One indicator I keep an eye on regarding market risk taking behaviour is to look at the spread between AAA and Baa bonds LINK1. There are less and less AAA bond issuers around these days but Baa is also investment grade and there are many companies with this rating. By looking at the difference in yields between these two parties borrowing costs we can get an idea about the risk premium demanded by the market. Well that premium is now around 53 basis point which is historically extremely low as the graph below shows. That is not to say the spread cannot get lower but the record low on the chart is January 1966 when it reached a mere 30 basis points. Given the higher default rate of Baa bonds this is now a risky trade ! The spread is typically around 80 to 120 basis points with a 1970-June 2014 of 110 basis points, the long term 1919-June 2014 average is 119 basis points.
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A lot of people that go to fill up their cars with petrol don't realize just how much of a gallon goes to the government in taxes. As the receipt below shows if I put 60 litres into my car then of the £81.47 bill over £48.35 is simply tax to the government the filling station makes only £3 LINK1. Bloomberg have a nice article showing how petrol prices vary across countries LINK2. So Americans please stop whining about your $3.69 a gallon petrol I am paying $8.25 in the UK ! Anyhow your team are also doing better than England in the World cup - what an embarassment and no wonder the Manager Hodgson is not resigning he is getting £3.5 million a year and what did he achieve well nothing !!! Nice story here suggesting he would have been sacked if he were a foreigner LINK3
Japan's central bank owns over 20% of its government bonds and no one is willing to trade them !6/19/2014 Abenomics is a Japanese experiment designed to print money to buy government debt on an unprecedented scale LINK1. The Central Bank has committed itself to buy government debt until a 2% inflation target is achieved even of that means doubling the narrow money supply over 2 years. Data from the Bank of Japan shows its holding of Japanese government bonds is in excess of ¥200trillion ($1.96 trillion) or about 20% of outstanding issuance this is up by 60% from ¥125 trillion one year ago.
Well since this policy started in April 2013 the Japanese stockmarket has doubled and the bond yield has not budged and remains at 0.6% on the 10 year bond. According to this story LINK2 the Japanese Central Bank now owns over 20% of the the government debt and yesterday no one in the private sector was willing to bid for them ! Its a crap yield when you have 2% inflation and the yield is rigged by central bank policy. How long can this rigging of markets by central banks continue???.....Rigged markets usually blow up and in Japan's case a higher bond yield will be a disaster with a government debt to GDP ratio approaching 250%. The VIX index closed on Friday 6 June at a low for the year of just 10.73. It has averaged around 20 in the last 20 years and at the peak if the financial crisis reached an unprecedented number of 80. The VIX index measures the expected volatility in the S&P500 index by looking at variety of call and put options in the index. A low volatility number on the VIX is the result of low call and put premiums (the index can lie anywhere between zero and 100). Such a low implied volatility in the S&P500 does not usually last that long as shown in the chart below. It seems that market participants are so confident that central banks will come to the rescue that they are getting less concerned about risk in the financial system......government bond yields are too low, stocks are now getting pricey as measured by Shiller's Cyclically Adjusted Price Earnings (CAPE) ratio which is over 25 and no one seems to be worried about risk anymore. Typically 5 year returns are only 2.7% over the next 5 years when PEs are this high as shown below. Sounds like people are getting to complacent again. In these times it is usually a good idea to be a contrarian and prepare for future spikes in volatility and falls in stock prices.
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AuthorThe author of this blog is Keith Pilbeam who is currently Professor of International Economics and Finance at City, University of London. Archives
January 2021
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