Archive - Jun 27, 2012

For the past six months we have extensively discussed the topics of asset depletion, aging and encumbrance in Europe - a theme that has become quite poignant in recent days, culminating with the ECB once again been "forced" to expand the universe of eligible collateral confirming that credible, money-good European assets have all but run out. We have also argued that a key culprit for this asset quality deterioration has been none other than central banks, whose ruinous ZIRP policies have forced companies to hoard cash, but not to reinvest in their businesses and renew their asset bases, in the form of CapEx spending, but merely to have dry powder to hand out as dividends in order to retain shareholders who now demand substantial dividend sweeteners in a time when stocks are the new "fixed income." Yet while historically we have focused on Europe whose plight is more than anything a result of dwindling cash inflows from declining assets even as cash outflow producing liabilities stay the same or increase, the "asset" problem is starting to shift to the US. And as everyone who has taken finance knows, when CapEx goes, revenues promptly follow. Needless to say, at a time when still near record corporate revenues and profit margins are all that is supporting the US stock market from joining its global brethren in tumbling, this will soon be a very popular point of discussion in the mainstream media... in about 3-6 months.

Traversing roads that seem like roads in some third world countries, I have to ask where is all the money going?

What few media pundits seem to grasp is that when our trade deficits transfer hundreds of billions of dollars to other nations, those dollars have to end up in dollar-denominated assets like bonds, stocks or real estate. Many people have missed the difference between dollars used to settle accounts and dollars held as a result of trade deficits. Many of those emotionally wedded to the belief that the U.S. dollar is doomed gleefully grabbed onto the news that China and Japan will swap currencies directly (yen and yuan) rather than intermediate the trade with U.S. dollars. This was mistakenly seen as a nail in the coffin of the USD. If I am in Japan and I have yuan due to trade with China, and I want to exchange those yuan for yen, I only need USD for about 10 seconds to intermediate the exchange. Cutting out the USD simply cut the exchange costs and lowered the daily trading volume of the USD. This reduction in the transactions needed to exchange yuan for yen did nothing to change the dollars held by China or Japan as a result of their trade surpluses with the U.S. This also didn't lower the amount of assets or credit (debt) denominated in USD. In other words, the effect on the value of the dollar is trivial. No matter how many exchanges the USD sitting in overseas accounts are pushed through, they still end up in dollar-denominated assets somewhere.

It takes a lot of talent to do so much with so little.

In the past 24 hours, some readers have been surprised to learn that as Jeff Reeves of InvestorPlace states, total Q2 CNBC viewership as calculated by Nielsen, has tumbled to to the lowest it has been since Q3 2005. This merely confirms that the trendline in our periodic observations of CNBC traffic was more than merely seasonal or VIX-related: it has been one long secular decline, peaking in the quarter of Lehman's demise and down hill ever since.

Germany keeps being told that it must pay up to save the euro. But how much can Germany pay? No-one seems to have thought about that, but there is already concern about the possible size of bill – German bond yields rose soon after news of the Spanish bail out, even before it was announced where the money was going to come from. (And it was of course a bail out for Spain, regardless of what Spain’s prime minister says. If I borrow money and then lend it to someone else I’ve still borrowed it.) There is though a more basic question. How much does it make sense for Germany to pay? What sort of bill would it be reasonable to present to them? In fact the best approximation one can arrive at is a bill of zero. Why zero? What about all these exports that have been produced because Germany has a currency whose value is determined not just by Germany but also by less productive, higher cost, economies?  That link has artificially depressed the prices of German exports. These net exports resulting from Germany’s Eurozone membership are actually the problem.

The two presidential candidates may be neck and neck in most (un)popularity polls, and according to some metaphorical sources are even the same person just with different Wall Street backers, but when it comes to the critical topic of resisting an alien invasion, Obama is far better prepared, according to two thirds of the population.

Something strange has been happening in India in the last year: while the rest of the "developed" world has been doing all in its power to crush its currency in order to promote exports within a globalist mercantilist system suddenly gone haywire, India has had the opposite problem: with its economy slowing down even as rampant inflation persists, its currency has been sliding against all other currencies. But probably more importantly: plunging against gold, as can be seen on the chart enclosed. It appears that finally after months of "being long of Gold in Indian Rupee terms" having proven to be quite a resilient and profitable strategy, the Indian state has also figured it out. And they are unhappy. Because to them, the key reason for the rupee weakness has nothing to do with the actual economy, and all to do with the Indian population trying to protect against currency debasement coupled with inflation: i.e., purchasing gold. And they will no longer allow it.

Another interestingly odd day. One of the lowest (non-holiday) volume days of the year but a big pick up in average trade size as the S&P 500 e-mini futures shrugged off Treasury strength, USD strength, and Gold's somnambulism seemingly led by an energy sector focused on only one thing - the bounce in WTI. Copper also drifted higher even as the USD leaked modestly higher (as assume the two got some hopium-infusion from China RRR cut rumors early on and sustained momentum as liquidity disappeared in many risk markets. Credit once again was a split-decision with the CDS markets underperforming (and notably thin from our discussions) while HYG (high-yield bonds) decided to lead the way (also on one of its lowest volume days of the year). Treasuries remain in a tight range over the last few days, as EURUSD limps lower, but VIX had a high vol day with its move higher in the face or rising stock prices (up to 20% vol at one point) providing some ammo for the late day surge in stocks as it was sold hard to close -0.25 vols only around 19.5% (as implied correlation broke 71% before plunging into the close).

In banking, what goes agound comes around - again.

In an excellent summary of the world's interconnected nature, reliance on everyone else to solve their problems, and Europe's epicentric catastrophe, Nouriel Roubini joined Bloomberg TV's Tom Keene for some serious truthiness and doomsaying. From the 'slowdown/recession becoming a depression' to 1930s CreditAnstalt comparisons and Germany's lack of trust that a few years of abstinence will regain peripheral Europe's virginity, the original Dr. Doom along with Ian 'G-Zero' Bremmer offer much food for thought as to the various scenarios as investors anxiously await an expected central bank response to the 19th failed summit and how "we will be lucky if we end up like Japan" as he concludes: "It’s getting worse, there’s already a sovereign debt crisis, a banking crisis, a balance of payment crisis, an economic crisis and all of those things together are getting worse."

While it is seeming common knoweldge that the state of the economy has a significant bearing on the outcome of the presidential election in the US, Barclays notes that in the case of an incumbent running, economic performance appears to be most important. The three presidents who failed in a re-election bid in the post-war period (Gerald Ford in 1976, Jimmy Carter in 1980 and George Bush, Sr. in 1992) did so against a backdrop of weak growth, high unemployment, and low consumer confidence. These same factors all pose significant headwinds to the current incumbent. To overcome them, history suggests that unemployment would need to keep trending down and consumer sentiment would need to strengthen prior to the vote in November.

Game Over for the once high flying hedge fund manager: "“Today’s charges read like the final exam in a graduate school course in how to operate a hedge fund unlawfully,” said Robert Khuzami, Director of the SEC’s Division of Enforcement."

The last few minutes of the European day ended with a resplendent surge in stock prices in the face of sideways to wider credit markets and deteriorating sovereign and FX markets. Not to be outdone, US equities remain in a world of hope of their own today having disconnected shortly after the US day-session open as Treasuries, Gold, and the USD have all moved in a more derisking mode. Also, despite S&P's 0.6% gain, VIX has just pushed higher into the green for the day.