Volatility

Back on May 30 we wrote "The Second Act Of The JPM CIO Fiasco Has Arrived - Mismarking Hundreds Of Billions In Credit Default Swaps" in which we made it abundantly clear that due to the Over The Counter nature of CDS one can easily make up whatever marks one wants in order to boost the P&L impact of a given position, this is precisely  what JPM was doing in order to boost its P&L? As of moments ago this too has been proven to be the case. From a just filed very shocking 8K which takes the "Whale" saga to a whole new level. To wit: 'the recently discovered information raises questions about the integrity of the trader marks, and suggests that certain individuals may have been seeking to avoid showing the full amount of the losses being incurred in the portfolio during the first quarter. As a result, the Firm is no longer confident that the trader marks used to prepare the Firm's reported first quarter results (although within the established thresholds) reflect good faith estimates of fair value at quarter end."

With AAPL and several other strange-attracting hedge fund hotels dominating the holdings of the 2-and-20'ers, we thought it timely that Bloomberg TV would point out today that their aggregate hedge fund index is now significantly underperforming the S&P 500 (from both the top in 2007 and the lows in 2009 - in order to be fair). While the assumption is that 'sophisticated' investors are paying for alpha - and as always the focus is absolute return on the way up no matter what the mandate - it seems the extreme correlations both across asset-class and within-and-across individual equities (as we have discussed in depth - most recently here) have indeed eaten into any 'value' that has empirically been added. As The Economist notes, in June "funds suffered the largest withdrawals in assets since October 2009." Furthermore, as Citi's recent study on risk drivers shows, the high-beta momentum trade has become by far the most crowded trade around - so even sales of DB9s and NYC apartments are now entirely dependent on NEW QE coming before year-end.

Anticipating another leg-down in commodities (and mining stocks) before sufficient stress emerges in markets to force a decisive policy response - which will create an attractive buying opportunity - UBS joins our ranks of the anti-reflexive NEW QE front-running 'small-crowd'. Laying out five clear signals that keep them cautious: Equity valuations remain well above the October 2011 lows; Positioning is short in base metals and less long in oil and gold – improving this contrarian signal; China’s policy stance is not sufficiently stimulative to trigger restocking, and we see structural declines in commodity intensity there; and, Europe and emerging markets are in the early stages of destocking, with no stocking due in the US; UBS believes that investors will buy gold and gold equities early this cycle - correctly suggesting that it is right to move just ahead of the broader investor community, and buy gold and gold equities now. Clearly, buying gold early into a downturn carries greater risks and will be volatile – consequently, they advise investors wishing to go long gold and gold equities to hold a short or underweight copper and copper equity position against it. Interestingly within industrial commodities, they also like being long oil and short copper on a 3-year view.

Prepare to have your minds blown courtesy of what is easily the most astounding chart we have seen in a long, long time, prepared by the economists at the, drumroll, New York Fed, which finds that absent what the Fed calls "Pre-FOMC Announcement Drift", or the move in the S&P in the 24 hours preceding FOMC announcements, the S&P 500 would be at or below 600 points, compared to its current level over 1300. The reason for the divergence: the combined impact of cumulative returns of in the S&P on days before, of, and after FOMC announcements. But, but, fundamental, technical, coffee grinds, Finance 101, Oprah Winfrey, Jim Cramer and Econ 101 analysis (in declining order of relevance and increasing order of voodoo) all tell us this is im-po-ssible? Because if the Fed is right about the Fed induced drift, it is all about, you guessed it, easy money. 

European equities are seen firmly in the green at the North-American crossover, with outperformance noted in the peripheral bourses. Overnight news from the Eurogroup has confirmed that the EFSF/ESM rescue funds will be given the powers to intervene in the secondary bond markets, easing sentiment towards the European laggard economies. Gains are being led by a particularly strong technology sector, with the riskier financials and basic materials also making solid progress. Asset classes across the board in Europe are benefiting from risk appetite, with the Bund seen lower and both the Spanish and Italian 10-yr yields coming below their key levels of 7% and 6% respectively. The moves follow a spurt of activity in Europe with a number of factors assisting the way higher.

Netflix stocks surged more than 21% in one week primarily due to an upbeat Facebook update from the company's CEO.

Copper is sometimes referred to as "Dr. Copper," because the metal is used in so many industrial applications and is essential for many different sectors of the economy, from infrastructure to housing to consumer electronics. That usually makes its price action a good indicator of the state of the global economy. Between China's stockpiles, slowing demand, and output of copper products expected to slow; and Europe's market 'expected to be dead' for the rest of the year, Casey Research's Louis James is bearish economically near-term and bearish on Dr. Copper - preferring instead to build a shopping list of good contrarian picks for when the economic situation doesn't look so dire.

Despite BoE's Tucker telling us this morning that there is no need to look at any other market but LIBOR, it appears the world has moved on from this debacle of indication of anything. As we pointed out here, the 'stability' of LIBOR given everything going on around it is incredulous (whether due to the ECB's crappy-collateral standards-based MROs or the Fed's FX swap lines - since unsecured interbank financing is now a relic of the pre-crisis 'trust' era). Furthermore, as we discussed yesterday, the machinations of the LIBOR market and calculations (which Peter Tchir delves deeply into below) suggest that this not the act of a lone assassin suggesting quite simply that complaining or suing Barclays is redundant - any Libor-related suits (from the public or the government/regulators) must sue all the submitters or it misses the critical facts of the manipulation.

What's in the "Print" today? Not these issues.

We have long warned that the effects of a ban on 'free-market' hedging instruments could well have a negative impact on the underlying market that political leaders are 'trying' to protect (consider the fall in equity prices after the short-sale-bans) and this week brought some clarity with regard Europe's Short-Selling-Regulation (SSR) on CDS. As Citi's Matt King notes: "the technical standards underlying its short selling ban reinforce the view we held previously: the ban seems likely to add to selling pressure on cash bond spreads in peripherals, even if it brings down CDS and tightens the basis." The SSR defines 'naked' as CDS that are 'highly correlated' with long bond positions, but bonds have only tended to be quite correlated to their own CDS at periods of low volatility, and this correlation breaks down over sell-offs, which is precisely when hedging is needed most. This will leave portfolio managers unlikely to want to rely on sovereign CDS hedges (which they may now be forced to unwind at any moment) and presumably means they will be reluctant to take out initial long positions in both peripheral sovereigns and corporates in the first place - reducing demand for cash bonds. Once again - regulators and politicians should be careful what they wish for.

Steve Forbes has a message for a nation dominated by increasingly short-term decisions made on Wall Street and in Washington D.C., and by ever greater economic, financial and currency instability.  As long as America continues moving away from sound money; away from sound financial and economic policies; and, ultimately, away from freedom, its future grows more dim.  The dot-com and housing bubbles followed by the 2008 financial crisis and the most severe economic decline since the Great Depression serve as powerful lessons.  A future of bigger government, higher taxes, more burdensome regulations, less consumer choice and more unrealistic government promises requires more and more Federal Reserve play money. Steve Forbes has a quintessentially American policy prescription rooted in American history.  The answer to America’s economic problems is—and has always been—new wealth creation.  New wealth creation doesn’t come from the government or from the Federal Reserve’s printing press.  New wealth creation is what happens naturally with stable money based on the gold standard, lower taxes on individuals, a simplified tax code, reduced bureaucracy and free markets.

A 10 point rally off the lows, thanks to a well-timed Hilsenrath-rumor, dragged stocks up to their day-session opening levels (and unsurprisingly perfectly to VWAP) and while bonds/FX/spreads all limped along with stocks in the last hour, broad risk assets were not as excited by the rumors as the NASDAQ and S&P seemed to be. US equity indices are all lower from Friday's close (with NASDAQ least worst) but they remain +1.3% (S&P) to +3% (NASDAQ) from pre-EU-Summit levels. With the USD ripping higher (on EUR weakness as much as QE-hope fading) up over 2% on the week (with EURUSD -3% on the week and JPY the only 'major' stronger as carry unwinds hit), commodities plunged (growth questions and QE-less) ending the week at their lows (except for WTI - which traded lower on Monday) as Gold outperformed (down only 0.85% on the week). Treasury yields dropped 5bps or so today - leaking back higher into the close but ending the week down 7-9bps (notably less sanguine than stocks). Staples were th eonly green sector on the day as Tech lagged along with Industrials. While the Financials sector fell 0.8% (with a nasty leg down into the close), the majors did worse as MS and BofA caught-up with JPM's post-summit weakness. Most interestingly, the late-day surge in stocks (which saw decent volume and average trade size as we crossed VWAP) was accompanied by a collapse in volatility. VIX ended the day down 0.4 vols at 17.1% despite a 9pts loss in ES leaving it notably cheap relative to credit/equity fair-value.

Volumes were not that far below average today as the Dow and the S&P (but not the miraculous NASDAAPL - not that story again please!) ended the day lower after some significant intraday volatility early (around the ECB/BoE decisions and jobs/ISM data in the US). S&P 500 e-mini futures levitated off the day's early lows to stabilize around VWAP before testing up to unchanged and then losing it all into the close on heavy volume and larger average trade size. Financials were the biggest losers, as the big banks dumped off most of their EU-Summit gains (with JPM and MS down over 4% today), followed closely by Energy names - even with WTI basically treading water close to close (despite some +/-2% swings early on). USD strength saw Silver lagging on the day and gold dropped a little but rather notably since the EU-Summit, gold and the S&P have been trading more in lockstep (with Treasuries and the USD pointing to more risk-off perspectives). Elsewhere in commodity-land, corn continues its upsurge - now up 40% in the last 3 weeks. After falling off the 1.25 cliff as Draghi disappointed, EURUSD tracked sideways just under 1.2400 for the rest of the day; carry FX pairs tended to drift lower most of the day but the afternoon was quiet. Treasuries limped a little higher in yield into the close - led by the long-end - but ended the day down a few bps from Tuesday's close (with 7/10Y outperforming). Treasuries are unch from the last NFP report (as is EURUSD) while ES is 55pts higher - hhmm. VIX ended the day up almost 1 vol accelerating above 17.5% as futures dived after-hours and cross-asset class correlation remained relatively low today - though ES traded with CONTEXT - as Europe's tensions were once again shrugged off once it had closed and then remembered into the US close.

Whether gold-bug, permabull, or deflationst; BofAML provides a little something for everyone in the most complete picture guide to 'financial markets since 1800'. A collection of almost 100 charts on asset price returns, correlations, volatility, valuations and many other market and macro factors for the US, UK, Europe, Japan, and Emerging Markets.

“History does not repeat itself but it does rhyme.”
-Mark Twain

Closing in unconvinced ROn mode. European equities taking their final lead from US peers. Peripherals pushing just the last basis points tighter. Note that these curves are finally steepening through renewed short end strength with both 2-3 YRS area down 20bp on the day. On the other hand, Core EGBs have not been driven into the wall, as one could have expected in full ROn modus. German 2 / 5 / 10s about unchanged from Friday.

Tug of war between wary optimists and tired pessimists? Glass half full or empty? Dusty diamonds, anyone?

Not a highly inspirational day to write about. Reduced volatility and very range-bound. Lack of real news flow. Action more in the financial people press, as it stands. And in EUR New Issues, as borrowers have come to learn that windows of opportunity, when seeing one, should be used. Knowing, too, that new issues will grind to an end probably as of the end of next week. Hence, EUR 7.5bn senior bank debt served in 2 days. Ce qui est pris n’est plus à prendre…