Archive - Jun 2012

We have discussed the use of correlation (cross-asset-class and intra-asset-class) a number of times in the last few years, most recently here, as a better way to track 'fear' or greed than the traditional (and much misunderstood) VIX. As Nic Colas writes this evening, a review of asset price correlations shows that the convergence typical of 'risk-off' periods in the market is solidly underway. While we prefer to monitor the 'finer' average pairwise realized correlations for the S&P 100 - which have been rising significantly recently, Nic points out that the more coarse S&P 500 industry correlations relative to the index as a whole are up to 88% from a low of 75% back in February. In terms of assessing market health, a decline in correlation is a positive for markets since it shows investors are focused on individual sector and stock fundamentals instead of a macro “Do or die” concerns.  By that measure, we’re moving in the wrong direction, and not just because of recent decline in risk assets.  Moreover, other asset classes such as U.S. High Yield corporate bonds, foreign stocks (both emerging market and develop economies), and even some currencies are increasingly moving in lock step.  Lastly, we would highlight that average sector correlations have done a better job in 2012 of warning investors about upcoming turbulence than the closely-watched CBOE VIX Index.  Those investors looking for reliable “Buy at a bottom” indicators should add these metrics to their investment toolbox as a better 'mousetrap' than the now ubiquitous VIX.

With the Supreme Court likely to announce its decision on the constitutionality of Health Care Reform Law this Thursday, BofA outlines five possible scenarios and their potential impact across the healthcare sectors. They base the likelihood of their scenarios on a review of the March oral arguments, previous circuit court decisions, as well as surveys of legal experts and former Supreme Court clerks. Everything you need to know about the possible outcomes and actions to take.

In a finding that many have subliminally known about for years, but never been actually proven, yet is still quite shocking, the WSJ is reporting that tourism portal Orbitz "has found that people who use Apple Inc.'s Mac computers spend as much as 30% more a night on hotels, so the online travel agency is starting to show them different, and sometimes costlier, travel options than Windows visitors see." Which is not really surprising: after all Mac users tend to "see" far pricier computers too, not to mention "buy." As a result, Orbitz has decided to automatically redirect Mac users: aka the rich, but gullible ones, to seeing hotel offers that are more expensive than those seen by PC users by on average $20-$30. Call it OS screening, and call it perfectly acceptable: because it appears, empirically, that Mac users are perfectly ok with spending more than they have to for virtually anything.

The underlying premise for much of the management of other-people's-money (OPM) is that if the market drops by an appreciable amount, then Bernanke will step in and save the day. The problem with these 'perceived truths', as Charles Biderman of TrimTabs notes, is that they come-and-go; much like buy-and-hold and China-as-the-engine-of-the-world's-growth. The belief in the Bernanke Put has been around since the end of 2009 and is why the biggest holders of stocks are today mostly fully invested because they really believe that the Fed will remain the buyer of last resort. Unfortunately, as Charles points out, 'market truths always end badly' and in this case what is underlying the belief is that sooner of later the US economy will grow fast enough to allow the Fed to stop priming the pump with newly minted money into stocks; and in this case, he fears, "the headwinds are just too big and that rapid growth will not happen any time soon".

One of oil's most important characteristics is its fungibility, which means that a barrel of refined oil from Texas is equivalent to one from Saudi Arabia or Nigeria or anywhere else in the world. The global oil machine is built upon this premise – tankers take oil wherever it is needed, and one country pays almost the same as the next for this valuable commodity. Well, that's true aside from two factors that can render this equivalency void. In fact, crude oil prices range a fair bit according to the quality of the crude and the challenge of moving it from wellhead to refinery. Those factors are currently wreaking havoc on oil prices in North America: a range of oil qualities and a raft of infrastructure issues are creating record price differentials. And with no solution in sight, we think those differentials are here to stay.

Just out from the TOTUS, who manages to convert a Supreme Court slap into a piece of pre-election propaganda like no other.

The long anticipated downgrade of the recently bailed out Spanish banking sector has arrived. Moody's just brought the hammer down on 28 Spanish banks. Also apparently in Spain banks are now more stable than the country: "The ratings of both Banco Santander and Santander Consumer Finance are one notch higher than the sovereign's rating, due to the high degree of geographical diversification of their balance sheet and income sources, and a manageable level of direct exposure to Spanish sovereign debt relative to their Tier 1 capital, including under stress scenarios. All the rest of the affected banks' standalone ratings are now at or below Spain's Baa3 rating." Can Spain borrow from Santander then? They don't need the ECB.

While few want to think about their death, its becoming increasingly popular for folks to prepare for the inevitable by pre-planning their own funerals (we assume a little like England's soccer team yesterday). While cremation is rapidly gaining on straight-up-burial, funeral costs remain high; and despite non-traditional options like 'Angels Flight Inc.' which launches your ashes in fireworks or 'Space Services Inc.' which sends you posthumously into orbit around the moon, the following infographic is a guide to budget-busting your own 'happy-ending'.

US equities dumped out of the gate from the day-session open - after drifting lower with Europe all night/morning. Regimes shifted as Europe closed with Gold and Silver spurting higher (with the latter outperforming to play catch-up from last week) which led to the start of a correlated risk-on move in stocks (egged on in a 'ignorant' way but Oil strength from its increasing war-premium given the middle-east turbulence.) The levitation on low average trade size and low volume was mind-blowingly algorithmic as ES came to rest for the last hour almost perfectly at VWAP (and EURUSD seemed pegged at 1.25). Just like on Friday though, with a few minutes to go, ES dropped rapidly on heavy volume and average trade size as it would appear institutional sell orders plagued the market. The close took us back into the down-trend channel and back to 10-day lows for stocks. Modest USD strength (and JPY strength on carry-unwinds) left Oil lower from Friday but well off its lows as the rest of the commodity complex surged. Treasuries gained back all of Friday's losses ending at Thursday's low yields with 30Y outperforming. Financials and Energy sectors were worst with the major financials ending down 5-7% from the pre-downgrade close now. HYG (and HY) outperformed in the short-term but as we noted earlier remains a convergence trade than an indication of rotation or strength. The late-day dump in stocks lifted VIX back over 20% ending up 2.3 vols as implied correlation lifted back above the 70 'crisis' levels once again.

While everyone's attention was focused on details surrounding the household sector in the recently released Q1 Flow of Funds report (ours included), something much more important happened in the US economy from a flow perspective, something which, in fact, has not happened since December of 1995, when liabilities in the deposit-free US Shadow Banking system for the first time ever became larger than liabilities held by traditional financial institutions, or those whose funding comes primarily from deposits. As a reminder, Zero Hedge has been covering the topic of Shadow Banking for over two years, as it is our contention that this massive, and virtually undiscussed component of the US real economy (that which is never covered by hobby economists' three letter economic theories used to validate socialism, or even any version of (neo-)Keynesianism as shadow banking in its proper, virulent form did not exist until the late 1990s and yet is the same size as total US GDP!), is, on the margin, the most important one: in fact one that defines, or at least should, monetary policy more than most imagine, and also explains why despite trillions in new money having been created out of thin air, the flow through into the general economy has been negligible.

The NATO system — set up to oppose the Warsaw Pact system, which no longer exists — functions the same way — rather than dissipating risk, it allows for the magnification of international tensions into full-on regional and global wars. In the late 20th century the threat of nuclear war proved a highly-effective deterrent which limited the potential for all-out-war between the great powers, offsetting much of the risk of the hyper-fragile treaty system. Yet the potential for magnifying small regional problems into bigger wars will continue to exist for as long as NATO and similar organisations prevail. We do not know exactly what arrangements Syria has with Russia and China — there is no formal defensive pact in place (although there is one between Syria and Iran) though it is fair to assume that Russia will be keen to maintain its Syrian naval assets, a view which is supported by the fact Russia heavily subsidises the Syrian military, and has blocked all the UN-led efforts toward intervention in Syria. After the Cold War, the Warsaw Pact was allowed to disintegrate. Until NATO is similarly allowed to disintegrate, the threat of magnification will remain large. Could a border skirmish between Syria and Turkey trigger a regional or even global war? Under the status quo, anything is possible.

The last few days have seen high-yield credit markets remain remarkably resilient in the face of an equity downdraft.  Both HYG (the high-yield bond ETF) and HY18 (the credit derivative spread index) have remained notably stable even as stocks have lost over 3% - and in fact intrinsics and the underlying bonds have improved in value modestly. HY bonds are much less sensitive to interest rate movements (especially at these spread levels) and so, in general, this divergence in performance is aberrant (especially with equity volatility also pushing higher in sync with stocks and not with credit). So why is high-yield credit not so weak? The answer is surprisingly simple. As we argue for weeks from the end of LTRO2, credit markets were far less sanguine than stocks and have leaked lower ever since. This 'relative' outperformance of high-yield credit over stocks appears to be nothing less than the last of the hope-premium bleeding out of stocks and re-aligning with credit's more sombre 'reality' view of the world. Given the sensitivity of HYG (and HY) to flows, and the weakness in risk assets, we would suspect that outflows will now dag both lower as they resync at these higher aggregate risk premium levels.