Archive - Jan 2012

While skimming the latest draft of the "TREATY ON STABILITY, COORDINATION AND GOVERNANCE IN THE ECONOMIC AND MONETARY UNION" or the EU fiscal draft in short, which is supposed to give Europe reason to rejoice as it says something about the ESM potentially being levered more than €500 billion (not absent additional funding of course, and we have seen how good the EFSF is in procuring capital), we have found the only two clauses worth noting. Which unfortunately show just what a farce this whole process truly is.

While European leaders would prefer to eschew concerns about individual sovereign nations' ability to pay, borrow, and spend in favor of an aggregate EU that they believe reflects better in the world comparisons (if any aliens are considering stimulus support we assume), Goldman's Hugo Scott-Gall is out today with his normal compendium of insightful charts. One specifically caught our eye on How Governments Spend as we makes the critical point (from a real money investor and not a talking-head perspective) that it is crucial to look at end-market exposures as well as geography. Investors exposed to consumers in countries facing significant ongoing household deleveraging (ring any bells?) face a demand picture that is likely to be challenging for some time. In his view this is more likely Southern Europe than Northern Europe and his critical point is that while many extrapolate trends in GDP multipliers for corporate earnings expectations, the need to reduce deficits relatively quickly for many European governments will reduce corporate revenue forecasts dramatically relative to empirical ponzi spending habits.

The reason I don’t write about markets so much anymore is because I don’t believe there are markets any longer. Sure there are flashing prices on the screens for various assets and those can be addicting to look at on a daily basis, but I think these “markets” are now merely a mechanism for government propaganda and a method to ultimately fleece more money from the uniformed masses that play in it by the casino operators and their puppets in government. It’s basically a hologram. I have alluded to this in recent interviews, but I myself feel extremely uncomfortable being involved at this point in a way I have never felt before. For now, I am still willing to play the game with some of my own capital but I fear I may regret this decision and that the smart thing would be to pull out completely and go entirely into hard assets as well as real estate abroad. This game is not safe. By definition, the longer the period of tension building the more explosive the release will be when it ultimately happens. This period has already been going on for almost five months with only minor releases so I think we are already staring down the barrel of something horrific. Should they actually succeed and delaying the release until after the election I expect the release scenario to be downright cataclysmic. Should they succeed to delay it that far I hope I am wise enough to pull the remainder of my assets out of this casino beforehand and get entirely physical.

For those following the latest naval developments in the general Arabian Sea area and the Straits of Hormuz in particular, the latest news is that the duo of Aircraft carriers on location, as was reported last week, the USS Stennis and USS Vinson, has became a trio, with the arrival of the USS Lincoln, however, if only briefly. According to the US Navy's website, CVN 74 Stennis has left the 5th Fleet, and is now back in the 7th fleet, on its way home. Yet this is somewhat contradictory with the following picture posted on the facebook profile of one CVN 72 Abraham Lincoln (yes, faceook), which quite vividly shows CVN 74 - the same Stennis - and CVN 72, Lincoln, side by side, at least as of this morning. As such, absent further photographic evidence to the contrary, it may be the case that while the Stennis is planned to be on its way back, but in reality is still in the vicinity. Which begs the question: why three aircraft carriers in the Arabian Sea, and for how long?

While we are sure Mitt Romney would not care to comment, private equity firm KKR's Henry McVey is strongly suggesting investors should avoid European sovereigns in his 2012 Outlook. While his reasoning is not unique, it does lay out a fundamental fact for real money investors as he still does not feel that Core or Periphery offer value. Specifically noting that "fiscal austerity among European nations is likely to lead to lower-than-expected growth, which would ultimately increase the debt-to-GDP ratios of several countries in the coming quarters", the head of KKR's asset allocation group sees a slowdown in Europe as core macro risk worth hedging. Expecting further multi-notch downgrades across both the core (more like BBB than AAA) and periphery, McVey also concludes in line with us) that Greece may need to restructure again in 2012 and will disappoint the Troika.

Instead of opting for a publicly transparent BWIC in the disposition of its Maiden Lane II assets, the Fed has once again gone opaque - long a critique of the Fed's practices which have required repeated FOIAs in the past to get some clarity on its secret bailouts and transactions - and proceeded with a private sale, without any clarity on the deal terms, in which it sold $7 billion in face amount of Maiden Lane II assets direct to Credit Suisse. The alternative of course would be the same snarling of the MBS and broadly fixed income market that we saw in June of last year. In other words, the Fed looked at the options: transparency and risk of grinding credit demand to a halt, or doing what it does best, which is to transact in the shadows, and avoid capital markets risk. It opted for the latter. As to why the Fed decided to go ahead with a deal shrouded in secrecy? "The New York Fed decided to move forward with the transaction only after determining that the winning bid represented good value for the public." "I am pleased with the strength of the bids and the level of market interest in these assets," said William C. Dudley, President of the New York Fed. Because if there is one thing Bill Dudley and the Fed knows is gauging what is in the best interest of the public... and the callorie content of the iPad of course.

America's loss is China's gain. In the aftermath of the Keystone XL fiasco, which will see not only a number of jobs "uncreated" but a natural source of crude lost, Canada is already planning next steps. Which will benefit Shanghai directly and immediately. As Bloomberg reports, "Prime Minister Stephen Harper, in a telephone call yesterday, told Obama “Canada will continue to work to diversify its energy exports,” according to details provided by Harper’s office. Canadian Natural Resource Minister Joe Oliver said relying less on the U.S. would help strengthen the country’s “financial security.” The “decision by the Obama administration underlines the importance of diversifying and expanding our markets, including the growing Asian market,” Oliver told reporters in Ottawa." Ironically, it is diversifying away from the US, with its ever soaring, politically-predicated uncertainty, that is a source of stability and diversification. But it is not only crude. Wonder why no jobs are being created? Wonder why despite record low mortgage rates there is no bottom in sight for housing? Simple - nobody can plan one month, let alone one year ahead for any US-based venture or business. The political risk is simply too great - whether it is contract law (see GM and Chrysler) or simple solvency (see record high levels of cash hoarded by companies), it is there, and as long as it is there, there will be no hiring, no capex spending, no growth, and no real improvement in the economy, the real economy, not that defined by where the Russell 2000 closes on any given day.

Notes of interest as I browse through the Goldman Q4-2011 earnings release...

The rolling euphoria continues. European sovereigns have performed well again today with a significant surge into the close (helped earlier by ECB buying and optically successful auctions). Italian 10Y is trading back at 450bps over Bunds (one-month tights) and European banks ripped higher in equity and credit markets (as belief in capital raising plans takes hold). As we noted earlier, GGBs have been underperforming all week but equities and credit seem unstoppable here. USDJPY has crumbled in the last hour or so (around the same time as sovereign spreads started to accelerate their compression) and Treasuries (and Bunds) are very significantly underperforming (with the former now 13bps higher in 30Y for the week). While the dollar continues to weaken (and EUR strengthen back over 1.29) commodities are 'oddly' rolling over with Copper, Oil, Gold, and Silver all well off their earlier highs as Europe closes.

Back In May 2009 Zero Hedge was the only website to post (following a NYT Dealbook takedown for reasons unknown) the lament of one, now former, Deutsche Bank employee and whistleblower, Deepak Moorjani, who made it very clear that going all the way back to 2006, Deutsche Bank was allegedly fabricating data, and misleading investors about its commercial real estate holdings, courtesy of a lax regulatory strcuture and the "lack of a system of checks and balances". To wit: "At Deutsche Bank, I consider our poor results to be a “management debacle,” a natural outcome of unfettered risk-taking, poor incentive structures and the lack of a system of checks and balances. In my opinion, we took too much risk, failed to manage this risk and broke too many laws and regulations. For more than two years, I have been working internally to improve the inadequate governance structures and lax internal controls within Deutsche Bank. I joined the firm in 2006 in one of its foreign subsidiaries, and my due diligence revealed management failures as well as inconsistencies between our internal actions and our external statements. Beginning in late 2006, my conclusions were disseminated internally on a number of occasions, and while not always eloquently stated, my concerns were honest. Unfortunately, raising concerns internally is like trying to clap with one hand. The firm retaliated, and this raises the question: Is it possible to question management’s performance without being marginalized, even when this marginalization might be a violation of law?" The story was promptly drowned, despite our attempts to make it very clear just what practices the bank was engaging in in the follow up exclusive titled "One Whistleblower's Fight Against Goliath Over the Definition of Risk." Today, the questionably legal practices by Deutsche Bank are once again brought to the forefront with the Propublica article of former WSJ journalist Carrick Mollenkamp titled "Deutsche Analyst Sounded Alarm When Asked to Alter Numbers." This is the second time a pseudo-whistleblower has spoken out against an endemic culture of fraud at the German bank in two years. And nobody cares of course, for obvious reasons - the Zen-like tranquility of the status quo may never be disturbed, or else the endless crime and corruption lurking in the shadows will be exposed for all to see.

As financials and builders (and implicitly markets in general) levitate further, Peter Tchir of TF Market Advisors takes a brief and somewhat sarcastic look at the factors that are supporting the rally.

Friday comes early today

• GREEK POLICE ARREST WOMAN FOR EU48 MLN IN UNPAID TAXES

No commentary necessary

If you leverage $100 per month in surplus capital in a household into a $100,000 home equity loan that is squandered on luxury cruises, a new kitchen, boats and dining out, then that explosion of spending boosts "growth" like a shot of cocaine. But then what happens when the borrowed money has all been spent? What happens when the borrower defaults? The underlying assets--the boat, home, etc.--can all be auctioned off, but a massive loss remains to be swallowed by the lender. Needless to say, the bankrupt borrower will be unable to borrow another $100,000 any time soon, even if interest rates are lowered to near-zero. That's what happens when you try to fool Mother Nature by substituting debt expansion for increases in meaningful productivity. Eventually the surplus that is being leveraged into debt reaches the point where it cannot leverage any more debt, and the over-leveraged borrower defaults at the first financial bump. An economy that is dependent on constant massive increases in debt to fund its "growth" is not sustainable. In a very real sense, the U.S. has been fooling Mother Nature for 30 years. Now we've overleveraged the nation's shrinking pool of surplus capital and assets, and the last rabbit has been pulled from the magician's hat. Mother Nature (i.e. reality in the form of a transparent, marked to market balance sheet) is about to take her revenge on all those who reckoned she could be fooled forever by ever-expanding debt.

As usual benchmark revisions have saved the day for the headlines on the Philly Fed print. Expectations for the data was a 10.3 and it came at 7.3, a definitive miss to expectations, but of course thanks to revisions this rise to 7.3 (from 6.8 revised) is heralded (in a short-lived manner) as evidence of improvement. Under the covers though, things aren't so rosy. New Orders and Shipments dropped notably, number of employees was merely flat and while restocking seems to be occurring modestly (inventories improved) they still printed negative. On the six-months ahead outlook, expectations are for lower prices received but everything else reflects the hope-infused perception of steady growth - especially the notable rise in capex. Initial market reaction is negative to the miss.