David M Glassman, President

3055 Harbor Drive, Suite 1101

Fort Lauderdale, Florida 33316

Email: Stockmarketdoc@comcast.net

August 24,  2017



Ray Dalio's Gravest Warning Yet: "I Am Tactically Reducing Risk... This Is Broadly Similar To 1937"

Two weeks after Ray Dalio warned in his latest letter to Bridgewater clients that the right trade in the current environment is to buy gold in case "things go badly", the head of the world's biggest hedge fund is out with his gravest warning yet, saying that he is "concerned about growing internal and external conflict leading to impaired government efficiency." In his LinkedIn post, he writes that he "continues to closely watch how conflict is being handled a guide, and I’m not encouraged.”

Echoing a similar warning issued just days ago from perhaps the most prominent name in all of finance, Lord Jacob Rothschild, the head of the world's biggest hedge fund says that “conflicts have now intensified to the point that fighting to the death is probably more likely than reconciliation" and in a stark comparison to the days prior to World War II, observes that "politics will probably play a greater role in affecting markets than we have experienced any time before in our lifetimes but in a manner that is broadly similar to 1937."

Basically, Ray Dalio just compared the current political environment to the days just prior to the outbreak of World War II. That is probably not a coincidence.

His full LinkedIn note:

I believe that a) most realities happen over and over again in slightly different forms, b) good principles are effective ways of dealing with one's realities, and c) politics will probably play a greater role in affecting markets than we have experienced any time before in our lifetimes but in a manner that is broadly similar to 1937.

I'm essentially an economic mechanic who focuses on how reality works by studying the cause:effect relations and how they played out in history to help me bet on what's likely to occur. For reasons previously explained in "Populism..." it seems to me that we are now economically and socially divided and burdened in ways that are broadly analogous to 1937. During such times conflicts (both internal and external) increase, populism emerges, democracies are threatened and wars can occur. I can't say how bad this time around will get. I'm watching how conflict is being handled as a guide, and I'm not encouraged.

History has shown that democracies are healthy when the principles that bind people are stronger than those that divide them, when the rule of law governs disputes, and when compromises are made for the good of the whole --- and that democracies are threatened when the principles that divide people are more strongly held than those that bind them and when divided people are more inclined to fight than work to resolve their differences. Conflicts have now intensified to the point that fighting to the death is probably more likely than reconciliation.

Average numbers hide the depths of the divisions. For example, by looking at average figures, one might conclude that the United States economy is doing just fine, yet when one looks at the numbers that comprise those averages, it's clear that some are doing extraordinarily well and others are doing terribly, with gaps in wealth and income being the greatest since the 1930s.

Largely as a function of these economic differences and differences in the principles that people believe most deeply in, we are seeing large and increasingly firm political differences, which are apparent only by looking below the averages. For example, Donald Trump's approval rating of 35% is a result of 79% support among Republicans and 7% among Democrats (Gallop). Of those who approve of President Donald Trump, 61% say they can't think of anything Trump could do that would make them disapprove of his job as President, and 57% who disapprove of Trump say they are never going to change their minds on the President's job performance (Monmouth). Similarly 40% of those polled (PRRI) would favor Donald Trump’s impeachment, which consists of 72% of Democrats and 7% of Republicans, and most of them won't change their minds.

In other words, the majority of Americans appear to be strongly and intransigently in disagreement about our leadership and the direction of our country. They appear more inclined to fight for what they believe than to try to figure out how to get beyond their disagreements to work productively based on shared principles.

So, where does that leave us?

While I see no important economic risks on the horizon, I am concerned about growing internal and external conflict leading to impaired government efficiency (e.g. inabilities to pass legislation and set policies) and other conflicts.

I of course hope that the principles that bind us together are stronger than the ones that divide us. I believe that this is a time when it is especially important for us a) to be explicit about what our principles are in order to be clear about what we agree and disagree on, b) to practice the art of thoughtful disagreement, and c) to respect our ways of getting past our disagreements so we can start rowing in the same direction. I believe that how well this is done will have a greater effect on the economy, markets and our overall well-being than classic monetary and fiscal policies, so I continue to closely watch how conflict is handled while tactically reducing our risk to it not being handled well.

A 1970s self-help guru’s hint why investors may be duped (again)

America’s top forecasters missed the 2008 market crash, during which stock investors lost half their money. Now with stocks approaching bubble territory it looks they are again ignoring warnings signs. What gives?

The biggest red flag is the S&P 500 index, which groups 500 of America’s largest public companies and is trading near record highs. This despite a sluggish US economy driven by record government spending, borrowing and money printing.

In short, conditions look exactly like those that prevailed just before the 2008 financial crisis, when equities investors lost half their money in a matter of months.

So why haven’t the experts, many of whom are near-genius-level, ivy-league professionals, provided clear warnings about the risks in the system?

The S&P 500 index

Wisdom from a 1970s self-help guru?

One clue might come from consulting creative thinkers from outside the economics profession, like er…Robert Ringer?

Yes that Robert Ringer. The self-help guru, who in his 1970s best-seller Looking out for #1, outlined a useful template to use when assessing human behavior.

“All people act in their own interest all the time,” writes Ringer, who believes that people re-define self-interested actions to make themselves look virtuous.

What Ringer calls the “definition game” enables politicians, like recently-retired ex-Conservative Party leader Rona Ambrose who took home nearly $5 million in salaries and pension benefits for just 13 years work, to describe herself as a “public servant.”

Ringer’s “human nature group” theory in many ways explains modern human action better than Hobbes, Nietzsche and even Ayn Rand, yet appears dark when applied to individuals – even to politicians. However it has a strong basis in academic theory.

Foreign policy experts, for example, broadly accept that governments (which combine individual actions on a massive scale) act in their own interests all the time – and that they invent justifications as they go along. Otto von Bismark, a key innovator in international relations theory, describes this as realpolitik. If governments act that way, it should be no surprise that politicians - and the people who voted for them - would do so as well.

Are economics and financial forecasters "Looking out for #1?"

To apply Ringer’s theory to explain why expert, ivy-league-trained forecasters and regulators are all wrong, all the time when predicting recessions and stock market crashes, we would start by asking where their interests lie.


Governments want you to spend

Ringer’s theory suggests that - however well-intentioned they are - that politicians’ main interests are not to do a good job, but to get re-elected, and, more broadly, to maximize their lifetime potential earnings and prospects.

If Ringer is right, then it should not be surprising that politicians would condone optimistic forecasts that encourage governments, consumers and businesses to borrow and spend because the resulting short-term economic activity would help them win the next election.

In this scenario accumulated debts would only matter to those politicians if the issue showed signs of imploding on their watch.

Financial Institutions want you to borrow

Economists and forecasters at the big financial institutions are among the world’s best trained and highly-respected. This despite the fact they too missed the 2008 crash and recession.

If we believe Ringer’s theory that financial sector forecasters are acting in their own interests all the time, this would suggest that they are likely working for bosses who are more concerned with generating new business than with being accurate. In that scenario the accuracy of their forecasts would be less important than how much activity they encouraged.

It would also suggest that any big bank forecaster that had a consistently and markedly bearish outlook would be fired.

Auditors and regulators prioritize rent extraction

Experts say that one of the American financial system’s major advantages is the high quality its watchdogs, such as the SEC, FINRA, FASB, public accountants, ratings agencies and other regulators.

Yet despite positive reports from all major public accounting firms and US regulatory bodies, all the major US banks and much of the auto sector had to be bailed out during the last financial crisis. None, have provided any warning of significant threats this time around.

Ringer’s “self-interest theory” would argue that the reason for this is that regulators are more incentivized to extract rents from the system than in serving the public.

If that is true, you would expect to find regulatory bodies adding rules (such as voluminous Dodd-Frank regulations), staff and boosting salaries, but also making sure that their departments would only have undefined responsibilities, so they would not be blamed if another crisis hits.

They could then use a subsequent crisis to ask the public for even more funds, powers and staff.

Speak nicely, but verify

If Ringer is right why doesn’t mainstream media, or even independent analysts, report this? One reason, is that in polite society, it is very hard to question someone’s motives. Particularly if you have to deal with that person regularly and he (or she) may one day have an opportunity to help you (or to extract payback).

The Economist magazine balances its posture by only questioning the motives of leaders of countries outside the western orbit like North Korea, China, Iran and Russia, whom they regularly describe as “solely interested in keeping power.” However the actions of Western governments, whom the magazine courts, are generally reported as acting for the public good.

Hedge your bets

The idea that a 1970s self-help guru’s theory provides a guide as to why another financial crisis may be inevitable seems laughable.

However the fact that our Harvard economics PhDs, industry CFAs and regulators are so consistently wrong suggests that they may be putting their interests before those of the public.

It also suggests that individual investors had better hedge their bets.

Did Stocks Just 'Cross The Median'?

A key broad market gauge is potentially breaking a major line of support.

If you’ve followed us for awhile, you probably know about our affinity for the Value Line Geometric Composite (VLG). The VLG is an equally-weighted index of approximately 1700 U.S. stocks. It’s unique in its construction as it essentially tracks the performance of the median stock in its universe. As such, its construction makes the index particularly useful in monitoring the health of the overall stock market in the U.S. And if that is indeed the case, the market may be showing the initial symptoms of getting sick.

We say this because of a troubling development on the VLG’s chart. Following the presidential election last fall, the VLG surged to a new 52-week high, challenging its all-time highs in the process. It would run out of steam in December, however, and subsequently entered into an 8-month sideways trading range.

In late July, the VLG was able to finally break out to new highs, along with a barrage of other indices. However, at least for the VLG and other small and broad market averages, the breakout proved short-lived. By the end of July, the VLG had lost its breakout position and had dropped back into the former trading range. Throughout the first half of August, if the VLG continue to slide lower within the range. During last week’s selloff, the VLG was able to hold the bottom of its trading range near 508. The index was not so lucky during yesterday’s decline.

As our Chart Of The Day shows, the VLG closed yesterday below the bottom of its 8-month trading range.

So what is the technical significance of this development? Is it the end of the road for the bull? First of all, it confirms the late-July false breakout and projects a move lower. Secondly, the loss of the range support opens the door for such a move. Just how much of a drop are we talking about? And can a recovery negate this breakdown?

David Stockman Warns "Don't Forget About The Red Swan"

Given the anti-Trump feeding frenzy, we continue to believe that a Swan is on its way bearing Orange. But if that’s not enough to dissuade the dip buyers, perhaps the impending arrival of the Red Swan will at least give them pause.

The chart below comprises a picture worth thousands of words. It puts the lie to the latest Wall Street belief that the global economy is accelerating and that surging corporate profits justify the market’s latest manic rip.

What is actually going on is a short-lived global credit/growth impulse emanating from China. Beijing panicked early last year and opened up the capital expenditure (CapEx) spigots at the state-owned enterprises (SOEs) out of fear that China’s great machine was heading for stall speed at exactly the wrong time.

The 19th national communist party Congress scheduled for late fall of 2017. This every five year event is the single most important happening in the Red Ponzi. This time the event is slated to be the coronation of Xi Jinping as the second coming of Mao.

Beijing was not about to risk an economy fizzling toward a flat line before the Congress. Yet that threat was clearly on the horizon as evident from the dark green line in the chart below which represents total fixed asset investment.

The latter is the spring-wheel of China’s booming economy, but it had dropped from 22% per annum growth rate when Mr. Xi took the helm in 2012 to 10% by early 2016.

There was an eruption as dramatized in the chart. CapEx growth suddenly more than doubled in the one-third of China’s economy that is already saturated in excess capacity.  The state owned enterprises (SOE) in steel, aluminum, autos, shipbuilding, chemicals, building equipment and supplies, railway and highway construction etc boomed.

It was as if a switch had been flicked on by Mr. Xi himself, SOE CapEx soared back toward the 25% year-over-year rate by mid-2016, keeping total CapEx hugging the 10% growth line.

However, you cannot grow an economy indefinitely by building pyramids or any other kind of low-return/no return investment – even if the initial growth spurt lasts for years as China’s had.

Ultimately, the illusion of Keynesian spending gets exposed and the deadweight costs of malinvestments and excess capacity exact a heavy toll.

If the investment boom that was financed with reckless credit expansion is not enough, as was the case in China where debt grew from $1 trillion in 1995 to $35 trillion today, the morning-after toll is especially severe and disruptive. This used to be called a “depression.”

China’s propagated spurt in global trade and commodities was artificial and short-term. It was done to flatter China’s rulers at the 19th party congress.

Now that a favorable GDP glide path has been assured, China’s planners and bureaucracy are already back at it trying to find some way to reel in its runaway credit growth and bloated economy before it collapses.

Downside Surprises in China Are Virtually Baked In

The sell-by date has expired on this latest China credit impulse, as evident in the chart below. During the first quarter of this year, total social financing (bank credit plus shadow banking loans) reached the incredible rate of $4 trillion per annum. That’s nearly one-third of China’s entire GDP.

The figure scared the daylights out of leadership in Beijing, who have now moved forcefully to reel in China’s debt machine.

What is coming down the pike is the great China Debt Retrenchment.  Expect a global braking motion that will get underway once Mr. Xi dramatically consolidates his power at the 19th party congress.

This has the potential to drastically weaken the global economy – and the impact on corporate profits should not be underestimated.

The Red Swan Has Now Gone Berserk

Half of the world’s GDP growth since the 2008 crisis has been in China, and that, in turn, was purchased by the greatest credit eruption in recorded history.

As China’s nominal GDP was more than doubling from $4.6 trillion in 2008 to $11.2 trillion in 2016, its national leverage ratio soared from 175% of GDP to 300% in less than a decade.

There’s reason to seriously doubt that Beijing can bring the Red Ponzi to a soft landing.  It cannot and will not permit the nation’s debt load to quadruple again during the next eight years, meaning that China’s days as the world’s ultimate stimulus machine are over.

The fading of the most recent China growth impulse will soon reveal that most countries, to adapt Warren Buffet’s famous metaphor, have been swimming naked from a fiscal perspective. It has left the world vulnerable to a renewed wave of funding crises as the ECB and other central banks attempt to launch monetary normalization.

In sum, during the last 19 months the Red Ponzi propagated a false upturn in the global economy that is already decisively reversing. This comes at the same time that central banks of the major developed world economies are finally bringing their printing presses to a halt.

The major central bankers have finally recognized that at $22 trillion on central bank balance sheets have become egregiously extended.  China is the epicenter of the world’s two decade plunge into central bank monetary fraud and credit explosion.  They have deformed and destabilized the very warp and woof of the global economy.

So, yes, even as the Orange Swan stumbles toward the Donald’s White House, there is a Red Swan following closely behind.

"The Dreaded Phase 4": What Happens When Credit Spreads Finally Rise

With investors, traders, analysts and pundits focused on the chaos in the White House, and the daily barrage of escalating geopolitical and social news, whether terrorist attacks in Europe or clashes in inner America, the market is finally starting to notice as Friday's last hour sell-off demonstrated. And yet, according to one of the best minds on Wall Street today, Citi's Matt King, what traders should be far more concerned about, is not who is in the Oval Office or how bombastic the war of words between the US and North Korea may be on any given day, but rather what central banks are preparing to unleash in the coming months. To underscore this, two weeks ago, King made a stark warning when he summarized that we are now more reliant on central banks banks holding markets together than ever before:

"with asset prices displaying a high degree of correlation with central bank liquidity additions in recent years, that feedback loop makes the economy, upon which both corporate profitability and bank net interest margins depend, more reliant on central banks holding markets together than almost ever before. That delicate balance may well be sustained for the time being. But with central banks beginning to move, however gingerly, towards an exit, is it really worth chasing the last few bp of spread from here?"

One week later, he followed up with what was arguably his magnum opus on why the market is far too complacent about the threat to risk assets from the upcoming rounds of balance sheet normalization, summarized best in the following charts, showing the correlation between central bank asset purchases and the returns across global stock markets. The unspoken, if all too familiar, message was that riskier financial assets, such as credit and equities, have been artificially boosted by central bank actions, actions which are soon coming to an end whether voluntarily in the case of the Fed, or because the central bank is simply running out of eligible bonds to monetize, in the case of the ECB and BOJ.

In short, King is worried the global market is about to enter another tantrum.

Is he right?

To answer that question, another Citi strategist, Robert Buckland, admitting that "we are (always) worried", takes a look at where we currently stand in the business cycle as represented by Citi's Credit/Equity clock popularized also by Matt King in previous years.

For those unfamiliar, here is a summary of the various phases of the business cycle clock:

  1. Phase 1: Debt Reduction – Buy Credit, Sell Equities

Our clock starts as the credit bear market ends. Spreads turn down as companies repair balance sheets, often through deeply discounted share issues. This dilution, along with continued pressure on profits, keeps equity prices falling. For the present cycle, this phase began in December 2008 and ended in March 2009. Global equities fell another 21% even as US spreads tightened.

  1. Phase 2: Profits Grow Faster Than Debt – Buy Credit, Buy Equities

The equity bull market begins as economic indicators stabilise and profits recover. The credit bull market continues as improving cashflows strengthen company balance sheets. It’s all-round risk-on. This is usually the longest phase of the cycle. This began in March 2009, and according to most Wall Street analysts, is the phase we find ourselves in right now. Equity and credit investors both do well in this phase.

  1. Phase 3: Debt Grows Faster Than Profits – Sell Credit, Buy Equities

This is when credit and equities decouple again. Spreads turn upwards as fixed income investors become increasingly worried about deteriorating balance sheets. But equity markets keep rallying as EPS rise. Share prices are also boosted by the effects of higher corporate leverage, often in the form of share buybacks or M&A. This is the time to favour equities over credit.

  1. Phase 4: Recession – Sell Credit, Sell Equities

In this phase, equities recouple with credit in a classic bear market. It is associated with a global recession, collapsing EPS and worsening balance sheets. Insolvency fears plague the credit market, profit warnings plague the equity market. It’s all-round risk-off. Cash and government bonds are usually the best-performing asset classes.

* * *

The reason why Citi is concerned where exactly in the business cycle the US economy and capital markets are to be found at this very moment, is that as Goldman showed recently, corporate leverage has never been higher...

... and yet, corporate spreads remain at or near all time lows. Behind this paradox is - once again - the active intervention of central banks, and explicitly the ECB, which starting in March of 2016 announced its plans to start purchasing corporate bonds, sending corporate spreads to record lows, and in some cases, pushing junk bonds yields below matched US Treasurys.

Or, as Citi puts it, "Central banks hold back the clock"

Citi credit strategists suspect that this central bank intervention decoupled credit spreads from the underlying company balance sheets. As corporates lift leverage, we would normally expect the credit clock to enter Phase 3. Spreads should widen to reflect higher Net debt/EBITDA ratios. But that hasn’t happened in this cycle. In the last 18 months, corporate leverage has risen but credit spreads have fallen.

Buckland's summary is an echo of what we posted nearly a month ago in The ECB's Impact On The Bond Market In One Chart : "It seems that the corporate leverage clock has marched on to Phase 3, but the central banks have managed to hold the credit spread clock back in Phase 2."

Whatever the reason for the break in the business cycle, where we are currently located is critical as it could mean the difference between BTD across all assets, or, focusing on just a specific subset. In fact, it's all about credit spreads: as Citi explains, the credit market has turned up (spreads start falling) before the equity market early in the cycle and turned down before the equity market (spreads start rising) later in the cycle. This is also shown in the next two charts below which show the progression of high yield spreads and global equity markets across the 4 phases of the cycle:

Going back to the original trhust of the article, if indeed credit spreads are finally starting to rise due to excess leverage/central bank concerns, in other words if we are finally shifting from Phase 2 to Phase 3, what are the implications?

Key among them, is the as spreads rise, volatility follows, and market dips become bigger and more frequent, jeopardizing the profitability of the BTFD "strategy." Buckland explains:

If credit spreads do start to widen as central banks taper later this year, then we could finally move into Phase 3 of the credit/equity clock. What are the characteristics of this phase? And what are the investment implications for global equity investors?

Equities Up, But More Volatile

The credit/equity clock suggests that, despite widening spreads, equities can still generate decent returns in Phase 3. However, those returns are usually accompanied by higher volatility. This reflects the traditionally close relationship between credit spreads and volatility. As spreads rise, observed volatility (and the VIX) tend to follow (Figure 8). Investors should continue to buy the equity market dips, but these dips may get bigger and more frequent. While the headline equity market returns in Phase 3 are similar to Phase 2 (Figure 9), the risk-adjusted returns (Sharpe ratio) tend to be lower. The high return/low vol phase of the market cycle is over.

More importantly, this is the phase when bubbles emerge in full view, and in this case, the most obvious candidates for a bubble are global Growth stocks and US IT in particular.

It’s Bubble Time: Bubbles are common in these ageing equity bull markets. Indeed, all the great bubbles of the last 30 years have occurred in Phase 3 of the equity/credit clock (Figure 10). The late 1980s Phase 3 was dominated by Japanese equities, which rose to 44% of global market cap (now 8%). The late 1990s Phase 3 saw global Growth stock indices rising to unprecedented levels. The last cycle saw a sharp rerating of EM equities. All of these bubbles inflated even as credit spreads were rising. The bursting of these bubbles was a key driver of the subsequent bear markets.

Citi also issues a warning to value investors, whose "natural inclination to fight bubbles can get them into serious trouble at this point in the market cycle. The most obvious candidates for a bubble this time round are US Growth stocks and US IT in particular (Figure 10). We recently suggested that Growth stocks everywhere are looking expensive, but they are not yet in a bubble comparable to the late 1990s."

But the most critical aspect of timing Phase 3 is because the "dreaded" Phase 4 follows right after. Citi explains: "The strategies that work in Phase 3 get smashed in Phase 4. This is when a global recession pushes both equities and credit into a bear market. Bubbles collapse."

The problem with the advent of Phase 4, however, is that Phase 3 is inbetween, and even if the party is nearly over for corporate bonds (and spreads), it can continue for equities according to Buckland.

But how long does Phase 3 continue?

That's the question that everyone will soon be asking, and here is Citi's attempt at an answer:

Investing in Phase 3 is a dangerous game. Equity markets are moving into overshoot mode. This is nice while it lasts, but the dreaded Phase 4 may not be too far away. The late 1980s Phase 3 lasted 16 months. The late 1990s lasted 32 months. But in 2007 it only lasted 4 months.

Adding to the complexities of timing the transition from Phase 3 to Phase 4 is that - as observed twice already in this cycle - credit markets can give head fakes, especially if central banks step in to stop the sell-off. This is why when Buckland cross checks against the rest of Citi's Bear Market Checklist, he is comforted because even as "credit spreads are important factors in our checklist but they are not the only factors. The others help to reduce the head-fakes. For example, our bear market checklist helped us hold our nerve during the early 2016 sell-off even as credit spreads were signaling imminent doom."

Right now, only 2.5 factors out of 18 are worrying (Figure 14). If credit spreads widen significantly, we may turn them amber/red. But, everything else being equal, 4.5/18 red flags would still suggest that it is too early to call the move into Phase 4. However, we will continue to watch closely.

* * *

So as Citi refuses to sound an alarm, despite its increasingly more concerned research reports, and warnings about credit spreads, especially in the junk bond space, in theory, some of the biggest names in finance are quietly moving for the exits in practice, and as Bloomberg reported this week, "investors overseeing about $1.1 trillion have been cutting exposure to the world’s riskiest corporate debt as rates grind too low to compensate for potential risks."

These professional investors are worried for all the reasons voiced by Citi above: leverage is at record highs, yet even with the recent market turmoil stemming from North Korea and US political tensions, the Bloomberg Barclays index of junk bonds is yielding just above all time lows, or 5.3%, 100 bps below its 5 year average.

How much longer will it stay here, and how much longer will the market assume that we are still in Phase 2 instead of Phase 3? Some of the world's biggest money managers aren't waiting to find out, to wit:

JPMorgan Asset Management, AUM: $17 billion (for Absolute Return & Opportunistic Fixed-Income team)

  1. In early July told Bloomberg they have cut holdings of junk debt to about 40 percent from more than half.

  2. “We are more likely to decrease risk rather than increase risk due to valuations,” New York-based portfolio manager Daniel Goldberg said.

DoubleLine Capital LP, AUM: about $110 billion

  1. Jeffrey Gundlach, co-founder and chief executive officer, said in an interview published Aug. 8 he’s reducing holdings in junk bonds and emerging-market debt and investing more in higher-quality credits with less sensitivity to rising interest rates.

  2. European high-yield bonds have hit “wack-o season,” Gundlach said in a tweet last week.

Allianz Global Investors, AUM: $586 billion

  1. David Newman, head of global high yield, said in an interview his fund has begun trimming its euro high-yield exposure because record valuations make the notes particularly vulnerable in a wider selloff.

Deutsche Asset Management, AUM: 100 billion euro ($117 billion) in multi-asset portfolios

  1. Said earlier this month it has reduced holdings of European junk bonds.

  2. The funds are shifting focus to equities, where there is more potential upside and higher yields from dividends, according to Christian Hille, the Frankfurt-based global head of multi asset.

Guggenheim Partners, AUM: >$209 billion

  1. Reduced allocation to high-yield corporate bonds across core and multi-credit strategies to the lowest level since its inception, according to a third-quarter outlook published on Thursday.

  2. Junk bonds are “particularly at risk due to their relatively rich pricing,” portfolio managers including James Michal say in outlook report.

Brandywine Global Investment Management, AUM: $72 billion

  1. Fund has cut euro junk-bond allocations to a seven-year low because of valuation concerns, Regina Borromeo, head of international high yield, said in an interview this month

* * *

Of course, the final complication, and what Citi did not mention, is that virtually all of the "safe" indicators in Citi's "recession/Phase 4 checklist" above are a function of funding pressures (or lack thereof) and thus, credit spreads. By the time there is a blow out in spreads - and yields - it will be too late to time the phase shift appropriately as the economy is likely already in a recession at that point. Which is why we find the Citi's spread guidance most useful:

What might tell us that the shift into Phase 4 is imminent? We find that US HY credit spreads (currently 400bp) of around 600bps are high enough to indicate an oncoming recession. The equivalent level for US IG spreads (currently 110bp) is around 175bp. Historically, equities have been able to handle spreads rising up to these levels, but anything higher gets dangerous.

Ultimately, the catalyst that finally sends the market (and economy) hurtling out of Phase 2 and Phase 3 and into the "Dreaded" Phase 4, will likely be the simplest, and oldest one in the book: more sellers than buyers... and as the list above shows, the sellers have arrived.

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