Archive - Oct 27, 2011

SPX could end the year above 1300

For some reason, investors' goldfish-like brains forget every quarter that time and again around 70% of names beat expectations and this fact is used as reason to buy buy buy. Certainly this time around, earnings beats are well within historical norms and furthermore are simply beating significantly lowered expectations. However, that is backward-looking and no matter what metric you use for valuation, the only one that really counts is how expectations are priced into the market. With regard to this, 12Month forward EPS expectations have started to roll-over quite significantly for the S&P 500 (at around a -8.5% annualized clip) - the last time we saw this was Q4 2007 and we know how well that ended.

As we come to terms with the new reality (or perhaps same old reality) that governments will do anything to maintain the status quo, Goldman Sachs took a step back this morning to consider what is worth focusing on in the medium-term. Obviously the European Summit proceedings impact their perspective, but less positively than one might expect as they expect slower global growth, a possible European recession, refocus on US data, Chinese policy responses, currency wars, and a balanced portfolio approach to risk. It certainly seems like Goldman remains less sanguine than an exploding US equity market might suggest and we tend to agree that ignoring the fact that the EU Summit conclusions leave more questions than answers, it may allow us to focus once again on the fundamentals and those fundamentals are not a rosy as many would have us believe.

Mortgage principal writedowns may sound like a political panacea, until we consider the effects not only on borrowers, but on banks, and taxpayers, as well...

Buying stocks with the confidence that all has been resolved and all open questions have been answered? Or just doing it because everyone else is doing it, and there is "career risk" for those who actually sit to think what the events over the past 24 hours mean? It's ok if it is the latter: everyone else is in the same boat. After all the whole purpose of today's rally is to get everyone exposed the same way, so when it all crashes again, nobody can be singled out for having been contrarian. Why are we so sure? Because when even Goldman Sachs has at least 10 outstanding questions on not only the structure of the European bailout, but the layout of the revised EFSF, it is safe to assume that few have the answers (which, incidentally, don't exist). So in between chasing VWAP ever higher, it may be worthwhile to read these 10 questions which nobody has the definitive answer to. At least not yet. And whose answer is assumed will be a satisfactory one...

The suit seeks a civil penalty against MERS of up to $10,000 for each willful violation of the Deceptive Trade Practices Act, as well as restitution to borrowers who were harmed by these violations.

Back in September we noted that "Wen Jiabao Says China Willing To Extend Help To Europe... For A Price" the price in question being that, among other things, the EU should recognize China's market economy status, and to split Europe with the US on the topic of Chinese currency manipulation. Naturally, being the biggest import partner for China's goods, the topic of providing vendor financing to Europe has always been a critical one. Well, as was made clear overnight a key part of the European rescue effort is to get China on the same page, and to have it allocate capital to the EFSF. As the FT reports this may have happened, although with more or less the same conditions that China delineated 6 weeks ago. Only this time China has all the leverage. According to the FT: "China is very likely to contribute to the eurozone’s bail-out fund but the scope of its involvement will depend on European leaders satisfying some key conditions, two senior advisers to the Chinese government have told the Financial Times." So what are the conditions: "Any Chinese support would depend on contributions from other countries and Beijing must be given strong guarantees on the safety of its investment, according to Li Daokui, an academic member of China’s central bank monetary policy committee, and Yu Yongding, a former member of that committee." Obviously, Europe will promise the latter. As for the former it could be a tad problematic because as observed previously Brazil has voiced against rescuing Europe in the form of non-IMF participation. But there are more conditions: "It is in China’s long-term and intrinsic interest to help Europe because they are our biggest trading partner but the chief concern of the Chinese government is how to explain this decision to our own people,” said Professor Li. “The last thing China wants is to throw away the country’s wealth and be seen as just a source of dumb money.” Alas, that is precisely how the entire world sees China. As for the final condition: "He added that Beijing might also ask European leaders to refrain from criticising China’s currency policy, a frequent source of tension with trade partners." And this is how you declare political check mate and shut up all voices that threaten to protest against mercantilist policies. And since it is only a matter of time before China will have to rescue the US, we hope Senate enjoys the time remaining in which it can debate whether or not China manipulates the CNY. That time is about to end.

There is no shortage of hatred for the biggest banks. Indeed, the Occupy Wall Street movement is leading a national revolution against these byzantine, powerful Goliaths for the economic devastation they have caused. This makes it difficult to choose the worst of the bunch. That said, a strong case can be made that Bank of America deserves the title of the nation's most despised bank. Here are ten reasons to take your money out of Bank of America - and park it at a credit union or community bank near you. (And yes, that may be near impossible if you have a mortgage with them, as refinancing away from any big bank nowadays is a nightmare.)

Today's epic risk rally has been punctuated by something probably not all that surprising: a very weak $29 billion 7 Year auction, which has since dragged the entire bond curve even lower. The bond priced at a high yield of 1.791%, a notable 3 bps tail to the When Issued which was trading at 1.76 at 1 pm. But the internals are again where the action is: the Bid To Cover of 2.59 was the lowest in the series since the 2.26 back in May 2009! Additionally it appears that foreigners, either China or Europe, had very little desire to load up on this paper, with just 33.9% in Indirect Take Down, and a corresponding 86.9% hit ratio on the Indirects. So while Indirects came at the lowest since June, so the Primary Dealers took down the most since that month, at over half of the entire auction, or 54.15%. Directs also stepped up, bidding up 11.95% of the whole, compared to 8.95% last twelve auction average. And as the chart below shows, the disappointing auction has dragged the entire treasury complex lower in price. As a reminder, this bond auction brings total US debt to over $15 trillion, a number which would have resulted in a 100%+ debt/GDP using the Q2 GDP. As it sands, following today's update, the market has about $160 billion in capacity before that threshold is breached again.

So, the European joke has come full circle. Indebted nations borrow more money to bail out other indebted nations who ask insolvent banks to cut a 50% off deal on the loans that were given to them, but the insolvent banks will then have to raise capital which the will of course borrow from the over-indebted nations whom they just gave money to. Get it? Problem solved - BTMFD!!!

It has been long in coming but finally the credit market is noticeably refocusing its attention to the two countries that are supposed to carry the burden of bailing out the world on their shoulders: Germany, and, that perpetual placeholder for global rescues, China. As noted yesterday, while following today's anticipated ISDA decision to effectively make price discovery in CDS null and void, and in the process also put the whole premise of sovereign debt insurance into doubt, CDS still provides a very useful metric courtesy of the DTCC, namely open interest, or said otherwise, gross and net notional outstanding in the CDS. And while we will reserve the observation that not only did ISDA kill sovereign CDS, but in the process it also ended bilateral netting effectively pushing up net CDS to the level of gross, we will highlight that as of the last week, net notional in both German and China CDS has hit a record, of $19.6 billion and $9.3 billion, respectively. This is occuring as notionals in the two most active countries to date, France and Italy, have been declining. In essence, what the CDS market is telling us is that while the easy money in French and Italian default risk has been made, it is now finally the turn of China and Germany to defend their credit risk and sovereign spreads. We expect that if China is indeed confirmed to be the backstopper of Europe through funding the EFSF in whole or in part, that while its CDS may or may not surge, net notionals will continue to increase as it means that ever more are laying insurance, as hobbled as it may be, on the country which recently was forced to bail out its own banking system, let alone Europe. Keep a close eye on China, which while the bulk of the market is taking for granted as the global rescuer of last resort with hard money, the smart money is already positioning itself for the next big disappointment.

Jed Rakoff is well known to frequent readers of Zero Hedge: he is the judge who nearly brought down the SEC settlement with Bank of America over the whole bonus non-disclosure issue two years ago, and where Bank of America effectively acted under the duress of Hank Paulson and Ben Bernanke. Granted at the end of the day he sided with the status quo., but this may be his chance to redeem himself. Just out from Bloomberg:

• CITIGROUP'S $285 MILLION SEC SETTLEMENT QUESTIONED BY JUDGE
• CITIGROUP JUDGE ASKS PARTIES TO JUSTIFY FAIRNESS OF SETTLEMENT
• SEC CLAIMED CITIGROUP MISLED INVESTORS IN $1 BILLION CDO

When we witness the clash between the Austerity and Stimulus camps, on the surface there is the appearance that a true debate is taking place between diametrically opposed economists. For example, Austerity folks correctly note that our economy has been badly weighted towards consumption for some decades. They want to clear out the excesses, let the malinvestments fail, and elect an overall path of acute economic pain in order to reset the system. Stimulus advocates find such plans completely unnecessary, if not downright masochistic. Armed with a more humanistic approach, Keynesians want the government to run large deficits to help the private sector deleverage, which of course could take years....A rather serious problem in the ability of Developed Economies to coherently allocate resources started showing up well before the 2008 crisis. This status quo, made in part by policy mistakes, credit creation, and the energy limit, still remains today. Crucially, neither stimulus nor austerity will dislodge this status quo. Unless, of course, by austerity we mean to intentionally collapse the system, or if by stimulus we mean to engender a runaway inflation that will eventually yield the same result.

With OVER $46 trillion in assets outstanding, this means that European banks would need to raise $1.77 TRILLION in capital to bring their leverage levels down to 13 to 1.

Presented without comment - except to say the 11% rise in Silver since Friday (and 16.7% rise since last Thursday's lows) is the highest 4-day move since 7/18/11 and is over 2 standard deviations on a long-run mean.