Archive - Aug 2013 - Story

If you want to track how close we are to the next financial collapse, there is one number that you need to be watching above all others.  The number that we are talking about is the yield on 10 year U.S. Treasuries, because it affects thousands of other interest rates in our financial system.  When the yield on 10 year U.S. Treasuries goes up, that is bad for the U.S. economy because it pushes long-term interest rates up.  When interest rates rise, it constricts the flow of credit, and a healthy flow of credit is absolutely essential to the debt-based system that we live in. 

With the Fed set to begin tapering its "credit creation" or rather enabling, through monetization, of public debt, one would think that US commercial banks, after four years of QE, are finally ready to pick up the pieces and open the lending spigots. One would be wrong.

Everbright Securities - already banned from raising fresh funds due to ongoing investigations - has 'scapegoated' a system malfunction for its causing a 5.6% instantaneous spike in the Chinese stock market on Friday morning. However, while they assure investors that this was 'not' human error, the FT notes, analysts said the trading error was a sign of the industry’s shortcomings as it tried to shift from its old model of managing IPOs and retail sales towards more sophisticated operations such as ETFs, "they don't really have the talent pools or the systems to deal with this new, innovative type of business." However, it didn't take long for the brokerage to screw up yet again by apologizing Monday for 'mistakenly' selling 10Y Chinese government bonds at 25bps above market yields. But apart from that, Everbright seems tip-top, though one analyst familiar with the sector summed it up perfectly we suspect - "the whole system is still pretty incapable."

Over the weekend we posted an in-depth narrative of what may happen in a theoretical worst case scenario in Fukushima, one in which the government continues to do nothing and pretends all is well, and where the end casualties are millions of innocent Japanese (and other) citizens, whose only crime is believing their government. Sadly, with every passing day the theoretical is becoming all too real, and moments ago reality struck again, when the Nikkei newspaper reported that readings of tritium in seawater taken from the bay near the crippled Fukushima nuclear plant has shown 4700 becquerels per liter. This was the highest tritium level in the measurement history. It gets better: Earlier, Tepco admitted that an estimated 20 to 40 trillion becquerels of tritium may have flowed into the Pacific Ocean since the nuclear disaster.

On July 30, when FERC announced that it had agreed to resolve it allegations of JPMorgan manipulation of the energy market for a $410 million fine, with the bank neither admitting nor denying guilt, we posited that the only question on Jamie Dimon's mind was whether to pay the fine from petty cash or just to charge it on his corporate Amex. Three weeks later he may have some other questions swirling in his head, such as "whose Christmas lobbying stocking did I not fill with campaign donations?" after the WSJ reported that it is no longer FERC, but the DOJ itself, led by Preet Bharara, which is investigating whether JPM manipulated energy markets. Ironically, this is a deja vu of the SAC take down by the same Bharara, when a few months after SAC settled with the SEC it was shocked to be crushed by the Department of Justice which pulled an "Arthur Anderson" on it and for all intents and purposes shut it down (although with nobody sent to prison). It remains to be seen if Bharara will have the balls to take this prosecution to the next level and whether after he made SAC into Arthur Anderson, he will make JPMorgan into the New Normal's Enron and whether Jamie Dimon or Blythe Masters will be the next Lay and/or Skilling. One can hope.

With Greek haircuts likely (or Cyprus-style bail-ins), Merkel elections (and the potential for less positive coalitions and post-election 'sternness'), and the possibility for the German court to curtail plans for OMT; there is plenty to  remove the 'magic' that is supporting Europe's market 'recovery'. However one topic not often discussed is the ongoing surge in people seeking refuge in EU countries from North Africa and the Middle East. Countries such as Greece or Italy that make up the European Union's southern border have long struggled to deal with flows of refugees from across the Mediterranean. The issue, as Stratfor notes, has been magnified by high unemployment rates in destination countries, where social security systems are strained and anti-immigrant sentiment is high. However, the combination of continued northern flows of European migrants, the increase in asylum applications and the spread of the European economic crisis appears primed to weaken some of the achievements Europe has seen in integration.

So let's pretend for the moment that the Federal Reserve gets everything it has stated it wants.  And even further: that Washington, D.C. gets everything it wants, too. The credit markets are repaired, and massive new loan growth flows out the door.  Loans are made to businesses that hire gobs of new people.  Consumers borrow and borrow some more to go to school and buy homes, cars, and gadgets. Inflation remains low and job growth explodes.  Tax receipts climb and the deficit falls.  The stock market goes higher and higher, gold falls and then falls some more, as confidence in the system, its masters, and its institutions grows. The Fed wins and D.C. wins. But in reality, we all lose. It's all just a matter of timing (and un-sustainability).

BlackRock's fixed income CIO Rick Rieder is worried about the impact that higher rates will have on the stock market. In this brief interview with Bloomberg TV's Tom Keene, Rieder explains that while equities look 'cheap' given where rates are, this is a mis-pricing and warns (as we have repeatedly) that "people don't spend any time looking at cash-flow discounted by cost of financing, which is really where we think equity should be valued." In that case (as we have noted), a surge in financing costs will weigh heavily on stocks. While he is concerned about investors' general lack of awareness of the risk in bond funds - "the volatility in fixed income could actually be higher than the equity market," he fears the impact of higher rates on mortgages and other credit vehicles on the recovery. However, as Rieder notes they have been saying for a long time, "QE’s too big. You’ve got to taper down QE. It's created this tremendous distortion in interest rates," as he sees fair-value for the 10Y around 3.25%.

Treasury bond yields have risen for 5 of the last 6 days (with the 7Y yield up 35bps in that period) adding 5bps today but since the latest cluster of Hindenburg Omens began to appear, the S&P 500 has fallen for 9 or the last 11 days (-3.6% from the 08/02 highs) and closed below its 50DMA today (on light volume). Today saw 430 new lows (the second highest since Oct 2011) and only 15 new highs. The S&P joined the Dow and the Trannies in the red for the period post-FOMC (June); and only Healthcare, Discretionary, and Industrials remain green from that 6/19 event. The USD ended the day practically unchanged but FX markets were very volatile (AUD and JPY all over the place in the majors and INR in the locals). Commodities in general slid lower by around 0.7% or so in a relativley highly correlated way with stocks. Credit markets continue to underperform, leading stocks lower. VIX was banged back above 15% to its highest close in 7 weeks. Today was the 4th negative close in a row for the S&P - the first time this year.

SEC SAYS FALCONE CONSENTS TO BAN FROM ASSOCIATION WITH ANY BROKER, DEALER, INVESTMENT ADVISER, OTHER ENTITIES, WITH RIGHT TO REAPPLY AFTER FIVE YEARS

The equity rally that began in 2009 has pushed valuations higher, but has received little support from earnings. Indeed, as Morgan Stanley notes, since June 2012 the equity market rally was entirely driven by valuation and not earnings. While there have been cases when better economic conditions pushed up earnings, providing equity market support, there have also been occasions when valuation driven equity market rallies translated into weakness, as witnessed in October 1987. The equity market rally which began in 1986 and peaked in the summer of 1987 falls into this category.

In case Ben Affleck was looking for his next Oscar-winning CIA-o-mentary, the Central Intelligence Agency (which alas in a time of NSA permasnooping has become a bit of an anachronism) may have just provided the script, with the first official admission that the flipflops on the ground orchestrated at least one Iranian coup and is ostesnibly behind all other global coups (and non-coups coughegyptcough) in the past 50 years, but until they are confirmed they will remain merely "conspiracy theories."

As is well-known by now, one of the main reasons why the Fed's hands are tied when it comes to the future of QE, is the dramatic drop in the US budget deficit which cuts down on the amount of monetizable gross issuance (read Treasurys) and for which a big reason is that the GSEs have shifted from net uses of government cash to net sources. So in what may be the best news for Bernanke, and/or his successor, we learn that according to a report written by the Federal Housing Finance Agency (FHFA) inspector general and reviewed by Reuters, "Fannie Mae and Freddie Mac are masking billions of dollars losses because of the level of delinquent home loans they carry."

Presented with little comment (over our earlier detail) but just to note that around the world there are significant events occurring (even as the US equity market slumbers). So much for the gold coin ban - gold now trades at 4 month highs in Rupee terms.