Archive - Feb 2010

Are exogenous events on the real economy about to bring a round 2 of the eurodollar short squeeze, and will the newly-instituted USD-funded carry trade amplify the effects of the unwind?

5.7% GDP growth for Q4 2009 is a phantom. Understand that a normal part of the business cycle is to replenish shelves when retailers realize that 90% (or 84%, depending on what you believe) of Americans are working and buy some stuff. But the fundamentals are still bad. It's just the foam off the stimulus brew.

James Bullard,president of the Federal Reserve Bank of St Louis, told the FT that the US has escaped the danger of a Japanese-style deflationary trap. He may be right, for now...

Just another good news story. The Feds are doing the right thing on loan mods. They will be accelerating the process. The unintended consequence will be that defaults and foreclosures will have to rise. When? About 5 months from now.

Many people have expressed a concern that because gold and the dollar are closely correlated, the recent surge in the DXY will imminently cause a major crash in the price of gold, as gold is no longer seen as a risk haven to dollar devaluation. While that may ultimately be the case, a simple observation of gold and DXY price levels indicates that while the dollar has retraced losses stretching all the way back to August 2009, gold is merely at levels first seen in November (and again in December and January). We should also note that silver is once again, at least on a relative basis, when compared to gold, looking cheap. The ratio of gold to silver prices is now back to levels last seen in August. A long silver-short gold pair trade may be an interesting option for those who, like LTCM, believe in spread compression.

A peculiar side-effect of the current low-volume rise market dynamic can be seen by the curious price (and volume) action in investing public darling Google. When the market was climbing in the low volume days since November, the stock grew from $531 to a peak of $626 in 42 days, on average volume of 2.02 million shares per day. Then, when the selling started, the volume picked up by more than 100%, with daily average volume of 4.7 million shares, while the decline in the stock to the onset price of $531 took less than half the time, or 19 days. Such are the vagaries of the VWAP unwind, as algorithms seek to reverse to a longer and longer mean. Google demonstrates very accurately what would happen to the stock market should there be a real, exogenous selling catalyst. Now consider that the S&P's VWAP since the March lows is around the 950 level. If the market is unable to sustain the most recent relief rally, and if this is coupled with geopolitical news or a default the PIIGS or some other unpredictable event, expect a very prompt but highly doable correction. If the market volume doubled and the time of decline was cut in half relative to the rise, consider what would happen if all mutual funds suddenly switched from a buying to a selling posture... And what this would mean for the final closing level on the S&P of that particular D-Day.

Did Societe Generale ever view its $1.2 billion investment in Adirondack 2005-2 as a buy-and-hold proposition? Or was the bank's original intention to offload the risk on to AIG? The answer is central to our understanding of the portfolio of collateralized debt obligations, or CDOs, that wiped out the insurance behemoth. The circumstances of SG's, and other banks', holdings, suggest that CDO market was a Potemkin's Village, a facade constructed to give the illusion of economic substance to a series of sham transactions.

We have previously speculated extensively on the recent appearance of direct bidders as a key participant in Treasury auctions. What is known is that the direct take down during the last 2-3 months has at least doubled for most coupon auctions up to and including the 7 year. What is not known is/are the identities of the bidder(s). We have provided some observations on the topic previously (here and here) although our preliminary conclusions are based on circumstantial evidence at best. Additionally, we have highlighted that even as direct bidding take downs have increased, bid-to-cover ratios have reached near record highs, which in itself is also paradoxical and the only immediate explanation is that this is simply a confirmation of Say's law, as this phenomenon certainly does not fit the normal supply/demand pattern.

Our obsession with the direct bidder conundrum is easily explainable as this is a new and very critical presence in the treasury bidding process. The last thing primary dealers need is a source of volatility in the auction process, which could potentially have destabilizing consequences on this most critical cog in funding America's future record deficits. Today, Daniel Kruger at Bloomberg picks up on the topic and thrusts it front and center into the public spotlight, his analysis further confirming our concerns.

The Middle East peace talks are at a deadlock. Negotiations between Israel and the Palestinians to move ahead with the plan established by the so-called Quartet – the US., U.N., EU and Russia -- have faltered and come to a complete standstill. Continuing with this inertia will have a long-term negative effect on the future of the region both from a political point of view as well as from a business perspective. With the exception of a few risk-takers, what company or business executive would be willing to invest in the Middle East once the region plunges onto the abyss amid renewed violence?

And whenever trouble brews in the Middle East it tends to spill over into other parts of the world. The risk that Mideast violence could spread to nearby Europe might have been one of the reasons that pushed Italian Prime Minister Silvio Berlusconi to say that Israel should be admitted into the European Union earlier this week. Berlusconi made the statement during an official state visit to Israel. Berlusconi, of course, is one of Israel’s strongest supporters.

Sovereign risk was once again front and center on the minds of investors today. Despite the EU's efforts to 'back' Greece's cost cutting plans, investors remain far less sanguine than Almunia. Greek bonds managed a small 7bps rally relative to Bunds (which widened 2bps) as CDS were around 9bps wider (compressing the basis a little more). Don't read too much into the small rally in bonds (the basis remains wide at 55-60bps and we suspect given the convergence today that some are putting the trade on).

Spreads were mixed in the US with IG unch, HVOL wider, ExHVOL weaker, and HY rallying. IG trades 1.5bps wide (cheap) to its 50d moving average, which is a Z-Score of 0.2s.d.. At 92.25bps, IG has closed tighter on 30 days in the last 282 trading days (JAN09). The last five days have seen IG flat to its 50d moving average.

Did some Goldman trader have a huge house party bash last night and as a result half of Wall Street did not report to work today. Starting around 10 am today, it appears everyone took one long Starbucks break and never looked back. It is amazing the Dow didn't hit the proverbial 36k.

Earlier we presented a Bloomberg op-ed by an increasingly pessimistic Mohamed El-Erian. For those too lazy to read it, we recommend the following 4 minute interview by Bloomberg's Tom Keene of the Pimco skeptic. In a response to what policy recommendation El-Erian would suggest, the humble ex-Havard endowment head(who sure got out when the getting was good) who prefaces his response by saying he is not smart enough to propose policy (so who is - Tim Geithner?), says America should expect a bumpy journey as the economy resets "There is no silver bullet." Those mid-term elections are looking uglier by the minute.

Now that American equity markets are controlled by Atari and Commodore, which in turn means stocks go up or down purely based on nanosecond colo lag variations, investors who wish to invest in stocks based on this crazy thing called fundamentals are forced to look elsewhere. One such place could be Europe, and now that the Baltic states, Greece, Portugal, Spain, Iceland and Ireland are literally living on an IMF's prayer, the first market which will take a big leg down will in all likelihood be Europe. Starting with that bearish assumption, we present several ideas out of Morgan Stanley's "Sellers' Compendium February 2010" by Ronan Carr. As the title of the report indicates, Europe bulls may want to skip this post. For everyone else, let's dig in.

Not much happening in the equity markets today, other than the huge roller coaster ride in Toyota shares, as this gangster "LaHood" attempted to smash the company's shares. Meanwhile, investors today were de-risking and fleeing to the safety of the dollar and REIT stocks today.

Last October the BLS announced it would revise historical payrolls lower by 824,000 on February 5 (this Friday's NFP release). While this number will not impact the actual January NFP report (a loss of nearly one million jobs in a month would probably even take out the persistent SPY algo that has been hugging the bid for the past 10 months), it will be prorated across all months in the 2008-2009 reporting period. The reason for this adjustment has to do with a huge glitch in the birth-death model, which is exactly the same problem that the rating agencies faced when housing prices plummeted : the birth/death model assumes, in the long-run, jobs are created, not destroyed. Any period of excess volatility in the stock market therefore translates into major prior downward revisions to already disclosed payrolls. And while we know what the current revision will be, the scarier prospect is that the next historical adjustment, due out in early 2011, will be even larger, at least 990,000. This means that the government has overrepresented running payroll data by over 1.8 million jobs over the past 20 months.