Fund Flows

If Peter Schiff is selling gold, then maybe you should too!

Everyone's favorite bull made another magnificently arrogant appearance on TV this morning. Following his recent CNBC embarrassment, Bloomberg TV interviewed the outperforming hedge fund manager this morning - during which he explained his 'where else ya gonna go' bullish stocks thesis. From expectations for an "explosion of greatness" in the US to his gratuitous flirtation, he appears to have the inane ability to use many words where few are needed and his bullish thesis has the ring of any and every guest pumper (with nothing new to add): the same supposedly 'low' multiple, central-banks-are-printing, and wide spread between bond and equity yield argument that everyone's mom can explain. From expectations for the 'great rotation' from bonds to stocks and his 50%-upside prediction in Citi, Tepper is "balls to the wall" the best guest ever on any stock-touting network. However, one little thing gets in the way - the last time the Great-and-Powerful Tepper appeared so overtly bullish of stocks (and financials specifically), he also was dumping his holdings into the rally that followed.

Over the course of the last two weeks, I attempted to explain to the general investing public how, thanks to the virtual impossibility of distinguising between 'legitimate' market making and 'illegitimate' prop trading, some of America's systemically important financial institutions are able to trade for their own accounts with the fungible cash so generously bestowed upon them by an unwitting multitude of depositors and an enabling Fed. 

As we have been warning for over half a year, and as conventional wisdom has finally caught on, the economy most impacted in Europe by the recent surge in the EUR exchange rate (not because of an improvement in the economy but due to wholesale engineering of asset prices by central banks) is the one that has so far been able to keep it all together - Germany, the same country where Angela Merkel last night suffered an embarrassing last minute loss which may be a harbinger of things to come should Germany slide deeper into recession. This, as also noted repeatedly before, is part of the grand paradox in Europe: unlike every other central bank in the world, the ECB's interventions achieve only one thing: to push the EUR higher, in the process stabilizing secondary market indicators (bond prices, the DAX, swap spreads) but destabilizing EUR-denominated exports. And while the adverse impact on core exporting countries from ECB intervention is by know understood by everyone (and this is ignoring the impact of potential inflation as a result of fund flows to the few safe regions in Europe), few appreciate just how big the EUR impact on the periphery is as well. The chart below from the Spanish economy ministry showing the recent stunning divergence of Spanish exports, should explain why a low EUR is good for not only Germany, but certainly the PIIGS, in this case Spain. And vice versa.

Even if the US economy really takes off in 2013, don`t look for oil and gasoline demand to overtake supply in the equation.

It took the charming three tries for Greece to get its third "bailout", which incidentally does not bail out anyone except the hedge funds who went long GGBs because the only actual winners resulting from yesterday's transaction - those benefiting from Europe's AAA club fund flows are hedge funds as explained previously. As for Greece, what the "deal" did was buy it more time to get its hockeystick GDP forecast in order as the only thing that may win the country some future debt forgiveness is hitting an unbelievable 4%+ current account surplus and GDP growth of a ridiculous 4.5% per year. That said, of the cash proceeds going to Greece, to be released in three tranches, totaling €43.7 billion, only a de minimis €10.6bn for budgetary financing, i.e., the Greek population (read government corruption) and €23.8bn in EFSF bonds for bank recapitalisation, read keeping German and French banks solvent. Once the €10.6 billion runs out in a few months, the strikes will resume. So what does this third, latest, greatest and certainly not last can kicking exercise mean? Simple: in the words of SocGen, a short-term reprieve has been hard bought, nothing has been fixed, and "more will be likely."

While the developed world's central banks may enjoy trading FX and stocks, either directly or indirectly, with each other in a demonstration of monetary policy "stability", the historically biggest source of capital inflows into stocks - the retail investor - has once again just said "nein", for the 17th consecutive week, and excluding tiny inflows of $95 million in the week of July 18 and $907 million in the week ended May 30, has pulled money from stocks for an unprecedented 39 consecutive weeks, with $6.6 billion pulled out in the last week, the most since the first week of October. In fact going back to the beginning of 2010, according to ICI, while $44.5 billion has been invested into domestic equity stock funds, $412 billion has been pulled out. Where has the money gone on an almost dollar for dollar basis: bonds, confirming that the New Normal mantra is all about return of capital.

What is the latest state of play that has the biggest support from all parties? It appears that the plan which is now back in play, is one which Greece had previously nixed, namely a partial Greek bond buyback of the private bonds at a discount to par: with numbers currently rumored anywhere between 25 cents and 50 cents on the euro. And even if Greece agrees with this proposal, there is a question of where Greece will get the money for this distressed debt buyback? After all Greece is completely broke, and any new cash would have to be in the form of loans, as not even the most nebulous interpretation of the Maastricht treaty would allow an equity investment, or to use the proper nomenclature, "a fiscal investment" into Greece. But the kicker is when one traces the use of funds. Because what is will happening is a payment not to Greece, obviously, but to its creditors: entities which for the most part are hedge funds, and which have bought up GGB2s in the mid teen levels as recently as 4 months ago (recall Dan Loeb's major position in Greek bonds).

The recent market sell-off has not been about the re-election of President Obama but rather the repositioning of assets by professional investors in anticipation of three key events coming between now and the end of this year - the "fiscal cliff", the debt ceiling and the expiration of the Transaction Account Guarantee (TAG).  Each of these events have different impacts on the economy and the financial markets - but the one thing that they have in common is that they will all be battle grounds between a divided House and Senate.  While there has been a plethora of articles, and media coverage, about the upcoming standoff between the two parties - little has been written to cover the details of exactly what will be impacted and why it is so important to the financial markets and economy. We remain hopeful that our elected leaders will allow cooler heads to prevail and that they will begin to work towards solutions that alleviate some of the risks of economic contraction while setting forth logical plans for fiscal reform.  However, while we are hopeful of such progress, "hope" is not an investment strategy to manage portfolios by.  If we are right things are likely to get worse before a resolution is reached - but maybe that is why the "investment professionals" have already been heading for the exits.

Life imitates math.

Market indexes and recessions are two very different data series...

~ Doug Short

While it is just as perplexing that Goldman still has clients, what is most surprising in this week's David Kostin "weekly kickstart" is that Goldman's clients have shown a surprising lack of stupidity (this time around) when it comes to the impact of QEtc. Shockingly, and quite accurately, said clients appear to be far more worried about the inflationary shock that endless easing may bring (picture that), than what level the S&P closes for the year. Incidentally with Q3 now over, and just 3 months left until the end of the year, Goldman's chief equity strategist refuses to budge on his year end S&P forecast, which has been at 1250 since the beginning of the year, and remains firmly there. From Goldman: "QE has succeeded in increasing asset prices and inflation expectations but has not convinced investors to raise their US growth expectations. Instead, equity investors have expressed concern about inflation risks while both gold prices and implied inflation rates show similar shifts."

Liquidity, Fund Flows and Technicals matter now. Fundamentals, Dow Theory and the real economy, not so much. 

With global growth slowing, global trade tumbling, and earnings revisions falling rapidly, equity market outperformance has been (as we noted earlier) based on the Fed/ECB's largesse. The unanswered question is - how much is now priced in? Given recent 'stability' post-FOMC, it seems the follow-through is not there (especially if we look at sectoral performance) and based on David Rosenberg's estimate of Fed QE's impact on stocks, we think we know why. In the last three months, the S&P 500 has 'outperformed' the Fed balance sheet by around 220 points - which equates to a pricing-in of around 11 months of additional QEternity.

There was a time about a year ago, before the second Greek bailout was formalized and the haircut on its domestic-law private sector bonds (first 50%, ultimately 80%, soon to be 100%) was yet to be documented, when it was in Greece's interest to misrepresent its economy as being worse than it was in reality. Things got so bad that the former head of the Greek Statistics Bureau Elstat, also a former IMF employee, faced life in prison if convicted of doing precisely this. A year later, the tables have turned, now that Germany is virtually convinced that Europe can pull a Lehman and let Greece leave the Eurozone, and is merely looking for a pretext to sever all ties with the country, whose only benefit for Europe is to be a seller of islands at Blue Aegean water Special prices to assorted Goldman bankers (at least until it renationalizes them back in a few short years). So a year later we are back to a more normal data fudging dynamic, one in which Greece, whose July unemployment soared by one whole percentage point, will do everything in its power to underrepresent its soaring budget deficit. Case in point, on Friday the Finance Ministry proudly announced its budget deficit for the first eight months was "just" €12.5 billion, versus a target of €15.2 billion, leading some to wonder how it was possible that a country that has suffered terminal economic collapse, and in which the tax collectors have now joined everyone in striking and thus not collecting any tax revenue, could have a better than expected budget deficit. Turns out the answer was quite simple. According to Spiegel, Greece was lying about everything all along, and instead of a €12.5 billion deficit, the real revenue shortfall is nearly double this, or €20 billion, a number which will hardly incentivize anyone in Germany to give Greece the benefit of another delay, let along a third bailout as is now speculated.