Archive - Sep 1, 2010 - Story

If you poke them enough, it appears they do eventually wake up. After many months of rants by Zero Hedge on both subjects of quote stuffing and sub-pennying, it appears the SEC is finally getting involved. Of course, this being the SEC, which a year after saying it will ban Flash trading, still allows HFT frontrunning as a perfectly acceptable and encouraged practice on such exchanges as DirectEdge (and Nasdaq, although the latter has recently voluntarily recanted from abusing the public's, tee hee, trust in regards to frontrunning), we don't have very high hopes. Nonetheless, the fact that the HFT marauders are finally in the regulator's bullseye, will promptly make such occurrences as daily flash crashes hopefully a thing of the past. In other news, we are happy that the SEC is finally starting to catch up with this thing called "teknoulogee."

A reader writes in with some troubling observations on what could potentially be a pretty substantial scheme to artificially "boost" existing home prices by up to 40%, putting all the NAR data, and all other relevant public housing data materially into question. Since trick is painfully simplistic, and all too easy to spot, we wish to open it up to our readers for verification, as this could be a huge hit to the credibility of all existing home price metrics, and put into question all transitory upticks in home prices, such as the backward looking Case-Shiller index indicated yesterday.

As per the August 31 DTS statement, the US ended the month with a new all time record of $13.45 trillion in debt, and increase of $210 billion from the beginning of the month (or $225 billion in public debt, net of intragovernmental holdings). With just 30 days left in fiscal year 2010, the US has added $1.54 trillion in the eleven months ended August 31, a monthly average increase of $140 billion. As a point of reference, the US has received $1.53 trillion in withheld income tax over the same period, confirming that the US continues to issue more than one dollar in debt for every dollar it receives via income tax revenue. This balance will likely be tipped soon courtesy of changes to the tax law, which will adversely impact the withheld tax line, implying even more funding has to come in the form of debt. Additionally, the US rolled another $513 billion in short-term debt: a number which continues to be persistently high, even as the total amount of short term debt as a percentage of total has declined steadily from 30%+ of total to around 20% as we have written elsewhere. Another $106 billion in Notes was rolled as well, with the intramonth cash balance dropping to a dangerous sub-$5 billion.

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While the merits of its conclusion are at best questionable, and at worst, completely worthless, the IMF study presented earlier provides one statistical curiosity vis-a-vis sovereign defaults. Specifically, in "Default in Today's Advanced Economies: Unnecessary, Undesirable, and Unlikely" the author Carlo Cottarelli presents an observation which could be classified as a "Hindenburg Omen" type of signal for sovereign default. Unlike the real H.O. observation (which incidentally has now been experienced 5 times in the past three weeks) for stocks, the one relevant for sovereign bankruptcy has a much simpler gating threshold: 1,000 bps spread in credit risk. And just like in the Hindenburg Omen, this is a necessary (but not sufficient) condition for a crash: only in this case it is not the market that collapses, but a country's solvency. Cottarelli finds that since the first Brady deals in 1991-92 there are 36 instances in which a country’s spreads rose above 1,000 basis points. "Of those instances, seven eventually resulted in default; in the remaining 29 cases, however, the spreads stayed high for a few months and eventually fell back well below 1,000 basis points, with no default." The 1,000 is logically an inverse gating factor: no single country defaulted with spreads being below the 1,000 threshold. In other words, once a country passes 1,000 bps, it has a one in five chance of defaulting, roughly in line with the crash expectations of the traditional Hindenburg Omen.

The ongoing retail abandonment of stocks is well into record territory, which may occur for any of a variety of reasons (need for cash via redemptions, focus on return of capital than on and shift into fixed income, market distrust, etc.), yet the resulting increasing relative participation by electronic feedback loop chasers and by beta levered players, and the subsequent increase in implied and absolute stock correlations may be a vicious circle that will make future retail participation increasingly more difficult. We have been warning about the threat of lack of stock diversification for many months, although have not been able to explain it as succinctly as BNY's Nicholas Colas succeeds in a recent note, titled "Looking for diversification in all the wrong places", in which he concludes: "If you cannot use diversification to manage incremental risk, then why would you take on risk in the first place?" This hits the nail on the head in terms of the ongoing and future lack of stock inflows, since in simple terms in makes the ever greater correlations between various asset classes a barrier to entry for all those very rational investors who seek to diversify bullish or bearish bets with a matched trade. In other words, the market is receptive only to those who blindly wish to bet it all on black or red (with or without leverage). And with ever more people chasing ultra short term return horizons (think numerous underperforming hedge funds that only have one month left to generate some returns in Q3 before their LPs send in the redemption notices), and placing all their bets on just one side of the line, those who wish to pursue rational trades, and generic long-short funds, increasingly obsolete and redundant. All in all, this is a perfect storm for a feedback loop that selects only for those who are willing to bet on an ever more one-sided, and thus unstable, market. Have we gotten to the point where only another market crash will provide retail with suitable speculative entry points?

The International Energy Association (IEA) has spoken. What the world needs now is a clean energy technology revolution. June saw the 2010 launch of IEA’s biannual report, Energy Technology Perspectives. Speaking at the launch was Nobuo Tanaka, executive director for IEA. The Gulf oil spill, he said, could prove to be a tipping point in the world’s energy consumption habits. He added that the disaster serves as a tragic reminder that our current path is not sustainable.

A week ago TCW's chief economist announced he would hold a presentation for clients explaining why the Double Dip has arrived. Here is the powerpoint used by Komal Sri-Kumar on the call.

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 01/09/10

A paper by the IMF which set off to reassure investors that all is well with the world, and that sovereign defaults are nothing to worry about, concludes that, "under the current and future pressures on public finances—large primary gaps and rising health care and pension spending—public debt would spiral out of control in the absence of fiscal adjustment" and hilariously adds: "The surge in debt in this scenario, however, does not even take into account the possible negative feedback effects that higher debt could have on interest rates and economic growth." And yes, these guys are the perpetual optimists...

The man who back in May wrote "Why the world is better than you think", only for the world to turn out about as bad as thought, if not much worse, Jim O'Neill, has just released the sequel to his required reading Kool Aid, "The World Is Down, But Far From Out" (is that a tacit apology for the previous title full of sound and fury?) which is currently making the rounds at all pension and mutual funds as well as all other institutions whose existence depends on the perpetuation of the illusion that the market is undervalued and that America is solvent. The latest essay provides absolutely nothing new and original in terms of though, and merely regurgitates the traditional expectation that China will rescue the world, as it continues decoupling from everyone else. We wonder if it has ever dawned on anyone that the only reason why China is so "resilient" in the face of the ongoing depression is because all of its numbers are completely made up? But that is apocryphal so we wont even ask that rhetorically, and accept at face value O'Neill projection that Chinese GDP will increase by over $7 trillion in the next 9 years, or nearly 3 times more than the US, even as both countries issue about $20 trillion in incremental debt (not bad: $2 of debt for $1 in GDP - even economists can probably figure that out). And where will this growth come from if not from the traditional driver of near-zero cost growth: low interest debt? Oh, so Jim is basically saying the world will grow arithmetically, as the credit bubble (now in its global iteration) grows semi-exponentially. Truly wonderful news. Yet even O'Neill, in his permabullish element, finally agrees that his entire forecast is based on one and only variable coming true - the Fed's ongoing debasement of the dollar: "Over the past couple of months, as evidence has accumulated that the US economy is slowing once again, US financial conditions have not tightened. Indeed, as a result of the aggressive policies of the Federal Reserve, conditions have remained very easy. In order for our more positive underlying views of the world to bear fruit, it is important that this situation persists." Basically, the entire global growth story, decoupling included, is based on what side of the bed the chairman of the politically and special interest independent Federa Reserve wakes up on.

Buyers got control from the get go today and the better than expected ISM data at 10 am pushed the S&P 500 and Nasdaq Comp right through their resistance levels of 1065 and 2155. Where are the doctor doom and gloomers today? Let’s get an updated outlook from Roubini, Feldstein, Rosenberg. Not now, CNBC has to wait for a big down day to bring those guys out so the public keeps watching that station.The S&P has stalled out just below its 50 day moving average sitting at 1081. With the NYSE a/d of 7 to 1 positive, I expect any pullback this afternoon to be minor. Assuming a strong close today, the market will be faced with the weekly unemployment claims tomorrow, factory orders and pending home sales. Any one of these could derail this rally but it is not the news but the market’s reaction to it that matters most. - Sitfel Nicolaus

Even as the melt up continues with the US economy double dipping, things in Europe are just getting plain worse by the day. First it was the disappointing series of PMI data out of the old continents, with a focus on the periphery, where pretty much every number missed expectations. Now Reuters is reporting that due to refinancing requirements to the tune of €25 billion by its two most insolvent banks Anglo Irish and Allied Irish, the banks, and the government of Ireland itself, has quietly request an extension of the European Commission bank guarantee program which bailed out the country back in 2008, and which is needed to bail it out all over again. "Ireland's guarantee, which is set to run out at the end of the year, saved its financial system from collapse when it was first issued in September 2008 and has continued to be a lifeline for lenders since the Greek crisis shut off their supply of term funding. Both Anglo Irish and Allied Irish Banks, the country's second-largest lender, have called for the guarantee to be extended and the government said it was in discussions with Brussels about its future." In other words, nothing continues to work in the European banking world, except that which is explicitly backed by the ECB, which in turn is implicitly backstopped by the Fed. If there was a reason for the melt up to surge another 3-4%, this is it.

Some happy news for all the bankers who have been living in fear lately of how the new financial regulations – also known as the Dodd-Frank Legislation – will affect their business. I’m proud to announce: Problem solved! It was Morgan Stanley who put me on the track to this brilliant solution a couple of weeks ago when they announced the launching of its first UCITS III Fund on the Firm’s FundLogic trading platform. Since then, I’ve discovered that all the big US, and all global non-European, banks are doing the exact same thing. They are in practice outsourcing their investment bank activity to Europe. The new financial regulations in both US and EU are aimed at traditional hedge funds (who have been blamed for everything from causing the financial meltdown to climate change) and the well-known tax heavens – also known as offshore banking. But the financial industry seems to have found an alternative in EU’s UCITS III Funds. (Undertakings for Collective Investments in Transferable Securities). And the alternative is about to get even better with the introduction of UCITS IV in 2011. In fact, it’s so good that several financial institutions are bringing their offshore accounts from places like Calman Island and Bermuda onshore – inside the EU area.

The below chart shows all three key correlation metrics relevant to today's market: ES, AUDJPY (or FX carry), and the UST butterfly (or Treasury curve funding). In essence in a perfectly closed system, all three should track perfectly, absent massive exogenous inflows of capital into one or more of the three, which would result in dramatic dislocations. And today's action is showing precisely this kind of dislocation: currently ES is indicating a "richness" of about 15 ES points, or almost 1.5%. For all who believe that today did not see about $150 billion of new inflows into stocks alone, this is today's convergence arb, in which the long leg could be any combination of the AUDJPY and 2s10s30s butterfly, while the short leg is, naturally, ES. Yesterday, the spread closed almost 60% at which point we suggested unwinding. We don't see why today should be any different, and the positive feedback loop algos should be proven right for once, with absolutely no fundamental validation.