Risk Management

Three weeks ago we discussed the ultimate-doomsday presentation of the state of Spain which best summarized the macro-concerns facing the nation and its banks. Since then the market, and now the ratings agencies, have fully digested that meal of dysphoric data and pushed Spanish sovereign and bank bond spreads back to levels seen before the LTRO's short-lived (though self-defeating) munificence transfixed global investors. However, the world moves on and while most are focused directly on yields, spreads, unemployment rates, and loan-delinquency levels, there are two critical new numbers to pay attention to immediately - that we are sure the market will soon learn to appreciate. The first is 5%. This is the haircut increase that ECB collateral will require once all ratings agencies shift to BBB+ or below (meaning massive margin calls and cash needs for the exact banks that are the most exposed and least capable of achieving said liquidity). The second is 10%. This is the level of funded (bank) assets that are financed by the Central Bank and as UBS notes, this is the tipping point beyond which banks are treated differently by the market and have historically required significant equity issuance to return to regular private market funding. With S&P having made the move to BBB+ this week (and Italy already there), and Spain's banking system having reached 11% as of the last ECB announcement (and Italy 7.7%), it would appear we are set for more heat in the European kitchen - especially since Nomura adds that they do not expect any meaningful response from the ECB until things get a lot worse. The world is waking up to the realization that de-linking sovereigns and banks (as opposed to concentrating that systemic risk) is key to stabilizing markets.

The music is playing. 

Several days ago we published the latest seminal paper by Artemis Capital Management, a must read for everyone confused about market dynamics in the "central-planning normal." Since a core focus of Artemis' long-running narrative has been the impact of endless interventions in markets, and their distortions of volatility, the firm's Chris Cole has prepared the following addendum animation showing the vol curve over the past 20 years, which ultimately has led to what we have dubbed a "centrally-planned, liquidity addicted, temperamental abortion".

Ten more years of low returns in the stock market.  If you are one of the millions of baby boomers headed into retirement - start saving more and spending less because the stock market won't bail you out.  Now that I have your attention I will explain why this is the likely future ahead for investors. In this past weekend's newsletter I wrote that “If you put all of your money into cash today and don’t look at the market for another decade – you will be better off..."  I realize that this statement is equivalent to heresy where Wall Street is concerned but there is one simple reason behind my apparent madness - the power of "reversion". This is not a new concept by any means as witnessed by Bob Farrell's rule #1 - "Markets tend to return to the mean over time."  However, the reality of what "reversion" means is grossly misunderstood by Wall Street, and the mainstream media, as witnessed by the many valuation calls that "stocks are now cheap because the market is now trading in line with its long term average."

As clearly indicated well over 2 yrs ago, Italy will first default on its over optimistic promises (check), then look to actually default on (restructure) its debt (next).

The Bonds in Spain will drain without restrain showing utter disdain for the Euro domain. Research that Rhymes!!!

Addressing his perception of lessons learned from the financial crisis, Ben Bernanke is speaking this afternoon on poor risk management and shadow banking vulnerabilities - all of which remain obviously as we continue to draw attention to. However, more worrisome for the junkies is the total lack of QE3 chatter in his speech. While he does note the words 'collateral' and 'repo' the proximity of the words 'Shadow, Institutions, & Vulnerabilities' are awkwardly close.

"What Bernanke is to the Treasury market, Iksil is to the derivatives market"

Last week we had the Fed's hawks line up one after another telling us how no more QE would ever happen. We ignored them because they are simply the bad cops to the Fed's good cop doves. Sure enough, here comes Bernanke's right hand man, or in this case woman, hinting that one can forget everything the hawkish stance, and that ZIRP may last not until 2014 but 2015! Which, by the way, is to be expected: since ZIRP can never expire, it will always be rolled to T+3 years, as the short end will never be allowed to rise, until the Fed has enough FRNs in circulation to absorb the surge in rates without crushing the principal, as explained yesterday.

Chesapeake Energy took the road less traveled by entering 2012 "naked" with none of its gas volumes hedged.

Unfortunately, nobody in the Treasury seems to want to deal with the mess at Ally Financial before Election Day.  But the question is whether Ally can wait until then.

For all those who have long been curious what the precious metals "queen" thinks about allegations involving her and her fimr in gold and silver manipulation, how JPMorgan is positioned in the precious metals market, and how she views the fringe elements of media, as well as JPMorgan's ethical limitations to engaging in 'wrong' behavior, the answers are all here.

• China's Central Banker to Fed: Act Responsibly (WSJ)
• Spain's debt to jump to 78 percent of GDP: De Guindos (Reuters)
• Rajoy Needs All the Luck He Can Get (WSJ)
• Spain Faces Risks in Budget Refit (WSJ)
• Top JP Morgan banker resigns to fight abuse fine (Reuters)
• Reinhart-Rogoff See No Quick U.S. Recovery Even as Data Improve (Bloomberg)
• Program to help spur spending in domestic sector (China Daily)
• Barnier hits out at lobbying ‘rearguard’ (FT)
• U.S. CEOs' take-home pay climbs on stock awards (Reuters)

• Greece's Fringe Parties Surge Amid Bailout Ire (WSJ)
• ECB fails to stem reduction in lending (FT)
• More Twists for Spanish Banks (WSJ)
• Banks use ECB cash to buy bonds, lend less to firms (IFR)
• UK still long way off pre-crisis growth – King (Reuters)
• Dublin confident of ECB deal to defer payment (FT)
• Goldman's European derivatives revenue soars (Reuters)
• Japan Faces Tax Battle as DPJ Finishes Plan on Sales Levy (Bloomberg)
• Insurance Mandate Splits US Court (FT)