Archive - Nov 15, 2011

Even by a quick back of the envelope analysis, we find ourselves in an environment in which a single corporation such as Exxon is actually more trustworthy (from an investment perspective) than US Treasuries.

Say you are the CEO of Deutsche Bank (whoever that may be these days following Ackermann's stunner of an announcement yesterday), and you have so much dirty laundry that if the market so much as looks at you funny, you know very well it is game over the second you have to engage in reactionary damage control. After all your assets are 84% if not more, of total German GDP and there is no way that you can be bailed out by one country alone, even if that country is the only one that is not a complete Banana republic. So what do you do? Why you tell your bankers to write the best, most persuasive pitch book they can come up with, addressed to none other than Goldman Sachs alum and ECB head, Mario Draghi, and you tell him the truth: "Europe has hit its Tipping Point" and it is now or never. In other words, in 51 slides, your task is to convince the ECB that unless they terminally break away with their traditional stance of not monetizing, not only they, but the entire European status quo will cease existing. And that's precisely what you do. Behold: "The Tipping Point - Time To Call The ECB" - Deutsche Bank's definitive attempt to encapsulate the Mutual Assured Destruction that we are "certainly" all going to suffer, unless the ECB prints, and prints, and prints. The bottom line, you would tell Draghi, is "do nothing, and pull the cord now; or do something, risk hyperinflation which may or may not come, but at least extend and pretend for a few years." And one wonders why Crude is about to pass $100...

About a month ago we suggested that the EUR weakness was perhaps a major headfake as liquidity runs and repatriation flows would sustain a stronger-than-expected EUR (especially relative to the USD). Well, today Deutsche Bank's Macro strategist points out that French balance of payments data was hugely revealing about this potential source of strength. While we note that EURUSD remains hugely disconnected from its empirical relationship with sovereign spreads (GDP-weighted), swap-spreads, financial-to-corporate risk differentials, and equity prices - it seems the the typically negative investment abroad (outflows) has now seen 4 months of inflows (too long a period to be simply noise) and with considerable size also. While DB's analysis offers little guidance on when this period of repatriation will be over - we suspect there is more support to come than many expect - even as everything points to a weaker EUR. Perhaps most interestingly, DB notes one broad conclusion is that the EUR is probably the worst instrument to express negative EUR area views, with both periphery bonds and equities purer gauges of stress.

Isn't trading this market fun? As readers will recall, one of the two reasons for why the market plunged overnight was speculation that Monti may have trouble forming a cabinet. As is to be expected, stocks are now surging because according to recent information, at least the Italian government unknown may be taken off the checklist, even if nothing can be said about his ability to actually pass required austerity, to chance the country's medieval labor laws, which are controlled by the shadow government regardless, or the fact that Italy has over $300 billion in debt to roll in the next year. From Reuters, "Italian Prime Minister designate Mario Monti will meet Italy's President on Wednesday morning to inform him that he will be able to form the country's next government, a statement from the presidential palace said on Tuesday." Now, the other and far bigger reason for the plunge in futures, it bears reminding, is that the Spanish bond auction was a failure with just 3.2 EUR of the 3.5 EUR sought, was raised. If only Goldman could wave its magic wand and fix this far bigger problem which is endemic to all of Europe as it seeks to raise over $2 trillion in the next 2-3 years. That, and the fact that Belgium, Spain, France, Austria and virtually everyone else execept for Germany (for now) closed at what are new all time high spreads.

We are getting very close to a problem.

The stock market seems to be the last group still buying into the Europe "gets it" argument. The credit markets now seem to be fully diverging from equities, and offer more opportunities here than stocks.  In credit, Europe is starting to look attractive versus the US.  Sovereign credit looks better than bank credit in Europe.  High Yield may not be bad here, but we think HYG/JNK definitely got ahead of themselves at these prices.

But you can die trying.

Well, it didn't take one day... It took a whopping two days for our always contrarian call to do the opposite of what Goldman said on Friday, to materialize. As we said on Friday afternoon, "Time to sell the EURUSD with both hands and feet, not to mention with MF Global-type leverage: that uber-contrarian FX indicator, Goldman's Thomas Stolper, who has not had a notable call correct in the past 2 years, just came out with a long EURUSD call, calling for a 1.40 target and a 1.35 stop loss. Yes, this means Goldman is now selling EURUSD until 1.40 and will begin buying it at 1.35." 48 hours later Goldman's clients lose big, Goldman's flow desk wins, and anyone who agreed with our traditional cynicism made several thousand pips assuming the proper use of MF type leverage.

While bubble-spotting among equity investing tilts is often futile, the ever-increasing call for investors to buy high-quality dividend-paying stocks has become as over-used a term as 'long-term investor', and 'buy-the-dips'. It seems the general belief is that a 3-5% dividend yield will provide 'protection' to cushion volatility as it offers income above Treasuries. Back in September we highlighted both the apples-to-unicorns comparison that is dividend yields to TSY yields and moreover, how risk (and ultimately capital loss) should play a critical part in the decision of asset allocation. Today we take a quick look at dividend stock performance over the last few years and find something intriguing - and not often mentioned - that dividend stock portfolios appear to significantly underperform in sell-offs and marginally underperform in rallies. So if you want a high beta crowded trade, admittedly with some carry, buy high quality dividend-paying stocks.

We all know some 3 trillion euros of debt in Europe is uncollectible. So why isn't anyone talking about the one and only solution, which is writing off all that debt? Since nobody knows how much bad debt there actually is in the Eurozone--care to guess on the market value of all those underwater mortgages in Spain or the true size of Italy's debts?--that 3 trillion is just a guess, but it's probably a reasonable starting point. Let's start with the most basic fact about all this uncollectible, impaired, bad debt: every euro of debt is somebody else's asset. Wipe out the debt and you wipe out the asset. That's why there's no willingness to accept the writedown of debt: somebody somewhere has to suck up 3 trillion euros of loss. Can we please dispense with the fantasy "solutions"? There is no way Europe is going to "grow its way out of this debt." How much of the eurozone's "growth" was the result of rampant malinvestment and risky borrowing? More than anyone dares admit. It won't take austerity to crash the euroland economy, all it will take is turning off the debt spigot...Life will go on if the banks are wiped out and closed, pension funds and insurance companies take losses, etc.  If those who made the bets for their own private gain aren't forced to absorb the risk, then we don't live in either capitalism or democracy; we live in a financial-fascist tyranny.

Chatter across European bond desks that a sovereign downgrade is nigh has sent BTP spreads and yields soaring. ECB buying earlier is now under-water once again.

Yesterday's divergence/convergence in HYG/HY17 was another example of the interplay between various instruments in the credit market space and how they can be traded profitably. Taking a step up from the trees to the forest, unlike Mr. Fink's earlier comments on the cheapness of equities relative to any and every other asset class, we note that in fact - were you to have a bullish perspective on the world - then HY spreads are far cheaper (i.e. priced for much more of an Armageddon-like scenario) than equities and offer more upside if things work out. However, the bond ETFs have their own set of technical flows and idiosyncratic risks and Peter Tchir, of TF Market Advisors, sees growing concerns in this increasingly active area of the market.

As expected the latest spike in the market is on nothing more than a central planner usurping the role of the Fed and making it appear that the Doves are in charge. In this case it is the first Dovish dissenter on the FOMC in years, Chicago Fed's Evans who just petulantly said that he expects the policy rate to stay low for longer than mid-2013. Indeed, the guy who got slapped down by none other than Bernanke forcing him to "dissent" is now making his outlier opinion seem to be fact. That this is identical in credibility to Hoenig saying that he expects the Fed to hike the rate to 4.5% by the end of the year is irrelevant: the market has smelt liquidity blood and is in a frenzy for a few more minutes until the realization that the only variable here, the ECB, has just said it will not monetize.

We discussed the sudden and scary drop in the EUR-USD cross-currency basis swap last week and how it is perhaps a cleaner view of the funding crisis in Europe than the delinquent Libor market. Since our first discussion, the 3 Month EUR-USD basis swap has widened even further - only worse in the heart of the crisis in Q4 2008. As if that was not enough, GDP-weighted European Sovereign risk is back up to its highest levels ever as the clear message from the markets is the ring-fencing and backstopping of sovereigns and financials respectively is simply non-existent.