Risk Premium

The much anticipated Goldman Sachs list of "Top Trades Recommendations for 2012" is out... And the squid is bearish. Which is bad news, as if there is one thing one does not want is to be aligned with Goldman's salesforce. Let's dig in.

Pimco's Greg Sharenow has released a white paper on what the Newport Beach company believes are the 4 possible outcomes should Iranian nuclear facilities be struck as increasingly more believe will happen given enough time. The conclusion is sensible enough "Whenever the global economy is in a fragile state, as it is today, geopolitical concerns such as the possibility of a strike on Iran’s nuclear facilities become much more exaggerated. Although we cannot (and will not) predict whether an attack is imminent, or even likely, our experience and research tells us that any major disruption in the supply of oil from Iran could have either subtle or profound global repercussions – especially as excess capacity is virtually exhausted and we doubt that other OPEC nations would be able to compensate for a reduction in Iranian oil production." As for those looking for numbers associated with the 4 scenarios presented by PIMCO here they are: "i) Scenario 1: Exports minimally effected. Concerns would drive initial price response; Oil could spike initially to $130 to $140 per barrel and then settle in a higher range, around $120 to $125; ii) Scenario 2: Iranian exports cut off for one month. In this case, we would expect prices could reach previous all-time highs of $145/bbl or even higher depending on issues with shipping; iii) Scenario 3: Iranian exports are lost for half a year. We think oil prices could probably rally and average $150 for the six months, with notable spikes above that level; iv) Scenario 4: Greater loss of production from around the region, either through subsequent Iranian response or due to lack of ability to move oil through Straits of Hormuz. This is the Armageddon scenario in which oil prices could soar, significantly constraining global growth. Forecasting prices in the prior scenarios is dangerous enough. So, we won’t even begin to forecast a cap or target price in this final Doomsday scenario." Needless to say, even the modest Scenario 1 is enough to collapse global economic growth by several percentage points to the point where not even coordinated global printing will do much.

Dick Comes Clean A Week After I Did Him Dirty...

Risk markets are losing their patience.  The Eurozone situation is approaching a major climax.  This is by far the most important story to follow in the coming days and weeks.  U.S. Economic data has been quite encouraging and the economy remains muddling along.  If Europe took care of business quickly, global stock markets would rally sharply.  The S&P 500 could possibly make a run at the bull market highs. Unfortunately, there is a major ongoing political crisis in the region.  There are 3 options. Still, a Eurozone blowup would undoubtably sink the U.S. recovery.  The ball's in Europe's court and they need to take action.  If they act now, it may still be on time to avert a Chinese hard-landing.  The bulls would end up as winners and risk assets would make a comeback.  It has really all come down to this binary variable in the short-term.  Government officials wanted Globalization, well they've got it.

Financial contagion in Europe is pushing already fragile global economies towards recessions, and the risk of slipping into global recession are rising significantly. Indeed, as we have warned for many months, there is a real risk of a global Depression given the scale of the debt levels in most western countries and the massive imbalances globally. A senior Chinese official, Chinese Vice Premier Wang, said yesterday that a ‘chronic’ long term global recession is certain to happen and China must focus on domestic problems. While all the focus has been on Europe in recent weeks, markets may again focus on the not inconsequential matter of the appalling US fiscal position which could see further market volatility and the dollar come under pressure again. Washington's latest fractious effort to come to grips with its mounting debt looks set to end in failure today as negotiators look set to announce they have failed to reach a deal. The Congressional ‘supercommittee ‘charged with cutting the US government's crushing $15 trillion debt looks set to admit failure which should support gold. SPDR Gold Trust, the world's largest gold-backed exchange-traded fund, reported a rise of 3.631 tons from a day earlier to 1,293.088 tons in its holdings, the highest in more than three months. The ETF witnessed an inflow of 24.422 tons last week, the biggest one-week rise in holdings since mid-August. Commerzbank say they expect to see gold trading at $1,800/oz by the end of the year. Barclays says it is sticking with a fairly bullish call for gold and says it sees the price at $1,875/oz in Q4, according to Reuters. Deutsche Bank say they expect periods of risk aversion to remain through 2012 and their strongest conviction trade remains long precious metals and specifically gold, according to Reuters.

While at a glance this may seem like a straightforward question with a simple and obvious answer, troubled Italian bank UniCredit has released a ponderous article comparing and contrasting the two heavily indebted, politically challenged, and growth-retarded nations. Comparing debt-to-GDP ratios and trajectories, GDP growth, and unemployment (as well as funding needs), the answer actually becomes a little less obvious and boils down to the central bank (as does every trading decision in the world currently). Furthermore, their (admittedly biased) perspective leaves one wondering whether to invest in a country that hopes things will miraculously improve on its own, or in a country that has realized that reforms are needed and that has shown the willingness to take the painful steps in the right direction? Or c) none of the above.

Time to sell the EURUSD with both hands and feet, not to mention with MF Global-type leverage: that uber-contrarian FX indicator, Goldman's Thomas Stolper, who has not had a notable call correct in the past 2 years, just came out with a long EURUSD call, calling for a 1.40 target and a 1.35 stop loss. Yes, this means Goldman is now selling EURUSD until 1.40 and will begin buying it at 1.35. As a reminder here is how Stolper's last EUR/$ recommendation ended.

"We are all FX traders these days" - that is what we said yesterday, and unfortunately courtesy of record risk correlations to the EURUSD persisting, this is what will likely be the case until the end of the year and into 2012. As such, fundamentals go out of the window, and the only thing that matters is beta and the various FX pairs, with the EURUSD by far the most critical. Which brings us to what Goldman believes will be the key highlights in FX trading until the end of the year in 9 convenient bullets. As a word of caution: few have ever made money being across the table from Goldman; usually it is much wiser to be axed the same way Goldman's flow desk is position, i.e., doing the opposite of what the firm advises its clients.

Goldman's Francesco Garzarelli has just released a follow up to the "next steps" piece from yesterday (which so far has been woefully wrong in predicting a ceiling to Italian spread). So perhaps this time Goldman will be a little more accurate, which for those who may be buying Italian bunds on the dead cat bounce, will not be a good thing. Here's why: " Should Italian BTPs trade above 450bp relative to AAA-rated EMU sovereigns over a period of time, the initial margin would increase by a further 10%. Currently, the initial margin for repo on Italian securities on LCH ranges between around 4% and 20%, increasing along the maturity structure." The take away from the above - another 10% margin hike is coming. As for those who bought Italian bonds from Goldman yesterday on hope that the bottom is in, better luck next time - as Goldman says "In the meantime, the higher priced Italian government bonds will continue to be sold, as commercial banks raise liquidity buffers as higher margin requirements are applied. On our central case, intermediate to long-end bonds should continue to be supported relative to AAA-rated securities by the ECB." Considering the 5s10s is most inverted since 1994, this is not a very controversial call.

Some much needed clarity from the people who run Europe's printers. And, just as in the case of Credit Suisse, Goldman is desperately pushing for Italy to avoid precisely the outcome that Berlusconi has said is coming, namely early elections: "These could be held in mid-January at the earliest, although they would most likely be postponed until the Spring amid market turmoil. This would represent the worst scenario for markets, in our view. Since President Napolitano is aware of this, he will probably try to resist dissolving Parliament at this juncture. Also, most centrist parties would want to change the electoral law before a new vote takes place. All these scenarios will take some time to play out, a couple of weeks at least. In the meantime, the higher priced Italian government bonds will continue to be sold, as gradually higher margin requirements are applied. On our central case, intermediate to long-end bonds should continue to be supported relative to AAA-rated securities by the ECB."

Three of the smartest strategists at Goldman, Huw Pill, Francesco Garzarelli, and Peter Oppenheimer, have released what one could tentatively call a white paper on the "next steps" for Europe. Far from being the traditional permabullish sellside drivel, this is a must read note, as it cleanly lays out the risks for the Eurozone from this point. The note focuses on three key aces: 1) fiscal consolidation and the ongoing role of the ECB in the future of a Eurozone which still has no fiscal cohesion (which makes sense: just like in the US, the Fed is aggressively putting the ball in Congress' court, as neither the monetary nor fiscal apparatus has any interest in being blamed for ongoing economic deterioration, so in Europe the ECB wants a federal union, complete with Eurobond issuance powers, so it is not in the cross hairs: alas, European politicians realize this is career suicide and the question remains: when push comes to shove, and saving the Euro requires career harakiri from politicians, will they step up to the plate?); 2) Italy, of course, as the country under the spotlight now and going forward; and 3) what the above two mean for BTPs and thus the European (and Global) equity markets. The sense we get from the Goldman trio is that while the company which has just spawned Europe's latest central banking head, while cautiously neutral is pushing for a downside case: after all what better way to unlock the Heidelberger Druckmaschinen true potential, than with a full blown crisis...

In addition to the unknown factors impacting the European “solution”, next week the Federal Reserve will have their regular FOMC meeting and statement.

While only the market, and no one else, seems to have a grasp on the unknown unknowns in the Eurozone crisis, and has voted two toes up, despite really having no clue what is coming for Europe, here is a report from Exclusive-Analysis that summarizes the known unknowns, and comes up with a bleak conclusion: "We remain very doubtful that the relative optimism that has followed the EU summit will last. Last time, the 10th of October, following a Berlusconi announcement of austerity in the previous week, it took markets only a few days to distinguish between the detail of what was agreed and the more optimistic  principles that were announced." So as everyone scrambles to figure out what is still missing from European bailout plan, perhaps focus on what is already present, because if that is any indication, the Thursday rally is nothing but yet another confirmation of just how broken the market as a discounting mechanism truly is.

Yesterday the short squeeze in the EURUSD brought the pair to within pips of Citigroup's revised stop loss of 1.4260 even as it got even more bearish on the European currency, setting a new target of 1.3150. Today the bank's FX strategists continue their onslaught, stating in a note that wonders how long the Euro-love will last that "The post-summit EUR rally is driven by a continuing squeeze in short risk positions and unwinding of worst fears of financial contagion, rather than improvement in cyclical fundamentals." Here are their full thoughts on why the time to short the pair, and thus the entire EURUSD-driven market, lower.

For some reason, investors' goldfish-like brains forget every quarter that time and again around 70% of names beat expectations and this fact is used as reason to buy buy buy. Certainly this time around, earnings beats are well within historical norms and furthermore are simply beating significantly lowered expectations. However, that is backward-looking and no matter what metric you use for valuation, the only one that really counts is how expectations are priced into the market. With regard to this, 12Month forward EPS expectations have started to roll-over quite significantly for the S&P 500 (at around a -8.5% annualized clip) - the last time we saw this was Q4 2007 and we know how well that ended.