Meet The New Year, Same As The Old Year

Tyler Durden's picture

Via Pete Tchir of TF Market Advisors,

Stock futures are up sharply after another week of unprecedented volatility. Although last week was relatively tame, only 13 times in the last 60 years has the S&P 500 had a down 1% day during the week between Christmas and New Year's.  We managed one of those days last week.  We also had a 1% positive day.  Futures are strong and looks like stocks will open above 1272 (where they closed on Jan. 3, 2011).

Not only does volatility remain elevated, the stories are about the same. We have some new acronyms to contend with, but ultimately the European Debt Crisis (it is both a bank and sovereign crisis) and the strength of the US economy and China's ability to manage its slowdown are the primary stories. Issues in the Mid-East remain on the fringe but threaten to elevate to something more serious with Iran flexing its muscles more and more.

So what to do?  Prepare for more headlines, more risk reversals, and more pain.

There are a few "consensus" trades that particularly scare me.  It is almost impossible to find anyone positive on European stocks or US Financials. Finding someone positive on European Financials is impossible.  Back on December 15th we started to believe that going long Europe vs short the US made sense.  Too much "decoupling" had already been priced in.  I think that trade continues to make sense.

My belief that the LTRO does reduce funding and liquidity pressure on banks could provide some support for those stocks.  I don't believe in the "carry" trade hype of LTRO but do think that between last month's LTRO and the one coming up, the liquidity concerns will diminish.  The fact that the banks are all depositing money at the ECB shows that they don't intend to use it to source new assets, but will use it to deal with debt redemptions.  This is a benefit and given how many people seem pessimistic about the banks longer term (myself included), it might be enough to spark a rally.  More surprising, to me, has been the willingness of governments to support the banks without forcing shareholders dilution. 

Governments seem willing to help banks fund and are not acquiring equity stakes (certainly not at a significant discount).  That surprises me, as I expected governments to try and actually get some value for their citizens, but it looks like they have bought into the argument (made by banks) that bank share prices equate to banks' willingness to lend.  That argument is flawed, but if the governments are willing to help the banks without charging for it, then they could continue to perform well. 

I expect JPM will have a very strong quarter. They come out on January 13th.  They had a relatively small gain due to their own credit spread widening ("DVA") in the 3rd quarter, and at the time, seemed to be conservative about releasing reserves.  I expect they will increase reserve releases to more than offset any DVA give back.  C is the next big bank to come out, but not until January 17th, so strong JPM earnings could be enough to whet investors' appetites further.  Once BAC and MS are done reporting on the 19th and 20th the shine will be off the financials.  BAC seems to be a mess and is hard to guess what will happen, but MS is likely to have a weak quarter.  They settled with MBIA this quarter, booking a big loss.  Their 5 year CDS went from 161 at the end of June, to 490 at the end of September, but is back to 415 at year end.  That should result in some significant DVA losses.  Since the CEO was so happy to take the gains back in October (as opposed to JPM which seemed almost embarrassed to book those sorts of profits), I can only hope he bought back a lot of cheap debt to lock in some of the gains.  Obviously in this headline driven world, anything can change in a moment's notice, but these points are worth considering as the year starts.

More broadly, the view seems to be that we will start the year modestly or even weak, only to rebound later in the year.  I have trouble believing that since I think Europe is not close to being resolved, that our own economy is only doing okay at best, and that China is in worse shape than the data shows.  So, if the consensus is wrong, it is that we will start more weakly than most investors believe and that we will not bounce and in fact will do even worse in the second part of the year.  That would suit my views, but wouldn't cause me enough pain.  The pain trade might be a much much much stronger start to the year.  Enough strength to make all the shorts cut and for all the underweight bulls to fully load up, only to be followed by a disastrous sell-off.  I think a move like that would cause the most pain and damage to market participants, and seems far enough away from the consensus, that although I don't really believe it could happen, it is worth thinking about.

How could such a strong rally be ignited?  Nothing is fixed, but there is such overwhelming bearishness in regards to European Stocks and all financials, that there might just be enough tinder there to ignite something.  The spark might be a continued shift by policy makers to focus on Small Enough To Manipulate ("SETM") Markets.  Clearly, pretending that they could solve Italian debt problems in the secondary market didn't work. It is just too big.  Now they are focusing on the "auctions" rather than the secondary markets.  Each auction is relatively small and relatively easy to manipulate.  Coerce some banks to participate, push some EU money at it, let dealers whisper to hedge funds how "cheap" the issue is and how much demand there is, and "voila" you have a successful auction.  Convince market data sources to reference the bonds you want them to as "benchmarks" and manipulate those.  FX rates might be hard to manipulate, but take a market like basis swaps, and manipulate the heck out of them.  Flood them with central bank money, convince banks not to play in them, and "voila" you have created another benchmark that tells a positive story.  Why are Spanish yields so much lower than Italian yields?  The one explanation that makes sense, is that the market is so much smaller, it has been easier to manipulate.  I think we will see more targeted efforts to make the markets seem healthier than they are.  They won't be that convincing, but with continued high volatility and a complete lack of liquidity they may well work for brief periods.

Credit ETF's and CDS Indices

HYG and JNK have both done well.  Although they offer a decent "spread" in this environment, the duration is low, and the convexity is fairly bad, and they are both trading well above NAV.  On HYG we are neutral, and actually prefer JNK right now because it is trading at less of a discount, and the weaker portfolio would outperform if we get a grab for yield in the underlying bonds.  HY17 actually seems a better long.  It looks relatively cheap and still has a lot of "decompression" trade shorts.  It also has some bad shorts from other markets, so am slightly more interested in being long HY17 vs either of the ETF's.

LQD is also only marginally appealing.  It is trading a bit rich to NAV and has too much rate/duration risk for my tastes.  On the other hand, I could see the financial component rallying significantly here.  On a "hedged" basis (short some treasuries against it), LQD is more appealing.  Spread compression seems more likely than outright yield performance given where treasuries are.   IG17 at 119 isn't particularly appealing.  I don't mind it, but it seems like far more IG17 shorts have been taken off than HY17 shorts.  I also believe there is a decent amount of long Main, short IG out there, on the "decoupling" theory, and that too could come under some early pressure, creating a bid for IG17.

TLT (or the other treasury ETF's).  Is this the year to finally be short? With QE and Twist and the Fed in general supporting the curve, it is hard to be short, but this asset class probably has more muzzled bears than any other credit asset out there.  After being wrong 5 years in a row (or so), most of the treasury bears seem very silent, but they are still out there, waiting for the opportunity to jump on the bandwagon.

MUB and BABS should continue to do well.  On a treasury hedged basis these are our favorite credit ETF right now.  They survived last year and look reasonably cheap.  We have started to see stories pointing out how wrong Meredith Whitney was, which could help demand as retail investors decide they won't be open to ridicule at a cocktail party if they say they are long munis.  MCDX is just too thin and not diversified enough for me to focus on at these levels.

For a fling, some longer dated (lowest price possible) Italian bonds might be worth a shot, and buying some Greek debt may be worth a short.  Italy is a bet that any degree of stabilization sees a temporary bounce in their bonds, and Greek bonds seem cheap enough to own some and see how the negotiations play out.  If banks really do agree to a 75% haircut, any bonds that didn't participate should do better.  If there is a "hard" default, and that drags in bonds held by the ECB and pension funds, then the pressure to offer a recovery of closer to 50 would be higher, and the bonds could do well.  Picking some with a coupon due in January might not be bad as you aren't paying 100% for the coupon and it seems unlikely any resolution to the Greek debt default/restructuring/haircut/comedy occurs before the end of January.

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GeneMarchbanks's picture

'There are a few "consensus" trades that particularly scare me.  It is almost impossible to find anyone positive on European stocks or US Financials. Finding someone positive on European Financials is impossible.  Back on December 15th we started to believe that going long Europe vs short the US made sense.'

Asinine. Pete, are you Nassim's turkey?

Thomas's picture

I bust my chops to write this, schmooz ZH as much as possible (major ass kiss), yet can't get my blog posted here. I'm gonna thread jump here and post it, dag nabbit!....

It's a beast but nobody has complained yet.

Oh regional Indian's picture

A beast indeed David, but awesome job. 


Oh regional Indian's picture

Hah, at least then we'd have something to be thankful for.

For those paying attention, as is usually the case, bearish language is a good precusor for bearish behaviour. if one did a Half Past Human style analysis of financial headlines, it's going to be a really tough year, where many who think they've got the game figured out are going to be slammed from the vloatility. You'd lose all your gains just going batshit crazy trying to ride, up and down. A no safe bet year.




Everybodys All American's picture

I would love for someone to present a study of how much of the US markets daily move is in the pre-market as opposed to the normal trading day or after-market. I suspect much of the total daily upward move is in the pre-market.

HarryM's picture

It's 90% premarket

As usual , the premarket fugures late last night showed the DOW down slightly - Now up 192



oogs66's picture

futures didn't open until 6am or something, so was mostly catch up from yesterdays european strength

HarryM's picture

I've been doing 1 step forward and two back since Thanksgiving

francis_sawyer's picture

"Governments seem willing to help banks fund..."

With what... Magical pixie money?

Don't worry people... We're from the government & we're here to help with our deep pockets...

youngman's picture

I also think as the average Joe investor leaves the markets.....that all that will be left is the HFT´s....and they will take it up 200 pts a day and down 200 points a day...that is how they will make their money...churn ...churn...churn....

TheHillrat's picture

This is very true. Soon retail will just buy bonds as they realize they are gettting fucked everyday. 

oogs66's picture

i was wondering, how many algo trades does every retail trade create?  for every order on a single stock, i bet it generates multiple algo trades - especially if the single stock is JPM or GS so in multiple active ETF's.

knukles's picture

The rallies will be ignited as the market realizes that each and every credit problem has been way overblown by the nefarious evil credit ratings agencies.

Ministry of Financial Truth, here we come!

And people were saying it couldn't get any more fucked up from here.

SheepDog-One's picture

Its like the dark ages, mystics and wizards and oracles direct all actions. 

fonzanoon's picture

This is so freaking stupid. The argument that the market has to go up because so many people are so negative because things are so bad is retarded. It sounds like this guy is dying to say go long but is afraid to because it is not a widely accepted thought process on this site. He has been saying for weeks that the LTRO is nowhere near enough to help the euro banks recap themselves but all of the sudden it is enough and so a rally should ignite. Whatever dude, just say you changed your mind and you are going long the market. Good luck to you.

nugjuice's picture

While you're obviously right that it's a stupid argument I've heard too much of, I think he's just attempting to figure out a rigged game. Just because the market 'should' go down doesn't mean it won't. If you're trying to make money in this rigged casino, you have to try and figure out which way the house is betting. Part of acknowledging that the system is rigged also means acknowledging that security and asset prices don't reflect reality. So if these prices don't reflect reality, you can either get out of the game or attempt to figure out what the big boys are going to do and front run their moves. Cash out before the system goes boom and convert to PM.

ThrivingAdmistCollapse's picture

You are of course correct.  The market has way more to go down yet.  This is because the government and big banks have discovered the fine art of venipuncture through inflation.  Meanwhile the rest of us are having our life blood sucked out of us.

firstdivision's picture

I have noticed that over all, the long-term trend of volume in the equites is heading south.  I do not know if this is due to the average American not having any investible assests, or more dark pool activity. 

 Also, could someone explain to me what the markets are up on...besides too many drugs, and Pavlovian pigs trying to frontrun QE3?

nugjuice's picture

My guess is underperformers chasing beta. If I had a nickel last month every time someone mentioned "Santa Claus rally" or the "January effect" I'd be Kyle Bass Jr.

Tense INDIAN's picture

nothing has changed ....SnP going to 1300 ..Reversal comes around january 10-11....looks like it is going to be a sharp down move

Tsar Pointless's picture

Isn't this the way Wall Street always wanted Wall Street to run?

Highly volatile, with inisders controlling the price (running the books, you know, like a criminal organized syndicate is run), scaring money from emotional human investors out of the market, to clear way for their printed millions and HFT bot accomplices.

The perfect union of man and machine.

And, since these people always own those who write the financial and campaign laws for this "country" we call the USofA, they control the taxing and spending authority of same.

How's that for government "of the people" and all that jazz?

Casinos work better when the house rules.

Enjoy the Iowa caucuses, bitchez!

The Deleuzian's picture

I've watched (& participated) in the markets fairly consistently since around 02'...I can honestly say that I have no idea where the markets will be in 2012...Let alone 2 weeks from now...Nothing surprises me anymore!!! 

SheepDog-One's picture

Yes, just like last January, we'll sit here and examine each article and watch 'market reactions' and by next Dec 30, probably be lucky to be break-even again.

The Deleuzian's picture

SheepDog...Have you ever seen a more difficult market?  Fundamentals no longer matter...Technicals no longer really work...What should go up goes down and vice-versa...I would have never guessed the HUI below 500 at year end...

Hansel's picture

The S&P is at 1270, not 800.  I'd say there are plenty of bulls.  JPM has a market cap of $126 billion, Citi $76 billion, WFC $145 billion.  There are plenty of financial bulls.

Cdad's picture

...and the "horse fixers" are in on BAC this morning.  Completely absurd prints there.  Picture perfect HFT action.

maxw3st's picture

I agree the LTRO operation will stabilize things in the short run. However; it should soon become apparent to the market that LTRO is just another name for quantitative easing in the Euro-zone. Technically, this is a good thing. The Euro is grossly oversold at the moment, and needs a correction to at least the 1.3388 area. A 50% correction puts it at 1.3552. Sentiment has clearly changed, finally, but the last corrective phase saw the Euro retrace 78.6% of the first leg down from 1.45+.

In short, IMHO, the Euro should retrace 38.2% as an LTRO relief rally sets in. It may make it as far as 1.3552 before the reality of QE devaluation sets in and we continue, on trend, down towards 1.25 (on the way to 1.15-1.20 later in the year).

oogs66's picture

Euro has biggest short interest ever?  Will be watching that euro retracement, doesn't make "fundamental" sense, but could easily see it occuring

spastic_colon's picture

today should be no surprise with the euro indexes all up over two days........and over the last 22 or so election year markets, the US indexes have only had approx. 4 down years, not that I don't agree that it should but the probabilities of a down 2012 are slim regardless of the intra-year volatility, just use it wisely.

PS - dont be surprised to see a 2 1/2 to 3% day today especially again in the last 30 minutes

lotsoffun's picture

absolutely up 3% today by end of the day.  last 30 minute ramp huge.  nobody wants to miss out.

this is interesting and related:

not that nobody didn't know this.  it really is amazing how people like madoff become head of the nasdaq, or jon corzine.

Caviar Emptor's picture

New year-old year: all part of The Japanification Plan. Non-stop series of monetary easing, stealth and overt QE, stimulus, balance sheet expansion....and in the end: monstrous debt to GDP with biflation which in plain English means: wounded, contracting real economy with a prosperous banking sector. That's the plan