Archive - Sep 2010

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.

RANsquawk US Afternoon Briefing - Stocks, Bonds, FX etc. – 17/09/10

As the administration continue to recreate the ponzi bubble using the very same criminal methods that reflated the first housing bubble, more and more homes are being handed back to the original mortgage lenders - Fannie and Freddie (which incidentally are all now owned by everyone in America, ever since the GSEs were nationalized by the US, after Barney Frank's experiment in the early 2000s went so wrong, it nearly cost the default of America. How that human is still allowed to draft law after corrupt and worthless law, is beyond us). And today we discover that at the end of June, Fannie and Freddie are now the proud owners of 191,000 homes (double what they owned at the end of 2009) and rising with each passing day. And shockingly, the GSEs have decided to do the prudent thing and start selling this real estate, before the plunges really plunge and leave them straddled with millions of homes. On the other hand, this action alone will likely be sufficient to force the next leg lower in home prices. Because it gets worse: "Once they take homes back, Fannie and Freddie must not only cover the
utility bills and property taxes, but they are also relying on thousands
of real-estate agents and contractors to rehabilitate homes, mow lawns
and clean pools. Fannie took a $13 billion charge during the second
quarter just on carrying costs for its properties." Yes, dear taxpayer, this is money out of your pocket being used to prevent a drop in home prices, so that instead of being able to afford a home at a much lower price, you need to use even more 101% LTV Fannie debt and bid it up at still astronomically high levels, even as Fannie and Freddie become ever more default, so that one day all taxpayers end up with a big fat donut once America's pomzy debt issuance appartus finally implodes.

Developing news that the SEC is proposing a rule that will make EOQ window dressing, along the lines of the Repo 105 transactions that made so many headlines yet resulted in absolutely no criminal convictions, more difficult. We will bring you more some time in 2394 when this proposal actually becomes enforced, but in the meantime here is our chart that shows just how much of a pervasive phenomenon this is among the Primary Dealer community. Readers can find out more about this here: End Of Quarter Primary Dealer Asset Window Dressing Games Continue. We will update this chart in the first week of October when the Q3 window dreassing game is complete. We expect another 30 billion up and down swing as banks "fix" their capitalization ratios just in time for their 10-Q filings.

"The market stands on the banks of the Rubicon. The technical picture is unusually complex. There are various aspects that are normally associated with topping patterns. Yesterday, it was announced by the American Association of Individual Investors that the percentage of bullish investors had suddenly soared to 51%. That’s usually a big warning signal. Also, on the shelf for the bears remain the series of Hindenburg Omens and the recent VIX sell signal. The bulls are working on an inverse head and shoulders in the S&P. Interestingly, the “neckline” is very near the 1131/1133 level that marks the top of the three month trading range. Thus, a move above that level could suggest a new up-leg in the S&P with a target count of about 1240. That set-up leads traders to believe that a move up through that band might spark a frenzy of algorithmic short covering. That would certify the importance and validity of a breakout." - Art Cashin

The latest ECRI Leading Indicators data printed at -9.2, as it continues straddling the -10 level which is indicative of a double dip, improving modestly from last week's unrevised -10.1. At this point the Leading Indicator is merely feeding from market signals, and if the market jumps, so does the ECRI, and vice versa. Presumably a concurrent market is somehow supposed to predict the economic direction. Yet if one listens to Alan Greenspan, that is precisely what happens, proving that anything having ever come out of the Chicago School of Voodoo should be forever banned from actual practical implementation. Here is the overarching thesis of the Zero Hedge School For Non Robotic Trades who Wish To Learn To Trade Good: "The real EMT is really all about market manipulation higher, higher, higher. Any questions."

Markets and more generally the world are at a very interesting juncture. In physics, every system basically attempts to find a state of equilibrium. If a system that is in a state of equilibrium receives or loses energy from/to another system it can lead to a change in the state of equilibrium. Transitions at the micro level happen in steps even though looking at the world it seems like continuous evolution because what we witness is all the different systems that compose the universe in constant interaction. When a system is pulled with extreme force into two different directions it could appear like it is in a state of equilibrium, but the most minute change could lead to a drastic change in the system's state. An anecdotal example of this was offered to us a little over a decade ago when a group of illuminated brain surgeons decided to break the tug of war world record. For those like me who really don't understand what the world record of tug of war can be, it's just putting a record number of people pulling on each side. The experiment went wrong when after a few seconds of stand-still the tension in the rope exceeded capacity... the rope gave and sadly a few people lost their lives as each side of the rope backfired into the people pulling with extreme power. Why am I babbling about tug of war? Because the current state of the world economy is very similar to that world record attempt. The system is stretched in a lot of different directions: demand for resources, unemployment, conflicting stimulus policies chasing the same demand for goods, unsustainable amounts of debt... - Nic Lenoir

And thus QE2 is right back on the table... Sigh. The prior print was 68.9, and it was hoped it would move higher to 70.0. No such luck as we get the lowest print since August 2009. And probably the scariest indicator: the outlook is at the lowest since March 2009.

• Expectations: 59.1 vs. Exp. 64.2 (Prev. 62.9)
• Conditions: 78.4 vs. Exp. 79.0 (Prev. 78.3)
• 5-year Inflation: 2.8% vs. Prev. 2.8%
• 1-year Inflation: 2.2% vs. Prev. 2.7%

Earlier, we disclosed that concerns that the IMF could be called in shortly to rescue Ireland was the reason for Irish CDS to hit new records. It now turns out that another of the PIIGS may be in need of an imminent IMF rescue, namely, Portugal whose CDS is also surging. According to Diario de Noticias, "Portugal may be required to seek assistance from the International Monetary Fund (IMF) to address the problems of external financing." At least Tim Giethner's little Scam Test diversion bought Europe a quiet summer, full of vacations that would not be bothered with a stark reminder of just how ugly things are about to turn.

Core inflation kept flat thanks to....tobacco prices? Aside from that, deflation rules. The only question is: does Bernanke take secret smoke breaks inbetween think tank sessions on how to destroy the US middle class quickly and clinically.

With gold hitting a historic high this past Tuesday only to have it taken out yesterday, I thought it might be timely to take a look at another precious metal on the move: silver. Specifically, do the charts and the basic fundamentals support the sense that silver is set to continue its recent run as well? And perhaps more tantalizing, is there any evidence that points to the idea that silver can take out its more than thirty-year-old record high of roughly $50 per ounce? Based on a scrubbing of the charts and the fundamentals, I am more inclined than not to believe that silver’s future may look like gold.

Below is an updated visualization of the economic surprise tracker via the SocGen Policy Watch and Data monitor, which shows how since Jackson Hole, when Bernanke made it abundantly clear that QE2 is certainly on the table, the data has notably picked up. Which means that a green light for further monetary intervention will most certainly require a major gamble by the Census and BEA guys to report data materially closer to where it is in reality, and hope the market does not puke enough to offset any subsequent QE2 benefits. Of course, the market being "efficient" and "forward looking" has already foreseen all this. The bottom line here, however, as we pointed out previously: Bill Gross does not expect a September QE2 announcement. Which means one is not coming. All robots who are still confused, and trading with that expectation in Gallium Arsenide mind, will be disappointed.

• Defaulting on Anglo debts now on agenda (Indepentent)
• Government perilously close to calling in IMF, report warns (Independent)
• Japan to Seek Global Understanding on FX (Reuters)
• US Banks Braced for Further Bad News (FT)... seems so deja vu (Zero Hedge)
• China Central Bank Warns of Risks Ahead For Banks (Reuters)
• Geithner vows to take China currency dispute to G20. (Reuters)... But, didn't he do that already?
• Yuan Completes Best Week in 28 Months on U.S. Calls for Gains (BusinessWeek)
• Impact of Bank Rules Likely to be 30% Tougher (FT)
• Japan PM Rejigs Cabinet and Eyes Economy (Reuters)