Archive - Oct 14, 2011 - Story

UBS' Stephane Deo has rapidly become of one of the most vocal, and luckily most erudite, critics of the veritable rumor-a-palooza that Europe has become: a continent that is now desperately throwing anything and everything at the wall in hopes it will stick and generate another intraday EURUSD short covering squeeze to perpetuate the illusion that Europe is viable for at least one more day. His note today effectively puts an end to the most current approach whereby Greece will see a 50% haircut on its debt (the 21% haircut proposal from July 21 is now dead and buried as we had suggested back then). With that, he forces Europe back to the drawing table to come up with a plan that is endorsed by the market, with just 9 short days until the Eurogroup Summit on October 23 at which point kicking the can into the future will no longer be tolerated and the market will finally judge Europe not for promises, rumors, lies, innuendo and hyperbole, not necessarily in that order, but on actual decisions and policies. Alas, if the 50% haircut idea, which is now proposed by Germany (in diametrical contrast to a month ago), and staunchly opposed by France whose banks, unlike Deutsche Bank, have not been able to dispose of legacy exposure, is killed before it is even implemented, look for a spike in panic in Europe which will now have to redo everything from scratch.

A week ago, after we had already correctly predicted the unwind of the Dexia long CDS trade on the way up in advance of the bank's nationalization announcement, we suggested a Belgium-Dexia compression trade, now that the bank is the ward of not only Belgium but France. Quite obviously, the idea is that Dexia may well trade inside of Belgium once Belgium itself is downgraded by not only Moody's but also Fitch and S&P (look at today's blow out in Belgium CDS for an indication) imminently, while Dexia still has the implicit backing of AAA-rated (for now France). Net result: 110 bps in one week, from 452 bps last Friday to 343 bps today. We expect a pick of at least another 150 bps before unwind considerations.

As the U.S.-led Afghan campaign lurches into its second decade, the country’s vast untapped mineralogical resources are again emerging in the Western media, seemingly underpinning the benefits of International Security Assistance Force troops “staying the course” and defeating the insurgency, after which these resources can be tapped, both providing the administration of Afghan President Hamid Karzai with a source beyond drugs for reconstruction and Western companies who develop the reserves a handsome profit. The latest discovery is that Afghanistan is rich in rare earth elements (RREs). China currently has a near monopoly on the global production of RREs, and the price for a ton of unprocessed ore has soared to a dizzying $100,000 a ton. So, what’s wrong with this picture?

A few days ago we brought you the delightful Chinese boat launch straight into the river bottom. Today, we observe the curious case of the JH-7 "Flying Leopard" which during an exhibition airshow decided to show just how effective gravity is at combating those pesky "highly reliable license-built Spey Mk202 engines" which as the AP reports were "considered unlikely that both would have stalled at the same time"...They stalled. "The Chinese-made JH-7 entered service in 2004 and is a mainstay of the country's air force and naval aviation, with more than 100 built." Also, how do you spell oops in Mandarin? "China rarely released information about military accidents, but the public nature of the crash and the rapid spread of images of it happening on the Internet made it impossible to keep secret." Yeah, sorry about that. Next: we can't wait to see the official launch of the first (and only) Chinese aircraft carrier.

Cost-cutting days are here again. With the year grinding to a close, and with various banks around the world and in the US once again the target of popular adoration, management teams are wondering whether or not to cancel their "elves" parties come Christmas-time. The first bank to vote Nay on free booze, finger food and cheesy music is UK's nationalized RBS: "Royal Bank of Scotland Group Plc (RBS) is canceling Christmas for its investment bankers this year as the government-owned lender tries to reduce costs." It gets worse: the first person to laugh or joke gets the sack: "The bank will stop subsidizing holiday parties and has banned staff entertainment for the rest of the year, Chris Kyle, chief financial officer of RBS’s investment bank, wrote in an e- mail to employees obtained by Bloomberg News. A spokesman for the lender confirmed the contents of the memo." The latest development marks a new low for the bankrupt bank, which previously had the generous allowance of $16 per person for holiday spending: "RBS reduced its spending on holiday parties to 10 pounds ($16) a head, enough to buy two pints of lager and a packet of potato chips, in 2008 after receiving the biggest banking bailout in the world in the financial crisis. The lender announced 2,000 job cuts at the securities unit in August." Certainly this aggression will not stand: we expect white collar riots, powerpoints of mass demonstrations, and multiple scenario IRR excel models for the pros and cons of banker unionization, all organized via Blackberry-blasted calendar events, in which Wall Street will finally #OccupyMainStreet.

First Goldman, next the heart of all that is wrong and corrupt with Italian politics: the headquarters of Silvio Berlusconi's Milan Fininvest office itself. And this is just the beginning: many more protests are expected to take place tomorrow as "outraged" civilians take the streets of Rome.

While hardly the explanation for why the EURUSD has surged nearly 100 pips in the past 45 minutes on absolutely no news (or, in this bizarro market, explaining it perfectly), and as the market focuses its attention on where the line of angry young protesters is longer: by the New York Stock Exchange or in front of the Apple store, Italians, once again betrayed by their politicians who were bribed by Berlusconi to vote for him in the latest vote of "confidence" (at a price of €250k per vote), have decided to make their feelings for financial innovation, and its patron saint, known, by storming the Goldman office in Milan. From Corriere: "on Friday students took to the streets to demonstrate for and against the public school funds the crisis and the government. The procession was attended by about ten thousand young people (two thousand according to initial estimates of the Police Station). The raid at the headquarters of U.S. bank Goldman Sachs was the first action of the student demonstration. A group of twenty boys tried to get a surprise in the Milanese headquarters of the U.S. bank, Bossi in the square, near Piazza Cordusio. Rejected by some employees of the home, the young people then smeared with spray paint the hallway and throwing bags full of garbage to the cry of "Goldman Sachs has the courage to face the future without young people." We doubt this is the last expression of love for those who do God's work in Europe, primarily with austerity-delaying FX swaps... Now that the delay can no longer be delayed.

An hour after getting a whopper in the retail sales number, which handily beat all expectations, we get "confirmation" that consumers are not only more optimistic, with overall Michigan confidence sliding from 59.4 to 57.5, on expectations of 60.2, but that they have less to look forward to than ever in the past 31 years, with the consumer expectations number dropping from 49.4 to 47.0, the lowest since May 1980. Yet expectations for a Dow 36,000 are easily the highest since October 2007. Although the chart that will blow everyone's mind is this comparison of the YoY change in retail sales and consumer sentiment. Two words: Peak Schizophrenia.

A week ago we showed NYSE short interest, which in the aftermath of the massive slide in the EURUSD (the only real driver of beta these days, and with correlation at 1.000, also alpha), had soared to March 2009 levels. Naturally that left the market extremely exposed to any forced short squeeze, such as that witnessed 9 days ago when based on since refuted, but metastasized rumors, we saw a major flush higher in the Euro, and hence ES, which became self-sustaining once the short covering squeeze in stocks took over. Yesterday we got the latest NYSE short interest update and as expected, the shorts have dropped markedly with the number down from 15.7 billion on September 15 to 14.9 billion at the end of September. And since the SPY has moved from 110 to over 120 in the interim period, it is safe to say that when the next short interest update is released in two weeks, the number will be well in the low 14 billion range if not below it. The question is when the market will start pricing in the end of the short squeeze. Our estimate: at about the time when the EURUSD stops surging on hope and lies.

When we looked at the latest release of consumer debt a few days ago, we spread the data into its constituent government and non-government loans. Needless to say, taking away the "government" means consumer credit has imploded. So where does all this government debt go? Two places: car financing (see previous post about retail sales surging on a spike in car sales especially subprime loans to Government Motors clients), and student loans. Below we look at the letter. As the following infographic from HealthcareAdministration.com shows, student loan debt, now at $830 billion, has surpassed credit card debt—a statement not likely to have been heard 20 years ago. Student loans, unlike any other form of debt, cannot be forgiven via bankruptcy—these loans must be repaid. Is this the next bubble to burst? Look for clues in this comprehensive infographic.

There is good and bad news in today's economic data release: on one hand retail sales in September beat expectations at 1.1%, on expectations of 0.7%, and up from an upward revised 0.3% in August. Retail sales less autos was a modest beat at 0.6% on expectations of 0.3%, although the previous number was revised substantially higher from 0.1% to 0.5%. Yet confirming that the bulk of the "beat" was in auto and associated gas sales, was that Retail Sales ex Autos and Gas (duh) came at 0.5% on expectations of 0.4%. Basically, surging subprime loans to autopurchasers and the resulting increase in gasoline sales was the reason for this "surprise" beat. And as for the bad news, import prices jumped to 0.3% in September, on expectations of -0.4%, a surge from August's revised -0.2%. And while fuel imports had dropped in August -1.4%, in September these jumped to a positive 0.1%, showing just how big the monthly sensitivity to any moves in the energy complex are. In other words, should inflation persist, don't expect for retail sales, which we expect to decline to recent deleveraging at the consumer level, to persist.

This morning feels like a bad facebook scam. Mr. Geithner continues to remain convinced that nothing bad would have happened had Lehman not gone bankrupt - in spite of a dearth of evidence supporting that view - and has decided that giving more of my money to the IMF will help "solve" things. Solve had been re-defined to mean temporarily, possibly, delay facing consequences only to face bigger problems at some point in the not too distant future. The IMF, EFSF, EU, G-20 are all busy figuring out how to take more taxpayer money to "solve" the problem. The problem is debt that cannot be paid back. Nothing is being done to ensure that the original lenders can pay back the debt. Not a single word of what is being discussed does anything about that. All this done is shift who will ultimately lose when that debt is not repaid. That is it. Instead of banks bearing the risk for bad credit decisions, they will roll out of their positions and shift it into all the supra-sovereign creations they have devised...I am sure we are due to get a good IMF rumor, a good EFSF multi trillion rumor, or even plan, so am prepared for one more good run in stocks, though I think a lot of this is built in, and shortly after any new grand plan is announced, the attention will shift to France and its problems.  French and Belgium bonds are the worst performing bonds in Europe today.  I would expect that trend to continue.

Update: it's over - the going rate for votes was met and Silvio got 316 to 301. The Bunga Bunga shall continue until morale improves and Italy is broke.

Just out from Bloomberg: Italian Prime Minister Silvio Berlusconi won enough votes in the first round of balloting to survive a confidence vote today in parliament, an opposition official who attended the vote said. Berlusconi won 315 votes in the first round, the party official said. Lawmakers are still voting in the second round of balloting. Not surprisingly, just like in America, Italians completely deserve the politicians who lead then.

• S&P downgraded the long-term sovereign rating of Spain by one notch to AA- from AA with a negative outlook
• Fitch placed five major European commercial banks – namely, Barclays, BNP Paribas, Credit Suisse, Deutsche Bank and Societe Generale - on credit watch negative
• Strong corporate earnings from Google boosted appetite for risk during the European session
• The French/German 10-year government bond yield spread widened to a record level on concerns surrounding the impact of an EFSF leveraging on the French sovereign ratings
• Market participants keep a close eye on the outcome of the confidence vote in the Italian Parliament. In latest news, according to ANSA, Berlusconi has enough votes to win the confidence vote

Don't tell the stock and EUR momo squeeze-based melt up, but even as European funding markets continue to be completely snarled up, default risk has taken a big step wider today. As usual, expect the HFTs which now thoroughly control both equity and FX markets, to be the last to get the memo. Most notable: Belgium CDS have just soared to over 300 bps, a 15 bps move wider on the day (and a welcome boost to anyone still holding on the Dexia-Belgium compression trade), and are about to invert.