Archive - Jul 21, 2010

Bill Miller says: "U.S. large capitalization stocks represent a once in a lifetime opportunity in my opinion to buy the best quality companies in the world at bargain prices. The last time they were this cheap relative to bonds was 1951." That's funny, because according to our regression analysis (recreated below), the fair value of stocks is 750. But who needs facts when you have propaganda and a massively underwater stock position to offload. Bill Miller's desperation letter to sucker mom and pops in buying his dangling tech holdings can be found below, but here is a quick refutation of his point, which we discussed as recently as three weeks ago. And just in case there is any confusion, the dividend yield on the S&P compared to that of 10 Year Bonds, implies a fair value for the S&P of... 655! Perhaps Bill was experiencing a "Warren Buffett" moment and actually meant stocks are a once in a lifetime opportunity to short?

A week ago we published a guest post from David Galland of Casey's Daily Dispatch in which Galland presented his view on what the consequences of the upcoming introduction of a 1099-filing requirement for gold transactions over $600 would be. "Can’t a person just keep their gold purchases under $600? With the price
of gold heading higher, that will increasingly require buying
smaller-denomination bullion coins – which typically carry a higher
premium. More importantly, a large body of case law gives the government
license to charge people for “structuring” – i.e., taking active
measures to get around a particular law. Thus, two $500 gold purchases
could be construed as active evasion and carry additional penalties." The topic is suddenly red hot once again, this time with ABC finally getting on the bandwagon. 

Another rogue algo takes matters into its own binary hands. Time to institute circuit breakers for the tiny FX market, which alone celebrated Obama's latest set of oratory delight by flash crashing all on its lonesome...

RANsquawk US Afternoon Briefing - Stocks, Bonds, FX etc. – 21/07/10

Barack Obama: "No more taxpayer funded bailouts of Wall Street Institutions"

Reuters: "Increased housing
commitments swelled U.S. taxpayers' total support for the
financial system by $700 billion in the past year to around
$3.7 trillion, a government watchdog said on Wednesday."

We are happy to know that the government's support of bankrupt Fannie and Freddie ends today, as per Obama's promise to the entire nation.

Even as Bernanke is receiving his last minute briefing on what to say (everything, EVERYTHING, is good) and what to play dumb on (explaining the price of gold for example), a new report by the Center for Economic and Policy Research concludes that digging ourselves out of the current unemployment hole which is 7.5 million less people having jobs than did in December 2007, will take at least 4 years, and not occur prior to March 2014. However, this assumes a flat working-age population, something the Fed would love to be the case. Alas, the country is growing: and if one incorporates the effects of labor force growth into the above analysis, as the CEPR authors have done using CBO projections, then we may have a much larger problem on our hands: the study concludes that taking into account the approximately 14 million new job seekers in the future, then the December 2007 unemployment rate will not be met until April 2021! Welcome to the new normal. Of course, both of these analyses assume that the economy will immediately commence growing and generating jobs at the recovery rate seen in the 2000s, when about 166,000 jobs per month were being added. With every month that this does not happen the 2021 date will continue being pushed out further into the future. Perhaps one of the Senators today can ask a question of Bernanke just how he plans on reconciling this glaringly simple explanation for why the US economy will be underwater for a period of over a decade.

BN   7:52 *MORGAN STANLEY SMITH BARNEY HAD SET 15% MARGIN GOAL FOR 2010
BN   7:52 *MORGAN STANLEY'S PORAT SAYS `FLASH CRASH' SCARED AWAY INVESTORS
BN   7:52 *MORGAN STANLEY CFO PORAT SPEAKS IN INTERVIEW ON PROFIT GOALS
BN   7:52 *MORGAN STANLEY TO MISS BROKERAGE PROFIT-MARGIN GOAL, PORAT SAYS

Luckily the SEC is all over restoring investor confidence in the market... of hard core internet porn.

Earlier today Germany announced the "successful" placement of €3.195 billion in 30 Year bonds at a 3.33% Yield and a glowing 1.2 Bid To Cover.... Only if one were to take out the €805 million retained by the Bundesbank as so often happens these days, the auction was really undersubscribed. As the government sought to place €4 billion and received just €3.764 billion in total bids (of which €2.691 billion were in competitive bids and just €1.073 billion were non-competitive), there is no other way to classify the auction than a failure. And with the 'allotted at high' (or low price) coming in at 95%, there was certainly less than an enthusiastic reception for this latest auction which sported a coupon of 3.25%, the lowest coupon ever for a long-dated eurozone bond.

The sudden bout of market weakness has been attributed to a large ES Put order in the process of being executed. We will keep an eye out on the most active options and confirm if and when this hits the tape. Indeed the tape so far does show a preponderance of various Puts (top 6 contracts by volume are all bearish) with the 700 strikes showing up consistently, as someone continues to put on major bets on a large swoon in the market.

In yet another confirmation that the only sure way to make money in the current market is to bet against Goldman's sellside research is the revelation (indeed, reminder) that the primary cause of the firm's now well-known Q2 trading loss, namely the bet that volatility would decline, is precisely what its Top Recommended Trade for 2010 was. During yesterday conference call, David Viniar disclosed that "as a result of meeting franchise client and broader market needs, we had a short equity volatility position going into the quarter. Given the spikes in volatility that occurred during the quarter, equity derivatives posted poor quarterly results." Ironically, on December 2, 2009, as part of its report "Exciting... with Risks" which we previously disclosed, the firm came out with its Top 8 Recommended Trades for 2010, the first of which was the following: "Short S&P 500 Dec10/Dec11 Forward Starting Variance Swap, at 28.20, Target 21. At current levels, forward variance suggests that the coming years will be as volatile as 2009. But this year was the eighth most volatile year on record, and our recent work on the 2004-template—and our models linking macro outcomes to volatility—suggests that even in a sluggish recovery, volatility can continue to decline. While near dated volatilities remain only moderately elevated, the upward-sloping term structure has kept forward variance higher—and well above where it ‘belongs’." In other words, Goldman recommended selling vol, yet it only did so as a flow counterbet after a customer did precisely the opposite of what Goldman was pitching.

There was massive selling in Calls all the way up yesterday by funds and bullion Dealers. Translation: the funds are ”Trapped longs” and the bullion dealers know it. Technical traders understand this best. Essentially there are out-of-the-money futures and options spec longs who are running out of patience. Every rally will be met with selling by them. This does not mean we will not go up. It just means that it should be orderly, with a washout when whoever is buying is done. Yesterdays’ rally seemed to be a dollar weaker/ commodity stronger based impulse. So perhaps the inflation trade is stepping in here a little. For me, that means orderly movement in a rally as well, as opposed to deflationary crisis. The key is open interest. If OI decreases in the rally, I would not buy strength. In fact, I’d go so far to say that with trapped longs and expiry approaching, this market will be between 1190 and 1210, 7 days from now. Book that bet.

• E.U. Test May Need to Fail Some Banks (NYT)
• BOE's Posen: More Bond Buys the Most Likely Next Move (WSJ)
• Vince Reinhart: Setting the table for fiscal restraint (American)
• The View From Bernanke's Perch at the Fed (WSJ)
• Fed in Hot Seat Again on Economic Stimulus (NYT)
• Krugman versus Ferguson: round two (Telegraph)
• European Bank Stress Tests Said to Describe Three Scenarios (Bloomberg)
• Derivatives reform to punish property industry (FT)
• Double dip in the baltic (Telegraph)

Tempt me all you want, you seductive vixen. A weak summer rally in a bear market, something to be avoided like the clap. Change your slumming ways, and I might take a second look. A surreptitious visit to the local free clinic might help too.

A useful presentation for all those who continue to be bullish despite that fact that the double dip has officially begun. In one of the better compendiums of bearish data, oddly enough coming from Goldman's Jan Hatzius, the chief economist summarizes all the adverse trends that continue to not be priced into stocks. He notes that while the inventory cycle has boosted growth, this artificial rise is now losing steam. Key headwinds facing the economy are that fiscal policy, which has been expansionary, has now become to restrictive; that there has been no overshoot in layoffs for a mean reversion expectation; that the labor market multiplier is very much limited; that while capital spending is just modestly above replacement levels, the large output gap suggests spending should be subdued; the housing overhang is still huge and house prices have further to fall; that there are risks to US from European crisis; that inflation is dropping (and non-existent) even as utilization is low everywhere, which creates a major deflation risk; that the scary budget deficit will destroy any hope for future fiscal stimulus as public debt is surging out of control; lastly, with Taylor-implied Fed rates expected to be negative, the Fed's monetary policy arsenal is non-existent. All this in 18 pretty charts.

As widely speculated previously on the pages of this blog, the SNB confirmed earlier it has lost billions of euros due to currency speculation in attempting to keep the CHF low. As the FT reports: "The Swiss National Bank on Wednesday revealed the cost of its massive foreign exchange interventions to restrain the value of the franc, with losses of more than SFr14bn ($13.3bn, €10.4bn) in the first half of this year." Following such a massive losses for the small country (nearly 2% of GDP) it was only a matter of time before the other 26 Swiss cantons, which share in the profits and losses of the SNB, said enough. "The SNB said last month it had stopped intervention. Its official reason was because deflationary risks from the surging currency had declined, but most economists ascribed the move to growing concerns about the risks from the massive foreign currency holdings." Yet it appears Switzerland has its gold holdings to thank for keeping the loss manageable, and why, at least the SNB, will not allow a quick depreciation in the price of gold, for as long as the EURCHF continues to be at these low levels: " the central bank was, as in the past, a significant beneficiary of the
surging gold price, allowing it to take big paper profits from revaluing
its large bullion holdings. The rising gold price allowed the SNB to
“hold the loss within certain limits”, it said in a short statement." Elsewhere, we read that the Swiss economy is being aggressively liquefied with both M3 (up 7.7%) and loan issuance (up 4.4%) surging in June.