Archive - Dec 17, 2010

As Zero Hedge had been claiming for about two weeks now, with volatility in stocks virtually gone due to the fact that nobody trades a market that is nothing more than a policy tool, those chasing vol have had to shift elsewhere, namely FX (the vertigo-inducing EURUSD is one example) and, surprisingly, treasuries. As we speculated, the fact that the world's most "liquid" market can experience 6 sigma shifts in the 2s5s10s butterfly in the span of days (more on that later), is indicative of something very bad developing under the surface. We have a feeling that should stocks continue to be shunned as they have been, and as the MOVE index continues to creep higher, the likelihood of some major wipe out is imminent. It seems that the CME has finally agreed with our line of thinking. Late last night, the CME hiked its margin requirements across pretty much all asset classes. The different options and futures involved in this drastic action were everything from natty, to copper (cough Blythe cough), to palladium, to silver. But most notably the CME both new initial and new maintenance margins on 5,7, 10 and 30 Year IR Swaps, 5,7, 10 and 30 Year Bond Futs, and, of all thing, the 30 Day Fed Fund Futures. If it has gotten so bad that the exchange has to regulate the vol in Fed Funds (the indicator of future inflation), then certainly one or more wheels are about to fall off. As to whether this action will have its typical impact of warding of shorting is unclear. We believe it will merely make fails to delivery increase substantially.

• 2010 in Review (BusinessWeek)
• Ron Paul Appears Poised to Irk the Fed Chief (NYT)
• EMU’s Critics Will Eat Their Words Again (by Klaus Regling, Chief Executive of the European Financial Stability Facility (FT)
• EU Leaders Create Debt-Management Mechanism From 2013 (Bloomberg)
• PBOC's Zhou Indicates Global Turbulence Is Delaying Chinese Move on Rates (Bloomberg)
• Bailout Deal Fails to Quell EU Rifts (WSJ)
• Bullishness now at disturbingly high levels (MarketWatch)
• Banks Urged to Use Profits as a Buffer (FT)

There is going to be a showdown next week at Kananaskis...

As there is very little trading volume in general these days, and far less non-robotic trading volume, today's trading will likely be defined almost exclusively by Wall Street's option trading brigade. As it is option expiration day, we expect a very rigorous attempt to take out all the pins where the open interest is highest. And courtesy of Sentiment Trader, we could be in for a doozy. Based on his Equity Hedging index, we are at an all time low in terms of his just created proprietary Hedging Activity index. Which means that a record number of people are currently unhedged. Couple this with rumors of one of the highest open interests in existence, and it may get ugly soon. As for forecastability of what this means in terms of returns, it's not pretty: "When the EHI dropped below 20, during the next three months the maximum gain in the S&P 500 averaged +2.5% while the maximum decline averaged -5.9%.  Each time, any short-term upside progress was erased during a swift corrective period at best." Then again, in a bizarro market entirely dominated by the Fed's telegraphing of its equity purchase decisions, we are fairly confident that the predictive prowess of any existing indicator is largely in doubt at a time when none of the traditional market dynamics are even close to being relevant. 

Who would have thought that all it takes to be removed from that holiest of holys, the Goldman conviction buy list is a simple 12% plunge in the stock? Yet after yesterday's Fed decision on debit card interchange fees, Goldman analyst Julio C. Quinteros Jr. has validated precisely this thesis. And for all those who think being on the CL with a Buy rating does much if anything for one's stock, here is the kicker: "Since adding V to the Conviction List on July 9, 2010, the shares are down 13.2% vs. +15% for the S&P 500 (-22.8% and +12.1% over 12 months)." But luckily for those who suffered substantial losses yesterday, little else has changed: "We make no changes to our estimates or price target"... of $93/share. One wonders what happens to the other 50 some Conviction Buy companies (and one sell) should the reality of the massively stimulus-funded rally be exposed. That said, the ZH basket of shorting the firm's conviction buys, and long the conviction sell, proposed a few days back, is working out quite nicely so far.

I tend to harvest the internet for interesting stories on Apple as it has become such a bell weather for the capital markets. On a German forum I found the interesting case of Balda which I thought might be of interest.

Goldman, very much in sticking with their newly found fame of Wall Street's biggest bullish flipflopper, has decided to pen a lengthy missive, explaining why the recent surge in mortgage rates, contrary to logic, will actually not have much if any impact on housing prices. The kicker: per Goldman, rising equities creates a wealth effect. "Equity prices are moving the other way. One key reason why US consumers retrenched in 2008, besides the unpleasant novelty of widespread, steep home price declines, is that equity prices were also falling sharply. However, equity prices have risen more than 20% since mid-year, and our equity strategists expect significant additional appreciation in 2011. Under these circumstances, the bar for a home-price-induced consumer pullback is fairly high." Presumably the very same middle class which is the backbone of home purchasing will somehow forget that they have taken money out of stocks for 32 weeks, and splurge on a new home with the proceeds. And the funny thing is that even the dumb plebs realize that a 1% rise in rates is the equivalent of a 9-10% drop in purchasing power, as that is money that will go to covering interest payments over the 30 year life of a mortgage. And should rates continue rising without any indication of stoppage, all buyers will have to factor the fact that sellers are increasingly more desperate into their purchasing decisions... Which means another leg down in bids. But that is the logical, and simple, explanation. For a much longer one, which could have come straight from some Federal Reserve research desk, read the profound ruminations by Ed McKelvey below.

And like that, just before midnight, Congress, despite much protesting and posturing, passed the tax vote by a massive margin. 277 voted for with just 148 against. Now the tax extension faces the final formality of passing Obama's signature. The upside: no new taxes; the downside anywhere between $800 billion and $5 trillion in incremental debt to fund this latest stimulus which will only work if all the Wall Street sellside analysts who pushed for it so hard, are right. Given Wall Street's prediction track record we have "100% confidence" they will be spot on as usual.