Archive - Aug 2011 - Story

Well over two months ago we first reminded the Marxists of the world that something big may be coming over the horizon in "Attention Marxists: Labor's Share Of National Income Drops To Lowest In History" a theme, whose violent reprisals in the real world we have been observing since before the Arab Spring began (courtesy of the Fed of course).  Lo and behold, suddenly the coolest thing among the post-sophist punditry is to bring up the name of Marx for this and for that, because, guess what -  he was right all along or something. Where were these same pundits when Marxist postulates were becoming apparent not only across the past year, but past century, we wonder. That said, one analysis that does merit mention is that by UBS George Magnus, who several days ago does the most comprehensive summary of the modern world through the lens of Marxism. His conclusion is spot on: "We have had a gathering crisis of political economy this year, which is partly about economic growth and jobs, but also and importantly, about a malaise in politics and policymaking, in which governments are seen as unwilling, unable, divided or ineffective when it comes to economic management and stability. It’s this resistance or backlash against the political order that runs through the propagation of the political economy convulsions around the world, including, in extremis, the uprisings through North Africa and the Middle East." Granted this is not at all surprising, nor is it odd considering that all that central planning under the modern monetary system has done is to perpetually push off disasters, with each increasingly frequent subsequent one hitting with greater severity until not all the money printing in the world can save the modern broken socio-political (and economic) framework. But everything in due course. And yes, expect many more references to Marx by hollow econo-historians who bring nothing new to the table and merely stampede in where the herd has already boldly gone before.

Those of us who are history buffs, specifically World War II, including events that preceded and postdated that war (1937-1947), tend to look at the Nuremberg Trials (1945-6) with different degrees of criticism.  One does not need to be a legal scholar to realize that much of the Nuremberg proceedings simulated more a lynching party, or a guillotine exhibition, than a trial conducted according to universal precepts of common law.  The defendants, prisoners of war, were not allowed to challenge the fairness of the judges, nor were they given the right to appeal.  Many of the crimes for which they were charged, and convicted of, had been and were being committed by the accusers, or their governments; at times such crimes falling under retrospective law.  And, to top it all, the trials were conducted under their own, and unchallengeable, rules of evidence. Yet, even if History ultimately renders the Nuremberg Trials as illusory justice, or even a mockery of justice, the argument will remain strong that an important purpose was served by these trials: placating the demands for justice of a bleeding continent which had shed 40 million lives and experienced ruinous destruction; even if in reality it was a victors’ justice, it was by most accounts a remarkable improvement over past historical situations where post-war resolution usually amounted to no more than vengeance over an entire nation or people.

It appears that in the aftermath of the recent update of Obama's job approval polls which as we reported just hit an all time low, the market has formally priced in a 50%+ probability that the president will be limited to just one-term. According to the latest InTrade odds, Obama's chance of being reelected in 2012 is now at its all time low, or 48.5% after soaring to a high of 70% back in May in the aftermath of the Bin Laden death at sea. This result however is far from conclusive: InTrade 2012 presidential odds for Rick Perry have risen, but only to 18.5%, Palin is at 5.5%, and Ron Paul's chances are at 3.2% (Bachmann is at 2.5%). So there certainly is some arbitrage to be made there.

As if the global liquidity crunch was not bad enough (as we enter a vacation sleepy week, the key report on Monday will be the ECB's bond purchase update for last week - we estimate another E30 billion in secondary market monetizations, in addition to how many banks pulled dollars from the ECB in the 7 day liquidity providing operation on Wednesday as occurred first last week), geopolitical risk is back after headlines from both Libya and Israel indicate that the Levant region is on the verge of systemic instability once again. The first two stories put Israel smack in the middle of the Middle East action. First is Egypt, which earlier "said Saturday it would withdraw its ambassador from Israel, insisting the killing of five Egyptian security personnel while Israeli forces pursued gunmen across the border was a breach of its 1979 peace treaty with the Jewish state." Complicating matters is the announcement out of Iran, via AP, that "two American men arrested more than two years ago while hiking along the Iraq-Iran border have been sentenced to eight years in prison on charges that include espionage, state TV reported Saturday, a sharp blow to hopes their release was imminent. The announcement seemed to send a hard-line message from Iran's judiciary — which answers directly to the ruling clerics — weeks after the country's foreign minister suggested that the trial of Shane Bauer and Josh Fattal could clear the way for their freedom. It also was likely to raise speculation about Iran using the Americans as political bargaining chips and could bring added tensions to Iranian President Mahmoud Ahmadinejad's expected visit to New York next month." The cherry on top is late news out of Libya that the local rebel movement may be making headway (since denied by the government) in taking over Tripoli. Net result will be even more instability in the crude market which has been expected to drop courtesy of the recent spike in deflationary expectations. Alas, when geopolitics enters the equation, the only certain thing is a surge in uncertainty. That this will likely not benefit global equity markets goes without question.

About a decade ago I realized we were putting the finishing touches on our own extinction party, with the party probably over by 2030. During the intervening period I’ve seen nothing to sway this belief, and much evidence to reinforce it. Yet the protests, ridicule, and hate mail reach a fervent pitch when I speak or write about the potential for near-term extinction of Homo sapiens.

“We’re different.”
“We’re special.”
“We’re too intelligent.”
“We’ll find a way out. We always do.”

We’re humans, and therefore animals. Like all life, we’re special. Like all organisms, we’re susceptible to overshoot. Like all organisms, we will experience population decline after overshoot. Let’s take stock of our current predicaments, beginning with one of several ongoing processes likely to cause our extinction. Then I’ll point out the good not quite so bad news.

They say that the simplest analysis is always the most powerful one. That appears to certainly have been the case with our presentation of global banks' Tangible Common Equity ("TCE") ratio to total assets from last Thursday, and specifically our observation of the glaringly obvious, namely that of the 30 most undercapitalized banks in the world, Canadian ones represented a whopping 33% of all. Note: this was not an attack on Canada, this was not some hedge-fund inspired start of a bear-raid on the Canadian banking system, this was nothing but an attempt to warn our readers of, again, what is out there for anyone (who is not blinded by cognitive bias) to see for themselves. Alas, the reaction to that post, particularly in the Canadian media, has been swift and severe, provoking such respected publications as The Globe And Mail to pen not one but two responses, one being the by now so-oft discredited attempt to ignore the message and target the messenger (Who is Zero Hedge, and why should we care?), followed by a more coherent attempt to debunk the claim that a painfully low TCE ratio is never a good thing (Is Zero Hedge looking at the wrong numbers?). The argument of G&M's Boyd Erman boils down to the statement that TCE is not a fair indicator of balance sheet stress and instead one should focus on a "Tier 1" approach of risk estimation, one that includes Risk Weighted Assets. Here we could provide the reference to Lehman's Tier 1 ratio, which was well in the double digits on the day when it filed for bankruptcy, even as the bank's true leverage was about 40x, a number which eventually brought on the biggest bankruptcy in history. We could but we won't, instead we will ask, rhetorically, who is John Paulson, and why should the Globe and Mail care?

In his weekly chart packet, Goldman's high frequency strategist, David Kostin, who now changes his year end S&P targets almost as frequently as the firm's economic team changes its GDP forecast, once again gets decidedly fatalistic (very much like Citigroup did yesterday, and Morgan Stanley last week), and is now openly contemplating downside cases to his EPS forecast. And with 2012 EPS numbers thrown around like $91 based on what is certainly an upcoming (but for now still hypothetical) margin contraction, $82 based on a 2% drop (almost guaranteed) in GDP Y/Y, and $75 based on historical earnings plunges in a recession, it may be time to listen up, because apply a traditional contractionary multiple of about 9-10x, and you have yourself a tidy little range of 700 - 910 on the S&P in about a year, absent yet another round of fiscal and/or monetary stimulus.

On its way to becoming the world’s greatest superpower, the United States pulled off some truly remarkable trades.  Two notable transactions come to mind and were both outstanding bargains: 1) The Louisiana Purchase (purchased from the French); 2) Alaska (purchased from the Russians). For a mere $15 million, America instantly doubled its size with the 1803 purchase of the Louisiana territory.1 Sixty-fouryears later, oil-and mineral-rich Alaska was obtained for a paltry $7.2 million.2  Even adjusting for inflation, the combined value of these deals in today’s dollars would be very small. However, these two transactions pale in comparison to the greatest trade of all time, one which remains ongoing. This particular trade has allowed the US to exchange more than $8 trillion worth of paper for an unbelievably enormous amount of real goods and services over 36 straight years. We’re referring, of course, to the United States trade deficit. As Chart 1 shows, imports have exceeded exports every year since 1975. For much of the past decade, America’s annual trade deficit has soared past the $600 billion mark, while the accumulated trade deficit has moved relentlessly higher.

Sorry Goldman, in the race to downgrade the US to 0.0001% above contraction, you are still well behind The Fonz in coolness. Frankly, following your December 2010 report you are not even cool enough to pass off for Richie Cunningham. But your third downgrade of US GDP in a month, this time slashing Q3 and Q4 GDP is surely a valiant attempt at regaining some of the Fonz pre-Jersey Shore panache. Keep at it. Another year of being just thiiiiis much behind the curve, and atoning for your shark jumping adventures, and you may be cool again. From a just released report by recent addition to the Goldman economics team (supposedly Jan was too busy elsewhere) Zach Pandl: "In light of the downshift in the data this week, we are cutting our second-half growth forecasts further. We now expect GDP growth of 1.0% in Q3 and 1.5% in Q4, both down from 2.0% previously. These changes reduce our forecasts for full-year 2011 GDP growth to 1.5% from 1.7%. Exhibit 1 shows the details." Now: who will join Zero Hedge in calling for negative GDP in Q3 and most likely Q4 (absent QE3; with QE3 the BEA will mysteriously find another 4-5 GDP percent hidden under the carpet). Far more importantly, Goldman once again explains what to expect at next week's Jackson Hole. We say importantly, because while Goldman is about as clueless at most at predicting the future, when it comes to monetary policy, Goldman determines it. So it is always useful to pay attention: after all Hatzius "predicted" the QE2 announcement roughly about a year ago to the dot.

Since Zero Hedge updates over the next sevearal few hours will be sparse, please use this opportunity to share your transitory outlooks on current events, life, google trending topics, and pretty much anything else.

The week is finally over, and the numbers are in: after narrowly avoiding the "bear market" two weeks ago when we dipped by 19.63%, or about two ticks away from the dreaded 20% correction, the subsequent dead cat bounce fabricated in no small part courtesy of Europe's unprecedented intervention in all markets, both bond and stock, has ended, and we are back to being under 2% away from reentering a Bear Market (and closing at the Lows of the Day). That however will not be the end of the world: as the chart below shows America will actually be the last major market to enter join the Bear party, so little shame there. As the second chart from Rosenberg today shows all the developed countries plus all the BRICs are already there. We expect an ongoing selloff into the last week of August (no need to remind what happens then), at which point the market may get a surprise or two. In the meantime, we depart with Rosie's words: "the US economy is slipping into recession, Europe is as well, and HP served up a reminder that this earnings season has not been the slam-dunk positive reporting period posted in the prior eight quarters. But disciplined investors who took our advice should not be feeling much pain at all." Who laughs last again?

So we all know that gold prices and UST 10Y yields are as high, and low, respectively, as they have ever been. This is nothing more or less than human adrenaline overriding reason and logic, driving return expectations to the distribution of max entropy. It’ll pass. Sometimes it makes sense to fight the crazy impulses of greed and fear. But often this gets you creamed in the center. Sometimes it doesn’t. For those times, the prices of straightforward hedges like 10Y Ts and gold make them very unhedge-worthy. There is no sense in jumping on trades that already have the risk premium baked in. The alternative is to ride the apocalypse with an eye on the relative mispricing of extremal points. I’m creating what I call a braided basket to do this. I’ll take two pair trades and go short the rapier points of the apocalypse and long something correlated, but underperforming it. In this way I’ll catch some hedge on tail risks on my core book due to the darkening outlook. At the same time, I’ll catch some cover when people come back to their senses. Why braided? Check out the charts, and see how the pairs interweave.

Following the recent surge in blue light special asset dispositions courtesy of Bank of America's precarious liquidity conditions, many have speculated that the bank will be forced to sell none other than Schrodinger's Goose: Merrill Lynch, which is at the same time both dead (pre bailout) and golden (due to some legacy reputation it has as a fabled Wall Street firm, now mostly based on intangible value). Nowhere else is this more evident than in the CDS spread between the two entities. After trading at close to convergence for about a year, the CDS levels between the two entities have seen a dramatic dispersion in recent days, soaring to over 50 bps (BAC CDS at 340, ML at 394). This is the widest the spread has been since early 2009 when the world was ending and everyone was buying whatever CDS they could get their hands on. The only comparable widening was in May 2010 when Europe blew up for the first time. So what should one do here? A divergence trade would mean that BAC is going to deteriorate so much it will have no choice but to dump Merrill, an outcome which will likely see both spreads blow out to 2008 wides, only to be followed by the need to nationalize CFC which will likely mean a collapse in Countrywide Home Loans spread (as we hypothesized two weeks ago). As if that was not confusing enough, the likely future of standalone BAC CDS post this event will likely be a tightening as the bank spins off its most toxic division, but then widens as the realization that America's biggest depository is no longer TBTF and spin offs are imminent. That... or the divergence collapses as the BAC blow out continues while investors speculate that upon its sale Merrill will have less risk than its old parent. In either case, keep an eye on this spread as it could be the canary in the coalmine for what BAC management plans to do w/r/t the Schrodinger Goose, CFC, and overall future business as a going concern expectations.

And now for something different. For all our fixed income/credit-focused readers we have two things to say. The first: if you were in High Yield in the past month, our condolences. The second is: if you survived the past month, here is the definitive breakdown of the 50 largest credits in the US with the all important and often times oh so expensive capital structure diagrams. So next time your PM asks you which HoldCo is the parent od what OpCo debt, there will be no excuses.

The first shot was just fired in today's battle with daily record gold prices. IB always tends to be a few minutes ahead of the CME. And following last week's 22% margin hike in gold, we are confident the CME will do everything in its power to pull a "silver" on gold. Are we about to experience a barrage of margin hikes in gold? Stay tuned and find out.