Equity Markets

The low interest rate 'logic' is not working and "the economy can't gain any zest, can't gain any vigor" is how Michael Steinhardt describes the crushing of 'widows and orphans' that the Fed has embarked upon. In a Bloomberg TV interview, the WisdomTree chairman notes the broad 'pall' over the equity markets (conjuring images of a funereal procession down Trinity Street) pointing out that there is no reason to be wildly bullish here. Citing Wall Street's lack of 'spirit', he questions the entire raison d'etre of efficient capital transfer as becoming secondary as he rather poignantly asks who has benefited from Fed's policies "Certainly the banks. But ordinarily you'd say, well, low interest rates benefit housing. It certainly hasn't benefited housing." Reflecting on his performance as a hedge fund manager he concludes that extraordinary performance is sadly not necessary anymore as the money flowing into hedge funds means people do exceptionally well for themselves despite diminished performance. While finding equities broadly unappealing, and suggesting talk of QE3 should cease, he notes there are pockets he would invest in but ends by noting that "Bonds are no place to be".

Risk-aversion is noted in the European markets with all major European bourses trading lower heading into the US open. Participants remain particularly sensitive to Spain following a release from the ECB showing that Spanish bank’s net borrowing from the ECB hit a new record high at EUR 227.6bln in March against EUR 152.4bln in February. Further pressure on the equity markets was observed following the overnight release of a below-expected Chinese GDP reading, coming in at 8.1% against a consensus estimate of 8.4%. As such, markets have witnessed a flight to safety, with Bund futures up over 40 ticks on the day. In the energy complex, WTI and Brent futures are also trading lower, as the disappointing Chinese GDP data dampens future oil demand, however a failed rocket launch from North Korea may have capped the losses.

Earlier today JPMorgan announced results that were better than expected, with revenue of $27.4 billion on expectations of $24.1 billion, and EPS of $1.31 or $5.0 billion, on expectations of $1.17. As previously noted, the bank increased its dividend to $0.30/share, and has authorized a $15 billion new repurchase, which however will likely not be a sizable factor, as JPM has already said with the stock price at the current level buybacks are not accretive. As for the EPS beat, as usual the one-time items swamped everything else, of which the primary one, reduction in loan loss reserves which is the traditional way for the bank to pump up the bottom line, accounting for $1.8 billion or $0.28/share. We are curious how Jamie Dimon will justify this accelerating release even as the firm's Nonperforming loans increased for the first time in years from $10 billion to $10.6 billion: just the TBTF put or something else? Other amusing "one-time" items were the $1.1 billion ($0.17/share) from the WaMu bankruptcy settlement as well as a $0.9 billion loss ($0.14/share) loss from DVA this time hurting the bank as JPM's CDS tightened in Q1. Also curious was a substantial $2.5 billion expense for additional litigation reserves, which is certainly not a one-time item now that every bank is suing JPM and is merely a catch up for Dimon to where he should have been reserved. That, or something else - just what is JPM seeing that others are not (hint: ask Bank of America). This number will continue rising. So net of the real one-time items, EPS was less than a $1.00.

As we have recently pointed out (here), the exponential level of global central bank one-upmanship has created a level of dependency in capital markets never seen so obviously before. Critically, though, it is not the sheer scale of the balance sheet (or STOCK of assets) that is good enough anymore - equity market performance is all about the marginal change in that stock (FLOW). Nowhere is this "It's The Flow Stupid" better highlighted than in the chart below showing the periods of central bank balance sheet expansion coinciding almost perfectly with the largest surges in equity market performance. Furthermore, as the flow fades so the performance starts to fade (unable to counter the natural tendency of retail to exit the risky markets perhaps) and as the Fed's balance sheet begins to actually compress marginally (as it has the last few weeks), so equity market performance has turned negative - and notably so. This leaves the Fed with the dilemma that it is not just about the size of the bazooka anymore but the frequency with which you are willing to use it - and as we are likely to see this week - jaw-boning alone will not do the trick (no matter what today's market might have been hoping for) as unless we see the balance sheet of the Fed expand again (which would mean a rise of around 0.4% - something we haven't seen since mid February), we should expect the rolling 4-week performance of equities to continue to fall.

More jaw-boning helped squeeze shorts as equity indices, credit, and precious metals all closed their highest since the NFP dive as QE3 hope is back on the table. The best day in four months for Materials (now the only sector green from before the NFP print) and Industrials, and the best two-day gain in financials and energy in four months but the S&P 500 remains around 1% off pre-NFP levels (but managed to fill the gap to the lows of last Thursday in S&P futures). Credit (both investment grade and high-yield spreads) managed - just as in Europe - to rip up to pre-NFP levels also (outperforming stocks). Notable divergence between AAPL and SPY started at 1045ET today - as GOOG volume picked up and accelerated which was also when ES (S&P e-mini futures) broke Tuesday's opening level and ran stops. Volume was average with higher average trade size coming in as we reached post-NFP highs (suggesting again professionals selling into strength as weak shorts are squeezed out in a hurry). The dovish comments sent Gold and Silver surging (and China rumors pushed Copper up - and WTI to around $104). VIX crumbled into the close - with its largest drop in over 5 months in percentage terms - though still higher than last Thursday's close. FX markets were noisy once again through Europe but USD ebbed higher in the afternoon - still very modestly lower on the week and day (with JPY leaking weaker today helping carry support risk a little). Treasuries also leaked higher in yield but remain at the immediate spike low yields post-NFP (pretty much in line with stocks generally) but between FX and TSYs, broad risk assets were not as excited as credit and equity markets specifically as we suspect this was weak recent shorts being shaken out suddenly. In context, the S&P 500 is down over 3% in gold terms from before the payrolls print.

"In the last three plus years, central banks have had little choice but to do the unsustainable in order to sustain the unsustainable until others do the sustainable to restore sustainability!" is how PIMCO's El-Erian introduces the game-theoretic catastrophe that is potentially occurring around us. In a lecture to the St.Louis Fed, the moustachioed maestro of monetary munificence states "let me say right here that the analysis will suggest that central banks can no longer – indeed, should no longer – carry the bulk of the policy burden" and "it is a recognition of the declining effectiveness of central banks’ tools in countering deleveraging forces amid impediments to growth that dominate the outlook. It is also about the growing risk of collateral damage and unintended circumstances." It appears that we have reached the legitimate point of – and the need for – much greater debate on whether the benefits of such unusual central bank activism sufficiently justify the costs and risks. This is not an issue of central banks’ desire to do good in a world facing an “unusually uncertain” outlook. Rather, it relates to questions about diminishing returns and the eroding potency of the current policy stances. The question is will investors remain "numb and sedated…. by the money sloshing around the system?" or will "the welfare of millions in the United States, if not billions of people around the world, will have suffered greatly if central banks end up in the unpleasant position of having to clean up after a parade of advanced nations that headed straight into a global recession and a disorderly debt deflation." Of course, it is a rhetorical question.

We all know that central banks and governments have been actively intervening in markets since the 2007 subprime mortgage meltdown destabilized the leveraged-debt-dependent global economy. We also know that unprecedented intervention is now the de facto institutionalized policy of central banks and governments. In some cases, the financial authorities have explicitly stated their intention to “stabilize markets” (translation: reinflate credit-driven speculative bubbles) by whatever means are necessary, while in others the interventions are performed by proxies so the policy remains implicit.  All through the waning months of 2007 and the first two quarters of 2008, the market gyrated as the Federal Reserve and other central banks issued reassurances that the subprime mortgage meltdown was “contained” and posed no threat to the global economy. The equity market turned to its standard-issue reassurance: “Don’t fight the Fed,” a maxim that elevated the Federal Reserve’s power to goose markets to godlike status. But alas, the global financial meltdown of late 2008 showed that hubris should not be confused with godlike power. Despite the “impossibility” of the market disobeying the Fed’s commands (“Away with thee, oh tides, for we are the Federal Reserve!”) and the “sure-fire” cycle of stocks always rising in an election year, global markets imploded as the usual bag of central bank and Sovereign State tricks failed in spectacular fashion.

While equity trading last March trading was affected by the excess volatility arising from the Fukushima explosions a year earlier, and the Japan earthquake induced volatility in general, today's monthly volume update by the NYSE shows that no matter what the reason for the volume collapse, toplines for banks and traders will suffer, on both a Y/Y as well as sequential basis. Per the NYSE: "European and U.S. Cash ADV Down 13% and 24% Year-over-Year.... NYSE Euronext European cash products ADV of 1.6 million transactions in March 2012 decreased 12.7% compared to March 2011, but increased 0.5% compared to February 2012. NYSE Euronext U.S. cash products handled ADV in March 2012 decreased 23.6% to 1.8 billion shares compared to March 2011 and decreased 0.6% from February 2012." An even bigger year-over-year collapse took place in the one product which everyone thinks is taking the place of individual stock trading: the synthetic CDOs known as ETFs: "NYSE Euronext U.S. matched exchange-traded funds ADV (included in volumes for Tape B and Tape C) of 222 million shares in March 2012 decreased 29.3% compared to March 2011, but increased 4.1% compared to February 2012. In the first quarter of 2012, NYSE Euronext U.S. matched exchange-traded funds ADV of 221 million shares was 21.8% below prior year levels." The YoY collapse in trading volumes for derivatives was less compared to cash, but the sequential drop from February 2012 was even more pronounced: "NYSE Euronext global derivatives ADV in March 2012 of 8.1 million contracts decreased 11.5% compared to March 2011 and decreased 15.4% from February 2012 levels." We can only hope that banks have found some innovative ways of compensating for this collapse in overall market participation, such as traditional revenue pathways like underwriting and advisory fees, as well as lending and arbing the carry trade. Alas, as the following Bloomberg piece points out, this will hardly be the case, as Zero Hedge has warned previously.

As North America comes to market, there is a lot to digest. European equity markets are trading higher, with the FTSE MIB in particular outperforming after a volatile morning’s session, with bargain-hunting the active theme among investors. The first major risk event came and went with the Italian T-Bill auction. Participants were looking for a poor auction due to the ongoing Eurozone woes, and although bid/covers fell short and yields did increase, the auction was not as poorly received as many had feared.  As such, Italian and Spanish 10-yr spreads have tightened with the German Bund, with the Spanish spread closing in on 400BPS, with talk of domestic buying in the periphery and profit-taking from the last few sessions adding to the tightening effect.  A flashpoint of the day was the German Bund auction; results came in showing the auction to be technically uncovered, failing to sell the expected EUR 5bln. Analysts have pinned the poor auction on the Bund having record low yields providing a disincentive to buy the German security. Following the minutes after the auction, around 25,000 contracts went through on the Bund, spiking lower around 20ticks.

If yesterday was risk off on concerns Europe is sinking following last week's disastrous Spanish long-term auction, today is risk on after Italy managed to successfully place 91 and 361-Day bills, in line with expected amounts, if at much higher yields, and lower Bid To Covers. Specifically, Italy sold €3 billion in 91 day bills. The yield soared from 0.492% on March 13 to 1.249%, while the Bid to Cover plunged from 2.23 to 1.81. Same for the 361-Day Bill auction, where €8 billion in Bills (in line with target) were sold at 2.840%, double the yield of 1.405% from a month ago, and a Bid To Cover just modestly better: from 1.38 to 1.52. As usual the market continues to blatantly ignore the thin white line of bond issuance: every Bill and Bond auction that matures within the maturity (3 Years) of the LTRO will succeed: period. It is the ones maturity longer than 3 years - such as Spain's last week - that are the test. Comparing one to another is apples and oranges. But risk on don't care, and as a result futures are surging disproportionately, even as Spanish and Italian bonds are just modestly tighter following the bond results. But we will once again meander whack-a-mole style from auction to auction until the market is reminded of this little nuance. In other news, Iran just announced it is following its cut in Greek and Spanish exports, by halting exports to Germany next, while continuing the theme of 2011 Deja Vu, Indonesia's Aceh was struck two hours ago with a massive 8.7 Earthquake, with an 8.8 aftershock off Sumatra, coupled with a tsunami warning. Luckily, there are no initial reports of casualties or major damage.

UK and EU markets played catch up at the open this morning following Friday’s miss in the US non-farm payroll report. This coupled with on-going concerns over Spain has resulted in further aggressive widening in the 10yr government bond yield spreads in Europe with the Spanish 10yr yield edging ever closer to the 6% level. As a result the USD has strengthened in the FX market in a moderate flight to quality with EUR/USD trading back firmly below the 1.3100 and cable falling toward the 1.5800 mark. There was some unconfirmed market talk this morning about an imminent press conference from the SNB which raised a few eyebrows given the recent move in EUR/CHF below the well publicised floor at 1.2000, however, further colour suggested an announcement would be linked to the naming of Jordan as the full-time head of the central bank when they hold their regular weekly meeting this Wednesday. Elsewhere it’s worth noting that the BoJ refrained from any additional monetary easing overnight voting unanimously to keep rates on hold as widely expected. Meanwhile, over in China the latest trade balance data recorded a USD 5.35bln surplus in March as import growth eased back from a 13-month peak.

Nothing is going on this morning that did not already happen at 8:30:01 am on Friday. As a result, the three robots who are the sole churners of stocks this AM will keep risk where it was just after NFP, because that is part of the new regime, one in which USD weakness is now stock weakness, and one where stocks have a ways to drop before NEW QE is greenlighted. Also with Europe offline all day, the robots won't even be able to frontrun the European close. Bank of America summarizes the lack of events shaping the market this morning.

Much has been made, and rightly so, of the echoing crisis that is evolving in Spanish bank and sovereign credit (and equity) markets in the last few weeks. The impact of the LTRO on the optics of Spain's problems hid the fact that things remain rather ugly under the surface still and with the fading of that cashflow and reach-around demand from the Spanish banking system, the smaller base of sovereign bond investors has shied away. Stephane Deo, of UBS, notes that while the Spanish budget is a positive step (with its labor market reforms), Spain's economy remains weak and will face a severe recession this year followed by still significant contraction next year. However, he fears the measures announced may not be enough to calm investor angst as he doubts the size of fiscal receipts numbers and the ability to half the deficits of local authorities. Furthermore, the measures will have a large impact on corporate earnings - implicitly exaggerating the dismal unemployment numbers (which is increasingly polarizing young against old) with expectations that the aggregate unemployment rate could well top 26% and youth well over 50%. This will only drag further on the housing market, which while it has suffered notably already, is expected to drop another 25% before bottoming and credit is contracting rapidly (compared to a modest rise overall in Europe). Spanish banks remain opaque in general from the perspective of the size and quality of collateral and provisioning and Deo believes they are still deep in the midst of the provisioning cycle and tough macro conditions will force restructuring and deleveraging. Spain scores 5 out of 5 on our crisis-prone indicator and markets, absent intervention, are starting to reflect that aggressively.

Liquidity never solves issues of solvency and the time that it buys is generally of a relatively short duration. After the $1.3 trillion loan by the ECB to the European banks which helped drive up the prices for European sovereigns what do we now find as the liquidity ebbs? Yesterday’s Spanish auction was abysmal and the French auction today did not go too well with rising yields and less demand. The austerity measures are driving Europe into a worsening recession and the financial positions of Spain and Italy are deteriorating even as new measures are put into place. In fact there are only two ways out of the European mess which are growth, not happening, and Inflation which may be the ultimate strategy employed by the EU and the ECB if the construct holds to the point of changing strategies which is surely no outlier event.

And like that, Europe is broken again. Following a spate of negative European data (what else is there), including a miss in German industrial production as well as a miss in UK manufacturing output, all eyes are again on Spain, especially those of the bond vigilantes, who have sold off the sovereign European bond market, sending the Spanish-Bund spread to over 400 bps for the first time since December 2011. The main reason today: a Goldman report saying Spain will unlikely meet its 2012 and 2013 budget targets, as well as JPM Chief Economist David Mackie saying Spanish government "missteps" have raised questions about its credibility, making investors reluctant to purchase Spanish debt. Stress has returned to periphery, if it broadened into bank funding markets more LTROs would be forthcoming; if that “failed to hold yields at an appropriate level” Spain may need assistance from the EFSF/ESM and the IMF. Euro area unlikely to return to stability in sovereigns without some burden sharing; nominal growth likely to stay below borrowing costs, making fiscal targets “all but impossible to achieve”. UBS piles in saying Spanish banking stresses still haven't been addressed. Finally, a big red flag is that market liquidity is once again starting to disappear, and as Peter Tchir points out, Main is now being quoted with 3/4 bps bid/ask spread, all the way up to 1 bps spread. In other words, as we have been warning for weeks, the period of fake LTRO-induced calm is over, and the market is demanding more central planner liquid heroin. The question becomes whether Europe has even more worthless collateral in exchange for which the ECB will continue handing out discount window money in sterilized sheep's clothing. Yet nowhere is the resumption in risk flaring more evident than in the Swiss Franc, where the EURCHF all of a sudden broke through the critical 1.20 SNB floor, which was set back in September 2011, the day gold was trading at its all time high. Said otherwise, everyone is once again scrambling for safety. And since they can't get it in the CHF, it is only a matter of time, before gold resumes its ascent as the paper currency alternative that sent it to its all time highs late last summer.