NASDAQ managed its largest gain in four months as Apple came back into vogue and saved the day. The equity indices were alone in their magnificent exuberance after the European close as Gold, Treasuries, and the USD all tracked sideways in a very narrow range. As we have been warning, the mania is back in equity (and credit markets but less so) as April has now seen six of the last nine days swinging between 2 sigma gains and 2 sigma losses (for the NASDAQ). Volume was average today in ES (the S&P 500 e-mini futures) and NYSE (stocks) but high in Apple's equity and options markets as the schizophrenic behavior pushed the stock from under $572 at the open to almost $610 by the close (though notably stuck between Friday's close $605.19 and its closing VWAP at $610.74). The last day to fund your IRA combined with tomorrow's VIX futures/options expiration likely helped some of this momentum (as we note VIX is about 1 vol higher than it was when the S&P closed at these levels on Friday). Just as in Europe, credit markets were simply not as enamored with the Spanish auction or Apple's awesomeness as equities and drifted sideways to weaker all afternoon (with some late-day weakness in HYG as it starts to fall back towards its NAV). Financials and Materials lost some ground into the close and ES gave all its post-Europe-close gains back as volume and trade size picked up significantly at last Thursday's swing highs (near pre-NFP levels again). The Treasury complex saw all its 'losses' in the early going and went sideways in an extremely narrow range for much of the US day session - ending the day slightly higher in yield (0.5-1.5bps) on the week. Commodities surged early on as the USD slipped but drifted back from mid-morning on (except WTI which broke above $105 (ended above $104) for the first time in 2 weeks. Gold and Silver nose-dived right after the US open only to recover it all by the European close. EUR strength (and USD weakness) occurred early this morning on the Spanish auction and aside from a rip in CAD the rest of the day was relatively tight ranges with a very small drift higher in DXY. All-in-all, it seemed like an oversold snap that saw opportunistic sellers coming in at the end as average trade size surged and ES closed back above its 50DMA again - echoing last week's mania and worryingly raising realized vol for all those hopes and dreamers. Equities look over-their-skis again relative to risk assets in general.
Last night, Goldman entered into unchartered territory with its first observations of the student loan bubble in a piece titled "Are Student Loans Driving Consumer Credit Growth?" Most of the observations are nothing new, although author Alec Phillips does bring up one amusing implication of what the soaring student debt may mean in macro terms. Specifically, to Goldman the rise in debt is merely "A more important source of countercyclical credit. Since federal student lending standards are looser than most other forms of credit, they now rely mainly on Treasury borrowing for financing, and demand for them appears stronger when the labor market weakens, it seems likely that education-related debt will grow fastest at times when the economy slows and other lenders are pulling back." In other words, the rate of change in student debt is inversely proportional to the improvement in the US economy, or directly proportional to its deterioration. So since the student debt chart is, for lack of a better word, parabolic, what does that mean for the broader economy?
(Today, we have the date correct) DoubleLine's Jeff Gundlach (whose AUM is now well into the $30 billion area - a scorching ascent for the former TCW manager) will host a live call at 4:15 PM Eastern today, on the ever so salient topic (if somewhat regurgitated soundbite) of whether "To QE3 or Not To QE3: That is the question." As is traditional, Gundlach will accept questions from the audience. And as always, lots of very interesting tangential info to be gleaned from one of the truly objective and original thinkers out there.
It was only last week that we highlighted the facts and fiction behind JPMorgan's prop-trading CIO office activities and Bruno' London Whale' Iksil's magnificent market cornering 'hedging' activity. Well, Bloomberg's chart-of-the-day provides the clearest and most destructive indication of just how ridiculous this supposed 'hedge' position had become. Thanks to Mary Childs and Shannon Harrington's data scrubbing, its turns out that, according to the DTCC, the net notional of contracts on Series 9 on the Investment Grade credit index (this is the credit derivative index that is most closely tied to the massive haul of outstanding tranche deals that remain in the market) surged an incredible 65% (to $148.2bn) in the last 14 weeks. As is clear from the chart, relative to every other credit derivative index this level of activity cornering, which managed to drive the index 18% below its 'fair-value', stands out rather dramatically and perhaps should jog a few regulator's from their porn-surfing lunch-breaks. The footprints of this particular whale seem a little too large to ignore but that then again, Spain did manage to sell some short-term debt so who cares?
First we got Italy telling the world quietly it would not meet its deficit target for 2013, and will in fact experience debt/GDP growth in all outer years, and now we get the Bank of Spain, also taking advantage of today's market rally to dump its own set of bad news, namely that Spanish banks will need to provision another €29.1 billion, and will have higher core capital requirements of €15.6 billion (this is fresh capital). 90 banks have already complied with the capital plan, 45 have yet to find the needed cash. Putting this into perspective, the amount already written-down is €9.2 billion. So, just a little more. And this assumes there are no capital shortfalls associated with any impairment from the YPF -> Repsol follow through, which as Zero Hedge already showed, would leave various Spanish banks exposed. In other news, there is one more hour of trading: we suggest every insolvent entity in the world to quickly take advantage of the interim euphoria, as tomorrow may not be so lucky. Of course, in the worst case, Japan will just bail everybody out.
In the terminal collapse of the Roman Empire, there was perhaps no greater burden to the average citizen than the extreme taxes they were forced to pay. The tax 'reforms' of Emperor Diocletian in the 3rd century were so rigid and unwavering that many people were driven to starvation and bankruptcy. The state went so far as to chase around widows and children to collect taxes owed. By the 4th century, the Roman economy and tax structure were so dismal that many farmers abandoned their lands in order to receive public entitlements. At this point, the imperial government was spending the majority of the funds it collected on either the military or public entitlements. For a time, according to historian Joseph Tainter, "those who lived off the treasury were more numerous than those paying into it." Sound familiar?
It will come as no surprise that the Spanish 'experiment' with the euro is not going well. Spain now relies more heavily on the ECB than at any time and today's bill auction sums up all that is wrong about our financial markets when an event that absolutely should be expected to be a non-event (a sovereign nation selling a small amount of short-dated debt) becomes a catalyst for algorithmic excess. In perhaps the greatest analogy for today's auction, Micheal Cembalest pronounces "throughout my career, central banks having to buy or finance sovereign debt to avoid a debt crisis was like going to the prom with your sister: there’s something very unnerving about it, even though it looks normal from a distance." It did not take long for the honeymoon following LTRO2 to end and despite today's exuberance, Italian and Spanish equity markets (as well as financial credits) have collapsed as Spain's sovereign risk has skyrocketed. While Spanish bank holdings of Spanish govvies, ECB lending to Spanish banks, and Spanish credit risk are surging so is one other much more worrisome fundamental trend - that of corporate non-performing loans. Dismissing the dichotomous relationship between consumer and residential delinquency calmness relative to unemployment's explosion (much as the market has in its pricing of bank stocks), the JPM CIO remains underweight Europe arguing that while contrarian calls are often the most profitable, this time being underweight European equities is the gift that keeps on giving.
Recently I was asked by a high school teacher if I had any ideas about why students today seem so apathetic when it comes to engaging with the world around them. I waggishly responded, "Probably because they're smart." In my opinion, we're asking our young adults to step into a story that doesn't make any sense. Sure, we can grow the earth's population to 9 billion (and probably will), and sure, we can extract our natural gas and oil resources as fast as possible, and sure, we can continue to pile on official debts at a staggering pace -- but why are we doing all this? Even more troubling, what do we say to our youth when they ask what role they should play in this story -- a story with a plot line they didn't get to write? So far, the narrative we're asking them to step into sounds a lot like this: Study hard, go to college, maybe graduate school. And when you get out, not only will you be indebted to your education loans and your mortgage, but you'll be asked to help pay back trillions and trillions of debt to cover the decisions of those who came before you. All while operating within a crumbling, substandard infrastructure. Oh, and by the way, the government and corporate sector appear to have no real interest in your long-term future; you're on your own there. Yeah, I happen to think apathy is a perfectly sane response to that story. Thanks, but no thanks. To understand how our national narrative evolved (or, more accurately, devolved) to become so unappealing, we have to take an honest look at money.
Sure enough, just out from the FT: Argentina will not pay Repsol of Spain what it is asking ($10.5bn) in compensation for nationalization of YPF, says deputy economy min
... but will settle for what it ends up getting: nothing. Of course, in the meantime, there will be a lot of kicking and screaming, but that's great: Risk On - Off markets demand distractions. From the FT: "These acts will not go unpunished" said Antonio Brufau, Repsol’s executive chairman during a two-hour press conference on Tuesday, at which he attacked Argentina’s “revisionism” over YPF’s success, and its energy policy over the past decade." Said otherwise, this aggression will not stand, man. Ok, fine. Here is Argentina's counteroffer.
While a lot of time is spent scrubbing through the details and nuance of each and every macro data point, auction result, earnings comment, central-banker hint, and politician's demeanor, from the top-down the imbalances created by the euro between the North and the South are, in Michael Cembalest's opinion, skyrocketing. They are far greater than any that preceded the Euro, even during the bouts of inflation and devaluation which beset the South in prior decades. Nevertheless, the region appears committed to soldiering on with it, despite the costs. These developments are amazing for a project like the Euro, which was designed to harmonize and sustain Europe’s post-war social, political and economic integration.
As reported last week, and as shown brilliantly by Artemis Capital, the end of every reliquification phase by the Fed, such as the imminent end of Operation Twist with nothing firmly set to replace it, is always accompanied by a surge in vol, which in turn leads to market days like the past week, when market summaries are simple: either it is all Risk On, or Risk Off. Expect many more of these until Twist finally ends in just over two months at which point much more liquidity will be needed to achieve the same "flow" results. It just so happens that today is a risk On day, driven by previously noted "catalyst." Yet what is great about such days is that they allow all the bad news to be packed into a tidy little package and disseminated without anyone noticing, or pretending to notice. Such as the just announced headline from Reuters, which on any other day would have crippled the mood, that "Italy will delay by a year its current plan to balance its budget in 2013, according to a draft forecasting document to be approved by the cabinet on Wednesday." And while we have seen this over and over in the past 2 years, first with Greece, then with all the other PIIGS, it merely exposes the fact that exuberant optimism never pans out in a world in which the real average debt/GDP is what Reinhart and Rogoff would simply call "unsustainable." And while this news will matter once Germany realizes that its precious fiscal pact is already been soundly rejected, first by Spain and now Italy, for now it is but a footnote in the otherwise lacking newsflow: after all Spain managed to issue €2 billion in Bills, which contrary to yesterday, provides that all is again well in Europe. Until Thursday at least when Spain has to issue 10 year bonds, which just happen to mature outside of the LTRO. The narrative then may be somewhat different.
Just as with the broad market, Apple is showing the schizophrenic signs of a market caught between two increasingly distinct Known Unknown scenarios. From down over three-standard deviations (most in 6 months) to up over two standard-deviations (most in 3 months) - even as implied vols remain elevated (as realized vol starts to pick up once again), Apple manages to deny gravity (for a day so far) as it has its best up day in over a month.
The Fed and the Administration should be on their knees and giving thanks for the blessings they have received for the economy over the past 9 months. First, falling oil prices last summer gave individuals an effective $60 billion tax cut. Then during the winter where normally heaters are turned up to stave off the wintery blasts the balmy winter added roughly $30 billion to consumer's wallets due to decreased utility costs. Those impacts gave individuals more dollars to spend and when combined with seasonal adjustments it gave the illusion of a strongly recovering economy. With "Operation Twist" now rapidly coming to an end and the Fed apparently in a trap of rising inflation I am not sure what the next "support" for the economy will be. My expectation continues to be that the economy will continue to run at a sub-par growth rate though the end of 2012 and that we could see a recession by the end of 2012 or by mid-2013. Of course, that is assuming we are boosted by further rounds of artificial intervention by the Fed or Mother Nature.