Reality

Looking at the parabolic rise in AAPL shares in the past 3 months one would imagine that the company's product line up, so well telegraphed over the past several years, has changed, or at least has found a way to cure cancer, while expanding margins, and also providing loans to cash-strapped US consumers to buy its products exclusively. Truth is nothing substantial has changed - we have merely seen a ramp as every hedge fund and asset manager jumps on the Apple bandwagon (we fully expect at least 250 funds to hold Apple as of March 31: at least 216 were in the stock as of December 31 and then even Dan Loeb jumped in after) which is fun and games on the way up, but pain and tears when the bubble finally does pop. Many have attempted to warn the public about the latest manic phase of Apple expansion, but few have succeeded - such as the the reality of bubbles: they pop when you least expect them. Yet giving it the old college try, here is Obermeyer Asset Management's John Goltermann with an extended commonsensical approach to his perspective on the company with two main growth products, and why unlike everyone else, he is not buying the iKool-Aid.

We have discussed numerous times the surge in Student Loans as the lifeblood of the consumer credit expansion that we seem to be having but now its just getting ridiculous. Smart Money reports on the growing use of student loans for the private K-12 education needs of affluent families. This is not affordable loans for impoverished savants to get their PhD at 14 years old, roughly 20% of families that applied for aid to pay for their children's kindergarten through 12th grade private school education had incomes of $150,000 or more, up from just 6% in 2002-3. 'Pre-college' loans are becoming more popular as the story notes "It used to be that families first signed up for education loans when their child enrolled in college, but a growing number of parents are seeking tuition assistance as soon as kindergarten." These loans, which do not have to be repaid until the child graduates college are expensive (varying between 4 and 20% and average $14,000) which would be on top of the nearly $34,000 average that 1 in 6 parents already carry for college graduates - leaves parents at risk of owing considerably larger sums of debt.  Still, perhaps the e*Trade baby will put that cash to good use but one parent sums up the alternate reality that exists within so many US households with regard to debt: "We'll figure out how to pay for it then, or with any luck they'll get scholarships," he says. "Right or wrong, we're hoping our experiment works." Keep buying those Mega Millions tickets too...

When I first attempted to find a more realistic debt to GDP ratio for Spain, Belgium, Italy et al I did it on a stand-alone basis; no inclusion of their European liabilities. When I approached Germany, given their size and importance in the EU, I focused upon their liabilities to the European Union. Several institutions have since asked me to consider the total liabilities for each country as every nation in the European Union has national debts as well as debts for their percentage of ownership for the EU and the European Central Bank. Using the combination of national liabilities and any nation’s percentage of EU/ECB liabilities one then could ascertain a final and complete picture of a real debt to GDP number that, unlike the Eurostat data, would be inclusive of sovereign guarantees, contingent liabilities and their responsibilities to the EU and the ECB. This schematic then would tell each of us what a given country actually owed so the total reality could be assessed for judgment.  Given that Spain is currently in focus and that nowhere that I have ever seen has there been an accurate national debt coupled with Spain’s European debt schematic; I have decided to provide you one.

The sad reality of an austerity induced slowdown in Europe and an ESFS/ESM as useful as a chocolate fire-guard seems to be creeping into risk asset premia across Europe (and implicitly the US). GGB2s are all trading back under EUR20 (that is 20% of par), Sovereign yields and spreads are leaking wider despite the best efforts of their respective banks to back-up-the-truck in the 'ultimate all-in trade' and the LTRO Stigma has reached record levels as LTRO-encumbered banks' credit spreads are the worst in over two months. Spanish sovereign spreads are back at early January levels and with Italian yields comfortably back over 5% and the bonds starting to reality-check back towards the much less sanguine CDS market. It seems apparent that much of the liquidity-fixing LTRO benefits are now being washed away as investors realize nothing has changed and in fact things are considerably worse now given encumbrance and subordination concerns and the increased contagion risk that the LTRO and the Sarkozy trade has created.

It’s tough out there. The giants are losing. But there is an astonishing winner....

For the last month or so, despite ongoing fund inflows, high-yield credit's performance has been generally muted. Compared to the exuberance of the equity market it has been downright flaccid and given how 'empirically' cheap it is on a normalized spread basis through the cycle (and the fortress-like balance sheets we hear so much about) some would expect it to be the high-beta long of choice in the new-new normal rally-to-infinity. However, it is not (and has not been since late January). There are some technical factors including a bifurcated HY credit market (between really 'good's and really 'bad's and illiquids and liquids), low rate implications on callability and negative convexity affecting price but the lack of share creation in the HYG (high-yield bond) ETF also suggests a lagging of support for high-yield credit. This is a very similar pattern to what was seen in Q1/Q2 last year as equity kept rallying away from a less sanguine credit market only to eventually collapse under the weight of its own reality-check. European credit and equity markets are much more in sync together as they have fallen recently but financials in the US exaggerate this credit-signaling-ongoing-concerns trend while equity goes on about its bullish business. Another canary dead?

The last 90 minutes of the day dragged ES (the S&P 500 e-mini futures contract) back up to the safety of its VWAP on what seems to be some comments by Jamie Dimon on the Fed looking for much larger job creation (prompting QE3 moves) or another housing bottom-call? After what had been an ugly day in which stocks sold off (aggressively after the European close) back to the post-Bernanke reality that is the less sanguine credit markets, the USD weakened, commodities and stocks popped (led by financials), and Treasuries sold off (belly underperforming). It seems that no matter who comes on TV nowadays and says anything, the algos market will rally. By the close, Financials were the only sector in the green (as GS and JPM surged but not so much BAC or MS) but Materials, Energy, and Industrials were the worst. VIX managed to get above 17 before reversing back to unchanged and the term-structure steepened back a little. Gold (which dropped the most in 2 weeks today after Goldman's long call) remains the only metals/oil commodity higher on the week - though only marginally - as plunges in Oil and Silver bounced quite positively into the close. Stocks underperformed credit on the day in general but the low volume limp up into the close saw them even out and we note that as ES hit its VWAP - heavier negative delta volume came through somewhat suggesting this was an effort to ease institutional exit - as both NYSE and ES volume was above average. 30Y Treasuries are back to higher in yield for the week but this afternoon's selloff lifted yields 4-5bps off their earlier lows. Broad risk assets led the equity market down but quite coincidentally, the S&P ended the day almost perfectly in CONTEXT with risk assets and credit/vol (after a significant dislocation the last few days).

James Bianco plays straight-man to Charles Biderman in this extended (and admittedly audio-challenged) discussion of the reality behind money printing, inflation, and the US Treasury market. Following our discussion of the deficit earlier, it seemed appropriate to listen to this back-and-forth as Bianco addresses who is really buying US Treasuries, how 'money' is created by the Fed for the banks, and where inflation is leaking into the system. "The day the Fed admits there is an inflation problem is the day they are too late" is how they summarize the temporary/transitory verbiage that the Fed needs to keep using to placate the masses. Gold (and TIPS) remain their preferred strategy as Bianco argues that putting the 'inflation' threat in context is critical - this is not about 14/15% comparisons, this is about investor expectation that we get 3% inflation with the Fed at ZIRP and intending to keep printing money - which is just as toxic. The two end with an interesting conversation on the simultaneous debt deflation and price inflation and the importance of not comparing either to their extremes by way of shrugging off concerns.

We were delighted to see that the old headline scanning algos are still in charge of the FX market following "news", which were not even news, having been expected by absolutely everyone, that the EU is about to propose an expansion of Europe's bailout fund to a total of €940 billion for one year, by merging the €440 billion EFSF and €500 billion ESM - leading to a very transitory spike in the EURUSD. From Bloomberg: "European governments are preparing for a one-year increase in the ceiling on rescue aid to 940 billion euros ($1.3 trillion) to keep the debt crisis at bay, according to a draft statement written for finance ministers. The euro-area finance chiefs will probably decide at a meeting in Copenhagen March 30 to run the 500 billion-euro permanent European Stability Mechanism alongside the 200 billion euros committed by the temporary fund, a European official told reporters earlier today in Brussels. Beyond that, they are also set to allow the temporary fund’s unused 240 billion euros to be tapped until mid-2013 “in exceptional circumstances following a unanimous decision of euro-area heads of state or government notably in case the ESM capacity would prove insufficient,” according to the draft dated March 23 and obtained by Bloomberg News." Three  things here: 1) Of the bombastic €940 billion in headline bailout money, only €300 billion or so will actually be available (sorry PIIGS - you can't bail out the PIIGS, also a third of the EFSF money is already tied up); 2) Europe is already preparing for the fade of the impact of the LTRO, which as pointed out earlier, has not only peaked, but courtesy of the LTRO stigma, which we suggested months ago to trade by going long non-LTRO banks and shorting-LTRO recipients, is starting to hurt all those firms who thought, foolishly, that the market would not go after them. They were wrong. And now Draghi is also boxed in an runaway inflation corner. And 3) Europe is back to the old mode of thinking that more debt will fix debt, even as the banking sector is forced to delever ahead of Basel III and due to shareholder requirements. This simply means that the eye of the hurricane over Europe's sovereign debt is about to pass. Those who miss 7% yields on BTPs won't have long to wait. Reality is once again starting to reassert itself.

Germany's recent 'agreement' to expand Europe's fire department (as Goldman euphemestically describes the EFSF/ESM firewall) seems to confirm the prevailing policy view that bigger 'firewalls' would encourage investors to buy European sovereign debt - since the funding backstop will prevent credit shocks spreading contagiously. However, as Francesco Garzarelli notes today, given the Euro-area's closed nature (more than 85% of EU sovereign debt is held by its residents) and the increased 'interconnectedness' of sovereigns and financials (most debt is now held by the MFIs), the risk of 'financial fires' spreading remains high. Due to size limitations (EFSF/ESM totals would not be suggicient to cover the larger markets of Italy and Spain let alone any others), Seniority constraints (as with Greece, the EFSF/ESM will hugely subordinate existing bondholders should action be required, exacerbating rather than mitigating the crisis), and Governance limitations (the existing infrastructure cannot act pre-emptively and so timing - and admission of crisis - could become a limiting factor), it is unlikely that a more sustained realignment of rate differentials (with their macro underpinnings) can occur (especially at the longer-end of the curve). The re-appearance of the Redemption Fund idea (akin to Euro-bonds but without the paperwork) is likely the next step in countering reality.

You can listen to CNBC, and the president, drone on about the recovery, about the wealth effect, about trickle-down economics, about why adding $150 billion in debt per month is perfectly acceptable, and about a brighter future for America and the world... or you can take a quick look at these two charts and immediately grasp the sad reality of where we stand, and even sadder, where we are headed.

A prevalent theme over the past 3 months has been the emergence of the Schrödinger world, where on one hand we have a world as it is, and on the other, as central planners, propaganda media, and a president caught up in a reelection campaign would want it to be. Luckily, that world only had a binary bifurcation associated to it - and a simple observation of the mythical collapsed its wave function in less time than it would take BATS to commit corporate suicide.  A much more fun world emerges when one enters the superstring reality of the Federal Reserve, and especially its chairman, where there are not two, not three, but a whopping six dimensions of (mis)perception, all dependent on one's point of view. Courtesy of Silver Circle we present them all.

Have you wondered what really drives consumer confidence? The answer is simple. Jobs. If consumers are to be confident about their future, they need to feel secure in the present and future employment. The chart shows (gold bar) the confidence gap, which is the difference between the present situation index and the future expectations index. The red and blue lines are the number of individuals surveyed who feel that jobs are currently hard to get or plentiful. When confidence is high, so are the number of people who feel that jobs are plentiful. This is generally because they are currently employed and feel like they could get another job if they wanted one. The opposite is true today. This gap between jobs being hard to get and plentiful has closed slightly in the last couple of years; however, we are a long way from getting back to levels that are more normally associated with recoveries.

A relatively quiet day after the excitement of the last few as T+3 settlement day into Quarter-end bought little action until the last hour or so. Two main themes appeared for the whole day - VIX pushed higher all day - notably more than the equity move would suggest (which is interesting given our comments on the capitulative normalization of the short-end volatility term structure yesterday) though some looked like catch up to yesterday's blow-off, and Treasuries rallied consistently all day long (with the short-end notably outperforming - as 5Y also down through its 200DMA and saw its largest percentage drop in yield in 2 months). Stocks leaked lower from an early morning spike on German Ifo (stuck in a very narrow range for much of the US day session), FX markets were dull with JPY stable at its lows while the USD rallied very modestly (dragging FX carry off a little and not supporting risk), Oil wavered around with the USD once again (ending up a little) as metal traded lower with a bigger gap down into the last hour or so. Stocks remain notably rich to credit which underperformed once again today. The last hour saw financials and Discretionary stocks start to rollover and then Tech (mainly the majors as GOOG showed the biggest drop top-to-bottom but most did not close strong - though AAPL made new highs once again). Certainly did not seem like a confirming move today of the 35pt rally off Friday's lows as perhaps Quarter-End sees some chips coming off the table - though hard to read too much into today's action.

This chart tells millions of stories. That’s right: since 1984 (surely an appropriate year) while the elderly have grown their wealth in nominal terms, the young are much worse off both in inflation-adjusted terms, as well as nominal terms (pretty hard to believe given that the money supply has expanded eightfold in the intervening years). So why are the elderly doing over fifty times better than the young when they were only doing ten times better before? There is enough money to keep the economy flowing so long as there are opportunities for people to make themselves useful in a way that pays. With the crushing burden of overregulation and the problem of barriers to entry, these opportunities are often restricted to large corporations. These issues of youth unemployment and growing inequality between the generations are critically important. Unemployed and poor swathes of youth have a habit of creating volatility in response to restricted economic opportunity.