In most countries, deleveraging is only in its early stages. In a report today, McKinsey notes that total debt to GDP has declined in only three countries since the 2008-09 crisis (US, South Korea, and Australia) as total debt has actually grown in the world's ten largest mature economies (due mainly to rising government debt - Keynesian style?). Greatly concerned that the UK and Spain are slow to delever, they do note that the US is more closely following the two phase deleveraging process that 1990s Finland and Sweden followed but point to the household segment as leading the way with 15% reduction in debt to disposable income (driven unsurprisingly in major part by mortgage defaults). The bottom line is US (households) are at best one-third of the way through their deleveraging and the UK (financials) and Spain (non-financials) face much more significant pressures (which will inevitably impact aggregate demand given governmental borrowing pressures) as their deleveraging has only just begun. Historically, deleveraging has begun in the private sector and government has stepped up to borrow and fill the aggregate Keynesian hole left behind. McKinsey points out deleveraging normally takes 4-6 years which we suspect will remain an anchor for demand and growth in the mean-time (perhaps as disappointing earnings revisions are already pointing to).
LTRO version 1.0 continues to capture the market's attention. It was a reason to rally, then fade, now back to an excuse to rally. Our contention all along has been that LTRO was good for banks. It dramatically reduced the liquidity risk for banks. It did nothing for the solvency of banks or sovereigns, and we continue to believe it doesn't do anything for the liquidity risk of sovereigns. We think the belief that the carry trade is at work is a fallacy. Banks did NOT take down LTRO to buy new assets and are still in deleveraging mode, so will NOT use the next LTRO offering to take on new money. We will see what happens but Peter Tchir believes that the second tranche of LTRO will be a pale comparison of the first in terms of size which will damage market excitement over how much of the "carry" trade is going on.
The only thing that is as consistent as Marc Faber's message to get out of government bonds ahead of a bout of global hyperinflation which will arrive once the vicious cycle of printing to pay interest finally dawns (which in turn would happen once central planners lose control of an artificially created situation, which by definition, always eventually happens), is the passion with which he repeats it over... and over... and over, like a man possessed, if ultimately 100% correct. In an interview with Bloomberg's Sara Eisen and Erik Schatzker this morning, he does what he does best - cuts to the chase: "if you think it through and you are as bearish as I am, and you think the whole financial system will one day collapse, we don't know if in 3 years, or 5 years, or 10 years, but one day there will be a reset, and everything will be essentially started anew, then you are better off in equities than in government bonds, because a lot of government bonds will either default or they will have to print so much money that the purchasing power of money will depreciate very rapidly." When asked if he feels uncomfortable predicting a calamity in bonds again, as he did back 2009, Faber is laconically empathic: "it is true that last year the 30 year bond returned 30%, and i owe David Rosenberg a bottle of whiskey" but analogizes: "from August 1999 to March 2000, the Nasdaq doubled, but at no time in that timeframe was it a good buy. And after it people lost a lot of money. We have now a symptom of monetary inflation and this is record corporate profits, and the second symptoms is essentially a bubble in high quality bonds: people seem so insecure and so much worried, they would rather be in a US bond with no yield, than in bonds that may not repay me, or in equities that may drop 30%. But it does not make them a good buy longer term." Yep: only Faber can get away with calling the bond market the second coming of the Nasdaq bubble and look cool doing it.
Earlier in the week we highlighted a number of charts that indicate VIX (or short-dated vol) is under-pricing risk. The cheapness of vol has continued - especially now that Goldman has started to promote the buy-write strategy (offloading their positions?) that we felt was largely responsible for the rise in implied correlation (more macro demand for protection than micro). Today we look at what appears to be another leading indicator of stress ahead in short-term vol. The skew (or difference between an at-the-money option and an out-of-the-money option) 'measures' the market's comfort with normal risk (small moves) relative to more extreme moves - the higher the skew, the more concerned a market is at hedging extreme moves. Over the last few years, when the skew has spiked, VIX has been very close behind reflecting an underlying and consistent concern of tail risk juxtaposed with momentum chasing vol-premium gatherers in the short-term at-the-money options. Current levels of skew are the highest since early 2011 and as the chart infers, suggest VIX is due for a correction significantly higher.
So it looks like we should get an announcement sometime today about the proposed Greek PSI deal. Yes, proposed, not finalized. Asides from the obvious fact that there will be limited or no documentation for the deal, we still have no clue who has agreed to what. As far as we can tell, no one has given the IIF negotiators any binding power. We think this will be a relatively small portion of bondholders and then the real game begins. If the terms of the deal being leaked are true, it will be extremely interesting to see what other countries do. Why should Portugal or Hungary bother with painful steps to reduce debt when the alternative is spend more, reduce debt via restructuring, and get lower rates on that reduced debt?
A few days ago, we noted how in light of the most recent temporary bout of market insanity, which has seen the worst of the worst companies broadly outperform risk, one should go long the 30 most hated companies in the US as determined by the short interest to float ratio. We ourselves are unsure if this was a mock recommendation, or the only way to make money in a time when short covering is the only viable trading "strategy." Now as it turns out, precisely the same approach of pursuing the biggest losers has worked in the bond world as well. As the following graphic from Reuters shows, the three best performers of the year in rates, is 10 Year paper from Ireland, Italy, and, yup, Greece, all of which have returned over 4%. The US? Down 0.7% YTD. Why the divergence? Simple - the market is fully positioned for continued massive balance sheet expansion out of Europe which at least for the time being appears to have been passed the baton of monetary irresponsibility. At least that is what the market prices in. That and some ridiculous amount in one the next 3 year LTRO next month (which however does nothing at all to fix solvency, and in fact merely makes the day of reckoning even more painful when it starts - what happens in 3 years: the ECB is forced to do a €100 trillion 7 day MRO every week to roll the entire European balance sheet on a weekly basis?). Whether the market be disappointed, we will known in just under 6 weeks. Either way, here is what bond returns look like Year To Date. For anyone hit by a case of treja vu, you are not alone: this is precisely the same pattern we have seen for the third year in a row. What happens next is well known.
From Kyle Bass / Dylan Grice prognostications on Japan as poster-boy for the end-results of a desperate central bank / government cabal to Richard Koo's perception of the land of the rising sun as a great example of how to get out of a depressionary funk, no one can argue with the facts that Japan's debt situation and total lack of financial flexibility is a ticking debt-bomb (with a fuse varying from 3 months to infinity given market participants' pricing implications). McKinsey provides some clarifying perspective on the Lessons from Japan today suggesting the country provides a 'cautionary tale for economies today'. Noting that neither the public nor the private sectors made the structural changed that would enable growth (a theme often discussed here) with public debt having grown steadily as economic stimulus efforts continue. But, as they note, the price - two decades of slow growth - has been high, and the final resolution of Japan's enormous public debt has yet to come.
Nowhere in S&P’s statement about “global economic and financial crisis”, did it clarify that sovereigns were hit due to backing their largest national banks (and international, US ones) which engaged in half a decade of leveraged speculation. But here’s how it worked: 1) Big banks funneled speculative capital, and their own, into local areas, using real estate and other collateral as fodder for securitized deals with derivative touches. 2) They lost money on these bets, and on the borrowing incurred to leverage them. 3) The losses ate their capital. 4) The capital markets soured against them in mutual bank distrust so they couldn’t raise more money to cover their bets as before. 5) So, their borrowing costs rose which made it more difficult for them to back their bets or purchase their own government’s debt. 6) This decreased demand for government debt, which drove up the cost of that debt, which transformed into additional country expenses. 7) Countries had to turn to bailouts to keep banks happy and plush with enough capital. 8) In return for bailouts and cheap lending, governments sacrificed citizens. 9) As citizens lost jobs and countries lost assets to subsidize the international speculation wave, their economies weakened further. 10) S&P (and every political leader) downplayed this chain of events.... The die has been cast. Central entities like the Fed, ECB, and IMF perpetuate strategies that further undermine economies, through emergency loan facilities and bailouts, with rating agency downgrades spurring them on. Governments attempt to raise money at harsher terms PLUS repay the bailouts that caused those terms to be higher. Banks hoard cheap money which doesn’t help populations, exacerbating the damaging economic effects. Unfortunately, this won't end any time soon.
European indices as well as major currency pairs are trading in slight negative territory at the midpoint of today’s session due to profit-taking and cautious sentiment dominating the market, with the worst performing sector being Oil & Gas showing volatile trading this morning. In European macro news, Greek PSI talks are closer to coming to a conclusion, with a source saying that the haircut announcement is likely to be today.
One won't find many orthodox strategists who believe that currency printing, and thus dilution, is favorable for said currency. Yet they do exist (as a reminder, this is precisely what saved the REITs back in early 2009, who came to market with massively dilutive follow on offerings, but the fact that they had market access was enough for investors to buy the stock despite the dilution). One among them is Citi's Steven Englander who has released a rather provocative piece in which he claims that as a result of reduction in tail risk, or the possibility of aggressive ECB bond buying (and implicitly, Englander suggests that what we believe is a core correlation: between the sizes of the Fed/ECB balance sheets and the relative value of the respective currencies, is not as important as we suggest), the "EUR will be stronger if the ECB compromises its ‘principles’, but succeeds in convincing investors that the sovereign risk is limited to the smaller peripherals, rather than the core." Currency stronger on central bank printing? And by implication, an x-trillion LTRO being FX positive (and thus risk-FX recoupling)? We have heard stranger things. And remember it is the bizarro market. And finally, Morgan Stanley, which won that shootout with Goldman's Stolper two months ago on the EURUSD, has just turned tactically bullish on the currency (more shortly). For now, here is how Steven Englander explains his contrarian view.
Remember that Greek bondholder PSI agreement that was "imminent", and which we said ain't coming any time soon, probably never? Well, the latest bout of the IIF's overpromising and never delivering, something the Charles Dallara agency has been so good at in the past, is starting to creep into market sentiment, precisely as predicted by the Einhorn diagram that explains market trading patterns, and newsflow excrement, better than anything in the past year. Below Bloomberg summarizes just how the latest revulsion at leadership betrayal is starting to hurt the market which may be about to lose all its recent gains driven purely by optimism.
- Fed Holds Off for Now on Bond Buys (Hilsenrath)
- Bonds Show Return of Crisis Once ECB Loans Expire (Bloomberg)
- Greek Debt Talks Enter Third Day After ‘Substantial’ Discussions (Bloomberg)
- Sharp clashes at Republican debate ahead of vote (Reuters)
- Lagarde Joins Warning on Fiscal Cuts Before Davos (Bloomberg)
- Investors exit big-name funds as stars fail to shine (Reuters)
- Payday lenders plead case to consumer agency (Reuters) - the EFSF included?
- EU Toughens Fiscal Pact Bowing to ECB Objections, Draft Shows (Bloomberg)
- Minister Urges Japan to Use Strong Yen (FT)
- China Eyes Pension Fund Boost for Stock Market (Reuters)
- China Manufacturing Contraction Boosts Case for Easing: Economy (Bloomberg)
RANsquawk European Morning Breaking News - Stocks, Bonds, FX -- 20/01/12
As retail investors continue to appear significantly pessimistic in their fund outflows ($7.1bn from US equity mutual funds in w/e January 4th - the largest since the meltdown in early August) or simply stuff their mattresses, David Santschi of TrimTabs asks the question, 'who is pumping up stock prices?' His answer is noteworthy as a large number of indicators suggest institutional investors are more optimistic than at any time since the 'waterfall' decline in the summer of 2011. Citing short interest declines, options-based gauges, hedge fund and global asset allocator sentiment surveys, and the huge variation between intraday 'cash' and overnight 'futures market' gains (the latter responsible for far more of the gains), the bespectacled Bay-Area believer strongly suggests the institutional bias is based on huge expectations that the Fed will announce another round of money printing (to stave off the panic possibilities in an election year). The ability to maintain the rampfest that risk assets in general have been on (and the cash-for-trash short squeeze that has been so evident) must be questioned given his concluding remarks.