In June 2014, European and American equity markets surged to new highs, driven by low volatility and speculation fueled by margin debt and corporate buybacks, despite warnings from analysts about underlying economic issues and potential market corrections. The U.S. corporate profits were reported to have dropped significantly, yet the stock performance was buoyed by investor sentiment rather than fundamentals, creating concerns of a speculative bubble. Concurrently, bond markets displayed record low yields, yet liquidity concerns surfaced, suggesting that ordinary investors may struggle to navigate an increasingly complex and speculative landscape.

1. Investors witnessed another rally in Pan American and
European equities in June 2014. On the 5
th
June European
Stocks neared a 6 year high and Germany’s DAX Index briefly
topped 10,000 for the first time, Bloomberg, 5
th
June 2014.
Global stocks also hit a new all time high on Monday 9
th
June,
with the FTSE All World Index trading at 281.48. This activity
occurred on the back of the record rally on the S&P 500 in the
US which went above an all time high of 1900 basis points
earlier in June.
Investors seeking to profit from bullish sentiment in the market
may be buoyed by another happy coincidence, volatility on the
stock markets of Europe and America neared multi year lows
in June. Wall streets ‘Fear Guage’ the VIX (Exchange Volatility
Index) hit 11.5 by Friday 7
th
June, the same week as the surge
in the stock markets. Along with a similar index for global
currency volatility the VIX is flirting with lows that have existed
for centuries.
For risk averse investors, a tanking VIX may give confidence to
call the top of the market and become a catalyst to throw
caution to the wind and pile into stocks where they otherwise
would not. This is not altogether surprising as in theory the VIX
reflects the price investors are prepared to pay to insure
against future volatility in equity portfolios, thus acting as a
gauge of future volatility. The lower the VIX the less fear there
is in the market.
The consensus view is that such lows in volatility bounce off
perceptions that ‘official interest rates will remain exceptionally
low for a long time’, Financial Times, Ralph Atkins & Michael
McKenzie, 9
th
June 2014. In our view this type of punditry from
the corporate mainstream only serves to fuel speculation in this
market.
Linear analysts have previously discussed the high stakes bet
we believe stock investors in America are making with the S&P
and DOW, assisted by the sentiment survey industry, in a
classic hedge on tightening of central bank liquidity.
Stock and Debt Securities Rally: Is There
Safety in The Numbers?
Prepared by Dr. Marcus Bent, Head Of Global Wealth
Y O U R E Y E O N T H E F I N A N C I A L M A R K E T S
Research Note 4
24th
June 2014
T H E F U L L R E S E A R C H R E P O R T I S M A D E A V A L I A B L E T O T R A D I N G C L I E N T S O F E N G F I N C A P I T A L M A N A G E M E N T
We believe this will have market moving implications in
2014/15, more of which we will discuss later. For the
average investor trying to make sense of all the data
there may be a temptation to resort to a baseline
reduction like, this must all mean risk is low and returns
are high right?
This would be incorrect in our opinion. Linear analysts
take the view that most of the recent rise in stock market
performance in the USA and hence Europe is based on
valuation anomalies, not on company profits or
productivity. For example analysis by the USA
Commerce Department's Bureau of Economics suggest
profits by U.S corporations fell 13.7% in Q1 2014 alone,
Reuters, May 29
th
2014. US company profits are
therefore the lowest since 2010 and dropped sharply
from the record highs produced in the last 2 years. The
fall in US corporate profits is contextualised by a general
slowdown in the US economy.
According to the same report real GDP in the first
quarter fell at an annual rate of -1.0 per cent. Optimism
in the US equity market seems to be misplaced, but can
be explained. Linear analysts reported in March that
Margin Debt on the NYSE hit a record high in the same
period as the market surge Q1 2014 and currently
stands at over $451bn against brokerage accounts, (see
Linear report, An Analysis of Risk in Global Capital
Markets’ 06 /03/2014). This means investors have
levered themselves to the ears, courtesy of loans direct
from central banks, in order to speculate on stocks,
pushing stock values higher.
To illustrate the principle of co-determination between
the S&P 500 and margin debt, see graphs A & B
overleaf. If one compares the performance of the S&P
500 1998-2014 (Graph A) and margin debt over the
same period (Graph B), it is clear the movement of one
index tracks the other closely.

2. Stocks & Security Rally: Is There Safety in
Numbers (cont.)
Graph A: (S&P 500 Index)
Graph B: Margin Debt Index
T H E F U L L R E S E A R C H R E P O R T I S M A D E A V A L I A B L E T O T R A D I N G C L I E N T S O F E N G F I N C A P I T A L M A N A G E M E N T

3. The S&P 500 index tested resistance levels of 1,500 basis points in 2001 and 2008 and briefly brakes out of this range before a
market correction ensues. This phenomena roughly coincides with peaks in margin debt on the NYSE in 2000 and 2007 at
approx. $2.7bn and $3.7bn, respectively.
The slight time lag between bursting of the margin debt and speculative bubbles on the NYSE in this time frame are in line with
what one would expect as risk averse retail investors buck the trend and typically pile into the market at the top of the curve.
The ‘twin peaks’ oscillation in the indexes in this time frame is stark. This should tell investors a couple of key things: between
1998-2014 the S&P index tracks rising debt allocation to speculators. The movement also suggests we are nearing the top of
both indexes. Investors should now turn attention to what happened to the S&P 500 after margin debt topped in 2000 and 2007!
Also look at how far above those tops the current high is. Linear analysts believe this is not good news for equity portfolio
holders going forward.
The news on valuations doesn’t get any better unfortunately. The New York Post recently reported that companies on the S&P
500 issued a record amount of debt in Q1 2014 (around $160bn) mostly used to buy back their own shares in order to return
value to shareholders. This again has inflated the value of stocks. This suggests corporate America is the US stock market’s
biggest customer this year and companies like APPLE, IBM, Goldman Sachs, Exxon are driving up share price through
alternatives to productivity. Debt issuance for buy backs has not only ‘propelled the DOW and CEO compensations to new
records, but has also propped up the equity market around a time when stock market volume plummeted by around 15% April
to May 2014. Current stock market volume is approx 19.5% lower than the five-year average’, New York Post, John Byrne, May
31, 2014. In other words what investors are seeing is a speculative bubble in the equity markets.
Judging by the current focus on the rally in securities in the business press, Linear analysts suspect many investors have not
been given the full picture about the low volatility we are witnessing. Right now volatility in equities, currencies and bonds are
near historic lows. This should not happen in ordinary market conditions. Wily investors will know that people flock to equities in
the good times and away from lower risk investments like bonds. High volatility in the equity market usually occurs during
periods of low volatility in the bond markets when the trading ranges on yields tend to be more narrow and vice versa.
Investors are also advised to consider another peculiar feature of these markets. From the year 1990 to date, near record lows
in volatility of bonds and equities have only occurred at the same time twice. Three guesses for when? In 1998 and 2007.
A significant market correction has followed each time. Investors are no doubt starting to see a similar pattern emerge now.
The parallel between current bond and equity markets do not end with volatility levels. The activity of corporations and those of
the central banks are moving in alignment in a worrying fashion. Investors would do well to remember the central banks have re-
written the book on interference with the free market in the last 6 years and are essentially another big market participant
engaging in buyouts of whole market sectors, namely through purchases in the mortgage and treasury securities sectors. Large
corporations seem to have realised fair value can no longer be driven by fundamentals so consequently have attempted to copy
central bank policies. Linear analysts believe recent share buyback trends have evidently inflated asset prices temporarily and
reduced market liquidity. The by-product of this activity is that ordinary investors are being pushed out of both markets, assets
are being hoarded by fewer counter-parties and liquidity is slowly drying up. This is a worrying trend. Shrewd investors will be
attuned to the signal the market is sending through sky high valuations and will look at rebalancing their portfolios in the short
term.
For all the reasons cited above it is our view that the stock markets in America and Europe are in bubble territory and may be
due for a significant correction in 2014. A prudent fund manager with a focus on preserving wealth will advise clients to
immediately manage this risk, as our portfolio managers have done.
For further information contact Dr Marcus Bent, Head of Global Wealth, Linear Investments Ltd. Our analysts work closely with our
portfolio managers to present clients with opportunities on an advisory & discretionary basis. Our flagship Cassandran Hedge portfolio is
uniquely structured to take advantage of long-term emerging trends. These are mixed with highly active trading strategies whilst
implementing a capital protection approach in line with our contrarian view.
T H E F U L L R E S E A R C H R E P O R T I S M A D E A V A L I A B L E T O T R A D I N G C L I E N T S O F E N G F I N C A P I T A L M A N A G E M E N T

4. The return of investor appetite for fixed income products is one of the big market
stories of 2014. A bounce in bond prices has been most keenly felt in the UK and
America where borrowing costs are currently near 300 and 240 year lows
respectively. According to Bloomberg, bond yields have halved in the last 5 years to
an average of 1.78%, bringing options on US Treasuries to within 0.1 percentage
point of an all time low, Bloomberg, June 16, 2014. At the same time, the difference
between the yields of 5 and 30 year securities has narrowed to the lowest point since
2009 as the long bond rallied, Bloomberg, 23
rd
June 2014. The record low yields
evident in bond markets around the world this year would suggest investors are
flocking back to low risk investments.
If ever there were a litmus test for revival of debt markets this year, demand for
European Sovereign debt is a good candidate. The popularity of this type of
investment surprised many this Easter. Portugal which had only returned to the bond
market in January 2013 after exiting in April 2011, managed to raise €6.25bn through
sales this April. Portugal's 10 year securities, which if one remembers were trading at
yields of 18.29% in January 2012 sold for value $1.04bn. In the same month Greece
resumed its debt sales so successfully that it had to limit debt issuance to €3bn from
an order book of €20bn, CNN Money, April 10
th
2014. Cyprus beat all market
expectations when it returned to the bond market in June 2014 with a $1.02bn bond
valuation for 5 year debt from an order book of €2bn, Reuters, June 18
th
2014. As the
country that set the bank bail in precedent for Europe last year, Cyprus wasn’t the
obvious candidate for the fastest comeback to the market of any bailed out euro zone
country. Yet many investors chased yields which gave Cyprus among the highest
returns for 5 year debt in the euro zone!
Bond Investors it would appear have short memories and are piling into investments
they would not have touched with a barge pole as recently as a year earlier, as in the
case of Cyprus. With Portuguese 10 year securities now yielding at roughly half the
level of January 2011 (3.35%), 10 year Greek debt yielding around 5.75% (less than
a third of levels in January 2012), and 5 year Cypriat debt yielding among the lowest
for the peripheral region at 5.85%, the temptation may be there for investors to use
bonds to hedge more risky bets in the market. Linear Investments analysts believe
few investors in peripheral debt are stopping to ask themselves whether the growth
expectations in said countries in the range of -3.9% to 0.8%, warrant current bond
valuations. To illustrate the point, growth is barely above negative territory in the euro
zone and the economies in question were in solidly negative territory last year
(Greece -4%, Portugal -1.8%, Cyprus -8.7%), EUbusiness.com, 5
th
November,
2013. Whilst bond values soar and yields drop investors are eyeing the opportunity
as opposed to the cost.
In the fast moving bond markets of 2013/14, a couple of months appear to be a long
time! Liquidity in the international bond market has recently become a serious issue.
On 16
th
June, Bloomberg reported on risk in the bond market, “A boom in fixed
income derivatives trading is exposing a hidden risk in the debt markets around the
world: The inability of investors to buy and sell bonds”. It would appear that whilst the
value of government bonds soar and yields are at record lows, trading volume in
some maturities has plummeted by a third as investors pile into derivative contracts
to hedge against future rate rises. One casualty is the market for day trades,
particularly for large order trades. For example 'In Japan's $9.6 trillion debt market,
the second largest in the world, the benchmark Note opened late 4 days and didn't
trade until midday for 2 of those days, in 2
nd
week of June 2014’. This was largely
due to lack of volume. Japanese bonds failed to trade at all on April 14
th
that year the
first time since 2000. In other words Japan's bond market “virtually ground to a halt”
as its central bank took 70% of the interest-bearing debt trade that month leaving little
for other counterparties to buy. According to Bloomberg, a similar lack of liquidity
occurred in Italy last month, the World’s third largest Sovereign bond market, causing
transaction costs to spike and an eightfold surge in Italian futures'. Although the
decline in daily trading volume in bonds may have accelerated in recent months, this
seems to be part of a longer term trend. The fact that Italy, Europe’s second largest
Sovereign debt market worth some $2.43tn, saw daily trading volumes fall by 57% in
the last decade whilst derivatives have soared by 800%, should make all investors in
the regions debt pause for thought.
Debt Reduction Predicts Growth in US:
Is Yellen’s Word Her Bond?
For those investors who think the American
bond market is a safer refuge from liquidity
risk, think again. ‘Even the US which has
the deepest most liquid government debt
market worth more than $12tn has seen
buying and selling activity shrink’ at a time
when bonds have seen stellar performance.
For instance, weekly trading of US T-Notes
with maturities of between 7 and 11 years
fell by 32% ($96.3bn) from a year ago’,
according to Bloomberg, June 16
th
. Another
casualty is dealing volume in the bond
market is starting dry up. Bloomberg
reported that ‘global dealer inventories have
declined by 75% since the start of the crisis
in 2007. Five of the 6 biggest Wall Street
firms said trading revenue fell in fixed
income divisions in Q1 2014’. The view of
the mainstream is that this is an unintended
side effect from central bank monetary
policy to purchase debt and keep rates low.
The concern now is that ‘investors may be
more vulnerable to losses when yields rise
from historic lows leading to a “squeeze” as
they try to exit their positions’, Bloomberg,
Anchalee Worrachate and Liz McCormick,
June 16
th
, 2014.
As we approach Q3 2014, a curious
situation exists in the international bond
markets. On paper, bonds, particularly US
and UK, look the most appetizing they have
done for years, yet ordinary government
bond buyers are crowded out of the market
by the official sector, are forced into
derivative contracts (bond securities) worth
$100tn and may not be able to exit all
positions as the market turns and rates rise,
due to lack of buyers. To add to the slightly
surreal feel of current bond markets, central
banks are showing no sign of reversing the
historically low base rates and tapering that
are now draining liquidity and volatility from
the bond markets

5. Debt Reduction Predicts Growth in US:
Is Yellen’s Word Her Bond (continued)
Shrewd investors might think that a low rate environment
will be difficult to justify for much longer in view of growth
projections for the UK and America. However if tapering
proceeds unabated as the liquidity crisis continues in the
bond markets and this causes values to start falling rapidly,
Linear analysts believe investors will start to ask serious
questions before investing in debt or keeping capital in that
market. The first question the central banks have so far
dodged and will have to answer is why after 6 years have
emergency measures like zero/negative interest rates and
QE not succeeded at injecting sufficient liquidity into the
bond markets? The second question is why central banks
still own most government debt and cannot sell it, 6 years
on? Our guess is the banks cannot answer these questions
in a satisfactory manner. The plain truth is interest rates
have been kept low to prevent deflation from spiraling, there
is no plan B, and plan A is starting to unravel and the bond
markets are picking up on this signal. If growth falters in the
UK, US or the euro zone and the central banks are forced to
admit ZIRP and QE are a permanent feature of the
landscape, the printing presses will start up again, and
investors will realise the game is up and exodus the bond
markets en-mass.
In the meantime the US FED appears to be oblivious to the deflationary risks inherent to the large scale reduction of bond
purchases and historically low rates, even though this is now beginning to impact liquidity, volume and volatility in the
international bond markets. On the 18
th
June, Janet Yellen announced in a FED news conference that ‘growth was bouncing
back and the job market was improving’ as it reduced the monthly pace of asset purchases by $10bn for a fifth straight
meeting, Bloomberg, Cordell Eddings, June 23, 2014. Linear analysts believe that by ignoring this risk Janet Yellen is playing
with fire and bond investors will be one of the biggest casualties.
The squeeze in liquidity in international bond markets has surprised Linear analysts much less than the timing. Whilst the
market looked on in wonder at the surge in the bond markets this year, our analysts were warning investors about risk in this
market. In fact we anticipated a liquidity squeeze much earlier in the tapering cycle, in tandem with a spike in short and long
term rates in Europe and America. The combination of these outcomes we thought might threaten to derail asset purchases
much earlier than appears to be the case. For example In March 2014 we warned investors that a $10bn per month reduction
in asset purchases by the FED and the effective removal of the biggest buying counter party for US Treasuries would lead to
deflation risk in the bond markets of Europe and America in 2014. We noted that a spike in 10 year T-Notes and Gilts both of
which virtually doubled in value to around the 3% mark over 8 months last year and a spike in the normally stable German
Bund, after taper speculation last summer, was a prescient warning to investors. We also warned investors that this would be
just the start of the problem as the $440tn worth of interest linked swaps in the global derivatives market began to unwind. In
the view of our analysts “the sheer size of the liabilities floating around in the credit derivative market render alternatives to QE
an absurdity, (See Linear report: 'An Analysis of Risk in Developed Capital Markets', 6
th
March 2014).
For bond investors the question of why a rupture in the debt markets has not followed tapering by the FED, matters now more
than ever. As we saw last summer, if the market does eventually react negatively to the tightening of credit, bond yields could
spike and many bond investors will find themselves trapped. At that point investors will feel the current bond market liquidity
squeeze much more keenly as they struggle to find willing buyers for debt. The market has offered some explanation for the
fact bond yields have tanked and not spiked this year. Susan Walker of Bloomberg offered a view shared by many in the
market that a $460bn dollar shortfall in the debt supply is the reason bond values have increased, Bloomberg, June 10
th
, 2014.
Therefore the view of the mainstream is that removal of debt from the market through central bank asset purchases has
decreased debt supply globally and pushed bond yields down. Linear analysts and many others believe this simply does not
stand up to scrutiny. In the context of $4tn plus extension of the FED’s balance sheet since 2006, and a substantially larger
increase in the balance sheet of the BOJ, a $460bn dollar reduction in the debt supply should not drive bond yields to record
lows.
Linear analysts think the critique put forward by Michael Pento of Pento Portfolio Strategies LLC is highly persuasive. Citing
data on American fiscal policy in the last 15 years he shows that record low T-Note yields are not correlated to debt levels seen
in recent times. For example yields on 10 year T-Notes were trading in the 5-6% range between 1998-2001 when the US ran a
budget surplus ( 0.6% - 2.2% GDP), and nominal debt was on average $5.5tn. If yields are correlated to the debt supply it is
unlikely 10 yr T-Notes would now be trading at half the yield spreads of 14 years ago when the current US budget is in deficit
(negative 3% GDP) and nominal debt is now three times higher ($17.5tn).

6. So what then of a credible explanation for bond yield
performance during the taper cycle? Michael Mackenzie and co
at the Financial Times delivered the knockout blow on taper talk
recently. According to their analysis the FED may not be tapering
asset purchases in any meaningful way at all in 2014. It appears
the Bank of Belgium has been buying US treasuries at an
alarming rate recently. For example ‘Belgium’s holdings of US
debt rose by $30.9bn this February alone, according to US
Treasury data released 8
th
April 2014’. Since last August, the
month before tapering was announced, US Treasury debt
attributed to Belgium more than doubled from $160bn to
$341.2bn, according to official US data. This means a small
country with a population of 11m, no previous record as a
financial centre in Europe, has this year become the third largest
holder of US Treasuries, a holding almost equal in size to its
Gross Domestic Product ($484bn). In view of this information
bond Investors may not be surprised to learn that the FED
reported a record weekly drop of $105bn in foreign holdings of
US Treasuries in March 2014. It would also appear that Belgium
is not a unique case. Euroclear, which holds more than €22tn
worth assets under custody announced its volume of US
Treasuries had “gone up dramatically in recent months”,
Financial Times, April 15
th
, 2014.
Linear analysts take the view this activity indicates the ‘taper’ of
$10bn treasuries per month is more than offset by bond
purchases by similar counterparties from Q3 2013 to present.
The message to bond holders is very clear. The FED is more
than likely supporting its bond buying programme via off balance
sheet purchases of US debt via other central banks.
This means the central banks are propping up the bond market
with cheap liquidity at an even greater rate than before the ‘taper’
and are so concerned about deflation in this market they are
prepared to risk the inflation of other asset classes like equities,
property and commodities, and are misleading investors in order
to preserve this policy. For Linear analysts this is a credible
explanation for why bond yields are falling rather than rising
during the taper cycle. Except as our analysis shows, after 6
years the bond markets are now showing sign of fatigue with
central bank easing policy and deflation is beginning to surface
anyway. Our analysts think this state of affairs should not fill
existing bond holders with confidence in the performance of this
asset class after 2014.
The stakes could not be any higher for bond investors. Currently
bond holders seem to be buying the message from the central
banks on future economic growth and stability of markets. If this
proves to be as incorrect as Linear analysts believe, bond
holders could be in for a very difficult time within the next 6-12
months. The warning signals given to bond investors recently are
ominous: On the 25
th
June, growth forecasts for the US economy
were revised down by 3% after US GDP contracted by 2.9% Q1
2014 according to figures released by the US Commerce
Department. This is the US economies worst performance in 5
years, The Economic Times, 25
th
June 2014. Yet just one week
earlier the present FED chairperson projected growth for the US
economy and described a 2% increase in inflation as “noise”.
Bloomberg, June 23
rd
2014.
If the mainstream view is this wrong, investors must be prepared
to rethink the market forecasts that view supports. We urge
investors to take on board our forecast that current rallies in the
debt securities market will not last beyond Q2 2015 and
advanced economies in the west are not recovering in the
fashion mainstream market analysts suggest. Investors are
urged to consider an alternative view. Perhaps the record low
yields in government debt around the world, record low volatility,
shrinking liquidity and volume, and now a tanking US economy,
are a signal from the market that serious deflation exists in the
global economy and this is set to accelerate in 2015?
A shrewd investor should be looking to cut their exposure
to government debt at the top of the market which we
believe to be now.
As our analysis has shown, the distortion of the capital
markets through central bank interference has now
meant that the bond markets have substantial downside
risk which will affect bondholders in the near future.
Central Bank activity has been a game changer for the
bond markets. Prior to 2006 investors priced bonds
based on market fundamentals whereas now policy
announcements are a major component of the bond
price. Bond buyers are now required to navigate a market
in which interest rates may turn over night, investors are
behaving irrationally and are simply chasing momentum
and economic data is a less important indicator of price
action. In this environment few bond holders can afford to
park their capital in bonds and rely on the coupon
premium to protect their investment.
In view of the risks identified in this analysis we suggest
bond holders seek advice on diversification of their
assets and risk spread. Linear Portfolio managers
specialise in helping investment clients to manage risk. A
prudent fund manager with a focus on preserving wealth
will advise clients to manage this risk, as our portfolio
managers have done.
For further information contact Dr Marcus Bent, Head of
Global Wealth, Linear Investments Ltd.
Linear analysts work closely with our portfolio managers to
present clients with opportunities on an advisory &
discretionary basis. The flagship Cassandran Hedge portfolio
is uniquely structured to take advantage of long-term emerging
trends. These are mixed with some highly active trading
strategies whilst implementing a capital protection approach in
line with our contrarian view.
Debt Reduction Predicts Growth in US:
Is Yellen’s Word Her Bond (continued)

7. .
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