Archive - Aug 2012

Moments ago, Egan Jones downgraded Knight Capital again, having downgraded the firm yesterday, from B- to CCC. The reason: the math just does not work out (pretty much as is the case with Europe, and the entire Welfare state developed world paradigm, but that's a different story). Full logic below.

Investors are piling into income-generating stocks at the fastest pace seen in decades. In the second zero-rate environment created by the Fed over the last decade, JPMorgan's Michael Cembalest brings attention to the frenzy of demand for income. This has led to a rush into income-producing stocks (e.g., ones that pay high dividends). As shown in the accompanying chart from Mike Goldstein at Empirical Research, the P/E ratio of the highest dividend payers is at a record valuation premium compared to the P/E of the broad market. Of course, this will not end well; as the constant apples-to-unicorn comparison of 'risky' stock dividend yields to risk-free Treasury yields (risk-free in terms of capital return - no matter what your view on inflation/default) that we have pounded the table (here and here most recently) about remains a stock-seller's commission-maker's portfolio-manager's stock-broker's dream.

For months everyone was confused, like lost lambs in a sea of noise and 500x leverage, not knowing how to navigate the stormy, choppy FX seas. Now we know. For that beacon of anti-precision, the man, the myth, the legend who bats 0.000 and thus is the most certain contrarian bet in history, Goldman's Tom Stolper has spoken: "We would now recommend going long EUR/$ at current levels with a one-day stop on a close below 1.18 for an initial target of 1.30." Start your selling.

Update 2: and spreads some more: Sterne Agee Not Routing Trades to Knight Capital

Update: it spreads: Fidelity Investments Not Routing Orders Through Knight: Reuters

Earlier, when interviewed by Bloomberg TV, Knight Capital CEO refused to say, prudently under advice of counsel, if any counterparties have cut off their lines to the fallen Knight. Well now we can confirm with 100% certainty that at least one Prime Broker has terminated all funding to and fro the firm which may not have much time left. We are certain it is not the only one. And now the scramble for a deal is on. If Lehman and MF Global are any indication, the odds are good to quite good. Inversely of course, just like Knight's berserk algo yesterday.

"Surely not" screams California's Comptroller. "Surely, Yes" sneers Knight Capital's self-aware destructo-capital algo. Faceberg just broke a monumental barrier, trading back into the teens for the first time - somewhere the Winkelvi are bathing in a salty pool of Schadenfreude.

Earlier we said that Knight better sell itself today or it's lights out. Sure enough, here come the rumors via the WSJ:

Knight Capital is in talks with Virtu Financial, a big player in high-speed trading and "designated market maker" on the NYSE, about a potential merger or infusion of capital

And more from Dow Jones:

• WSJ: Knight in Discussions About Possible Deal With Electronic-Trading Firm Virtu — Sources
• WSJ: Talks Also Involve Silver Lake Partners, An Investor in Virtu — Sources
• WSJ: Talks in Early Stages and No Deal Guaranteed — Sources
• WSJ: Knight Also in Talks With Other Potential Funders, Partners — Sources

Will it happen? Maybe. Although we doubt it - why pay for equity value when one can pick up the functioning assets in a Chapter 363 asset sale which also sticks the creditors with all the crappy assets? Just like Barclays did with Lehman for millipennies on the dollar.

Far fetched? Yes, but not crazy....

Ken Wattret who is chief Euroarea economist for BNP is quite furious with Draghi: the reason? Precisely what we warned last week: that Draghi is posturing and attempting to bluff the Bundesbank into accepting his "conditions." End result, Buba called the bluff and the ECB blew it in a fashion so spectacular that Draghi actually had to defend himself from reporters who were mocking him and the ECB with questions if the ECB won't get its inflation call wrong "again." It also prompted the head of the Central Bank to spin off Mario Draghi FX trading advisory, of which he is the sole employee, and issue the following Series 7 and 63 unauthorized advice: not to short the EUR, which incidentally was the dumbest thing he could say, because the one thing that can save Europe is if its currency keeps sliding (much to the benefit of Germany) in the process boosting Europe's manufacturing sector. That he openly warned against this is perhaps precisely why the EUR tumbled just after he said it. Trust us: the Chairsatan would love if investors were shorting the USD. Anyway, back to Draghi and the biggest French bank which realizes all too well one simple thing: Draghi no longer has credibility, and all those European banks which rely on the ECB for their day to day operations (like BNP) are suddenly far more exposed than ever before.

Spanish sovereign bond spreads blew almost 60bps wider today - that is the single-largest absolute move in spreads on record. Almost the entire gain in bonds post-Draghi 'Believe' speech from last week has been retraced in a mere few hours and while the front-end of the Italian and Spanish curves has outperformed, the sad fact is that in promising to maintain that end, then the entire rest of the curve becomes subordinated and therefore is sold as hope fades. Swiss, German, and Dutch short-dated bond yields all dropped to new record low rates. EURUSD has retraced its entire gain from Draghi-'believe', back to 1.2150 - despite his call not to short the EUR. Equity markets in Europe has dumped across the board today - with Italy and Spain -7% from pre-Draghi this morning - though notably still full of some hope from last week. It would seem that perhaps Mr. Draghi should keep his arrogant mouth shut a little more as we thought price stability was his mandate? The largest rise in EGB yields in a decade - all on the back of his misguided and over-confident egotistical attempt to jawbone markets to his reality. All mouth; no trousers.

Ron Paul’s signature Audit the Fed legislation finally passed the House; on July 25, the House bill was passed 327 to 98. But the chances of a comprehensive audit of monetary policy — including the specifics of the 2008 bailouts — remain distant. All that the current state of secrecy does is encourage conspiracy theories. What is the FOMC trying to hide? Are they making decisions that they think would prove unpopular or inexplicable? We can’t have a real debate about policy unless we have access to all the data about decisions. Those who believe the Fed’s monetary policy has worked should welcome transparency just as much as those who believe the Fed’s monetary policy has not worked. If the Fed’s actions have been beneficial, then transparency will shine kindly on it. If not, then transparency will help us have a better debate about the road forward.

It seemed as Rajoy and Monti let us all down, so something 'snapped'. EURUSD cracked lower and Spanish and Italian bonds re-accelerated lower but most critically an anomalously large volume rip went through S&P 500 e-mini futures (ES). 72,000 contracts traded very suddenly dragging ES down 8pts as it crossed the almighty VWAP line. 65,000 down volume or around $4.4bn notional equivalent wanted out very rapidly.

As hope fades of an ECB-funded lift to their bonds, Spain's Rajoy and Italy's Monti skip hand in hand to a press conference where they just agreed that water is wet and the sky is blue and that:

• *RAJOY: WE WANT BANKING UNION, FISCAL UNION SOON (and ponies)
• *RAJOY SAYS WE ARE ASKING GREAT SACRIFICES FROM CITIZENS
• *RAJOY SAYS SPAIN, ITALY CONVINCED ON NEED FOR BUDGET CUTS

But, as the market is indicating - no request for a bailout (why would they need that?) - and so Italian and Spanish bond yields are soaring and EURUSD is plunging further. It seems the Kubler-Ross model remains front-and-ceter with denial critical as beggars once again believe they can be choosers but the inexorable belief that they can magically grow their way out of over a decade of debt-fueled excess remains. (Spain 10Y Spread +65bps now from pre-Dragi and Italy +62bps)

In the aftermath of Knight's crushing algo-driven error and subsequent cash loss, which may well prove terminal for the business - an artifact of a broken market we have been warning and writing about since 2009 - we present some informative insights into the various eras of Wall Street trading errors courtesy of that grizzled trading veteran, the Chairman of the Fermentation Committee, Art Cashin.

To me the message is clear, Germany is going to do all it can to appear ready to help, but it will forestall any actual helping, especially if it involves increasing Germany’s exposure to the PIIGS (note: Merkel stated that there would never be Euro-bonds for as long as she lived). This is not political posturing. Germany has already brought its own solvency into question (see the Moody’s warning) by propping up the EU. Angela Merkel is not going to lose Germany’s AAA status the year before she’s up for re-election.