Equity Markets

It' quiet out there... Too quiet, as everyone is awaiting the most important earning number of the quarter - that of Apple. Everything else is secondary. Here is how the secondary data is driving the market so far in the trading session.

An ugly European market initially dragged stocks notably weaker overnight, with plenty of headline-makers from Apple's moves to WMT's 'Sinko-de-Abril' accounting for 20% of the Dow's loss, and Europe's macro data but after the first 30 minutes or so, S&P futures bounced off 4/10 day-session lows and leaked higher all day from there to end around last Monday's closing print. Volumes lagged as we rallied - as did average trade size - but in the last few minutes heavy volume and large average trade size stepped back in more biased to the downside. Stocks and volatility continue to follow very similar paths during this reflation phase as they did in 2010 and 2011 and while much was made of VIX's more-positive-than-expected performance today, we remind readers that we are at 8-month wides relative to realized vol - suggesting markets are anticipating a lot more anxiety ahead. FX markets leaked higher in the USD until shortly after the US day-session open and then drifted USD weaker from there as Treasury weakness coincided with EUR buying - smelling a lot like more repatriation flows. The drift higher in equities is therefore supported from a correlation-perspective as carry and rates (and oil) pushed up from soon after the US open. The USD ended up around 0.25% from Friday's close (with JPY the best performer and stable from the Tokyo close) which matches gold's 0.25% loss (though still best of the group) as Commodities all lost ground today with Silver underperforming. WTI managed to get back over $103 by the close. Credit markets underperformed close-to-close but from the lows intraday, they managed to out-gain stocks with a late-day pop in HYG bringing it in line with its intrinsic value and SPY for the first time since 3/29.

One scene from the movie Titanic depicts a lounge in one of the upper class quarters of the ship as it slowly sinks beneath the waves. Notwithstanding the vessel listing alarmingly, a motley band of toff revelers are determined to go out in the finest style. Some continue to play at cards with a fatalistic resolve while others determinedly quaff spirits direct from the bottle. Having considered for some time the most appropriate metaphor for the current market environment, we think this may be it: one may be doomed, but one can still party on. Having already hit the iceberg, one major problem we see is the common perspective for both investors and the asset management industry to view debt and equity as the entire universe of investor choices available. Having long exhausted the armory of conventional policies to keep the unsustainably indebted show on the road, increasingly desperate politicians are doing increasingly desperate things, be that gifting money to the IMF in a brazen display of fiscal denial that we can ill afford (US, UK) or simply stealing from other sovereigns (Argentina). The ironic triumph of the Keynesians means that, in trying to save the economy, our central bank may end up destroying it completely by means of the printing press; as a consequence, we now get to experience some of the full-on horror of the Japanese malaise.

As we noted this morning, the perfect 'reality-check' storm hit Europe this morning and with Draghi dismissing hope for more printing and nationalism raising its ugly specter, broad European equity markets made nearly their largest drop in five months. With the BE500 (Europe's S&P 500 equivalent) at three-month lows and Spain's IBEX within a few points of the March 2009 lows, things are becoming critical once again. Spanish yields jumped back over 6% but Italian spreads actually underperformed on the day +14bps vs Spain +12bps as Holland 5Y CDS blew past 130bps to near crisis-peak levels - leaving GDP-weighted European sovereign risk at three-month highs. The LTRO Stigma has broken above 150bps for the first time since before the LTRO as the realization of the implicit subordination of LTRO-encumbered banks is crushing unsecured bond-holders (on average trading at 350bps near four-month wides). EUR-USD basis swaps deteriorated a little remaining near their worst levels in three months but EURUSD remains miraculously just above 1.31 (though almost 100 pips off Friday's close) as repatriation flows are not helping correlation-driven algos in the US anymore.

Our equity Bloomberg screens are bright red, as equity markets sell off across the globe. Several reasons are contributing to the market selloff: 1) several firms in Asia posted weaker-than-expected earnings, 2) worries that Europe's debt crisis still threatens global growth, 3) the French elections, and 4) a breakdown of budget talks in the Netherlands.

If last week was Europe's days of hope, even as the continent was again breaking, predicated by the utterly ridiculous such as a successful Bill auction, a weak Spanish Bond issue, somehow spun by the propaganda crew as good despite pricing at an utterly unsustainable interest rate, and various German confidence indicators which soared to multi-year highs, today is the bitter hangover. Where to start...

At first we were going to comment on this "response" by the high priest of Keynesian shamanic tautology to Mark Spitznagel's latest WSJ opinion piece, but then we just started laughing, and kept on laughing, and kept on laughing...

Take your pick of how to describe this week's action. The Dow was green, S&P 500 unch (ES closed right at its 50DMA), and NASDAQ down for its biggest 2-week loss since the rally began. Heavy volume and incessant selling pressure pushed AAPL to its biggest 10-day loss in over 8 months as it closed at 5-week lows just shy of filling the gap from 3/13 and very close to testing its 50DMA for the first time in 4 months. Credit and equity markets generally did a round-trip today closing near their lows after opening the day-session near their highs off the ubiquitous overnight ramp. HY is practically unchanged on the week as IG saw up-in-quality rotation and outperformed while the S&P ended in between the two as they all traded in a broad range for the second week in a row - even though volatility remains intraday. Treasuries slid to their lowest yields of the day into the close today (though off the week's best and unch today) once again somewhat range-bound but with a notable falling-yield momentum down a few bps on the week with the long-end outperforming and 10Y closing under 1.96%. Copper and Oil rallied solidly today but aside from a little volatility Gold and Silver trod water ending the week with Gold -1% and Silver +0.55% as WTI ended back over $104. The EUR kept rallying all week (more repatriation flows?) dragging the USD lower as JPY underperformed on the week (flat today as the rest of the majors tracked USD weakness) and GBP outperformed. Broadly, the Treasury strength balanced the Oil and FX market risk-on-sentiment but risk-assets proxied higher into the US day-session open only to give it all back and drag stocks back down. It feels like there is still hope for some re-liquification but the weakness in AAPL and the financials suggest at best rotation and at worst steady risk-off while earnings beats (of drastically lowered expectations) keep the dream alive.

A sea of red is flowing from European equity markets and it seems they are unable to stem the flow as IBEX (the Italian Spanish equity index) nears March 2009 lows (down 18% YTD) but dispersion across European indices is very high from the DAX +14% YTD to Italy, Greece, and Spain very much in the red YTD. However, for the second week in a row, European equity markets (as tracked by the narrow Dow-equivalent Euro Stoxx 50) close with a negative return year-to-date -0.3%. The broader BE500 index is still up around 5% (compared to over 10% YTD gains in the S&P 500). European high yield credit is back at 3-month lows and investment grade credit at 2-month lows. This week, however, followed the exact same path as last week with equity and credit trading in a wide range but notably this week credit markets dramatically underperformed the ever-hopeful equity market with financials underperforming the heaviest. European sovereigns are generally wider close-to-close on the week but just like corporate credit and equity, they generally followed a similar path to last week with a broad range trade - though a clear trend generally wider overall. Italy underperformed Spain on the week and Portugal, as we noted earlier was the big winner on what looked like basis trade-driven flows as opposed to whole new world of relief. Ahead of the G-20 meetings, it did not seem like there was much hope in sovereign credit - even as financials and corporates did lift a little off their multi-month lows and having seen the headlines of the G-20 draft, it appears there is no magic bullet there anyway - no matter how big they think their bazooka is.

All you need to know.

NYSE volume was 20% above yesterday's and S&P 500 e-mini futures (ES) volume surged to its 2nd highest of the year as the last 30 minutes saw heavy volume and large average trade size very active as it pushed up towards VWAP and oscillated around its 50DMA. ES closed below its 50DMA for the first time since Monday but equities notably underperformed Treasuries (playing catch-up to bond's recent rally). Equities hit their lows at around 1430ET as ES coincided with Monday's closing VWAP (and Apple also tested and stayed around Monday's closing VWAP) and with a spike down and recovery in WTI prices (margin calls?). The major financials saw their best levels pre-open and slid lower all day with very little bounce at the close. While there was plenty of volatility in FX and commodity markets, close-to-close changes were relatively benign in the USD (DXY) and Oil, Copper, and Gold (while Silver modestly outperformed). All the action in FX was between US open and Europe's close but the afternoon saw AUD drifting weaker and CAD lose most of its spike gains from yesterday as JPY also slipped relative to the USD reducing some of the negative carry impact. Just as we had noted, and reiterated this morning and afternoon, equities performed the same hope-driven rally relative to broad risk assets as last week, and before the late day VWAP-seeking surge, almost completed their shift to fair-value. VIX also pulled higher to its credit-equity-implied fair-value before falling back as we rallied into the close. Overall average trade size today in ES, given its very heavy volume, was among the lowest of the year which suggests a lot of algos trying to wriggle their way back to VWAP to release some orders and with equity reverting to Treasury's, credit's, and broad-risk-asset's views of the less-than-stellar world, we suspect there is more selling to come here - albeit with OPEX complications.

Keeping it simple, Europe was a sloppy mess today. In an almost perfect copy of last week's sovereign, corporate, and financial credit market movements, today saw all of these assets plunge back near post-Non-Farm-Payroll lows. Equity markets, which had miraculously managed to regain those pre-NFP levels this morning after the Spanish auction knee-jerk, rapidly retraced and aside from some stick-save efforts from US markets and Lagarde, keeps the chaos-ball rolling with yet another multiple-sigma flip-flop. Ugly all around as it seems the reality check we discussed on the Spanish auction overnight was better received than the spin the Euro-Elite tried to put on it as we reinforce our view of the instability as the LTRO Stigma widens further to post LTRO1 wides as 10Y Spain approaches 6% yield and 425bps spread and Italian CDS over 440bps as 10Y yields break back above 5.5%.

"You apparently can survive betting against bull market irrationality if you meet three conditions. First, you must allow a generous Ben Graham-like “margin of safety” and wait for a real outlier before you make a big bet. Second, you must try to stay reasonably diversified. Third, you must never use leverage."...It is the classic failing of value managers (and poker players for that matter) to get impatient and bet too hard too soon. In addition, GMO was not always optimally diversified. We are generally more cautious (or, if you prefer, “more experienced”) now than in 1998 with respect to, for example, both patience and diversification, and at least we in asset allocation always stayed away from leverage. The U.S. growth and technology bubble of 2000 was by far the biggest market  outlier event in U.S. market history; we had previously survived the 65 P/E market in Japan, which was perhaps the greatest outlier in all important equity markets anywhere and at any time. These were the most stringent tests for managers, and we were 2 to 3 years early in our calls in both cases. Yet we survived, although not without some battle scars, with the great help that we did, in the end, win these bets and by a lot. Hypothetically, resisting the temptation to invest too soon in 1931 may have been a tougher test of survival in bucking the market. Luckily we, and all value managers, were not around to be tempted by that one.

As Europe approaches the halfway point of the week, equities are suffering losses on the day as North America comes to market, with underperformance observed in the CAC and peripheral bourses. Markets have been weighed down upon from the open with commentary from the Portuguese PM garnering attention in the press, saying that there are ‘no guarantees’ that Portugal will return to the financial markets as planned. A Bank of Spain release has shown the bad loan ratio for the country’s banks has increased to 8.16%, further weighing on sentiment. There was also market talk of stop-loss buying of German Bunds at the cash open, the security had sold off since then but safe haven flows have kept the Bund in positive territory.

Following a blistering two days of upside activity in Europe and a manic depressive turn in the US in the past 48 hours, the rally is now be running on fumes, and may be in danger of flopping once again, especially in Spain where the IBEX is tumbling by over 3% to a fresh 3 year low. Still, the Spanish 10 year has managed to stay under 6% and is in fact tighter on the day in the aftermath of the repeatedly irrelevant Bill auctions from yesterday, when the only thing that matters is tomorrow's 10 Year auction. Probably even more important is that the BOE now appears to have also checked to Bernanke and no more QE out of the BOE is imminent. As BofA summarizes, "The BoE voted 8-1 to leave QE on hold at their April meeting: a more hawkish outturn than market expectations of an unchanged 7-2 vote from March. Adam Posen - the most dovish member of the BoE over the last few quarters - took off his vote for £25bn QE, while David Miles judged that his vote for £25bn more QE was finely balanced (less dovish than his views in March)." Even the BOE no longer know what Schrodinger "reality" is real: "The BoE judged that developments over the month had been relatively mixed, with a lower near-term growth outlook, but a higher near-term inflation outlook. However, they thought that the official data suggesting very weak construction output and soft manufacturing output of late were “perplexing”, and they were not “minded to place much weight on them”." Naturally, this explains why Goldman's Carney may be next in line to head the BOE - after all to Goldman there is no such thing as a blunt "firehose" to deal with any "perplexing" issue. Finally, the housing market schizophrenia in the US continues to rule: MBA mortgage applications rose by 6.9% entirely on the back of one of the only positive refinancing prints in the past 3 months, which rose by 13.5% after a 3.1% drop last week. As for purchases - they slammed lower by 11.2%, the second week in a row. Hardly the basis for a solid "recovery."