Archive - Aug 2012 - Story

We have critically examined the question of whether the stock market 'discounts' anything on several previous occasions. The question was for instance raised in the context of what happened in the second half of 2007. Surely by October 2007 it must have been crystal clear even to people with the intellectual capacity of a lamp post and the attention span of a fly that something was greatly amiss in the mortgage credit market. Then, just as now, both the ECB and the Fed had begun to take emergency measures to keep the banking system from keeling over in August. This brings to mind the 'potent directors fallacy' which is the belief held by investors that someone – either the monetary authority, the treasury department, or a consortium of bankers, or nowadays e.g. the government of China – will come to their rescue when the market begins to fall. 'They' won't allow the market to decline!' 'They' won't allow a recession to occur!' 'They can't let the market go down in an election year!' All of these are often heard phrases. This brings us to today's markets. Nowadays, traders are not only not attempting to 'discount' anything, they are investing with their eyes firmly fixed on the rear-view mirror – they effectively trade on yesterday's news.

Of course, we are sure this will not weigh on Bernanke's decisions in the next week or two but for all those who don't see inflation, courtesy of John Lohman, gas prices have never been higher during this third week of August. We remain flabbergasted that in the Wizard of Washington's recent defense of QE, there was no mention of record high gas prices as justification for it 'working' and it would appear that 'transitory' means something different than us mere un-omnipotent-beings can comprehend.

The empirical data is in. And it turns out that as we have been suggesting for a very long time — yes, shock horror — helicopter dropping cash onto the financial sector does disproportionately favour the rich. Here are four simple questions to the venerable Bank of England (just as applicable to any and every Central Banker); and sadly, we expect to see the announcement of more quantitative easing to the financial sector long before we expect to see answers to any of these questions.

When your local friendly Too-Big-To-Fail bank needs a 'helping hand' loan to get through pay-day or buy some extra S&P futures, it picks up the shiny red phone and asks Ben for unlimited access to free money. When the 'rest-of-us' need a little extra - to get through the next week before our pay-check hits, we call this guy - who charges a 400% APR. The Central Bank Discount Window - Priceless.

Simon Black recounts a recent experience as he pulled in to a gas station in Italy; he whipped out his American Express card and asked the attendant in broken Italian to turn on the pump. He acted like Simon had just punched him in the gut, wincing when he saw the credit card. "No... cash, only cash," he said. I didn’t have very much cash on me, so I drove to the next station where a similar experience awaited me. This is a trend that is typical when economies are in decline– cash is king. Businesses often won’t want to spend the extra 2.5% on credit card merchant fees... but more importantly, distrust of the banking system and a debilitatingly extractive tax system pushes people into cash transactions. You can’t really blame them.

Volume was dismal - aside from a massive surge in S&P 500 e-mini volumes as the combo Bernanke bluff and ECB bond-band-rumor hit the tape and exploded stocks up from two-week lows. A late-day attempt to close the S&P green for the week failed and the Dow ended with its first down week in seven weeks - and largest loss in nine weeks - despite a magnificent centrally-planned triple-digit gain today (+100.1pts!) Stocks were 'aided' by new cycle highs in HYG as it saw its best performance in a month - amid massive fund inflows and heavy issuance (notably outperforming credit spreads in CDS land). The shift in HYG does look like some convergence trading with SPY though  - after a month of flat-lining. Gold (and even more so Silver) were the week's big performers (up 3.35% and 9.25% respectively) even as the USD only lost 1.1%. Treasuries ended the week better by 9 to 14bps (considerably different from stocks relative performance). The week was characterized simply as stocks bouncing between QE-off (Treasury strength) and QE-on (USD weakness and Gold strength) - on de minimus volumes.

Thanks for everything...

Presented with little comment - for the simple reason it has become a joke...

"The numbers are coming in and we are looking at them with a sense of amazement," is how the director of the Snow and Ice data center in Colorado describes the 'startlingly rapid rate' of melting at the Arctic Ice Cap this year. As Agence France Presse notes, if the melt stopped today, this would be the third lowest level of ice on record. Of course while this maybe terrible news for some; others are 'increasingly interested'. The thaw in the Arctic is rapidly transforming the geopolitics of the region, with the long-forbidding ocean looking more attractive to the shipping and energy industries. The first ship from China – the Xuelong, or Snow Dragon – recently sailed from the Pacific to the Atlantic via the Arctic Ocean, cutting the distance by more than 40%. Five nations surround the Arctic Ocean – Russia, which has about half of the coastline, along with Canada, Denmark, Norway and the United States – but the route could see a growing number of commercial players. Of course this 'benefit' of global warming appears to rely on the fact that there are people left to trade goods with.

With central bankers increasingly eclipsing even the most famous TV, music, and movie stars for the headlines, it appears the lengths we will go to in order to become 'famous' know no bounds. To wit, how to become famous? Appear famous!

It seems everyone and their pet Goldfish has been brainwashed into the belief that because it's an election year, we have to buy stocks. There is plenty of noise in that empirical study with some large outliers. However, Credit Suisse's Harley Bassman notes there is another cycle in election years - that of implied volatility - and he adds "the clearly defined economic nature of this election should increase implied volatility on most financial assets." As the chart below shows, volatilities tend to trough in August and peak in October into a November election - only to fall once again from two-weeks before to one week after the election. The pattern is clear.

The past several weeks have made one thing crystal-clear: Our country faces unmitigated disaster if the Other Side wins.

The odds of Fed easing at the September FOMC meeting seem close to 50-50 (with both sides vehemently talking their books - Fed officials and equity managers alike). Recent data has been a bit better: payrolls, claims, retail sales, and industrial production. As UBS' Drew Matus notes, other factors that will play a role include the ISM report, claims reports, and 'fiscal cliff'-related events. However, the primary determinant will be the upcoming August payroll report. The chart below ignores these other factors and offers up the odds of further easing in September based on the base case that Bernanke’s primary concern is the state of the US labor market. July’s 8.3% unemployment rate and payroll gain of 163k put current odds of further easing at 45%.

If you haven’t heard yet, the committee which is drafting the platform for next week’s US Republican National Convention has announced that they are including a proposal to return to the gold standard. Big news. Remember, a gold standard is a monetary system in which individual currency units are fixed to an amount of gold held by the government; under a gold standard, the paper money supply cannot be expanded without also increasing the amount of gold on hand. At present, the market value of the federal government’s gold holdings only amounts to about $250 billion which constitutes a mere 2.5% of US money supply. Clearly one of the key risks in this scenario is that the US government would need to acquire as much gold as they can get their hands on, likely through Roosewellian-style gold confiscation, and if so - the safest place for your gold is going to be a snug safety deposit box in a place like Hong Kong or Singapore.

With the polls apparently seeing it all tied up at 46-46 (and heading into the period when McCain and Obama diverged so strongly in 2008), a recent Gallup poll brings up the age-old question of whether the electorate will vote with their hearts or their wallets. Only in a Facebook-world; but 54% 'like' Obama versus 31% 'like' Romney but this huge social-network-factor disappears when asked who will better handle the economy - 52% believe Romney will be better for the economy as opposed to 43% believing in Obama. Of course none of that matters if the market remains up here.