Equity Markets

Now that the German high court ruling is out of the way and the Dutch elections results produced no real surprises the European equity markets are essentially flat with position squaring evident ahead of the keenly awaited FOMC rate announcement and accompanying press conference. Bund futures have followed a similar trend having ticked higher through the morning with some modest re-widening of the Spanish and Italian 10yr government bond yield spreads, wider by 9bps and 5bps respectively, also in Euribor will did see a decent bid after comments from ECB member Hansson who said the ECB council must now start debating a negative deposit rate. Today’s supply from Italy and Ireland had little impact on the general sentiment, that’s in spite of the fact that demand for debt issued by the Italian Treasury was less than impressive to say the least. Also of note, Catalan President Mas said that Spain should debate staying in the euro, which unsettled the market somewhat. Overnight it was reported that the US Navy have stepped up their security presence in Libya by ordering two warships to the country's coast, according to US officials. This is after the US ambassador to Libya and three American members of his staff were killed in the attack on the US consulate in the eastern city of Benghazi by protesters earlier in the week. Today, there were more reports of demonstrations in the region, however supplies remain unaffected.

Broadly speaking, risk assets were not as dismal as equity markets today - holding on near the highs for much of the day. The late day surge higher in AAPL - that dragged everything higher - was a recoupling to risk-assets on the day as volume surged and average trade size picked up significantly. AAPL ended up at the record-high day's closing VWAP (around $672) perhaps suggesting some algo-driven liftathon to enable the bigger boys to exit the heavily-weighted-in-the-index name - and right in front of Bernanke's big day tomorrow, it seems odd - other than short-covering squeezes - to be positioning this heavily long. HYG once again soared (playing catch-up to HY credit spreads), VXX tumbled into the close as VIX dropped following the ESM decision (though was not as ebullient as stocks ahead of tomorrow's NFP). Treasuries just kept leaking higher in yield (now 5 to 30Y yields higher by 5-10bps on the weeks) - and crushing the spread to MBS. The USD was stable most of the day after early weakness, on EUR strength after the ESM decision, was unwound. A bump-and-dump in commodities ended generally unchanged aside from Silver which had its own mysterious flash-crash soon after the US day session close. Credit tracked stock generally on the day and was quiet. S&P futures take out (after-hours) the highs of the day/year/four-years (as contracts rolled). Need Moar QE.

There has been a lot of bluster this week that tail-risks have been removed from Europe (thanks to The Dreme) and now ESM ratification can continue to hold up Europe's insolvent states. Europe's equity markets continue to lift (though slower and slower), Europe's VIX has fallen again (post ESM decision), Europe's credit spreads continue to compress and squeeze tighter, and sovereign bonds rally - at the short-end. The one fly in the ointment - is that the last three days have seen very little movement in Bond yields for Spain, Italy, and France - only Germany's 10bps yield decompression has been the driver of perceived risk changes for the periphery. EURUSD is now 1 sigma rich to its swap-spread fair-value model - which is unusual. It seemes -just as in the US MBS market - the rumor has been bought, as stocks in Europe also leaked lower from the ESM announcement time spike.

Lakshman Achutan, ECRI (Economic Cycle Research Institute) made a recession call for the US on September 30, 2011 (and confirmed it multiple times since then). Gary Shilling, titling his August letter “Global Recession”, says “We are already in a global recession.” However, equity markets don’t think so, with the S&P 500 trading less than 10% away from a new all-time high. Only one side can be right. Could this be a repeat of October 2007, when the S&P 500 hit new all-time highs mere six weeks before the “Great Recession” began? Are so-called leading indicators, as used by the Conference Board, still reliable? Established leading indicators incorporate questionable input. While there is no perfect indicator, a combination of the ones tested here, weighed by accuracy, confidence and timeliness should produce a good reading. The higher-confidence indicators say that 2011 was a “close call”, but we are currently not in a recession. However, a lot of lower-confidence indicators are showing readings consistent with a severe recession.

The fundamental backdrop, in the shape of economic lead indicators and earnings momentum, has been deteriorating: manufacturing PMIs for the US, China, Japan, Korea, the Euro zone, and the UK are all now sub-50, and consensus earnings growth estimates for 2012 have been halved in recent months. What has this meant for Global Equities? Well, as UBS notes, in the last three months, very little. The MSCI AC World index is up more than 12% from the 4 June low. That markets have rallied while fundamentals have deteriorated in this manner is unusual. Historically, equity market rebounds have tended to coincide with a trough in PMIs and earnings momentum – that is, when PMIs have stopped going down and the pace of earnings downgrades slows (waiting for PMIs to recover to 50 or for earnings momentum to turn positive is usually too late). Markets now appear to be taking their cues from central bankers: potential policy actions are becoming a sort of ‘lead indicator of the lead indicators’, if you will. Given the recent rally, in addition to underlying macro weakness, policy action - and effective action at that – has become increasingly important for investors. Without it this recent rally could end up looking more like a false start than a head start.

A few days ago, the BOE's Andy Haldane, rightfully, lamented that the apparent "solution" to the exponentially growing level of complexity in the financial system is more complexity. Alas, there was little discussion on the far more relevant central planning concept of fixing debt with even more debt, especially as the US just crossed $16 trillion in public debt last week, right on schedule, and as we pointed out over the weekend, there has been precisely zero global deleveraging during the so-called austerity phase. But perhaps most troubling is that with 2 days to go to what JPM says 77% of investors expect with be a NEW QE round (mostly MBS) between $200 and $500 billion in QE, the world is, also in the words of JP Morgan, drowning in liquidity. In other words, according to the central planners, not only is debt the fix to record debt, but liquidity is about to be unleashed on a world that is, you guessed it, already drowning in liquidity. The bad news: everything being tried now will fail, as it did before, because nothing has changed, except for the scale, meaning the blow up will be all that more spectacular. The good news: at least the Keynesians (or is it simply Socialists now?) out there will not be able to say we should have just added one more [    ]illion in debt/liquidity and all would have worked, just as our textbooks predicted. Because by the time it's over, that too will have happened.

Curious why legendary hedge fund managers are shutting down shops left and right in disgust with the mockery that central planning and algorithmic short-termism had made of equity markets? Don't be: his name is Julian Marchese, he runs a "macro fund"... and he is 16. Don't get us wrong: we enjoy the next youth trading prodigy, and here the Schwab baby comes to mind, as much as everyone else. Our concern is when it is the people who have never even seen half of a business cycle that start running your money, and, probably worse, making money, which leads them to believe they know what they are doing, and gets gullible LPs to allocate capital to them based on a 3 month track record, when in reality the entire market is one merely primed for outperformance courtesy of central planner puts and priced to Bernie Madoff ponzi perfection, targeting a specific investor type. And here the Schwab baby comes to mind again.

Forget the conditionality, Draghi said it would be solved and we should believe - and believe everything in Europe did! Equity markets soared 3-5% (with EuroStoxx catching up to Gold YTD), credit spreads - which had outperformed in the last few days - rallied rather notably, European sovereign bond yields (2Y yield down 15-20bps) and spreads tumbled dramatically (10Y spreads down 30-50bps), Europe's VIX collapsed 4.5 vols to 23%, and EURUSD surged back to the highs of the day into the European close (after being down immediately after the press conference). Capitulation? who knows? Reality? not even close.

The first responses by the Wall Street sellside brigade to the ECB's "unlimited" yet somehow "sterilized", no longer rate capping thus unsterilized plan emerge and they are, in a word and as expected, unimpressed.

Saving the World somehow seems like an extreme sport. It is talked about by many but practiced by few. The newest attempt has been claimed by Mario Draghi but it may be one of those Lance Armstrong kind of things where the steroids of the moment pushed the claimer past his boundaries. The markets, the equity markets in particular, have been betting for weeks that the world was going to be saved and have been waiting for the evidence of the transformation as I have stood on the sidelines and shook my head. I have seen the prophets before; the world is going straight to Heaven, the world is going straight to Hell and yet somehow we always find ourselves stuck in Perdition where mankind vacillates between the two. In Mario Draghi’s case, you see, he needs the parishioners to go along with the scheme and while everyone may share the same Bible the interpretation is not the same.

This is a rally based upon hope and vapors.

Year-to-date, before the decimation that the Knight x1000 Algo wreaked upon the market, volumes had trended lower YoY but had not cratered. As the charts below suggest - in somewhat stunning technicolor - that since the Knight-algo was put-to-death, NYSE volumes have coincidentally plunged by 40%! Today's run-rate with an hour to go was the lowest of the year. For those that hang on the consideration that this is due to high-priced stocks and USD-volumes are stable - err, wrong answer - futures volumes cracked in half also (and that is a stable USD volume); The summer doldrums explains it - err, wrong answer - we are 20 percentage points below a normal summer-drop-off. The simple fact of the matter is, with retail suddenly the smart-money and exiting stage left (unable to trade this ridiculous market), it seems that losing one market-maker algo has almost halved trading volumes; what happens if GETCO ever goes down?

We don't need recession

Or means of repression

Just give us some money

Our life could be sunny too...

The fulcrum security is bleeding; 10Y Spanish government bond spreads jumped 19bps today, the largest gain in almost a month, and are trading back above 525bps over Bunds (the worst in over three weeks). Even the front-end of the Spanish and Italian bond curves lost ground today - as the game of chicken between Rajoy and Draghi continues - with the ridiculous brinksmanship highlighting the entirely dysfunctional dis-union that really exists behind the scenes. European equity markets drifted lower all day, slammed lower after the US opened (with Germany's DAX underperforming - thanks to weak Autos - no surprise there for us), but bounced a little into the European close. EURUSD slumped 70 pips from its post-US-open intraday highs today - ending at 1.2500. Europe's VIX jumped back above 28% (from 21% just 10 days ago) - its highest in a month. Credit widened on the day, financials underperformed, and notably credit did not jump into the close like stocks did.

Last week we discussed in detail the shifts in regimes and positioning in the FX markets - most notably relative to the EUR. CitiFX is out with a note today that extends our concern as their proprietary CitiFX Positioning Indicator shows a rise from a record short in EUR in mid-July to a record long by last week. The EUR buying has been broad based and not just concentrated against the USD, with investors covering short exposure on pairs such as EURAUD and EURCAD. The shift in positioning came as peripheral spreads tightened and US yields fell, implying that it was kick-started by the surge in expectations for Fed and ECB easing. With equity markets roughly steady in recent days and data flow still relatively weak, this leaves the impression that the continued shift in FX positioning has been more about momentum than improvement in sentiment. This suggests that FX markets may be pricing in a higher degree of confidence on easing (or signs thereof) at the Jackson Hole conference and later ECB meeting. Given that absolute positioning for EUR is now long, this sets a high bar for policymakers to exceed and suggests risks are skewed in favor of a reversal on disappointment with Chairman Bernanke and President Draghi.