Three years ago, when it first became largely adopted by the mass investing population as a hedge to a collapsing market, the 3x levered ETF known as the Direxion Daily Financial Bear 3X Shares, or FAZ in short, was the hottest thing since sliced bread. Subsequently, it has transitioned form being an object of affection to one of infinite scorn, hatred and outright homicidal urges, for one simple reason: it, like many of its other levered bearish peers, is anything but a way to profit from a collapsing market. In fact, as a recent proxy filing by Direxion indicates, it is virtually impossible to make money in the long-term using FAZ... or medium-term... or, as many would say, even intraday as well. The reason for this is simple: while nobody gets the true inner workings of these inverse x-levered ETFs, certainly not the "experts" who post three times a day on Seeking Alpha, one thing everyone should understand is what the following table straight from Direxion is saying: namely that even if the market collapses by 60%, one could lose up to 96.1% of their entire investment in the FAZ, if for some ungoldy reason, annualized vol surges to 100%. Because, you know, vol only occasionally rises when the S&P plunges by more than half. The same is applicable on any time frame: in essence the FAZ only works if the two massively contradictory Venn diagrams overlap: a market plunge and not rise in vol. Uhm, maybe they should have disclosed that a little bit sooner...
While we have long known that the drachma, and recently the lira, have seen significant "when issued" interest by institutional clients desiring to hedge their currency collapse exposure, and thus early markets by various trading desks, little did we realize just how destabilizing this fact to the system would be, at least according to SWIFT. According to the WSJ, this organization, best known for making an abrupt appearance any time one wishes to do a wire transfer, then promptly disappearing until the next such instance, ended up promptly shutting down any Plan B optionality when "at least two global banks took steps to install back-up technology systems that could handle trades in old European currencies like drachmas, escudos and lire... quickly found, is not so easy in a financial world that is trying to both exhibit confidence in the ailing euro and—just in case—plan for its possible demise. Technology managers at the banks contacted Swift, the Belgium-based consortium that manages the network used in financial transactions, said people familiar with the matter. The banks wanted Swift's technology support and the currency codes that would be necessary to set up the backup systems." And got promptly rejected: "Swift declined to provide some information for such contingency planning, including whether old codes could be used in the system, said the people familiar with the matter." The reason is that in Europe, the mere admission that Plan B is a possibility, apparently set off a chain of events that makes Plan B an inevitability: "...officials there feared that releasing the information could fuel further doubts and instability in the euro zone."... And the kicker: '"As soon as you start contingency planning . . . it can become a foregone conclusion," said Alastair Newton, senior political analyst at Nomura PLC. "But if things go wrong and you don't have plans in place, you're in trouble."
Often times we are asked "why does Zero Hedge prefer to provide information in piecemeal increments and isolated snapshots (of irregularity) rather than write comprehensive articles (or even a book) that explain, from beginning to end why everything is broken - the end?" There are two answers - a short and a long one. The short answer is that finance, more so than any other field, changes so rapidly that the nuances are always and constantly on the margin, which in turn is stable only for the period of time that it is observed, and then it becomes part of "technical analysis." (Indeed, the Schrodinger wave function collapse is just as alive and well in finance as it is in the quantum arena). As such, we adhere to the paradigm describing the distinction between giving a man a fish and teaching a man to fish: we believe that it is far more useful to demonstrate all that ways in which the market (and global economy) works, or rather doesn't, than engage in extended exercises of vanity, which serve as much to stroke the author's ego, and demonstrate one's knowledge of SAT words, as they do to elucidate the matter at hand. By sharing our own views of events as they transpire in real time, be they right or wrong, we hope to provide our readers with the "connect the dots" patchwork required to evaluate relevant financial events as they occur in real time, instead of describing them in the in vitro vacuum of moody brooding. (As for a book, we are more than confident enough "independent" bloggers out there will succumb to the very system their protest against, and pen a few hundred pages on the goal-seeked topic of their choosing - the last thing the vast upcoming book pyre needs is our own intellectual self-pleasuring). The long answer is far longer, and, ironically, deserves a post of its own. But this is neither the time nor the place. What then is the purpose of this post is to break away from our tradition, but also not to recreate the wheel, as many others find delight in doing. Instead, as a special present to our readers, we share the seminal analysis by Citigroup's Matt King from September 5, 2008, titled "Are The Brokers Broken?" which in one place explains, better than anyone else has ever done, why the system is terminally broken, and why the best anyone can hope for is to keep kicking the can down the road until it all comes crashing down.
The folks at mapsofworld.com have been kind enough to compile a list of the top events of 2011 broken down by country, coupled with a fully interactive drill down. Furthermore, they have compiled a list of the top 5 events of 2011 based on popular voting (open to anyone). We were surprised (or maybe not) to find that while in our little microcosm we focus on the nuances of the financial world, and occasionally branch out into its nexus of geopolitics, people in the real world appear to have a whole different set of priorities. Confirming this is the fact that 3 of the top 5 most important events are i) the recognition of LGBT rights by the UN; ii) the launch of Google Plus and iii) the 100th anniversary of the IBM - three developments that have received precisely zero coverage on Zero Hedge. At least the top two events are somewhat relevant to both the world and our readers, namely the Tunisian Revolution aka the Arab Spring, and the Japan Earthquake. Oddly enough such earthshaking events as the loss of the US' AAA rating (which as documented here before led to the terminal break of the stock market), is barely in the top 5, while the "Greek Crisis" and the aftermath that is the European insolvency crisis, whose escalation in our humble opinion was the event of 2011, is relevant to exactly... nobody. And there you have this nation's priorities in a nutshell.
Stratfor Hacked, 200GB Of Emails, Credit Cards Stolen, Client List Released, Includes MF Global, Rockefeller FoundationSubmitted by Tyler Durden on 12/24/2011 - 22:10
This Christmas will not be a happy one for George Friedman (who incidentally was the focus of John Mauldin's latest book promotion email blast) and his Stratfor Global Intelligence service, because as of a few hours ago, hacking collective Anonymous disclosed that not only has it hacked the Stratfor website (since confirmed by Friedman himself), but has also obtained the full client list of over 4000 individuals and corporations, including their credit cards (which supposedly have been used to make $1 million in "donations"), as well as over 200 GB of email correspondence. And since the leaked client list is the who is who of intelligence, and capital management, including such names as Goldman Sachs, the Rockefeller Foundation and, yep, MF Global, we are certain that not only Stratfor and its clients will be waiting with bated breath to see just what additional troves of information are unleashed, but virtually everyone else, in this very sensitive time from a geopolitical point of view. And incidentally, we can't help but notice that Anonymous may have finally ventured into the foreign relations arena. We can only assume, for now, that this is not a formal (or informal) statement of allegiance with any specific ideology as otherwise the wargames in the Straits of Hormuz may soon be very inappropriately named (or halfway so).
Inspired by recent work at the China Economics Seminar, we were shocked at the recent shifts in USDCNY. While all has been calmly proceeding in the right direction from US perspectives with CNY appreciation (though maybe not fast enough for Chuck Schumer's liking), under the surface there is what appears to be a fierce battle between market participants and the PBoC. By breaking down the cumulative shift in USDCNY into intraday 'market/trading' movements (from fixing to close) and interday 'government-assisted' movements (from prior close to fixing), we can draw some perspective on what the market is trying to do and what the government is doing. Evidently from the chart, the outward appearance that CNY appreciation is slowly but surely occurring (the green line) is misleading, the clear signal is a market trading the USD higher (helped by European angst) and a PBoC massively intervening. Incredibly, since the fixings began consistently in Jan 2006, intraday cumulative moves are now exactly ZERO at the close on Friday, with the entire move higher in CNY now accounted for over the past five years by the PBoC's actions. Furthermore, the shifts of the last four months are on a scale we have not seen before making us wonder just how many USD are being sold out of Chinese reserves into the market to stabilize the CNY?
The compare and contrast discussions of Keynes and Hayek have wended their way over the last few years from learned academic texts to YouTube sensationalist rap videos. We have to say we have our preference among those two extremes. However, in a recent interview with Nicholas Wapshott of Reuters, INETeconomics pulls back the veil a little more of the borrow-and-spend short-termist optimism of Keynes versus the 'if it can go wrong, it will' pragmatist pessimism of Hayek. Unfortunately, it seems we are rapidly unlearning a number of the lessons of the eternal optimist - fixing the world right now in favor of solving the underlying problems and furthermore as Wapshott notes, civilization is a lot more fragile than one can imagine. Starting from the perspective that Hayek was engaged by the LSE to take on the establishment Cambridgian, their very different personal experiences of post-war, post-depression life set them looking for solutions from very different perspectives. While their public arguments were seen as ungentlemanly at the time, though published in journals, it became clear that Hayek faced an uphill battle, and perhaps only now, thanks to the collapsing capabilities (or willingness) of governments to borrow-and-spend, are we able to 'mess with the Keynesians'. While avoiding extreme politics and authoritarianism may be a common-sense raison d'etre, the ongoing devaluation wars could perhaps be as capable of pushing the world to these limits as any non-Keynesian solution ever was.
In its "pre-Christmas" note, it is somehow appropriate that Goldman's Jose Ursua reprises the role of Ebenezer Scrooge, and explains how, in this contemporary Christmas Carol, "The world economy is struggling: to begin with. There is no doubt whatever about that" and, logically, gets a visit from the three ghosts of the world's past, present and future. However, while the narrative is similar for the most part to the Carol morality play, where it diverges is in the Hollywood ending: "As in Dickens’ story, avoiding this outcome will require decisive actions. Unlike Ebenezer Scrooge’s overnight redemption, however, we believe the solution to the current global problems will potentially take much longer. So, although some steps are clearly visible in the right direction, the post-holiday environment will likely continue to be challenging for both policymakers and markets alike." And that's only for the macro; the "micro", as Morgan Stanley explained yesterday, is already slipping regardless of how long the US pretends that Europe is irrelevant for the big picture. The only question is whether the macro follows suit (which in Morgan Stanley's case was left as the optimistic case with full resolution), in which case the ghost of the coming "Great Stagnation" will be one scary dude.
As was reported yesterday, Iran has now officially commenced its 10 day wargame exercise in the Straits of Hormuz. What happens next is 10 days in which one false move, either planned or false flagged, can have some serious (if required by the status quo) consequences: after all WTI is at $100, and the ECB has quietly "printed" $700 billion in the past 6 months, with the Fed not far behind - there has to be some implicit backstop to keep crude from soaring once it becomes clear that print mode is on, and the only way that can happen is the "possibility" of expanded oil supply through control of the main supply channels. From Reuters: "Iran began 10 days of naval exercises in the Strait of Hormuz on Saturday, raising concern about a possible closure of the world's most strategic oil transit channel in the event of any outbreak of military conflict between Tehran and the West. The military drill, dubbed "Velayat-e 90", comes as the tension between the West and Iran is escalating over the Islamic state's nuclear programme. Iranian authorities have given no indication the strait will be closed during the exercise, and it has not been shut during previous drills. "Displaying Iran's defensive and deterrent power as well as relaying a message of peace and friendship in the Strait of Hormuz and the free waters are the main objectives of the drill," Sayyari said. "It will also display the country's power to control the region as well as testing new missiles, torpedoes and weapons."
One of the problems with economic crises is that mainstream economists and financial advisors either don’t see them coming or simply won’t admit to them. That’s exactly what happened in the fall of 2008, when the financial crisis kicked off in the United States. Since that time, governments have continued to spend, all while production has slowed and unemployment has skyrocketed. As we enter the fourth year of the post-crisis environment, there is no sign of growth that is impressive enough to get us out of the negative feedback loop in which governments have continued to operate. A negative feedback loop takes hold when massive government debt loads, a weakening financial system and a slowing economy feed off each other, interrupted by Federal Reserve and other central bank reflationary attempts. As shown in the chart below, rising debts become unsustainable and trigger austerity measures designed to reduce spending and/or increase taxes or other revenue sources to try and reduce debt. The more production and employment falter, the more lending contracts, causing further harm to the economy, missed budgets and higher bond yields. The result is a downward spiral of business and financial activity and a banking crisis usually ensues. Under pressure to stimulate the market, the Federal Reserve and other central banks carryout band aid fixes by printing money and governments implement additional austerity measures which starts the vicious cycle of the feedback loop all over again. The fix needs to come from a unified front, not just a single country or continent. When we look at the three global pillars of the world economy — the United States, Europe and China — sure, each has its own problems, but each one’s fiscal choices impact the globe as a whole. And really, it’s four pillars when we add the Federal Reserve. We are a four-legged intertwined economic and financial system that relies heavily on each other for banking resources, government debt issuance, investments and exports. The feedback loops are never ending. And when economic growth stalls, debt accumulation increases. Without taking tough, systemic and coordinated economic measures including fiscal consolidation and a commitment by governments to cut rising deficits and reduce what are, in some cases, dangerous levels of national indebtedness, a second crisis may indeed be inevitable. The world is trying to recover from the worst financial crisis in 70-years and is suffering from debts levels not seen in decades and the crisis continues to intensify. And, as the graph below shows, with the exception of Ireland, countries need just as much, if not more, financing to cover debts in 2011 compared to 2010. Nothing has changed.
Every time series of prices reflects the ongoing valuation of worldviews in a collective sense. These prices can be used to generate a probability distribution that reflects that worldview. Is it best to buy the tails that reflect extreme events, or to be long the center, where the majority of views dominate? Buying the tails is a barbell. Buying the center is well, a center bet. Which is best? Here is an approximate answer from contemporary history. Center bets beat barbells pretty consistently. BB (XOver proxy) all beat other comers, followed by BBB (HiVol proxy), CCC (proxy for distressed debt), then AAA from 2010-2011. What you get with AAA is low volatility offered by stable liquidity features and cashflow performance. What you get with CCC gives you huge volatility to be exploited by trading. The center, true to the intuition behind it, offers better credit risk profile than distressed debt plus lower liquidity than AAA debt.
Take all you know about the formation of equity prices... and throw it out of the window, at least according to the following paper out of (fittingly Austrian) Erste Group, which applies Austrian theory to stock "valuation", by looking at a world in which the only determining factor for "fair value" is credit money creation. Indeed, the 2011 market, in which cross-asset correlations broke all records, and in which fundamentals were cremated once and for all, showed that the only thing that matters is who prints first, and more importantly, who frontruns said printing (it also means that most hedge fund analysts will soon be redundant). Here is Erste with a slightly less jaded view: "We come to the conclusion that it makes sense for equity investors to track monetary and, especially, debt developments closely. We believe that the changing dynamics of monetary as well as debt aggregates are often a good leading indicator for equity markets. Historic data shows that accelerating money and credit growth drives equity prices, while decelerating growth in the money and credit supply generally puts pressure on equity prices...Financial history shows that equity markets are ‘addicted’ to new money and credit creation. To keep rallies going, the equity markets need ever more fuel (faster rate of change in the money and credit supply). As soon as the rate of change is negative (decelerating money and credit supply) markets tend to become sluggish and lose momentum, even though in absolute terms the money and credit supply is still rising." And while this is not telling Zero Hedge regulars something they didn't know already, with the fiscal pathway of creating new money blocked in a (mock) austere world, the only other way to generate M1-X is by printing. Summary - much more currency debasement and devaluation ahead, only this time with a $100 base in WTI. Which most certainly means that very soon the world will need to find an extended source of cheap energy (read oil). And everyone knows what that will be...
Morgan Stanley On Why 2012 Will Be The "Payback" For Three Years Of "Miracles" And A US Earnings RecessionSubmitted by Tyler Durden on 12/23/2011 - 16:26
Yesterday, we breached the topic of the real decoupling that is going on: that between the macro and the micro (not some ridiculous geographic distribution of the US versus the world), by presenting David Rosenberg's thoughts on why Q4 GDP has peaked and why going forward it is energy prices that are likely to be a far greater drag on incremental growth than the preservation (not the addition as it is not incremental) of $10 per week in payroll taxes (which only affects those who are already employed), even as company earnings and profit margins have likely peaked. Today, following up on why the micro is about to return with a bang, and why fundamentals are about to become front and center all over again, albeit not in a good way, is, surprisingly, Morgan Stanley's Mike Wilson, who has issued his loudest warning again bleary eyed optimism for the next year: "Think of 2012 as the “payback” year….when many of the extraordinary things that happened over the past 3 years go in reverse. I am talking about incremental fiscal stimulus, a weaker US dollar, positive labor productivity, and accelerated capital spending." Said otherwise, 2012 is the year when everything that can go wrong in the micro arena, will go wrong. And this is why Morgan Stanley being bullish on the macro picture! As Wilson says, his pessimistic musing "tells the story for what to expect in 2012 assuming the situation in Europe doesn’t implode. In other words, this is not the macro bear case." If one adds a full blown European collapse to the mix, then the perfect storm of a macro and micro recoupling in a deleveraging vortex will prove everyone who believes that 2012 will be merely a groundhog year (in same including us) fatally wrong.