Equity Markets

Just over three short years ago, as equity markets were re-surging on a wave of taxpayer-funded bailout euphoria, we wrote "There is nothing that can be done at this point to prevent the administration from leeching every last dollar out of its taxpayers to benefit the terminally addicted and zombied bank system". We, in the imagined words of Ryan Lochte on Saturday, "Nailed It" as we see a market now so bereft of any human-based reaction to reality and merely a product of a drug-peddling central bank that appears to have become self-aware in its omnipotence. To wit, the present day; as we are teased and tickled day after day with the promise of more CB crack if we are just good boys and BTFD, the sad nay terrible fact is that even the most 'say hello to my little friend' of drug-dealers - those of the Brazilian Favelas - have decided to refuse to sell their 'crack' to their own people since it "also brought destruction in [the] community". Maybe, just maybe, the Fed will up its level of conscience this week to that of Brazilian drug-dealers.

As everyone is staring off into the distance and admiring the sunset we advise you to turn your head towards what may be truly important and that is our old friend Greece.

Greek political leader, "We agreed on one thing - that we disagree on everything.  The Troika men came to Greece as doctors and prescribed the medicine that would save the Greek economy and people; but in the end they proved to be charlatans."

 

Uncle Scrooge. “Them that’s got the gold makes the rules”

We submit that Draghi can say what he likes. He may wave the flag in front of the gates of Hell filled with good intentions but it is not his call; will never be his call. It will always be the Bundesbank who will allow the monetary spigot to be opened or demand that it be closed.

Most people, most markets, operate on the basis of reality and probable scenarios based upon fact. This is not true for the equity markets however as it is here where hopes and prayers and visions of Tinkerbell and little blue fairies that will come to the rescue reside. It is in the stock markets where great dreams take place and where Batman guards Metropolis. It is also here, however, where eyes tightly closed are pried open from time-to-time and where the horrors of the known universe stare back at you with disquieting eyes. Draghi represents the Southern contingency, the periphery nations, the troubled cousins who cannot live on what they make. This is all fine and dandy but do not kid yourself; if the Germans say “Nein” then it is “Nein” and any other conclusion is foolhardy. Whoosh and sorry for the dose of reality.

Fixed income markets have always focused closely on news about the US macro-economy; while traditionally, equity market participants have focused more on the “micro” data – in particular, news about current and prospective corporate earnings – to form their views about the relative attractiveness of different stocks or the market as a whole. Goldman finds that the financial crisis changed all that. The responsiveness of the US equity market to economic news increased dramatically, now showing about twice as much sensitivity to macro data as it did in the years before the financial crisis. While micro data remains important - especially in quantifying just how much QE-hope the market is 'abiding' by, macro news is likely to be the critical driver of equity markets until the global economic outlook is considerably brighter than it looks today (or macro decouples from Fed/ECB jawboning). On average the market’s responsiveness to all these economic indicators suggests that we are still very much living in a macro world. In the meantime, there are some exceptions to the fairly consistent reactions to economic news that we see between equity and bond markets.

The Europeans have played the Great Game badly; are playing it badly and there will be consequences for their failures. All of this nonsense with Greece, with Spain, could have been avoided by telling the truth about the numbers, by not goose stepping with plans meant to mislead instead of illuminating the truth, with trying to hide the self-evident and presenting scams as solutions or by addressing the size of firewalls instead of trying to cure the sickness of the nations that lie within them. There is no Prince, there are no glass slippers and the bills have to be paid and the money to pay them will not be found in the pot of gold at the end of some rainbow. Unless the Germans are willing to have the same standard of living as those in Greece and that will not be happening so that it can be foretold that the play will end badly. It is not economics that will determine the end of the European fantasy but politics.

"The global growth picture is, as per our long-term contention, weak and deteriorating, pretty much everywhere – in the US, in the eurozone and in the emerging markets/BRICs.... We in the Global Macro Strategy team still think the market consensus is far too optimistic on policy expectations both in terms of the likelihood of seeing more (timely) fiscal and/or monetary policy assistance (globally), and in terms of any meaningful and/or lasting success of any such policy moves. In particular, we think that the period August through to November (inclusive) represents a major global policy and political vacuum. Based on the reasons set out earlier and also covered in my two prior notes, over the August to November period I am looking for the S&P500 to trade off down from around 1400 to 1100/1000 – in other words, I expect over the next four months to see global equity markets fall by 20% to 25% from current levels and to trade at or below the lows of 2011! US equity markets, along with parts of the EM spectrum, will I think underperform eurozone equity markets, where already very little hope resides. For iTraxx crossover, this equates to a spread wide for 2012 of – in my view – 800/1000bp.... And of course I still see a very clear path to 800 on the S&P500 at some point in 2013/2014, driven by market revulsion against pump-priming money printing central bankers, but this discussion is also for nearer the time."

Spain's IBEX equity index closed at Euro-era lows today having dropped over 10% in the last 3 days (crushing the hopes of the afternoon post-short-sale-ban squeeze yesterday). This leaves IBEX down over 30% for the year (and Italy down over 18% YTD). Add to that; inverted long-end curves in Spain (and almost Italy), all-time record high short- and long-term spreads for Spanish debt and euro-era record high yields, record wide CDS-Cash basis, dramatic short-end weakness in Italy, new low negative rates in Switzerland (-46bps) and Germany (-7bps), and EURUSD at its lowest since June 2010 at 1.2059. But apart from that, the EU Summit seems to have done the trick nicely. Financials have been crushed in credit-land as subs notably underperform seniors and HY and IG credit continues to lead the equity markets lower in reality. Meanwhile, remember Greece? 30Y GGBs have dropped almost 20% in price in the last few days and have closed at all-time record low closing price at just EUR11.55!! S'all good though - where's Whitney?

The avuncular Art Cashin is sounding a lot less sangune than many of his market-watching peers. UBS' main man notes that traders are particularly struck by the continued weakness in the transports group (with FedEx and UPS down 8 of the last 11 sessions - and the Dow Transports down the equivalent of 300 points for the Industrials on Friday alone). "The sharp contraction in the Transport area and recent sharp drops in several trucking statistics add to growing fears that the economy may have stalled over the last four weeks," is how he puts it, but it is his cocktail-napkin charting that concerns the most. Historically, even in years that don't have multiple "end of the world as we know it" headlines in the news, the equity markets decline in the week after July option expiration. Twice in the last five years the S&P lost more than 4% in the week after July expiration. So, does that mean we should tether the elephants? No, but we should be alert and nimble on a week with a somewhat spotty history - with 1332/1335 as his key line in the sand for more downside in cash S&P.

Spain's broad equity index suffered its second largest single-day drop in almost 4 years and Italy also tumbled almost 5% as everything European was sold hard. EuroStoxx (the broad Dow equivalent) is down almost 3% as EURUSD dropped to two year lows, EURJPY to 12 year lows. AAA safe havens were massively bid with Germany, Denmark, and Switzerland all to new low (negative) rate closes. Core equity markets did suffer though with Germany down 2% but it was the periphery that saw the damage in credit-land with Spain 10Y closing at 7.27%, 610bps over Bunds (and 5Y CDS over 605bps). Spanish spreads are +130bps from post-Summit (and pre-Summit) and Italy +78bps, but it is the front-end of the curve that is most worrisome - Spain's 2Y is 132bps wider in the last week. Europe's VIX exploded by over 4 vols to 24% today and once again looks decidedly high relative to US VIX.

Presented with little comment but it seems that in yet another unintended consequence of the short-term haste to make noise ralative to any sustainable long-term solution, the nations that were supposed to benefit the most from the EU Summit are now the biggest losers as their equity markets are the only ones in Europe that are down from pre-Summit levels after today's sell-the-news events. It seems once again those looking at the equity markets to signal the success of an 'event' have been dangerously wrong-footed once again... Spain swung from an 8% gain to a 4% loss

Market-top economics could be an entire university course, if people cared enough about such phenomena.  Most only consider the signs of a market top months or years after a crash when some unyielding economics researcher puts the pieces together.  As human-beings we have developed an uncanny ability to rationalize what we know to be bad news and convince ourselves, "This time is different," despite the fact that it usually never is. In a previous article we provided analysis on economic/equity decoupling (cognitive dissonance) and showed that the economy as we know it cannot persist--we are either due for a literal gap-up in leading economic conditions, or we are due for a serious correction in US equities.  With today's 5.4% slip in existing home-sales, let's go with the latter.

UPDATE: AXP (down AH) and IBM (up AH) miss top-line; QCOM misses everything and guides down (up AH - AAPL staggered a little but unch now), EBAY beat (small up AH); KMI miss (down AH)

Far be it from us to say but once again equity markets spurted far and away beyond credit, interest rates, FX carry, commodities, and reality would have expected with only good-old VIX crashing to breathe that levered life into them. Ending the day with a 15 handle, VIX closed at its lowest in over three-and-a-half months and notably beyond where equity and credit relationships would expect as the front-end of the curve remains under huge pressure. Gold, the USD, and Treasury yields all played along on the day - trading with a decent correlation in a relatively narrow range but the open of the US day-session saw the appearance of the infamous equity rally-monkey who lifted us 1% in 30 mins then extended 10 more points into the European close. EUR roundtripped on the day leaving USD practically unch but -0.35% on the week. Credit markets were quiet (cash busier than synthetic) as IG, HY, and HYG all underperformed for the second day. Gold and Silver limped lower on the day as WTI surged back above $90 to two month highs. Treasuries traded in a very narrow range ending the day -2bps across the curve. Financials underperformed as Tech and Industrials reached for the skies with a 1.75% boost today (makes perfect sense after the earnings?). Decent average trade size on the day which was more prevalent up above 1365 suggests more unwinds of blocks into strength but something has to give with VIX for this train to stop running.

VIX is now trading with a 15 handle - at its lowest since early April. At current levels of exuberant complacency, the S&P 500 should be trading over 1400 and HY credit spreads back at 500bps. The volatility term structure has collapsed in the last month or two as it appears that there remains an extremely well-capitalized vol-seller at the front-end of the curve - unafraid of risk flares as they pick up those nickels in front of the European steam-roller. We can see two reasons for this compression (from a fundamental perspective): extreme confidence in NEW QE appearing shortly (and suppressing vol as it does) or more likely a vol steepener out beyond the German judge's decision on Spain's bailout constitutionality - or just call-writing retail monkeys following TD Ameritrade's CEO's advice - what could go wrong.

Things are getting a little 'strange' in Europe. European equity markets (and voatility) have disconnected from the reality of European corporate, financial, and sovereign credit. As the massive bifurcation in sovereign yields continues - with Spain near record-highs and Swiss/German at record-lows - equities are still significantly higher post the EU-Summit (and vol massively so) as credit of any kind is dramatically wider. Specifically, 1) Europe's broad equity index is massively outperforming credit post EU Summit; 2) Europe's broad equity index Vol is majorly disconnected from XOver credit; and, 3) Europe's broad equity index is in-line with GDP-weighted sovereign risk BUT dramatically dislocated from Italian and Spanish risk (that is reflective of the core of the stress). Just as we have seen in the US, the method of choice for 'pumping hope' into equity market valuations is through the levered selling of volatility - it seems some-one/-thing with very deep pockets is getting awfully brave as Europe's VIX drops to near pre-crisis levels (and its steepest in months as short-term complacency surges).

Here are the key highlights from the just released Citigroup Q2 earnings:

• Net Income of $0.95 or $1.00 excluding CVA and one time loss; Exp $0.86
• Citigroup Net Income of $2.9 Billion; $3.1 Billion Excluding CVA/DVA and the Loss on Akbank;
• Citigroup Revenues of $18.6 Billion; $18.8 Billion Excluding $219 Million of CVA/DVA and the $424 Million Loss on Akbank; Exp. $19.01 Billion
• Where the bottom line beat came from: Loan Loss Reserve Release of $984 Million in Second Quarter, or 35% of pretax net income.
• Complete freeze in capital markets:
  
  • Fixed Income markets revenue plummets from $4.7B in Q1 to $2.8B in Q2 (and down 4% Y/Y from $2.9 billion)
  • Equity Markets revenue slides 39% sequentially from $776MM to $550MM, down 29% Y/Y from $776MM. It's a zombie zone out there
• Total Securities and Banking revenues slide 22%, yet Expenses decline just 4%
• And just like JPM, Americans can't wait to hand over their deposits to Citi: Citigroup Quarter-End Deposits of $914 Billion, 6% Above Prior Year Period
• This compares to total Loans of $655 billion or a $259 billion mismatch; we know that this surplus is what JPM uses as funding for its Treasury/CIO group. Does Citi also use the excess deposits to fund its internal hedge fund?