Archive - Aug 2012

Anyone who has been following US fiscal policy over the past three years, which by implication means US monetary policy since Congress and the president have dumped everything in the lap of the Fed, which by implication means the Fed's guide to investing in the Russell 2000, knows too well that it can be summarized in two words: financial repression. Read the attempt to force everyone out of "riskless" assets such as Treasurys and mortgages and into risky assets such as Amazon and its 200+ P/E. All else equal, there has been one huge error with this policy which is akin to the Fed attempting to herd cats: instead of pushing investors into other asset classes, all the Fed has achieved is to get everyone to front run it in buying whatever bonds the Fed has not committed to monetizing just yet as we showed before. The other problem is that all else is not equal, and as SocGen shows Financial Repression, even by construct assuming practice and theory were the same, will not be sufficient due to the following three reasons.

It's very simple really. Please point out where on the below list of Top 20 contributors to a randomly selected US politician, in this case New York's Chuck Schumer, can one find Standard Chartered, Barclays, or HSBC?

Only the little people are meant to suffer for their country.

For the last four days, HYG (the high-yield bond ETF) has seen a significant underperformance in the latter part of the day. As we noted yesterday, high yield bonds (and investment grade) are seeing the advance-decline line rolling over. Stocks stand notably expensive relative to high-yield credit once again and VIX smashed over 1 vol lower from its gap up open at 16.5% to end at near 5 month lows under 15.25% - its most discounted/complacent to realized vol in over six months. A weak 10Y auction spurred Treasuries to underperform - which helped pull S&P 500 e-mini futures (ES) risk higher (along with oil strength) but in general stocks and gold tracked one another loosely higher while the USD pushed conversely higher - ending the week so far unch. Cross-asset-class correlations drifted lower all day - with credit and carry FX listless while stocks/oil/Treasuries did their risk-thang (though oil tapered back to lows of the day by the close as Gold/Copper/Silver trod water. Three days of terrible volume, even worse average trade size, and the lowest range in five months suggests anyone serious has left the building and perhaps explains why stocks aren't following credit lower.

Every now and then we prefer to sit back and let some of the smartest money speak, especially when said smart money agrees with us. In this case, we hand the podium over to none other than Paul Singer's Elliott Management, which after starting with $1.3 million in 1977 was at $19.8 billion most recently. No expert networks, no high frequency trading, no "information arbitrage", no crony capitalism and pseudo monopolies of scale, and most certainly no bailouts: Singer did it all the old fashioned way: by picking undervalued assets and watching them appreciate. The timing is opportune because while Elliott has much to say about virtually everything in their latest 20 pages Q2 letter, it is the billionaire's sentiment vis-a-vis US Treasury debt that may be most critical, and may be the catalyst that resulted in today's abysmal 10 Year bond auction. To wit: "long-term government debt of the U.S., U.K., Europe and Japan probably will be the worst-performing asset class over the next ten to twenty years. We make this recommendation to our friends: if you own such debt, sell it now. You’ve had a great ride, don’t press your luck. From here it is basically all risk, with very little reward." There is little that can be misinterpreted in the bolded statement. And while many have taken the other side of the Fed over the past 3 years, few have dared to stand against Paul Singer because if there is one person whose opinion matters above most, certainly above that of the Chairsatan, it is his.

In a genuinely free market, rich corporations people have both the resources and incentive to corrupt the government in order to make the market less free. In other words, Capitalism only works in a world in which people have integrity and are accountable to others and themselves - which is the weakest link. And so you end up with? America. In short: "there ain't no such thing as a free market" - which is not to say that we shouldn't try. The following clip points out that even seemingly pro-business legislation is not beneficial to society or businesses themselves broadly with the analogy that "what's good for GM may not be good for America after all"; which begs the question: do humans doom capitalism by default?

Just over a month ago we laid out the market's key indicator for whether NEW QE (or the just as fungible LTRO / unsterilized money printing from Europe) was likely. The 5Y5Y forward inflation expectation has been invaluable in front-running decisions by the world's anti-deflation central banks. What is amazing is that the market has become so conditioned now to the glut of easy money (knowing deep down it fixes nothing but needing that fix for their 'assets') that based on this framework, it appears inflation expectations have now priced in another EUR1 trillion worth of LTRO. We strongly suspect, given the one-year highs in inflation expectations that the Fed will disappoint in September (no matter how much insanity Rosengren spouts) but Draghi will come under increasing pressure not to disappoint (like he did last time).

Trying to be “outside” of consensus is difficult, as it requires “mental capital”. You have to be able to withstand the daily barrage of tainted news, opinions and stock price movements. Going against the stream does not “feel” good and consumes more energy than simply floating with the tides. No pain, no gain. It is not easy to maintain your views given the unhelpful mainstream media (concerned about advertising dollars from financial services firms). Politicians and central bankers are nothing but bubbling fountains of propaganda (they somehow make it easier to read the truth between the lines, since they always seem to lie; for example, if the Spanish Prime Minister says “Spain has not asked the IMF for a bailout” you can safely assume that he if just off the phone with Christine Lagarde, begging the IMF for help)....Back to the stock market: even IF everyone was smart enough to buy stocks in the darkest days of a recession it wouldn’t work – every buyer needs a seller. The structure of the market – relatively constant supply of shares and relatively constant amount of money available for stock market investments (= demand) require any changes in investor preferences (cash or shares) to be resolved via the price. Humans are hard-wired to behave rationally. This makes it so hard for us to escape the “rationality-trap” of the stock market.

As channel-stuffing shifted from the US (here) to China (here) and Europe (here), so the new vehicle sales data has disconnected from a number of realities. Whether it is economic growth or Ford's share price, things look a little over-cooked in the land of if-we-build-it-the-government-will-buy-'em. However, there is one index that tends to see through all the unreality much more clearly than our analysis above, that is the Used Vehicle Price index. Each time this index has dropped and broken below its two-year average, the auto industry has tended to fade rapidly. After yesterday's comments on the lowering of collateral standards for subprime auto lending, it would appear we are setting up nicely for some whocouldanode moment in the manufacturing sector's most critical industry.

The ECB's announcement that it stands ready to act, first despised then embraced by the market, has left as many questions as it answers. Barclays has prepared a simple flowchart of the known unknowns from what has been discussed so far - starting from our premise that things have to get a lot worse before they get better since any action is contingent on countries (cough Spain cough) first losing face requesting help from the EFSF.

Real Wages Much Lower Than They Were Four Decades Ago

A month ago, the US issued $21 billion in 10 Year paper in what could only be dubbed as a "WTF Auction" - one in which every record was broken as demand for paper could seemingly not be satisfied. At 1 PM on July 11 the paper priced at 1.459%, a record-shattering 6 bps inside of the When Issued. What a difference a month makes. Not a month later and the just completed issuance of $24 billion in 10 Year paper could be classified as a collapse in demand, as the auction priced at 1.68% or a whopping 2.5 bps tail. Just as notably, after hitting an all time of 3.61 high last month, the Bid to Cover imploded to 2.49: the lowest broad demand indication since August of 2009. The internals were just as loopy: Direct take down imploded from a record 45.4% of total to just 5.2%, the lowest since November 2009, and with Indirects refusing to budge, the Primary Dealers were forced to take down 54.2%, or the most since October of 2011. And while the lack of interest was not surprising, especially in the aftermath of the just released Elliott Management letter (more on the later), the violent swings in demand for US paper at issue are starting to make quite a few desk traders very concerned. Because all it will take to crush the credibility of the bond market next is a few more such wild swings, and Geithner and Bernanke better hope that Knight can somehow be a DMM in TSY paper as well.

In the immortal words of Robin Williams in Good Morning Vietnam: July was Hot, Damn Hot! In fact, according to NOAA, it was the hottest July and hottest month on record and there's no short-term indication of this massively dry spell ending anytime soon. What is perhaps even more impressive is that the the last year has been the warmest 12-month period for the contiguous US since records began in 1895!

The easing of credit conditions (in other words, the enhancement of banks’ ability to create credit and thus enhance their own purchasing power) following the breakdown of Bretton Woods — as opposed to monetary base expansion — seems to have driven the growth in credit and financialisation. It has not (at least previous to 2008) been a case of central banks printing money and handing it to the financial sector; it has been a case of the financial sector being set free from credit constraints. Monetary policy in the post-Bretton Woods era has taken a number of forms; interest rate policy, monetary base policy, and regulatory policy. The association between growth in the financial sector, credit growth and interest rate policy shows that monetary growth (whether that is in the form of base money, credit or nontraditional credit instruments) enriches the recipients of new money as anticipated by Cantillon. This underscores the need for a monetary and credit system that distributes money in a way that does not favour any particular sector — especially not the endemically corrupt financial sector.