Archive - Sep 17, 2010

This is the final part of two parts of "The Economics of Mass Destruction." I examine the fallout of globalization of bad economics. At the end there is a link to a PDF of the entire article that you may download.

BNY's Nicholas Colas is once again delightfully insightful with an explanation for the "cash on the sidelines" phenomenon so simple, and so elegant, no wonder it has eluded all the neosophists on CNBC for so long. "One of the lingering questions about U.S. equities remains the conundrum of “cheap” price earnings valuations on so many high quality stocks. Perhaps estimates are too high, but after several quarters of generally in-line-or-better earnings reports, that doesn’t seem to be the worry (at least for now). We think the DuPont model, an old (ancient, really) financial analysis model highlights why multiples are as low as they are. Problem #1 – cost cutting only takes you part of the way to maximizing shareholder returns in a cyclical downturn. Problem #2 – investors need to see a resumption of corporate investment growth to allow valuations to return to more normal, long term levels." Perhaps, in a wholesale revulsion to the Frankenstein monsters of modernity, starting with a thoroughly roboticized market, and quadrillions in capital flows each year in the form of electrons, investors have subconsciously reverted to the simple days of yore, in investing analysis as well as in everything else...

Continuing the analysis of today's Z.1 report, we next focus on recent developments in the shadow banking system. And it's a bloodbath: total shadow bank liabilities dropped by $680 billion in Q2, and a massive $2.1 trillion YTD. If one wonders why Ben Bernanke (yes, it's technically TurboTim) continues to print trillions and trillions of debt, and it is still doing nothing (yet) to stimulate the system, here is your answer.

Last week the government released the latest unemployment data. Bloomberg, always ready to roll up the sleeves to help its friends in government (get reelected), was running a headline that “Companies in U.S. Added 67,000 Jobs in August.” While I haven’t had time to go through the minutiae of the report, I find myself scratching my head at Mr. Market’s rather positive reaction to the report, given the bullet points...

A brief word on stocks: Ever since the VIX posted a reversal outside the lower Bollinger band I am very cautious and bearish on stocks. We tested this morning the key upside level in S&P and so far rejected it. I have included the chart of the Nasdaq here to show that a weak trading session Monday would complete an evening star on important levels. The Shanghai composite is also sitting on a the 50- and 100- DMA ad a break would be very bearish. So I stick to my bearishness and will look for a break of 1,105 in S&P futures to confirm downside acceleration. - Nic Lenoir

A continuation of recent strength in Aussie Dollar / US Dollar (AUDUSD), above major overhead resistance at its 0.9380 November 2009 benchmark high, would indicate that the Aussie's larger October 2008 major uptrend versus the US currency is resuming. Considering the tight and stable positive correlation between AUDUSD and commodity prices, and more specifically with economically-influential copper prices, continued strength in AUDUSD would indirectly suggest increasing economic demand and the likelihood of a similar rise in the Dow Jones Transportation Index

A couple of weeks ago, U2 performed in front of more than 100,000 fans at the Olympic stadium in Athens. Listen to Bono's comments on the Greek economy...

Citadel is no stranger to headlines: in late 2008, the firm was a prominent fixture in the news, typically mentioned in the same paragraph as some (now long former) LP who had attempted to redeem capital from Ken Griffin's firm only to hear redemptions were indefinitely, and without warning, halted, followed up by an expletive laden tirade. After all it is only called a hedge fund: in reality it is merely a levered bet that Moody's assumption that nothing can ever go lower, is correct. Well it wasn't, and as a result in 2008 Citadel lost more than half of its assets. The net result is that with profits of 62% in 2009 and 4% YTD, the firm (and, incidentally most other funds) has no chance of hitting its high water mark for a second year in a row.  Which brings us to today's surprising news that Ken Griffin (allegedly perceived in the industry as arrogant beyond comparison, so this must hurt overtime) has finally decided to eat humble pie and to lower its management fee. As hedge fund veterans know too well, this is often the first step of the beginning of the end, as it may indicate either a i) liquidity shortage, ii) a surge in redemptions, iii) a performance that is far worse than officially represented, iv) a megalomaniacal dictator at the head of it all, or  v) all of the above. Most of all, it indicates that very soon every LP in Citadel will demand the same terms, making profitability for the hedge fund turned market market turned investment bank turned FRBNY collaborator into a living hell of razor thin margins. As for the title, it is rhetorical.

Another day demonstrating just how pathetic stock trading has become. Up until the close, the NYSE was on track to record the lowest quad witching volume in history. Fast forward to 1 minute after the close, and the machines kick in, sending in almost one billion shares down the frontrunnable chute known as the NYSE pipeline. Too bad most retail investors still don't understand that the only time when trading actually occurs now is after the market is officially closed. And even with the post-close spike, this was still arguably one of the lowest quad witching days ever.

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 17/09/10

Pento's earlier return to CNBC can only be attributed to the ratings surge resulting from the episode of him being "rude" and kicked off by Erin Burnett, after he dared to question her assumption that the world will continue to fund US debt in perpetuity. Nonetheless the tension (of somewhat ambiguous origin) between the two remains which may explain why Mike Pento appeared on the Kudlow show to discuss how Obama can satisfy Wall Street. Pento was sterling as usual, saying Obama's best bet is to convert to the tea party, but absent that he "should remove Ben Bernanke, and put the head of the Fed should be someone who is not so enamored with counterfeiting, and put someone who believes in markets. That would help to a great degree." Yet today's moment of insight comes from Keith Boykin who points out that the conflict between Wall Street and Main Street continues, in that the former couldn't care less about jobs (unlike the latter), and are much more fixated on the bottom line. Although obviously without jobs, the economy will crumble, which explains why Pento once again points out the obvious that America, to be competitive with the Chinese, should "lower taxes, lower wages, and reduce regulations" - all three of which have virtually no chance of passing in a country used to being coddled by cheap credit and ever rising wages, even if this money continues being devalued day to day. And while Boykin seems unable to grasp the concept that a bottom line has an expense component to it (i.e., cutting record bloated government spending), the line of the day goes to him: "We are all greedy and selfish." And there you have it - Americans can look at the administration for answers, at Wall Street for scapegoating, but fundamentally, when it comes down to actual change, this can only happen at the individual level. And deluding oneself and preventing any real change is what the average American individual excels in, more than anyone else in the world.

Economic Patterns: What we now call “economics” determines power and conflict patterns because wealth, or the deprivation of it, determines survival, and, for those who survive, “economics” determines the relative control they may have over individual and societal destiny. Thus social behavior determines economic viability, and the failure or success of economic patterns determines social corrective or compounding action. We are about to see an acceleration of social reaction to economic failure - a reaction to the inflexibility of policies which have failed to adjust to changing circumstances.

By now, after Zero Hedge has been demonstrating for about a year, even the kitchen sink is aware that cross-asset correlations between stocks, bonds, FX, and commodities is at or near all time highs, which in itself is a very deplorable situation simply because it eliminates virtually all long/short hedging opportunities, courtesy of the Synthetic CDO redux boom whereby most of the trading in stock is conducted via ETFs, as both high beta and low beta, or quality and crap assets all trade as one. But few if anyone was aware of peculiar intraday correlation patterns which may be an eye opener to some readers who believe that stocks are uniformly broken during the day. That is not true: in fact, stocks are only untradeable for the rational investor during the times when the market is most active, around open and close. In fact, in a paper by Michael Bommarito II, "Intraday Correlation Patterns Between the S&P 500 and Sector Indices", we discover that average return correlations have a very distinct U-shape, whereby correlations are near their highs (0.75) just after the open, and before close, while dropping to a statistically significant 0.6 at 1 pm, when volume is the lowest. This merely confirms that increasingly more market participants, read - electronic traders and algos, trade exactly the same strategies at the time when volume is at its peak, indicating that most strategies have nothing to do with actual fundamental investing and all to do with gaming market structure, and hoping to capture some idiot who thinks they can beat the machine. And as we demonstrated recently, many traders no longer trade during the hours between 10am and 3pm. Which means that this is actually a very interesting arb opportunity, for those who wish to take advantage of the machines' downtime, but shorting correlation at open and close, and bidding it up during the day. In fact the trade can be structured as a pair trade with almost no capital downside opportunity. As to the specifics, read inside.

We are continually amazed at movements in the foreign exchange market that come as a direct consequence of moves in peripheral 5-Year Credit Default Swaps (CDS). The chart below details the relative correlation of a GDP weighted basket of the relevant countries within the Euro. The relationship makes sense. When spreads blow out they do so because investor anxiety over Europe's credit position increases, anxiety over credit worthiness in Europe sees investors selling EUR/USD. However lately moves in the smaller peripheral components have been resulting in out-sized moves in the EUR. Something strange is a-foot.

Arguably the most useful report to come out each quarter out of the Federal Reserve is the Z.1, or the Flow of Funds report, which was released minutes ago. And it's a doozy: household net worth (assets less liabilities) in Q2 2010 plunged by $1.5 trillion, almost exclusively due to a plunge in Corporate Equities ($0.9 trillion) and Pension Fund holdings ($0.7 trillion). In other words, the net wealth of the US household continues to track the performance of the stock market tick for tick. And one wonders why the Fed, per Alan Greenspan's admission, is only focused on ramping stocks up to all time highs. Total household financial assets declined by $1.7 trillion to $43.7 trillion, which was the biggest swing factor, as the tangible assets, or housing, was kept flat at $23.7 trillion. Incidentally, to assume that Real Estate value increased in Q2 from $18.7 trillion to $18.8 trillion in Q2, is one of the dumbest things to ever come out of the Fed: we expect that this number will plunge soon after it is realized that the double dip in housing is here, forcing another major contraction in household net worth. On the other side of the balance sheet, liabilities were also flat at $13.9 trillion sequentially. And possibly the most important data point: the change in borrowings, confirmed that everyone is deleveraging except for the government... whose borrowing surged at a 24.4% SAAR, the second highest ever, after the 28.9% surge in Q2 2009. In other words, Keynesianism is alive an well in the US, and any talk of austerity in the US is nothing less than not that funny stand up comedy.

Chart showing total financial asset breakdown: at $43.7 trillion, US consumers are now back to the same net worth levels they had in Q3 of 2009.