Archive - Jun 2012 - Story

Remember when Whitney Tilson praised every drop in the price of JC Penney stock as a gift from heaven, give or take? Well the gods really are generous to the Sharpe ratio 0.000 asset manager of over a hundred million in stock call equivalents, all of which are now deeply underwater. Because if Tilson liked JCP at $27 one short month ago, he must absolutely love it at $21 where it is today after collapsing over 10% overnight. After yesterday's announcement of the departure of the company's president, the stock is getting blowtorched and is now down to 2 year lows. Someone else who better be doubling down is retail "genius" Bill Ackman who is down $100 million on the stock today alone, and will need to seriously defend his these or, well, else. Who else is getting pulverized? See below.

Between markedly higher yields at the Spanish T-Bill auction (which has been spun as 'successful' due to demand?),  a step in the right direction for ESM (from the German courts), and a dismal ZEW survey, finding a reason for the outperformance of Spanish bonds this morning - where 10Y bond spreads have rallied around 20bps (but remains above 7% yield) is a guess at best. However, while this fulcrum security is encouraging risk-on (reality-off) around the world, we suspect in a sorry-to-disappoint way, that the marginal bid on Spanish bonds is in fact once again the CDS-bond arbitrage trading community. Since last Monday's open (post Spanish bailout), the spread between the Spanish bonds and CDS has widened to over 100bps (from around 0bps). This underperformance of bonds relative to CDS has again and again provided an arbitrage opportunity at around these levels and given the thinness of the Spanish bond market, we suspect some renewed arbs (trying to lock in 80-100bps of 'risk-free' carry and convergence) were the real drivers of Spain's strength. So, be careful in believing what you are seeing as sometimes the whole picture is obscured when you don't know where to look - as 10Y Spanish bonds are 20bps tighter while 10Y CDS are 12bps wider. And once the spread between CDS and bonds is gone then away goes that marginal bid for bonds - so now you know what to watch for a signal of pending weakness in Spanish debt.

As if last week's bought and paid for by JPMorgan media circus in the Senate was not enough, in which Jamie Dimon played several bribed muppets like a fiddle, today we get part two. Momentarily, the Committee on Financial Services will pick up the baton where the Senate left off, and confirm to everyone that the people who lead this country, at least on paper, are some of the most incompetent, and outright clueless when it comes to financial matters. The same matters that have led America to the Second great depression, which has so far been prevented from wiping out 20% of the economy only courtesy of Bernanke's relentless money printing. Dimon's testimony, which is a replica of last week's, can be found here. In other news, Jamie Dimon is furious he never bribed Maxine Waters before. Now he will have to explain introductory math for absolute idiots. Karma is a bitch.

The question of whether conflict between US and China is inevitable is among the most important for the world as the US-China relationship, as JPMorgan's Michael Cembalest notes, is likely to be one of the most important issues of the 21st century. The inevitability view is sometimes explained by the thesis that countries rarely rise economically without also doing so militarily. The chart below looks at the major economic powers of the world since the year 1 at various intervals. Ignore for the moment some of the abstract issues which this kind of data involves; it’s pretty clear that China’s rise, fall and subsequent rise is something that hasn’t happened a lot over the past 2,000 years, and that the United States is on the front lines of having to adjust to it. Cembalest's recent interview with Henry Kissinger noted the impact of China's troubled relations with the West during the 19th century, which remains on China's political consciousness, and how China might define its interests in different ways than the West would, whether they relate to global energy security, North Korea, global warming, currency management or trade.

We have long been concerned at the implicit and explicit subordination of both financial and sovereign bondholders in Europe by the actions of their overlords political elite in pursuit of short-term liquidity fixes to insolvency issues. As talk of the ESM coming to life in the short-term and a 'Redemption Pact' in the intermediate term - which as Goldman describes involves mutualizing a portion of each country's debt (resulting in a partial upgrade of the existing pool of Eurozone sovereign bonds) in a European Redemption Fund (ERF) and, in the process, extending debt maturities (kicking that can) onto the public sector's balance sheet. As with all these mutualization schemes, the ERF ineluctably raises the twin problems of  'moral hazard' and 'subordination', which need to be mitigated. Goldman discusses these two sides of the same coin as it notes subordination is explicit when the ESM intervenes (and also with the ECB's SMP) but a little less obvious in the ERF (though still as painful) which is, we note, perhaps more appealing to keep the masses unaware.

We just got another indication of how US housing has "bottomed"... if only in terms of promises and strong words. While permits, or promises that at some point in the indefinite future, a house will be built, soared from 723K to an annualized rate of 780K, the highest since September 2008, on expectations of a 730K print, actual holes dug, or Starts plunged from a revised 744K to 708K, the biggest miss of expectations of a modest improvement from the pre-revision number since April 2011, and the biggest sequential drop since August 2011. And while recently all the starts strength was in multi-family units as America prepares to become a renter society, in May it was actually the 1-unit houses that saw an increase from 500K to 516K units, as multi-family tumbled from 236K to 179K. So much for the REO-To-Rent plan? Finally, looking at actual completions, the number tumbled by 10.3% from an annual rate of 667K to 598K in May.

Europe also allows for sovereign debt to be counted as risk-free assets and not marked-to-market. Many nations, Spain is one example, allow for Real Estate loans, mortgages and even commercial loans to be carried at face value as a matter of financial engineering. I think it is a bad joke but the bite has come. This occurs when the loans no longer pay and the revenues are no longer present no matter how you carry them on your books. Then, if the banks try to off-load the properties they have assumed they take losses which are real losses and have to be accounted for on the books or they are securitized and placed as collateral at the ECB which then hides the problem for a while but not indefinitely and the “indefinite” has run out of time which is why any number of banks are calling “Uncle” and why the sovereign nation nations are crying “Uncle” and trying to deflect their problems first back to the ECB and then to find some new scheme so that the country does not fall victim to the Men in Black. All fine, all dandy, but, once again, the central issues are not dealt with and all of the schemes like all of the King’s men and horses cannot put Humpty back together again.

Humpty has fallen off the wall.

After a volatile morning’s trade, European equities are making gains. Having progressed through the session, markets saw a distinct period of volatility wherein peripheral 10-yr government bond yield spreads tightened markedly with their German counterpart, with the Spanish 10-yr yield making a test, but stopping short of a break below the 7.00% handle. The moves came in the wake of a relatively smooth Spanish T-Bill auction, which saw decent bid/cover ratios albeit with markedly higher yields on their 12- and 18-month lines. A modest relief rally was also observed when markets received confirmation that a recent ruling from the top German court regarding information on the ESM’s configuration does not bar the fund from coming into action and taking effect. In terms of data, markets have shrugged off a particularly poor ZEW survey from Germany, however a substantial weakening was observed in GBP following the release of the first deflationary May reading of CPI since records began. The pullback in cost-push inflation has given markets further reason to believe the BoE may conduct additional QE, as the price-level pressures have eased across the past two months.

The key headline in the overnight session was that China was willing to add a token pittance to the IMF "warchest" even as it itself is struggling to find ways to stimulate its economy. Ignore that China had demands of a complete quota overhaul that would see China nearly on par with the US in voting rights, something the US, which incidentally have exactly $0.00 to the bailout effort, would agree to. The amount that warchest has increased to is now $456 billion. It was $430 billion in April just to keep things in perspective. Hardly the Deus Ex the EURUSD is trying hard to make it appear. In the meantime, a gaping hole, as large as $350 billion has opened in Spain. And that excludes the hundreds of billions that will shortly be needed by Italy. Also out of Greece we get rumors that a government may or may not be formed. As to how long said pro-bailout government will last when over half the country voted against he memorandum, that is a different question entirely. Overall, expect a quiet session with everyone praying loudly that Bernanke will launch a new LSAP program tomorrow. If the Chairman does something far less spectacular like merely expanding Twist or raising the maturity of bonds for sale from 1-3 year to 1-4 year, the market will not be happy. Lastly, the G-20 came, ordered lots of shrimp Ceviche at the best restaurants Las Ventanas and One and Only Palmilla has to offer (charge the taxpayers of course), and conquered nothing. But issued a statement that they hope things will fix themselves all over again. In short: nothing but solid reasons for the futures to be up, up, and away.

• With big conditions, China Offers $43 Billion for IMF Crisis War Chest (Reuters)... US offers $0.00
• Mexico is not Spain: Mexican Yields Drop to Record as Spain’s Borrowing Costs Soar (Bloomberg)
• And live from Las Ventanas al Paraiso: G-20 Leaders Focus on Banks as Spain's Woes Challenge Merkel (Bloomberg)
• German Constitutional Court Gives Victory to Opposition in ESM Suit (WSJ)
• EU Europe’s Leaders Urged to Resolve Crisis (FT)
• Backing Grows for One EU Bank Supervisor (FT)
• Greek Leaders Close to Coalition, Aim to Ease Bailout (Reuters)
• China Economy Improves in June, Commerce Minister Chen Says (Bloomberg)
• China Looks for Loan Boost (WSJ)

In a meaningless "test" of investor appetite for Spain's Thursday issuance of 2, 3 and 5 years bonds, Spain today sold €3.04 billion in 12 and 18 month bills, well inside the LTRO maturity, and completely meaningless from a risk perspective - after all even Greece is issuing Bills. Yet for some reason the market which continues to be dumber by the day, somehow took the "successful" auction as an indication that there is actual demand for standalone Spanish subordinated debt. And what a 'success' it was: €2.4 billion in 12 month Bills were sold at 5.074%, the highest since at least 2003 and possibly on record. This is more than 2% greater than the same such auction at the end of May. In other words, Spain just locked in absolutely unsustainable 1 year rates. It also sold €639 million of 18 month paper at 5.107% compared to 3.302% less than a month ago. The good news: bids to cover for the two maturities, from 1.8 and 3.2, to 2.2 and 4.4 respectively. And of course they would: Spanish banks found what little LTRO cash they had lying around and in act of total desperation tried to do a carry trade whereby 3 year paper priced at 1% is used to buy 1 year paper yielding 5%.

The Pew Center has released its annual summary of US pension and retirement health care (under)funding. As of 2010, the total underfunding gap rose by $120 billion from the prior year's $1.26 trillion deficit to a record $1.38 trillion underfunding. This number consists of $757 billion in pension promises, not backed by any hard cash, representing pension liabilities of $3.07 trillion and assets of $2.31 trillion. In 2000, more than half of the states had their pensions 100 percent funded, but by 2010 only Wisconsin was fully funded, and 34 were below the 80 percent threshold—up from 31 in 2009 and just 22 in 2008. But that pales in comparison to the ridiculous spread between retiree health care liabilities of $660 billion and assets of, drum roll, $33 billion, or a funding shortage that is $627 billion, roughly 19 times the actual assets in the system! Just seven states funded 25 percent or more of their retiree health care obligations: Alaska, Arizona, North Dakota, Ohio, Oregon, Virginia, and Wisconsin. What this means is soon US pensioners will have no choice but to experience not only austerity unlike any seen in Europe, but broken promises of retirement benefits which will never materialize. The response will likewise be proportional.

For our quote of the day, we go to none other than the Fed's favorite mouthpiece, the WSJ's Jon Hilsenrath:

Fed officials have been frustrated in the past year that low interest rate policies haven't reached enough Americans to spur stronger growth, the way economics textbooks say low rates should... Multiply the fruit of cheap credit across millions of households—with healthy portions of interest savings spent on goods and services—and the U.S. should be recovering more quickly, according to textbook economics.

No... not the textbooks... Does this mean... Economics 101 is... nothing but one epic lie, based on Ponzi assumptions which work in a world of constant and gradual leveraging, and completely fall apart in a deleveraging world such as the one we have now?