Archive - Dec 23, 2011 - Story

Every time series of prices reflects the ongoing valuation of worldviews in a collective sense. These prices can be used to generate a probability distribution that reflects that worldview. Is it best to buy the tails that reflect extreme events, or to be long the center, where the majority of views dominate? Buying the tails is a barbell. Buying the center is well, a center bet. Which is best? Here is an approximate answer from contemporary history. Center bets beat barbells pretty consistently. BB (XOver proxy) all beat other comers, followed by BBB (HiVol proxy), CCC (proxy for distressed debt), then AAA from 2010-2011. What you get with AAA is low volatility offered by stable liquidity features and cashflow performance. What you get with CCC gives you huge volatility to be exploited by trading. The center, true to the intuition behind it, offers better credit risk profile than distressed debt plus lower liquidity than AAA debt.

Take all you know about the formation of equity prices... and throw it out of the window, at least according to the following paper out of (fittingly Austrian) Erste Group, which applies Austrian theory to stock "valuation", by looking at a world in which the only determining factor for "fair value" is credit money creation. Indeed, the 2011 market, in which cross-asset correlations broke all records, and in which fundamentals were cremated once and for all, showed that the only thing that matters is who prints first, and more importantly, who frontruns said printing (it also means that most hedge fund analysts will soon be redundant). Here is Erste with a slightly less jaded view: "We come to the conclusion that it makes sense for equity investors to track monetary and, especially, debt developments closely. We believe that the changing dynamics of monetary as well as debt aggregates are often a good leading indicator for equity markets. Historic data shows that accelerating money and credit growth drives equity prices, while decelerating growth in the money and credit supply generally puts pressure on equity prices...Financial history shows that equity markets are ‘addicted’ to new money and credit creation. To keep rallies going, the equity markets need ever more fuel (faster rate of change in the money and credit supply). As soon as the rate of change is negative (decelerating money and credit supply) markets tend to become sluggish and lose momentum, even though in absolute terms the money and credit supply is still rising." And while this is not telling Zero Hedge regulars something they didn't know already, with the fiscal pathway of creating new money blocked in a (mock) austere world, the only other way to generate M1-X is by printing. Summary - much more currency debasement and devaluation ahead, only this time with a $100 base in WTI. Which most certainly means that very soon the world will need to find an extended source of cheap energy (read oil). And everyone knows what that will be...

Yesterday, we breached the topic of the real decoupling that is going on: that between the macro and the micro (not some ridiculous geographic distribution of the US versus the world), by presenting David Rosenberg's thoughts on why Q4 GDP has peaked and why going forward it is energy prices that are likely to be a far greater drag on incremental growth than the preservation (not the addition as it is not incremental) of $10 per week in payroll taxes (which only affects those who are already employed), even as company earnings and profit margins have likely peaked. Today, following up on why the micro is about to return with a bang, and why fundamentals are about to become front and center all over again, albeit not in a good way, is, surprisingly, Morgan Stanley's Mike Wilson, who has issued his loudest warning again bleary eyed optimism for the next year: "Think of 2012 as the “payback” year….when many of the extraordinary things that happened over the past 3 years go in reverse. I am talking about incremental fiscal stimulus, a weaker US dollar, positive labor productivity, and accelerated capital spending." Said otherwise, 2012 is the year when everything that can go wrong in the micro arena, will go wrong. And this is why Morgan Stanley being bullish on the macro picture! As Wilson says, his pessimistic musing "tells the story for what to expect in 2012 assuming the situation in Europe doesn’t implode. In other words, this is not the macro bear case." If one adds a full blown European collapse to the mix, then the perfect storm of a macro and micro recoupling in a deleveraging vortex will prove everyone who believes that 2012 will be merely a groundhog year (in same including us) fatally wrong.

Just as in nature, the economic world has its own bloodsucking vermin in the form of banking elites which are a wretched drain on the whole of the human race.  Without their vicious and predatory presence, I envision a world so rapturously above and beyond what we wallow in today that it is impossible to describe.  The disgust many feel when considering the virulent feeding habits of the common mosquito or the slithering leech does nothing to compare to the utter gut churning revulsion I feel when studying the financial habits of banks like the Federal Reserve and the “too big to fails”.  They are without a doubt the most malignant form of social cancer imaginable.  And yet, after nearly four years of ongoing fiscal exsanguination, a sizable portion of the American populace is still looking to these pests for economic comfort and reassurance, just like farm animals consistently grazing near the entrance of a vampire bat cave, as if it is a shelter from harm.  Worst of all is the willingness by which investors still, to this day, commit their savings and their livelihoods to the stock market meat grinder.  Let’s be honest; the typical American daytrading investor is a complete moron.  They have absolutely no sense of the fundamentals of our financial structure nor the eccentric rules by which it operates.  They only have the faintest inkling of the functions of the highly manipulated stock market.  They foolishly believe that what little money they make today riding the wave of an illegitimate liquidity driven rally they will actually get to keep.  For them, stock investment is no different from buying a scratch-off lotto ticket at a hillbilly gas station; it is a cheap and tawdry game rife with failure but exciting to play, if only for a fleeting guilt addled thrill. To be fair, they play because the game is indeed “rewarding”, at least, initially.  The first taste is so sweet that it soils the plasma; the very skin of the cellular membrane of the financial mind becomes saturated.  It swells within the weakening heart of a culture, and overrides its sense of logic.  It makes us do terrible and stupid things, and we clasp our hands together and pray that it will never end.  But, of course, an ending is painfully inevitable.  The more we indulge, the more it takes down the road to satisfy us.  We become an addict nation, riding the chemical wave of a pharmaceutical roller coaster fed by the opiates of fiat and fantasy. The bottom line; we are being drained of our lifeblood as a country.

Now that US Congress provides "solutions" on a month to month basis with outcomes delayed until the 11th hour and 59th minute, the Treasury funds itself paycheck to paycheck, hedge fund LPs only allow a daily lock up and demand liquidity statistics (as in how much of the entire book can be sold on an hour's notice), and all that matters is what happens in the next few hours, it is JPM's turn to raise Q1 GDP... at the expense of future growth. Because nobody really cares about the future anymore: after all following yesterday's lowering of Q3 GDP, US debt/GDP is now 100.04%. But nobody wants to talk about that because, once again, it's about the future. And we are having enough issues with the present as is. Here is JPM's Michael Feroli just hiking his short-term forecast, knowing too well he will eventually have to lower future growth. But that is tomorrow's, and thus, someone else's problem. In the meantime, #40dollars sure goes a long way.

We already know 2011 was horrible for hedge funds, for Wall Street bonuses, and soon, for luxury retailers. So before we write off 2011 for good, here is the penultimate HSBC report (#52) showing HF performance through mid-December. Some notable mid month numbers: Moore -0.05%; Caxton:  -0.09%; Clive: -1.22%; York: -1.20%; Third Point: -1.80%; Pershing Square: -0.70%; Perry: -2.94%; Owl Creek: -1.70%; Highbridge: -2.11%; Landsdowne: -0.89%; Viking: -0.57%; Maverick: -3.08%; Kingdon: -0.77%; Marshall Wace: -0.23%; Odey: -5.34%; Canyon: -0.30%; As for Paulson... oh well.

Europe closed uneventfully with equities mildly outperforming credit (diverging for much of the day) as sovereign spreads were mixed with BTPs higher in yield (and spread), Belgium lower in yield/spread, and Spain unch. Volumes were obviously very light and bond markets went dead in the afternoon - especially gappy post BTP's break of 7% as bid-offer spreads cracked wider. Interestingly, cable (GBPUSD) slid relatively significantly into the close (GBP weaker, USD stronger) - losing around 100 pips from its earlier highs to close at pre-LTRO levels extending losses from the earlier weak data print. US markets have traded quietly all morning with most risk assets in line (credit and equities in sync) but TSYs are completely divergent on the day (from the start of the US day session). Stocks managed to pull back to CONTEXT but amid low volumes they are oscillating around VWAP and jumping a few pts on any flow. Credit looks to be simply reracked on ES moves - as we hear very little actual flow. Much is being made of the drop in VIX today but we suspect this is much more simply explained by vol steepeners across the holiday period - a very seasonal pattern that benefits from normally lower realized vols across the year-end - perhaps Greece's bond maturities next week will upset that plan this year?

“It is no coincidence that the century of total war coincided with the century of central banking.”

- Ron Paul, End the Fed

One thing becomes apparent when looking at the price range breakdown in the just released latest New Home Sales breakdown - the quality, or rather price, of homes sold continues to deteriorate. As can be seen on the chart below, November is the 4th month in a row in which there was (Z), or less than 500 houses sold in the $750,000 category. And while there has been a consistent deterioration in virtually all other price buckets, one is stable: that of the under $150,000. Luckily, the banks keep on leaking out those foreclosed upon properties with the regularity of Old Faithful. Now if only they could releases the 6 million in shadow inventory homes so the housing market could finally clear, thing may actually be optimistic. Alas, as long as they are held on the books, and buyers, who it just happens are not idiots, refuse to pay top dollar knowing well tomorrow a far better deal may hit the market, there is no hope for either the housing market rebounding, or by implication job creation finally picking up. Thank you Centrally Planning Ben. May we have another?

As the rest of the world enjoys Festivus or whatever celebration one indulges in, Iran is launching a "massive" 10 day war games naval exercise right in the belly of the beast. From Xinhua: "Iranian Navy Commander Rear Admiral Habibollah Sayyari on Thursday announced the upcoming launch of ten-day massive naval exercises in the international waters, the local satellite Press TV reported. Sayyari said at a press conference on Thursday that the naval maneuvers dubbed Velayat 90 will start on Saturday and will cover an area of 2,000 (1,250-mile) km stretching from the east of the Strait of Hormuz in the Persian Gulf to the Gulf of Aden, the report said. This is the first time that Iran's Navy carries out naval drills in such a vast area, he was quoted as saying. He said that the exercises will manifest Iran's military prowess and defense capabilities in the international waters, convey a message of peace and friendship to regional countries and test the newest military equipment among other objectives, said the report. He added that the newest missile systems and torpedoes will be employed in the maneuvers, adding that the most recent tactics used in subsurface battles will also be demonstrated. Iranian destroyers, missile-launching vessels, logistic vessels, drones and coastal missiles will also be tested, said the Iranian commander, according to the report." And while conventional wisdom is that the market is focused on what the upcoming closure of the Straits of Hormuz means for tanker routs and oil prices, there is another more disturbing possibility: with all those Iranian canoes, and soapboxes floating around, one wonders if one is bound to have a close encounter with USS CVN-74 John Stennis, which as the updated naval map below from Stratfor shows, will be smack in the middle of the action.

While we just noted the insanity of chaotic market shifts in the face of the broad market's lackluster performance, Nic Colas, of ConvergeX Group, goes one step further. Dismantling the 592 point rally in the archaic (yet seemingly so important to mom and pop) Dow, Nic shows that the majority of this move was simply thanks to just two stocks (IBM and MCD). The 5.1% outperformance of the Dow, in the face of the S&P's blank, is the seventh year of the last twelve (we suppose thanks to the lower financial exposure) but the weighting scheme seems to be so rife for 'help' - especially with blue-chip names so easy to defend for every long-only manager in the world, that it seems we should all thank Mr. Buffett for another good year on the Dow. On a less tin-foil-hat basis, Nic points out that confidence in the business models of the Dow names may have something to do with the remarkably sanguine perspective the sell side has on the earnings predictability of the companies in the index.

In a must read Op-Ed in the WSJ, Mark Spitznagel, founder of "fat tail" focused hedge fund Universa, where Nassim Taleb has been known to dabble on occasion, explains the fundamental flaw with central planning, and specifically why "moral hazard" or the attempt to avoid the destructive part of natural cycles, is the greatest unnatural abomination ever conceived by man. His visual explanation should be sufficient for even such grizzled academics who have no clue how the real world works, as the Chairsatan, to comprehend why what he is doing is an epic abomination of every law of nature: "Suppressing fire, creating the illusion of fire protection, leads to the wrong kind of growth, which then invites greater destruction. About 100 years ago, the U.S. Forest Service took a zero-tolerance approach to forest fires, stamping them out at the first blaze. Fast forward to 1988 when a massive wildfire at Yellowstone National Park wiped out more than 30 times the acreage of any previously recorded fire." Another way of calling this, is what we have been warning about for years: delaying mean reversion does nothing but that. And when the Fed finally fails to offset the inevitable, and it will - it is a 100% certainty - the collapse and destruction will be unprecedented. Ironically, the only way the system could have been saved would be by letting it fail in 2008. Now, we are sorry to say, it is too late.

Presented with little comment...10Y BTP yields just broke above 7% once again. It would appear the MtM on those LTRO-funded BTP purchases is hurting already. Cue LCH margin hikes...

We have previously described the change in market structure post the mid-year USA ratings downgrade as the impossible was suddenly made possible. Nowhere is this more evident than in the huge difference in cumulative distance traveled by the S&P 500. Considering close-to-close changes from the beginning of the year, we see that the average shift of 6 points per day (pre-USA-downgrade) has more than doubled post the downgrade to 12.6 points per day. The S&P 500 has traveled, close-to-close only an incredible 3193 points on the year while from the 12/31/10 close, the index itself has moved a mere 3.64 points. At this rate, should the US be downgraded another notch, we will see 25 point per day ranges and the broken market that we described post-downgrade will become more of a farce than it already is.