Archive - Dec 14, 2009

There has been much conjecture on whether using CDS is an effective way to hedge against US default risk. Many theoreticians, especially those of the post-March lows variety, have sprung up and are speculating that buying Credit Default Swaps on the US is ultimately a futile and pointless endeavor. The main argument: a US default would likely mean that interconnected dealers won't recognize contracts on a US default event, as they themselves will be out of business. Even if they continued to exist, like cockroaches in a postapocalyptic world, the collateral which backs derivatives is mostly US Treasurys: the same obligations that would end up being massively impaired. Furthermore, even though US CDS try to isolate currency risk by being euro denominated, a somewhat gradual collapse into default would make the dollar lose its value, which would make premium payments in euros untenable for the protection buyer. Then again, regardless of theoretical considerations, in a world fleeing from any risk, it is precisely US CDS where everyone would be rushing to: just recall the 100bps US CDS wides reached in March.

Spreads tightened notably today with HY outperforming IG and credit outperforming equity as Abu Dhabi's hail-mary provided support for the bulls systemically on a slow econ data day. Breadth was very positive with winners far outpacing wideners on the day as FINLs outperformed non-FINLs in credit-land but underperformed in equities.

Paul Samuelson may have been a brilliant man, but he was the problem, not the solution. We can trace many of our current problems to his "scientific" econometric technocracy.

As Europe continues shouldering the burden of the devaluing dollar, courtesy of a Euro that just wont quit, even as the Eurozone is constantly putting out fires in its own backyard (Greece, Hypo, Latvia, ongoing downgrades), the optimism over European prospects is now more pervasive than ever. In a report titled "Key Surprises for 2010" Morgan Stanley's ever insightful Teun Draaisma has attempted to present the intangibles: the unquantifiable risks. As he points out "if there is a lesson the markets keep telling us, it is the persistence of uncertainty. Unlike risks, which are known and measurable, uncertainty is difficult to calibrate. We can never know the exact payoff distribution for any given investment." In order to conceptualize the 4 key areas of possible systematic impact, the strategist has provided 4 main scenarios he believes may shape equity returns over the coming year in a downside case.

While certainly a "slight" improvement from last week's ratio of 82 sales for every buy (in dollar value), this week we see a reversion back to the recent mean of about 30x, or a 32.4x ratio of insider selling to buying, to be specific. In the last week insiders sold $332.7 million worth of stock and bought $10.2 million. The recession continues being over.

Six months ago, Bill Ackman's Pershing Square came out with a research piece called "The Buck's Rebound Begins Here" in which he concluded a fair equiy value for bankrupt REIT General Growth Properties is between $10.40 and $30.08 per share. While since May the liquidity bubble has lifted all dodgy commercial REITs to unbelievable valuations, courtesy of round upon round of diluting capital raises, GGP being among them, the question of whether the tide has moved too far too fast is once again relevant, both for the broader REIT segment as well as for GGP in particular. Today we present the opposite view courtesy of Hovde Capital Advisors, and their report "General Growth Properties - Fool's Gold: We Think Current Equity Investors Will Be Disappointed in the Company’s Reorganization."

A quant fund voicing against the proposed transaction tax is hardly surprising. We expect many more letters from Asness' colleagues at GETCO, RenTec and all other HFT venues whose livelihood depends on strictly continuing the status quo. We eagerly expect a follow on essay in which Mr. Asness discusses the pro and cons of High Frequency Trading.

Should Congress and the President find enough appeal in HR 4191 to enact it, there are
three possible outcomes. The first is that there are enough loopholes that the tax raises
little money but has unfortunate side effects like driving jobs and tax revenues overseas
or inflating the balance sheets of banks. The second is that there are no meaningful
loopholes but, surprisingly, people still trade a lot and enormous taxes are paid, in which
case we expect stock prices to fall dramatically. The third, and most likely, is that there
aren’t enough exemptions and investors react by sharply reducing trading activity, so
there is little revenue but great harm to the market and the economy. Whichever of these
occurs, the sponsors of the Bill will face a hard time explaining how, when aiming to
shoot the banks, they shot their constituents who will then pay for the next Wall Street
bailout. - Cliff Asness

A 20 year chart comparing oil with railcar loadings may have something to say about either the mispricing of the commodity or provide some insight into Buffett's thinking on his long-term interest in rail. Granted, he started buying rails at or about the market peak so it is unlikely that the Omaha recipient of governmental generosity has this particular correlation in mind, however, it is oddly striking that while in the past the two trendlines have had a very distinct pattern, ever since the pop in the commodity bubble and the collapse of America into a recession the two have converged. On the other hand, as oil prices are driven purely by speculation and reflect very little of fundamental supply/demand metrics, and thus reflect nothing but excess liquidity, this particular convergence may persist for as long as Bernanke deems it relevant.

With most fund managers having packed it in for the year, not a lot of players to drive the tape. However, a pitched battle is forming between those wishing to push stocks up and defer gains into 2010 and those who cashed out early and are ready to short. Who is going to win?

If you needed a reason to buy today's deja vu listless and volumeless tape, here it is. Mexico cut by S&P from BBB+/A-2 to BBB/A-3. Outlook is "stable"... absent a hyperinflationary collapse. Expect a rebuttal from Goldman Sachs, which has been axed the wrong way for quite a while.

Strange bedfellows ...

Natural gas has become an almost forgotten commodity with poor market fundamentals keeping a lid on the price. But the fuel is not forgotten by Exxon Mobil (XOM). Exxon just announced this morning that it will buy XTO Energy (XTO) in an all-stock deal worth $31 billion as the oil giant moved aggressively towards the abundant unconventional natural gas source at home.

Heretic! Heretic!

"The intensifying economic and solvency crises, and the responses to both by the U.S. government and the Federal Reserve in the last two years, have exacerbated the government's solvency issues and moved forward my timing estimation for the hyperinflation to the next five years, from the 2010 to 2018 timing range estimated in the prior report. The U.S. government and Federal Reserve already have committed the system to this course through the easy politics of a bottomless pocketbook, the servicing of big-moneyed special interests, gross mismanagement, and a deliberate and ongoing effort to debase the U.S. currency. Accordingly, risks are particularly high of the hyperinflation crisis breaking within the next year." - John Williams, ShadowStats