM, EWZ, FEZ, IWM shows how world shares have soared compared to the Russell 2000.

III ... Countries gained:

FEZ, Europe, 4.6%, rose just above its April 26, 2010 high. 

EWP, Spain, 4.7%, rose above its April 26, 2010 high.

EWD, Sweden, 4.6%, rose just above its April 26, 2010 high 

EWQ, France, 4.1%

EWU, United Kingdom, 3.5%

RSX, Russia, 4.2%

EWG, Germany, 3.3% rose to its April 26, 2010 high

EWK, Belgium, 3.4% rose to its April 26, 2010 high

EWN, Netherlands, 3.6%

GXF,  Nordic, 2.6% rose to its April 26, 2010 high

EWO, Austria, 3.4%

FXI, China, 2.8% rose well above its April 26, 2010 high 

DNH, Asia, 3.4%

EEM, Emerging Markets, 2.6%, rose to its April 26, 2010 high.  

EWZ, Brazil, 2.4%.

INP, India, 1.7%

ECH, Chile, 2.4%, rose very well above its April 26, 2010 high

BRF, Brazil Small Caps, 2.0% rose very well above its April 26, 2010 high

EWS, Singapore, 2.7%, rose very well  above its April 26, 2010 high 

EWH, Hong Kong, 2.2% rose very well above its April 26, 2010 high

EWA, Australia, 3.3%

EZA, South Africa, 2.0%, rose just above its April 26, 2010 high

TUR, Turkey, 2.1% rose just above its April 26, 2010 high

THD, Thailand, 1.2% rose well above its April 26, 2010 high

EPU, Peru, 1.3% rose well above its April 26, 2010 high

GXG, Columbia, 1.0% soared near an all time high.

IWM, Russell 2000, 1.7% rose to 66.15 which is near a pivot point of 66.2 and 66.6

SPY, S&P, 2.2% 

DIA, Dow, 1.9%

World Stocks relative to US Stocks, VT:VTI, rose to its 200 day moving average.

 Emerging market shares to world shares, EEM:VT, remained elevated 

Here is a Finviz screener of stocks

IV ... European and foreign banks soared

BAP, 4.0% Credicorp Peru 

SAN, 5.3% Banco Santender Chile 

Here is a Finviz screener of European and wold banks

V ... Sectors rose:

XLV, 1.9%, Health Care 

XLU, 2.1% Utilities

XLB, 2.7%, Basic Materials

IYR, 3.0% Real Estate

SMH, 1.8%, Semiconductors

IWN, 1.7%, Russell 2000 Value

XLI, 2.0% Industrials

IBB, 1.89% Biotechnology

TAN, 3.1% Solar Stocks

XRT, 2.2% Retail

XHB, 2.6% Home Building

IYR, 3.0% Real Estate, rose strongly near its April 26, 2010 high 

XLE, 3.6% Energy

Here is a Finviz screener of sectors

VI .... Financials gained

EUFN, European Financials, 5.4%

EMFN Emerging market Financials, 2.3%

XLF, Financials, 2.5%

VII  ... Commodities gained

JJN, Nickel, 3.1% 

JJC, Copper, 2.6%

DBB, Base Metals, 3.9%

USO, Oil, 3.2%

DBA, Agriculture, 0.1%

Here is a Finviz screener of commodities.

VIII ...  Emerging bonds gained

EMB, 0.3%

IX ... Debt fell as bond deflation commenced today

Peak Debt was attained Friday, July 30, 2010, as Aggregate Bonds, AGG, fell significantly lower.

US Treasuries, TLT,  fell considerably lower today.

The US Ten Year Note, IEF, fell only slightly.

Country Default Risk. Default risk for sovereign debt has declined quite a bit since the start of July when equity markets here in the US made their correction lows. Below we highlight the default risk as measured by 5-year credit default swap prices for a large number of countries as well as four US states that have the highest default risk. The left side is sorted by percent change since July 2nd, and the right side is sorted by CDS price (highest to lowest).

HYD, -0.4% High Yield Municipal Bonds

MUB, -0.2% Municipal Bonds

JNK, -0.2% Junk Bonds

LQD, -0.6%, Corporate Bonds,

BAB, -0.4% Build America Bonds

Here is a Finviz screener of bonds.

X ... Bear market ETFs fell

Here is a Finviz Screener of bear market ETFs:  SRS, SJH, SSG, EEV, SMN, BZQ, SIJ, EPV, FXP, SCO, JPX, BOM, EWV, INDZ, BRIS, BIS, SDP, RXD, DGP, VXX

The gold ETF rose slightly … it is on the verge of breaking out or on the verge of falling lower  

XI ... Conclusion and investment application

“Peak credit” likely occurred July 30, 2010; and thus “credit deflation” that is “bond deflation” and “sovereign debt deflation” will commence beginning in August 2010 with interest rates going higher across the board.

The chart of AGG, TLT, IEF, CFT, CMF, HYD makes for a handy reference chart for following bond deflation.

The EU Stress Tests errored on three counts. First, they missed an opportunity to fortify the banks. Second, they failed to mention the systemic risk poised by the plummeting liabilities in the shadow Landesbanken banking system. And Third, they failed to highlight the tight credit existing in Europe, specifically the continual contraction of interbank lending.   

1) Andrew MacAskill in Bloomberg article EU Stress Tests May Be `Missed Opportunity’ to Fortify Banks relates: Before the results were published, analysts at Nomura Holdings Inc. estimated the banks would have to raise 30 billion euros. Goldman Sachs Group Inc. predicted they would need 38 billion euros and Barclays Capital said they would require as much as 85 billion euros. Tests carried out in the U.S. last year found that 10 lenders, including Bank of America Corp. and Citigroup Inc., needed $74.6 billion.

“If we had at least one bank which the markets hadn’t really expected to fail, that would have given the stress tests more credibility,” said Lothar Mentel, chief investment officer at Octopus Investments Ltd. in London, whose team manages more than 600 million pounds ($926 million). “That hasn’t happened.”

The European tests ignored the majority of banks’ holdings of sovereign debt. Regulators don’t believe there will be a national default, European Central Bank Vice President Vitor Constancio said July 23. The evaluations took into account potential losses only on government bonds the banks trade, rather than those they are holding until maturity, CEBS said.

“The fact that they did not stress the bank book is going to be seen as a weakness,” said Robert Talbut, chief investment officer at Royal London Asset Management Ltd., which oversees about $52 billion. “I don’t think the results of the tests will resolve anything.”

Lenders hold about 90 percent of their Greek government bonds in their banking book and 10 percent in their trading book, according to a survey by Morgan Stanley. They have to write down the value of bonds in their banking book only if there is serious doubt about a state’s ability to repay in full or make interest payments.

Citigroup said that 85 banks provided breakdowns of their government-debt holdings when they published the stress test results. The six that didn’t are all German banks and include Deutsche Bank AG, the country’s biggest bank, Citigroup said.

2) There is very much a black swan leading to the  of depression will be Europe, FEZ, and the European Financials, EUFN, as the banking and lending institutions crack due to the plunging liabilities in the shadow banking system, primarily the Landesbanken, that is the German state-owned wholesale banking system, responsible for securitization of debt, and accounting for mortgage-backed securities, much like America’s Fannie Mae and Freddie Mac, as reported by Tyler Durden who references the report “Shadow Banking,” by  Zoltan Pozsar.

3) Credit tightening is seen in the LIBOR-OIS (USD SWAP) 3M Graph, provided courtesy of The USMicroeconomicsBlog  

I believe the stock rally in Europe is near its end now that the bank’s are reporting their profits.  

And I believe the rise in the industrials, XLI, will not follow through to other sectors such as retail, XRT as EconomicPolicy Journal reports the current recession is deeper and slower to recover.  And in the U.S. Economy: Manufacturing Slowed in July as Orders Cooled. The manufacturing rebound that propelled the U.S. out of the recession cooled in July, reflecting a slowing in orders and production. The Institute for Supply Management’s manufacturing gauge dropped to 55.5 last month, exceeding the median forecast of economists surveyed by Bloomberg News, from 56.2 in June. The ISM’s new orders measure dropped to 53.5, the lowest level since June 2009, from 58.5. The measure was as high as 65.7 in May. The group’s production gauge decreased to 57 from 61.4.

In as much as I believe stock deflation will commence again as the rally ends; and commodity deflation will commence again as currency traders take carry trade profits, for institutional investors I recommend

1)  Two stock bear market mutual funds: Profunds UKPSX, 200% short Japan, and the Direxion DXRSX, 200% Small Caps  

2)  One bond bear matket ETF: TMV 300% inverse of the US Treasuries

3) One stock bear market ETF: VXX volatility

4) One commodity bull market ETN: DGP 200% long gold

5) One currency bear ETN: DRR 200% inverse of the Euro

6) Several bear stock sector ETFs

BIS 200% inverse of Nasdaq biotechnology

EPV 200% inverse of Europe

SGP 200% inverse of Utilities

RXD 200% inverse of Health Care

SIJ 200% inverse of Industrials

SSG 200% inverse of Semiconductors

7) A short sell of

TAN as this was a stock market loss leader up until recently

WMH as this also was a loss leader up until recently

 TTH as this is likely o correct as it has risen to resistance

For individual investors I recommend an investment in gold coins

Disclosure: I am invested in gold coins