Archive - Aug 28, 2011

That European wholesale, and particularly dollar, funding has been "problematic" in past weeks is an understatement. One merely needs to look at the Fed's recent expansion in its transatlatnic swap lines to figure out that someone, somewhere is struggling to meet their USD-denominated obligations. However, is it just one bank, as recent data out of the ECB suggest, or is this merely a symptom of a far more acute underlying cause? Alas, as Barclays' Joseph Abate confirms by looking at the transformation in funding patterns within that most fulcrum of European banking systems - that of France - the threat is far more prevalent than has been speculated. In fact, based on the rapid transition in funding from unsecured to secured lending markets within French banks in general, and one name in particular, it seems that while SocGen stock may have avoided its daily rout courtesy of the extension in the short selling ban, there is a far greater concern for the bank: one of maintaining orderly daily operation funding. And there is little that European stock market regulators can do to restore liquidity, aka confidence, once it starts evaporating. Which it has... although mostly in unsecured markets... for the time being. Should secured funding (ABCP and Repo) wilt next, then it gets really, really bad. To wit: "Bank funding worries have flared up again with the news that the Federal Reserve’s currency swap line with other central banks has been tapped at least twice this month. The trivial amounts borrowed belie significant wholesale funding stresses for some institutions in dollar markets." Let's take a look at what "some" means...

The response of the market makes sense from the perspective of Pavlovian conditioning.

Since this chart from the WSJ sums up petty much everything about the "efficient market hypothesis" or whatever it is those wacky Chicago PhD's call their multi-variable, self-similar, Lorenzian "strange attractor" equations that describe human irrationality to the dot, there is little need for commentary (those who wish to do so, can read more about it at "Fed Faces Old Foe as Hazard Returns")

Sales must increase. That is largely dependent on household formation, which in turn is dependent on growth in full time jobs. And that's not happening.

What we do have to note is the most recent parabolic run away from the 20EMA created an abnormal spike never before seen in history with a reading of 2718 or price closing $271.8 away from the 20EMA. So the next logical question becomes what do we make of this and is it the end of this massive uptrend? Our view is this is unlikely, considering the historical relationship to the 20EMA as noted before (8% of time below). In fact, we may consider a pullback to the 20EMA to be a healthy thing as it will put Gold through a re-distribution phase and allow the order flows behind it to start another run higher. But, the extreme nature of this suggests price is likely to pullback to the 20ema within the next 2mos or by year end. Across most instruments, price rarely has this kind of extreme or unstable relationship to the 20EMA and usually means the orders behind such movements have to normalize a bit before starting another run. Keep in mind, this does not have to happen with a violent sell-off and could be the result of price hanging around the $1700-$1900 range while the 20EMA catches up to current price levels.

What about less Debt?

The news out of Europe just keeps getting worse. While earlier we described how the squabbling within Merkel's own party could scuttle her political career, not to mention hopes for ongoing German funding of European bailouts, next we learn that she has not only outright rejected Finland's demands for loan collateralization out of Greece (which would in turn make Greece a selective Debtor In Possession lender, or, in other words, a prepack bankruptcy candidate 101), a move which Finland will likely balk over and very likely unilaterally exit from the second Greek bailout (remember that whole "Greek Bailout #2 is Dead on Arrival" from June 5?), but what is worse, according to Der Spiegel, tomorrow CDU coalition partner CSU will likely propose several "explosive ideas" which not only reject a common "economic government" for the eurozone (thereby slapping Sarkozy fully across the face), but also consider "creating a bankruptcy procedure to kick out of the euro countries that aren't willing to stick to the debt limits laid out in the euro zone's Stability and Growth Pact." In other words zero steps forward, and as many steps back as it takes to get us to before not only the July 22 Greek bail out, but all the way back to the beginning of the year. Only this time, the market is fully aware that both Italy and France are also on the hook: that can not be unwound with any paper.

Update: sure enough, here is Ambrose Evans-Pritchard with his own perspective on just this topic, which is oddly comparable to Zero Hedge's: "Mrs Merkel's aides say she is facing "war on every front". The next month will decide her future, Germany's destiny, and the fate of monetary union."

Every time we discuss the futility of the n^th bailout of [Greece\PIIGS\Europe\the Euro] we make it all too clear (most recently here and here) that the trade off between Germany onboarding ever more peripheral financial risk in one after another all too brief attempt to prevent the implosion of European capital markets and its currency, is not only a relentless creep higher in German default risk (and lower in the German stock market, as August has so violently demonstrated) but increasing political discontent, which after claiming countless political regimes across the world, has finally settled down on one that truly matters: that of German chancellor Angela Merkel. And as Reuters reports, Merkel's disappointing response to an ever escalating set of crises, both domestic and international, means that the beginning of her end (and by implication of the Eurozone, and of the Euro) may be as soon as September 23, when the vote over the expansion of the latest and greatest European bailout lynchpin, EFSF, will take place. 

The consumer driven recession has begun. Keeping it very simple of the four GDP components (consumer, fixed investment, government and net trade) the consumer has simply rolled over. In Q1 2011 the consumer contributed 1.46% to the 0.4% total GDP. In other words if it was not for consumer growth or even if .5% of that growth was removed the economy contracted in Q1 2011. Fast forward to Q2 where the consumer component is now 0.3%. In other words the trend of the consumer is deteriorating. Representing roughly 70% of total GDP the consumer is the economy. Confidence drives the consumer, the consumer drives demand and demand drives the economy. Well judging by the epic fall in University Of Michigan Sentiment, now at multi year lows the economy is in serious trouble. To get a sense of the economic reality facing the US look at the historic correlation between sentiment and real GDP.

I am not an anti-intellectual...I am an anti-moron of the counter buffoonery school. 

Bond King's cardinal sin at the Treasury market analyzed..... 

The NYSE has just announced that precisely zero vacuum tubes were inconvenienced by the biggest climatic let down since global warming.

For anyone who is still confused why the tail-wags-dog reverse relationship of the stock market as a leading indicator to the economy, and to western civilization in general, can be a problem for said civilization (not to mention the former) once the current iteration of central planning loses control over everything, as it always does, here is an interview between German daily Spiegel and Paul Woolley, a one time fund manager, and currently head of the LSE's center for Capital Market Dysfunctionality (sometimes affectionately known as the Princeton Economics department) who explains why things are on the edge of a precipice. His message for anyone who thought that Irene may have been a risk: you ain't seen nothing yet. "The developments in recent weeks have made it quite clear that the markets don't function properly. Things are spinning out of control and are potentially dangerous for society. Only a fraternity of academic high priests connected to the finance markets is still speaking of efficient markets. Still each market participant is pursuing their own selfish interests. The market isn't reaching equilibrium -- it's falling into chaos."

For awhile now, the market has loved to talk about risk-on or risk-off.  Occasionally a few outliers exist, but by and large that pattern of everything risky up or down together has been holding.  It felt like that is potentially starting to fall apart this week. The first thing that caught my eye, was the difference in performance between credit and stocks.  The CDX IG16 index was actually wider on the week.  It closed at 123 the prior week and finished this week at 126.25.   That is not a major move, but is in sharp contrast to the SPX which was up 4.7% on the week.
That relative out performance of stocks left many investors scratching their heads.  For all the talk about "credit" leading stocks, or warning signs in the credit markets, they were all ignored this week, at least in U.S. Stocks. Good luck, and hopefully the simplicity of risk-on or risk-off will return, otherwise I suspect this will get very messy as so many trading strategies have depended on it.

There was a time when being short was a bad idea. Not anymore. As David Kostin' summarizes in his latest weekly chart packet, the level of 3 month S&P and sector correlation is now at a 20 year high, an environment which never leads to good outcomes for long-only whales, and which has led to sizable outperformance for hedge funds due to their recent loading up on short positions. To wit: "S&P 500 three-month correlation is 0.73, the highest in at least the past 20 years, and up from just 0.44 at the start of August. Sector correlation is similarly high, with all major S&P sectors experiencing realized correlation above their 95th percentile since the late 1980s. While it is difficult to specify a cause for higher correlation, a spike in S&P futures and ETF trading volumes and parallel reduction in open interest held by institutional and levered funds as reported by the Commodities and Futures Trading Corporation (CFTC) indicate significant de-risking in August." What does that mean for recent performance? Nothing good if one is a mutual fund: "Elevated correlation is generally considered a poor environment for long-only fundamental investors. In highly correlated sell offs the market does not discriminate based on company fundamentals, reducing the value of stock picking. Recent performance trends support that case." As a result hedge fund LPs are doing ok: "The typical hedge fund has generated a 2011 YTD return of -1% through August 19 compared with a -10% decline for the S&P 500 and an -11% return for the average large-cap core mutual fund." Alas, if the hedge fund in question is Paulson & Co., this average statistic is very misleading.