Flight to Safety

8/6/2019 Flight to Safety

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Introduction

To be quite frank, there are a lot of mixed signals out there. Things out there feel likegloom & doom with a possible market top in place. However, we have to respect thatthe bull market is still alive, at least for now.

On one hand, the reason confusion is arising is because we havent experienced a washout in sentiment and overbought levels. But on the other hand, the money has alreadybeen fleeing risk assets for over a quarter now and finding its way into safe havenassets. Therefore, this weeks newsletter will focus on the specific issue of money flows.

Fleeing Risk

While there might not be a complete sense of capitulation from classic sentiment survey,money has been fleeing risk assets. Furthermore, money is flowing out of risk assets likestocks and commodities at a very rapid rate.

Source: Barclays Capital

Consider that in May and June, commodities have experienced the strongest outflowssince they bottomed in February 2009. This data includes flows into indices, electronictraded funds, notes and other products.

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Source: ICI, The Short Side Of Long

According to ICI, Junes retail fund flows for the US equity mutual funds reached thelargest outflows since October 2008 crash. What is interesting to note is that Juneoutflows were surprisingly larger than May 2010, when the Dow Jones experienced a oneday 1,000 point flash-crash drop. Back than the market was down 15% into July 2010,while today, the market is down barley one third of that decline.

Outflows in July currently stand at over $15 billion with one week left to report andlooking back at the way this week have played out, with all five trading down days inthe row, one could assume that final July outflows are going to be even larger thanJunes.



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Source: Lipper FMI, SentimenTrader

Lipper FMI fund flow data confirms this outlook. According to their data, this weeksoutflows were the biggest since August 2010, when the S&P 500 put in a strong bottomat 1040. Also to note is that 9 out of the last 12 weeks have been outflows, which iscompletely different environment from early in the year.

Imagine for a second that investors did not follow news headlines at all and just basedtheir investment decisions by judging the actual price of the asset itself...



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Keeping that in mind, if one was to look at the price of S&P 500 solely on its own,without all the background noise and media baggage, one would realize the price is

currently about 6% away from its recent peak.

So why are investors jumping out of the equity and commodity markets likeparatroopers? Looking at the recent headlines should pretty much answer all thequestions.

Source: Google Search

Flight To Safety

There is fear out there and the money is flowing into safe haven assets. It all startedwith a Crude Oil spike in February which was linked to Libya and MENA turmoil. That wasfollowed by Japanese earthquake and the Fukushima incident, than came along thecommodity rout in early May due the economic slowdown, followed by Eurozone fears ofa Greek default.

Early in the month US jobs report was a huge disappointment, while Italy was throwninto the cocktail mix as their yields on the 10 Year Government Bonds jumped over 6%, afigure not seen since the late 90s. Last, but not least, US consumer confidence plungeddue to slowing economy and fears of a default if the debt ceiling is not raised, and as oflast night the GDP posted a near flat print of 0.4% growth rate for the quarter.



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As a result of all of these problems plaguing the world markets, investors who have beentaking their money of commodities and equities, have been piling into safe haven assets

like Gold, Swiss Franc, Japanese Yen and US Treasury Bonds (as well German Bunds orJapanese Government Bonds). Lets have a look at each of these:

Gold

According to the SPDR GLD electronic traded fund, which tracks the price of Gold bybuying the physical asset as a backing, retail investors have poured in over $8.66 billionsince the 01st of July. That is a 15% increase in the overall fund in just four weeks.

As we can see from the chart above, which shows a four week moving average of fundflows, every time investors became excessively bullish on Gold, it resulted in at least adecent correction. On top of that, the above trend is quite mature, where the price of

Gold has more than doubled since November 2008. Usually, even the most powerful bullmarkets need to take a rest after such a strong run up.



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Swiss Franc & Japanese Yen

Such is a love affair with safe haven currencies like Japanese Yen or Swiss Francin the chart above, that when I did a Google Trends search for "Swiss Franc" Inoticed the results of both the search volume as well as news references are atan all time high, just like the price.

Source: Goole Trends



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Source: SentimenTrader

Sentiment surveys for both of these safe haven currencies have also reached a 20 yearextremes in bullish sentiment. The fear trade is now so recognized, that the regularson CNBC or Bloomberg are concluding the current market environment as a win/win forthe Swiss Franc.

Pundits are saying that if the Greece defaults, Franc will gain, if Italy defaults, Francwill gain, if EU breaks up and Euro crashes, Franc will gain, if US defaults next week,Franc will gain, if North Korea attacks the South, Franc will gain, if Saudi Arabia has anuprising, Franc will gain, if the economy does not recover, Franc will gain and the Francwill rally during "Risk On" as well as "Risk Off" environments. In their own belief, no

matter what happens, Franc will gain... something that is also known as too good tobe true.



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Treasury Bonds

Source: Federal Reserve, The Short Side Of Long

With inflation running at 3.4%, one has to be an ultra bear, with a bunker mentality tobuy a US Treasury Bond right now. If we look at the interest rate across the whole yieldcurve spectrum, from the 3 Month Bill to the 30 Year Bond, we can notice that everysingle Treasury Note up to the 20 Year is paying a negative real interest rate. Considerthe following:

2 Year Note is currently at 0.36%, which is yielding a 3% negative real interest

5 Year Note is currently at 1.35%, which is yielding a 2% negative real interest

7 Year Note is currently at 2.09%, which is yielding a 1.3% negative real interest

10 Year Note is currently at 2.82%, which is yielding a 0.6% negative real interest

20 Year Bond is currently at 3.77%, which is yielding a 0.4% real interest

30 Year Bond is currently at 4.12%, which is yielding a 0.7% real interest

I would find it absolutely insane, if someone was to tell me today to buy a Treasury Long

Bond due to the current economic slowdown, which yields 0.7% real interest rate overthe next 30 years. As Chris Puplava said in his commentary this week:

Think about it for a moment, what would you rather invest in for the next tenyears, a 10-Yr UST yielding 2.78% or a blue chip Dow stock like Proctor &Gamble with a dividend yield of 3.3% and a 5-year compounded dividend growthrate of 11% that is more than three times the inflation rate and does notprovide a flat income stream like UST? More than 80% of the stocks within theDow have higher dividend yields than a 10-Yr UST, and have sizable dividendgrowth rates to boot. As baby boomers move into retirement they are going toneed income from their savings and the UST market just isnt going to cut it,

with solid blue-chip high dividend paying companies like those in the Dowproviding great alternatives.



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Source: Citigroup, The Short Side Of Long

After bottoming out in February, just as everything was fine and dandy and the USeconomy was beating economists expectations on regular basis, its as if the Treasurymarket already start predicting all of the up-and-coming problems coming our way andstarted rallying.

Since than, Treasury ETF has rallied more than 11%, and for 6 months now has beenpricing in European debt problems, US economic problems amongst others. Judging bythe Citigroup Economic Surprise Index, which is a mean reverting tool, majority of thebad news has now been recognized by majority of the market participants. To acertain degree, the upward move in Treasuries could have more juice in the short term,but is ultimately setting itself up for one of the great shorts.



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Cash

The retail investors who arent piling into safe haven assets like the ones mentionedabove, are sitting on large amounts of cash. Bloomberg recently reported that manyfund managers, including Jeffery Gundlach and George Soros have above averageexposure to cash.

Source: Merrill Lynch Fund Managers Survey

Survey of over 260 money managers, with almost US$800 of assets under management,confirms this, as it showed that a substantially large number of managers wereoverweight cash (chart above). This is despite the Federal Reserve keeping rates at zeropercent, meaning that these money managers, who are under constant pressure toperform, are watching inflation erode their cash value.

The type of current readings resembles the May, June, July and August period of lastyear, where investors ran into cash due to the possibility of a double dip recession. Fastforward 12 months and we have a dj vu on our hands.



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Source: The Short Side Of The Long

Finally, I ran a poll asking the readers of the blog to tell us what they have been buying,if anything, over the last week or so. Despite relatively low votes, not surprisingly onethird of those who voted said they were holding cash. One quarter of those who votedsaid that they were buying stocks, while one sixth said they were buying the US Dollar.

Conclusion

If I analyze the current environment, I come to the conclusion that the money which hasbeen fleeing equities and commodities over the last quarter, is moving towardsperceived safe havens such as Gold, Treasury Bonds, Japanese Yen or Swiss Franc.

These trends, at least over the short term, seem extremely overdone. Looking at all ofthese events, which should have effected the equity market. it is actually quiteremarkable that the equity markets have held up so well. Maybe Mr. Market is trying totell us something...

While I think we are slowly approaching a possibility of a bear market for risk

assets and another global recession, I do not think it is about to happen right here,right now.



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Flight to Safety