good afternoon welcome to capital account i'm lauren lyster here in washington d.c. these are your headlines for tuesday september twenty fifth two thousand and twelve u.s. corporate bonds more than one hundred billion dollars worth were issued first september the bar this is only the third time issuances crossed that monthly thresholds and at least nine hundred ninety five that's according to data provider deal logic as reported by the wall street journal so is the appetite driven by this. judge. i turned

a little. retreat to. reaching for you know in this low rate environment is the risk of falling off the cliff becoming more than the herd is willing to bear though and will overturn flight to quality leaves some investors for why and off into the abyss will discuss plus r.b.s. managers took part in live or manipulation that's according to a bloomberg report citing interviews and instant messages of get every time we get angry about private bank manipulation rightfully so but where are the headlines about the public private consortium that is bought and now controls thirty five percent of the long term treasury market duncan about the fed of course we'll talk to peter chair of t.f. market advisors about it and wall work on treasuries we parse the prospectus on a popular treasury e.t.f. will bring you the breakdown and word of the day let's get to today's capital account.

there are certain historical relationships that investors look at when deciding where or how to invest in in today's environment stocks look pretty cheap relative to treasuries but does this fail to take into account a fundamental change in the underlying assumptions specifically the changes brought about by a federal reserve that now owns thirty five percent of the long bond treasury market according to our next guest and as the fed expands its balance sheet and its appetite for a long term u.s. debt it emits bills of credit that you and i call dollars and then these dollars are taken by investors some of whom in search of higher than negative return on

their money are not willing to sit in ten year government debt and they plough into assets like commodities stocks corporate bonds but as these same investors stretch out further and further in search of the holy grail of the year olds do they risk this. there is a classic it's a look at the greek ten year bond it hit montaigne year highs as investors were piling in to get the incremental yield and then boom look at that they just got decimated that's a lesson for ya let's bring in peter chair to see where those pitfalls are risks are today's founder t.f. market advisors and he's going to talk about the latest chase for yield and where it is getting us or leading us really so first peter chair welcome back to the show thanks for being on and thanks for having or so before we talk about the reach for you know let's talk about how we got into this perverse situation of low rates and let's talk a little bit about the dynamics of what you call very cleverly benny robbing from

timmy to pay to me ok we're talking about ben bernanke he intended the geitner of course so in what way is the fed directly subsidizing the government in your view yeah i think this is taken on you know we started with q.e. one then we had q.e. two that ultimately had operation twist and now we have something that doesn't really look like a free market anymore the fed owns about twenty percent of all the coupon treasuries that are outstanding but because of operation twist the fed now owns about thirty five percent of all treasuries that have maturities a five year or greater so effectively the has bought up a large chunk of the back and they have had a huge influence on rates and not just because of their direct purchases but you know every hedge fund myself we all know that the fed's out there buying so that makes you slightly more comfortable buying treasury just so you know you have this deep pocket investor who is going to continue buying and isn't particularly yield sensitive in fact is an old sensitive at all so i think that's had a huge influence on rates so if you look at the eight trillion or so that's outstanding just on coupon paying debt assume he's been able to keep the rates down

by one to two percent a year say two percent that right there would be one hundred sixty billion that he's saving congress separately when we look at the coupons that are being paid those treasuries pay about two hundred billion a year of which the fed gets fifty six bill. and the fed collects that fifty six billion and returns it to treasury as a profit which is a very weird dynamic so the treasury pays the fed on the day the fed then turns back and pays that coupon interest back to treasury along with all their other holdings so i think last year last fiscal years we haven't seen this year's. the fed gave eighty eight billion dollars of profits back to congress so the estimates are the fed is directly probably subsidizing our budget deficit by between one hundred fifty to two hundred fifty billion a year so it's not insignificant in fact it's very substantial becoming one of the biggest line items hot one hundred nice of them you know the deficit needs all the help it can get but i can imagine that this has some impact on distorting markets

to put it mildly and possibly some impact on confidence in the u.s. dollar as the reserve currency as the world still currently looks at it to be so what does it have that the fed is it has this large of a controlling stake in the market was the purchaser of sixty one percent of the treasuries that the treasury issued last year according to one figure i saw yes i think it's starting to make people question you know what is the value of treasuries how should we be looking at them and i think you know a lot of people look at historical data and show what's the dividend yield on the s. and p. five hundred versus treasuries and by that measure it comes up with stocks looking very cheap i think a lot of people are going to pause and scratching their head and saying ok well that's fine but what happens of the fed backs out of the treasury market where's the real market clearing rate so then we kind of moved away from this true market pricing which is something we've all assumed and during the crisis kind of no one's really thought about but i think over the last couple weeks particular after q e

unlimited everyone's really starting to think about that means and q.e. unlimited was another really weird thing if you think that where the reserve currency where people come to us because they have faith in our ability to manage our economy we're starting to do stranger and stranger things. so fannie mae which is owned by the treasury is implicitly if not explicitly guaranteed by the federal government issues mortgages it guarantees that it now sells it to the fed the fed takes that coupon interest and pays it back to treasury he's starting to have a system that doesn't look right and i think people are starting to question what does that mean you know when europe started doing this we would laugh at the ponzi bonds they were creating that greek banks were funding themselves weirdly it was a kind of go go go weird europeans they don't get it and now we're seeing more and more of that activity here and i think it's it's troublesome it is troublesome just to carry it through on the huey unlimited that targets and b.s. what does that do just just to be very clear to the holdings of fannie mae and

freddie mac. which is controlled by the government the treasury you know this is another thing where we're starting to see you know very coordinated action between various entities of the government congress basically demanded that fannie and freddie start reducing the size of their balance sheet so they want fannie and freddie to hold less direct mortgages they're still fine with them guaranteeing it but they want them to hold less so as soon as that kind of and you know if the fed steps in and will take some of those mortgages on their balance sheet so they're working very very hard to control you know fund flows mortgage flows all of which i guess in some ways seems fine and should be encouraging but i think more people are sort of scratching their head and say you know where is the real economy where is the true capitalism and what data can we trust absolutely and so all of this to the other. thing that it inspires as investors to reach further and further first some yield but at the same time you have this dynamic where investors are concerned about return on capital so that causes flight into perceived safe haven so where do

you see the real risks say like what we saw with that great ten year bond that just everybody plowed into and then it just plummeted you know what i sent out a note this afternoon and all that and and i think up until recently whenever the q.e. was announced the. they reacted pretty positively they did a little bit what the fed told them to do they reached for you and they went out the curve so they bought a longer maturity or they went down the credit spectrum and were buying you a lower quality investment grade or moving into high yield or they pushed that money all the way to equities so i think they were kind of the fed was getting the reaction they were looking for we're not seeing that same spike since it was announced we had initial spike kind of an all asset classes but since then we've seen a pullback and i think a lot of investors are just starting to say you know i don't want to be the last one and i don't want to be buying an asset that's only at this level because it's got government support what happens if romney wins a need to do this then what happens do we get afraid that all of a sudden they're going to dump six hundred seven hundred billion of treasuries on

the market so i think all of a sudden people are starting to say ok this is interesting maybe i can profit from it short term but i'm not going to play the game of chasing yield i want to be a little bit conservative because i don't know the next step is so one other area that we hear people plowing into is corporate debt and i'm a little confused about how to look at it because for example there was this report that corporate debt issuance had a record that it's had only three times or something since one thousand nine hundred five and there's both this aspect that corporations are able to issue debt at at a relatively lower yield than historical averages but at the same time maybe investors have such a demand for it because they're chasing some yield and that's offers more of a yield then some other investment that you could could pour into it so how do you look at that dynamic you know i think definitely people have got comfortable with buying investment grade bonds it's been a long term trend but everything i look at terms of fun flows have been that it's been slowing amongst the retail side we're seeing more institutions pick that up

there's also a lot of kind of strange dynamics going on the federal reserve is pushing back on banks about lending basel three which is still a ways off will make it very unattractive for banks to provide all these. unfunded revolvers so the typical sort of loans a corporation would get. are being kind of squeezed out by basel three so i think corporations are relying more heavily on the bond market so it's very good that it's own but some of this isn't just them accumulating new debt it's shifting how they fund themselves so they're going to be lie less on banks more in the capital markets so that trends been going we also saw a real severe slowdown this summer we had a lot of problems in europe in july august was a very quiet month so some of this issuance that's coming up is meeting demand that accumulated over that slow time so i think it's going to be more important to see how october november play out everything i see though looks like retails potato desire to own corporate debt has slowed down i think they were very early on that last year i think the earlier this year retail really responded well to the fed

extended maturity of being zero interest rates forever but lately i have not seen that same enthusiasm for the retail side so i think this is much more institutional as i think this is hedge funds that have been underperforming a lot of credit hedge funds of underperform and their best hope i guess of catching up is to buy these new issues levered up and hope for the best so i'm not sure this is truly a positive and it may come back to create a cycle where we've issued too much debt and there's not the real underlying liquidity to support it aha that's a firm miliard pattern that we know all too well coming up rearing its head and more and more places that so we're going to keep you on we're going to go to a quick break when we come back i want to talk to you about the vix you know it's been a little quiet in terms of reports on it but is that just the calm before the storm or with peter chair founder of t.f. market advisors and then it also still ahead we'll take a look at treasury bonds and e.t.f. and today's word of the day thank you won't want to mention that first year closing

market numbers. courageous and creative. elegance and full of public speaking. felt sorry. for. a few european bodybuilders against millions of which immigrants. her. this may not seem so serious now for this could be a real flight to mars. european extremists. on positive. i am

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will. welcome back afore the break we were talking about the vicious cycle of benny robbing to me to pay it to me now let's talk about the vicious cycle that may be going on in the markets but under the radar because joining me is peter chair founder of t.f. market advisors and he is going to tell us what he sees in the vix so peter cheer the vix the volatility index a while ago i can't remember exactly when we were hearing a lot about it seemed like every day there were headlines and blog posts about the vix and volatility but now i feel like that's died down so why are you looking at the vix. exactly because it's died down when it first came out there was all these stories you know kind of hit fourteen fifteen and i was talking was such

a sign of complacency so i did a bit of work and looked at it and the reality was the actual volatility of the stock market had dropped dramatically so it made a lot of sense that this was coming down because the reality is vix is the short term volatility of the stocks or what someone expects it to be over the near term so people aren't going to pay much for that as stocks come down so a it made sense because we saw a near term volatility decrease and then at the other end of it what we saw were longer dated options remained well bid so people were still buying longer dated options so the vix equivalent for those who remained high that told me that the market wasn't that complacent people were buying longer dated options and since everyone was talking about the complacency it seemed too many people were focused on it vic spiked up a little bit i think we went from fourteen maybe as high as seventeen and here we are back to those fourteen sort of levels yesterday and no one's talking about it and i looked up sure enough volatility of stocks was about the same as it was

before so at least that made sense but on the other hand long dated volatility it decreased people were paying less for options so i think people become very complacent that with ben bernanke he with mario druggy all support of there was no need to buy put options there was no need to protect your portfolio so now i actually think people are very under hedged i think people have gotten along people have become very complacent so this time around i actually think people are complacent and i look at that they call it the skew but the difference between longer dated up put option volatility and short dated and since that is actually flatten that's telling me there's real complacency so i think we should be watching and i think it's why when we see down days like this we will see an acceleration because no one's protected you don't get the short covering bounce you don't get the people who are more comfortable adding so i think we've actually set ourselves up for a potential five percent five to ten percent correction just because everyone got so complacent. aha so if this is the calm before the storm everybody's complacent

everybody think everything's going to work out just fine what do you think would be the tipping point to create that storm and what do you think this fall out from that would be and i think i'm looking at two things that are kind of creating that tipping point one is once again looking at europe were they unveiled this all empty or the new market purchase plan that they had and yet spain has refused to join in italy hasn't done anything on it and time is dragging by and what i see now to europe is the elite if you want the politicians the central bankers seem to be finally forming a plan that spain isn't onboard and we're seeing much more dissension i think within the populace i think there's far less support for a plan and every day that drags on i think we see more risk that economies there continue to deteriorate and that they can't do anything useful and then the other and i see apple as a good potential catalyst here i think earnings are going to be good for us companies as a whole but one of the things that we saw certainly is

a macro trader was a lot of people were bearish the market and we're losing money as we kept getting this rally and i've been bullish at that time they started buying apple because somehow they could close their eyes and say well ok hit the market but apple such a great company so i think all of a sudden we had a lot of longs and then last week a lot of the trading seemed very bubble mentality you know oh we might have sold an extra million i phone so the stock goes up ten points ok the reality is that represents almost ten billion of equity market cap. one hundred million two hundred million of profits so i think people got really caught up so i think we see a lot of long as there are a lot of people been longing for a while and are potentially worried about the tax consequences of holding it through next year if obama wins there is real concern in the fifteen percent capital gains gets taken away so i think that creates a selling pressure in that sort of name and then hedge funds who've been underperforming you know if they start seeing. this one of their big winners lose i think they get out and hedge funds more than anyone are very involved in apple and

more than anyone have stop loss trading mentality so i think that's another potential trigger and because we have to excuse me so much of the s. and p. and of the nasdaq indices and the under-performance and it immediately shows up in the big indices wow so it's crazy that the two things that you're looking at that could be the trigger are an entire continent or currency zone and apple begs the question of apple's too big to fail in the market one funny thing i do want to point out before we go on your no you said you know nobody's going to buy those apple i phone who what suckers are going to buy that without having the upgrade in their contract i'll tell you one sucker our producer peter chaired to me jerry had a lot of value. but. there's one to counter your says but we're going to have to leave it there today i really appreciate you being on the show a lot of very interesting insight our viewers are going to love it peter chere founder of t.f. market advisors thanks very much. all

right it's time now for word of the day where we break down a financial term or concept for our smart viewer but maybe not the financial expert and since we've been talking about treasury bonds today with peter cheer and as a follow up to last week's breakdown of e.t.f. focusing on precious metals in a word of the day we have again e.t.f. exchange traded funds as word of the day but now with a special focus on treasury bond e.t.f. because the moral of the story with these financial products is always to read the fine print and now we will give you another reason as to why let's dig a little deeper into one of the more popular treasury bond e.t.f. that's called the t l t and it's managed by blackrock if you are interested now if you think this e.t.f. sounds like a safe investment because its underlying assets are u.s.

government securities which many consider a risk free asset you may be surprised to find out how much risk you are actually taking on you probably thought i was going to say that but let's take a look at the prospectus so i can show you the fine print exhibit a the fund may engage in securities lending securities lending involves the risk that the fund may lose money all right that sounds great later on it goes on to state the fund may lend securities representing up to one third of the value of the funds total assets a third so one third of the underlying assets in the e.t.f. in this case treasuries can be used as collateral to take out loans to get cash all right let's continue because i'm not done the fund also may invest up to five percent of its assets and repurchase agreements collateralized by u.s. government obligations and in cash and cash equivalents including shares of. money market funds so let's put the pieces together because this is all like legally

after all so t l t can lend up to a third of its total assets in cash and then invest that cash in things like money market funds and i should know this is something you could only find out by reading this statement of additional information a supplement to the prospectus ok so we have that thirty three point three percent then the fund can also invest up to five percent of its assets in repose cash in money market funds so let's get this straight up to thirty eight point three three percent of assets can be put in the money market now let's see what this looks like in reality back to the prospectus well what do you know low and behold thirty six point zero one percent of the twenty year plus t l t treasury bond fund is invested in money market funds now there isn't necessarily a problem with money market funds but this is certainly an area of additional risk especially if you thought the underlying assets were a direct liability of uncle sam alone and just recall so that we could have some

context. money market may have around two thousand and eight after the collapse of lehman brothers in two thousand it gave rise to headlines like the ones you see rushing to save money market funds money market funds get fifty billion dollars back step stop from the u.s. so remember before investing in an e.t.f. even in an apparently safe one it is very important to do your homework a sophisticated investor or trader may have good reason to use such an e.t.f. but if your buying into the t l t is a long run alternative to buying u.s. treasuries sitting there at home you may want to think twice about where you are parking your hard earned money and that is why we are breaking down once again e.t.f. . all

right let's wrap up with a quick loose change dimitri kofi anan it's wrong listen let's talk about bringing home the bacon was there what is about quite literally i'm going to show you all right along with all that well i don't care what are you going buying all of my going to commercial all right all right well there is no doubt that the drought we faced earlier this year has led to a food shortage some food price rises but did you know it has an effect on the bacon industry look at this. oh oh britain's national pig association blames drought conditions that affected this year's corn and soybean crop that will make it more expensive to feed the little here. prices are expected to go up because of the shortage of pork because people are rushing to slaughter their pigs now

why is it up to others because of the it is too expensive feed prices have gone up they've got to kill the pigs now because they can't afford to feed them it's. friend sam would say it's those evil speculators i wish i knew about this we could have played as a clip from the trading places where you know eddie murphy is the pork bellies the tone the pork you know i don't know because i can't recite every movie i've ever seen. again but this brings up a whole new you know meeting to bring home the bacon it may be more expensive to do so but i just think this is just one other interesting aspect to what comes back to government policy at the end of the day because if there wasn't a guaranteed customer for farmers a requirement of corn for ethanol subsidies then feed wouldn't be as expensive and everybody could have their pay just like they want to when this goes through into prices or there you go with your i'm with you they're all a big big consumer so i don't really know oh i'm broken down and i don't mind it and it's pretty good and it's really right you think that's what our viewers want to hear how do you feel about it what will they don't like mark phone purchase so

my mother. can relate to my work very. well ok let's move on from dimitri's bacon preference and really quickly touch on this story a las vegas based company allegiant airlines is known for having some of the best prices for flights at this. soda league we've decided to give you clues things together like sun we like solution and some seriously. yeah they get sounds nice but hey this airline wants to take a gamble which is ironic a bit offering customers an option for their tickets either pay the regular way or pay a lower regular ticket price and they'll have to pay. separate bill based on whatever the market prices are for fuel at the time of travel this is so funny that this is a vegas airlines and they're actually taking a gamble and allowing customers to get on the right wing take on just alright take it or want to reverse futures contract yeah that's sort of locking in the priors right there like let's do

a variable gabble price basically playing the market for the brochure or potion of florida hoping the gas price will drop as though they were driving yes this thing it is interesting to know it's a runaway when i was it reminded me of adjustable rate mortgages just you know that was the first thing that came to my so they just took it from me no i actually said that in our morning meeting and so this year i did not really thought of myself i don't know we're talking about now ok we can go but anyway it was a red flag to me as. you know sometimes you see a story and it seems so you think you understand it and then you glimpse something else you hear or see some other part of it and realized everything you thought you knew you don't know i'm tom hardy welcome to the big show.

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