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Subject: Control Panel: Shadow banking TBTF? Date: 1/12/2014 1:09 PM
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The Control Panel shows a moderation of risk-on behavior, with a slight shift of emphasis from stocks and high-yield bonds to Treasuries and gold. This may be noise. The underlying trends are intact and the temper of the market is Greed.

Bonds had more interesting activity than stocks this week. The 10YT yield fell suddenly, perhaps indicating that the market has more than incorporated the Fed's taper.

Junk bonds continued a rising trend in their bull market -- a trend that is diverging from the upward MA that could indicate a bubble if it continues. The BofA Merrill Lynch US High Yield CCC or Below Option-Adjusted Spread is low though not razor-thin. Financial stress is very low. Weaker companies (including REITs) are able to borrow at low interest rates which are similar to 2005.


Guggenheim High Yield and Bank Loan Outlook - January 2014

Given record low yields, aggressive capital market activity and record demand in bank loans, we sense an erosion of safety beneath the surface. The prominence of covenant-lite loans, the gradual uptick in payment-in-kind (PIK) toggle notes and the acceleration of corporate bond rating downgrades are concerning. ...
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(A recent Fed study shows that investment expenditures by non-financial businesses may not be strongly negatively affected by interest rates. Unsurprisingly, those which said they are less affected are those that are less likely to borrow, those with good current cash flow management and those which expect future growth.)

Economic fundamentals appear stable to positive, consistent with the past 4 years of slow, steady growth. Stock market internals and sentiment are stable to positive.

However, strains are building in the system. As in 2008, only part of the problem is in the regulated banking system. A big part of systemic risk is in the unregulated Shadow Banking System.


Bailout Risk, Far Beyond the Banks

Gretchen Morgensen, New York Times, JAN. 11, 2014

Everyone knows that the largest of our nation’s banks would be destined for a taxpayer bailout if they ran into trouble anytime soon. But which nonbank financial institutions — say, asset management companies offering hedge funds or mutual funds — might also pose too-big-to-fail risks because of their size and interconnections?

It’s what you could call the $53 trillion question. That’s the amount of assets currently overseen by the United States money management industry, federal regulators say....Size is not the only indicator of a systemically significant institution, the regulators note. Interconnectedness is another. Trading partners that have provided financing to a troubled fund could be destabilized by its heavy losses, while investors owning the same types of assets held by the troubled fund could suffer when those holdings are liquidated quickly to meet redemptions by panicked shareholders. The amount of borrowed money that a large fund uses can also increase the potential for contagion. ...
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Anyone who can remember back 5 years remembers the bailout of AIG, an insurance company whose failure would have been systemically devastating.

The U.S. GDP is about $17 Trillion, so you do the math.

The METAR is bullish. It will remain bullish until signs of failure in the economy -- or, worse, in the Shadow Banking System. Those who think that Shadow Bankers and hedge fund geniuses are always right should read "When Genius Failed."












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