Archive - Jul 2012 - Story

"Two weeks after a summit that promised to bring solutions to the European financial crisis, the European Union has once again revealed its fundamental contradictions" is how Stratfor's Adrian Bosoni introduces a succinct clip on the reality the European leaders faced once they arrived home after that strenuous weekend of blithering. Between Asmussen and Schaeuble who have steadfastly stuck to the no-monetary-transfer-without-sovereign-transfer tack - which actually make a fair amount of sense on a long-term basis - a robust and unified budgetary regime is precisely what Europe has lacked. Unfortunately, Bosoni notes, "even in a best case scenario this could not be achieved before 2015" thanks to treaties, referenda, and ratifications. In a little over 3 minutes, the analyst outlines exactly what is holding it back and why the short-term is all they have as budgetary discipline is proving particularly difficult for the EU members to maintain (see more Spanish riots tonight). Between Spain's delays in meeting targets, Greece's 'impossible' budgetary goals, Ireland's demands for concessions, and Finland's collateral agreement with Spain, unifying anything over there seems impractical and impossible.

Two years ago, in January 2010, Zero Hedge wrote "This Is The Government: Your Legal Right To Redeem Your Money Market Account Has Been Denied" which became one of our most read stories of the year. The reason? Perhaps something to do with an implicit attempt at capital controls by the government on one of the primary forms of cash aggregation available: $2.7 trillion in US money market funds. The proximal catalyst back then were new proposed regulations seeking to pull one of these three core pillars (these being no volatility, instantaneous liquidity, and redeemability) from the foundation of the entire money market industry, by changing the primary assumptions of the key Money Market Rule 2a-7. A key proposal would give money market fund managers the option to "suspend redemptions to allow for the orderly liquidation of fund assets." In other words: an attempt to prevent money market runs (the same thing that crushed Lehman when the Reserve Fund broke the buck). This idea, which previously had been implicitly backed by the all important Group of 30 which is basically the shadow central planners of the world (don't believe us? check out the roster of current members), did not get too far, and was quickly forgotten. Until today, when the New York Fed decided to bring it back from the dead by publishing "The Minimum Balance At Risk: A Proposal to Mitigate the Systemic Risks Posed by Money Market FUnds". Now it is well known that any attempt to prevent a bank runs achieves nothing but merely accelerating just that (as Europe recently learned). But this coming from central planners - who never can accurately predict a rational response - is not surprising. What is surprising is that this proposal is reincarnated now. The question becomes: why now? What does the Fed know about market liquidity conditions that it does not want to share, and more importantly, is the Fed seeing a rapid deterioration in liquidity conditions in the future, that may and/or will prompt retail investors to pull their money in another Lehman-like bank run repeat?

The subject of revolution is a touchy one.  It’s not a word that should be thrown around lightly, and when it is uttered at all, it elicits a chaotic jumble of opinions and debates from know-it-alls the world over.  The “R” word has been persona non grata for quite some time in America, and until recently, was met with jeers and knee-jerk belligerence.  However, let’s face it; today, the idea is not so far fetched.  We have a global banking system that is feeding like a tapeworm in the stagnant guts of our economy.  We suffer an election system so fraudulent BOTH sides of the political spectrum now represent a hyper-rich minority while the rest of us are simply expected to play along and enjoy the illusion of choice.  We have a judicial body that has gone out of its way to whittle down our civil liberties and to marginalize our Constitution as some kind of “outdated relic”.  We have an executive branch that issues special orders like monarchical edicts every month, each new order even more invasive and oppressive than the last.  And, we have an establishment system that now believes it has the right to surveil the citizenry en masse and on the slightest whim without any consideration for 4th Amendment protections. Unless tomorrow brings a miraculous shift in current totalitarian trends, revolution may be all we have left...

With Corn hitting its highs again, we are reminded that global food production has been hitting constraints as rising populations and changing diets hit against flattening productivity, water and fertility constraints, and the likely early effects of climate change. As was described in the recent all-encompassing theory of global-collapse, there is general agreement that one of the contributing factors to the rolling revolutions beginning at the end of 2010 was increasing food prices eating into already strained incomes. It is unclear how much impact easing has had on food prices this time, weather has very much made its presence felt (as we noted here). From one omnipotent force (central bankers) to another (hand of god), the fear is that more broadly, food is likely to be a more persistent problem than oil supply. This is because we require almost continual replenishment of food to stay alive and avoid severe social and behavioral stress - food is the most inelastic part of consumption. This says nothing of the pernicious inflationary impact that will likely quell the kind of free-flowing printing so many hope to see from China et al.

Market-top economics could be an entire university course, if people cared enough about such phenomena.  Most only consider the signs of a market top months or years after a crash when some unyielding economics researcher puts the pieces together.  As human-beings we have developed an uncanny ability to rationalize what we know to be bad news and convince ourselves, "This time is different," despite the fact that it usually never is. In a previous article we provided analysis on economic/equity decoupling (cognitive dissonance) and showed that the economy as we know it cannot persist--we are either due for a literal gap-up in leading economic conditions, or we are due for a serious correction in US equities.  With today's 5.4% slip in existing home-sales, let's go with the latter.

The world's largest hedge fund is not as sanguine about the hope that remains in the markets today. The firm's founder, Ray Dalio, who has written extensively on the good, bad, and ugly of deleveragings, sounds a rather concerned note in his latest quarterly letter to investors as the "developed world remains mired in the deleveraging phase of the long-term debt cycle" and has spread to the emerging world "through diminished capital flows which have weakened their growth rates and undermined asset prices". Between China, Europe, and the US, which he discusses in detail, he sees the lack of global private sector credit creation leaving the world's economies highly reliant on government support through monetary and fiscal stimulation. The breadth of this slowdown creates a dangerous dynamic because, given the inter-connectedness of economies and capital flows, one country's decline tends to reinforce another's, making a self-reinforcing global decline more likely and a reversal more difficult to produce. After discounting a relatively imminent return to normalcy in early 2011, markets are now pricing in a meaningful deleveraging for an extended period of time, including negative real earnings growth, negative real yields, high defaults and sustained lower levels of commodity prices. Lastly he believes the common-wisdom - that the Germans and the ECB will save the day - is misplaced.

Is it us? Today felt very nervous. The equal narrowest range in S&P 500 e-mini futures (ES) in over 3 months along with dismally low volume and even worse average trade size as we peaked over July 5th's swing high and fell back. Aside from the farcical trading in the big Dow supporting stocks that we just noted, most asset classes traded along with stocks - in a very narrow range. The big movers were oil - up over $92 - on Israel-Iran tensions (among other things) and the major financials - which in general have retraced all of their post-EU Summit euphoria now (with MS breaking down 6% today). EURUSD did its by no standard dip and rip through the US open to EU close and ended the day unchanged. Treasuries limped a little higher in yield (~1-2bps). VIX plummeted to 15.45% (zero premium to realized vol), down 0.75vols - its lowest close in over 3 months - but this was not enough to provide any more juice for stocks which meandered, ending fractionally higher. Gold and Silver slithered sideways - with a very modest upward bias as Copper was helplessly led a little higher by Oil's exuberance and a slight limp lower in the USD on the day as the AUD extends its gain to 2% on the week against the greenback. We can't help but reflect on this chart as we see a retest on low volume and low average trade size following the very same path as last year. For now, complacency rules.

UPDATE: In case you were wondering, IBM's magnicently efficient market behavior today provided 53.6 points for the Dow - which ended the day up only 34.6 points - phew!!

We are sure someone smarter than us can come up with a story and narrative to explain what is going on here. We just sit back and enjoy the beauty of a sentient SkyNet picking off every single stop trade possible.

For investors, the continued increases in profitability, at the expense of wages, is very finite.  It is revenue that matters in the long term - without subsequent increases at the top line; bottom line profitability is severely at risk.  The stock market is not cheap, especially in an environment where interest rates are artificially suppressed and earnings are inflated due to "accounting magic."  This increases the risk of a significant market correction particularly with a market driven by "hopes" of further central bank interventions.  This reeks of a risky environment, which can remain irrational longer than expected, that will eventually revert when expectations and reality collide.

As we warned yesterday, the curse of the inverse correlation between CNBC appearances and investment performance has struck once again. The rumor is true as everyone's favorite knife-catching, Buffett-following, leveraged beta fund manager Whitney Tilson has split from his 'colleague' Glenn Tongue who has gone off to run his own 'unencumbered' fund. As the full letter below (h/t DealBreaker) explains, he couldn't be more optimistic about T2's future (so this is a good thing then?) and have no fear since he sees 'a target rich environment' as he has already picked up some 'low hanging fruit'. We wait with bated breath for the next letter...

Most of you that are taking the time to read this have already experienced some level of "waking up" over the past several years or longer.  Most of you have also probably felt from time to time that the knowledge you possess is a burden and have fully appreciated the meaning of "ignorance is bliss."  We know this because we have felt these very same emotions at times.  The most important thing to remember; however, is that we are just awake individuals within a wave or cycle of awakening.  There were those that came before us and there will be many, many more to come after us. Most importantly, once you are truly awakened you never go back to sleep.

Hidden under the covers of this morning's already dismal headline print in the Philly Fed data was a considerably worse than expected employment sub-index. Historically this has correlated highly with the non-farm payroll print and suggests (albeit correlation is not causation but gathering real evidence of a slowdown is) that we are heading for a negative print in the next employment report.

In the U.S. economy, the driplines are debt-based spending and leverage. Thanks to endless intervention and manipulation, the economy is now totally dependent on massive debt-based spending and increased leverage for its "growth." The person or business that becomes dependent on welfare loses resiliency and resourcefulness. To the degree that economies become dependent on debt and leverage just like individuals and companies become dependent on welfare, entire economies lose their resilience and resourcefulness. A healthy forest offers another apt analogy. A healthy temperate-region forest depends on occasional forest fires to clear out deadwood and refertilize the depleted soil with ashes. In suppressing all fires--what we might call "stress" and feedback-- management virtually guaranteed that when the forest was eventually set ablaze by a random lightning strike, the resulting fire would be catastrophic because the deadwood had been allowed to pile far higher than Nature would have allowed. The "managers" of the economy have let a couple hundred billion dollars in bad debt burn, and they think the $15 trillion economy is now restored to health. Writing off a couple hundred billion is like letting a few acres of grassland around the parking lot burn and reckoning you've cleared the entire forest of deadwood. The buildup of deadwood--fraud, impaired debt, leverage, bogus accounting, malinvestments, promises that cannot possibly be met and the multiple pathologies of crony capitalism--continues apace, untouched by Federal Reserve intervention. Masking risk and suppressing feedback do not restore resiliency or vitality; they cripple the system's ability to respond to reality.

By now it should be more than clear that the entire hope-based, short-squeeze driven, algo-mediated rally is the result of the last traces of hope: with the US economy openly in free-fall mode, housing supported only by once again increasing shadow inventory (and even that myth is starting to falter following today's existing home sales update), corporate profits just barely holding in as a result of the last possible cuts into the bone via personnel terminations now that YoY revenue numbers have once again sloped lower and the corporate growth cycle has turned, there is little sustaining the market aside from the mysterious seller of endless vol, which could be well, anyone, and some quiet prayer that China may step in and once again, like back in 2009, be the marginal economic dynamo that restarts the global economy one more time. It would do that in the conventional way, of course: by easing as much as it possibly can. There is, however, one problem with this: food prices. As everyone knows the product the PBOC pays more attention to than anything else is food: pork, soy, corn, etc., and particularly food prices. Because if there is one thing that can cause social upheavals in the world's most populous country, it is a rerun of the spring of 2011 when as a result of global easing, we saw not only the Arab Spring, but violent flare ups throughout China. Which brings us to today's topic: black swans. Deep fried black swans.  As UBS explains the record drought that has gripped America may well have far-reaching implications beyond just the price of corn in the US. If, indeed, adverse US climatic conditions spread, and it appears they already have as "the monsoon season, which is critical for that country’s agricultural production, is 22% below normal conditions for the year" it means that Asian food prices will broadly be the next commodity sector to go sky high, and with that kill any hope of either an RRR cut, or an outright reduction in the PBOC's Interest Rate.