We expect a return to a skittish environment in markets. We are confident in my prediction for the course of the economy by leveraging simple game theory in handling the upcoming crisis as Congress returns for its lame duck session. “Compromise” reflects a decision from either side that each find unpalatable. Both President Obama and Speaker Boehner would rather shove two sticks in their eyes than move from their hardened stance despite some of the recent rhetoric in favor of bargaining in good faith. As long as the loss of utility from both sides’ digging in their heels is more favorable than conceding to the preferences from those across the aisle, then the game arrives at a Prisoner’s Dilemma. the above matrix concludes that the fiscal cliff virtually guarantees an aggressive selloff for equities until the stop loss for the Democrats and Republicans has been triggered. For example, if the clock hits midnight on New Year’s Eve with the blue chip index at or near its September peak, each faction would feel comfortable standing up to the other well into January.
On October 21st, 2012, Ambrose Evans-Pritchard wrote a note titled “IMF’s epic plan to conjure away debt and dethrone bankers”, on UK’s The Telegraph. The article presented the International Monetary Fund’s working paper 12/202, also titled “The Chicago Plan revisited“. I will begin the discussion on this working paper with two disclosures: a) my personal portfolio would profit immensely if the Chicago Plan, as presented by the IMF’s working paper 12/202, was effectively carried out in the US. The reason I write today, however, is that to me, it is more important to ensure that my children live and grow in a free and prosperous world, and b) I have not read the so called Chicago Plan, as originally proposed by H. Simmons and supported by I. Fisher. My comments are on what the IMF working paper tells us that the Chicago Plan proposed, without making any claim on the original plan.
The Fed sees the need to reduce interest rates as it takes over the US Treasury and MBS markets; but the ECB's actions are more aimed at reducing divergences between peripheral nations and the core. As SocGen notes, it remains unclear how and when the Fed would exit this situation and in Europe, bond market volatility remains notably elevated relative to the US and Japan as policy action absent a political, fiscal, and banking union remains considerably less potent.
Hugh Hendry: "I Have No Idea Where The Stock Market Is Going To Be"... But "I Am Long Gold And Short The S&P"Submitted by Tyler Durden on 10/25/2012 14:51 -0400
Hugh Hendry: "I have resigned from the professional undertaking of coin flipping. I am not here to tell you where gold’s going to be. I have no idea. That’s my existentialism. I am a student of uncertainty, I have no idea where the stock market is going to be. So when I am creating trades in my portfolio for my clients, I am agnostic. I just want to enhance the probability that I make money come what may."
Greg Smith's 15 minutes of fame has come and gone, but the muppet crushing at Goldman is only starting to ramp up, courtesy of the man who singlehandedly has made sure Goldman's FX prop trading team should be the most profitable one in the entire universe by simply doing the opposite of what Goldman's clients do. As a reminder, sent out at 5 pm yesterday, as we alerted our Twitter followers: "Go long EUR/CAD on further risk premium compression in the EUR and a more dovish BoC... We recommend going long EUR/CAD at a current level of 1.296 with an initial target of 1.37 and a stop on a London close below 1.26." Big Oops (see chart). Then again, after Stolper epic failure to Impala the muppets on his last EURUSD trade reco, it is great to see him back to 0.000 batting form.
IBM weighed on the Dow - much to the chagrin of the mainstream media - but if they'd replaced IBM with AAPL things would have been just as ugly (if not worse). The tech-darling dumped after trying to ramp in the last hour and once again failing at VWAP on heavy volume as the big boys exited. S&P futures auctioned up to QEtc. spike levels and were unable to get through but still had a solid day. Interestingly, while today was an 'uncorrelated' day across risk assets, the rise in Treasury yields, rise in stocks, drop in Gold, and drop in USD has brought them all back together in sync post-QEtc. - from here who knows? Credit markets tracked equities generally - but HYG and LQD saw major volume spikes early on this morning (looked like HYG sells and LQD buys). VIX limped sideways most of the day - falling 0.14vols to 15.08% (though for the year remains on average at a high premium to realized). The USD is down 0.85% for the week with EUR back above 1.31 and only JPY weaker vs USD among the majors.
Economists, market analysts, journalists and investors alike are all talking about it quite openly, generally in a calm and reserved tone that suggests that - to borrow a phrase from Bill Gross – it represents the 'new normal'. Something that simply needs to be acknowledged and analyzed in the same way we e.g. analyze the supply/demand balance of the copper market. It is the new buzzword du jour: 'Financial Repression'. The term certainly sounds ominous, but it is always mentioned in an off-hand manner that seems to say: 'yes, it is bad, but what can you do? We've got to live with it.' But what does it actually mean? The simplest, most encompassing explanation is this: it describes various insidious and underhanded methods by which the State intends to rob its citizens of their wealth and income over the coming years (and perhaps even decades) above and beyond the already onerous burden of taxation and regulatory costs that is crushing them at present. One cannot possibly "print one's way to prosperity". The exact opposite is in fact true: the policy diminishes the economy's ability to generate true wealth. If anything, “we” are printing ourselves into the poorhouse.
The biggest headlines (and refutations) have been saved for the struggling nations of Europe's periphery. Top-down, this makes sense as PPP-weighted PMIs show Europe notably decoupling (badly) from the rest of the world - with periphery and eurozone-ex-periphery having resynced at these lower levels. This convergence (down) of the core with the periphery is not good news but what is more concerning is that while many investors have assumed the 'pricing' of risk assets in the periphery relative to the core is due mostly to 'contagion', there is in fact a massive fundamental divide between the core and periphery's corporate debt credit quality. With ECB's OMT apparently removing much of the systemic risk premium (though we are clear on our views of this short-term LTRO-esque reaction), the idiosyncratic risk differential between Core and Periphery credit quality is large and getting larger. It seems the need for simultaneous private and public deleveraging in the periphery - especially in Spain - is as critical as ever.
Goldman's equity strategist David Kostin has been very quiet for the past year, having not budged on his 2012 year end S&P target of 1250 since late 2011. Today, he finally released a revised forecast, one that curious still leaves the year end forecast unchanged at a level over 200 points lower in the S&P cash, and thus assuming a ~15% decline. The reason: the same fiscal cliff (which would otherwise deduct 5% in GDP growth) and debt ceiling debate we have warned will get the same market treatment as it did in August of 2011 when the only catalyst was a 15% S&P plunge and a downgrade of the US credit rating. However, one the fiscal situation is fixed, Kostin sees only upside, with a 6 month target of 1450 ("We raise our medium-term fair value estimates for the S&P 500 in response to openended quantitative easing (QE) announced by the Fed."), and a year end S&P target of 1575, calculated by applying a 13.9 multiple to the firm's EPS forecast of 114. Of course, this being bizarro Goldman Sachs it means expect a continued surge into year end, then prolonged fizzle into the new year. Why? Because there is not a snowball's chance in hell the consolidated S&P earnings can grow at this rate, especially not if the Fiscal Cliff compromise is one that does take away more than 1% of GDP thus offsetting all the "benefit" from QE. Simply said, companies who have already eliminated all the fat, and most of the muscle, and are desperate for revenue growth to generate incremental EPS increase, have not invested in CapEx at nearly the rate needed to maintain revenue growth, having dumped all the cash instead in such short-sighted initiatives as dividends and buybacks. Also, recalling that revenues are now outright declining on a year over year basis, and one can see why anyone assuming a 14% increase in earnings in one year, is merely doing all they can to make the work of their flow desk easier.
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."
With the combination of a strong quarter (week or two) for stocks, futures rolls (and CDS yesterday) and the OPEX / index re-weighting it seems we had a modest case of small doors, large crowds into the close today (S&P futures end 1pt above FOMC-day close). Volume picked up dramatically (NYSE highest in a year) as the Dow closed lower on a Friday for the first time in nine weeks! Treasuries outperformed - ending near the low yields of the week (having retraced all the post-QE move - down 10-15bps on the week) but Gold remained relatively bid ($1775) and Oil also rose in the last couple of days. VIX was unch but noisy thanks to OPEX (and remember it's still at a high premium to realized vol - not entirely complacent). Credit underperformed as risk-assets in general led stocks lower. On the quarter, Silver was the big winner (up ~26%) followed by Gold (up ~11%) both beating all the major US equity indices.
Equity markets rallied into the close (pre-OPEX and index re-weightings tomorrow) to end near their highs for the day but this was only enough to get back to practically unchanged. The Dow was the only index to manage a green close on the day-session (as AAPL dragged NASDAQ lower and the S&P couldn't get above Tuesday's or Wednesday's closing levels). With the CDS market rolling today (and indices being recomposed), we saw a somewhat unusual selling pressure into the roll - suggesting many credit longs were less than willing to roll that long into the new index (though technicals do make this uncertain). HYG underperformed. Stocks seemed to levitate back up to track Gold and the afternoon's weakness in Treasuries (unch on the day but 3-4bps higher in the afternoon) and strength in Oil dragged risk-assets more in sync with stocks (after suggesting weakness in the middle of the day).
Portuguese bond spreads have been weak all week; Spain has been bleeding in the front-end and belly of the curve; and today saw Italian bonds start to lose some gains. What is perhaps more notable is the weakness in Italian stocks (most notably banks) since the short-sale ban was lifted on Friday. FTSEMIB is down 3.5% from pre-FOMC and -5% from post-FOMC spike highs. EURUSD is back below 1.30 (and stands 1.5 sigma rich to swap-spread-implied levels). Meanwhile, Europe's VIX plummets to six-month lows as realized vol plunges - but the volatility risk premium is still high.
As Cantor's Peter Cecchini notes today "when things are this senseless, a reversion to sensibility will occur again at some point." His view is to be long vol and as the disconnect between the economic cycle and stocks continues to grow, we present three mind-numbing charts of the exuberant hopefulness that is now priced in (oh yeah, aside from AAPL actually selling some iPhones in pre-order). Whether it is earnings hockey-sticks, global growth ramps, or fiscal cliff resolutions, it seems the market can only see the silver-lining. We temper that extreme bullish view with the fact that all the monetary policy good news has to be out now - for Ben hath made it so with QEternity.
We destroyed the myth that the LTRO would not in fact stigmatize bank balance sheets when it was first introduced as the encumbrance was evident from the start - though took the market a while to comprehend and reprice (exuberant on the new-found liquidity optics). The expectations that the ECB will embark on a new scheme of sovereign debt purchases, implicitly funding governments - no matter how many times they tell us that it is to ensure transmission mechanisms flow, have three objectives or rationales, according to Goldman's Huw Pill: Easing private financing conditions through monetary expansion, Financing governments, and/or Reactivating private markets. However, there is one glaring unintended consequence of this 'aid' - the risk exists that well-intentioned sovereign debt purchases result in perverse incentives and a perpetuation of chronic fiscal and structural problems (much as Bernanke's band-aids have eased the fiscal pressure on our own government and led us further down the rabbit hole). The lack of political legitimacy and blunting of incentives for more fundamental consolidation and reform to take place can only turn the acute pain of the moment in Spain into a truly chronic problem for Europe as a whole - be careful what you wish for.