Sigma X

First of all, let's get one thing straight: if instead of about to breach a 20-handle, the Facebook stock price was in the $60, nobody would care about anything that happened in the past 3 days, everyone would be happy and delighted, and increasing the velocity of money with the comfort that some greater fool would be willing to pay even more for ridiculous overvalued ponzi, pardon, portfolio holdings. Alas, we are not there, and as a result, the fingerpointing phase has come and gone. Now come the lawsuits, because people, led to believe in huge short-term profits, are now faced to face with a grim sur-reality in which the tooth fairy was just exposed as the cookie monster. And the latest farcical development: Nasdaq finally pulling market conditions, but not just any market conditions - retroactive ones.

Last Wednesday we put up the following blurb: "Five months ago, when Italian yields were still tame in the 3% ballpark, and not 7% where they are today, we suggested that based on trading patterns and overall volume in Goldman's dark pool, Italy may be about to experience a "Greek episode." Days later we were proven right as Italian yields and spreads started their relentless move wider, with only those who had access to Sigma X being able to get an advance whiff of what was about to happen. Well today we are happy to report that the German diversion may have worked: the truth is that nobody appears to care about Germany. Instead what everyone does seem to care about, is the nation with the greatest combined debt (government, corporate and household) to GDP in the world. Yup. The UK." Following that, a quick Twitter update from this morning indicated something was again going on with the UK from the perspective of the world's most connected insiders: "UK's LLOYDS and RBS top of most active on Sigma X this morning." Sure enough, here's Fitch with what may well be a precursor to the bond vigilantes finally focusing their attention on the last, latest and greatest AAA credit.

• FITCH: UK GOVT MAY BE MOST INDEBTED OF AAA SOVEREIGNS EX U.S. -BBG
  
• FITCH: NEW UK FISCAL VIEWS 'SIGNIFICANT DETERIORATION' VS MARCH - BBG
  
• And the punchline: "the capacity of UK public finances to absorb adverse economic and financial shocks that would result in yet higher public debt while retaining its 'AAA' status has largely been exhausted"

And cue the imminent downgrade rumors - and ensuing safe-haven outflows to TSYs.

Five months ago, when Italian yields were still tame in the 3% ballpark, and not 7% where they are today, we suggested that based on trading patterns and overall volume in Goldman's dark pool, Italy may be about to experience a "Greek episode." Days later we were proven right as Italian yields and spreads started their relentless move wider, with only those who had access to Sigma X being able to get an advance whiff of what was about to happen. Well today we are happy to report that the German diversion may have worked: the truth is that nobody appears to care about Germany. Instead what everyone does seem to care about, is the nation with the greatest combined debt (government, corporate and household) to GDP in the world. Yup. The UK.

....or else you will figure out not only that there is such a thing as sovereign crisis spillover into financials, but why UniCredit was once again the most active name on Sigma X yesterday, and why earlier today it is rumored that the bank is scrambling for emergency ECB assistance. But such is life when your equity is €14.5 billion and your total holdings of Italian bonds ar... €40 billion! If we were betting people, we would probably out a dollar down that UCG is the next Dexia.

Following a relatively quiet overnight session which despite various bond auctions in Europe did not see any flagrant contagion, and in which ongoing ECB buying of Italian bonds led the 10 Year BTP spread back to 6.75%, things have taken a very quick turn for the worse once again, and the BTP is now back at the day wides at 7.10%, following the following Reuters headline which is rather self explanatory: RTRS-UNICREDIT CEO, IN MEETING WITH ECB, TO ASK FOR MORE ACCESS TO  ECB FUNDING FOR ITALIAN BANKS BY WIDENING TYPE OF COLLATERAL  USED-SOURCE CLOSE TO BANK. Hmmmmm, UniCredit....where is that name familiar from. Oh wait, that's right - it was, once again, the top name on yesterday's Sigma X report of most actively traded companies by Goldman's special clients. Good to see there was no leakage here at all, none. And making things worse across the Mediterranean is the rumor that LCH Clearnet will promptly follow suit, and hike Spanish margins now that the spread to German Bunds is over 450 bps. Bottom line: Same Europe, Different Day. Here is our perfectly uneducated guess - market plunge in the morning in which institutions dump, ramp in the afternoon in which retail and HFTs buy.

For years Zero Hedge has been exposing the persistent fraud that goes on behind the trading scenes, not only in High Frequency Trading, but also in various dark trading venues, known better as dark pools where exchanges, typically the banks themselves get to match buyers and sellers without any indication of a trade having occurred, until much later if at all. Recently, and very much as we expected, trading firm Pipeline was smacked down by the SEC for gross violation of customer orders, an offense which can be summed up simply as: frontrunning. We now learn that, as the Wall Street Journal reports, Pipeline is pretty much finished after the Chairman and CEO have both quietly left the sinking ship. The WSJ adds: "The case was the SEC's first enforcement action involving dark pools, and it shocked the trading community, according to traders and other operators of electronic-trading systems. People who know Messrs. Berkeley and Federspiel said they were highly regarded among their peers. Mr. Berkeley was a former president and vice chairman of the Nasdaq Stock Market. Mr. Federspiel once worked at the Los Alamos National Laboratory as a nuclear physicist." Well, we certainly were not shocked, having predicted the demise of dark pools as early as the summer of 2009.  What will shock the trading community, however, even more is if the SEC decides to go after not some tiny unknown firm, but the real dark pool transgressors, the biggest one of which is and has always been Goldman's Sigma X. Of course for that to happen, Mary Schapiro would actually have to do her job. And that, unfortunately, ain't happening.

Intesa may be halted for trading on the MIB, but that sure doesn't mean that Goldman's Sigma X clients are prohibited from dumping their shares on the hedge fund's dark pool, which incidentally is always happy to accept and match client orders. Sure enough, as the puke fest in European banks resumes (and both Italy and German CDS are now materially wider on the day, the Italian 2-Year Note yield rising 30 bps to 3.95%, and the 10-Year up 20 to 5.60%), the top traded names on Goldman's dark pool once again is the who's who of insolvent European banks, starting with Italy, passing through the UK and rounding up the top 5 with Germany. But, but, the second European bailout was supposed to work? What happened? 

Many associate exploding CDS as a feature of backward third world countries, or, as they are better known these days, PIIGS. It may thus come as a surprise to most that the default risk of not only the US, which we reported had recently hid a multi year high, but especially Germany and the UK have surged by well over 50% in the past month. In fact, Germany, by most objective evaluations, an economy that is far more resilient and productive than America's, has in the past 3 days seen its CDS surge to a level 10 basis points wide of the US. And if not the actual economy, what then? Why such monstrosities as Deutsche Bank and Commerzbank, which as reported previously have caused many to doubt are as viable as the stress tests represents, and whose combined asset bases are well over the total GDP of Germany. As the for the UK, after trading at around 55 bps for months, the spread has jumped to nearly 80 bps. So as Sigma X indicated earlier that it may now be time to shift attention to the UK, have the vigilantes already succeeded in penetrating all the way to the very core of the Eurozone? Or, courtesy of ISDA's criminal abdication of its responsibilities by pre-determining that no development in the future of Greece would be an event of default, perhaps the only natural response now is to buy protection on those names which have not blown out to ridiculous (read 600 bps or wider) spreads. Which, however, is very bad news for the Eurozone core, as going forward investors will simply hedge peripheral cash risk with core synthetic: a process which will result in the eventual wipe out of both instruments. But that's precisely what happens when the CDS administrator and "regulator" decides to play ball with the central planners instead of the siding with market participants: unintended escalating consequences galore.

Over 3 weeks ago, before Italian treasury spreads blew out by several hundred basis points, and before Italian bank stock trading halts became a daily occurrence, we suggested that the European contagion was shifting to Italy based on Goldman dark pool Sigma X trading. To wit: "Today's most active names are Banca Monte dei Paschi di Siena, Unicredit and Intesa Sanpaolo. Translation: someone is actively positioning for serious action in Italy shortly." That someone sure was right, and it is precisely this trifecta of stocks that at last check was halted on the Borsa. Well, based on today's action at Sigma X, the next, and probably biggest domino may be about to fall: the UK itself, because coming in at position #2, just behind UniCredit, we see Lloyds Banking. And if Lloyds goes, the ones that will follow are Barclays and RBS. At that point, the financial crisis goes global.

As was reported last week, Europe has suddenly found itself shocked, shocked, that the bond vigilantes decided to not pass go and go directly to the purgatory of the European core, in the form of the country that, at €1.5 trillion euros, has more debt than even Germany, but far more importantly, has a debt/GDP ratio of over 100%, and has the biggest amount of net notional CDS outstanding (not to mention that it has dominated Sigma X trading for the past several weeks). Italy. On Friday we explained why things are about to get really ugly for the boot as a flurry of bond auctions is now imminent. Which is why it was not surprising to read that tomorrow morning the European Council has called an emergency meeting "of top officials dealing with the euro zone debt crisis for Monday morning, reelecting [sic; we assume Reuters means reflecting] concern that the crisis could spread to Italy, the region's third largest economy." Newsflash: the crisis has spread to Italy. And it will only get worse at this point as Spain is largely ignored for now (until its own mortgage crisis starts making daily headlines like this one, however, where courtesy of the insolvent Cajas which are simply a GSE waiting to be nationalized, the can will be kicked down the road for at least 6-9 months ) and the vigilantes start dumping Italian debt and buying up every CDS available and related to Italy. "We can't go on for many more days like Friday," a senior ECB official said. "We're very worried about Italy." But, but, didn't Draghi just say Italy's banks will pass the second, "far more credible" stress test en masse? Welcome to the second, and final, part of the European insolvent dominoes contagion, the one which culminates with everyone bailing each other out... and the death of the euro currency of course.

Another day, another implosion in Italy, this time focusing on core bank UniCredit, which earlier dropped by 6.5% resulting in a stock halt, only to reopen just modestly higher. There was no immediate catalyst, just more of the same: rumors that FinMin Tremonti is resigning, especially following the arrest of Marco Milanese which indicates the fallout is imminent (see below), rumors that Italian banks are failing stress tests, rumors that Italy has the most exposure to Greece, and other generalized fears which today coalesced around the bank that was the most active today on the European version of Sigma X.In other news, 2 Year government spreads are once again surging as GDP-weighted EU sovereign risk is at fresh all time highs (probably to make company to the Dow Jones Transportation index).

Back in December, when noting the first material blow out in PIIGS spreads following the first Greek bailout 6 months earlier, we touched upon Italy, and specifically looked at a way to best play the coming shift in Eurozone contagion from the periphery to the core, coming up with one unique corporate name. Back then we said: "We all know what has happened to Italian bond prices in the past weeks: as of today, Bund spreads have just hit a fresh all time high. But all this is irrelevant since the bank must have a capital buffer to accommodate the losses. After all, what idiot would run a company with almost €300 billion in Euro-facing bond exposure and not factor for deterioration in risk after the events of May... Well the ASSGEN CEO may be just such an idiot. The company's balance sheet as of 9/30 discloses that the firm had a mere €10 billion in tangible capital (excluding €10.7 billion in intangible assets). So let's recap: €262 billion in Euro bonds on.... €10 billion in tangible equity! A 26x leverage on what is promptly becoming the most impaired asset class in the world." In a nutshell, Assecurazioni Generali, one of Italy's largest insurers, is a highly levered windsock for Italian and other PIIGS stress, and better yet, can be played in either equity or CDS. Now that the European bond vigilantes are once again looking beyond Greece and focusing particularly on Italy (especially based on recent Sigma X trading), none other than JP Morgan (which just cut its estimates on GASI.MI, a very appropriate equity ticker) validates the thesis that Generali (or ASSGEN per its memorable corporate/CDS ticker) is the best proxy for contagion: "Generali is one of the most sensitive stocks to both the sovereign debt crisis and the implications for the financial sector through both its government, corporate and equity investment portfolios...Generali’s sovereign exposure is mainly concentrated in Europe with Italy accounting for the largest share (37%; home market bias)."

Yesterday, the Italian government introduced additional fiscal austerity measures that aim to reduce the general government deficit by €47 billion (3% of 2011 GDP) by 2014. Despite these measures, however, we believe substantial downside risks to the government's debt-reduction plan remain, primarily due to Italy's weak growth prospects. in light of Italy's weak growth (per capita GDP growth averaged minus 0.9% between 2005 and 2011) it is our opinion that far more substantial microeconomic and macroeconomic reforms will be required to incentivize private investment and match wage levels with productivity. Without such measures, we believe Italy's economic potential will not be realized. This will imply insufficient wealth creation to deliver meaningful declines in the general government's debt-to-GDP ratio, which was a high 119% at end-2010. As a consequence, we continue to hold the view that there is an approximately one-in-three likelihood that the ratings on Italy could be lowered within the next 24 months, as reflected in our negative outlook.

Italian banks and other companies refuse to relinquish the top volume spots on the world's most active dark pool, Goldman's Sigma X. As a reminder, non-open ATS venues like dark pools, represent what the big money is trading when not masked with the churn volume of HFT darlings that provide easy liquidity rebates, and thus massive volume (but absolutely no liquidity). As we reported in the past two days, Intesa, Unicredit and Banca Monte dei Pasci have been consistently among the top traded names, and continue to be so for the third day in a row. Today it may be time to add Enel SpA. Also, Italian CDS in the 175 bps range are likely very cheap now that the law of communicating insolvent vessels means the bond vigilantes will finally shift their attention to an increasingly troubled Italy.

Following up on our inaugural post tracking Sigma X transaction, where as we first reported Italian banks had captured the imagination of the big money, accounting for the three most active positions in Goldman's Dark Pool, today's update should not come as a surprise. For the second day in a row, the most actives continue to be UniCredit and Banca Monte dei Paschi di Siena (Intesa has fallen from 3rd to 12). This builds on earlier rumors of a major shake up (see below) in the Italian government, where Finance Minister Tremonti has allegedly threatened to resign again, and this time Berlusconi may be prepared to accept the resignation. Should this happen, look for Italy CDS and Bund spreads to react appropriately. The Sigma X signal is merely the continuing writing on the wall.