Nic Lenoir On Starting The Week With A Bang
From Nic Lenoir of ICAP
It's always good to walk in with markets up over 1% for absolutely no reason knowing that the move for the day is behind us and there is nothing to look forward to all day. Good news range from "Banks are going to face tougher capital requirements but have 8 years to comply" aka they are broke but don't have to admit it just now, to dismissal to double dip theory based on one data point out of China. Leaving aside the obvious lack of credibility of any number coming out of China, it's interesting to note how the market learned its lesson from the Madoff debacle. 11% return every year like clock work? Sure no problem. +9% to +10% GDP annually like clock work anyone? Maybe a little similarity here no? Not even a bit? The top of the Chinese miracle must be close when Michael Douglas is out there touting he made all his money back after a rough 2008 by buing AUD bonds. He is to AUDUSD what Gisele or Jay-Z were to EURUSD. Watch CAC open tomorrow to see if today's rosy mood is here to stay as the chart attached looks a bit like an abandoned candle on the highs...
Besides all this great news though, the bond market did not buy the enthusiasm today and yields finished down. I attached the Tnote and Bunds chart. Both have very similar wave formations, and 10Y UST futures saw their downside target at 123-00 this morning. Bunds seem to have slightly more room to go with the key support / buy zone at 129.10 but they came relatively close overnight and next push should be the last. As I equate for now on paper a return to the bond rally with more flattening of the yield curve, I tried to revisit today conditional 5/30s flattener. Remember last time when we had pitched those bear flatteners when the curve was at its steepest based on the fact that the structure was virtually free to buy? Well today the 136 USZ0 calls X -2.8 121 FVZ0 calls traded at +45 ticks even though it is out of the money 8 basis points to the curve and 15 basis points in terms of yields. That tells us that volatility curves have adjusted to price in that more flattening is a lot more likely that was assessed early in August. For that reason though the trade is not very attractive, whereas buying FVZ0 121 calls outright is. If Bond calls are pretty expensive, downside for 5Y yields is a pretty cheap bet here. The calls, which once adjusted for roll-carry (see sep/dec spread in 5Y futures) are only 15bps out of the money don't even cost 5bps... Certainly worth keeping in mind if you buy into the economic slow-down theory as I do. A 20bps rally (equivalent to revisiting the lows in 5s) assuming all else equal would quadruple the premium invested.
I will conclude with AFSSR, America's Funniest Sell-Side Recommendation, today awarding Tobias Levkovich for his positive outlook on stocks based on demographics. When most focus on the 45/60 year-old demographic tranche to assess investoment outlook, he decided to pick a different tranche and conclude unlike everyone else who uses demographics that we are about to enter the next bull market. The chart he joined to his study, which ironically indicates that if the correlation is respected S&P should be at 350 in early 2012 before the big bull market (at which point he would no longer have a job), is simply the most amazing arbitrary 1-factor analysis of a several million variables economic system. The results are obviously of staggering stupidity. Meanwhile assuming a constant salary/age distribution, demographics imply that population will go from a +1.5% to +2% contribution to GDP over the past 30 years to only +0.65% over the next 15/20 years. Maybe next he can prove how budget cuts would be a boost to the S&P.
Good luck trading,