Cape Fear? S&P Peak PEG ratio At All-time High, Shiller CAPE Ratio At Second All-time High As Dow Pierces 26K Mark

Yes, the stock market is on a roll with the Dow recently piercing the 26,000 mark. And the S&P500 index has pierced the 2,800 mark. Of course, the massive Federal Reserve intervention (along with other global central banks) has certainly thrown gas on the fire.

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Looking at price levels alone is not meaningful. So, let’s look at two stock market adjusted indices.

First, there is the S&P Peak PEG ratio.  It is a price to peak-earnings multiple, adjusted for long-run trend growth. It is at the all-time high.

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Second, we have Bob Shiller’s CAPE (Cyclically Adjusted Price-Earnings) ratio that is now at the second highest peak (after the Dot,com bubble) and above the notorious Black Tuesday of 1929.

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But it is not just the stock market that may be overheated. How about home prices … again?

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And if we adjust home price growth by hourly earnings by the majority of the population, we see that home prices YoY are growing 3 times faster than hourly earnings YoY.

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This might help explain why The Fed is so timid about unwinding its balance sheet.

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Did someone mention fear?

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Fed Paid $29.3 Billion To Banks NOT To Lend In 2017 (Excess Reserves), Fed Earned $80.2 Billion For Treasury

Yesterday, The New York Federal Reserve announced that it actually increased their $4.2 trillion balance sheet by $1 million rather than shrinking it.

This comes on the heels of The Federal Reserve announcing that it provided $80.2 billion in payments to the US Treasury in 2017. This is the lowest remittance to Treasury since 2015, but still positive.

The Fed’s $4.45-trillion of assets – including $2.45 trillion of US Treasury securities and $1.76 trillion of mortgage-backed securities that it acquired during years of QE – produce a boatload of interest income. How much interest income? $113.6 billion.

Which brings us to excess reserves. Excess reserves—cash funds held by banks over and above the Federal Reserve’s requirements—have grown dramatically since the financial crisis. Holding excess reserves is now much more attractive to banks because the cost of doing so is lower now that the Federal Reserve pays interest on those reserves.  Excess reserves as of the end of 2017 are around $2 trillion and the interest rate paid on excess reserves is now 1.50%.

In 2017, the interest that the Fed paid the US banks and foreign banks doing business in the US jumped by $13.8 billion to $25.9 billion. The Fed also paid banks $3.4 billion in interest on securities sold under agreement to repurchase. That brings the amount that the Fed paid to banks of $29.3 billion.

The Fed will likely raise rates further this year, perhaps 4 times.

This would push the rate on excess reserves to 2.5% by the end of the year. Excess reserves will likely shrink as QE is being unwound, but I am doubtful. And the amount that the Fed pays the banks this year might surge to $40 billion or more (slow shrinking and rising interest paid on Excess Reserves).

So, Treasury is receiving a windfall every year from The Fed courtesy of QE. And Treasury receives another windfall from the notorious 2012 profit sweep from Fannie Mae and Freddie Mac. (Can you spot Treasury’s changing of the Fannie/Freddie bailout terms??)

Yes, Treasury makes good money from The Federal Reserve and having seized the profits from Fannie Mae and Freddie Mac. Will they relinquesh control?

A Huge Player (Kingpin) in VIX Options Just Changed Its Buying Behavior (Elephant Trades)

Kingpin? Like the movie with Woody Harrelson and Randy Quaid about bowling?

(Bloomberg) — Trading patterns associated with the new kingpin in volatility options resurfaced on Wednesday, hours before concerns about trade protectionism roiled markets.

The so-called “VIX Elephant” — the moniker bestowed upon the options giant by Macro Risk Advisors head of derivatives strategy Pravit Chintawongvanich — traded more than 2 million contracts, closing out positions in January VIX options and rolling the trade over to same-strike options that mature the following month.

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This entailed buying back 262,500 January VIX puts with a strike price of 12, selling 262,500 15 calls, and buying back 525,000 25 calls in order to close out the existing position. Then, the new position was established by selling 262,500 12 February puts, buying 262,500 15 calls, and selling 525,000 25 calls.

This particular trade, which stands to gain should implied equity volatility rise moderately, confirms a definitive shift in the Elephant’s buying and selling patterns.

“While the ‘Elephant’ originally traded three-month options, rolling after two months, they appear to have switched to a one-month cycle,” the strategist writes.

Daily volume in options tied to the Cboe Volatility Index hit their second-highest level on record Wednesday, exceeded only by the last time the Elephant — joined by another mystery volatility buyer known as “50 Cent” — went on the stampede at the start of December.

The 1 year holding period return (HRP) for the VIX is -13.85%.

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The timing of that roll proved fortuitous: a spike in implied volatility allowed the Elephant’s previous positions to be closed at a loss of $2 million rather than $20 to $30 million.

However, Chintawongvanich estimates that this trader is down roughly $35 million since then as market calm prevailed.

“More generally, the ‘Elephant’ trades reflect a trend towards low premium outlay hedges with minimal convexity,” the strategist concludes. “Clients we talk to have been more interested in VIX call flies or S&P put flies that carry well and have a fairly low initial cost, but may not mark up as much as an outright option in a risk-off scenario.”

In other words, this Elephant might soon be seeing a new animal on safari: copycats.

The Fed has just begun raising rates (only back to October 2008 levels) and barely unwinding their balance sheet. Apparently, there is considerable concern over an unraveling on the stock market with further rate increases/unwinding.

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True,  the trade picture is murky as is The Fed’s will to further raise rates and unwind its balance sheet.

10-year Treasury note volality remains extremely low with all the Central Bank microaggression.

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Did someone mention Kingpin?

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Is The Fed Short Volatility? (Or Is Jerome Powell Actually Thurston Powell III?)

The Federal Reserve doesn’t activley manage its interest rate exposure on its over $4 trillion balance sheet. Yet it purchases and sells Treasury Notes/Bonds and Agency Mortgage-backed Securities (AgMBS) in a measured way to impact interest rates.

Chris Whalen has a nice writeup on Fed Chair (to be) Jermore Powell’s thoughts on expanding and then shrinking the balance sheet.

[W]hen it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response. So there are a couple of ways to look at it. It is about $1.2 trillion in sales; you take 60 months, you get about $20 billion a month. That is a very doable thing, it sounds like, in a market where the norm by the middle of next year is $80 billion a month. Another way to look at it, though, is that it’s not so much the sale, the duration; it’s also unloading our short volatility position.

we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road. You can almost say that that is our strategy.

I hope Powell’s messaging skills have improved since 2012 when he uttered these words. He does sound more like billionaire Thurston Howell III than a future Fed Chair.

Yes, The Federal Reserve can manipulate interest rates through its policies and INFLUENCE the volatility and duration of Treasuries and Agency MBS. (He should have made that clear, particularly for Agency MBS).

Here is a chart of U.S. JP Morgan Treasury Investor Sentiment Active Client Net Long positions are The Fed has been SLOWLY unwinding its Treasury Note/Bond portfolio over the past year. Notice that net long sentiment is in negative territory.

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For Treasury shorts, the investor sentiment has been rising with the slight T-note/bond unwind.jpmsohr.png

10-year Treasury Note volatility remains repressed despite the teeny sales of The Fed’s balance sheet.

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It really does look like The Fed is scared to actually try to unwind its balance sheet, particularly for Agency MBS extention risk where duration (risk) rises with rate increases. Particularly since we are in a low rate environment where small rate increases can crush note/bond/MBS prices.

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Here is a photo of the next Fed Chair, Jerome Powell.

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When do we start calling Powell “The Skipper”? And who gets to be Vice Chair “Gilligan”?

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Sloth-like Fed Shrinks Balance Sheet By 0.14% Or $6 Billion (Will Take 700 Weeks or 13.46 Years To Unwind)

The good news? The Fed continued to unwind its $4.4 TRILLION balance sheet.

The bad news? The Fed is shrinking it at sloth-like speed.

As an example, the latest SOMA report from the Fed on New York saw a $6 billion decline in the Fed balance sheet. That is only 0.14% per week. At this rate, it will take over 700 weeks (or 13.46 years) to unwind.

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This week, Treasury notes and Treasury bonds were the primary driver of the decline. Agency MBS? Not so much.

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Here is a video of Fed Chair Janet Yellen shrinking The Fed’s balance sheet.

Yellen’s last presentation.

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Fed Shrinks Balance Sheet By … $4.8 Billion or 1/10 of 1% (Mostly Agency MBS This Time)

The Federal Reserve continues to shrink its balance sheet at a speed that rivals that of a penguin. 

Yes, The Fed of New York shrank the balance sheet by $4.8 billion over the past week.

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This past week, the T-Notes and Bonds barely shrank, most of the shrinkage occurred in Agency Mortgage-backed Securities.

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But in the general scheme of things, you can barely see it.

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Here is the reaction of the 10-year Treasury Note yield to the unwinding of T-Notes and Bonds  thus far.

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Yes, The Fed is unwinding their $4.4+ trillion balance sheet at a speed slower than a penguin.

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S&P 500 Dividend Yield FINALLY Above US Treasury 2Y Yield (10 Years Afer)

The last time that the S&P 500 dividend yield was above the US Treasury 2Y yield was in September 2008, just prior to The Federal Reserve launching their quantitative easing (mass purchases of Treasury Notes/Bonds and Agency MBS).

For the first time since 2008, the dividend yield on the S&P 500 Index and theyield on two-year Treasury notes are essentially the same. For years after the financial crisis, the gap between the income generated from holding equities relative to government securities bolstered the case for U.S. stock markets to climb to record highs. Now, with the Federal Reserve raising interest rates, the yield on short-term Treasuries is attracting investors like BlackRock Inc.

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But Ten Years After, massive monetary stimulus is finally going home. By helicopter.

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