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By Walter Kurtz, Sober Look

There is a great deal of discussion in the market about the dislocation between US equities and treasuries. It is somewhat surprising that people are only now starting to focus on the issue – the divergence has been visible for quite some time andwas discussed here.

But another divergence which is quite striking exists now between corporate bond spreads and treasury yields. The chart below compares the investment grade CDX (index CDS) with the 10-year treasury yields.

The treasury market continues to trade with a built in “Europe risk premium“. Some managers hold treasuries as a hedge against European surprises – a strategy that has worked quite well recently (as opposed to equity index puts). But this divergence is not sustainable in the long term and treasury yields should startrising later this year.

Snake eyes from the players….

“Individual investors have become enamored with high-yield (junk) bonds lately, seeking to better the puny yields offered by Treasury and investment-grade corporate bonds.

Indeed, junk bond mutual funds have seen a net inflow of $6.1 billion in January and almost $17 billion over the past year, Morningstar reports.

With the economy rebounding, investors are growing more confident that junk bond issuers won’t default. Junk bond funds have offered a return of 5.2 percent so far this year.

“High-yield bond funds do offer the potential for higher returns than high quality bonds and may be used to complement core bond funds with lower risk profiles,” Morningstar editor Adam Zoll writes.

But he warns that junk bonds can plunge, just like they did during the financial crisis, dropping 26 percent in 2008.

Morningstar recommends three funds for their high returns and low risk: Vanguard High-Yield Corporate (ticker: VWEHX), Janus High-Yield (JNHYX), and Metropolitan West High Yield Bond (MWHYX)….”

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Federal Reserve Chairman Ben Bernanke on Wednesday offered a tempered view of the U.S. economy, pouring cold water on the notion recent upbeat signs herald a stronger recovery.

Bernanke told Congress that unless growth accelerated, the unacceptably high U.S. unemployment rate would not keep dropping.

But he stopped short of signaling further Fed bond purchases, dashing the hopes of some traders in financial markets who were betting on more monetary stimulus.

“The job market is far from normal,” Bernanke said.

“Continued improvement … is likely to require stronger growth in final demand and production.”

The swift decline in the U.S. unemployment rate in recent months, to a three-year low of 8.3 percent in January from 9.1 percent in August, has surprised economists both within and outside the Fed given the economy’s relatively soft performance.

Last year, the economy expanded only 1.7 percent, although the fourth quarter proved to be the strongest.

“The decline in the unemployment rate over the past year has been somewhat more rapid than might have been expected, given that the economy appears to have been growing during that time frame at or below its longer-term trend,” Bernanke told the U.S.House of Representatives Financial Services Committee.

Bernanke’s tentative outlook knocked the Dow Jones industrial average below the symbolic 13,000 level it had closed above on Tuesday. The Dow closed off 53 points, or 0.4 percent.It is up 2.5 percent on the month.

Stock prices had been marching higher all year on optimism about gathering economic momentum.

While Bernanke’s tenor was dovish, the lack of a direct allusion to the possibility of a third round of so-called quantitative easing also undercut prices for government bonds and pushed the dollar up. Gold prices slumped
3 percent, their biggest one-day drop in 2-1/2 months.

“Bernanke implied that the Fed was no closer to QE3 …Investors were disappointed,” said Cary Leahey of Decision Economics in New York.

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“Last week Rick Santorum called the President “a snob” for wanting everyone to get a college education (in fact, Obama never actually called for universal college education but only for a year or more of training after high school).

Santorum needn’t worry. America is already making it harder for young people of modest means to attend college. Public higher education is being starved, and the middle class will shrink even more as a result.

Over just the last year forty-one states have cut spending for public higher education. That’s on top of deep cuts in 2009 and 2010. Some, such as the University of New Hampshire, have lost over 40 percent of their state funding; the University of Washington, 26 percent; Florida’s public university system, 25 percent.

Rising tuition and fees are making up the shortfall. This year, the average hike is 8.3 percent. New York’s state university system is increasing tuition 14 percent; Arizona, 17 percent; Washington state, 16 percent. Students in California’s public universities and colleges are facing an average increase of 21 percent, the highest in the nation.

The children of middle and lower-income families are hardest hit. Remember: The median wage has been dropping since 2000, adjusted for inflation.

Pell Grants for students from poor families are falling further behind; they now cover only about a third of tuition and fees. (In the 1980s, they covered about half; in the 1970s, more than 70 percent.)

Student debt is skyrocketing – the New York Federal Reserve Bank estimates it at $550 billion. Punitive laws enforce repayment, and it’s almost impossible to shed student loans in bankruptcy. There is no statue of limitations for non-repayment.

And yet, Santorum’s rant notwithstanding, good-paying in America are coming to require a college degree. Globalization and rapid technological change are putting a premium on the ability to identify and solve new problems. A college degree is also a signal to prospective employers that a young person has what it takes to succeed.

That’s why the median annual pay of people with a bachelor’s degree was 70 percent higher than those with a high school diploma in 2009 (the latest Census data available)….”

Full article

Some chart porn showing how the consumer fared in past recessions and what we might expect going forward….

Update:

Yields fell across the region while France and Spain got off auctions without any problems…

No baby sitters for Greece….

Anything to lessen the grip of the too big to fail…but then again they will just prey overseas; especially in emerging markets.

This is a really interesting semi-annual report from Hussman.  In it he shows the returns of his main fund, both hedged and unhedged.  The take-aways are that a) his stock picking has added a lot of value over the broad indexes and b) the hedging has added value, not on an absolute level, but a lot on a risk adjusted level by reducing volatility and drawdowns over the past decade.  Click on chart to enlarge.

We have presented a lot of hedging ideas over time, the main one being a momentum, or trend, based system (A Quantitative Approach To Tactical Asset Allocation).  Most of the results of a moving average system have similar properties in that the they do not increase absolute return over buy and hold, but rather reduce volatility and drawdown. (One can use other methods such as momentum/relative strength and or leverage to increase absolute returns like Relative Strength Strategies for Investing.)

Hussman’s fund is interesting, as it essentially increases equity exposure as valuations come down, and decreases exposure or hedges as valuations increase.  Reminds me a lot of GMO.  So in some ways it is a bit of a dynamic short volatility fund based on valuation (I know not quite the right description but works for purposes of this post).  Here is an older post we did on hedging using CAPE, and found that a simple method of investing when the CAPE was less than average generates equity returns with less risk and drawdown.

Anyways, I think it is instructive to demonstrate how pairing a fund like this with a long volatility strategy would have worked since inception.  So, I’m going to include the GTAA strategy from my paper here, only using the hypothetical 5 asset classes and the 10-month simple moving average.  I’m also going to lop off a very conservative 2.0% for fund expenses,  trading friction, etc.

To see the strategy and the returns, go here.

(Reuters) – U.S. money managers increased their equity holdings in February to the second highest level in 14 months, tracking a rally in the S&P 500 stock index, a Reuters poll showed on Wednesday.

The poll, which surveyed 13 U.S.-based fund management companies between February 17 and 28, found that firms allocated 65.6 percent of their assets into equities, a gain of nearly 3 percentage points since January.

February’s equity allocation figure is only exceeded over a 14-month period by 66.8 percent in December.

The benchmark S&P 500 – which has risen 3.5 percent in February and on Tuesday closed above the May 2011 intraday high of 1,370.58 points – is up more than 9 percent this year. Also on Tuesday, the Dow Jones Industrial Average closed above 13,000 for the first time since 2008.

Risk has made a huge comeback this year on signs of improvement in the U.S. economy, including job growth, manufacturing and consumer confidence, as well as an attractive risk-reward ratio on equities relative to other asset classes.

“There’s almost a crisis fatigue, and cash has been on the sidelines for such a long period of time and people want to have a better return than the 1.98 they get on the 10-year Treasury. They’re looking for more,” said Colleen Denzler, senior vice president and head of fixed income strategy for Janus Capital Group.

“So if there’s any chance that clarity and consistency is around the corner, they’re going to reach for high yield, they’re going to reach for equities, and that’s what we’ve seen since January.”

Read the rest here.

Top 10 Hedge Funds By Net Gains Since Inception

1. Ray Dalio’s Bridgewater PureAlpha: $35.8 billion net gain since 1975
2. George Soros’ Quantum Endowment: $31.2 bn net gain since 1973
3. John Paulson’s Paulson & Co: $22.6 bn net gain since 1994
4. Seth Klarman’s Baupost Group: $16 bn net gain since 1983
5. Brevan Howard: $15.7 bn net gain since 2003
6. David Tepper’s Appaloosa Management: $13.7 bn net gain since 1993
7. Bruce Kovner’s Caxton Associates: $13.1 bn net gain since 1983
8. Louis Bacon’s Moore Capital: $12.7 bn net gain since 1990
9. Thomas Steyer’s Farallon Capital: $12.2 bn net gain since 1987
10. Steve Cohen’s SAC Capital: $12.2 bn net gain since 1992

What else would he say ?

You are welcome.

Click on Bernanke’s beard below to access live stream.

“It’s like Thailand was 50 years ago,” Alexandre de Lesseps told me. We were talking about the next big emerging market to bloom in Asia. It may surprise you, but it is one heck of a story… and opportunity. It also fits our grand thesis on emerging markets and is the subject of my upcoming book, World Right Side Up. The country I’m talking about is Myanmar (or Burma, as most people still seem to call it).

I caught up with Alex over the holidays because I remembered his infectious enthusiasm for the country. He is an accomplished investor of frontier markets, those half-forgotten realms on the fringe of the investing world. Alex has been investing in Burma for 15 years as a partner at SPA Capital Partners, working with Serge Pun & Associates. The latter is an investment holding company that has been in Burma since ’91. (And yes, Alex is the great-great-grandson of Ferdinand de Lesseps, the French developer of the Suez Canal, who also oversaw the early construction of the Panama Canal.)

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A ‘secretive market’ has tripled recently giving investment banks a chance to make money as beneficial as the IPO market.

“Euro-area banks tapped the European Central Bank for a record amount of three-year cash in an operation that may boost bond and equity markets.

The Frankfurt-based ECB said today it will lend 800 financial institutions 529.5 billion euros ($712.2 billion) for 1,092 days. Economists predicted an allotment of 470 billion euros, according to the median of 28 estimates in a Bloomberg News survey. In the ECB’s first three-year operation in December, 523 banks borrowed 489 billion euros.

“The astonishing number this time is the number of banks participating, which signals that a lot more small banks looked for the money and it is likely they will pass it on to the economy,” said Laurent Fransolet, head of fixed income strategy Barclays Capital in London, who estimates about 300 billion euros of the total is new lending. “So the impact may be bigger than with the first one.”

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