Risk Management

Events in Cyprus stem from precisely the same source as the surge in US home prices, namely monetary expansion by the Fed.  

Hopefully the memory of the new Eurogroup head, who in a one day lost more credibility than his admittedly lying predecessor Juncker ever had, will be jogged courtesy of this full transcript provided by Reuters and the FT of what he told two reporters - on the record - and for the whole world to read. Because, by now, we are confident everyone has had more than enough with watching the entire Eurozone rapidly and tragically turn itself into a complete and utter mythomaniac, kletpocratic circus.

For those curious about the timeline of the world's biggest prop-desk blow up, here it is day by day and, pardon the pun, blow by blow.

"Since my departure I have learned of the deceptive conduct by members of the London team, and I was, and remain, deeply disappointed and saddened to learn of such conduct and the extent to which the London team let me, and the Company, down."

• Dimon’s ‘Harpooned’ Whale Resurfaces With Senate Findings (BBG)
• Greece and lenders fall out over firings (FT) - as predicted 48 hours ago
• Dallas Fed Cap Seen Shrinking U.S. Banking Units by Half (BBG) - which is why it will never happen
• Xi elected Chinese president (Xinhua)
• Russia Bond Auction Bombs as ING Awaits Central Bank Clarity (BBG)
• U.S. and U.K. in Tussle Over Libor-manipulating Trader (WSJ)
• Chinese firm puts millions into U.S. natural gas stations (Reuters)
• In Rare Move, Apple Goes on the Defensive Against Samsung (WSJ)
• Berlin Airport Fiasco Shows Chinks in German Engineering Armor (BBG)
• Ex-PIMCO executive sues firm, says was fired for reporting misdeeds (Reuters)
• Bank of Italy Tells Banks in the Red Not to Pay Bonuses, Dividends (Reuters)

The Reserve Bank of Australia’s computer networks have been repeatedly and successfully hacked in a series of cyber-attacks to infiltrate sensitive internal information. The RBA disclosed to The Australian Financial Review (after their investigation) that multiple computers within the RBA’s network were had been infiltrated by a Chinese-developed malicious software. While no details were given on what information was stolen, a defense department official warned, that "the targeting of high profile events, such as the G20, by state-sponsored adversaries... is a real and persistent threat. Cyber intruders are looking for information on... the government’s intentions." The hack appears related to the 2011 G-20 summit, at which the French government have already confirmed over 150 computers were hacked for months with files "redirected to Chinese sites." Australia’s cyber-spy agency, the Defense Signals Directorate, said “there are many examples of [Australian] entities being targeted due to involvement in high profile events” like the G20. Currency wars meet cyber wars - or is it the other way around?

The State has monopolized all authority, giving it essentially unlimited power to make things worse. Since concentrations of centralized capital, authority and power does not relinquish control easily, if ever, the Status Quo will have to decay and implode before authority can be pushed down to more responsive, appropriate levels.

At Deutsche Bank, the job title “risk manager” might be more appropriately characterized as “campaign manager.” That is, Deutsche Bank is no more concerned with the active mitigation of risk than the unscrupulous politician is with actively avoiding extra marital affairs. Like campaign mangers then, risk managers at Deutsche Bank must accept the fact that occasionally (or perhaps quite often) messes will be made and spin campaigns will need to be devised and deployed in order to keep public opinion from turning sour and in order to keep the few regulators who aren’t on the payroll

Movements in equity prices are driven by many factors, such as the economy, government policy, earnings, interest rates and valuation. But we think tactical moves (<3 months) are often better explained by sentiment, positioning and technicals. While macro, policy and valuations matter, sentiment has worked well in recent years as a contrarian tool to identify short-term inflection points in asset prices. According to BofAML's new Bull & Bear Index investor sentiment toward risk assets is at a more bullish level today than 99% of all readings since 2002. The current reading of 9.6 (out of 10) is close to max bullish and thus triggers a contrarian "sell" signal for risk assets. In their view, the relative risk-reward of owning equities is unfavorable at this juncture. Since 2002 a "sell" signal of 8.0+ was on average followed by a 12% peak-to-trough correction in global equities within three months.

There have been several articles as of late discussing that the next great secular bull market has arrived. However, the reality is that this cycle is currently unlike anything that we have potentially witnessed in the past.  With massive central bank interventions, artificially suppressed interest rates, sub-par economic growth, high unemployment and elevated stock market prices it is likely that the current secular bear market may be longer than the historical average. No matter how you slice the data - the simple fact is that we are still years away from the end of the current secular bear market. The mistake that analysts, economists and the media continue to make is that the current ebbs and flows of the economy are part of a natural, and organic, economic cycle. If this was the case then there would be no need for continued injections of liquidity into the system in an ongoing attempt to artificially suppress interest rates, boost housing or inflate asset markets. From market-to-GDP ratios, cyclical P/Es, misconstrued earnings yields, and the analogs to previous Fed-blow bubbles, we appear near levels more consistent with cyclical bull market peaks rather than where secular bear markets have ended.

The NY Fed is the single most powerful entity in charge of the Fed’s daily operations. How can any investor believe that the Fed can manage the system and restore trust when the NY Fed granted MF Global primary dealer status a mere nine months before the latter went bankrupt?

• Boeing misses Q4 top line ($22.3 bn, Exp. $22.33 bn) beats EPS ($1.28, Exp. $1.18), guides lower: 2013 revenue $82-85 bn, Exp. 87.9 bn
• Hilsenrath discovers DV01: Fed Risks Losses From Bonds  (WSJ)
• Airlines had 787 battery issues before groundings (Reuters)
• Monte Paschi ignored warnings over risk, documents show (Reuters) as did Mario Draghi
• China averts local government defaults (FT)
• Economy Probably Slowed as U.S. Spending Gain Drained Stockpiles (Bloomberg)
• Bono Is No Match for Retail Slump Hitting Dublin’s Fifth Avenue (BBG)
• Catalonia requests €9bn from rescue fund (FT)
• US plans more skilled migrant visas (FT)
• Japan PM shrugs off global criticism over latest stimulus steps (Reuters)
• CIA nominee had detailed knowledge of "enhanced interrogation techniques" (Reuters)
• Cleanliness Meets Godliness as Russia Reeled Into Cyprus (BBG)
• Deutsche Bank Seen Missing Goldman-Led Gains on Cost Rise (BBG)

Prior to the crisis, the 29 largest global banks benefitted from just over one notch of uplift from the ratings agencies due to expectations of state support. Today, those same global leviathans benefit from around three notches of implied support. Expectations of state support have risen threefold since the crisis began. This translates into a large implicit subsidy to the world’s biggest banks in the form of lower funding costs and higher profits. Prior to the crisis, this amounted to tens of billions of dollars each year. Today, it is hundreds of billions. Too-big-to-fail is far from gone.

• White House delays 2014 budget after "fiscal cliff" standoff (Reuters) - And Senate will pass this... never?
• Amari Signals Limits to Abe’s Campaign to Weaken Yen (BBG)
• Draghi’s Bond Rally Masks Debt Doom Loop Trapping Spain (BBG)
• Obama backs gun limits, concedes tough fight ahead (AP)
• Bernanke to Weigh QE Costs as Fed Assets Approach Record (BBG)
• Japan to Sell Debt Worth 7.8 Trillion Yen to Pay for Stimulus (BBG)
• France more than doubles forces in Mali (FT) and yet...
• Malian Rebels Take Town and Vow to Avenge French Attack (NYT)
• China’s Li Calls for Patience as Government Works to Reduce Smog (BBG)
• EU berates China over steel subsidies (BBG)
• Number of working poor families grows as wealth gap widens (Reuters)

In money management long term success lies not in garnering short term returns but avoiding the pitfalls that lead to large losses of invested capital.  While it is not popular in the media to point out the headwinds that face investors in the months ahead - it is also naive to only focus on the positives.  While it is true that markets rise more often than not, unfortunately, it is when markets don't that investors are critically set back from their long term goals.  It is not just the loss of capital that is devastating to the compounding effect of returns but, more importantly, it is the loss of "time" which is truly limited and never recoverable. Therefore, as we look forward into 2013, we want to review three reasons to be bullish about investing in the months to come but also review three risks that could derail the markets along the way. The reality is that no one knows for sure where the markets will end this year; and while it is true that "bull markets are more fun than bear markets" the damage to investment portfolios by not managing the risks can be catastrophic.