Archive - Sep 2012 - Story

While a gold standard could work, we remain sceptical that it will be considered (barring a serious financial crisis, perhaps associated with highly volatile inflation). In large part we blame the low probability on culture. The world economy has, over the past century, morphed into a highly integrated, government dominated system guided by conventional wisdom (group think). The self-reliant, individualism of the free market has been left behind in favour of a ‘new age’ of coddled consumerism. Culturally this represents a very powerful force in our view, one which minimises creative options/solutions to economic impasses. On this basis we are cautious of predicting such a radical solution to monetary imbalances.

John Taylor, founder and CEO of the world's largest FX hedge fund, spoke with Bloomberg TV this morning and was his typically clarifying - if not sanguine - self when it comes to prospects in Europe and the US. Stating that he'll "probably always be a bear on the Euro", Taylor added that it is "hard to look at the European situation and see a cloudy sky become clear," and while there has been noisy swings in the movements of currencies of late, "the reason the euro is up is because the dollar is down - two guys have done this: Draghi and Bernanke." Ranging from FX to volatility, Taylor opines on the time-varying correlation of the weak euro with a strong US equity market and notes, however, that "the equity market is not showing any legs."

If there is one dominant consensus in the financial sphere, it is that the Federal Reserve's $85 billion/month bond-and-mortgage-buying "quantitative easing" will inevitably send stocks higher. The general idea is that the Fed buys the mortgage-backed securities (MBS) and Treasury bonds from the banks, which turn around and dump the cash into "risk on" assets like equities (stocks). This consensus can be summarized in the time-worn phrase, "Don't fight the Fed." This near-universal confidence in a QE-goosed stock market is reflected in the low level of volatility (the VIX) and other signs of complacency such as relatively few buyers of put options, which are viewed as "insurance" against a decline in stocks. The usual sentiment readings are bullish as well.

But what if QE fails to send stocks higher? Is such a thing even possible? Yes, it does seem "impossible" in a market as rigged and centrally managed as this one, but there are a handful of reasons why QE might not unleash a flood of cash into "risk on" assets every month from now until Doomsday

10Y Treasuries hit a 1.60% handle as yields fell without a bounce all day. Equities managed a post-European-close bounce (notably to VWAP and unable to break above it) off pre-FOMC levels but that faded rapidly into the close of the US day session as volume and average trade size picked up. VIX traded over 17% (up over 1.4vols on the day). Gold held up better than stocks - especially given the strength in the USD - and remains well above pre-FOMC levels (holding its bounce into the close). Of the major US equity indices, only the Dow remains green from pre-FOMC as CRAAPL sees its worse 3-day slide in 5 months dragging NDX down (and high-beta Russell dropping fast). MS and GS are down 4.2% from pre-FOMC levels now as Financials are the biggest losers (just trumping Energy and Industrials) from when Ben opened his book. Healthcare remains the clear winner. WTI dived into the EU close but recovered to close at $90 (-3% on the week) but in general risk-asset correlations with US equities are extremely high (with risk suggesting more downside to come).

As America's mania with cell phones as an aspirational status fad hits new records every day, this borderline addiction to "thinner, longer" mobility and a sub-1 year upgrade cycle, is starting to extract its pound of flesh: average cell phone bills that have risen by over 10% in one year (from $1,110 to $1,226), even as total household spending rose by half, or $67. In a word: iNflation. It gets worse. As the WSJ reports, "spending on food away from home fell by $48, apparel spending declined by $141, and entertainment spending dropped by $126." Like a true faux status/gadget junkie, Americans don't care what other discretionary items are cut, even such "American staples" as eating out and watching movies, just so they can keep up with all the other Joneses sporting a brand new iPhone X+1, while everyone's credit card bill just gets larger and larger, and the collective wealth evaporates.

Color us unsurprised by this litte gem (via Bloomberg):

• *POSTAL SERVICE SAYS IT WON'T MAKE MANDATED PAYMENT ON SEPT. 30
• *POSTAL SERVICE COMMENTS ON HEALTH BENEFITS PAYMENT IN E-MAIL
• *U.S. POSTAL SERVICE SAYS OPERATIONS WON'T BE AFFECTED

Miss a payment here, miss a payment there; never mind. It would appear that everyone wants to be bailed out before the election so they can pledge votes for taxpayer cash

Today's quote of the day award goes to...

• AHMADINEJAD SAYS SITUATION IN IRAN `NOT SO DIRE'
• AHMADINEJAD SAYS IRAN ECONOMY `CERTAINLY BETTER' THAN U.S., EU

The irony of course is that absent the trillions in fiat created out of thin air by the "developed world's" central banks, and the destruction of the purchasing power of their populations, he would be absolutely right. The bigger irony is that the Iran is by far winning the global race to debase, with its currency hitting a new record low of 26,500 vs the USD just yesterday, and has lost more than half of its value in the past year. Needless to say, Iran's epic ability to destroy its currency with such utter disdain is making central bankers around the world green with envy.

The odd timing of the Fed's QEternity (given macro data, risk, financials conditions, inflation expectations, and equity valuations) provided some impetus for the markets which had anticipated Bernanke's action. The supposed 'safety net' which we suspect has now been used up - by market front-running from a lower than implied Fed Put strike - does however look in question as the US fiscal cliff looms and global growth concerns grow. However, as Deutsche notes, there remain a large number of hurdles ahead for Europe - and while many 'believe' that progress has been made, it seems now that the rubber is meeting the road, that path forward looks a little less clear - and hence risk-wary investors are unwinding peripheral ST exposure and reverting back to the core (or US MBS/TSYs).

We discussed the unintended consequence of QEternity previously as we noted the massive front-running of the Fed's MBS buying program that was occurring as 30Y current coupon mortgage bond yields were tumbling. While the last week or so has seen Treasury yields reverse their rising trend, the trend of front-running the Fed has not abated. In what, quite frankly, stunned us more than Sofia Vergara's wardrobe malfunction this weekend, we note that today the spread between the 30Y FNMA CurCpn mortgage bond (at 1.66%) and 10Y US Treasuries has smashed to incredible all-time lows of around 3bps. The day before QEternity, this spread was 60bps - having been over 100bps at the start of June 2012. The previous low from July 2010 of 54bps has been obliterated as Bernanke has managed to remove one more market from the lexicon of risk (and in the meantime, PIMCO's Bill Gross has earned back his 'bond guru' title by making a killing). Can we see Mortgage yields trade inside of Treasury yields?

Recall from Warren Buffett's 2011 letter to investors: "Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion....You can fondle the cube, but it will not respond. " This is what said gold cube would look like, with distinctions for the various types of gold currently in existence:

Lately, it has become particularly fashionable to bash private equity, especially among those workers in the employ of the state. The argument, in as much as capitalism can be summarized in one sentence, is that PE firms issue excess leverage, making bankruptcy inevitable (apparently those who buy the debt are unaware they will never get their money back), all the while cutting headcount to maximize cash flow (apparently the same PE firms don't realize that their investment will have the greatest terminal value to buyer if it has the highest possible growth potential, which means revenue and cashflow, which means proper CapEx investment, which means streamlined income statement, which means more efficient workers generating more profits, not less). The narrative ultimately culminates with some variation on a the theme that PE firms are responsible for offshoring jobs. While any of the above may be debated, and usually is especially by those who have absolutely no understanding of finance, one thing is certain: when it comes to bashing PE, America's public workers should be the last to have anything negative to say about Private Equity, and the capital markets in general. Why? Because when it comes to fulfilling those promises of a comfortable retirement with pensions and benefits paying out in perpetuity, always indexed for inflation, and otherwise fulfilling impossible dreams, who do America's public pension fund administrators go to? The very same private equity firms that have suddenly become outcast number 1.

As the NFL torments it players, coaches, and viewers by playing hardball over 'real' referee earnings, the truth of Monday's blown call is coming out. Courtesy of American Banker, we now know that the referee at the center of the most controversial call of the season so far is in fact a vice president for small-business banking at Bank of America in California. Lance Easley - previously at Wells Fargo, has worked at BofA since June 2011 - (we assume) moonlighting as a referee in the Santa Barbara area (officiating high school and junior college football and basketball games). Well done Lance, you have managed to move from the most-hated occupation (bankster) to the most-hated individual (outside of Seattle) in one weekend. Is it any wonder Small Business confidence and uncertainty is so high?

We warned yesterday that European credit markets were sending very different signals to the equity markets and sure enough today saw a bloodbath across European equity, credit, and sovereign bond markets. Portugal and Spain 10Y spreads are now +46bps wider on the week (and Italy +30bps) with Spain back over 6% yield (460bps spread) and at more than three-week wides. While plenty will say 'but look where we came from' when today's dumpfest is put in context, but the critical aspect is the velocity and severity of today's 3-4% drop in Italy and Spain's equity markets and European banks now down over 9% from their post-FOMC peak (retraced more than 60% of the post-ECB rally). Europe's VIX jumped to over 22% as credit spreads (most notably subordinated financials - thanks to the 'AAA'nxiety over the banking union) were smashed wider. It seems Ben's all-in move was the catalyst to bring a realization that things may indeed be worse than we thought - as sovereigns have blown wider since.

The EU assembly just voted affirmatively to impose a spate of rules to control 'high-frequency-trading that, as the WSJ reports, was advanced by Germany following their concerns that speedy traders have brought instability to markets. It is somehow reassuring that three-years after we first brought HFT to the mainstream's agenda, at least one nation is taking it seriously, doing something about it, instead of being filibustered into the 'liquidity-providing' meme. The rules will initially require registration, collect fees on excessive use of HFT methods, and install circuit breakers with the goals to "limit the risks associated with high-frequency trading" per a senior German FinMin; but the more stringent rules to come will have the greatest impact as they intend to include requirements for orders to rest on the exchange book for at least half-a-second, and potentially order-to-trade ratio caps. Not surprisingly, the HFTs believe a "one-size-fits-all approach would be very harmful." Indeed - to their profits.

Just because there may be a word or two out of place here...