Archive - Jul 2010 - Story

With everyone now agreeing fundamentals are completely irrelevant, the only things that could possibly matter are charts. And in this particular case, the key one on an ultrashort term momentum-driven basis likely is the ES upchannel as seen on the chart attached. Every time the support barrier is approached, a few hundred blocks appear our of the woodwork to preserve the self-fulfilling fantasy. Yet, it is getting increasingly more difficult to validate the phantom buying. Keep an eye out on this channel in the next few hours/days.

Last Friday we reported that the most important (and most underreported) story of the week was Bloomberg's disclosure that Chinese banks may struggle to recoup about 23 percent of the 7.7 trillion yuan ($1.1 trillion) they’ve lent to finance local government infrastructure projects, and that only 27 percent of the loans to the financing vehicles can be repaid in full by cash generated by the projects they funded. As this is a topic that deserves much more attention, we present the views of Goldman's Ning Ma on this critical issue, which when combined with Fitch's recent disclosure that the CDO market is ramping up in full force halfway across the world, and that China has 66 million vacant homes, should all come together in a nice and tidy confluent package of a combustible real estate-cum-credit explosion. Of course, this being Goldman, guess which way the spin is pointed: "We continue to believe systemic risks associated with such loans are limited. Key to watch: The results of restructuring and NPL recognition in 2H10 (mainly from unrecognized social projects and misused loans, but likely far less than 23% NPL ratios), and credit cost allocation among banks and local gov’ts." In other words, ignore the biased conclusion, but certainly focus on this most recent unravelling of the Chinese bubble.

Even as stocks continue pricing in QE2 (presumably some time in the next 2 years), bonds keep on laughing. The $38 billion in 2 Year Bonds just auctioned off at a 0.665% high yield, the lowest yield for a 2 Year primary issue. The bid to cover came in at 3.33, compared to 3.45 previously, and 3.15 average. Indirect participation plunged to 32.8%,compared to 41.41% previously. As the directs took down "just" 13.5%, the Primary Dealers ended up taking down a majority of the $38 billion bond auction, or 53.7%. The recycling of cheap Fed money has now fully arrived, and with an Discount Window to 2 year arb of 0.4% (0.66% - 0.25%), it shows just how bad things must be for the PDs.

Ever wonder why according to the latest economic poll published by Reuters earlier the general public's satisfaction with Obama's handling of the economy is deteriorating faster than any other issue? (not to mention that 46% of Americans believe Obama is not focused enough on job creation, and that 72% of republicans say they are certain to vote at the November congressional elections versus 49% of democrats). A part of the answer comes courtesy of a new study produced by National League of
Cities, the U.S. Conference of Mayors and the National
Association of Counties titled simply enough: "Local Governments Cutting Jobs and Services: Job losses projected to approach 500,000", showed local governments moved to cut
the equivalent of 8.6 percent of their workforces from 2009 to
2011. As a result of local government cutbacks, almost 500,000 people will lose their jobs, and the total will likely rise. The summary of the report attached below, is particularly grim: "Over the next two years, local tax bases will likely suffer from depressed property values, hard-hit household incomes and declining consumer spending. Further, reported state budget shortfalls for 2010 to 2012 exceeding $400 billion will pose a significant threat to funding for local government programs. In this current climate of fiscal distress, local governments are forced to eliminate both jobs and services." If Americans are dissatisfied with Obama's handling of the economy now, just until 2012.

RANsquawk US Afternoon Briefing - Stocks, Bonds, FX etc. – 27/07/10

The age old debate of whether luck or skill is more important for an investors'a success will likely never be resolved, although the attached presentation by Legg Mason's Michael Mauboussin provides some colorful anecdotes to validate the view of either side of the polemic. To be sure, working with someone like Bill Miller, Michael must be all too aware of just how prominent a role luck plays (or at least decade long leveraging into a cheap market bull run, only to see all your profits and reputation evaporate overnight when it all comes crashing down), which is precisely why his conclusion tends to veer on the side of skill. Obviously, when dealing with such concepts that have Gaussian distributions, as stocks increasingly demonstrate fractal features (courtesy of HFT), the whole debate is becoming increasingly moot. Yet Mauboussin does have an interesting discussion on reversion to the mean phenomena: something which in a world of near 1.000 implied correlation is of huge and often underestimated, significance: "We have mentioned already that reversion to the mean ensnares a lot of decision makers. This is
so important for investors, however, that it bears additional comment. The sad fact is that there is significant evidence that investors—both individual and institutional—fail to recognize and reflect reversion to the mean in their decisions. To illustrate, the S&P 500 Index generated  returns of 8.2 percent in the twenty years ended 2009. The average mutual fund saw returns of about 7 percent, reflecting the performance drag of fees. But the average investor earned a return of less than 6 percent, about two-thirds of the market’s return. The reason investors did worse than the average fund is bad timing: they put money in when markets (or funds) were doing well and pulled money out when markets (or funds) were doing poorly. This is the opposite of the behavior you would expect from investors who understand reversion to the mean." Ironically, investors have learned their lessons: after a nearly 60% ramp from the all time lows, investors continue to refuse to buy when everyone else is buying, contrary to the pleading by Obama, and all the conflicted fly by night permabullish mutual fund managers which CNBC appears to have an infinite collection of to recycle and fill content inbetween all those incontinence ads 24/7.

For the few, the proud, the stuck in the 19th century, with an "originate to hold" business model (such an anachronism when originate to distribute by hedge funds, pardon, banks is all the rage), the latest data by Freddie Mac, in which the 30 Year Fixed just dropped to a new fresh all time low of 4.56%, down 1 bp from the last two weeks, is about the worst news possible. While the short end is still cheap (and in the case of 2 Year, near record), the ongoing flattening is a death knell for anyone who still relies on funding curves to a some profit. As the Bloomberg article pointed out earlier today, the 60 bp tightening in the 2s10s is a huge impact to P&Ls, which is now actively reverting profits afforded to financial companies in 2009 and early 2010. Soon enough, the Fed's active management of the yield curve will force banks to come up with new and improved ways to pinch pennies from US consumers now that the profitability margin on the curve has been cut by 25% in a couple of months. Alas, that would mean the risk of inflation would have to be taken seriously. In its absence, look for flattening to continue as all on the wrong side of the trade continue capitulating, and making the future for JPM, Wells and BofA uglier by the day.

Rosie's market commentary from today is quite colorful, taking on both Barton Biggs (why bother) and Richard Russell as inflection point contrarians (we fully expect Barton Biggs who has now generated enough commissions for his broker to kill his entire P&L for the decade, to go bearish in about two weeks in keeping with his latest standing wave oscillation from one extreme to another). Rosie discusses a topic near and dear, namely that bonds continue to not buy the equity rally, and that the market is really not only stupid and inefficient, but wrong and overshooting most of the time. The only question is for how long can it remain wrong. And courtesy of the Fed, the answer is long, long, long. Not surprisingly David ridicules the constant lack of volume to the upside, and concludes that the rally should be faded, and that "this market is completely unprepared for 500k claims and sub-50 ISM." Obviously, he expects both to occur shortly (and just in time for Shiller to say he believe the chance of a double dip is more than 50%).

Major plunge in Consumer Confidence, which came at 50.4, below expectations of 51.0, and down almost 10% from an upward revised prior 54.3 reading, previously seen at 52.9: yes lower, but this BS revision was enough to make the jump in new home sales appear amazing post revision. Let's see if a real plunge in consumer confidence is enough to take the market lower by 100 DJIA points. Something tells us the gaps on revised data are only to the upside.

Expect absolutely nothing to happen today, with the possible exception of a counter trend move higher due to residual pull from the August 1200 strike. That said, lots of interest in the 1150 put already today.

Even as Yale's Shiller says he still has no idea where prices are headed, and that he is still worried about the possibility of a double dip recession (no disclosure on how he feels about the ongoing depression), here is Goldman to continue the cold water spillage process, saying that "Case-Shiller home price index rises more than expected in May, due to continued boost from homebuyer tax credit." Don't tell that to the headline reading algos which are now programmed to not only ignore all bad news, but to not read between any lines.

• EUR Libor at Highest in 11 months, hits 0.8275% (Market News)
• Hussman: Betting on a bubble, bracing for a fall (Hussman Funds)
• BP Replaces Hayward, Quickens Asset Sales on Record Loss (Bloomberg)
• Gift From Fed Stops as Profits Shrink at Banks Led by JPMorgan (Bloomberg)
• Paul Farrell: Unless women take control of Wall Street and America, 'The End' is near (MarketWatch)
• Economists Dispute Effect of US Stimulus (FT)
• Chinese Banks Face State Loans Turmoil (FT)
• Forbes: Obama's soft-core socialism (Forbes)
• "Systemic risk" theory gains in stature (WaPo)
• IMF Sees Yuan as Undervalued (WSJ)

• Chinese banks face state loans turmoil; about Rmb1,550B in questionable loans.
• Euro-zone June M3 sees 0.2% rise, private loans up.
• German consumer confidence rose to 3.9 points from 3.6 points in July.
• IMF sees Yuan as undervalued.
• India raises lending rates by 0.25 points to 5.75%.
• Japan to cap spending and new bond issuance for next fiscal year.
• Plosser says weaker data don't yet justify more Fed stimulus.
• Acuity Brands acquires LED Luminaire Company, terms undisclosed.
• Alcon's Q2 profit rises 15% on sales and margin growth. Ups full-year earnings outlook.

Euribor is again spiking by 0.4 bps overnight, from 0.889% yesterday to 0.893% today. In the context of the massive (and insolvent) European banking system, this is yet another indication that all is unwell with Europe's banks, even as the Goebbels brigade goes into overdrive.The interbank lending market does not lie, unlike every single European and American politician. And just to make things worse, the ECB withdrew another E11 billion in liquidity via a reduced 7 Day MRO. From Market News: "The European Central Bank on Tuesday allotted E189.9864 billion in its main seven-day refinancing operation at a fixed rate of 1.0%. The ECB satisfied all of the 151 bids received. Today's operation resulted in a net drain of E11.2996 billion after the ECB allotted E201.286 billion in its 7-day MRO last week."

We have long warned about the collapse in traditional market neutral trading strategies which for the past decade provided a major portion of the moderate market liquidity, and whose participants offset at least to an extent the disastrous influence of the HFT self-fulfilling prophecy that drives fractal momentum to ridiculous levels and whips the market into an irrational, lemming-like frenzy based on microvolatility, until everything snaps. Furthermore, our observations of the deplorable performance of various MN indices and funds, confirms that between liquidations and capital losses, this investment category may be doomed. The second quarter report by the Friedberg Mercantile group confirms this observation: "We continue to experience problems with our equity hedge program, a market-neutral strategy applied to U.S. stocks. For many years a successful program, earning above-average returns that were totally uncorrelated to S&P 500 returns, the program has repeatedly disappointed us in the most recent past, losing money in each of the past five quarters. This persistence of unfavourable outcomes is a totally unique event in the 19-year history of the program... Structural changes such as the proliferation of exchange-traded
funds and super-rapid computer-based bloc trading, activities that are
totally unconcerned with valuation metrics and/or long-term trends, are
still taking place and there is little or no prospect of this
development coming to an early end." There is a massive shift going on behind the scenes in market structure, and it is now far too late for the SEC or really anyone to do anything about it now. We anticipate implied correlation to approach 1 quite soon as every trading day becomes a manic-depressive bout in which the last few remaining traders and algorithms push the market up and down by a thousand points as the market becomes nothing than a sleaazy, unregulated, second rate, back-door Atlantic City illegal gambling parlor with a few stripper poles on the side for the CNBC cheerleaders. The point being anyone who tells you they can predict any movement in stocks now that valuations play no role in asset prices, is a charlatan, an idiot, is selling a subscription to a newsletter, or all three. Full must read Friedberg observations below.