The Queen Of Spades

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by: Macronomics
Summary

In this week's conversation, we would like to look at the additional dovishness coming from the ECB.

Do not focus solely on the current low default rates when assessing forward credit risk.

As we stated before if it's D for "Deflation" and "Deleveraging," then it's good for credit markets in a "Japanese" fashion.

"Luck is believing you're lucky." - Tennessee Williams

While enjoying a much-needed short break from blogging, hence our uncommon silence, we still managed to follow the macro news such as February's anemic 20,000 new jobs creation in the United States from the latest nonfarm payroll report (when 180 K was expected). With global negative yielding bonds increasing by $509 billion in the last three-day trading to $7.437 trillion, given the global weaker tone in the growth outlook, no wonder the D word for "deflation" fears has staged a comeback. Given the recent dovish tone taken by our "Generous Gambler" Mario Draghi we also like to call "Le Chiffre," and that we do have "Sympathy for the Devil" because as we said on numerous occasions, "The greatest trick European central bankers ever pulled was to convince the world that default risk didn't exist," so, when it came to selecting our title analogy, we decided to go for both a great literature reference and another card game reference. "The Queen of Spades" is a short story by Alexander Pushkin about human avarice and was written in the autumn of 1833 and was first published in 1834. The story was also the basis of an opera by Pyotr Ilyich Tchaikovsky in 1890. It tells the story of Hermann, an ethnic German, who is an officer of the engineers in the Imperial Russian Army. He constantly watches the other officers gamble, but never plays himself. One night, Tomsky tells a story about his grandmother, an elderly countess. Many years ago, in France, she lost a fortune at the card game of faro, and then won it back with the secret of the three winning cards, which she learned from the notorious Count of St. Germain. Hermann becomes obsessed with obtaining the secret:

"The countess (who is now 87 years old) has a young ward, Lizavyeta Ivanovna. Hermann sends love letters to Lizavyeta, and persuades her to let him into the house. There Hermann accosts the countess, demanding the secret. She first tells him that story was a joke, but Hermann refuses to believe her. He repeats his demands, but she does not speak. He draws a pistol and threatens her, and the old lady dies of fright. Hermann then flees to the apartment of Lizavyeta in the same building. There he confesses to have killed the countess by fright with his pistol. He defends himself by saying that the pistol was not loaded. He escapes from the house with the aid of Lizavyeta, who is disgusted to learn that his professions of love were a mask for greed.

Hermann attends the funeral of the countess, and is terrified to see the countess open her eyes in the coffin and look at him. Later that night, the ghost of the countess appears. The ghost names the secret three cards (three, seven, ace), tells him he must play just once each night and then orders him to marry Lizavyeta. Hermann takes his entire savings to Chekalinsky's salon, where wealthy men gamble at faro for high stakes. On the first night, he bets it all on the three and wins. On the second night, he wins on the seven. On the third night, he bets on the ace - but when cards are shown, he finds he has bet on the Queen of Spades, rather than the ace, and loses everything. When the Queen appears to wink at him, he is astonished by her remarkable resemblance to the old countess, and flees in terror. In a short conclusion, Pushkin writes that Lizavyeta marries the son of the Countess' former steward, a state official who makes a good salary. Hermann, however, goes mad and is committed to an asylum. He is installed in Room 17 at the Obuhov hospital; he answers no questions, but merely mutters with unusual rapidity: "Three, seven, ace! Three, seven, queen!" " - source Wikipedia

The card game of faro also plays an important role in Pushkin's story. The game is played by having a player bet on a winning card. The dealer then begins turning over cards, burning the first (known as 'soda') to his left. The second card is placed face up to his right; this is the first winning card. The third card is placed face up in the left pile, as a losing card. The dealer continues turning over cards, alternating piles until the bet has been won or lost. A reading of The Queen of Spades holds that the story reveals the Russian stereotype of the German, one who is cold and calculating person bent on accumulating wealth (Germans increasing savings at the expense of consumption, which depresses economic activity), one might wonder if indeed the "uber" mercantile policies followed by Germany versus the rest of the world in general and its European peers in particular such as France and Italy will eventually spell its downfall, but we ramble again. After all Pushkin's Queen of Spades is an "eternal" tale of gambling and avarice, such as the current financial markets we see in front of our very own eyes.

In this week's conversation, we would like to look at the additional dovishness coming from the ECB which we think in Europe will continue to reward more actively the financial sector credit markets over equities.

Synopsis:

  • Macro and Credit - Betting on the ace in European Rent-seeking credit markets
  • Final charts - ECB rates on Japanese path
  • Macro and Credit - Betting on the ace in European Rent-seeking credit markets

Given our "Generous Gambler" aka Mario Draghi known as Le Chiffre fired his "Chekhov's gun" and unleashed QE in Europe, the consequences have been fairly simple. We have long been declaring that in that case credit would outperform equities when it comes to financials which is what we posited in January 2015 in our conversation "Stimulant psychosis":

"Rentiers seek and prefer deflation - European QE to benefit credit investors:

"In similar fashion to what we wrote about Japan in general and credit versus equities in particular in our April 2012 conversation "Deleveraging - Bad for equities but good for credit assets":

"Financial credit may be the next big opportunity

The build-up of corporate leverage in the 2000s was confined to financials which, unlike other corporates, had escaped unscarred from the 2001 experience. However, this changed in 2008. Judging by the experience of G3 (US, EU, Japan) non-financial corporates, there should be significant deleveraging in banks going forward. Indeed, regulatory pressures are also pushing in that direction. All else being equal, this should be bullish for financial credit." - source Nomura

Given the performance of European financial credit over equities, we are not surprised. On this very blog we have been advocating favoring exposure to credit markets when it comes to financials in Europe because of the "Japanification" process facing Europe. The recent dovish tone from "Le Chiffre" still at the head of the ECB is a reminder. The new TLTRO will continue to favor rent-seeking investors but probably less strongly than during the last decade following the Great Financial Crisis (GFC).

On that note we read with interest Bank of America Merrill Lynch The European Credit Strategist note from the 8th of March entitled "A decade of hubris":

"A decade of hubris

A decade ago, on March 12th 2009, European credit markets were on their knees, and companies faced extinction. But of course, the Armageddon never came, and years of exceptional monetary support from global central banks instead ignited a decade of significant returns across credit. Secular "winners" in the post-GFC era have been LT2 banks (102% cumulative total returns), transport (71% total returns), media (67%) and tech (66%). The "losers" on the other hand, have been healthcare (60%), energy (58%), autos (51%), and senior banks (48%). Secular contrarians would buy the "losers" as a catch-up trade. In fact, senior banks should reap the benefits of yesterday's TLTRO announcement from Mr Draghi.

10yrs ago, on March 12th 2009, European credit markets were on their knees. High-grade spreads had peaked at 403bp (high-yield at 2147bp in mid-Dec '08) and companies faced extinction…with spreads implying default rates of 7% for high-grade and 40% for high-yield. Years of exceptional monetary support from global central banks instead ignited a decade of phenomenal returns across the corporate bond market (chart 1).

Secular "winners" in the post-GFC era have been LT2 banks (102% cumulative total returns), transport (71% total returns), media (67% total returns) and tech (66% total returns).

The "losers" on the other hand, have been healthcare (60%), energy (58%) given oil price ructions, autos (51%) given trade tensions, and senior banks (48%) partly given the emergence of TLAC.

Secular contrarians would buy the "losers" going forward, as a catch-up play. In fact, senior banks should reap the benefits of yesterday's TLTRO announcement from Mr Draghi - as historically has been the case (see our "who wins" under a TLTRO analysis)." - source Bank of America Merrill Lynch

From a Macro and Credit perspective, as posited by our Friend Paul Buigues in his 2013 post "Long-Term Corporate Credit Returns":

"Even for a rolling investor (whose returns are also driven by mark-to-market spread moves), initial spreads explain nearly half of 5yr forward returns." - Paul Buigues, 2013

As concluded as well in this previous 2013 by our friend Paul:

"Benjamin Graham's famous allegory of a "Mr. Market" who alternates between periods of depression and euphoria applies especially well to corporate credit investors. In addition to having a bipolar disorder, corporate credit investors are afflicted by a severe case of myopia, as they focus on current default rates, rather than trying to estimate realistic future default rates.
As a consequence, spreads themselves are a very good indicator of long-term forward returns, for both static and rolling investors." - Paul Buigues, 2013

Do not focus solely on the current low default rates when assessing forward credit risk. Trying to estimate realistic future default rates matter particularly when there are more and more signs showing that the cycle is slowly but surely turning in both CRE and consumer credit. Fed hiking cycles and tighter bank lending standards have historically been preconditions for recessions. By tracking the quarterly Senior Loan Officers Surveys (SLOOs) published by the Fed you can have a good view into credit conditions. As we told you recently, next publication of the SLOOs will be essential in assessing credit conditions. Please also note that jobless claims are one of the best indicators of a regime shift, because they generally start to rise about a year before the economy enters a recession.

But if "D" is for "Deflation," then again, looking at the growing concerns from credit investors about US companies' leverage, the biggest risk, for equities is a slowdown in buybacks and a cut in CAPEX spending and dividends for some companies to address leverage issues put forward by many investors. This would make credit more favorable than equities from an allocation perspective due to "Japanification" concerns.

Some might be expecting the Queen of Spades and a return to "goldilocks" when it comes to credit markets, yet we think you shouldn't expect a continuation of such a strong rally in high beta we have seen so far this year given the macro backdrop regardless of the strong dovishness playing out.

On the subject of "complacency" in the current market set up, we read with interest Bank of America Merrill Lynch's take from their High Yield Strategy note from the 8th of March entitled "Complacency Breeds Opportunity":

"Rebound loses momentum as unresolved risks resurface

Risk assets continued to struggle this week, as there appeared to be few takers interested in holding, let alone adding risk at current levels. For the HY market, the invisible wall demarcating poor value appeared to be somewhere around 400bps on the OAS scale, as the asset class has been oscillating around these levels for three weeks now, unable to meaningfully break through this barrier. The liquid benchmarks have been going nowhere for even longer, with HYG currently trading half a point away from its closing levels on Jan 30th, the day of the Fed meeting that marked the policy pivot. So what stands in the way of better risk appetite here? We think two key factors: high asset prices and unresolved risks. We have written extensively in recent weeks about high prices/tight spreads being the most important hurdle that would make it difficult for HY to continue to show outsized performance. Simply put, strong bids for HY usually don't come at three-handle spreads.

The second set of factors describing the risk backdrop has improved materially since Q4, and it unquestionably helped market sentiment earlier this year. The list was in fact unusually long in late 2018 - ranging from trade talks falling apart to the US government shutdown to European economies slowing to the Fed potentially making a policy mistake to oil prices falling sharply to large IG issuers losing investor confidence to EPS growth slowing to financial conditions tightening. Given the length of this list and the potential severity of some of these issues, it is little surprise that even a modest pullback in those concerns created a powerful backdrop for improving risk appetite.

But that is all history; now is the time to reassess these risks and get a better sense - with the benefit of hindsight and all the new information we have learned since then - what we got wrong back in Q4 and how much room there is for new mistakes at this point.

We think some of these risks have, in fact, been largely addressed. For example, the US government has been reopened and we think the latest experience has taught both sides of the political spectrum not to go there again, reducing the probability of a repeat occurrence. The chance of a serious Fed policy mistake - never high to begin with, in our opinion - has been reduced to effectively zero. Oil prices are no longer falling; and while we do not claim to possess a particular skill to forecast this volatile commodity, we find sufficient comfort in a simplistic thinking that it has less room to go lower from $55 than it had from $75.

The rest of risks on our list have also subsided, but we would stop short of calling them addressed. For example, all signs continue to point toward some sort of a trade agreement to be signed between the US and China in coming weeks, which should have a limited market impact at this point given that it has been well telegraphed. We remain doubtful that this event resolves most residual concerns about trade, however. Europe appears to be next on the "to-do" list for trade talks, with auto imports likely presented as a threat to US national security, as our economists describe here.

Assuming European negotiations end with some form of an agreement, an eventual outcome we have little doubt in, the larger question remains whether we can expect trade flows to return to their pre-2018 levels on the other side of all this. We have doubts that an average corporate executive committee planning the location of strategic supply chain elements for coming years is comfortable assuming most trade frictions will be resolved by then. A rational decision here should err on the side of caution by postponing/reducing cross-border investments.

On the other side of all this, the US trade deficit increased to $620bn in 2018, up 25% since the Trump administration made its reduction a key focus. It is hard to describe this outcome as a surprise if one takes into account the expected likely response functions on the other side of each trade channel. What were the chances of foreign consumers becoming more interested in US products in this environment? Not far from zero. Could the nominal signing agreements with China and/or Europe change this attitude in foreseeable future? Unlikely.

The slowdown in Europe is another risk that rose in Q4 but was subsequently swept under the rug of a tactical market rebound. The ECB has reminded us of that risk earlier on Thursday, by slashing its growth estimates, postponing its intentions to begin normalizing rates later this year, and reintroducing new measures of policy support (TLTROs). None of this should be particularly surprising, as Barnaby Martin, our European credit strategist, has been discussing these expectations for weeks now (for full details of his latest views on EU credit, see here). One of the key arguments he makes is still not fully appreciated by consensus, in our opinion: even if Presidents Trump and Xi sign a trade deal, and China agrees to buy more of US goods - a widely expected outcome - shouldn't this also imply they will have to buy less elsewhere? And if so, isn't Europe poorly positioned along this particular geopolitical scale? We think the consensus view of trade disruption as a non-risk is still failing to connect these important dots.

The risk of IG issuers losing investor confidence has receded as well, with several key names in the BBB space announcing strong measures in response to the market wakeup call they received in Q4. Their intentions are ranging from suspension of share buybacks to dividend cuts to asset sales, with proceeds promised to be directed toward debt reduction. This change of heart potentially represents great news for bondholders in each particular cap structure in question. What the market may be overlooking here is the aggregate impact of all these measures, i.e., if all large BBBs decide to delever simultaneously, what would that mean for their aggregate capex spending, earnings growth, and M&A appetite?

Our estimates suggest that gross share buybacks may have been responsible for up to a half of cumulative EPS growth of many of these issuers over the past five years. Such a contribution must be smaller going forward, assuming BBB issuers maintain their deleveraging discipline. So EPS growth - currently standing at +12% yoy for all S&P 1,500 issuers (large + small caps) - is poised to come under pressure going forward from at least three sides: tax reform comps turning into a headwind, fewer share buybacks, and slower global macro.

The last risk on the list from Q4 - tightening in financial conditions - has naturally improved since year-end; however, it remains elevated by the standards of last year when HY spreads were pushing into low-300s. As we discussed last week, cracks remain visible, particularly in the CCC space, where one-third of all names still trade at distressed levels and the extent of dispersion (proximity to average index levels) has actually increased since year-end. Wider dispersion implies less reliable risk appetite, as the rebound so far has only increased the gap between potential winners and losers.

Taking all of the above arguments into account, we think that while various risks culminated in late 2018 and have been addressed or reduced in recent weeks, some of them still remain in place. The most important among them are disruptions to trade flows coupled with deleveraging among the largest IG names and tax reform coming out of yoy comps, all leading to negative earnings impacts. We think many investors remained complacent about these interconnected risks, and - until most recently - were willing to hold risk despite high asset prices. This behavior may have started to change over the past couple of weeks, but it remains largely in place.

Complacency on the part of other investors creates opportunity for those who share our view of the world. We think these issues are likely to resurface in coming weeks and months, and when they do, more appropriate pricing of risks should reestablish itself. We think this potential path is inconsistent with HY spreads going deeply into the three handles, and as such we continue to advocate an underweight position with an eye toward more significant levels of risk reduction if spreads were to grind tighter. Importantly, we think HY is likely to generate meaningful negative excess returns at some point in coming weeks and months from current levels, although we find it impractical to try to pinpoint the exact turning point.

Our default rate indicator continues to produce 5.25% issuer and 4.25% par estimates over the next 12 months. We realize this is an out-of-consensus view, and as such we continue to constantly question our confidence level around it. It remains firm so far, with all the improvement in risk appetite earlier in the year captured by model inputs.

Importantly, we advise our readers to think about this model estimate more in terms of its directional view and the order of magnitude, rather than a simple point on a scale. The critical argument here is not whether the par number happens to be 4.25% or 3.75%, but rather that the lows in defaults for this credit cycle are most likely behind us, a legacy of 2018, and that future credit losses are likely to be meaningfully higher.

The risk taking mentality in leveraged credit must therefore undergo a significant change, particularly at current tight spread levels. We recommend continued up-inquality positioning coupled with increased cash balances at these levels. We will be looking to redeploy this capital at more attractive levels in the future." - source Bank of America Merrill Lynch

We agree with Bank of America Merrill Lynch that going forward, fewer share buybacks, and slower global macro will weigh more on equities than credit and given the recent direction taken by US Treasury notes, long dated Investment Grade credit should benefit as well from the most recent move.

As we stated before if it's D for "Deflation" and "Deleveraging," then it's good for credit markets in a "Japanese" fashion. So all in all, yield "hogs" will benefit more in this Chinese year of the pig relative to equities we think. Dovish tone by central banks equals reach for yield again across credit, that simple.

When it comes to the validation in playing defense, recent fund flows points towards a reach for quality (Investment Grade) over quantity (High Yield) as indicated by Bank of America Merrill Lynch in their Situation Room note from the 7th of March entitled "Monetary stimulus vs. global weakness":

"Outflow from risk

Inflows to US high grade mutual funds and ETFs remained strong at $4.68bn this past week ending on March 6, compared with a $5.01bn inflow a week earlier. On the flip side, outflows from risker asset classes such as high yield accelerated to $0.93bn this past week from $0.09bn one week earlier. This as flows also turned negative for loans and equities to $0.13bn and $5.83bn of outflows, respectively, following $0.05bn and $6.00bn of inflows a week ago. Hence inflows to all fixed income declined to $2.74bn this week from $5.72bn in the prior week (Figure 3).

The inflow to high grade funds increased to $4.24bn from $3.54bn one week ago, while the inflow to high grade ETFs declined to $0.44bn from $1.47bn (Figure 4).

On the other hand, the maturity breakdown of high grade inflows remained about evenly split between short-term (to +$2.55bn from +$2.70bn) and ex. short-term (to +$2.13bn from +$2.31bn). Flows improved for global EM bonds and money market funds to $1.61bn and $30.43bn, respectively, from $1.06bn and $3.29bn the prior week. Government bonds experienced $1.95bn in outflows following $0.75bn in outflows the prior week. Munis and mortgages both reported smaller inflows to $0.76bn and $0.23bn, respectively, from $1.24bn and $0.58bn one week ago." source Bank of America Merrill Lynch

We do watch with great attention fund flows when it comes to gauging risk appetite as our readers already know by now given fund flows have a tendency to follow total returns.

Leveraged players and Carry traders do love low risk-free interest rates, but they do love even more low interest rate volatility. For instance, we were not surprised to read from Nomura Quants Insight report from the 13th of March entitled "How sustainable is this algo-supported goldilocks market?" that Risk Parity Funds have slightly increased their exposure to Investment Grade bonds:

"Nomura's estimates that a raising portfolio leverage ratio by risk parity investors should have some effect on DM rates markets. When risk parity funds increase their leverage ratio to reach their target portfolio volatility level (usually set at ~10%), their activities tend to create buying pressure on a wide range of asset classes.

As a result, the market environment is similar to a "Goldilocks" state on its surface. However, we note that the portfolio exposure of a typical trend-following program like CTAs or risk parity funds continue to skew towards the long-side of DM bonds, which also means that DM bond markets gradually become vulnerable to unexpected increases in interest rate volatility." - source Nomura

As long as interest rates volatility remains muted, it's hard to be negative on credit markets. Also the slowdown in global growth in conjunction with weaker macro data overall have led to even more dovishness which has been highly supportive of the strong "high beta" rally seen. Yet, we do think that in a context where investors are starting to put pressure on leveraged players, an allocation to credit rather than equities for these weaker players would seem prone to less "repricing" risk should buybacks dwindle and some dividends start to be cut in some instances. Again, in this late cycle we are seeing rising dispersion. It doesn't mean there are no opportunities, it means you need to ensure you get smarter with your issuer selection process.

When it comes to the different paths taken by Europe and the United States, given the ongoing woes for the ailing European financial sectors as per our final points below, we still believe in the "Japanification" process of Europe and continue to be much more supportive for financial credit over financial equities. That simple, no need to point to us book value or any additional snake oil salesman tricks when it comes to European banks' stock prices, we are simply not buying any of it.

  • Final charts - ECB rates on Japanese path


Back in August 2016, in our conversation "The Law of the Maximum," we indicated that the outcome for Europe would be different than in the United States:

"Credit dynamic is based on Growth. No growth or weak growth can lead to defaults and asset deflation. The change in credit growth is a flow variable and so is domestic and global demand!

The big failure of QE on the real economy is in "impulsing" spending growth via the second derivative of the development of debt, namely the change in credit growth.

As we have argued before QE will not be sufficient enough on its own in Europe to offset the lack of Aggregate Demand (AD) we think." - source Macronomics, September 2015"

What is very clear to us is that the Fed and the ECB have been following different path, which obviously have led to different "growth" outcomes in recent years. The lack of "credit impulse" in Italy for instance, leading to lack of economic growth is entirely due to the capital constraints put on already stretched balance sheets of Southern European banks which had no choice but to collapse their loan books, in effect, the credit crunch in Europe was a self-inflicting wound." - source Macronomics August 2016

Our final charts come from Bank of America Merrill Lynch The European Credit Strategist from the 26th of February "Is it Japan all over again?" and shows clearly the "Japanification" at play in Europe:

"After a mega January for returns, February, by contrast, has felt more pedestrian. That said, high-grade spreads have still been able to grind 10bp tighter on the month (high yield 25bp) as the earnings season has driven the customary drop-off in supply. We remain of the view that March will be a tougher time for spreads given seasonally high issuance, coupled with the weaker firepower that investors now seem to have.

While spreads have tightened this year, the European manufacturing data has remained glum (albeit, with services the bright spot). Our favoured indicator - PMI manufacturing new orders - slipped further into recessionary territory last week. At 46.2, it is now far below the levels reached during the China growth scare in '15, and now not far from the lows seen during the 2011 Eurozone periphery crisis.

The upshot of this is that spreads continue to look very dislocated from the reality of the economic data, in our view (see appendix chart). And while the Eurozone momentum should improve in the following quarters - buoyed by China stimulus, Germany/France fiscal loosening, and domestic wage growth - it seems to us that credit markets have already priced much of this in, if not more. The risk is that a protracted war of words on trade between Trump and the EU results in a shallower Eurozone recovery than the base case…leaving Euro credit spreads looking priced for perfection.

Is it Japan all over again?

The dovish pivot by central banks has undoubtedly made the rally this year. Even ECB members have sounded more concerned about the growth and inflation outlook, despite bringing QE to an end only 8 weeks ago. Accordingly, interest rate vol in Europe has fallen to a record low (now sub 40) and is yet again driving a conspicuous reach for yield across credit markets. After all, Draghi dovishness has almost always been a precursor to tighter credit spreads, since July 2012.

See you in 2033!

In our latest credit survey, we noted plenty of references to "Europe is Japan…" given how quickly the ECB appears to have altered its tune. While such a debate is clearly more complex, the comments, we think, are nonetheless prescient…as 20yrs ago to the month (Feb 12th '99) the BoJ first cut interest rates to zero. And with the exception of a few years in between, Japanese interest rates have barely moved since.

While history is never meant to repeat itself, it does seem to be coming close. Chart 1 shows that the progression of Japanese and ECB interest rates has been eerily similar when overlapping the two time series to match the point of zero interest rates (ECB deposit rates fell to zero in July '12).

A crude extrapolation of chart 1 implies that ECB deposit rates will still be broadly at today's levels in 2033!

History says…a policy error

Note, as well, that a crude extrapolation of chart 1 suggests that the ECB will raise interest rates towards the end of this year, in line with the current view of our Eurozone economics team (albeit they have frequently noted the risks to no hike given the recent data weakness.

Back in July '06, the BoJ raised rates by 25bp after 5 successive quarters of positive growth. The feeling was that Japan had moved away from the spectre of deflation (the BoJ statement at the time said: "Japan's economy continues to expand moderately, with domestic and external demand and also the corporate and household sectors well in balance"). But this turned out to be premature. Post the Global Financial Crisis, the BoJ cut interest rates from 0.5% back down to 0.1% (and subsequently cut them to -10bp in late Jan '16).

Eerie similarities

But it hasn't just been interest rates that seem to be mimicking each other across Japan and the Eurozone. In fact, we find eerie similarities in many other areas. For instance:
• Chart 2, shows the progression (months) in headline inflation rates for Japan and the Eurozone.

Again, we overlap them at the point at which interest rates for both countries first hit zero ("Month=0" in the chart). The correlation of Japanese and Eurozone inflation since then has been 52%.

• Likewise, chart 3 shows the progression of 10yr government bond yields for Japan and the Eurozone. The correlation between the two (from "M=0") has been an eerily impressive 76%.

• And chart 4 shows the progression of Japanese and Euro high-grade credit spreads. Here, the correlation has been 50%. Note that Japanese high-grade spreads are roughly the same today as they were in February '99.

But conspicuously high correlations alone don't do justice to the debate of Europe is heading to Japanification, in our view. The story of Japan is one of huge debt growth and fiscal spending as governments have attempted to banish deflation demons. But an ageing population has been Japan's Achilles heel for many years. Chart 5 shows that during the '81-'91, and the post-GFC economic expansions, Japan has witnessed both low inflation rates and high growth in the percentage of the 65-year old plus population." - source Bank of America Merrill Lynch.

In their interesting note Bank of America Merrill Lynch indicates that the best performing sector, after 6m of a new TLTRO were senior financials (20% spread tightening) and likely reflected two themes: first, that with liquidity support the default risk and deposit flight issues for the banking sector are minimized. Second, given that TLTROs have usually been cost-effective funding for banks, the expectation of senior supply falls.

Finally, we still think that the more repressed the volatility by our central bankers, the more instability is brewing so in relation to our title analogy, on the first QE , investors bet it all on the three cards and won the "high beta" game. On the second large QE by the ECB, investors won on financials credit. on the third time, which is right now, investors risk betting on the ace - but when cards will be shown, they might find out that they had bet on the Queen of Spades, rather than the ace, and loses everything, but we ramble again...

"Diligence is the mother of good luck." - Benjamin Franklin

Stay tuned!

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.