Archive - Aug 24, 2012

It seems everyone and their pet Goldfish has been brainwashed into the belief that because it's an election year, we have to buy stocks. There is plenty of noise in that empirical study with some large outliers. However, Credit Suisse's Harley Bassman notes there is another cycle in election years - that of implied volatility - and he adds "the clearly defined economic nature of this election should increase implied volatility on most financial assets." As the chart below shows, volatilities tend to trough in August and peak in October into a November election - only to fall once again from two-weeks before to one week after the election. The pattern is clear.

The past several weeks have made one thing crystal-clear: Our country faces unmitigated disaster if the Other Side wins.

The odds of Fed easing at the September FOMC meeting seem close to 50-50 (with both sides vehemently talking their books - Fed officials and equity managers alike). Recent data has been a bit better: payrolls, claims, retail sales, and industrial production. As UBS' Drew Matus notes, other factors that will play a role include the ISM report, claims reports, and 'fiscal cliff'-related events. However, the primary determinant will be the upcoming August payroll report. The chart below ignores these other factors and offers up the odds of further easing in September based on the base case that Bernanke’s primary concern is the state of the US labor market. July’s 8.3% unemployment rate and payroll gain of 163k put current odds of further easing at 45%.

If you haven’t heard yet, the committee which is drafting the platform for next week’s US Republican National Convention has announced that they are including a proposal to return to the gold standard. Big news. Remember, a gold standard is a monetary system in which individual currency units are fixed to an amount of gold held by the government; under a gold standard, the paper money supply cannot be expanded without also increasing the amount of gold on hand. At present, the market value of the federal government’s gold holdings only amounts to about $250 billion which constitutes a mere 2.5% of US money supply. Clearly one of the key risks in this scenario is that the US government would need to acquire as much gold as they can get their hands on, likely through Roosewellian-style gold confiscation, and if so - the safest place for your gold is going to be a snug safety deposit box in a place like Hong Kong or Singapore.

With the polls apparently seeing it all tied up at 46-46 (and heading into the period when McCain and Obama diverged so strongly in 2008), a recent Gallup poll brings up the age-old question of whether the electorate will vote with their hearts or their wallets. Only in a Facebook-world; but 54% 'like' Obama versus 31% 'like' Romney but this huge social-network-factor disappears when asked who will better handle the economy - 52% believe Romney will be better for the economy as opposed to 43% believing in Obama. Of course none of that matters if the market remains up here.

Debt offers a compelling fantasy: there is no need for difficult trade-offs or sacrifices, everything can be bought and enjoyed now. If income is flat and interest rates already near zero, then where is the leverage for additional debt going to come from? The answer is the game of relying on ever-expanding debt is over. You can claim phantom assets and income streams as collateral for a while, but eventually the market sniffs out reality, and the phantom assets settle at their real value near zero. Once the collateral is gone, the debt is also revalued at zero, and the debtor is unable to borrow more. This is the position Greece finds itself in; the collateral and income steams have been discounted, the credit lines have been pulled, and so the reality of living within one's means is reasserting itself. Living within one's income (household or national income) requires making difficult trade-offs and sacrfices: either current consumption is sacrificed for future benefits, or the future benefits are sacrificed for current consumption. You can't have it both ways once the collateral and credit both vanish.

Bloomberg has run a story, citing two anonymous central bank officials, stating the ECB may not be ready to finalise its plan to buy government bonds at the September 6th meeting. JPMorgan's European economists note that the story cites two reasons for this: (a) The Governing Council wish to wait until they have seen the German constitutional court ruling on September 12th before proceeding; and (b) The programme is still being worked on staff may not be able to finalize it by then. Critically, JPM, like us, regard (a) as something of a smokescreen. The idea that work “is not complete” may also be a euphemism for the fact agreement on the contours of the policy is proving elusive - which in turn contributes to the sense that opinion on the Governing Council is deeply divided, and hence its commitment to any policy intervening in markets will not run deep. That could undermine the effectiveness of policy interventions themselves - and no matter how many rumors you hear, you should focus on what you DO know - that a decision is delayed - and everything else is as useful as a personal guarantee from Samaras.

Despite the valiant attempts to create something from absolutely nothing in the last few minutes of the European week (to wit Hilsenrath's Bernanke story and ECB bond 'corridor' rumors), Europe fell back from its hope-ridden highs this week. Spanish 5Y CDS broke back above 500bps, as did its 10Y spread to Bunds - giving back 10 days of 'gains' - while the exuberant front-end closed the week basically unchanged (but 40bps higher in yield from Monday's best levels). For context, Spanish bond spreads remain well above the peak crisis levels of last November - having bounced perfectly off them on Monday. European stocks ended today with small gains but all red on the week with Spain's IBEX -3.4%. EURUSD gained 200pips on the week as Fed QE hope faded and we suspect the re-appearance of EU pain repatriated more EUR.

It is Friday, and the market is in danger of posting its first weekly loss in months. Which means it is time for everyone's favorite Fed mouthpiece, Jon Hilsenrath to hand over the podium to his true superior, Ben Bernanke, by posting the Chairsatan's response letter to Republican Darrel Issa in which he defends QE and leave in the following: "There is scope for further action by the Federal Reserve to ease financial conditions and strengthen the recovery." And just to make sure that as Hilsenrath is to the Fed, so Reuters is to the ECB, we get the following tried and now simply pathetic regurgitation of the Spiegel rumor from this Sunday (which was since denied at least two times for the simple reason that Germany will never agree to open-ended debt monetization until global stock markets are literally collapsing) via Reuters: "ECB considering setting yield band targets under new bond buying programme according to sources." Of course, neither Ben has said anything new, nor the ECB has said something that is on the margin either credible or actionable (recall that earlier today the ECB explicitly said its hands are tied until the Kardinals of Karlsruhe make their decision in 3 weeks), but the market doesn't care, and surges. Sadly for the programmed market ramp, the non-news was leaked too early, and should have been released at 3:30 pm at the earlier. Look for a full German denial shortly.

"It is rather amazing that a 2.8% yield on the long bond couldn't do the trick. By hook or by nook, it looks like the Fed is going to make an attempt to drive the rate down even further — but if that was the answer, wouldn't Switzerland, Japan and Germany be in major economic booms right now seeing as how low their 30-year bond yields are? Monetary policy in the U.S.A. is not the problem, so it is doubtful that it will be the solution. It all boils down to fiscal and regulatory policy and how the government can part the clouds of uncertainty — the Fed may be able at the margin to cushion the blow, but that's about it."

Next week will see a slew of key data releases across the Euro area. The week will kick off with the German Ifo for August due on Monday which Goldman expects to fall slightly, reflecting the softening in the August composite PMI.  The business climate index has been signalling a further loss of momentum in the German economy, with both key dimensions - the assessment of current conditions and business expectations - deteriorating since May. The chart below shows how both components have evolved during the European debt crisis. The 'expectations' component appears to have been particularly affected by European developments. As far as the sectoral breakdown is concerned, the Ifo was still signalling rather robust domestic growth in construction, and in retail and wholesale goods, while the manufacturing sector seemed to have been adversely impacted by a weakening in external demand. The 'flash' reading of the August manufacturing PMI for Germany, however, seems to indicate that this could be changing. As the chart indicates, between the survey's mediocre perspective of the current situation and its negative expectations for the future - we have completed the circle and stand back at precarious Mid 2008 levels - and we know what came next.

It is often said a picture paints a thousand words; in the case of this chart, it paints more. Day in and day out, there is one inimitable indicator that if looked at will tell you everything you need to know about the day's market performance - volume. The last few weeks - post-Draghi, Post-Knight, stunned many with just how low volume can get; and implicitly just how much the battle-bots remain in charge. Clarifying this picture of low volume strength and high volume weakness, John Lohman has created the following chart - summarized thus: YTD, low volume days have seen the S&P 500 rise around 15% in aggregate, while high volume days have seen the S&P lose around 5% in aggregate. The linear nature of the low-volume move is simply remarkable - perhaps September will bring some real volume back, and now we know what that means for market direction.

Breaking news that the 5th Avenue and 34th street area in New York has been closed after 5 people were shot outside of the Empire state victim, including the gunman. According to police scanner reports, the perpetrator has been shot by NYPD ans is is DOA on scene, with EMS assistance requested.

The market was just starting to digest the schizophrenic Durable Goods data when chatter broke of the German FINMIN discussing a 'temporary' GRExit. In other words, just like Mario Draghi could transmogrify the twilight zone into reality during Merkel's vacation, and spread unfounded rumors that Europe is fine, now that the Chancellor has returned, the rumors take on the other side of the equation, and the mice no longer can play. This pushed S&P futures below overnight lows (down about 5pts from Dur Goods), EUR down 40 more pips (-75pips from close), and 10Y Treasury yields dropped 3bps (down 6bps from their overnight open). As we stand S&P 500 futures appear poised at an important trend-line tipping point in this move as Draghi's dreams are delayed to mid September and the world stops believing - as there is market talk also that Netherlands, Finland, Slovakia and Estonia are said to back the German plan.