Equity Markets

The Dow Transports broke its 10-day streak with a very marginal down day today but the Dow Industrials and the S&P 500 all pushed on miraculously running stops and pushing higher. While VIX remains decoupled the two markets traded in a correlated fashion to get the ramp going early and along with Treasury weakness risk-on was well supported. Risk-assets in general are becoming more systemically correlated as USD weakness and oil strength also contemporaneously pulled stocks to highs (led by energy on the week). The afternoon saw VIX decouple from stock's strength and also on the day overall, credit markets were not following along. Volume was above average with some larger block size up near the highs. FX markets reconverged (JPY weakness and GBP strength) to more systemic USD moves as the 10Y tested up near 2.000% but closed just below it. Gold and Silver rose continued their gains from yesterday midday. In general it appears risk is recoupled ahead of tomorrow's FOMC - apart from HY and VIX which appears more hedged.

Once again equity markets disconnected (positively) from their risk-related cousins at around the European close and while broad equity markets closed around unchanged, the weakness in HY credit, and rise in VIX and Treasury bond prices as the day wore on told a slightly more concerned story than stocks would suggest. AAPL rose helping the tech sector; homebuilders saw their biggest loss in 5 weeks following weaker than expected housing data; and CAT's incredulous rally on total lack of clarity for their outlook provided just enough juice to keep the Dow near unchanged. S&P 500 futures fell rapidly to Friday's low as the US day session opened but found support and oscillated around unch/VWAP for the rest of the day. The USD round-tripped from early strength to end unchanged with GBP weakness and JPY strength. Oil rallied, Silver slipped, Gold tracked the USD, but Treasuries' overnight weakness halted instantly as the US day-session opened. Volume and average trade size were low which combined with the VIX expansion and broad risk-off suggests the equity rally is losing steam - but who knows anymore.

• CAT beats ex-Chinese fraud: $1.91, Exp. $1.70; Warns 2013 could be a "tough year"; sees 2013 EPS in $7.00-$9.00 range, Exp. $8.54, sees Q1 sales well below Q1, 2012
• Yi Warns on Currency Wars as Yuan Close to ‘Equilibrium’ (BBG)
• Monte Paschi seeks new investor as scandal deepens (Reuters)
• Assault Weapons Ban Lacks Democratic Votes to Pass Senate (BBG)
• Toyota Again World's Largest Auto Maker (WSJ)
• Curious why all those Geneva Libor manipulators moved to Singapore? Bank probes find manipulation in Singapore's offshore FX market  (Reuters)
• Japan eased safety standards ahead of Boeing 787 rollout (Reuters) - so like Fukushima?
• Goldman is about to be un charge: Osborne cools on changing inflation target (Telegraph)
• Abe Predicts Bump in Revenue as Japan Emerges From Recession (BBG) - actually, "hopes" is the correct verb here
• Toxic Smog in Beijing Fueling Auto Sales for GM, VW (BBG)
• Fed waits for job market to perk up (Reuters) ... any minute now that S&P to BLS trickle down will hit, promise
• BofA shifts derivatives to UK (FT)

"Regardless of what the markets do near-term, a correction is overdue," Marc Faber tells Bloomberg TV's Betty Liu. From discussing Europe's 'apparent' stabilization - "anything can go up when you print money"; to US equity exuberance - "a correction is overdue and February is a seasonally weak month"; Faber sees no change from Geithner's handover to Lew as he opines: "The only thing I know is one day the markets will punish the interventionists, the Keynesians and the monetary policy that the Federal Reserve and ECB has enforced because the markets will be more powerful one day. How will this look like? Will the bond market collapse or equity markets become a bubble, which would be embarrassing for the Fed's sake if the U.S. market became a gigantic bubble and at the same time the economy does not recover."

It is a well-known phenomenon that quiet markets, low volatility and a lack of visible risks on the horizon can lead to complacence and increasingly dangerous, leveraged positions. In doing so, these market conditions set the stage for the next cycle of deleveraging and losses. What has also become apparent is a predictable behavioral response to this cycle: when the markets experience large losses, tail risk hedging comes back into fashion; on the other hand, when markets are quiet, investors can quickly forget the pain suffered during prior crises. As PIMCO's Vineer Bhansali points out, the current hedging characteristics are comparable to 1/15/2008, right before the crisis.  He adds that, for many investors, it paid to have tail hedges then. If investors believe we are still investing in a dangerous, potentially even more dangerous, environment, they should consider hedging; adding that in their view, tail hedging is not just a trade, but an asset allocation decision for robust portfolio construction. In this light, today’s valuation levels make it easy to be countercyclical and add to tail hedges. Perhaps today's VIX-SPX decoupling is the first sign?

Everyone's favorite bull made another magnificently arrogant appearance on TV this morning. Following his recent CNBC embarrassment, Bloomberg TV interviewed the outperforming hedge fund manager this morning - during which he explained his 'where else ya gonna go' bullish stocks thesis. From expectations for an "explosion of greatness" in the US to his gratuitous flirtation, he appears to have the inane ability to use many words where few are needed and his bullish thesis has the ring of any and every guest pumper (with nothing new to add): the same supposedly 'low' multiple, central-banks-are-printing, and wide spread between bond and equity yield argument that everyone's mom can explain. From expectations for the 'great rotation' from bonds to stocks and his 50%-upside prediction in Citi, Tepper is "balls to the wall" the best guest ever on any stock-touting network. However, one little thing gets in the way - the last time the Great-and-Powerful Tepper appeared so overtly bullish of stocks (and financials specifically), he also was dumping his holdings into the rally that followed.

Over the course of the last two weeks, I attempted to explain to the general investing public how, thanks to the virtual impossibility of distinguising between 'legitimate' market making and 'illegitimate' prop trading, some of America's systemically important financial institutions are able to trade for their own accounts with the fungible cash so generously bestowed upon them by an unwitting multitude of depositors and an enabling Fed. 

As the world's equity markets prepare to rally on the back of yet more central bank printing as Japan's Shinzo Abe takes the helm with a 2% inflation target and a central bank entirely in his pocket, The Telegraph's Ambrose Evans-Pritchard suggests a rather concerning analog for the last time a Japanese prime-minister attempted to salvage his deflation/depression strewn nation. The 1930s 'brilliant rescue' by Korekiyo Takahashi, who removed Japan from the Gold Standard, ran huge 'Keynesian' budget deficits intentionally, and compelled the Bank of Japan to monetize his debt until the economy was back on its feet managed to devalue the JPY by 60% (40% on a trade-weighted basis). Initially this led to exports rising dramatically and brief optical stability, but the repercussion is the unintended consequence (retaliation) that the world missed then and is missing now. Though the economy appeared to stabilize, the responses of other major exporting nations, implicitly losing in the game of world trade, caused Japan's policies to backfire, slowed growth and left a nation needing to chase its currency still lower - eventually leading to hyperinflation in Japan (and Takahashi's assassination). With no Martians to export to, why should we expect any difference this time? and how much easier (and quicker) are trade flows altered in the current world?

The recent landslide victory of the Liberal Democratic Party (LDP) on a platform that promised positive change for the long-struggling Japanese economy has thrust a somewhat forgotten Japan back into the headlines. Indeed, as Goldman notes, asset markets have already responded aggressively to the prospective changes with Japanese equity markets climbing to multi-year highs and the Yen declining to multi-year lows against the US dollar and the EUR. But, as Kyle Bass has recently explained, very real questions remain about the ability of the LDP and new Prime Minister (PM) Shinzo Abe to deliver on promises and break the damaging cycle of low growth and deflation that has become well-entrenched in the Japanese economy over the last five-plus years. These doubts are reinforced by concerns about the health of the domestic banking sector and of Japan Inc. in general. "Abe-nomics 'appears' positive, but for how long?" Goldman asks and Hamada's recent concerns over 'going too far' are very real - though in general Goldman's positive 'take' is a useful counter-point to Bass' somewhat more realistic apocalyptic endgame thesis.

Well, my fellow Slope-a-Dopes, your selfless Idiotic Savant servant, whom is securely chained to his desk, has spent a significant part of the long weekend, perusing nearly every finance blog on the world wide web for you.  Therefore, I can reliably report to the SOH, that the overwhelming consensus out there in the financial blogosphere, which has now reached a nearly universal feverish pitch, is boldly & proudly heralding that a most encouraging new economic dawn is finally upon us.  It seems, a pristine permanent plateau of prosperity has been patently perfected.

According to “Economics 101”, quantitative easing, on the heroic scale we have witnessed thus far, should already have led to rampant if not hyper inflation. That it hasn’t is down to the continuing decline in the velocity of circulation of money. In simple terms the banks aren’t lending (compared with the amount of money available to them), but instead are punting on financial assets, which is where “inflation” is ending up and benefitting their balance sheets. Markets generally front run the economy, but if, as many folk believe, including our commentator above, that quantitative easing has been a failure from the start, then why are equity markets indicating an upturn in economic activity? At the end of the day, if the central banks continue to believe they have no other option than money printing and you can put up with the volatility, it’s all aboard the equity train. Bond yields won’t rise much either; if at all. The gold price should give some indication of whether this strategy is working or not, but that is a market that is far easier to rig than sovereign debt – the Germans seem to think so as they contemplate repatriating some of their bullion held by other central banks.

An overview of the key factors and events that are shaping the investment climate in the week ahead.  It looks at some emerging market developments as well.  These are the main talking points and considerations that ought to be on your radar screen as investors or pundits.  

We make more than we’ve ever made, we owe more than we’ve ever owed, and we have less than we've had in decades which is distributed to those that did not earn the money. This is a working definition of Trouble. The stock market is at an all-time high while the financial condition of the country has seriously deteriorated. The world is in a gigantic bubble and it is going to get pricked. You cannot keep printing money without consequences and when absolute and intrinsic valuations replace relative valuations then the game is afoot. When the survival of the State puts its people in dire straits then, eventually, the citizens will rebel as the nation has forgotten just who composes its constituents. The people and institutions that have the capital will only go along quietly for so long when nations try to take what they have earned and dispossess it for others. The rich will become poorer and the poor will become poorer and when those with the capital have been deprived of it so that everyone is worse off then the Lords of Chaos will be in control once again.

With the Dell LBO potentially heralding the renaissance of re-leveraging risk transfer from equity-holders to credit-holders, Goldman's screen among investment grade and high-yield companies attempts to uncover the names most likely to engage in shareholder-friendly (or more specifically bond-holder unfriendly) events. From quantitative screens on cashflow, leverage, and cash to stock 'cheapness', industry suitablity, and management reputation, the following 47 names warrant further attention (in both CDS and equity markets).

The last few months have seen US equity markets swinging from confidence to grave concerns (briefly) and back to exuberance even as the looming 'debt ceiling' and sequester remains dead ahead. The pattern is eerily similar in price (and volatility) terms to the movements ahead of the Summer 2011 'debt ceiling' debacle. What is just as concerning is, as Bloomberg's Chart of the Day shows, is the mass psychology aspect, as mentions of the words 'debt ceiling' are once again gathering pace, just as they did in 2011. Markets may not repeat, but they do echo; and as UBS' Art Cashin noted, this month marks the 40-year anniversary of a significant top in the market as stocks broke to all-time highs and "all appeared right with the world." Perhaps, it is our inexorably optimistic belief that the politicians will fix it all (or kick the can) at the last minute - so there is nothing to fear but fear itself; or perhaps this time, there is a line in the sand that both sides need to defend.