Archive - Dec 20, 2010 - Story

By now everyone has seen and played with the US debt clock via usdebtclock.org whereby anyone who so wishes, can find every little detail about America's current sad fiscal state. The fact that America currently has just under $14 trilllion in national debt should be no surprise to anyone who professes to having an even modest interest in the state of the US economy. Yet a new feature on the "debt clock", namely one which extrapolates future debt at current rates of advancement (instead of one based on the always completely inaccurate CBO estimates), and looks at US debt in the year 2015 will probably make many stop dead in the their tracks. If anyone thought that $14 trillion in 2010 debt is bad, just wait until we hit $24.5 trillion in total US national debt in 2015. And it gets even more surreal: total US Unfunded Liabilities are estimated at $144 trillion, roughly $1.2 million per taxpayer... Was that a pin dropping?

We want everything and we want it now, and we don't want to sacrifice anything to get it. Our solution is pathetically childlike: just borrow trillions of dollars every year to buy what we want, so no adult trade-offs are ever required. Just buy our energy from somewhere else so we don't have to make any sacrifices or balance competing demands...We want abundant, cheap energy, and we want someone else to supply it to us so we don't have to make any difficult trade-offs. We want all our entitlements and we also don't want higher taxes. Isn't this the acme of childish fantasy? When pressed about energy, we want to hide behind fantasies of fusion, or algae-based fuels, or some other technology which has been "10 years away" for the past 30 years or which is 20 years away from scaling up to industrial production, if ever. Our ignorance of the actual science is breathtaking, but we refuse to consider the possibility that breeder reactors and algae-based fuels may not pan out. At some point, probably within the next 5-6 years, the oil exporters will stop shipping their hydrocarbons to us in sufficient quantities to meet our demands, and bond buyers will stop trading their capital for absurdly low rates of return on U.S. Treasury bonds. Once it costs $1 trillion just to pay the interest on existing (and rapidly ballooning) debt, then we won't be able to borrow enough to fund the Empire and the Savior State and the interest. Trade-off time will finally be forced upon us.

One look at last week's insider transaction list confirms that the deluge of insider selling refuses to end, and is now well in the double digit billion category in recent months. S&P Insiders sold $512 billion in notional in the week ended December 17 per Bloomberg, slightly above the 6 month average, with the top five sales taking place in Google, Ralph Lauren, UnitedHealth, General Dynamics and Starwood Hotels: in these five names alone executives sold nearly $200 million worth of stock. On the buy side, one purchase skewed the distribution to the tune of 96%: an acquisition of TIMET stock (TIE) for $34 million represented nearly all of the $35.7 million in insider purchases in the past week. Incidentally this is the second week in a row in which we have observed material purchasing in TIE, with $2.6 million in Titanium Metals purchased last week (when it accounted for 75% of all insider buying). And with this week's TIE purchase, the insider buying recorded in the past week is the biggest we have seen since beginning to keep track of insider transactions.

As noted earlier, the first POMO of the day is now complete and the Fed's balance is now $7.790 billion bigger. This is only part one of today's monetization game as the afternoon will see Bernanke's asset increase by another $8 billion at 2 pm. The Submitted to Accepted ratio one POMO 1 came at a surprisingly low 2.2x, which indicates that PDs are not cash starved, and instead it leads us to believe that the selling in the markets is Primary Dealer driven. Hopefully the GETCOs will be able to sustain the offer-pressure should the selling intensify by day end as more and more banks seek to exit profitable risk positions.

From under the always interesting pen of CRT's David Ader and Ian Lyngen comes the firm's 2011 outlook for the Treasury market. The summary: "From the supply and demand perspective, there’s QE lite and QE2 vs. knowledge that at some point they’ll stop, eventually hike, and follow suit possibly on asset sales. (In point of fact we doubt the Fed may EVER do asset sales, but rather allow their assets to simply mature/redeem and stop reinvesting.) In any event we don’t see this as a 2011 threat but it’s fair to say that any bear market will be more substantial than whatever bull market we can connive. The problem is positioning for the latter when the former hangs as an inevitability someday." This dovetails perfectly with what we have been saying: ever increasing supply of USTs (potentially hit up to $2 trillion in 2011), will be offset by an ever more ravenous Fed monetization. Should rates continue to rise, the moment when this dynamically unstable balance reaches its tipping point will come far sooner than most expect. If, on the other hand, new signs of economic weakness-cum-deflation emerge, and if Rosenberg is proven right for the second year in a row, the Fed may just be able to postpone the point of "inevitability" as defined by CRT. Much more nuanced observations inside, which also include the firm's forecast for possible "tail risk" events.

Today is only the second time in 2010 that the New York Fed has scheduled not one, but two POMOs. Currently in process is a buyback of $7 – $9 billion of 2018-2020 bonds. After this concludes at 11 am, it will be promptly followed by a second POMO, this one beginning at 1:15pm and ending at 2:00pm, and will seek to monetize $6 – $8 billion of 2014-2016 in bonds. Of particular attention is CUSIP PC8 which is the 10 year auctioned off on December 8, less than two weeks earlier, and at a rate of 3.340%. It will be interesting to see just how much instaflip the PDs will exercise in order to pad their year end P&Ls via the move in price and the wide bid/ask margins paid by Brian Sack. We will provide the results as soon as they are published in just under half an hour. And just to make sure there is a wealth effect in time for Christmas, today's double POMO will be followed by another double POMO... tomorrow.

As usual, trust Rosie to cut through the chaff regarding the $858 billion tax package, which he views not as stimulative, contrary to what the suddenly bullish sell-side crew claims, but merely as preventing the government becoming a "contractionary economic force" - "How much
of the tax cuts will go into saving and imports remains to be seen. We think the “stimulative” effects are over exaggerated." Specifically, his trade recommendation based on a paralyzed congress and a debt ceiling hike is as follows: "by the time the second quarter rolls around, it will be time to buy volatility, S&P 500 puts, and gold." And in further debunking the perpetually wrong sellside groupthink, Rosenberg looks at bond forecasts from late 2009 and finds that virtually everyone who is now once again calling for a drop in yields was doing the same a year ago...and was wrong. The tangent is that if Morgan Stanley's Jim Caron is completely wrong for the second year in a row, we fail to see how the rates strategist can possibly claim to have credibility should he get this most important call wrong in two consecutive years. Lastly, for those who care about market fair values, Rosie shares his fair value model updates on the S&P, the TSX, Corporate bonds and the CAD.

In the past few days, European peripheral spreads have once again taken to widening both in absolute terms and relative to Bunds. The culprit: the ECB's permabid for insolvent debt has plunged from €2.7 billion to €603 million in the past week: this represents the lowest amount of bonds purchased by the ECB since the beginning of November. And without the backstop of wanton ECB buying sure enough the sellers emerge. Total debt holdings in the ECB's SMP program are now €72.5 billion. Incidentally one country which is certainly not benefiting from Jean Claude Trichet's largess with his bank's money is France, whose CDS earlier today hit an all time wide of over 100 bps on completely unfounded rumors that the country may be downgraded by one or more rating agencies. At this point expect to see the chart below yoyo in direct correlation to just how steep the sell off of European bonds may have been in the prior week.

It was only a matter of time: back in March, following revelations of the Lehman Repo 105 scam, we speculated that the days of Ernst & Young are numbered. Back then we said "we are confident that (again, with the assumption that we live in some
semblance of a sane/ration world), E&Y's Financial Services Office
is done...
and quite possibly the entire firm. Integrity is the number one
currency for an auditor, and just like Anderson, E&Y's just went out
in a puff of green-colored smoke." Today we learn that Andrew Cuomo is about to make E&Y's life a whole lot more difficult. Per the WSJ "State Attorney General Andrew Cuomo is close to filing the case, which
would mark the first time a major accounting firm was targeted for its
role in the financial crisis." Too bad - E&Y was surely hoping that just like everything else in this corrupt country, out of sight would mean out of mind, and soon everyone would forget about the firm's involvement in the biggest bankruptcy in history. Better luck next time...

One of our more successful predictions in advance of QE2 was that the Fed would raise the SOMA limit on holding at most 35% of any one treasury CUSIP. Sure enough, one of the paramaters of the QE2 launch included an indefinite lifting of the SOMA barrier. CNBC has just reported that the Fed will impose a new SOMA barrier of 70%. Of course, just like the US Treasury limit, this is a token number and can be removed on a whim - after all, the Fed is not accountable to anyone. We expect this new revised limit to be eliminated concurrently with the announcement of QE3 (or QE4 at the latest). In the meantime, this will have an impact on POMO dynamics as various treasurys that approach this barrier will see their buybacks slowed down. This is only relevant if one is involved in the Fed frontrunning business. Which these days is everyone.

In what is rapidly becoming a mockery of the investing process, after Netflix recently advised shorts to cover during their investor call, the firm's desperation has hit a new all time low. Today NFLX CEO, Reed Hasting, has responded directly to ongoing attacks by Whitney Tilson that his company is due for a major correction, by posting in financial website Seeking Alpha. Hastings' stunning conclusion: " Whitney lays out a series of potential issues for us: Our CFO’s
recent resignation; threats to the First Sale doctrine for DVDs;
Internet bandwidth costs potentially increasing; declining FCF
conversion; market saturation; weak streaming content; paying more for
streaming content; and increased competition hurting margins. He only
has to be right on one or two of these issues in 2011 for him to make
money on his short of Netflix. Odds are he is wrong on all of them, in my view. Let’s take them one at a time." And while Tilson has indeed suffered major losses so far on this short, we are very confident that his perseverance will pay off. As we noted previously, the major concern facing Netflix is not so much margins (which is a major concern), but cash flow generation. As such, we continue to view the probability of a follow on offering by the company to be very high, as the firm already issued high yield bonds recently and has very little dry powder left under the "indebtedness incurrence" basket.  In the meantime, we can all enjoy the spectacle that is NFLX' defense of its ludicrous 100x+ fwd P/E position.

• Debt Pyramid Scheme Now the Norm in America (Bloomberg)
• Mortgage-Bond Math Means Everyone Is a Winner (Bloomberg)
• Congressman Paul Says Fed Transparency is His Goal (Reuters)
• Drama needed to jolt Americans into tackling debt (FT) good luck
• The Chinese are playing grandmaster chess against an amateur America that can’t see beyond the second move (Weekly Standard)
• Soros Gold Bubble at $1,384 as Miners Push Buttons (Bloomberg)
• The Case Against Floating Currencies (WSJ)
• Video: 60min on the Muni Crisis with Meredith Whitney  (Mark's Market Analysis)

When looking at the price of gold, one wouldn't necessarily get the impression that there a material flight to quality. After all the shiny metal is a whopping $40 from its all time highs, courtesy of recent profit taking in the best performing asset class in 2010. Yet not all is well in Europe, where the EURCHF just plunged to a fresh all time low, as the flight to Swiss safety continues. At 1.2683, the EURCHF was lower in... never. What is odd is that for the time being this asset reallocation is ignoring precious metals. Yet the currency which is so far the most proximal compliment to gold, courtesy of the SNB's relatively prudent monetary policy, is indicating that gold should also be at record highs. In other news, expect Philipp Hildebrand to start panicking sooner or later: at the current rate of collapse, Switzerland can kiss its exports goodbye.

• Asian stocks decline on Europe debt concerns, South Korea artillery drill.
• BOE forecast to raise interest rate within 6 months: Confederation of British Industry.
• China drugmakers tumble after report medicine prices to be slashed by 40%.
• China's stocks plunge most in month on North Korea, interest-rate concerns.
• Crude oil trades near $88 a barrel on bets US recovery will raise demand.

A quick stop summary of the key market shaping developments from the US, Europe and Asia.