Strong And Stable, Valuations Edition

It's fun and trendy to point out valuations are elevated for a variety of financial assets these days, though thanks to the global bond market selloff over the last several months all manner of fixed income is showing some honest-to-goodness yield again. For the equities crowd, the "P/E" of the 10 year note (1/yield) is down to its lowest levels since 2011. It's a similar story for the broader Barclays Agg, the widely-followed aggregate for the fixed rate investment grade taxable bond market.


So are equity valuations down to? Why, in fact, yes they are! Thanks to a weaker dollar, stronger US and global growth, and of course tax reform, since the end of 2017 next 12 month estimated earnings are up over 11%, while valuations have dropped 2.2x to 16.2x those next 12 months' estimated earnings for the index. 




We can already hear the hoots of derision at the very idea of using analyst estimates. Calm down, folks, we aren't going to litigate that and we have to use some forward-looking estimate of earnings, so we'll go with that one for now. Analyst earnings are always and everywhere acceptable as a baseline, in this correspondent's view, and can create respectable set-ups to play the contrarian of course. But generally they're a decent way to capture a reasonable expectation of what happens next.

Okay so with that off our chest, we'll ask the question: is the US equity market really overvalued? The 16.2x valuation is pretty aggressive versus the ~11x forward earnings being priced in back in the dark days of autumn 2011, but they're hardly unprecedented. Buying ~16x forward earnings in late 2014 has delivered ~8-9% annualized price returns since, and 16.2x isn't that far from mid-2009 forward valuations. We of course don't need to be explicit about how that turned out for equity investors!

But, but! Isn't the US expensive versus the rest of the world? Sure, that's reasonable. We pulled data for a few different MSCI indices; this isn't a comprehensive sample but should give a rough idea. At 16.39x next 12 month estimated earnings, the US trades at a healthy premium. The MSCI World index trades about a turn lower at 15.42x while Europe enjoys a robust 2+ turn discount at 14.31x. High-growth EM is down at 14.09x, while China (still growing in the mid-single digit range real, give or take some fudging here or there) is 12.30x (note: MSCI China is all H-shares listed in Hong Kong).



The problem is that the US is relatively unique. Sticking with the MSCI indices, Tech's market cap is over 24% of total US market cap versus 16.2% for MSCI World. For EM, that's only 7.1%. Given gangbusters growth, it's pretty reasonable for US Tech to trade at a healthy forward multiple, 17.31x next 12 months' earnings. But wait: MSCI World Tech trades richer than that, at 17.53x! If you want to pay really exorbitant prices for forward earnings in Tech, head across the pond where the MSCI Europe Tech sector trades 20.6x next 12 months' earnings. EM Tech is valued at a similar level. So the US is expensive in aggregate, but its biggest sector actually looks pretty cheap!

This was recently explored in a good post by Lawrence Hamtil. [We also note @modestproposal1 as a frequent contributor to this theme.] The key thing here is that if we want to explore differences in valuations, it behooves us to adjust for the differing sectors; it makes perfect sense for an all-Utilities index to trade at a big discount to an all-Tech index. That's a pretty extreme example, but the intuition should be clear: higher growth should be valued more dear, and the more growth stuffed into an index the more we should be willing to pay for it.

To get things all nice and squared away, we adjusted the MSCI indices from the chart above to get to a nice like-for-like comparison where they all have the same sector weights both now and across time. The US multiple has actually gone up slightly, but so has everywhere else! Except for Australia, everyone else is within 3 turns now, and there's very little daylight between the MSCI World (third-highest) and Canada (lowest). The US still looks expensive, and in a certain sense stands out, but alternatives are all tightly grouped instead of dispersed. 



We're missing one other dimension here. In the charts below we show the next 12 month P/E, adjusted to global sector weightings, for the US, Europe, Japan, China, and EM. The US always retains a premium, but the re-weighting shows that the US investors have actually been quite discerning. At global weights, they've been unwilling to pay more than 19x forward earnings through a variety of market environments. US valuations have been high, but very stable...unlike the rest of the world. 


Our last chart below shows the current percentile of next 12 months earnings multiple for the MSCI indices we've been discussing. Once again, it's pretty hard to look at the US market as ridiculously over-valued. While valuation is certainly elevated, it's been higher about 30% of the time; Europe looks worse by this metric, as do Emerging Markets. Canada and Japan are relatively cheap versus recent years.



Valuation isn't everything. Many punters - especially those in the post-GFC world - have seen margin incinerated on the backs of "high P/E, gotta mean revert" trades. One of the most famous mean reversion advocates folded last year, and for once that sort of about-face didn't mark a major top for a trade. Therefore in our view there isn't much to do here other than to argue there isn't a trade. Sometimes capital saved by not following popular memes is capital earned, to say nothing of the abject frustration of incinerated options premium.

Note: all data for this post is via Bloomberg/author's calculations, value date 4/30/18.
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Nico G
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May 3, 2018 at 2:30 AM ×

Tesla.... my favourite proxy when equity valuation is nothing but a confidence game. And 10 years later, a flashing red light for the new credit crunch to come.

Findings from current lawsuit are on the Cam Hui website. Simply put, Musk is lying to investors, and he is not going to get away with it.


16. In May 2017, when Defendants stated that the Company was “on track” to meet its mass production goal, as production on a fully automated production line was supposed to be ready to begin, and in August 2017, when production on a fully automated production line was supposed to have already been in place and Model 3s were supposed to be coming off the line, according to a number of former employees, the Company had not yet finished building its automated production lines in either Fremont or Nevada. Tesla was neither ramping up mass production, nor “on track” to mass produce Model 3s at any time on or around the end of 2017.

17. Defendants Musk and Ahuja, who visited the Fremont facility on a regular basis, knew that the Model 3 production line was way behind the publicly announced schedule and that it would never mass produce the Model 3 in 2017.

18. As Defendants claimed to be on track for mass production in 217, the Fremont facility was assembling Model 3s, by hand , in the “beta” or “pilot” shop,” a facility to assemble prototypes. The actual mass production line at Freemont was yet to be completed. Workers in the pilot shop were not even able to build enough Model 3s to carry out the necessary testing on the vehicles, and most Model 3 workers were being reassigned, or spending their days cleaning. It was evident to anyone who visited the Fremont facility – and Musk himself visited the unbuilt production line area every Wednesday, known internally as “Elon Day” – that the production line was not yet built, that parts for the necessary robots were not present, and that construction workers were spending most of their shifts sitting around with nothing to do. Multiple former employees corroborate the fact that there was no fully functioning automated production line when Tesla was telling the world that there was, and that the construction site where the line was being built was clearly and visibly far from completion.

Skipping ahead to the accounts of the former employees:

125. Some time in late April or early May of 2016, FE1 participated in a meeting with Musk, CFO Jason Wheeler, and the Vice President of Engineering. FE1 stated that during that meeting, he told Musk directly that there was zero chance that the plant would be able to produce 5,000 Model 3s per week by the end of 2017.,,

190. According to FE9, the Gigafactory was plagued by problems related to producing usable models, and the first battery model was completed long past the deadline when the Model 3 was supposed to have been launched. The process required apply adhesive at a specific ratio, which if not done properly caused the batteries to “fall off.” Parts and spaces between parts were small, making correct module completion challenging. FE9 stated that prior to automated production, human error resulted in poorly produced modules “all the time,” with workers rushing products through the line, assuming problems “would fix [themselves],” which they did not…

195. During FE9’s tenure, which lasted almost to the end of the Class Period, the Gigafactory produced no more than two battery packs at most per day, sufficient for two cars. Realistically, it took a full day – comprised of two shifts – to produce a single battery pack, and, even then, it was not a “customer saleable pack,”, i.e., a pack that passed inspection and was ready to be installed in the Model 3.

196. The only “customer saleable pack” was completed in October 2017, shortly before FE9 left Tesla. A company-wide email was sent congratulating the engineers and production workers for their hard work.

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Anonymous
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May 3, 2018 at 6:21 AM ×

Nice analysis Cackalack Capital, thank you.

One might argue China's equities are vastly overvalued relative to the other regions, as China's increasingly autocratic state, appalling corporate governance, and questionable accounting and auditing (to put it mildly) warrant a hefty discount factor, like it's already the case for Russia.

Don't get me even started on Australia, which is essentially a derivative of the China growth story.

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Anonymous
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May 3, 2018 at 6:23 AM ×

On a different tack, from today's FT: "HKMA warns of 'possible volatility' in local interest rates".

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Cbus20122
admin
May 3, 2018 at 10:40 PM ×

US markets look like they're at a bit of an impasse in terms of where they want to head right now. If I had a guess,I don't think that US markets will break down for a little while. Earnings were still strong this quarter despite economic headwinds that'll eventually take hold, and share buybacks are pretty ridiculous, doing their best to provide a bit of a "put" effect on dips. The risk here of course is we could see a big drop or a big increase in volatility when share buybacks enter blackout periods. This would imply a late June increase in volatility if this is the case.

Overall, I think the best overall play right now is to be on the long side US equities, and on the short side EM / Euro equities. This is supported by rising dollar, rising interest rates, as well as deteriorating econ data from those regions.

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Skr
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May 3, 2018 at 11:51 PM × This comment has been removed by the author.
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IPA
admin
May 4, 2018 at 6:53 PM ×

Well, since you put it that way... Rule number one - don't let the market play Boccia with your testicles.

I am leaning long on Cable here and a bit lower, if allowed. USD could take a pause, nothing crazy, but there is a minor double top in place in DXY right now. GBP is oversold and could mount a retrace to 1.39 - 1.40 level. Shorts could cover ahead of BOE rate decision.

I am also thinking that REITs are having a releif rally but will be smacked hard soon. Primarily, the towers are a bunch of excess capacity waiting to be cut on mergers and lower phone demand. They are in every major REIT etf and trapped longs will be exposed to getting-even-itis disease in 200 dma area, imho.

SPX... I don't know what else to do other than fade the edges of the trading range.

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Alex
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May 5, 2018 at 11:44 PM ×

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be aware of it, Thanks a lot.

Kala Jadu, کالا جادو

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May 6, 2018 at 1:39 PM ×

You know what I love about this market.....The trust funds efts. lol.

I'm not giving away a seat on the exchange....I'm looking for one...far far far away from the passive trust funds efts. lol.

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May 7, 2018 at 12:30 PM ×

You'll be waiting for the next solar eclipse for the China central bank to step in. Why....I reckon it all a big joke...the lot of it. Its just funny a game for these f##kin trust fund etfs.

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May 7, 2018 at 12:36 PM ×

You know what I reckon... I reckon the people that outed stephen hawking as "genius" to the whole f##kin should be the ones paying up!

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May 7, 2018 at 12:40 PM ×

They should've locked stephen hawking up in the Lehman Brothers big house quant room and threw the key away at the very beginning. Dare anyone to tell me he would've been worse off.

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May 7, 2018 at 12:43 PM ×

What a f##kin joke all that the money can produce.

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May 7, 2018 at 12:51 PM ×

All the that money on the Goldman desk...and the best they can produce is a below par game of subterfuge on the homeless guy on Tenth ave. Admittedly, the only energy they spent was on escorts and phone calls....God forbid they actually have a go! Leave that part for the plebs.

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May 7, 2018 at 2:11 PM ×

If there is any quants out there do the maths on the market. Add all those billions together from the global money managers , then run those high frequency algorithms on the amount of currency going through the Brooklyn International "SWIFT" money transfer machine....then say to yourself how can the global money men lose to the homeless guy on Tenth Ave.

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Leftback
admin
May 7, 2018 at 3:45 PM ×

We are trading this market technically. The descending triangle remains in force, the upper bound being formed by the descending line from the Jan 26 close through the Mar 9 and Apr 18 closes, currently around the 50 day MA, 2679.6 and the lower bound arguably formed at the 200 day MA, currently at 2617.0. The predicted convergence of the triangle occurs at around SPX 2648 in 5-7 trading days.

We started the day looking to get short at the 50 day for SPX, which was tagged, along with the SPX 2680 level, and from which there is now a pullback underway. IWM is having a good day as it tends to do on strong crude oil news, but is now running into resistance around 156-157 (RUT 1570-1580) from which we are also short.

The XLF is struggling again today. AAPL punched through the upper Bollinger band this morning, and although it is clearly leading the market for now, this is a sign that we will soon be running out of buyers. VIX dipped only very briefly below 15, which has become the floor for volatility since February 1st.

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Leftback
admin
May 7, 2018 at 8:31 PM ×

Possible reversal candle for SPY. This market continues to observe technicals fairly well, although the media will discuss all of this in terms of the emanations from the Twittersphere. It could be an interesting close today.

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Cbus20122
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May 7, 2018 at 9:18 PM ×

Looks like a nice little doji there at the end right after falling back from hitting the downtrend resistance line for SPX. SMH has an even better formed doji right below resistance. Finally, VIX may be looking to bottom here, which would make sense if we see a bounce off the SPX resistance line into another trip south.

Fundamentally, consumer credit was the big report out today for the USA, and it showed a big decreased in revolving credit, going negative as it contracts. Credit is interesting since you can interpret this two ways. Either you see it as consumers being smart and not over-leveraging themselves, or you look at it as a sign that consumers simply have hit their limit on revolving credit and can't really go any further. Either way, lower credit expansion = lower consumer spending, which is a huge portion of the economy.

While consumer staples have long been the solid holds during a big drawdown, I see a lot of problems in consumer staple-land these days which is reflected in the charts, and contracting revolving credit will be a headwind for the sector as we continue on. For many reasons, I'm not fully convinced that XLP as a whole will be the strong sector it once was if we see another recession.

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IPA
admin
May 9, 2018 at 2:49 PM ×

Crickets... All aboard! GBP just left 250 pip channel.

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IPA
admin
May 9, 2018 at 6:47 PM ×

SPX sell zone 2706 - 2717:

2706 = 100dma
2709 = gap fill
2711 = daily upper BB
2717 = 4/18/18 swing high

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Leftback
admin
May 9, 2018 at 9:59 PM ×

That was the proverbial face-ripper.... nasty squeeze for anyone shorting energy stocks, banks, cyclicals in general. Ugly.

Dusting off the residue of a nasty day or two, and pondering IPA's sell zone above. It makes a lot of sense... especially the upper BB has been a great sell zone for months. But.... caution....

but ...not sure what to make of the VIX breaking lower, closing at 13.42. Lowest close since January. Traditionally we think of VIX 15-20 as being a zone of choppy volatile trading, and VIX 10-15 being the death zone for trading.

Are the vol selling algo-bots back in control again already? With seven trading days to go to May expiration we may see another epic grind-down of volatility.

For now, will just make the observation that WTI is looking quite overbought. Crude speculators may have run out of catalysts. That market looks like it may just be ripe for a reversal.

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Cbus20122
admin
May 9, 2018 at 10:10 PM ×

I'm really interested to see what markets do late june in terms of volatility. I wouldn't be surprised to see a big tick up in vol as the corporate buyback bid goes away.

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Nico G
admin
May 10, 2018 at 1:52 PM ×

just watch Italy

the key to Europe, and the reason why the hope fof an 'European relay' in multiple expansion will fail.

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May 11, 2018 at 4:50 PM ×

You know what I watch these days ..Nico.((foxandfriends)) From my beach house on the coast of Thailand watching all the toffs compete in the London snow. That poor homeless guy from Tenth Ave sure made some mistakes in his time....but steering clear from that ((mob)) wasn't one them.

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May 11, 2018 at 5:12 PM ×

Oh sorry.....Macro Man. Am I putting you on show?....dear me. I'll just take this laptop off my lap and stay out of you business. Cheerio!

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IPA
admin
May 12, 2018 at 4:25 PM ×

Sheer lunacy! Carry on...

I am watching NDX 7020 to go short tech. May coincide with SPX gap fill @ 2752.

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Al
admin
May 12, 2018 at 4:33 PM ×

The markets have definitely taken on a qualitatively different hue the last 7 trading days since the last third S&P500 bounce off the 200 dma. Intra market stock correlations have fallen, consequently volatility has fallen and the incessant rising and falling in reaction to the latest news seems to have stopped (note the US-Iran nuclear deal and 'populists' taking control of Italy which have barely registered in the markets) with bad news being ignored.

The very definition of a resumption of Bull conditions for a bit.



(by the way - please don't get despondent with having to police the forum, it is still an extremely worthwhile endeavour in many ways - it just goes with the territory)

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Shep
admin
May 14, 2018 at 10:00 AM ×

Unless I'm missing something, MSCI EM has well over 25% in tech stocks, far above the 7.1% quoted. are you referring to something else other than the composition of the index?

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Cbus20122
admin
May 14, 2018 at 9:08 PM ×

Nice ugly close across many indexes. Looking for a reversal here for a bit.

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Anonymous
admin
May 15, 2018 at 2:26 PM ×

USD/HKD pair at 7.85 - upper limit of the 7.75-7.85 currency board range - since May 2nd.

HKMA's Howard Lee said in his most recent media briefing on April 19th “... we have intervened in the market a total of 13 times, buying HK$51 billion and selling the US dollar. This has reduced the banking aggregate balance within our expectations.” Lee added “We don’t see large-scale sales of the Hong Kong dollar, and within our linked exchange rate system, there has been no sharp depreciation either.”


In spite of those interventions, the USD/HKD pair moved hardly below the 7.85 level. Starting on April 19th, what must have been a series of unreported HKMA interventions managed to bring the pair just below 7.842 by April 23rd. By May 2nd the pair was back at 7.85. How many hundred billions of HKD did the HDMA spend for a two weeks respite? We don't know because the HKMA has been silent since April 19th.

In the market no one seems to care. The ARS and the TRY keep sinking. The HKD is under never seen before pressure. The lowest previous levels were 7.75 during the 1997-1998 crisis, 7.80 during the 2000-2003 crash, and a brief 7.83 spike during the 2007-2008 crisis. Yet it all seems unrelated to analysts.

USD 3-month LIBOR is quoted at 2.34% while HKD 3-month HIBOR is only 1.74%. HIBOR would trade with a positive spread to LIBOR in a healthy market. Amazingly 1-month HIBOR has been actually declining to 0.96% in spite of HKMA overnight funds of 2.00% and unprecedented HKD selling. Most HK mortgages are indexed to 1-month and 3-month HIBOR. At some point - quite soon at the current pace of interventions - bank excess liquidity with dry up. Then what?

By the way, do we still have a free market in HK? Because the size of the unreported HKMA interventions since April 19th must have completely mopped up the excess liquidity of the banking system and then some, which stood at HKD 146B on that day. And yet interbank liquidity in HK has been amazingly hovering at just over HKD 128B since April 23rd. Is the HKMA working behind the scenes with the HK banking system to keep HIBOR down and avoid a real estate crash? And are HK data now being misreported or outright faked like it is typical in Mainland China?

I say we crash here and now, unless the Fed abruptly reverses course.

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Anonymous
admin
May 15, 2018 at 3:56 PM ×

Of course "How many hundred billions of HKD did the HKMA spend" should read "how many hundred billions of HKD did the HKMA buy".

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Skr
admin
May 15, 2018 at 7:57 PM ×

A Call To Arms... The Show Must Go on.

http://macro-man.blogspot.com/2017/12/a-call-to-arms-give-us-your-best-trade.html

Howdy folks,We are nearly at the half way stage of the year-and as Car dealers in some parts of the World operate on a new Reg every six months, let's do the same.

Come on Guys I know you all have been working hard and have been to busy to post here. Now is our chance to kick start this puppy.

If TMM want to start a new thread on this please do.

PS Congrats to the Left hander Mark Williams (Billy) on World Snooker win.

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Nico G
admin
May 16, 2018 at 8:57 AM ×

from DR:

The S&P as a whole spent roughly 2% of its profits on buybacks in 1981.

And last year?

That same index devoted 50% of its profits to buybacks.

Might we here have an answer for America’s stagnant productivity?

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Gus
admin
May 17, 2018 at 1:32 AM ×

And what % of the repatriation monies coming back to the U.S will go to buybacks?

For instance: "Apple announced a stock buyback equal to the size of Ecuador’s GDP, thanks to the Republican tax cut bill. In a quarterly earnings announcement the company said it would put in place a new $100 billion share buyback program (and increase its quarterly dividend by 16 percent). Of the multiple major buyback announcements companies have made since the tax bill was passed in December, Apple’s is by far the biggest. But there have been others as well: The tech conglomerate Cisco said it would put an additional $25 billion toward a stock buyback. Troubled megabank Wells Fargo announced about $22 billion in buybacks. Pepsi announced a $15 billion buyback, Amgen and AbbVie $10 billion, and Google’s parent company Alphabet $8.6 billion."

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JohnL
admin
May 17, 2018 at 2:58 AM ×


DB's chart looks like a dumpster fire and I'm not seeing any news stream on this, not even ZH.
I'm I missing something here, is a bailout such a perfect lock that it ain't worth watching the trainwreck?

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Nico G
admin
May 17, 2018 at 7:12 AM ×

DB is worth zero.

Germany (under the closed eye of Draghi) keeps its flagship bank alive for it can't afford the PR nightmare of its national gem going the way of the Lehman (note that DB balance sheet was saved in 2009 by a very obscure loan from...Russia. DB is the banking equivalent of the James Bond villain)

on the other side of the pond, buybacks are keeping US equity indices afloat

if you had told me in November 2016 that SPX would trade 2700 as the 30Y yield blasts through 3.20%... i would have bought your mushrooms. In a normal trading world, the 30Y action this morning would send panic throughout the risk spectrum.

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Mick
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