Smart Money

Just trying to make a buck...

As the mainstream media finally made a big story out of capital flows after ignoring the topic with impunity for 33 straight weeks (of $90 billion worth of outflows), the question many ask themselves is whether last week's minimal inflow into domestic equity funds is indicative of a shift in risk sentiment, and more specifically whether the outflows in bonds will if not accelerate, then at least remain at their current elevated levels. Probably the best answer to that will come from looking at not only the price action of the most liquid rate instrument, the 10 Year, but the actual net money flows for all UST contracts. While the first can be done with any charting program, the second is slightly more complex and for that we go to Credit Suisse's Carl Lentz and Eric von Nostrand.

It is inevitable that when you have a market run up like we have had recently driven mostly by liquidity and the Santa Claus Rally, many stocks would see pullbacks in the New Year. These are just five of such candidates that I believe capable of some meaningful downside risk.

China has been ranked as the top growing country among the G20 since 2001 and is expected to retain that title for at least another five years. However, the news coming out of China for the past three months has not been good.

One of the more peculiar observations we noted in our analysis of the Fed's balance sheet yesterday, was that in the week just ended, reserves held by banks with the Federal Reserve dropped by a very material $64.2 billion even as the Fed ended up buying a net of $4 billion in securities: a $68 billion mismatch between an increase in reserves and Fed asset increases. A quick look at how this mismatch has progressed since the announcement of QE Lite (and QE 2) demonstrates this phenomenon very distinctly: while during the QE Lite phase, net holdings of the Fed were flat, bank reserves, which should have followed suit in fact declined notably, by almost $40 billion. Yet it is during the POMO phase of QE 2 that this difference become glaring. During a period when the Fed added a total of $88 billion (net of MBS paydowns) in securities, reserves increased by only $14 billion. This does not include the cumulative differential since QE Lite. And all this came to a head in the just ended week, when the difference between cumulative asset purchases and reserve changes hit a whopping $138 billion. This is very disturbing for a variety of reasons, the number of which is that, as Jim Bianco points out, banks are rapidly exchange securities with higher reserve requirements for those with lower: the net result is a far slower increase in reserves held with the Fed. It also means that banks ever since QE Lite have been stealthily offloading lower quality fixed income products to the market and replacing these with Treasuries (motivation being unclear but likely having to do with presenting a better capitalized state). If true, this would mean that during the entire orchestrated HY bond rally sine August, those who have been buying are in fact the greatest suckers, and have been buying hundreds of billions worth of lower quality paper from none other than the allegedly smart money banks. Alternatively, what this means, is that instead of opening up capacity for banks to bid up riskier corporates and thus stimulate the economy, banks are forced to gobble up the toxic treasuries, that the Treasury puts upon them each and every week. Should this divergent trend persist, we would be very mindful of obtaining verification of either of these two hypotheses.

The fundamentals behind the gold trade are generally understood on a very superficial level. $3000 gold will have very little to do with inflation. It will have little to do with the economy being "bad"- we have had recessions with collapsing gold prices. In many ways we are talking about something far more menacing. We are talking about capital running for cover. We are talking about unprecedented skepticism towards government. We are talking about the long overdue self-destruction of a system that magnifies the folly of man.

In his December letter to investors, Niels Jensen from Absolute Return Partners has issued his twelve key risk factors for the global economy for 2012. "In the following I list a number of risk factors which I believe investors should give serious consideration, but I do not for one second pretend for that list to be exhaustive. Neither should you read anything into the order of which those risk factors are listed. If you want my assessment of how to rank the various factors, you need to take a look at the risk scatter chart at the end of the letter." As always, an entertaining read, and as Jensen is a rather indicative example of the smart money, readers can determine for themselves what it is that keeps the hedge fund community up at night (aside from worries that the Feds will bust their door in any minute).

One of the sad side-effects of taking away investment risk, as Ben Bernanke has done with his "global put" doctrine, is that the old maxim of the market staying irrational far longer than anyone can possible imagine, can now be exponented to some irrational infinite number (to throw some wacky number theory into the equation). Whether Bernanke can also succeed in defying nature and mathematics in broad terms remains to be seen: we have yet to see a system that can diverge from equilibrium in perpetuity without some very unfortunate unanticipated side-effects somewhere. Yet with the bulk of day-trading systems now primed to do nothing but chase momentum, this divergence could lead to unseen previously deviations. We are confident that while printing a reserve currency (whose reserve status is rapidly diminishing) is one prerogative that Ben has, changing the laws of thermodynamics is one field where Bernanke will fail. Nonetheless, in its attempt to destroy all bears, only to be followed by the annihilation of all bulls (as the TBTFs pocket all the margins, and capital gains) the market continues to be nothing less than a casino primed with far greater house odds than even the worst slot machines in Atlatnic City. And just like in AC, accrued profits are not real, until taken. And if taken one second too late, they merely become deferred losses. That said, we would like to present some very factual representations to just what extreme level the market has been overbought in this latest year end push to make hedge fund managers richer (who are the only ones who get to be paid at year end without booking profits, of course assuming they beat the S&P, which means about 33% of them). Courtesy of www.sentimentrader.com we can observe just how irrational the market has become... As to how much longer it can sustain this, feel free to address your questions to the Chairman.

Yet another odd letter comes from under Bill Gross' pen, in which he continues to bash "The Ben Bernank's" Ponzi policies ("policymakers at the Fed write trillions of dollars’ worth of checks under the guise of quantitative easing, a policy which takes Charles Ponzi one step further by purchasing the government’s own paper in a last gasp effort to support asset prices") while making it all too clear that the only beneficiaries are "Newport Beach mega-millionaires." Has Warren Buffet-style self-flagellation become trendy among the billionaire jet set? Lastly, Gross makes it clear that the American economy is doomed in the long-run absent a "policy revolution" in DC: "Unless developed economies learn to compete the old-fashioned way – by making more goods and making them better – the smart money will continue to move offshore to Asia, Brazil and other developing economies, both in asset and in currency space. The United States in short, needs to make things not paper, but that is not likely unless we see a policy revolution in Washington DC. In the meantime, our unemployed will continue to fill out forms and stand in line." And the Newport-beach mega-millionaires will continue to front-run the Fed. Nothing ever changes indeed.

While this data point is of interest, I would always ask the question: why use something if it doesn't work?

D'oh!

Zero Hedge readers already know that in the latest week the insider selling to buying ratio hit unprecedented levels. Obviously, corporate officers and insiders have decided to take advantage of the artificial wealth effect and bail, especially since it is still unclear whether capital gains taxes will be the same in the following year. However, it is not only insiders who see between the lines. As the following charts demonstrate, the smart money is now either bailing from the stock market in droves or hedging for a market crash like never before...

The fallout from Ambac's bankruptcy is not necessarily what many may think. The robo-signing plaintiffs and associated lawsuits will now get to see what happens when the spurned money of the big boys joins the fray!

Did CPPIB just overtake the Caisse as Canada's largest pension fund?

The Commitment of Traders Report is created by the CFTC – The Commodity Futures Trading Commission and is published weekly every Friday. This body gathers and publishes the open futures positions on all publicly traded US futures contracts as well as the corresponding options. The data consists of 3 main categories.