Copper

Your one stop, comprehensive summary of the past week's key positive and negative events.

Inflection points on four key markets that would serve as definitive indicators that the world is in a double-dip recession.

Equities ended on a very weak note, bringing the worst quarter since Q4 2008 for the S&P500 to an end. Stocks remain, perhaps remarkably to some, expensive relative to credit markets - especially HY which is feeling significant pain as issuance volumes drop 75% in the quarter to their lowest since Q2 2009. While stocks dropped around 2 standard deviations from a long-run mean, Treasuries did even better and rallied around 3.5 standard deviations - the second largest percentage shift in yields ever (once again Q4 2008 was the only better). Truly a remarkable day, week, month, and quarter and to be frank, one that shows no signs of slowing and as far as the rotation/re-allocation trade from bonds to stocks, we suspect risk-aversion will keep that on hold with a 4 standard deviation jump in VIX.

If the equity crowd only knew how difficult it is to trade financial instruments in secondary markets (or primary markets with IPOs non-existent and IG issuance taper off etc) and what each new non-agency valuation mark means for the next quarterly earnings report, given top five banks own near $800 billion of second liens and stuff not to mention other variations of housing stock.  Record long mortgage exposute in all its forms.  These asset markdowns will be reflected across the street in next slate of earnings statements.   Litigious environment too blurring liability thanks to partner government.  Financials CDS anywhere from +15 bps to +25 bps wider. Another thought is that this particular primary banking group is actually the lubrication, artery or aorta for the liquidity of the U.S. Treasury as primary role for distributing U.S. and other sovereign debt.  What does it mean when the equity valuations of these players plummets, what their OWN liquidity dysfunction and willingness and ability to raise liquidity for U.S. or any debt?  I suppose with the recent Op Twist release a few minutes ago, the Fed will buy some of it. 

All you need to read. (a little late today)

A funny thing happened right after the 'successful' EFSF vote in Germany, equity-credit-and-EUR sold off in sync, but this moment of sanity amid the chaos that is the European corporate capital structure did not last as soon after reaching swing lows, European equities surged dramatically ahead of credit markets only to pull back into the US open and stabilize. On a medium-term basis, stocks remain significantly expensive relative to credit expectations but with such a binary outcome (depression or safe-union) the smallest swing in the odds of one or the other tips risk assets rapidly in that direction (as opposed to discounting over a broader set of scenarios).

UPDATE: well that upset the apple-cart as darling of the carry currencies - NZD - gets downgraded - shifting FX carry and thus risk assets in general down with it.

All you need to read.

When one compiles the annals of the great deflationists of the early 21st century, they will be hard pressed to decide who is deserving of the title most ferocious deflationist in a runoff between David Rosenberg and Gary Schilling. And while David did not have much notable to say today, despite his daily release of interesting and insightful commentary from his perch atop Gluskin Sheff, Gary Schilling took advantage of the media vacuum to appear on Bloomberg TV and preach, what else, deflation. Among the topics touched upon were the #1 issue du jour - the Chinese hard landing, presented earlier here, and the resulting collapse in copper, on bond market volatility, on investing and speculation, and lastly on the S&P, which just like Rosenberg, he see as deserving of a 10x multiple applied to a soon to be revised S&P 500 EPS of 80 (do the math). All in all sensible stuff except for one thing: his statement "Inflating away is an excess supply world is almost impossible, even for the Fed" leaves a little to be desired. While he may be spot on, it does not mean the Fed will not try. And try it will: we expect rumblings for full blown LSAP to commence in a few days, and QE4 in which the Fed will pull a BOJ and buy ETFs, REITs (in addition to MBS and Agency bonds) early in 2012, after which it will be time to quietly depart from these continental US, or else load up on lead, spam and precious metals.

The risk faced by those who are analyzing macro trends is sounding like a broken record. For those younger readers who have no idea what that means, imagine an MP3 song that will stick on and endlessly repeat a random segment of the song you are listening to until you give your device a sharp knock on the side. That's what a broken record sounded like. The world economy is on the ropes and it won't ever recover. At least not to anything resembling its recent past. Neither the gleeful housing bubble nor the free-flowing credit that enabled that side bubble to emerge will return. The resources simply do not exist to repeat that final orgy of consumption. A new reality is upon us and - while fortunately more and more people are choosing to face our predicament rather than pretend the current risks and challenges do not really exist - the absolute numbers are still small and for the most part don't inlcude any of our political leaders.

Earlier today Bank of America released a presentation and a conference call in which the firm's head of China equity strategy David Cui spoke about the dreaded "China Hard Landing" or the event that would kill all decoupling dreams for ever and ever, and probably lead to a world depression. It seems that the latest down move in the market is being partially attributed to just this notification finally making the rounds as can be seen in the note below: "BofAML’s David Cui is the Markets’ #1 rated China Strategist according to the 2011 Institutional Investor All-China Survey. While he is not responsible for our China GDP forecast, he sees significant Chinese specific financial market risks that could trigger lower than expected Chinese growth. He sees that those financial market risks as having increased considerably. He will expand on this on the call, but he sees these financial stresses as having a very high probability of triggering lower than expected growth. That lower growth could well be sub 7%, and therefore by Chinese market standards would be termed a “hard landing”, clearly a HUGE issue for all global markets." Granted this is not news to those who have been following the Chinese situation (as fringe blogs have been for over a year), but the market does tend to have a habit of being about 12-18 months behind the curve. Here is what Bank of America had to say...

I'd say the world's biggest bubble is real estate in China, but real estate bubbles are just starting to deflate elsewhere, too—in Australia and Canada, for example. It's relatively hard to short real estate, of course. Shorting bank stocks is an indirect way to play it. I'd say bonds are the short sale of the century. They're going to be destroyed. Bonds pose a triple threat to capital because:

1. Interest rates are artificially low, and as interest rates rise—which they must—bonds will fall.
2. Bonds are denominated in currencies, and most currencies, let's say dollars, are going to lose a lot of value.
3. The credit risk of most bonds, certainly those issued by governments, is high.

On the long side, mining stocks are very cheap relative to the price of gold right now. I'd say there's an excellent chance of a bubble being ignited in gold mining stocks, especially the small ones; in fact, I'd put my finger on that as likely being the easiest way to make a killing.

Following the FT's news that (totally un-shockingly) there is disagreement among European member countries over pretty much everything, equities (and broader risk assets) rolled over and accelerated to the downside. We had been pointing to the early weakness in credit markets (especially European financials) as a signal that the rumors were made of nothing and that the rally in equities was starting to get ahead of itself - having been jump-started yesterday by a small cap short-squeeze (and potentially some asset allocation decisions which may have also impacted equities)but the velocity of the retracement was still surprising. The S&P lost 30pts from its highs, HY ended wider on the day (risk appetite seems low given new issue concessions) and financials in the US managed a small bounce off unchanged right before the close after giving up over 3%.

S&P futures managed an impressive 2.5% rally today making it back to the closing level from last Wednesday (Bernanke-Day) amid merely average volume. The leaked rumors of the EU's octuple-down CDO^2 bet on themselves was enough to get the buy-the-rumor juices flowing and we rapidly squeezed higher. IG outperformed, ending the day notably tighter than respective equity and HY spreads would expect as even though risk seemed on, we did not see a mad scramble for high beta and HY bonds remained offered in general. Gold and Silver managed a huge bounce off intraday lows ending the day -1.5 to 2% while the dollar sold off into the close (as EUR rallied) to end the day unch from Friday. ES ended a little rich relative to risk-assets in general as the small cap short squeeze seemed to take-over.

• ECB said to debate new 12-month loans at the October 6th policy meeting where they may discuss a rate cut
• EU may speed up ESM enactment to stem the crisis with Euro aides discussing setting up the fund in 2012 a year early.
• German IFO data higher than expected on all three readings
• CME raises margin requirements for longest dated T-Bond futures by 20%

All you need to read.