Archive - Aug 2012

Look out below!

In a gold-based monetary system, every asset is ultimately backed by gold. This does not mean that every debtor (including banks) keeps the full amount of its liability in gold coin just lying around. Why would one bother to borrow if one did not need the money? It means that every asset generates a gold income and every asset could be liquidated for gold, if necessary. If a debtor declares bankruptcy, the creditor may take losses. But he can rely on the gold income stream for each asset or if need be he can sell the asset for gold. In a gold-based monetary system, money is gold and gold is money. Money cannot disappear; it does not go “poof”. Bad credit can be defaulted and must be written off. But money merely changes hands.

Measuring the 'contentedness' during this summer of total comfort is tricky. With equities at the year's highs in nominal prices in the US and breaking multi-month highs in Europe, how do we 'know' the relative richness or cheapness (or hope or despair) that is priced into stocks and what the 'fall' ahead looks like. We may have found a way. Europe's economic and implicitly market performance is very much based on the explicit belief that the EMU remains in tact and that Draghi's recent 'promise' will enable sovereigns to go about their economic business (austerity and growth) without the hindrance of those nasty speculating long-only fixed income managers repricing cost-of-funds and eating into the nation's growth. In the US, it's all about multiples - P/E expansion (in the face of lower 'E') has maintained the hope; and so it is in Europe. The following chart shows the extremely high correlation between European equity P/E (hope multiples) and European Sovereign risk. At the end of LTRO2, European stocks were exuberant only to fade away; currently, European stock multiples are once again back to those exuberant 'hope' heights. Trade accordingly.

When financialization fails, the consumerist economy dies. This is what is happening in Greece, and is starting to happen in Spain and Italy. The central banks and Central States are attempting resuscitation by issuing credit that is freed from the constraints of collateral. The basic idea here is that if credit based on collateral has failed, then let's replace it with credit backed by phantom assets, i.e. illusory collateral. In essence, the financialization system has shifted to the realm of fantasy, where we (taxpayers, people who took out student loans, homeowners continuing to make payments on underwater mortgages, etc.) are paying very real interest on illusory debt backed by nothing. Once this flimsy con unravels, the credibility of all institutions that participated in the con will be irrevocably destroyed. This includes the European Central Bank (ECB), the Federal Reserve, the E.U., "too big to fail" banks, and so on down the financialization line of dominoes. Once credit ceases to expand, asset bubbles pop and consumerism grinds to a halt

VIX is nothing more than the market's implied 'factor' that makes the supply-demand of options prices fit with model-based parameters. In simple terms it measures the market's expectations for volatility (up or down moves - not just down) going forward. Empirically it has a relationship with realized volatility - how much the market actually moved up or down relative to what VIX expected - and professionals will use various 'scalping' techniques to lock in day-to-day gains from the difference between the market's actual movement and what options prices expected. To wit: the current expectations of central bank action, just as it did in 11/2011 (global CB action) and 1/2012 (LTRO1), has caused a slow steady leak higher in stocks which crushes realized volatility - currently at record lows. This in turn drags implied vol lower as the 'scalpers' sell vol to capture the difference. With September 'events' around the corner, we suspect there are only a few more days before realized vol picks up and implicitly implied vol momentum scalpers are squeezed out again (and despite a low absolute VIX, the market IS pricing for a pick-up in risk).

The face of Yemeni deli clerk Mutahar Murshed Ali was slashed nearly in two for committing that most grievous of offenses: refusing to "sell" a Colt 45 to a drunk 20 year-old in exchange for foodstamps (whose usage Zero Hedge readers know, recently reverted back to all time highs). Of course, Ali was perfectly in his right to refuse to exchange booze for EBT: we reported recently that "New York would prohibit welfare recipients from spending their tax-funded benefits on cigarettes, alcohol, gambling, and strip clubs under a bill passed overwhelmingly by the state Senate." That however appears to not have bothered the assailant, who nearly cut off the deli vendor's face off in retaliation for not getting the "entitled" quid-pro-handout.

Markets taking any negative news as additional must-have accelerators of a bail-out.

Time being of the essence.

But what if things just drag on? 

It's like Deja-Vu all over again. The last two days effluence exuberance in European stocks - most specifically Italian and Spanish broad indices - is extremely different from the lack-luster moves in corporate, financial, and sovereign credit markets. Yes, we know short-sale bans; we know fast-money; we know liquidity; but it is beginning to become a little farcical that equities are doing what they do with no follow-through from the actual underlying markets that 'should' benefit the most from whatever it is that the equity markets are rallying for. EURUSD ends the week perfectly unchanged from last Friday. Spain and Italy 10Y end the week down 60bps and 25bps respectively (but the gains were fading fast today - even as stocks accelerated). Europe's VIX collapsed 1.7 vols to around 21% today after being steady all week (as US VIX drops below 14%).

Bridgewater's Ray Dalio is quoted in a recent Barron’s interview, describing the current phase of the U.S. deleveraging experience as “beautiful”. He goes on to explain the three options for reducing debt: austerity, restructuring and printing money. “A beautiful deleveraging balances the three options. In other words, there is a certain amount of austerity, there is a certain amount of debt restructuring, and there is a certain amount of printing of money. When done in the right mix, it isn’t dramatic. It doesn’t produce too much deflation or too much depression. There is slow growth, but it is positive slow growth. At the same time, ratios of debt-to-incomes go down. That’s a beautiful deleveraging.” That sounds pretty good and makes sense. Or does it?

We all make mistakes. In the investment world, some mistakes arise from having imperfect information, some from not anticipating the future correctly and some from sloppy analytics. Sloppy analytics includes everything from outright mathematical errors or misinterpretations, to poor assumptions, to overfocusing on unimportant variables or underfocusing on important ones. Analytics is the most critical and controllable part of the investment process, but even if done flawlessly does not ensure a favorable outcome by any means because the views/ behaviors/incentives of other investors – and indeed, the investment environment itself – change continually in ways that can’t be anticipated. But there is one more common mistake that is a consistent source of perplexity for active investors. Over the years, my experience has been that those who lose money more often (and in greater amounts) than they should, often do so because of overconfidence. Overconfidence can lead to the conviction that one is only buying investments that will be highly profitable and one is only selling investments that no longer have significant upside potential. This can lead to a lack of diversification and a heavy concentration of money in a single investment or asset class. Overconfidence, however, also leads to overtrading.

The reason the market is up today? Jefferies' Peter Misek hikes his price target on Apple from $800 tio $900 (the same AAPL which is now supposed to grow almost exclusively in China, and where as Apple Insider just reported "China's second-largest carrier may end contract sales of Apple's iPhone"). Yes, middle market, $100-$200MM high yield bond issuer Jefferies has an equity research group. And yes, after working at JPmorgan, Scotia, Orion, Alpcap, and Canaccord in the past decade, Misek finally has found a place he can call home (for more than 2 years), or at least until the next bonus renegotiation-cum-upgrade option time. And yes, Jefferies actually is moving the volumeless market for the first and only time ever courtesy of 1.000 implied correlation between the NASDAPPLEURUSD. Which is great. Maybe Misek will be right here.,, Unlike his calls on DragonWave for example, where he was buying all the way from $7 until $2, in the interim moving his Price Target from $9.00 to $3.50 to $10.00 to $3.00. Peter likes even numbers. He keeps it simple, except for his $699 PT on AAPL back in March- why $699? "It's one iPad." Sometimes he likes it complicated.

How anyone can possibly do asset management business with the Goldmans, Morgan Stanleys or JP Morgans of the world is beyond me, and to even hint that they have analysis or performance on par with the independent shops is even worse than those "yo mamma" jokes from grade school!

"It's defining a new category in real estate" is how the ultra-luxury apartment business is seen in New York. Goldman's Lloyd Blankfein and his buddies (including Sting) at 15 Central Park West are set to double their money as Bloomberg reports four condos in the Richie-Rich style extravaganza of a building have hit the market at asking prices at an average 192% over what owners paid in 2007 and 2008. The most expensive (a five-bedroom 35th floor pied-a-terre), topping Oaktree's Howard Mark's previous $52.5mm record purchase at 740 Park, is priced at a stunning $95mm. Testing the glass ceiling of a $100mm apartment is nothing though - as just like the rest of the nation's apparent house price recovery 'tight supply is supporting the current spate of eye-popping asking prices' which obviously will mean an influx of 'very expensive' inventory hitting the market in the coming years. For $95mm we wondered exactly what the apartment comes with? Perhaps $90mm of gold bars on the coffee-table? Perhaps Hugh Verrier and his wife Celia sum up the largesse perfectly: "we just thought of it as a living space". Indeed, Hugh, indeed.

University of Michigan Consumer Confidence came modestly higher than expected and limped higher off the lowest levels of the year. However, aside from this apparently positive event (accoding to some media pundits), there are two worrying things shifting rapidly. Consumer outlook for the economy (as opposed to current conditions) dropped to their lowest of the year with the largest 3-month drop in 11 months (so much for hope?); and inflation expectations soared by the most in 17 months.