Volatility

The business cycle ought to be thought of as a series of discrete phases, each one quite distinct from the other, rather than as a smooth and uninterrupted process through time. This is how Goldman Sachs describes what is a compelling view of the dynamics of macro acceleration-and-deceleration and expansion-and-contraction and how these separate phases of their so-called 'swirlogram' can be mapped into asset class performance. This means that unlike traditional business cycle momentum jockeys and the extrapolating 'rulers' of the world, trade positioning should depend not only on the current state of the cycle but also on the near-term phase transition. As the cycle turns, so do assets; economic acceleration serves as an early indicator of looming shifts. Hence, vigilance in monitoring the business cycle with an eye towards identifying cyclical turning points is instrumental to a disciplined investment process. These lessons are timely too. Back in March, the business cycle peaked. The GLI shifted from the Expansion phase to the Slowdown phase; growth remained positive but acceleration turned negative. More ominously, April GLI growth was quite modest, with downward revisions to the last few months of data too. If the current downbeat data trajectory is extended, current GLI readings may prove to be overly optimistic. And should acceleration remains negative (which today's Philly Fed will drive), there is not much of a growth buffer to prevent the cycle from slipping into the Contraction phase, where the message for asset markets is clear and sobering.

With CDX and credit indices being such a topic of conversation, we took a look at the 1 month changes as of May 12th.  We selected U.S. and European Credit Indices that had NET position changes of $1 billion during that 4 week period.  We also included some with smaller changes where it made sense to me as either part of “normal” roll flows or the now legendary “whale” trade. The overall reduction in HY and XOVER is interesting.  Also, even in financials, the riskier sub index experienced a net decrease.  I’m not sure what it means.  Complacency?  Increased volatility forcing smaller position sizes?  JPM cutting HY short and shorting IG18 against IG9? The off-the-run data is a bit more interesting, especially in light of all the “whale” questions. IG9 tranche net actually increased in the period, though outright index dropped off.  Is that a sign that it was hard to get out of tranches? IG9 with that special place in everyone’s heart, does seem strange. It looks like positions in European indices got reduced pretty dramatically. In any case, all these products need to be moved to an exchange.  Look at the huge differential between the gross and the net?  That would go down.  Yes, banks would have to unwind offsetting trades, but who cares?  Banks would have to post collateral, possibly on longs and shorts, but again who cares?

Currently, there is massive negativity surrounding gold and silver and in particular, gold and silver mining stocks. At times like this, when gold and silver have taken a fairly brutal hit in a condensed period of time thanks to low daily trading volumes both in PM futures and PM stock markets that make it very easy for the banking cartel to manipulate them, it can be difficult not to sell out of everything and run for the hills if one allows emotions to dictate one’s decisions (always a bad move).

The World Gold Council has released the Q1 2012 Gold Demands Trend report. Gold demand grew 16% over the past 12 months to 1,098 tonnes. This had a US dollar value of just $59.7 billion spent on gold, globally, in Q1 2012. While global demand was down 5% from the record high of Q4 2011, it was significantly higher than demand in Q1 2011 suggesting that global demand may be consolidating at these higher levels.  Probably the most important aspect of demand and one of the most important fundamentals in the gold market is that of still very robust and increasing Chinese demand. In this the Chinese Year of the Dragon – China is becoming a fundamental driver of the gold market. Global demand was boosted by China posting a quarterly record of 98.6 tonnes of investment demand up 13% from Q1 2011. This increase was a result of investors’ continued move to preserve wealth amid ongoing concerns over inflation, volatility in equity markets and price falls in some property markets. Jewellery demand in China, much of which is also store of wealth demand, increased to 156.6 tonnes – 30% of the global appetite.  This increase places China as the largest jewellery market for the third consecutive quarter.

To all Dividend funds who bought AAPL on hope the Dividend would lead them to untold future riches and a perpetual stream of cash we have some bad news: since the March dividend announcement (of $2.65/qtr) you have already forfeited 5.66 years of dividend payments in the form of capital losses. Because what so many forget is that stock dividends also have another side: capital gains. Or in this case losses.

So nobody can say, "But no one could have seen this coming", I'm letting all know what's coming.

All you need to read.

European bourses are trading in modest positive territory ahead of the US open with early trade seeing moves higher across equities as Germany printed an expectation-beating 0.5% growth in their flash Q1 GDP. Elsewhere, Eurozone growth surprised to the upside somewhat, coming in flat against the expected contraction of 0.2%. However, as time passed, Greece garnered the focus of markets once more as they face a EUR 435mln foreign-law bond redemption today. Government source comments have somewhat reassured markets that the payment will be made, but participants await official confirmation. Further assisting the moves off the highs was a lower-than expected ZEW survey from Germany, with economists noting that the French and German elections have knocked confidence in the country over the past month.

Many pixels have been 'spilled' trying to comprehend what exactly JPMorgan were up to, where they are now, and what the response will likely end up becoming. Our note from last week appears, given the mainstream media's 'similar' notes after it, to have struck a nerve with many as both sensible and fitting with the facts (and is well worth a read) but we have been asked again and again for a simplification. So here is our attempt, in 22 simple tweets (or sentences less than 140 characters in length) to describe what the smartest people in the room did and in possibly the most incredible irony ever, how the Fed (and the Central Banks of the world) were likely responsible for it all going pear-shaped for Bruno and Ina. The key factor is that if systemic risk had remained in even a 'normal' range of possible regions based on history, then the JPM CIO office would have had no need to over-hedge their tail-risk hedge position, no greed-driven need to press the momentum, and no need for such an epic collapse as we are seeing now. The point is - this was a trader/manager with a good idea (hedge tail risk) that was executed poorly (and with arrogance) but exaggerated by the unintended consequences of the Central-Banks-of-the-world's actions (and 'models behaving badly' as Derman would say).

"One of my favourite comedians, Eddie Izzard, has a rebuttal that I find most compelling. He points out that “Guns don’t kill people; people kill people, but so do monkeys if you give them guns.” This is akin to my view of financial models. Give a monkey a value at risk (VaR) model or the capital asset pricing model (CAPM) and you’ve got a potential financial disaster on your hands." - James Montier, May 6

All you need to read and some more.

Update: now S&P is also one month behind Egan Jones: JPMorgan Chase & Co. Outlook to Negative From Stable by S&P. Only NRSRO in pristinely good standing is Moodys, and then the $2.1 billion margin call will be complete.

So it begins, even as it explains why the Dimon announcement was on Thursday - why to give the rating agencies the benefit of the Friday 5 o'clock bomb of course:

• JPMorgan Cut by Fitch to A+/F1; L-T IDR on Watch Negative

What was the one notch collateral call again? And when is the Morgan Stanley 3 notch cut coming? Ah yes:

So... another $2.1 billion just got Corzined? Little by little, these are adding up.

It would seem, just as during the crisis in 2008/9, that now might be an opportune time to push for 'improvement' in how banks are regulated (and more importantly how the instruments they trade in colossal size are priced and marked-to-market). Rick Santelli believes now has never been a better time but as his guest Tim Backshall of Capital Context notes, regulation of the CDS market can be summed up in one sentence "Get Them On Exchange". Something we have been saying for years (and has been tried before) but with dealers holding all the keys (to market-making) and exchanges cowering for fear of losing clients, we remain less optimistic. Santelli and Backshall critically address the complicity of banks, regulators, analysts, and The Fed in giving 'banks the benefit of the doubt' with regard their use of the bottomless pit of capital they implicitly have but what is more important is for the hordes of sell-side analysts and buy-side sheeple to understand just what this JPM debacle exposes about bank risk (VaR is useless), bank transparency (mark-to-model or worse is widespread), and bank valuation (traditional Price/Book metrics have no merit anymore).

• China Industrial Output Growth Slows Sharply In April (WSJ)
• Indian industrial output shrinks unexpectedly (AFP)
• China’s Inflation Moderates, Adding Room for Easing (Bloomberg)... a nickel for every "imminent RRR-cut" prediction
• Drew Built 30-Year JPMorgan Career Embracing Risk (Bloomberg)
• Spain Offered Time to Curb Deficit (FT)
• France Entrepreneurs Flee From Hollande Wealth Rejection (BBG)
• Venizelos Eyes Unity Deal After Agreement With Democratic Left (Ekathimerini)
• Berlin Reaches Out to the Periphery (FT)
• Bernanke Speaks About Risks From End of Pro-Growth Plans (Bloomberg)

There are a lot of moving parts in the Dismal tale of Dimon's demise... Iksil' large size in the market left a mark that hedge funds tried to fix - that was his index trading was making the index extremely rich (expensive) relative to intrinsics (fair-value). That is where the media picked up the story and as we detail below leads us to today. Attempts to hedge his over-hedged positions and/or unwind them impacted the market too much and we suspect created the need for today's admission of guilt. And so, we find ourselves with - net CDS/CDO notionals remain huge (and implicitly on JPM's shoulders), his very recent lack of selling has left the credit index maybe 20bps rich to where it might trade given its rough correlation with the S&P 500 and this would imply at least $3bn of losses already in addition at fair-value. Of course, the situation is far worse because 1) any efforts to unwind such a huge position will lead to the market yawning wide and swallowing him in illiquid bid-ask spreads; and 2) the rest of the world knows their position - so why would the hedge funds not push their position. Note, it is not the instrument that caused this - it is the trader as "you don't hedge risk when you bet on momentum continuing you idiot!"