Archive - Sep 14, 2011 - Story

While last night's quid-pro-quo from Chinese officials will likely be remembered as the start of escalating trade wars, Wikileaks has uncovered a declassified cable from John Huntsman indicating China's clear understanding of the growing tension and comprehension of the ability of the US to entirely destroy it economically with one swipe of the Presidential pen via a massive devaluation of the USD or repegging to gold. Choice quotes include: "The U.S. has almost used all deterring means, besides military means, against China. ", "United States is determined to beggar thy neighbor", "Chinese must be very clear what the key to victory is.  It is by no means to use new foreign exchange reserves to buy U.S. Treasury bonds.", and "[when] the new U.S. dollar is pegged to the gold - we will be dumbfounded."

In what is probably the riskiest escalation of the second credit crisis to date, IFR has released information that was until now speculated, but not confirmed, namely that European banks not only continue to make a mockery out of LiEbor by posting whatever rates they deem appropriate (for the simple reason they don't use interbank funding), while in the meantime going directly to US banks, using shadow, and hence completely unregulated conduits, in the form of private repo arrangements with "at least three of the five biggest US banks." Now where this is interesting is that as Zero Hedge disclosed three months ago, the bulk of the cash generated for the pendancy of QE2 went not to US banks, but to US-based branches of foreign banks. Which probably means that there is a roadblock to repatriating the US held cash (even in exchange for perfectly legitimate receivable debits). Because one would think that this is where the first source of cash for troubled banks would come from. Assuming it hasn't been repatriated already, or is not stuck in some IOER-GC carry trade that generates virtually no return (and when the Fed lowers IOER even more, absolutely no return). Alas this means that the 3M USD Libor which we update every day is substantially under-representing the true funding squeeze in Europe. Even worse, it means that US banks have lent us tens, if not hundreds of billions of cash, in exchange for collateral that could be virtually anything, and which collateral bypasses traditional Fed supervision. As a result, US banks can and will go hog wild in lending repo dollars (at big collateral haircuts but still) to European banks until everyone suddenly runs out of money, and the Fed realizes it has to not only fill traditional liquidity holes, but a massive shadow banking shortfall, precisely the stuff that none other than the Fed has been warning about over and over. Just like in 2008 when the big hit to the system came not from traditional sources of risk but perfectly innocuous and thus ignored money markets, so the same will happen this time, as the biggest crunch will come completely out of left field. It always does.

Watching politicians and bankers bickering over a Euro rescue on the back of Eurozone taxpayers for more or less 2 years by now, a group of Germans has staged the first protest in front of the headquarters of the European Central Bank (ECB) on Tuesday. Some 100 protesters, organized by the fringe Partei der Vernunft (Party of Reason) held up banners with two key demands: "Raus aus dem Euro" (Out of the Euro) and "Stoppt die Schuldenunion" (Stop the debt union), according to a report by German daily FAZ. Recent surveys show that 77% of Germans resist the creation of the European Financial Stability Fund (EFSF) and its highly undemocratic successor ESM (Euro Stability Mechanism). The German parliament will vote on the ESM on September 26 and due to heavy losses of the small liberal coalition partner in latest regional elections chancellor Angela Merkel must be less than certain to get a successful vote on an instrument that would put Germany into the  top position to pay for the long profligacy of the weaker Euro members. The strategy of paying thy neighbours debt has never worked in history.  The growing bifurcation of opinions among Eurozone politicians and the general populations cannot be overlooked anymore. Europeans are taxed to the hilt, suffer from economic conditions where all the freshly digitized money reaches the financial industry but never the real economy and are fed up with an increasingly undemocratic EU apparatus where the few sane voices in the European Parliament (EP) like Nigel Farage are ignored by autocratic decisions in the unelected European Commission and the EU Council. While politicians have busied themselves in the last 2 years with a string of weekly emergency meetings in 5-star locations - ironically preaching austerity - debts have seen only one way: up.

Our earlier post regarding the harrowing quarter that our dear friends at GS Global Alpha are having brought back some memories of a bygone age when all one needed was a multi-factor risk model and access to a massive marketing/propaganda arm. Of course as we pointed out earlier, the reason for the demise of so many of these long/short or even long-only quant-managed funds was simple - everyone following the same signal as it pulled them further and further away from benchmark performance - until finally, one after the other, they disregarded their factor models as redemptions (from underperformance) and pure-and-simple psychological trauma hit them hard. The bottom line is that the factors that quant funds have tended to be over-/under-exposed to at times of maximum underperformance (and market chaos) appear to be front-and-center once again among quant fund holdings. Expect more chaos.

Those who have been around for more than one trading generation (which in the old days was 3-4 years, but in the current centrally-planned, vacuum tube-traded times, is more like 3-4 months), will distinctly recall that the first rumbling of the financial crisis started not with the bankruptcy of Lehman, or even the handoff of Bear (and its massive silver legacy short) to Jamie Dimon, but in August 2007, when days after the market hit its all time high, something went massively wrong in the quant market segment (nobody still knows what it was but many speculate that is was simply every algo being on the same side of the trade and trading out all at the same time following the blow up of the Bear Stearns hedge funds). What the first week of August 2007 was notable for, in addition to massive losses for such legendary quants as RenTec (very well described in Scott Patterson's book titled appropriately enough "The Quants"), was that for the first time ever, the infallible Goldman Sachs... fell. Specifically, its heretofore mythical Global Alpha quant fund, which had the mythical allure of a 33rd degree Freemason dinner, imploded, and crashed, forcing the end of a quant generation, and the beginning of the end of Goldman's aura of invincibility. As Bloomberg recalls those August 2007 days: "Goldman Sachs Group Inc.'s $8 billion Global Alpha hedge fund has fallen 26 percent so far this year, a decline that may prompt more investors to withdraw their money, according to people familiar with the fund...On June 26, Goldman said Eric Schwartz, co-head of asset management since 2003, would step down in the next few months and leave Peter Kraus in charge of the fund unit. Global Alpha decreased 8 percent during the last full week of July and was down 16 percent from the beginning of January through Aug. 3. There is an Aug. 15 deadline for Global Alpha investors who want to redeem money on Sept. 30." Well, the reason we bring all of this up, is because unlike what everyone claims, it is not 2008.... it is 2007 all over again. To wit: Goldman Global Alpha just blew up, for the second and probably last time.

As usual, Goldman saves the best for last. From David Kostin: "We are cutting our year-end 2011 price target for the S&P 500 to 1250 from 1400. Our new target reflects a potential return of 5% from the current index level. Our revised price target reflects the heightened uncertainty that characterizes global equity markets today. Our earnings, dividend, and economics forecasts remain unchanged. The unstable macro environment appears likely to persist for the foreseeable future. Downside risk exists to our forecast if the European sovereign debt crisis deteriorates while upside exists if substantial progress is made in addressing the problem." And since Goldman is leaving its S&P EPS forecast untouched, this is merely a contraction in the multiple from 14 to 12.5. Now if one assumes that David Rosenberg, who earlier speculated that the real S&P EPS is closer to 75 than 96, is correct, and applies the revised Goldman multiple, that means that the S&P has about 400 points of downside. Of course all of this means that one can predict the future. Which is impossible. Which leads us to believe that today's firing of David Bianco was merely due to him refusing to play along with the revised script. Which is as follows: the banks are buying everything that their clients have to sell in advance of, you guessed QE3 in the US and more QE in the UK, Europe and Japan for one last record bonus hurrah. While we can only hope we are wrong, if we are right this means the short squeeze on the market is about to slam shut and Goldman will make out like a bandit as usual, with the S&P soaring several hundred points on ever worse macroeconomic and geopolitcal data.

Take the previous post (average American = dumb as bag of hammers) add one USA-style credit card with an "accordion feature" ceiling, and you get this...

Ever wonder why America will elect precisely the president it deserves in just over a year? Here's why.

The idea that the economy has grown at roughly 5% since 1980 is a lie.   In reality the economic growth of the U.S. has been declining rapidly over the past 30 years supported only by a massive push into deficit spending. From 1950-1980 the economy grew at an annualized rate of 7.70%.   This was accomplished with a total credit market debt to GDP ratio of less 150%.  The CRITICAL factor to note is that economic growth was trending higher during this span going from roughly 5% to a peak of nearly 15%.  There were a couple of reasons for this.  First, lower levels of debt allowed for personal savings to remain robust which fueled productive investment in the economy.  Secondly, the economy was focused primarily in production and manufacturing which has a high multiplier effect on the economy.  This feat of growth also occurred in the face of steadily rising interest rates which peaked with economic expansion in 1980. As we have discussed previously in "The Breaking Point" and "The End Of Keynesian Economics", beginning in 1980 the shift of the economic makeup from a manufacturing and production based economy to a service and finance economy, where there is a low economic multiplier effect, is partially responsible for this transformation.   The decline in economic output was further exacerbated by increased productivity through technological advances, which while advancing our society, plagued the economy with steadily decreasing wages.  Unlike the steadily growing economic environment prior to 1980; the post 1980 economy has experienced by a steady decline.   Therefore, a statement that the economy has been growing at 5% since 1980 is grossly misleading.  The trend of the growth is far more important, and telling, than the average growth rate over time.

From Eric Sprott: "In many of the funds we manage at Sprott, we’ve transitioned out of gold bullion and into gold equities to better participate in the continuation of the trend indicated above. As long-time investors in this space, we can assure you that the production growth rates will be significantly higher in the junior stocks. They continue to trade at discounted valuations, and we believe they offer the best opportunity to build exposure. Margin expansion is the key metric for this industry, and the market is now acknowledging the miners’ improvement in margin capture – which has occurred despite the increase in capital and operating costs. We meet with a large number of gold mining management teams on a weekly basis, and based on those meetings, it appears that the average cost of producing an ounce of gold today, all in, is now around $800. At $1,200 gold, these companies can capture roughly $400 in EBITDA. At $1800 gold, however, they’re now capturing $1,000 per ounce in EBITDA - representing an increase of 150% in profit margin. That is significantly far above what any other equity sector has been able to generate over the past year. Amazingly – despite this new reality for gold producers, we are still finding opportunities in select gold and silver mining companies that can be purchased today at 2-3 times their 2-year-out forecasted cash flow. These multiples are based on the current gold and silver spot price, and if these companies hit their production targets, and gold and silver continue their appreciation – we may discover that these stocks were trading at less than 1 times 2-year-out cash flow today. Having been in the business for many years, we can tell you that investing in a stock at 1 times 2-year-out cash flow tends to be a winning proposition – let alone in an industry that literally mines the world’s reserve currency out of the ground."

A little bit earlier, Peter Tchir was lamenting the latest market breakage courtesy of stocks once again being on their own, and ignoring all the clear macro risks, proceeding to melt up on nothing but a massive short squeeze, precisely as we warned yesterday. For those scratching their heads, below is a great way of visualizing how in the past hour stocks have completely broken away from credit in the form of IG and HY, and are now raging ever higher a solid 13 point rich to correlation fair value. One day, maybe, stocks will prove to be correct over credit... for the first time in history that is. Or, then again, they won't.

We hardly needed confirmation that a) Bank of America is a den of criminals and thieves, that b) its toxic $1.3 trillion mortgage division, better known as Countrywide, is an even scarier and more putrid den of criminals and thieves, and that c) it retaliates against anyone who dares to remind the bank that there are such things as laws, and the aforementioned criminals and thieves actually have to follow these. Yet this is precisely what we just got after the Department of Labor said that it must pay $930,000 to an employee who led internal probes of abuses at its Countrywide Financial unit and was fired in violation of whistleblower protections.  Bloomberg reports "the employee, who also must be reinstated, had claimed that people who tried to report fraud to Countrywide’s employee- relations department suffered persistent retaliation, the agency said today in a statement. He was fired after Charlotte, North Carolina-based Bank of America’s 2008 purchase of Countrywide, according to the statement." So is it possible that the general public can now get the documentation that said whistleblower was fired for attempting to bring to his retaliating superiors' attention? And just how damaging will this development be to a bank which is already embroiled in litigation with virtually every single entity that has every transacted in mortgages both in America, and now abroad?

The fact that stocks keep reacting more positively to Greek news, than Greek bonds is scary.  It is somewhat reminiscent of 2008 when stocks kept rallying on allegedly good news even when debt struggled to perform on the news that was supposed to impact it most.  And for all the talk that Greece is priced in, the reaction after the erroneous headline about Austria approving EFSF shows that is unlikely true.  Stocks hit 1163 on that news and the decline only stopped because the correction was printed.  That is over 2.5% lower than we are right now, so I don't think Greek default is priced in.  Stock futures are up a full 3% from their overnight lows.  Crazy and broken moves.  The truly scary thing is we haven't even had the full "Eurobonds announced" rally.  Where does that take SPX?  1230 again?  I just can't convince myself that long is the right trade right now.  Ironically, strong stocks may be their own worst enemy, as they give some European politicians the strength to do what they want - and not provide more funds to bailouts.  Now I'm clutching at straws, but hey, what else to do as stocks march higher.  I have checked the newswire several times while writing this.  Expecting to see some new comments or twist on the comments that justifies this push in stocks, and I just can't see it.  And I really don't see a strong reaction in the credit markets either. Even BAC cannot seem to rally back to Warren's strike price, let alone where they got in the immediate aftermath of his headline grabbing, stock spiking, investment.

Three years ago today, my best friend called me and told me to turn on my television. I remember the way he described it– “Lehman is finished.”  The TV showed guys packing up their desks on Sunday afternoon, moving out of their offices forever. That was the precipice from which financial markets plunged the following day, taking the global economy along for the next three years. We appear to be at that moment once more. Greece is out of cash. Again. The Greek Deputy Finance Minister said on Monday that his country only has enough cash to operate for a few more weeks. As I write this note, French, German, and Greek politicians are all on a conference call, feverishly trying to figure out a way to avoid default.  Everyone seems to understand the consequences at stake… given the chain of derivatives out there, a Greek default will completely dwarf the Lehman collapse. Unfortunately for the bureaucrats, dissent against the Greek bailout plan is spreading across Europe… and leaders can no longer ignore the growing wave of opposition in Finland, the Netherlands, Austria, and Germany.