Archive - Jan 2013 - Story

The main events of this week, monetary policy meetings at the BoE and the ECB on Thursday, are not expected to bring any meaningful changes. In both cases, banks are expected to keep rates on hold and to hold off on further unconventional policy measures. While significant economic slack still exists in the Euro area, and although the inflation picture has remained relatively benign, targeted non-standard policy measures are more likely than an interest rate cut. As financial conditions are already quite easy in the core countries, where the monetary transmission mechanism remains effective, the ECB’s first objective is to reverse the segmentation of the Euro area’s financial markets to ensure the pass-through of lower rates to the countries with the most need for further stimulus.

In the last two weeks we have pointed out that not only are equity futures traders the most net long in six years but NYSE Margin Debt is also near four year highs. Add to this the fact that VIX futures are the most net short they have ever been - crushed by an all too visible hand - and it appears that equity market participants were critically unafraid of the fiscal cliff uncertainty. What is even more concerning, at least for those who care to be modestly contrarian that is, is that the market appears to be running out of greater fools in every asset class as JPMorgan's speculative position indicator - which combines net positioning across 8 'risky' and 7'safe' assets - is at its most risk-on since just before the crash began in Q3 2007. So, for all those taking heads who expect a flood of new money, who still believe there is money on the sidelines that wants to be put to work, the fact is in the last decade we have been more speculatively positioned long only once - and that marked the top in stocks (and risk-assets everywhere).

As had been widely expected, days before a National Mortgage/Foreclosure settlement is formally announced, the most exposed banks have started tying up the loose ends with the other nationalized entities. Sure enough, moments ago Bank of America just announced a $10 billion settlement with one of the GSEs - Fannie, whose CEO Tim Mayopoulous was BofA's former General Counsel and one of the people scapegoated by Ken Lewis. As just reported, as part of the agreement to settle representations and warranties claims, Bank of America will make a cash payment to Fannie Mae of $3.6 billion and also repurchase for $6.75 billion certain residential mortgage loans sold to Fannie Mae, which Bank of America has valued at less than the purchase price. These actions are expected to be covered by existing reserves and an additional $2.5 billion (pretax) in representations and warranties provision recorded in the fourth quarter of 2012. Bank of America also agreed to make a cash payment to Fannie Mae to settle substantially all of Fannie Mae’s outstanding and future claims for compensatory fees arising out of past foreclosure delays. This payment is expected to be covered by existing reserves and an additional provision of $260 million (pretax) recorded in the fourth quarter of 2012. Bottom line: hit to Q4 pretax earnings will be $2.7 billion. Yet, as BAC notes, despite the settlement, "Bank of America expects earnings per share to be modestly positive for the fourth quarter of 2012." Which means prepare for one whopper of a loan-loss reserve release for the quarter as more "earnings" are nothing but bookkeeping gimmicks.

• Secret and Lies of the Bailout (Rolling Stone)
• Banks Win 4-Year Delay as Basel Liquidity Rule Loosened (BBG)
• Hedge Funds Squeezed With Shorts Beating S&P 500 (BBG)
• Bankruptcy regime for nations urged (FT)
• Is the Fed Doing Enough—or Too Much—to Aid Recovery (WSJ)
• Cracks widen in US debt ceiling debate (FT)
• McConnell Takes Taxes Off the Table in Debt Limit Negotiations (BBG)
• Abe Seen Spending 12 Trillion Yen to Boost Japan’s Economy (BBG)
• Monti, Berlusconi Spar on Taxes in Weekend Media Barrage (BBG)
• Cameron Sets New Priorities for U.K. Coalition (BBG)
• Defiant Assad Rules Out Talks With Rebels (WSJ)
• Korea Seen Resisting Rate Cut as Won Threatens Exports (BBG)

D-day - the real D-Day: the day after which the US government will have to start shutting down - is now 52 days away, but with the Pyrrhic victory on the Fiscal Cliff, which once more, did nothing to resolve the Fiscal Cliff issue but merely hiked payroll taxes for some, general income taxes for others, even as drunken sailor spending has persisted, it is virtually a guarantee that nothing will happen in D.C. for at least 3-4 more weeks until the posturing and jawboning soars in earnest. Only this time the can kicking won't be nearly as easy. In other news, for the first time in maybe 2 months, the algos are neither gripped by headlines about Washington, or macro events, but micro, as the fourth quarter earnings season kicks off, with Alcoa reporting on Tuesday, Wells on Friday and a true launch of Q4 earnings season next week. And since revenues are set to continue deteriorating despite estimates of a Y/Y increase in top lines following a disastrous Q3, and let's not even mention cash flow, operating earnings and capital reinvestment, once again it will all be about EPS rejiggering and accounting games.

When one speaks of a concept it is important that it is properly qualified so as to be correctly understood. Failure to accomplish that makes impossible for either the problem to be identified or a desired solution to be found. Perhaps this is why politicians have a tendency to speak of ill-defined and oft muddled concepts, like “social justice,” “a living wage” or “fair share.” These concepts are impossible to define in a way consistent with how they are represented, since their proponents represent them as definite, rather than abstract matters. Politicians and demagogues alike may debate these issues for as long or as short as they may desire, but whatever level they agree on is sure to be arbitrary, save for the only objective conclusion that such concepts are impossible to quantify. It follows that the “fair share” doctrine is an indefinable political tool intended to be used as needed, when needed, by office seekers. It is not a policy to be sought in order to bring equality under the law or economic prosperity, as it is a concept that runs against the principle of private property.

They say "be careful what you wish for", and they are right. Because, in the neverending story of the American "recovery" which, sadly, never comes (although in its place we keep getting now semiannual iterations of Quantitative Easing), the one recurring theme we hear over and over and over is to wait for the great rotation out of bonds and into stocks. Well, fine. Let it come. The question is what then and what happens to the US economy when rates do, finally and so overdue (for all those sellside analysts and media who have been a broken record on the topic for the past 3 years), go up. To answer just that question, which in a country that is currently at 103% debt/GDP and which will be at 109% by the end of 2013, we have decided to ignore the CBO's farcical models and come up with our own... To answer just that question, which in a country that is currently at 103% debt/GDP and which will be at 109% by the end of 2013, we have decided to ignore the CBO's farcical models and come up with our own. The bottom line: going from just 2% to 3% interest, will result in total 2022 debt rising from $31.4 trillion to $34.1 trillion; while jumping from 2% to just the long term historical average of 5%, would push total 2022 debt to increase by a whopping $9 trillion over the 2% interest rate base case to over $40 trillion in total debt!

The last week or two has seen Citi's economic 'surprise' indicator (ECO) take a decided turn for the worse. At Friday's close, the index that tracks not just absolute performance of the major macro prints but their relative performance to expectations, had hit a three-month low. Since the top in the S&P 500 in late 2007, the 3-month rate-of-change has shifted significantly negative four times - and each of these times has been followed by a significant downturn (or change of trend) in the S&P 500. As of Friday's close, the ECO index's rate-of-change shifted negative (its most negative in 5 months) and has signaled a quite intriguingly divergent lower high (from Q4 2011' previous peak) compared to the S&P 500's higher high. Is the short-term drop in ECO due to 'cliff' indecision? Or will earnings season be the market's catalyst to realize the changing macro landscape?

Reuters is reporting that many of America’s major brands have been quietly tweaking their coffee blends. While most coffee companies consider their blends trade secrets, and are loath to disclose exactly what goes into them, both circumstantial and direct evidence suggests they’re now substituting lower-grade Robusta beans for some of their pricier Arabica, and degrading the quality of our coffee. Research out of agricultural bank Rabobank confirms that demand for Arabica beans among coffee buyers “has fallen 27% year-to-date, while Robusta [demand] is 25% higher.” This seems to confirm a widespread alteration of the bean mix. Why the switcheroo? Prepare to not be shocked. The answer is: price. 

Presented with little comment, aside to note that 32-year-old Indian Datta Phuge, thought this $25,000 solid gold shirt would be just right to attract female attention: "I know I am not the best looking man in the world but surely no woman could fail to be dazzled by this shirt?" So much for the yellow metal being a barbarous relic.

2013's biggest Grey Swan might be not China's slowdown or Euro area's continued debt crisis (although both are pretty much still on the books, although the former is less likely than the latter). It might not even be the Japanese economic implosion (albeit Japan is sick beyond any repair)... oh, no... the real Grey Swan of 2013 might be the markets starting to take a closer look at the US. This might sound bizarre during the weekend following Friday, when the VIX index collapsed 39.1% - more than in any other trading day in its history, and when the US markets have ended the first week of the year with total gains almost equivalent to what some are projecting for the entire 2013... and yet... as some would say: "Houston, we've got a problem!" The problem is best illustrated in the following three sets of chart, all comparing US fiscal performance to the peers.

There was a time when everyone (who was anyone) wanted a Swiss bank account, as much as an offshore cash parking vehicle as for its hushed prestige, whispered to a select few during Hamptons' cocktail parties. Those days are now gone, with the last remaining anonymous offshore private banking bastion left being Singapore, if even that. So in a world in which country after country is scrambling to hike income (and soon financial wealth and asset) taxes on the superrich, is this, paradoxically, what the new "Swiss bank account" is going to look like? And with the Obelix case study officially in the books, who will be the next to take advantage of the former KGB spy's taxation generosity?

Back in July, when news of what we dubbed the French "Fairness Doctrine" first emerged, i.e., the new socialist government's intent to tax the evil millionaires at a 75% tax rate, we had two observations: i) that "we are rotating our secular long thesis away from Belgian caterers and into tax offshoring advisors, now that nobody in the 1% will pay any taxes ever again" and, somewhat contradicting the above, ii) that "The good news is that with the entire world set to adopt 100%+ taxes on "wealthy" individuals as defined arbitrarily by Ph.Ds, there will be no place to hide." Well, the US promptly followed France into a lite-version of the Fairness Doctrine, which proved us half right, yet one place that has refused to increase its tax rate for the poor or rich, keeping it at the flat 13% for individuals is Russia, which explains why following last week's news that Russia had granted famous French expat millionaire Gerard Depardieu citizenship, the actor best known as Obelix and Rasputin, eagerly rushed to accept his new red passport in Sochi following a bearhug from none other than Vladimir Putin. 

The term "invasive species" has been used to describe new types of plants or animals that have been introduced to a new area, whereupon they change the local biosystem. The sudden appearance of new lifeforms in an environment can cause rapid losses in some of the species present prior to this appearance. On occasion, however, the new players can overwhelm the stabilizing factors in the system, which undergoes dramatic changes, eventually stabilizing in a new configuration that is highly detrimental to many of the original players in the system. Which brings me to today's invasive species. Many of the characteristics of successful invasive species are shared by HFT algorithms. This is driving the retail investor to extinction, through the erosion in their margins brought about by HFT. In the presence of HFT, the unsophisticated investor pays a higher price on the buy and receives a lower price on the sell than would be the case otherwise. The professional traders manage to maintain their margins--the losses of the unsophisticated are the profits of the algos.