Volatility

The BTFD mantra is alive and well in a market, where futures overnight briefly dipped to a low of -0.5% only to be set to open at record high, following the biggest one day drubbing in China in months, where the Shanghai Composite closed -2.82% after new rules were issued by the Chinese banking regulator to limit the expansion and improve the transparency of so-called “wealth management products”. The products, which are marketed as higher yielding alternatives to bank deposits, are often used to fund risky projects including property developments, short-term corporate lines of credit or for speculative purchases of commodities and have been identified as contributing to the rise of shadow-banking in China’s financial system. As Deutsche reports, Fitch estimates the total amount of outstanding wealth-management products was around 13 trillion yuan at the end of last year—equal to about 15% of total banking-system deposits. Japanese equities were also weaker overnight (Nikkei –1.3%) and the yen is 0.3% firmer against the dollar after BoJ Governor Kuroda told parliament that he has no intention of buying foreign bonds because doing so could be seen as currency intervention. Finally, South Korea informally entered the currency wars after it slashed its GDP forecast from 3% to mid-2%, announcing it would use "interest rates" to boost growth, which naturally means use of monetary means and directly challenging the BOJ.

Below are portions of a comment letter submitted by R.T. Leuchtkafer to the SEC on April 16, 2010, just 3 weeks before flash crash. The second paragraph in the excerpt below, unknowingly describes exactly how the flash crash was started. The letter goes on to alert the SEC on the dangers of High Frequency Trading (HFT), phantom liquidity and other concerns.

As we previously expected, 2013 has started in a strikingly similar vein to 2012 and 2011 and we are nearing that deja-vu turning point once again. However, the extreme relative outperformance of stocks to bonds in Q1 suggests very sizable quarter-end pension-fund rebalancing flows - and perhaps today's ramp was perfectly presented to enable that into the next two days. UBS expects US defined benefit funds to do sizable Q1 quarter-end rebalancing - anticipating $29-35 billion of equity outflows and perhaps as much as $15-19 billion of fixed income inflows. Equity outflows should be dominated by domestic stocks, with $22-27 billion of large cap and $10-12 billion of small cap sales. Furthermore, reading through the recent 10K statements of large corporate pension sponsors, they note consistent, and growing, interest in liability-driven strategies and even full-blown de-risking - supporting high grade long and intermediate government and corporate bonds. Not only are the flows pointing in a similar direction but the catalysts are lining up too.

Markets are remarkably schizophrenic about where risk is flowing... and where it isn’t.  For example, ConvergEx's Nick Colas notes, the CBOE VIX Index is up from 12.3 a month ago to a close of 14.0 yesterday. And other risk assets such as Emerging Markets, U.S. Small Caps, Energy names, and developed economy international stocks all show higher 'VIXs' over the same 30 day period.  But... and it’s a big 'But'... just as many sectors/asset classes in our tracking universe show declines in their 'VIXs'.  The most pronounced are domestic Consumer Discretionary, Utilities, and Tech names as well as precious metals and High Yield Corporate bonds, where Implied Vols are 6-17% lower this month and in most cases are at/near 52 week lows.  If you are looking for spots where volatility might make a comeback, these are good places to start. This market reminds us of an old joke: Question: What do you call a person who is both ignorant and apathetic? Answer: I don’t know and I don’t care.

The developed world has now become a fully operational Something-for-Nothing society. Once a Something-for-Nothing psychology has been fully implemented the majority of its citizens have become the functional equivalent of LOCUSTS! 

Unable and unwilling (they no longer have the skills to make the wages they believe they are entitled to) to produce more than they consume and support themselves they set off the consume those that do to FEED on and SUPPORT themselves. The TAKERS or WEALTH EAT the MAKERS of WEALTH, Cannibalism of the worst sort.

The shorter FOMC preview: the green smoke rising from the Marriner Eccles building is not because a new Fed pope was picked. For the longer FOMC preview: here is Goldman Sachs...

Yesterday, at the close, the most lucrative "strategist" in the history of FX, Goldman's Tom Stolper, moments after he was closed out on his EURGBP long reco with a 2.8% loss in one week, came out with a new note, refuting his previous long-held view that in the long run the EURUSD is going much higher, specifically saying the following: "Once again we face rapidly rising uncertainty with regards to the next leg in the never-ending Eurozone crisis. Many of the features, including the unpredictability of the next headline during the final days of a bailout negotiation have been seen before, many times in fact. Short EUR positioning is not stretched yet and the EUR still looks like the natural hedge in case the situation in Europe derails more systemically. Although EUR/$ implied volatility has risen, it remains at levels that are well below those seen in past periods of stress, so options are not prohibitively expensive. The Euro has already responded and this move has pushed us beyond the stop loss in our long EUR/GBP recommendation. Moreover very near-term risks are once again skewed to the downside and a move to EUR/$ 1.25 or even lower remains entirely possible depending on the progression of the negotiations and the flow of headlines. The lack of clear majorities in the Italian parliament and the inability of the Greek government to deliver the agreed reduction in public sector payrolls all add to tactical downside risks here." We promptly took the hint and the second the note hit the tape, we advised on what is the only logical trade.

Most investors are nervous now and need to hold things together to include the Fed meeting announcement Wednesday. If bulls are lucky they’ll get their Turnaround Tuesday.  

Yi Gang, Vice Governor of the People's Bank of China (PBOC), recently made the headlines with his comments on Chinese gold reserves. On Wednesday, Mr. Yi stated that China's gold reserves remain static at 1,054 tonnes, and suggested that a sizeable increase in those reserves would be unlikely in the future. "We need to take into account both the stability of the market and gold prices," Mr. Yi stated, adding that as the world's largest gold producer and importer, China produces about 400 tonnes of gold annually, and imports an additional 500 to 600 tonnes of gold every year. "Compared with China's 3.3-trillion-U.S.-dollar foreign exchange reserves, the size of the gold market is too small," Yi said, rejecting speculation that China would further diversify its foreign reserve investments into the precious metal. "If the Chinese government were to buy too much gold, gold prices would surge, a scenario that will hurt Chinese consumers ... We can only invest about 1-2 percent of the foreign exchange reserves into gold because the market is too small," Yi stated.

Can't get enough of Cyprus? Then here is yet another post-post-mortem from Goldman's Jernej Omahen, once more trying to put some very silvery lining on this particular mushroom cloud, and providing some useful facts in the process. "As part of its rescue package, Cyprus introduced a one-off tax on deposits. This “tax” can be viewed as both (1) a depositor bail-in, and/or (2) a wealth tax. Cyprus aims to capture €5.8 bn of tax revenue in this way, which compares to the total bailout package of €10 bn. In absolute terms, the amounts are low; regardless, the market focus on potential read-across will be high, in our view. The tax on depositors is setting a precedent, which is likely to have an impact beyond the immediate term, in our view. Resilience of, in particular, retail deposits was an important element of stability during crisis peaks (e.g., Spain). Post the Cyprus precedent, however, it is reasonable to expect that the deposit volatility in stressed sovereigns could rise, for two reasons: firstly, perceived risk of deposit bail-in will have increased; secondly (independent of failing bank issues), perceiving savings as a potential tax-base – for wealth taxes – is new."

The stock market has now been up for ten straight days. Many on Wall Street are singing “Happy Days Are Here Again.” For them, that is probably the case. They finally have something to sell that will bring the rubes back into the markets. We are not in Kansas anymore. Fear is ebbing and greed is coming back. Those on the outside looking in are rounding up cash so that they don’t get left behind. The shills assist them with their pictures of economic recovery, new era crap and whatever other nonsense they can peddle successfully. So the cycle goes, as it has since the New York Stock Exchange came into existence. We are in another game of musical chairs where the music is playing joyfully. As in all such events, there are too few chairs to accommodate the participants when the music stops. And it always does!

The concept of the Great Rotation continues to garner significant investor attention. From a flow perspective, UBS'  analysis across various asset classes infers there is scant evidence of a large rotation out of corporate credit or fixed income in general. They make a few simple observations. First, that the thesis of a great rotation out of Treasury securities into corporate equities is a fallacy - the Federal Reserve and global central banks are the dominant holders of Treasuries; if they decide to sell, the money will not directly flow into equities. Second, the thesis of a great rotation out of corporate credit into equities is complicated by three main cross-currents which suggests, correctly, to them that the Great Rotation debate is much ado about nothing.

A few weeks ago we pointed out something curious: despite the so-called massive "slack" in the US economy - the traditional alibi used by Bernanke & Co. to justify ongoing endless QE, labor productivity has slumped while labor costs have soared at the fastest pace in 11 months. This is a result that is directly at odds with the assertion that the structural unemployment for the US is still at 5%, and indicates that the New Normal baseline jobless rate is more likely well above, perhaps in the mid to higher 7% range (which also means that the Fed will never voluntarily end QE as the unemployment will not drop to 6.5%, and as for inflation, well, there's BLS' Arima-X-12 goalseeker for that). While the immediate implication of this is that central planning has merely broken yet one more law, that of Okun which maps productivity to GDP, a topic we have covered in the past, there is another aspect to what lies in the future, which is the topic of Albert Edwards' letter today. In it, he observes as we do, the rising labor costs, and the inherent inflationary pressures these bring, yet his thesis is that any inflation will be short-lived, and that unlike the mainstream which is advocating for a rotation out of bonds (apparently falling on deaf ears as inflows into bond funds are once more far greater than those into equities), he is suggesting to stay invested in bonds.

A straight forward explanation of two elements of the options market and what it is suggesting about market positioning and psychology. Sometimes the options market acts as a parallel market to express views. Sometimes it acts as an insurance market. Written with the non-specialist in mind.

A 2-minute read on developments in the global capital markets. Equity markets are heavy, bonds little changed as is the dollar. Sterling is the big winner on short covering and bottom picking.