Why Stock And Bond Markets Are So Confusing Right Now

Below is a pretty simple chart from Morgan Stanley that illustrates a pretty important concept.

Historically, when 10-year bond yields fall below 3% for an extended period of time, stocks and bond yields tend to go in opposite directions (meaning stocks and bonds rise in tandem). That's more or less been the status quo during the past few years of sub-3% 10-year yields.

The last time bond yields rose above 3% – all the way back in the 1950s, as the chart shows – the correlation went positive. Stocks were rising while bonds were selling off, sending yields higher (think "Great Rotation").

The problem is that these transitions from one market phase to the next "can be very confusing," as Morgan Stanley puts it – after all, when correlations flip from negative to positive, they inevitably pass through a range characterized by little or no correlation.

Given the recent surge in stocks and some of the flirtation with rising bond yields we have seen so far in 2013, the correlation chart is worth keeping in mind.

Bloomberg, Morgan Stanley Research calculations

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Up To $30 Billion Reportedly Stolen From Russian Winter Olympics Preparation

REUTERS/Kai Pfaffenbach

The 2014 Sochi Olympics are already expected to be amongst the most expensive in history, with reports that Russia will dwarf the $6 billion Vancouver spent in 2010 with an estimated final budget of $51 billion.

However, not all that money is being spent as it should, according to a new report from Russian opposition figures Boris Nemtsov and Leonid Martynyuk.

The pair have spent six months analyzing Sochi Olympics spending and concluded that the games will be a "monstrous scam" with up to $30 billion in funds stolen — more than half the already inflated budget.

Nemtsov and Martynyuk argue that the most expensive sports complexes were built without proper competition or public tenders, with contracts going to friends of Russian President Vladimir Putin for inflated price tags.

"It is obvious that Putin's friends are running the preparations for the [2014 Sochi] Olympic Games," Nemtsov told RFE/RL in an interview. "It is also obvious that one is reluctant to put his own friends behind bars. However, we cannot look at all this passively because the scale [of their activities] will only grow bigger. The embezzlement they are presiding over is not just some kind of children's game but a real threat to Russia's national security."

Nemtsov is a former deputy prime minister while Martynyuk is a member of the Solidarity movement. The pair say that the money wasted would be enough to provide housing for 800,000 people in Russia.

The report is embarrassing for the games — Russia is likely hoping that they can dispel the persistent talk of corruption and inefficiency that lingers around the country with a well-run, efficient yet spectacular games (also take note of the millions the government is paying Goldman Sachs to boost its image this year). However the budget overrun (almost five times the original budget of $12 billion) and reports of snow being stored in case of a shortage in the relatively-warm Sochi are worrying omens.

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There Are No Reliable Predictors Of Stock Market Returns

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There Are Very Few Reliable Predictors Of Stock Market Returns (Vanguard)

Expected returns are an important part of asset allocation. Vanguard's chief economist Joe Davis said that in the short term, especially in the next year, there are very few reliable predictors of stock market returns. In the longer term there is somewhat more of an association. 

"Yet we also have to acknowledge that the correlation or the association, the ability of valuations to relate with future returns, even in a ten-year horizon, is somewhat less than 50%, so 40%. So again, it can help inform and help guide what a reasonable essential tendency of returns are, but it certainly is not so definitive that it would give you one number."

Vanguard

Market Vane Bullish Sentiment Is At 70% And That Last Time It Was Here Was In 2007 (Gluskin Sheff)

David Rosenberg says there may be "too much good (or stimulative) news priced into the stock market. Investors Intelligence shows 52.1% bulls and 19.8% bears. "That 32.3 percentage point gap can indeed be considered an extreme, and it turned out to be a bit of a yellow flag heading into last year's soggy summer."

Moreover, Market Vane bullish sentiment at around 70% is right where it was in the summer of 2007… just as a reminder."

Gluskin Sheff

Morgan Stanley Case Against Brokers That Left For Stifel (Reuters)

Three brokers that managed $229 million in client assets at Morgan Stanley's Coeur d’Alene office in Idaho, quit to set up a Stifel Nicolaus office. Now, Morgan Stanley is asking as Idaho court to prevent the three brokers from recruiting other advisors from its Coeur d'Alene office. Reuters quoted a court filing from Morgan Stanley that stated that this caused ""upset, anxiety, insecurity, uneasiness and concern" at "a relatively small office." Lawyers also told Reuters that this could help separate "raiding" from routine recruitment.

The Real Damage That ETF's Have Inflicted In Investment Performance (El Cap)

In recent years individuals and institutions have put $1.5 trillion into ETFs. Andrew Haigney of El CAP writes that ETFs have hurt investment performance. 

"The real damage ETFs have inflicted on investors lies in investment performance. By embracing ETFs, active managers have wholeheartedly embraced indexing.  We don’t have anything against indexing, in fact in most cases it’s the right way to go.  But remember that the only reason an investor pays an active manager is to get investment returns above and beyond the index.  When active management strategies heavily rely on the use of ETFs, investors get stuck with indexed returns, with very little chance for relative out performance."

Here's What 515 Interest Rate Cuts And $12 Trillion Will Do To The Global Credit Markets (Bank of America)

"In the past 6 years, central banks around the world have cut interest rates 515 times, increased global liquidity by $12 trillion and crushed bond yields to the point that almost 50% of all global government bond market cap currently trades below 1%," writes Michael Hartnett at Bank of America.

BAML

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A PERFECT STORM: Why South Africa's Currency Has Been Getting Destroyed

The South African rand (ZAR) is getting absolutely brutalized lately.

The currency has fallen from levels around 9.00 against the U.S. dollar just three weeks ago to levels around 10.00 today.

Business Insider/Matthew Boesler, data from Bloomberg

"The key negative risk from headlines out of the mining sector wage negotiations is playing out in a text book fashion – alongside plummeting gold prices and rising [U.S. Treasury] rates – creating a perfect storm for ZAR," write Bank of America Merrill Lynch currency strategists.

The ongoing unrest in South Africa's mining sector – which relies heavily on exports of gold and other metals – is dragging down the country's economy, as worse-than-expected first quarter GDP growth figures revealed earlier this week.

Today, South African President Jacob Zuma held what Jon Herskovitz, the Reuters correspondent on the ground in Pretoria, described as a "hastily convened" press conference in order to play down concerns about how wage negotiations with miners are progressing there.

Zuma's presser definitely did not work – the rand is down a massive 3.3% against the U.S. dollar today alone.

The weak GDP release, coupled with the latest drama in the mining sector, has sent the rand into freefall this week, but the underlying economic fundamentals have been missing from the story for a while.

"Countries like Hungary, Poland, Mexico, Malaysia – you always have some positives for real money investors to base their judgment on, that basically help them to withstand volatility," says Bartosz Pawlowski, Head of CEEMEA Strategy at BNP Paribas. "In South Africa there are very few positives in terms of fundamentals, so the only reason to be buying rand at this level at the moment is the fact that it has sold off so much, which may or may not be a great reason, but it's just the level – there's nothing beneath that."

Bad fundamentals. Bad headline risk. And to top it off, it seems global financial markets have all been subjected to the same earth-shaking developments in the U.S. Treasury market, the largest and most liquid bond market in the world.

The rand is no exception. Treasury yields and the U.S. dollar have been rising ever since fears that the Federal Reserve would begin to taper back its monetary stimulus sooner than was previously thought have seeped into the marketplace.

The rand is a "high-beta" currency, which means its own moves against the dollar tend to be more pronounced than those in other currencies.

One big reason why the rand behaves like that, says Pawlowski, is that it's much easier to "bully" the rand than other emerging market currencies.

The South African Reserve Bank is in a tough spot. It doesn't have a lot of currency reserves, so they don't have the same liberty to engage in currency interventions to defend the rand's value as some other central banks – Turkey, Brazil, and Russia, for example – currently enjoy.

"South Africa is one of the countries where you can be reasonably sure that there will be nobody stopping you," says Pawlowski. "So, this sort of thing adds up, and then it just becomes path dependent: stop-losses after stop-losses, and new levels, and so it goes."

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