Equity Markets

The last time we saw a bevy of regurgitated European rumors shortly refuted was last Friday. Today we get a redux, following a hard push by none other than Spiegel (precisely as we predicted a month ago: "And now, time for Spiegel to cite "unnamed sources" that the EFSF is going to use 3-4x leverage") to imagine a world in which the ESM can be leveraged 4x to €2 trillion. This is merely a replay of last fall when Europe's deus ex for 2 months was clutching at a cobbled up superficial plan of 3-4x EFSF leverage, which ultimately proved futile. Why? Because, just like in 2011, one would need China in on this strategy as there is simply not enough endogenous leverage in either the US or Europe which would make this plan feasible. And China, we are sad to say, has a whole lot of its own problems to worry about right about now, than bailing out the shattered dream of a failed monetary unions still held by a few lifelong European bureaucrats, which this thing is all about. As expected, moments ago Germany refuted everything. Via Reuters: "Germany's finance ministry said on Monday that talk of the euro zone's permanent bailout fund being leveraged to 2 trillion euros via private sector involvement was not realistic, adding that any discussion of precise figures was "purely abstract." This also explains why we devoted precisely zero space to this latest leverage incarnation rumor yesterday: we were merely waiting for the refutation.

As we enter the North American cross over, equity indices in Europe are seen higher, supported by telecom and health care sectors. There was little in terms of fresh news flow and instead the price action was largely driven by expiration of various futures and option contracts. On that note, it is not only the quadruple witching day, but also quarterly S&P rebalancing. As such, brief spells of volatility will be observed as market participants close out remaining positions. Looking elsewhere, range bound price action was observed in the fixed income market, where the benchmark German Bund is currently trading in close proximity to 140.00 level. Talk of demand from Middle Eastern accounts in EUR/USD earlier in the session saw the pair trip buy stops above 1.3000 and then above 1.3025. GBP/USD was a direct beneficiary of USD weakness, which in turn pushed the pair above 1.6300 level (touted option barrier). Going forward, the second half of the session will see the release of the latest CPI from Canada.

Equity markets rallied into the close (pre-OPEX and index re-weightings tomorrow) to end near their highs for the day but this was only enough to get back to practically unchanged. The Dow was the only index to manage a green close on the day-session (as AAPL dragged NASDAQ lower and the S&P couldn't get above Tuesday's or Wednesday's closing levels). With the CDS market rolling today (and indices being recomposed), we saw a somewhat unusual selling pressure into the roll - suggesting many credit longs were less than willing to roll that long into the new index (though technicals do make this uncertain). HYG underperformed. Stocks seemed to levitate back up to track Gold and the afternoon's weakness in Treasuries (unch on the day but 3-4bps higher in the afternoon) and strength in Oil dragged risk-assets more in sync with stocks (after suggesting weakness in the middle of the day).

Once again, the unintended consequences (or fundamental flaw as we noted previously) remain front-and-center, just as with prior episodes of QE, we have seen the market surge into the very assets that the Fed has promised to buy (in this case into Eternity). 30Y current coupon mortgages spread to 10Y Treasuries has fallen - rather stunningly - below 20bps. An all-time record low by a mile. Homebuilders and broad equity markets are not so excited as in his failed attempts to drive people into risky assets (stocks), those 'smart' people have simply front-run the Fed's MBS buying deluge  - more than willing to sell the market back to the Fed while reaping some additional yield.

Equity markets drifted from an unch open to the overnight post-BoJ highs - albeit in an 8 point range and low volumes once again, before giving it all back in the last few minutes - as it dumped to VWAP (again!!). In other 'real' markets, Treasuries rallied - led by the long-bond playing catch up, the USD sold off on the day - aside from a post-BoJ recovery higher which was dissolved into the US day session open, Gold/Silver/Copper inched higher as the USD weakened but Oil continued its post-QE ritual sacrifice - now down 5.5% from pre-FOMC (back under $92) as the Saudi's promise more supply and the IEA build was heavy. Credit markets underperformed - but we suspect this was pre-roll moves and is not too signal-prone. Some standouts in the unreal world of our efficient equity markets, JCP's remarkable rip-and-dip, AAPL's rapid devolution from record highs to VWAP and an unch close at the last minute on huge volume, and QCOR's multiple-halt day ending down 48%. VIX (fell modestly) and the S&P 500 are back in sync and tracked each other all day. After the day-session close (small green), S&P futures drifted further down and ended practically unchanged - on a heavy volume push.

The BoJ obediently submitted to pressure from stimulus addicted markets and announced yet another expansion to its JGB buying program. The program now stands at JPY 80trl, the expansion impacts only JGBs and T-Bills, both of which will be monetized by a further JPY 5trl. As a result, risk assets rallied overnight in Asia and in turn supported European equity markets in early trade. However, the half life of the latest policy easing action from the BoJ proved to be very short-lived and as the session progressed, the risk on sentiment quickly subsided. As such, as we enter the North American cross over, equity markets in Europe are seen lower, led by tech and financial stocks.  Elsewhere, Bunds topped yesterday’s high and look set to make a test on the 140.00 level should the sentiment deteriorate further. Nevertheless, peripheral bond yield spreads are actually tighter today, with the Spanish 10y bond yield spread tighter by 9bps and the shorter dated 2y bond tighter by 24bps vs. German equivalent. EUR/USD and GBP/USD edged lower throughout the session, currently trading in close proximity to intraday option expiry levels at 1.3000 and 1.6200 respectively. Going forward, the second half of the session will see the release of the latest housing data, as well as the weekly DOE report.

Those who expected a major response following the surprising, and "preemptive" easing by the Bank of Japan which has now joined the freely CTRL-Ping club of central banks, and went to bed looking for a major pop in risk this morning will be disappointed. The reason is that with every passing day that Spain does not request a bailout, all those who bought Spanish bonds on the assumption that Spain will request a bailout look dumber and dumber (a dynamic we explained nearly two months ago). As a result, the EURUSD has been dragging ever lower, and is now playing with 1.30 support. Providing no additional clarity was Spanish deputy PM Soraya Saenz de Santamaria who said Spain will decide if and when to trigger an ECB bailout once all details have been analyzed. Well the details have been more than analyzed, and Spain has been more than happy to receive the benefits of its bailout, it has yet to trigger the cause. Ironically in a Barclays study,over 78% of investors see Spain requesting a bailout by year end (even though as we explained over the weekend Spain really has to do this ahead of its major cash drawing bond redemption schedule in October when it may well run out of cash). And so, just like the US Fiscal Ceiling, the global markets are expecting some Catchy 22 deus ex machina, where traders can get their cake and politicians can eat it too. Alas, there never is such a thing as a free lunch. And what is making the much needed outcome even less probable is that Spanish bonds this morning are actually trading tighter once again making a bailout less than likely. The Spanish zombie has left its grave and is now romping through the neighborhood unsupervised.

US large cap corp profitability has been enhanced instead of eroded by outsourcing simply due to final demand being reflated by credit growth. That the US consumer’s deleveraging has not yet actually been felt in terms of final demand being squeezed and that the Federal government is going to go from supporting demand to detracting with some degree of fiscal cliff effect going into next year.  In a highly leveraged economy where SMEs are not performing well as evidenced by numerous anecdotal pieces of information and the overall weak post-08 recovery, the US could easily slide into a structural type deflationary recession. This is likely to have negative ramifications in EM/ EM FX where many of these companies have also enjoyed strong performance and negative implications for commodities and commodity exporters.

Equity markets traded in an extremely narrow range once again today with NYSE volumes dreadfully low. The USD, Treasury yields, and the S&P 500 in general tracked each other well all day. Gold swung from underperformance to outperformance and stocks lifted into the close to try and catch-up - as well as manage a green close - they failed (except the Dow - with CAT and MCD accounting for 14 of the 11.5 point gain on the day). AAPL closed above $702 (of course it did, silly) but NASDAQ was unable to make hay off of that. VIX remained under pressure and stocks reverted to catch down to it. The USD strength (+0.5% on the week) was ignored by Gold ($1770 - unch on the week) and Silver ($34.75) which had solid days but Oil ($95.50) kept sliding - below yesterday's spike lows. JPY's risk-on sell-off on BoJ news was also shrugged off by the equity market. With Staples and Healthcare outperforming and Energy and Financials laggards, as we noted earlier, the sectors post-Fed have converged rather dramatically - as TSYs have retraced much of the post-Fed move. There was also a small plague of epic Flash Smashes into the close... on massive volume shifts... perfectly normal.

While AAPL keeps levitating (no matter how high complacency in its options stands), it seems the rest of the equity markets are less enamored (for now) with this strange new normal of the Fed/ECB's own making. Below we present four charts indicating regime shifts in average trade size, index dispersion, high-beta sector convergence, and high-beta financials convergence. Whether these are bullish consolidations, short-coverings, or total capitulations - who knows? But with the S&P 500 reverting lower to catch-down to VIX's less sanguine view and the total lack of a move on the BoJ news today - we suspect (at least for now) that all the good news is out.

"The bottom line is simple: The Fed and the ECB are directing and attempting to orchestrate the grossest misallocation and mispricing of capital in the history of mankind. Their problem is that their actions have enormous unintended and even (eventually) intended consequences which serve to negate their actions in the shorter run, and which could create even bigger problems than we currently face in the near future. Kicking the can is not a viable policy for us now. The private sector knows all this, consciously and/or sub-consciously, which is why I feel these current policy settings are doomed to fail. Having said all that, the one area which for some reason still holds onto hope that Draghi and Bernanke can still perform feats of "magic" is the financial market, which central bankers assume, rely on and are happy to encourage Pavlovian responses. The reality here though is that even financial markets are, collectively, either sensing or assigning a half-life to the "positives" of central bank debasement policies, which to me means that even markets are only suggesting a short-term benefit from the latest policy actions. This is not what Draghi and Bernanke are hoping for, but in order for them to see the half-life outcome averted they know that we need to see major political and structural real economy reforms which somehow make Western workers competitive and hopeful again. The track record of the last four to five years inspires very little confidence that we will see such great necessary reformist strides taken anytime soon."

Following this morning's dismal Empire manufacturing 'growth' data (which generated zero impact in equity futures thanks to QEternity 'policy' having dampened the market's beta to any and every macro data points) we note Morgan Stanley's findings that while monetary policy can provide a temporary boost to valuations (driving investors quickly into higher beta and into value over growth), in fact over medium-term horizons (i.e. more than a week or two), it is in fact growth that dominates the drivers of equity performance. Since growth in our advanced 'new normal' economy means debt (and realistically has meant more debt for over 30 years), and with even the most exuberant of Fed heads seeing only modest growth over the next few years, perhaps the hubris of the last few days in the equity markets will dissolve into reality sooner than everyone hopes (i.e. before November) as the realization of Koo's impotent Fed comes to pass and the fiscal cliff remains unresolved.

Despite a last minute surge (as stock indices lurched from their day-session open to closing VWAP levels), US equity markets extended gains but basically slid lower once Europe had closed. The day session opened gap higher as Europe extended (though Spanish debt slumped) and rushed out of the gate to new multi-year highs only to stumble on high volume and large block size into the European close. Also notable that VIX - which had tracked stocks from the QE3 announcement, began to push higher as stocks 'capitulated' up in the high 1460s and then stocks rolled back downhill for the rest of the day. VIX ended the day up 0.5vol at 14.5% while ES closed up 8pts. Equity sectors have split into 3 groups from the FOMC statement - Materials/Energy/Financials +~3.5%, Industrials/Discretionary/Tech +~2%, and Healthcare/Staples/Utilities +~0.5%. The USD lost 1.65% on the week (EUR +2.3% and JPY -0.18%) as Treasuries saw some vol but were basically one-way street with the long-bond +26bps, 10Y +20bps, and 5Y +6bps. Commodities outperformed USD-implied moves with Oil/Silver/Gold all up around 2-3% on the week - while Copper surged overnight to gain just under 5% on the week. Credit markets were less exuberant than their tracking stocks yesterday with HYG ended the day red.

Against what seemed logical (given the assumption that Bernanke would save his limited ammo for a weaker market/economic environment), Bernanke launched an open ended mortgage backed securities bond buying program for $40 billion a month "until employment begins to show recovery."   That key statement is what this entire program hinges on.  The focus of the Fed has now shifted away from a concern on inflation to an all out war on employment and ultimately the economy.  However, will buying mortgage backed bonds promote real employment, and ultimately economic, growth.  Furthermore, will this program continue to support the nascent housing recovery? Clearly, the Fed's actions, and statement, signify that the economy is substantially weaker than previously thought. While Bernanke's latest program of bond buying was done under the guise of providing an additional support to the "recovery," the question now is becoming whether he has any ammo left to offset the next recession when it comes.

After almost forty years on Wall Street we understand both the joke and the punchline and you cannot pay off old debt with vastly greater amounts of new debt without consequences and, we assure you, there will be consequences. This paradigm does not work for a corporation or a sovereign nation and the borrower is eventually brought to his knees by the sheer weight of the debt that he has laden upon his back. The interest rate paid is only part of the equation with the rest being the absolute size of what is undertaken. The Euro and the equity markets rally upon misperception. It is not “unlimited” or “no cap” that are really the operative words for the scheme but the “condition” of use that is the most important part of the recent “Save the World” speech of Mario Draghi. Spain is an admitted user of “dynamic provisioning” which is a long and academic argument for shifting reserves but in the end it means but one thing and one thing only and that is they are admittedly fiddling with their books. Spain is scared to death of the “Obermeisters of the Troika,” the refrains of the three brothers Reich, that will show up in Madrid and demand explanation and sacrifice.