Archive - Dec 7, 2011

Reposting by popular demand, and because everyone has to understand the embedded risks in this market, courtesy of the shadow banking system.

In an oddly prescient turn of events, yesterday we penned a post titled "Has The Imploding European Shadow Banking System Forced The Bundesbank To Prepare For Plan B?" in which we explained how it was not only the repo market, but the far broader and massively unregulated shadow banking system in Europe that was becoming thoroughly unhinged, and was manifesting itself in a complete "lock up in interbank liquidity" and which, we speculated, is pressuring the Bundesbank, which is well aware of what is going on behind the scenes, to slowly back away from what will soon be an "apocalyptic" event (not our words... read on). Why was this prescient? Because today, Reuters' Christopher Elias has written the logical follow up analysis to our post, in which he explains in layman's terms not only how but why the lock up has occurred and will get far more acute, but also why the MF Global bankruptcy, much more than merely a one-off instance of "repo-to-maturity" of sovereign bonds gone horribly wrong is a symptom of two things: i) the lax London-based unregulated and unsupervised system which has allowed such unprecedented, leveraged monsters as AIG, Lehman and now as it turns out MF Global, to flourish until they end up imploding and threatening the world's entire financial system, and ii) an implicit construct embedded within the shadow banking model which permitted the heaping of leverage upon leverage upon leverage, probably more so than any structured finance product in the past (up to and including synthetic CDO cubeds), and certainly on par with the AIG cataclysm which saw $2.7 trillion of CDS notional sold with virtually zero margin. Simply said: when one truly digs in, MF Global exposes the 2011 equivalent of the 2008 AIG: virtually unlimited leverage via the shadow banking system, in which there are practically no hard assets backing the infinite layers of debt created above, and which when finally unwound, will create a cataclysmic collapse of all financial institutions, where every bank is daisy-chained to each other courtesy of multiple layers of "hypothecation, and re-hypothecation." In fact, it is a link so sinister it touches every corner of modern finance up to and including such supposedly "stable" institutions as Jefferies, which as it turns out has spent weeks defending itself, however against all the wrong things,  and Canadian banks, which as it also turns out, defended themselves against Zero Hedge allegations they may well be the next shoes to drop, as being strong and vibrant (and in fact just announced soaring profits and bonuses), yet which have all the same if not far greater risk factors as MF Global. Yet nobody has called them out on it. Until now.

Why would Mary and her friends lie?

Prices are at resistance.  There is risk of recession.  There are intermarket headwinds.  And investors aren’t committed either way.  I think this skews the dynamic to the downside even if there is headline risk.

America, land of the cowed and home of the mute?

Nassim Taleb is wrong about the financial crisis and black swans. The ongoing financial crisis is not the result of a perplexing phenomenon of complexity. It is the beginning of a train wreck we have seen for decades. We are not wandering into a surprise or horrified by the dark specter of a Black Swan rearing its long tailed head; this macro crisis appeared on the horizon long ago, easily calculated by any actuary armed with the knowledge that governments were not investing tax streams, but stealing them for current consumption. Our monetary policies do not defend inflation; they fund deficit spending and protect banking institutions. That is their empirical purpose, and that is what technocrats are now struggling to accomplish in the EU. Further, the monetary system as constructed is not modeled after complexity; it is an artificial hierarchical oligopoly with all the single process failure points that entails, pasted on top of complex economies and kept alive by increasing leverage and bailed out by equally non-robust, frail self-serving governments without the will or common sense to reform. We are not watching complexity at work; we are watching unsustainable bureaucracies self-destruct while they force complex economies to foot the bill. There is no Superman of bureaucracy. There are no rules or regulations that will prevent failure or negate investment on our road to prosperity that we do not already know. Our institutions have just consistently rejected them. After all, leverage and redistribution is much easier than successful investment. In a complex system, these bureaus would have died and been replaced by their betters long ago.

The reason why some profitable companies pay no taxes. And why others pay too much. It’s so fundamental to business taxation. But not even tax reformers dare to mention it.

Looking at this Friday's n^th European summit, one could be forgiven to forget that so far in 2011 there have been no less than 10 Eurozone finance minister meetings and summits. TEN. And courtesy of Reuters we have an annotated overlay of the MSCI Eurozone bank index' performance so far in 2011. Unfortunately, one quick glance at the chart leads us to two very sad conclusions: i) the time will not be different, and ii) a "favorable" market response will require an hourly barrage of FT/Guardian/La Stampa/Nikkei rumors just to get the ES green, if only for a few minutes. So without further ado, here is the interactive annotated superimposed analysis showing the Eurozone historical meetings/summits and the reaction in bank stocks, Greek and Italian bonds, and the all important Euro.

Obviously, measuring portfolios in dollars exaggerates performance in real terms. This isn't to say that one shouldn't invest in stocks. It means that one must: a) be cognizant of how results compare to gold or other real assets that one might buy with whatever currency one is dealing with; b) adjust brokerage statements to allow for currency dilution; and c) not rely on stocks in general to outpace inflation. In fact, it isn't just investments that are eroding. Our entire world is being devalued, even as one reads this article – from groceries and gas to cars and college. Someday we'll want to spend the gains we're making; how will we avoid the long-term erosion of the currencies we invest in?

The will-they, won't-they argument over the sustainability of China's capex-driven growth and the transition from an investment-led/high-growth economy to a consumption-driven/lower-growth model is becoming more polarized every day. Pivot Capital Management's take on the slowing growth and muddling transition will make the shift more painful and will likely lead to a credit bust. Their thesis focuses on the balance sheet transformation of the Chinese economy that has attempted to postpone such a transition at a time when the pro-cyclical shadow of global growth expectations demand it. They expound on three main reasons for the proximity of credit bust in China: shadow banking pushing credit expansion to the edge of a crisis (as the regulated markets lose control), real estate and infrastructure investment are at a critical juncture (as worsening fundamentals significantly dampen flows), and interdependence in China's financial system. They fully expect the upcoming credit bust to require government intervention, they expect this to dramatically slow the investment-led growth model and obviously this would be a global event as the world's reliance on China's 'economic miracle' is brought into question.

It has been a while since the Marc Faber graced Zero Hedge. It is time to remedy that. Providing his traditional dose of snark, tragedy and realism, the Gloom, Boom and Doom report author spoke to Bloomberg TV, and when asked what his outlook for the euro is, dispensed the following pearl: "I have a very special stock tip for you. The symbol is g-o-l-d. That is what I prefer to hold. Both the euro and the dollar are long-term undesirable currencies, especially given zero interest rates in the U.S. Equities to some extent become like cash because they become a store of value compared to cash at a zero interest-rates. Paintings become a store of value, stamps become a store of value." Needless to say, this is the kind of response that will get him banned from CNBC for life when Bartiromo breathlessly asks him, "ok, you think the world is ending, so what five stocks would you buy." As for his latest report, "It's actually quite gloomy but if you're very gloomy what do you invest in: Treasuries, Italian bonds or commodities or equities?  I happen to think U.S. equities are not terribly expensive, so relatively speaking to other assets, they may for a while actually do quite well." Considering the ridiculousness of the market over the past two weeks when it has gone up on nothing but lies, Faber just may have a point. 

It is no surprise that there is both an implicit and explicit link between financial entity risk and that of their local sovereign overlord. The multitude of transmission channels is large and the causalities, not merely correlations, run both ways, providing for both virtuous (2009 perhaps) and vicious (2010-Present) circles. Goldman Sachs, in its 2012 investment grade credit outlook takes on the topic of the feedback loop which is engulfing financials and sovereigns currently - noting that despite the 'optical' cheapness of financial spreads to non-financials (and equities) that it is unlikely to compress significantly without a 'solution' to the sovereign crisis being well behind us. The key takeaway is that pre-crisis sovereign credit premia were, in hindsight, uneconomically tight (unrealistic) and expectations of a return to those levels is incorrect as they see the current repricing of sovereign risk as a paradigm shift as opposed to temporary repricing due to market stress. "Sovereign spreads will likely emerge from the crisis both more elevated and more dispersed", meaning floors on bank spreads will be elevated and deleveraging pressures to be maintained raising the real risk, outside of spam-and-guns Euro-zone crashes, of a potential credit crunch. This is already evident in European loan spreads, which as we have discussed many times is the primary source of funds (as opposed to public debt markets as in the US).

We should wait until the data is in before hurting ourselves. 

As if we needed another confirmation that the sad joke of a market has now succeeded in driving virtually everyone out courtesy of precisely the kind of bullshit we saw in the last 30 minutes of trading today, here comes ICI with the latest weekly fund flow data. It will not surprise anyone that in the week in which the S&P rose by a whopping 8 points on absolutely nothing but more lies, rumors and innuendo, US retail investors pulled a whopping $6.7 billion from domestic equity funds: the most since the week after US downgrade when a near record $23 billion was withdrawn. Only unlike then when the market bombed, this time it simply kept rising, and rising, and rising. In other words, every ES point higher serves no other purpose than to provide an even more attractive point for the bulk of that now extinct class known as investors to call it a day, and pull their cash out of this unprecedented shitshow that central planning has converted the market into. And for those keeping score, a total of $123 billion has now been pulled from stocks in 2011, well over the $98 billion withdrawn in 2010.

Sometimes we just shake our heads. Other times, we just sob anxiously into our handkerchieves. This afternoon's rumor-ramp-denial-no-dump was absurdity at its very best. A 16pt rip in ES on the basis of rumor of another bigger bazooka from the IMF (courtesy of Nikkei not the FT this time as we all know what their rumors are full of) was ignored by pretty much every other asset class. We tweeted almost instantly that the denial would be forthcoming in 10 minutes and sure enough it was. But wondrously, what goes up, does not come down as ES gave back a measly 5pts leaving it very far bereft of broad risk asset's perspective of value. Perhaps the best perspective on the incessant IMF-and-other rumors is from Peter Tchir "This is all circular and that circularity is coming back to haunt those people desperately trying to come up with new ways to extend and pretend."