Archive - Aug 24, 2010 - Story

Given that bubbles are classically associated with the pursuit of prosperity, is there such a thing as a bubble in conservatism? When individuals are scared about their prospects they act conservatively by saving and paying down debt. Can a massive wave of conservatism, such as the one we’re experiencing today, hit a threshold that forces it to reverse (i.e. the ‘bubble’ pops)?

Some stunning bearish commentary from the staple CNBC goto analyst (Joe Lavorgna as if the clarification is needed) when worthless permabullish commentary is required. "We expect Q2 real GDP growth to be revised down sharply from +2.4% to +1.0% because of lower inventories (-$25B) and construction (-$4B) as well as a larger trade deficit (+$15B)." In other news, Zero Hedge still calls, and has for about 4 weeks now, a final Q2 GDP of under 1%, and under -3% when the impacts of the stimulus are excluded.

Goldman's Jan Hatzius explains why while he is still convinced that the Fed will ultimately have to undergo QE2, he presents the case why the Fed's hands are now most likely tied through its November 2-3 meeting (and why the J-Hole meeting will be a snoozer), at which point it will be too late for the market to benefit from monetary stimulus. The implication: very bearish for stocks, as Obama's only option for pumping up stocks in advance of the elections (monetary easing) is eliminated. With no means to implement a stock run up into the election (which would become a prompt self-fulfilling prophecy), the market is likely about to tumble.

Two few months ago we disclosed how the Illinois Teachers' Retirement System (TRS) was doing all it can to become the next AIG. In addition to, or maybe precisely due to, its deplorable fundamental condition, which can be summarized as being 61% underfunded on its $33.7 billion in assets, with a performance record of down $4.4 billion in 2009 and 5% in 2008, the fund, courtesy of a detailed analysis by Alexandra Harris of the Medill Journalism school at Northwestern, was found to be on its way to trying to become a veritable self-made TBTF: as was described then, "TRS is largely on the risky side of the contracts, selling and writing OTC derivatives, including credit default swaps, insurance-like contracts that guarantee payment in the event of a default." In other words, TRS was selling substantial amounts of derivatives, which held the fund's other assets as hostage in case the collateral calls started coming in, as should the market broadly decline, the value of the downside derivatives would "increase" and the seller (in this case TRS) would need to pledge ever more collateral against these wrong way bets. Not only that, but the Fund is currently getting annihilated on its curve exposure: "TRS appears to be betting that long-term Treasury yields will greatly increase" we wrote back then. So as a result of i) its massive underfunded fundamentals and ii) a bet that the market would turn bullish, i.e., spreads would drop (they are rising), and treasuries would plunge (we all know where they are today), which was supposed to happen by now but isn't as the economy is now officially double dipping, the fund has basically thrown in the towel and is proceeding with liquidations. The problem there is that due to its derivative exposure, liquidations now become self-reinforcing, as more cash needs to be pledged as collateral in a declining market, and the AIG death spiral we all know and love, follows. The only thing missing is for Goldman to raise its overnight variation margin requirements and it's game over, as we get a brand new AIG on our hands. And since Goldman is among the 60 or so asset managers that actually decide how the fund invests its meager assets, it is fully aware of its precarious position, and it is a sure bet that Goldman is currently deciding when to pull the plug on the TRS life support.

David's daily musings are as usual a treat, although we are very confused by how his call, that we are in a derpression, made a splash on CNBC - after all the man has been saying this for months now. Or is CNBC not allowed to utter the dreaded D and Double D words, unless the market has dropped by more than 5% in a week? Either way, the most applicable excerpt from today's piece was David's recommendation to "get small" as inspired by the Japanese, who have now lived an entire generation in a deflationary cycle. Alas, this very prudent advice will be lost and most certainly never work in the American culture, where bigger is always better, and living beyond one's means is the rule, not the exception, no matter the cost, or the credit card bills.

Renowned German economist Professor Wilhelm Hankel has written a second open letter to German Federal Chancellor Angela Merkel after his first plea to follow the dictates of reason and not introduce the constutionally disputed financial aid laws that will pump €750 billion into insolvent Eurozone banks while pushing Germany deeper into social and economic abyss was ignored. Hankel has already warned in 2005 that the Euro system is unsustainable. While I am still wondering to whom Germany will sell all the goods it now produces (and warehouses) when all important trade partners face the same economic and social problems, Hankel focuses on the adverse effects the hastily pushed through financial aid laws for Greece - which is already running into difficulties to comply with the austerity conditions that are part of the bailout - will have on Germany in the future.

He warns of dire consequences and states that Merkel may run afoul of the German constitution and her oath to stave off the German sovereign from bad damage.

Due to the various inventory and trade deficit overestimates by the CBO, the initial Q2 number is about to be revised much lower: realistically, it will come out at under 1%, although that will likely be saved for the second and final revision: therefore the adjusted number to be reported on Friday will likely be around 1.8%. Yet the real kicker is not that the government has ramped up data fudging to make poor China blush like a rank amateur, but that according to the CBO, of whatever the final Q2 GDP number is, 4.5% came from the stimulus. In other words, take away the end of the fiscal boost and the economy is accelerating its relapse into depression, just as Rosenberg (and Zero Hedge) have been claiming for about a year, over the din of the cheerleaders on propagandavision.

On Aug. 24, 2010, Standard & Poor's Ratings Services lowered its long-term sovereign credit rating on the Republic of Ireland to 'AA-' from 'AA'. At the same time, the 'A-1+' short-term rating on the Republic was affirmed. The downgrade reflects our opinion that the rising budgetary cost of supporting the Irish financial sector will further weaken the government's fiscal flexibility over the medium term. In light of the recent announcement of new capital injections into Anglo Irish Bank Corp. Ltd. (BBB/Watch Neg/A-2), our updated projections suggest that Ireland's net general government debt will rise toward 113% of GDP in 2012. This is more than 1.5x the median for the average of eurozone sovereigns, and well above the debt burdens we project for similarly rated eurozone sovereigns such as Belgium (98%; Kingdom of; AA+/Stable/A-1+) and Spain (65%; Kingdom of; AA/Negative/A-1+).

The market is now down 3.4% from the August 12 open, when the first Hindenburg Omen was sighted, on route to validating the prediction of a 5% drop. However, in the process it continues getting worse and worse - today we just got a third H.O. confirmation, and a 4th standalone HO event, as the market seems to be getting ever more schizophrenic, with increasing new highs and new lows, while the undercurrent is one of ever increasing implied correlation as noted earlier, as ever more asset managers simply rely on levered beta "strategies" to redeem their year. Unlike 2009, however, this time the trick won't fly, as it appears the market's downside potential is finally starting to be appreciated.

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 24/08/10

The $1Tr USD question today is whether this is it for equities and we are going to move aggressively lower. I am just about as bearish as it gets medium term and long term. However, short term it seems to me that it is not obvious we are going to move lower just yet. I was early to recommend taking profit around 1,070 the other day on the tactical shorts re-opened at 1,095 (we still recommended to be core short since 1,126), I am sorry as I misjudged how long this move could run. - Nic Lenoir

In light of Mr. Gross' earlier very humanitarian letter, we decided it would be sensible to demonstrate the holdings of PIMCO's flagship Total Return Fund (all 249 pages thereof) which at last check were just under $240 billion, and had a 4.92 effective duration. Setting aside Mr. Gross concerns for the broader society, we looked at what the suggested 300-400 bps adverse impact on just the the TRF's P&L would be: taking the $240 billion notional, and applying a 350 bps average hit to the fund's effective duration implies a hit of just over 17%, or a loss of about $40 billion. Assuming a comparable duration for Pimco's remaining $800 billion in AUM held in other vehicles, and one can see why Mr. Gross would be concerned about losing government backstops. We believe Mr. Gross may have forgotten to mention this slight tidbit from his letter. And for those who enjoy digging through letter appendices, oddly excluded in this case, here is the full breakdown of the TRF holdings.

When I read Paul Krugman and the other Keynesian boneheads saying that our debt is not a problem, they quote figures about our debt of $13.3 trillion versus our GDP of $14.6 trillion not being so bad. That is only 91% of GDP. They point to World War II when our national debt reached 120% of GDP. They say everything worked out after that. Today our reported National Debt is $13.362 TRILLION. This is the first big lie. There are two entities named Fannie Mae and Freddie Mac that happen to be 80% owned by the US government. Anyone who thinks these two companies can operate without the backing of the US Government are delusional. The US taxpayer is on the hook for these two disastrously run companies. Somehow, government accounting doesn’t require their debt to be considered the responsibility of the US taxpayer. This is a fraud, pure and simple. Their debt is our debt.

The 10 Year under 2.5%, Bunds, Gilts, JGBs all following suit to record risk-aversion levels, the EURCHF at record lows, the USDJPY at 15 year lows, and now this: the CBOE Implied Correlation index has just hit another historic plateau, touching on 85 earlier in the day, which means that all those who believe relative value can still be found are about to be carted off. Aside from the fact that the current level of JCJ would be the highest closing level in history, the intraday high of 84.50 is a very troubling indicator, which once again confirms that stocks continue to trade not on fundamentals, and probably not on technicals, but on ever increasing amount of leverage applied to some indication of beta. Essentially, market participants are likely levered to the gills like never before and betting it all on another daily Hail Mary. Another way of looking at the reading, as we have pointed out previously, is that stock dispersion: the most critical indicator of a healthy market, is at 15%! And let's not forget we are currently still in the H.O. regime (and to all naysayers we remind that the market has dropped almost 4% since the first Hindenburg Omen appeared). So many coincident records, can hardly be a coincidence... We look forward to getting Matt Rothman's thoughts on this increasingly disturbing trend, and for the NYT to pick up on this theme within 4-6 weeks.

The 1050 support level on the S&P 500 gave way as sellers reacted to the weaker than expected existing home sales. Take a step back: That break below support lasted for 15 minutes. The averages enjoyed a good bounce which took the NYSE a/d back to only 2 to 1 negative. The Russell 2000 came back and practically filled the gap from the opening. Now, the afternoon playbook. The Russell 2000 is outperforming on the noon time selloff and the volatility indexes, VIX, VXN and RVX are a lot closer to their lows of the session than the highs. For the bulls, we would like to see a close on the S&P 500 comfortably above 1050. On the other hand, if it looks like we are going to close under 1050, it will be all sellers in the last 30 minutes.