Archive - Nov 18, 2011

The more unequal countries are doing worse on all these kinds of social problems. It's an extraordinarily close correlation.

It is no surprise that everyone's attention, hopes and dreams, are now on the shoulders of a principled and sensible Bundesbank as they fight-the-good-fight against a torrent of seemingly-sensible print-baby-print commentators (and politicians). Of course, if they did the equity markets would rally (despite the circular EUR weakness, correlated equity weakness, equity strength on we-are-all-saved, EUR strength game theory response) and the trade would be equity to outperform credit (as we've seen before). The pragmatist might argue that this is not a solution, but interestingly Dylan Grice of SocGen, suggests that as opposed to prospectively common-knowledge (and Germany's anti-Weimar reputation), the notion to devalue first, does best and maybe it is time for the ECB to take that plunge. This is somewhat opposed to his previous views on the path to hyperinflation (as akin to being half-pregnant) and our perspective remains that once the ECB starts, how will they ever stop?

Let's begin by positioning the sector. Investing in a pipeline company is similar to investing in a utility: Like electricity providers, pipeline companies operate in heavily regulated environments, and once they are up and running, pipeline operators enjoy stable cash flows from long-term contracts. In an economy where uncertainty is the new norm and speculation is a more dangerous game than usual, investors are gravitating toward income-generating investments. However, it's not only the current economy that's pushing investors toward defensive stocks. As US baby boomers retire, they tend to reduce the risk levels in their investments and move toward steady-as-she-goes, income-generating stocks. Unfortunately, those two forces also mean that many of these defensive stocks are trading between 14 to 20 times forward earnings, putting them at the higher end of their historical range. More on that in a bit.

Who would have thought that doing away with your prop trading unit would have consequences? Surely not Goldman spokesman Lucas van Praag or anyone who read his response to Zero Hedge from December 2009 in which he made the argument that Goldman's prop trading unit is largely irrelevant to the firm. Alas, as the last quarter showed, it was. A lot. $2.5 billion worth. Net result: GS stock is now trading at imminent MBO levels, and more importantly, there is no joy in bankerville:

• GOLDMAN NAMES SMALLEST CLASS OF MANAGING DIRECTORS SINCE 2008
• GOLDMAN SACHS PROMOTES 261 EMPLOYEES TO MANAGING DIRECTOR

However as the video below proves, it still does, and always will, feel good to be a banker.

Some version of the following BIS-sourced chart from the BBC appears every week somewhere, and by now the default Pavlovian reaction to seeing it should be to think of the Klein bottle. Yet this one may be the prettiest so far. In case anyone was still wondering what happens in a world in which every financial asset is someone else's liability, and that same liability is a third bank's asset (and so on), and where the amounts involved are in the tens of trillions, and when even the smallest debt haircut starts an avalanche of remarking to market, here is the explanation. Oh, and whatever you do, don't click on the US. Because the "US is fine."

General Maritime filed for bankruptcy yesterday.  So far it has been treated as a non event, but it may actually be start of another wave of bank write-downs (given the loan status and the fact that many of the banks will have held this loan and other shipping loans at par). The default isn’t in itself a big issue, but if it forces write-offs or provisions against other shipping loans at the weaker banks, it could add to the banking crisis more than people currently think.

We like Dick X Bove. He is a funny guy. After all, who doesn't like Dick appearing every day on CNBC. Yet comedic value is all one should hope to extract out of Dick. The problem is that anyone who has listened to Dick over the past 5 years, is most certainly bankrupt, in some cases twice over. While we will ignore his Buy upgrade on Lehman days before the bankruptcy, below we have shown two simple charts ever since his move from Ladenburg (which he left for obvious reasons in the Lehman aftermath), to Rochdale. The first chart shows the price of Bank of America, together with Dick's buy recos (green) and his price target. The second chart shows how Dick has performed compared not to the market, but to his peer group! In other words, while he has been massively wrong on stock calls, one would think he may at least be in line with his permabullish cheerleaders. No. In fact, he has underperformed his peer universe by 25% in the past two years. As for anyone who has listened to his Buy reco on Bank of America... well, do the math.

While the disquieting calm (before the storm) of the last hour in European markets suggests traders sitting on their hands into a bazooka-ridden weekend, we thought a look at what happens when the ECB stops playing may help. Based on the velocity of price-jump, the last two weeks have seen at least 16 interventions by the ECB into the BTP market and still the price is down significantly. Most importantly, on the two occasions when the ECB has deemed to let free markets reign, we have seen BTP prices free-fall. Have a great weekend, Europe.

A system which suppresses information and the low-level instability of dissent and negative feedback thus suppresses the information the system needs to remain stable. Suppressing dissent, facts, transparency and feedback inevitably destabilizes the system. It is ironic, isn't it, that the suppression of dissent, facts and transparency creates the surface illusion of stability, but it is only a facade. Beneath the surface, the lack of information and low-level fluctuation/volatility builds up system instability which is suddenly released as non-linear, chaotic volatility and collapse. What Europe, the U.S., China and Japan have now are leaderships that substitute lies for fact, obfuscation for transparency, artifice for feedback and propaganda for communication. The essential negative feedback of dissent has been choked off, leaving only self-reinforcing positive feedback loops in the system, feedback that inevitably leads to runaway collapse.

When was the last time a politician prevented a crash by causing his/her car to instantly freeze in mid-collision? Exactly! Expect the same amount of success with these multiple, financially engineered schemes to get around recognizing the only true solution - DEBT DESTRUCTION - and by the boat loads!

Just over a month ago we wrote in depth that while many of the supposed smartest men in the room believe we are set for a muddle-through economy that will 'maintain' asset values with no tail-risk expectation, we believed there are only 'painful' ways out of this crisis. Furthermore, we noted (and BCG agreed) that a tax-the-wealthy (and the wealth explicitly) haircut is coming. Today, the venerable Howard Marks of Oaktree, has his own inimitable take on the issue of taxing - and, just like us, sees that "Whatever action is taken now, it will not be pain-free. The unpayable debts run up in the past will have to be dealt with.". Marks sees three (simple and obvious) possibilities for our future:the promises will have to be scaled back, the tax burden will have to grow, and/or the deficits will have to be permitted to increase.

It's official - Germany has become just like China (or, rather, has always been like it): the more it is pushed to do something (let ECB print), the more it will do the opposite. Half a year ago we discussed that the weakest point of the European bailout language was its reliance on Collective Action Clauses which imply that any resolution which does not have 100% backing of all bondholders would potentially push a country into default. In essence, this took control out of the hands of the Eurozone head, Germany, and put it to the bondholders. Well, according to a preliminary draft released by the Telegraph and FT, as part of the new bailout 'indenture' contained in the ESM, "under a section headed “The establishment of a procedure for an orderly default as part of the ESM”, Berlin makes clear that countries which are deemed to be insolvent – rather than just suffering a temporary loss of access to the financial markets – would be allowed, in effect, to declare bankruptcy and default on their bonds: If [a debt sustainability review] is negative, the affected member state would instead receive loans for a limited time only, during which the procedure for an orderly default would be prepared. In order to make sovereign defaults possible where they are unavoidable, the threat of instability in the financial system resulting from such a default must be able to be credibly excluded. A plan to maintain the stability of the financial system in the event of an orderly default needs to be developed in close co-operation with European banking regulators. This would determine which banks would be restructured and/or recapitalised, which will necessitate the drawing up of Europe-wide rules on bank restructuring." And as we discussed previously, the voluntary language will likely be taken out from the final draft, effectively giving Germany the unilateral ability to kick countries out. Which explains why the market is about to plunge: according to just released information from DPA, "the German Foreign Ministry on Friday confirmed that Germany was considering the possibility of more eurozone "orderly defaults" beyond that of Greece, as suggested by a paper leaked by the British press." In essence, what this means is that instead of relenting on the ECB issue, which as every investment bank has said would be the end of the world unless massive printing is permitted, Germany would rather kick countries out of the Eurozone instead of entering a hyperinflationary collapse. Perhaps it is now time for the banks to start toning down their language on the imminent destruction that would ensue if the ECB does not print, as this is apparently not happening...

Sovereign credit issues have been front-and-center in terms of recent headlines as cost of funds and the balance between growth and austerity becomes unhinged among the once-upon-a-time risk-free entities. What has had less play very recently is the crisis that is going in the banking systems of the world as investors are as loathed to take any exposure to an opaque and clearly insolvent group of organizations. Credit (and to a lesser degree - equity) markets have shown their disapproval as spreads are as bad (if not worse) than at any time before, and yet the ratings agencies have yet to act decisively - especially in the US. All that is about to change as Reuters gently reminds us that S&P is about to update it bank credit ratings framework. The model is complex by nature but as we have seen time and time again, the agencies tend to lag prices (spreads) and in that case, we can expect downgrades as an early Christmas present. The impact of a downgrade can be very significant - aside from simply reducing investor appetite for risk (in its simplest form), it can trigger collateral calls and in a world where liquidity is hard to come by, and with the magnitude of funding (and rolling maturing debt) due over the next few quarters, we suspect this will be the catalyst for another leg down in equity prices as they snap back to credit's reality.

Bob Janjuah channels the Stones when he writes in: "Germany appears to be adamant that full political and fiscal integration over the next decade (nothing substantive will happen over the short term, in my view) is the only option, and ECB monetisation is no longer possible. I really think it is that clear and simple. And if I am wrong, and the ECB does a U-turn and agrees to unlimited monetisation, I will simply wait for the inevitable knee-jerk rally to fade before reloading my short risk positions. Even if Germany and the ECB somehow agree to unlimited monetisation I believe it will do nothing to fix the insolvency and lack of  growth in the eurozone. It will just result in a major destruction of the ECB?s balance sheet which will force an ECB recap. At that point, I think Germany and its northern partners would walk away. Markets always want short, sharp, simple solutions. This is why the begging bowl is out for ECB unlimited monetisation. But, as in the immortal words of Messrs Jagger and Richards, "you can?t always get want you want?. And, this being Bob, the bottom line is pretty clear: "as far as I am concerned, nothing has changed my very bearish secular view on global risk for 2012, which targets the S&P 500 in the 800/900 area, with risk of an undershoot to the 700s."

It seems pretty clear that almost nothing from the big October 27th all-nighter is getting implemented.  The bank recap program is still a vague notion, EFSF can't find aggressive buyers of its more straightforward bonds, and the leveraging schemes seems to have died on the vine.  The IIF seems to be just beginning the process of negotiating what complex security they will create that pretends to be a 50% "haircut".  Direct investments from China and Russia also seem to be off the table. We are back to the ECB and IMF.  Even the reports can barely be bothered to talk about how Spanish or Italian bond yields are improving. We believe we are a long way from getting the ECB to fully turn on the printing press, and continue to hope that some alternative path is found.  We really think that in the long run, some defaults will lead to a much better future, than printing will.