Archive - Aug 2011 - Story

The consumer driven recession has begun. Keeping it very simple of the four GDP components (consumer, fixed investment, government and net trade) the consumer has simply rolled over. In Q1 2011 the consumer contributed 1.46% to the 0.4% total GDP. In other words if it was not for consumer growth or even if .5% of that growth was removed the economy contracted in Q1 2011. Fast forward to Q2 where the consumer component is now 0.3%. In other words the trend of the consumer is deteriorating. Representing roughly 70% of total GDP the consumer is the economy. Confidence drives the consumer, the consumer drives demand and demand drives the economy. Well judging by the epic fall in University Of Michigan Sentiment, now at multi year lows the economy is in serious trouble. To get a sense of the economic reality facing the US look at the historic correlation between sentiment and real GDP.

The NYSE has just announced that precisely zero vacuum tubes were inconvenienced by the biggest climatic let down since global warming.

For anyone who is still confused why the tail-wags-dog reverse relationship of the stock market as a leading indicator to the economy, and to western civilization in general, can be a problem for said civilization (not to mention the former) once the current iteration of central planning loses control over everything, as it always does, here is an interview between German daily Spiegel and Paul Woolley, a one time fund manager, and currently head of the LSE's center for Capital Market Dysfunctionality (sometimes affectionately known as the Princeton Economics department) who explains why things are on the edge of a precipice. His message for anyone who thought that Irene may have been a risk: you ain't seen nothing yet. "The developments in recent weeks have made it quite clear that the markets don't function properly. Things are spinning out of control and are potentially dangerous for society. Only a fraternity of academic high priests connected to the finance markets is still speaking of efficient markets. Still each market participant is pursuing their own selfish interests. The market isn't reaching equilibrium -- it's falling into chaos."

For awhile now, the market has loved to talk about risk-on or risk-off.  Occasionally a few outliers exist, but by and large that pattern of everything risky up or down together has been holding.  It felt like that is potentially starting to fall apart this week. The first thing that caught my eye, was the difference in performance between credit and stocks.  The CDX IG16 index was actually wider on the week.  It closed at 123 the prior week and finished this week at 126.25.   That is not a major move, but is in sharp contrast to the SPX which was up 4.7% on the week.
That relative out performance of stocks left many investors scratching their heads.  For all the talk about "credit" leading stocks, or warning signs in the credit markets, they were all ignored this week, at least in U.S. Stocks. Good luck, and hopefully the simplicity of risk-on or risk-off will return, otherwise I suspect this will get very messy as so many trading strategies have depended on it.

There was a time when being short was a bad idea. Not anymore. As David Kostin' summarizes in his latest weekly chart packet, the level of 3 month S&P and sector correlation is now at a 20 year high, an environment which never leads to good outcomes for long-only whales, and which has led to sizable outperformance for hedge funds due to their recent loading up on short positions. To wit: "S&P 500 three-month correlation is 0.73, the highest in at least the past 20 years, and up from just 0.44 at the start of August. Sector correlation is similarly high, with all major S&P sectors experiencing realized correlation above their 95th percentile since the late 1980s. While it is difficult to specify a cause for higher correlation, a spike in S&P futures and ETF trading volumes and parallel reduction in open interest held by institutional and levered funds as reported by the Commodities and Futures Trading Corporation (CFTC) indicate significant de-risking in August." What does that mean for recent performance? Nothing good if one is a mutual fund: "Elevated correlation is generally considered a poor environment for long-only fundamental investors. In highly correlated sell offs the market does not discriminate based on company fundamentals, reducing the value of stock picking. Recent performance trends support that case." As a result hedge fund LPs are doing ok: "The typical hedge fund has generated a 2011 YTD return of -1% through August 19 compared with a -10% decline for the S&P 500 and an -11% return for the average large-cap core mutual fund." Alas, if the hedge fund in question is Paulson & Co., this average statistic is very misleading.

The stock market is wearing a T-shirt that reads, "I broke a downtrend and all I got was this lousy pennant." Having just returned from nine glorious days camping in Washington State, I have no idea what "news" has effected the markets ("news" in quotes because the news is managed for its PR effect--the real news is what has been suppressed lest it undermine the Status Quo's carefully cultivated propaganda campaign), and so I have marked up the chart of the Dow Jones Industrial Average (DJIA) and the U.S. dollar without the "benefit" of the news flow. What pops out is a big fat pennant in both charts. Pennants can be continuation patterns--mere way points in a continuing up or down trend--or they can indicate points of trend reversals. The key feature of a pennant is the compression of price into a narrowing channel, as the relative indecision of buyers and sellers alike causes price to fluctuate less and less.

Wikileaks' threat to expose Bank of America came and went, and yet all it took for the bank to implode was reality, a little time, and an independent media. That said, Wikileaks has not yet been completely relegated to the compost heap of one time fads. In a blast submission of several thousand cables, Julian Assange tries to regain his one time star status. While we have to go through the bulk, one that caught our attention was a cable from the US delegation in Chengdu, China, where a counsel met with a local representative of the World Bank's International Finance Corporation, for some candid one on one. While the bulk of the exposition, which took place in December of 2009,  is not surprising, there are some frank admissions about the emergence of a Chinese bubble, long before the topic was mainstream (and only fringe investors would consider it), observation that urban housing prices are "here to stay for the coming few years as they are an unavoidable, long-term aspect of the nationwide, structural shift in the population from rural area to urban centers", the realization that the solar industry is plagued by overcapacity and due for a restructuring (many "solar" longs would have been delighted to know this well in advance of the recent decimation in the Chinese solar stock space), but most notable is the Chinese admission that "China will remain a "poor country" for years to come, and can expect to emerge as a "respectable mid-level" country only in another 10-20 years" in order to grow its service sector from the current 30-40% of the economy to a US-comparable 75%, many structural shifts will have to take place. And while such shifts "are already happening to some extent in places like the Pearl River Delta", and "Chinese companies increasingly setting up factories overseas" the biggest impediment is China's "terrible educational system" which "promotes copying and pasting over creative and independent thought." Explaining further, "the normal process undertaken by students when writing as essentially collecting sentences from various sources without any original thinking.  He compared the writing ability of a typical Chinese Phd as paling in comparison to his "unskilled" staff during his decade of work with the IFC in Africa." Well, if China's education system is worse than that of the US, we can probable stop worrying about the dollar relinquishing its reserve status. On the other hand, we would be the first to point out that China, which does not admit defeat, is probably in the early stages of the next bubble: that of importing teachers, educators, professors and generally Ivy League Ph.D.'s. Which is great: take as many as you want. The average tenured Ivy League (not to mention MIT and NYU) professor has already done enough damage to the US - it is only fair that they destroy China next.

The financial press has been inundated with articles comparing what is happening in global markets now to events in the latter part of 2008. Sure enough, the surge in Treasurys from 100 to 143 in the last two months of 2008 following the Lehman bankruptcy is most comparable to the move in the same security from 122 to 140 in the two months since the beginning of July 2011. What is disturbing is that the bulk of this move has happened after the August 2 debt deal, and after the announcement of QE2.5 or "ZIRP through mid-2013" by the Fed on August 9. Additionally, stocks have also traded in a pattern very reminiscent to what happened during the first round of the Great Financial Crisis, but the lock up in capital market liquidity, especially in Europe, may be the most obvious parallel between the two time periods. That said, there is one key difference between 2008 and 2011. Bill Buckler, in the latest edition of his Privateer, demonstrates what it is...

Over the past x months, one thing has become all too clear in FX land: the EURUSD must stay rangebound between 1.40 and 1.50, even though as Goldman's John Noyce presents in his latest "not-for-retail" packet, the fair value of the European currency continues to be higher than where it should be. Whether this is a simple case of the tail wagging the dog, whereby the ECB and China are terrified of the downstream effects should the European currency trade under the psychological barrier of 1.40, is unclear. What is clear is that every country in the world has skin in the game, and is forced to keep the EUR in Goldilock rangebound territory: not too low to spook European investors, and not too high to accelerate the German double dip. Some other risk assets correlations observed include the AUD vs 2 year swap spread basket, the VIX vs the S&P, and lastly, on the until recently massively overstretched CHF. Noyce tops it off with some technical perspectives on US govvies and the 2s10s, which is once again diving, although unclear if due to a bullish or bearish flattening.

This year's biggest winner from the botched DSK affair has been France's Christine Lagarde, who despite the dropping of all charges against the former head, is now in charge of the IMF. We admit that the ascension of Lagarde to the throne of the world's most irrelevant global bailout organization (what the IMF "does" is of not importance: the only thing that matters is who Beijing, and Chinabot, feels like rescuing today) happened even though we previously predicted that Germany would be very much against it. Well, Germany let it slide, and endorsed Lagarde. That may soon change though, after the former finance minister essentially threw the entire European (read French, Swiss and German whose assets as a % of host GDP are ridiculous... yes, a technical term) financial system under the bus at Jackson Hole, a day after Bernanke said to wait until September 20 for QE3 clarity. Per Bloomberg: "Bolstering banks’ balance sheets “is key to cutting the chains of contagion,” Lagarde said today in the text of remarks at the Federal Reserve’s annual forum in Jackson Hole, Wyoming. Without an “urgent” recapitalization, “we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis." Lagarde, a former French finance minister who took the helm at the Washington-based IMF in July, said recapitalization should be “substantial.” Banks should look for funds in the markets first and seek public funds if necessary. One way to provide capital could be through the European bailout fund, she said." And now, one can see why Germany is fuming: not only will Germany soon have no choice but to fund the EFSF's sovereign bailout ration all on its own, which as we, and other have speculated, could be as large as €3.5 trillion (or about $5 trillion), but it will be Germany's duty to also fund the rescue of all banks on a parallel track. What is the additional tally? Why at least $230 billion in Europe alone in the next several months. Then again, when you get to $5 trillion, what's a few hundred billions between friends?

Ron Paul has another illustrious supporter - Jim Rogers. The Quantum fund co-founder, who has been spot on about pretty much everything for the past 3 years (see Roubini Versus Rogers Is Right Debate for 2010: Investor Jim Rogers thinks gold will double to at least $2,000 an ounce. Economist Nouriel Roubini says that’s “utter nonsense.” As these well-known market personalities duke it out, they’re doing us a favor by highlighting a critical debate: Which is the bigger threat -- inflation or deflation?), not to mention gold (to the amusement of such Keynesian soundbites recorded for posterity as the following: "Maybe it will reach $1,100 or so but $1,500 or $2,000 is nonsense"), and especially inflation (perhaps the only thing that will prompt a chuckle out of Gadaffi and Mubarak these days is someone telling them that their multi-decade reigns are over due to hyperdeflation and plunging food prices), was caught on tape voicing his endorsement of the only sane person who can possibly do something for this country. "In this election if Ron Paul gets anywhere near the nomination I would certainly support him. He is the only one that I've seen in American politics that seems to have a clue about what's going on." Zero Hedge agrees on all counts.

Some perspectives on the one event that has consumed everyone on the East Coast from CNN: "Hurricane Irene continues to crawl north after making landfall Saturday morning in North Carolina. The storm is expected to head up the East Coast from Virginia to Maine, bringing hurricane-force winds, heavy rain, flooding and widespread power outages. President Barack Obama warned that Irene could be a "hurricane of historic proportions."

Bernanke said QE 3.0, without really saying it. The markets, seeing the enlarged schedule for the September meeting and interpreting the likelihood of heavy discussions, have gotten the message. Stocks threw off the daily mortal struggle that is life as Bank of America and bid for the QE future that is now September (good riddance to August apparently). Gold prices followed on those expectations of a resumption to the willful and wanton dollar destruction that QE purely represents. If the Chairman can influence a major market rally without ever having to face the growing dissent within the FOMC ranks, then his speech has proven to be a stroke of genius. That is the essence of rational expectations, making others believe you have magical powers so that they do your bidding without any actual work or direct engagement on your part. But there is a huge downside to waiting, and Bernanke knows it.  The financial crisis grows while the economy is sliding further into contraction.  Time is not on his side. So why does he wait? Simple, Bernanke and QE is in a box – conditions currently in the wholesale money markets, especially the repo market, will not suffer more QE.  As the unsecured Fed funds and eurodollar markets have effectively frozen for banks outside the primary dealer network, wholesale funding has been left to repos.  However, there is already a shortage of treasury bills, the prime, vital collateral of nearly all post-2008 repo funding arrangements. 

While we have no information as to who or why (we do know when and where) engaged in a transfer of 9,173 ounces of eligible gold (for a total of about $16.5 million) from HSBC's gold depository into that of JP Morgan, according to today's closing CME Group Metal Depository Statistics, we can merely point out that it happened. One back of the envelope hypothesis: we have counterparty risk at the bank level (which is currently manifesting itself at both the CDS, the stock price, and the Li(E)bor level) are we going to start seeing counterparty concerns at the gold depository level next? What next: a run on the [    ] gold depository in a self-fulfilling prophecy? The second hypothesis is by now well known- JPM needs all the gold it can get. But a paltry 9,173 ounces? Of course, the last hypothesis is that the two precisely 9,173 ounce transactions are in no way related.