Equity Markets

Here is what happened in Europe overnight, and why the market sentiment is already negative in advance of an NFP number which many are watching closely as a miss of expectations will cement the thesis that the US economy has now rolled over and will likely need more nominally dilutive aid from central planners to regain its upward slope:

• Spain Services PMI for April 42.1 – lower than expected. Consensus 45.4. Previous 46.3.
• Italian Services PMI for April 42.3 – lower than expected. Consensus 43.7. Previous 44.3.
• France Services PMI for April 45.2 – lower than expected. Consensus 46.4. Previous 46.4.
• Germany Service PMI for April 52.2 – lower than expected. Consensus 52.6. Previous 52.6.
• Euro-area Service PMI for April 46.9 – lower than expected. Consensus 47.9. Previous 47.9.

And while the data was bad enough to send European stocks and US stock futures lower, the latest meme spreading as the first US traders walk in, is one of reNEWed QE expectations already, if a very weak one for now.

Here is what Wall Street expects will be announced at 8:30 am Eastern today:

And while as usual the actual number will be largely meaningless, and is merely an indication of our headline chasing nature since as the BLS itself says the error interval is +/- 100,000, a few hnndred purely statistical jobs will make or break the market and send it soaring on either "virtuous circle" expectations, or on NEW QE coming back with a bang.

There are two forthcoming dates which will set the direction and strength of the tide and certainly have a marked affect upon the ventures. They are this Sunday, May 6, when both the French and Greek populace will decide on who is running their government and then on May 31 when the Irish have their refrendum. At the least one must be thankful that there are Democracies that are working and that no group of Generals or some thug is making the decisions. Forthcoming we visualize many Socialist demands such as Eurobonds being made and Germany standing alone in the corner and refusing to fund which will make for all kinds of volatile markets. The bigger crisis though, we fear, will be when Germany says no to funding some grand Socialist idea. The problem is the size of the economy. The German economy is 25% of the American economy and it is going to get down to a matter of capital and what Germany can afford without being downgraded and a European Union without a AAA rated Germany is a very different affair both for the EU’s debt structure and for the Euro. In June the Fed’s Operation Twist comes to an end. There is no new stimulus plan on the table in either America or in Europe now. This means that the last four years of monetary easing and living off of that which has been printed is coming to an end. The consequences of this, historically, have been declines in the equity markets.

Welcome to another morning which saw weak news out of Asia (Chinese Services PMI declining to lowest level since January), weak news out of the UK (Services PMI down to 53.3 from 55.3 previously), and weak news out of Europe where a Spanish auction once again paid well into the unsustainable levels to give the market the illusion that it is well funded. Completing the picture is the ECB which announced that yesterday banks deposited for the first time since early March a total over €800 billion (primarily as Northern European banks see their holdings of Southern paper mature and not get rolled over), or €803 billion to be precise, a €14 billion increase overnight, as one can make the argument that liquidity is once again starting to freeze up. However, despite all the ugly news, US futures are of course up, with the only question the headline scanning algos care about is whether initial claims will once again miss the consensus of 380K solidly (thus making sure tomorrow's NFP print is QE enabling). Our guess it that last week's print of 388K is revised as usual upward, into the low 390K region, with the number missing Wall Street forecast but posting a "decline" from last week's revised number. After all this scheme has worked for so long, why end now?

In the early hours of the European session, continental markets opened higher, reacting to yesterday’s positive performance in the US. Sentiment quickly turned as continental Europe released its respective Manufacturing PMI figures, with even the core European nations recording declines in the sector and lower-than-expected readings. Despite the poor data, some major cash markets are clinging on to positive territory, as the CAC and DAX indices both trade higher. The Spanish and Italian markets, however, tell a different story. With both their respective PMIs recording significant declines, both now trade lower by around 2% apiece. Against the flow of bad Eurozone news, the UK has released an expectation-beating Construction PMI figure, going somewhat against last week’s breakdown of the official GDP statistics. Markit research cites strength in commercial work and new orders as the main driver for the growth. The downbeat data from Europe has taken its toll on EUR/USD, currently trading lower by over 90 pips, but the pair has come off the lows in recent trade. GBP/USD has mirrored the moves in the EUR and trades lower by over 40 pips, however some support has been gained from the strong Construction PMI.

For those who follow the overnight session and know very well that the only factor there is whether Europe is open or closed (like yesterday), we have three words: Europe was open. As BofA summarizes: "Yesterday's stronger than expected ISM manufacturing sparked a solid rally in the S&P 500. Around mid-day the index was up about 1.2%; however, the markets slowly faded throughout the rest of the day ending up 0.6%. Our equity strategy team things that the S&P is roughly at its fair value given the macroeconomic backdrop and the continued troubles in the Euro area." It is hardly rocket science that Europe will continue to drag on the world. The only question is how long before this nexus of global trade drags everyone else down, because as hard as they try the US and the BRICs simply can not pull away from the tractor beam of the European black hole.

While cycle or wave analysis is often dismissed for its tough-to-utilize-going-forward nature, Charles Hugh-Smith and Gordon T. Long expertly and thoroughly discuss a myriad of critical processes that the world (and endogenously or exogenously human beings and markets) transitions through in this clip. The intersection of Hugh-Smith's four critical trends (generational (or Fourth Turning), wage-inflation/stagnation, credit expansion/contraction, and energy extraction/depletion) is where we find ourselves as he notes directly that the generational cycle (of four twenty-year cycles culminating in massive geopolitical upheaval) is due to climax in the not-too-distant future. This presentation, which builds on the idea of behavioral changes and the generational knowledge transfer that for instance is now missing from the last great depression (do we need to learn the lesson of "excess credit is bad" once again?), is akin to 'everything you wanted to know about long-waves in social, political, and economic cycles but were afraid to ask'.

Something funny happened when last August CNBC hired access journalist extraordinaire Andrew Sorkin to spiff up its 6-9 am block also known as Squawk Box: nothing. At least, nothing from a secular viewership basis, because while the block saw a brief pick up in viewership driven by the concurrent (first of many) US debt ceiling crisis and rating downgrade, it has been a downhill slide ever since. In fact, as the chart below shows, the Nielsen rating for the show's core 25-54 demo just slid to multi-year lows. And as NY Daily News, the seemingly ceaseless slide has forced CNBC to start panicking: "CNBC insiders tell us executives at the cable business channel are “freaking out” because viewership levels are down essentially across-the-board, particularly with its marquee shows, “Squawk Box” and “Closing Bell." “Their biggest attractions have become their biggest losers,” says one TV industry insider familiar with the cable channel’s numbers. According to Nielsen ratings obtained by Gatecrasher, from April 2011 to April 2012, “Squawk Box” is down 16 percent in total viewers and 29 percent in the important 25-54 demographic bracket that advertisers buy." Yet is it really fair to blame the slide of the morning block's show on just one man?

The recent LTRO by the ECB provided lquidity; but at a cost. It is apparent that the banks in Europe pushed up the prices for European sovereigns in the short term but also increased their own risks by doing so. Recent data suggests that almost 10% of foreign buyers exited many of the weaker sovereign credits in Europe while their domiciled banks picked up the slack but, in doing so, increased their own risk and as yields have gapped back out in Italy, Spain et al the banks are facing significant losses on their balance sheets. It is quite possible now that with this weekend’s elections in Europe that Germany will find itself backed into a corner and nationalism could become a self-centered affair in Berlin with surprising consequences that could result from finding itself backed up against the wall. As much of Europe now finds itself in recession I note the continuing possibility of social unrest that could burst at any time as the unemployment numbers for much of the youth in Europe are abysmal and idleness can ignite in the most controlled of societies.

Looking at your screens and seeing nothing but black? Don't worry, your internet feed did not get cut - it is just that virtually everyone else in the world is taking today off (although judging by recent volumes one could be forgiven to assume that it is "just another day"). Which is not to say that nothing is happening, with a surprising bigger than expected rate cut (50 bps to 3.75%) by the RBA crushing AUD longs overnight, and a Manufacturing ISM on deck which is far shakier now than it was before yesterday's major PMI miss. Compounding the concerns was a UK PMI print just barely above contraction territory at 50.5, below expectations of 51.5, down from 52.1. Finally, expect another record bout of GM channel stuffing which continues to be the only "shining" aspect of the now inflecting US recovery. To summarize with DB's Jim Reid: "Ahead of an important day, it has been a fairly quiet session for markets overnight. Most Asian markets (include Hong Kong, Singapore, Shanghai, and South Korea) are closed for Labour Day. Indeed much of Europe will be closed today. In terms of what's open overnight, the Nikkei is -1.2% but the ASX 200 is up +0.9%. China’s official PMI manufacturing inched a little higher in April to 53.3 from 53.1 in March but slightly below market consensus (53.6). For such a huge economy the Chinese official PMI series does seem to have been remarkably smooth of late as the reading has been gradually on the rise since hitting a recent low of 49.0 in November (50.3 in Dec, 50.5 in Jan, 51.0 in Feb, 53.1 in Mar, 53.3 in April). As we go to print the Reserve Bank of Australia has unexpectedly cut its key benchmark rate by 50bps to 3.75%. Indeed only 2 out of 29 economists polled by Bloomberg saw this coming. The market reacted aggressively post the announcement taking the front end bills 15-18bp lower in yields."

Another day of ugly news out of Europe, with both macroeconomic and monetary data coming in to confirm that downward slope of the European forward trajectory (not to mention funny: below is a chart of Greek retail sales. Hardly any commentary is necessary). Yet despite some recently gravity in the EURUSD, for the time being the futures are trending flat to slightly down, perfectly ambivalent as to how will ease first as long as someone eases. Will this sustain, or will a disappointing Chicago PMI at 9:45 am once again send stocks first plunging then soaring on hope of imminent NEW QE? We will find out shortly. In the meantime, here is a recap of the overnight market action.

The good days are over, at least according to Goldman's Jan Hatzius. Now that "Cash For Coolers", aka April in February or the record hot winter, has ended, aka pulling summer demand 3-6 months forward, and payback is coming with a bang, starting with what Goldman believes will be a 125,000 NFP print in April, just barely higher than the disastrous March 120,000 NFP print which launched a thousand NEW QE rumors. But before you pray for a truly horrible number which will surely price in the cremation of the USD once CTRL+P types in the launch codes, be careful: from Hatzius - "Despite the weaker numbers, we have on net become more, not less, worried about the risks to our forecast of another round of monetary easing at the June 19-20 FOMC meeting. It is still our forecast, but it depends on our expectation of a meaningful amount of weakness in the economic indicators over the next 6-8 weeks. In other words, our sense of the Fed’s reaction function to economic growth has become more hawkish than it looked after the January 25 FOMC press conference, when Chairman Bernanke saw a “very strong case” for additional accommodation under the FOMC’s forecasts. This shift is a headwind from the perspective of the risk asset markets....So the case for a successor program to Operation Twist still looks solid to us, and the FOMC’s apparent reluctance to deliver it is a concern."

The European Central Bank prints money and hands it to the banks in undiminished size and at an interest rate which compels massive carry trades. The European banks buy sovereign debt that helps to lower the price of the sovereign’s funding costs, the banks use some of the money to increase their own capital and lend some of the money to individuals and corporations in the nations where they are domiciled. The money gets used and eventually dries up and a some of the capital is used to come into compliance with Basel III. The yields of the periphery nations fall but then begin to rise again. Germany, using Target-2, keeps lending money to the other central banks which use part of the money to support their currency, the Euro. The circle is then completed and the equity markets, notably in America, trade off of the strength of the Euro and some days at almost a point by point movement. Never before in the history of the world has such a grand scheme been implemented and in such an all-encompassing fashion. The unlimited amount of money that is available, because they can print all the money they want, has allowed Europe to game the world’s financial system while no one looked or caught on to the scheme. The world’s fiscal system has been rigged by Europe.

The question puzzling currency markets is why the EUR is so strong.  While we have argued that during the risk-off period of the last month or so post-LTRO2 (before Tuesday) EURUSD strength appeared to be driven by repatriation flows and balance sheet reduction, new information over the last couple of weeks driving the expectation that growth will be weak enough in the US to keep US policy very stimulative for a nice long time, we tend to agree with Steven Englander of Citigroup who argues that it looks very much as if QE3/Fed-stimulus anticipations are behind the EUR relative strength recently. Indeed the recent USD weakness is pretty much across the board, suggesting that it is less EUR attractiveness than USD unattractiveness that is driving the EUR’s gains.  That said, I think the buzz around various euro zone measures to help out banks and ease the rigidities of the fiscal compact is also helping support the EUR by reducing tail risk, but right now the USD/Fed is the bigger story. Back of the envelope math based on the Fed/ECB balance sheets and EURUSD implies the market expects  around $700bn of QE3 and given swap-spread differentials there appears to be little liquidity premium to reduce this expectation.

It must be difficult for the BRICS countries today. On one hand, they continue to jockey for respect among the Western powers, insisting on participating in quasi-European bailout funds like the IMF. On the other hand, they are also clearly aware of the Western nations' continuing efforts to surreptitiously devalue their domestic currencies, and the pernicious effect that has had on them as exporters and as lenders of capital. In that vein, it was interesting to note that during the latest BRICS Summit held this past March in New Delhi, the main topic of discussion centered on the creation of the group's first official institution, a so-called "BRICS Bank" that would fund development projects and infrastructure in developing nations. Although not openly discussed, reports suggest what they were really talking about was creating a type of BRICS central bank - an institution that could facilitate their ability to "do more business with each other in their local currencies, to help insulate from U.S. dollar fluctuations…" Given the incredible scale of western central bank intervention over the past six months, the BRICS' increasing frustration with their printing efforts should be a given by now. The real question is what they're doing about it, and what assets they're accumulating to protect themselves from the inevitable, which brings us to gold.