Archive - Oct 2010 - Story

The key event in the coming week will be nonfarm payrolls on Friday as it will likely have a big influence on the ongoing debate over the likelihood of additional QE by the Fed. Goldman's forecast is for additional job losses on the headline figure (-50k vs consensus of flat) while the firm only expects slight private sector job gains (+25k vs consensus of +77k). It also expects the unemployment rate to tick up another 0.1 point to 9.7%, in line with consensus. A more cautious labour market outlook is consistent with expectations of additional QE, probably at the November meeting.

At least Bank of America is honest as to why it continues to recommend investors pursue risk assets: "Liquidity-friendly global central bank policies remain the lynchpin of our constructive view on risk assets...Our economics team believes that QE2 will come in the form of purchases of Treasury securities of $500bn - $750bn every six months until the economy reaccelerates." In other words, this is precisely what Morgan Stanley's Jim Caron said on Friday when he confirmed that in this market nothing else matters, except what side of the bed Ben Bernanke wakes up on: "Investment decisions across many asset classes today are tantamount to an educated guess on what the Fed decides to do regarding QE. In the near-term this trumps fundamentals, valuations and almost everything else. Thus the risk in the market is man-made, not freely determined by the market. In general, this is not a good thing because it may invite greater risks in the future." To be sure, the market is now trading nothing less than QE news, but with that comes the added uncertainty of how the world's central banks will react to this latest dollar debasement episode: while QE1 was crucial and needed by the entire world to prevent the collapse of the system, things this time around are far less clear cut. Yet it is so difficult to fight the tape: as the attached chart demonstrates, for the duration of QE1 (3/5/2009 through 3/31/2010), global equities surged 80.5% while since April 2010, and without the benefit of the Fed's generosity, global equities have only generated 0.8% in returns. Furthermore, Jim Caron points out that unlike QE1, there is a very distinct possibility QE2 will fail miserably (all fans of buying what David Tepper is selling would be wise to be very weary). Luckily, just like in the Morgan Stanley case, BofA now highlights that there is a distinct possibility of "fat tail" risks and advises clients how best to position against these.

A pair of very conflicting news articles over the weekend about secret currency talks caps yet another week full of central bank interventions in the FX arena (and, as Bruce Krasting points out, many more to come). Yesterday, the FT reported that France and China had been in secret talks over "heightened co-ordination of exchange rates" which is another way of saying finding alternatives to the rapidly debasing US Dollar. "The talks and their content have been kept secret, in an attempt to draw China into a discussion on global currency co-ordination, a subject that Beijing has been reluctant to countenance in the past. In an ambitious move reminiscent of the currency accords of the 1980s, President Nicolas Sarkozy hopes to open a debate on the subject when France takes over the presidency of the G20 group of leading nations in November, according to people familiar with the matter." Yet China's desire to engage in a currency axis away from the US is no secret, and many have alleged that Beijing has approached both Russia and Germany in the past about a USD substitute. The timing of the latest escalation of the battle to the currency bottom is not surprising: "The move comes against the background of rising concern over exchange-rate interventions by a host of countries, most notably China but also Japan and South Korea, to prevent their currencies from rising against the dollar." Perhaps China, which has been reticent in exposing its CNY domination plans in the past, was just waiting for the correct provocation to go public with its plans. And last week's move by Congress to retaliate against China and impose duties on imports because of undervaluation may be just that provocation.

The SEC's "definitive"(ly worthless) report on what happened on May 6th was a dud, and was nothing more than a distraction-based smear campaign against Waddell and Reed (an experiment in which we can only hope W&R participated involuntarily): a firm which did something that was completely in its right to do. But is this unexpected? After all had the SEC confirmed that it is indeed HFT who is responsible for a broken market structure, it would have effectively destroyed itself: if and when the SEC does indeed confirm that the entire market topology over the past 5 years has been hijacked by young and pustular math Ph.D.'s with fast computers, the implications to fair markets would be orders of magnitude worse than the fallout associated with the Madoff scandal, and could serve as grounds for the unwind of the SEC itself, which would have to explain why it has been avoiding calls against HFT impropriety for years. So in a sense Mary Schapiro's conclusion is nothing less than a lass desperate act of self preservation. Which however means nothing in the grand scheme of things. Tomorrow, as the WSJ reported a week ago, the Investment Company Institute, better known to Zero Hedge readers as the guys who track the now permanent weekly outflows from capital markets, is holding a secret meeting in which some of the participants "are determined to push for a plan to restrict high-frequency trading" (furthermore, the ICI was rather pissed about this particular leak, implying that things are really serious). While the SEC may have declared a market structure truce, and is peddling its usual worthless solution of circuit breakers (more on this below), actual market participants have had enough of seeing their profits plunge and seeing HFT extract more capital out of the market than the much maligned ten years ago market makers and specialists ever did.

Throughout recorded human history, legions of "experts" have developed and propounded scientific paradigms that, once objectively analyzed by a critical outsider, have proven to be nothing more than false and ritualistic. Galileo's view of the universe, Einstein's conceptions of gravity and general relativity, and Darwin's theories of evolution are but a few of the great 'Eureka' moments of scientific discovery that have revolutionized the way the world's experts think. In this context, it should not come as much of a surprise to learn that the Keynesian Aggregate Supply Aggregate Demand (AS-AD) model, the core model used by today's mainstream economists and central bankers to explain the dynamics of the modern economy, is patently misunderstood.

Many are quick (and correct) to blame Keynesianism for the current near pre-collapse state of the entire developed world. After all, the economy of the western world now functions strictly on an auction to auction basis (or, as is better known in layman's terms: "living paycheck to paycheck"): a state in which the US Federal Reserve and the global central banking cartel is responsible for making sure that not one hint of possible bond auction failure trickles down to the broader population. The fact that primary dealers, which are essentially the monetization vehicles of the New York Fed, account for taking down well over half of each auction is not lost on those who wonder what could happen in a world in which Ben Bernanke's organization were to lose its power, authority and market intervention capacity. Yet Keynesianism is merely an offshot of a far older thought experiment: that developed by Otto von Bismarck in the aftermath of the Franco-Prussian war 140 years ago. The "welfare state" regime created by Bismark is one that predates Keynesian economics, and serves as the nexus of today's rancid, nebulous and very much destructive intersection of economics and politics, at whose core, like a black hole which no wealth created through honest labor can escape, resides the "central bank" apparatus of status quo perpetuation. Luckily (for most), the welfare state experiment is ending. And as it departs one last time, it will expose the "depredations" of developed world governments for all to see, without the benefit of the cloak of the insurance provided by "welfare state" premises, which made the wealth transfer of 7 generations acceptable to those who knew they could extract at least something in exchange for the fruits of 140 years worth of labor. In his latest report, Bill Buckler, of the very highly recommended Privateer report, explains why and, more importantly, how this will happen.

Here is how you kill two birds with one stone, all the while confirming that Europe has been about a step away from a full collapse. Greece, which like Ireland, has been unable to peddle its bonds to anyone now that Bunds spreads are back to all time record levels, has just seen the last white knight of the Keynesian system come to its rescue: China. As Bloomberg reports, the European lender of last resort is no longer the ECB: "China has already bought and holds its Greek bonds,” Wen
said in joint comments with Papandreou today, which were carried
live on state-run ET-1 television. “It commits, very
positively, to buy new bonds to be issued by Greece." Yet herein lies the rub: in exchange for the Chinese last-ditch rescue financing, which by the way is so transparent that everybody, except maybe for the Norwegian wealth fund will see right through it, Greece, in what is an almost identical replica of the Petrobras shell game, will use the money to turn around and buy Chinese ships. "Wen said a $5 billion shipping fund will be set up to
tighten relations between the countries’ two maritime industries
and facilitate the sale of Chinese vessels to Greeks." Truly brilliant what Keynesians will come up with in the last days of a collapsing economic religion.

Spot the two SEC-endorsed differences in the attached chart. And repeat after us: it is all Waddell and Reed's fault.

One of the more important stories this week, in addition to the largely underreported collapse in the US foreclosures market courtesy of the Mortgage Mess, was the drop in Eurozone "excess liquidity" when roughly €225 billion in 3,6 and 12 month liquidity providing ECB credit facilities to Eurozone banks expired and were rolled into a far lower amount of replacement maturities: only 64% of the full amount was retendered, meaning about €80 billion in system liquidity was drained. What this means is that the excess liquidity in the eurozone dropped from an already low €100 billion to a paltry €20 billion. Could this be an indication that European banks have bought their own Kool aid as to their stability? If there is another systemic risk flaring episode, and Ireland is most certainly shaping up to be the next Greece and Portugal, just how will banks proceed to raise much needed liquidity, which has dropped from nearly €400 billion in late Q2 2010 to just above zero, and the lowest since the Lehman bankruptcy.

A very illuminating report out of BNY's Nicholas Colas and Beth Reed describing the front lines of the so-called gold bubble. A must read for everyone who would rather listen to third-hand anecdotes and speculation instead of actually doing their homework. As Beth summarizes: "Bubbles are clearly punctuated – and driven to their final demise – by bad behavior on the part of market participants. My short, but colorful, excursion to the heart of the physical precious metals market revealed no such excess. Is that enough proof to eliminate the possibility of a gold bubble? Of course not. But I think it is enough to characterize recent calls for the demise of the gold/silver rally as very much premature."

In this week's chartology from David Kostin, the Goldman strategist focuses on two key topics most pertinent to his client discussions: (1) The path of the US economy; and (2) whether profit margins will continue to establish new record highs. Kostin summarizes the divergence in views on the record corporate profitability (the micro bullish indicator) as follows: "No common ground exists regarding the outlook for profit margins. Bulls argue that further productivity gains will allow firms to drive margins higher to a succession of new record levels. Supporting evidence is that firms are not hiring (at least not in the US) so unemployment will stay high and the Fed will not raise rates, allowing firms to continue re-financing debt at low interest rates. Bears counter that weak top-line sales growth makes it difficult for firms to boost margins. Price hikes are impossible as the lack of job creation means wage growth is stagnant. A weak US Dollar (viewed by most clients as a secular trend) would help margins but only 30% of aggregate revenues for S&P 500 is sourced abroad and for the median firm the ratio is just 25%. Margins for emerging market operations are often lower than the overall company average." As for the macro picture: forget about it - as the Goldman macro team has noted numerous times, the economy is sliding, and only a last minute intervention from the Fed in precisely one month can help.

We continue our bedside reading series started last week with with a presentation of Didier Sornette's terrific "Critical Market Crashes" with this week's even more entertaining, introspective and troubling "Psychology, Financial Decision Making, and Financial Crises" by Tommy Gärling and colleagues of the Universrity of Gothenburg. The volatile nature of "product markets" has long troubled thinkers, theoreticians and philosophers alike who have struggled to explain why something which should on its face be efficient, be able to experience such demoralizing and turbulently violent events as May 6, Black Monday, and other historical crashes. Gärling proposes: "In product markets with full competition, prices represent the true value of the products offered. This does however not seem to hold in stock markets where stock prices, due to excessive trading, are more volatile than they should be if reflecting the true value of the stocks. Psychological explanations include cognitive biases such as overconfidence and overoptimism, risk aversion in the face of sure gains and risk taking and loss aversion in the face of possible losses, and influences of nominal representation (the money illusion) of stock prices. If no cognitive biases (strengthened by affective influences) existed or only some actors were susceptible to such biases, individual irrationality in stock markets would possibly be eliminated. This is however not what evidence indicates."

Continuing weakness in the US dollar, the perception that the economic recovery is starting to gain some traction and the somewhat contradictory – but just as bullish – feeling that the Fed is going to give the markets the long-awaited quantitative easing all worked together to boost oil prices on Friday. In the process, crude oil prices printed their highest level in seven weeks. The US dollar continued to get hammered, falling to its lowest level in six months against the euro. One of the more curious aspects of the recent advance has been the role of quantitative easing, the so-called “Q.E.,” which would be bad for the greenback once it happens – in theory – but has been even worse as a daily expectation." Cameron Hanover

I am starting to hear this mantra parroted through 'internet rumor' that because there is no inflation, gold has hit its high, and you're better off selling now while you still can, and certainly not buying any.

Everyone knows what Europe looks like on a political map: there are two or three countries in the center that are stable, and about 10 in the periphery that will be bankrupt very soon. The map is so boring we won't even show it. Luckily, courtesy of visual artist Yanko Tsvetkov, we have some European maps that are sure to enliven any cocktail hour. Note for the sensitive: these are not what one would call politically correct.