Barclays

We present another great review of market dynamics from the eyes of a quant, this time coming yet again Barclays' Matt Rothman. With Risk On, Risk Off the dominant regime since QE2 speculation, and likely to last into the end of the year, throw away all fundamental textbooks, and focus on what it is the momo machines are chasing. Which is simple: to outperform in this market, load up on high beta stocks and high short interest names. The rest is noise. Which means a bloodbath for "disciplined stock pickers" - as Rothman says "the investment managers who are suffering are the truly disciplined stock pickers. Those managers who are diligent about having no style tilts or theme tilts or sector biases are finding it nearly impossible to generate returns. There are no investment opportunities returns for these managers to capitalize on. There are no idiosyncratic  returns available in the market for them and the situation has, essentially, never been worse, anytime in the past 60 years." Then again, there are no traditional stock pickers left anymore - everyone now does the same as Pimco - stay one step of the Fed (and just imitate what everyone else is doing), or risk losing your job. In the meantime the biggest groupthink trade ever is getting bigger by the day, as everyone hopes and prays profit taking never occurs.

From Barclays' Jasraj Vaidya, who states: "At this stage, we are unable to ascertain what that exact issue might
be. What is certain is that foreclosure timelines in those states for
GMAC loans will be extend further, potentially adversely affecting their
eventual severity" which echoes verbatim what Zero Hedge suggested a week ago on the Florida Judge news: "The implications for the REO and foreclosures track for banks could be
dire as a result of this ruling, as this could severely impact the
ongoing attempt by banks to hide as much excess inventory in their books
in the quietest way possible." Jasraj also notes: "Using publicly available data from HUD and RealtyTrac, we have created a list of judicial foreclosure states. These are states where judicial foreclosures are most common and in which the lender has to appear before a judge and obtain a court order before initiating foreclosure proceedings against the delinquent borrower. Such states tend to have much longer foreclosure timelines than non-judicial states. What is striking about the list of states in the GMAC announcement is that all but one (North Carolina) are judicial states. Also, all judicial states in the country but one (Delaware) are in the GMAC list. This would hint at some potential issues with judicial states that is driving the GMAC directive." In the meantime, class actions lawyers across the country will not be sleeping for days.

At a time when the UK banking system is massively underwater, and exists only due to billions in ongoing daily government support, the last thing the country (or any other) needs is a forced locked out from one's bank account. Which is precisely what happened over the weekend in the UK, when Barclays clients were unable to access their accounts, or withdraw cash with no advance notice. Reuters reports that "thousands of Barclays customers in Britain were unable to access their bank accounts or withdraw money from cash machines on Saturday after a system crash caused chaos nationwide." Hopefully no cyberterrorists get whiff of this most easy way to create a nationwide financial panic like no other: with everyone's nerves continuously frayed courtesy of broken capital markets, and investors and savers pulling their money out of stocks and putting it into bonds and mattresses, the last tipping point would be an unexpected "crash" that locked out all ATM machines in America.

For the longest time it was consensus thought that only Wall Street could fuck Main Street. The ride is now turning. After what the FT reports was a 16% decline in fixed income, currencies and commodities trading
revenues for Q2, coupled with advisory revenues down 17%, the bank is now "planning to cut up to several hundred employees following a sharp fall in market activity in the second quarter. Sources close to the bank say that the job losses, which could be announced as early as Wednesday, will be spread across BarCap’s sales and trading staff as well as its back office support functions." Too bad the SEC has not, and will not realize that its only function is to restore the faith of the retail investors in the credibility of the capital markets. Yes, the same retail investor who both on margin and in total has always been the primary driver of stocks. Alas that has not happened and tens of thousands of Wall Streets will soon feel the wrath of Main Street as the boycott of stocks by the broader population comes to fruition, allowing the former "strategists" to experience just how real the difference between the U-3 and U-6 rate is first hand.

From Goldman, which is taking the miss in its QE2 target by $800 billion like a man (granted a very rich man, with discount window access): "In our view, this marks a "baby step" toward renewed quantitative easing later this year or early next, as discussed more fully in last Friday's US Economics Analyst, though this obviously depends on a view that the economy remains as sluggish as we forecast . Technically, the step marks the removal of a slight bias toward tightening in the sense that it keeps the balance sheet fixed rather than letting it shrink over time. In March, Brian Sack, Manager of the Open Market Desk, indicated that this shrinkage would be in the neighborhood of $200bn from that time through the end of 2011 (roughly a 21-month period, so just short of $10bn per month), though of course this figure may have risen as lower interest rates would have instigated more mortgage refinancing. To our knowledge, the Fed has not provided an updated estimate of this run-off. the opening statement recognizes a slowing in the pace of recover of both output and employment, the increase in equipment and software is downgraded to "rising" from "has risen significantly," and the last sentence is revised to recognize that the pace of recovery is apt to be "more modest …. than had been anticipated." On the other hand, the committee removed the statement that "financial conditions have become less supportive of economic growth.""

In advance of today's FOMC statement which the entire market is waiting for with bated breath, specifically focusing on just what form any incremental quantitative easing will take (if any), Barclays' Joseph Abate once again steps back to observe the forest in avoidance of the trees, and asks the critical question: just what is the objective of this round of QE: is it to force down short- or long-term interest rates. And since the economic benefit of the former is minuscule, the Fed will arguable be focused on the latter, thus forcing Abate to ask how this can be best accomplished "without causing the disruptions that cropped up in the first round of asset purchases." The Barclays strategist also wonders if the purpose of a possible MBS monthly purchases on a periodic basis, rather than en masse, is merely to prevent a problem that has recently become prevalent: namely the surge in MBS trade fails, a phenomenon that has received surprisingly little attention lately, yet which as the chart below from Mortgage News Daily shows is become quite a major problem, and one which the Fed is certainly concerned about (and if it isn't it should be). In other words, most pundits openly ignore the very likely distortions that will arise from a wholesale attempt at pushing LT rates lower. Read on for Abate's open ended question, as well as his logic as to why possible QE forms, at least as presented by the general media, are likely to be woefully insufficient.

Barclays' head of quantitative strategy Matt Rothman provides some additional information on one of the most notable facets of the current market regime, namely the record implied correlation and thus, near record low stock dispersion, in other words, the phenomenon that all stocks trade as one, regardless of fundamental differences across different publicly traded companies. While nothing a slight dip in 1 month implied correlation from all time records near 70% hit in the past month, Rothman observes that "low levels of stock dispersion generally correspond with difficulty in picking individual stocks...This high level of cross-sectional correlation also has implications for how certain characteristics are being priced. For if stock return dispersion is low but underlying fundamental (economic) performance of factors remains relatively constant then it would appear that mispricings in the market may be beginning to take root." In other words, as we noted last time we observed the record low stock dispersion a month earlier, alpha (continues to be) dead. Yet for those who are eagerly anticipating the dispersion to finally rise, Rothman says that the market is basically back to mid-2009, when high quality stocks were largely undervalued compared to low quality: "High Quality companies are cheap right now relative to low Quality companies. We believe this is due both to a compression of returns in the market and because of the current macro-economic environment that has favored lower Quality stocks." Of course, shorting high beta names in a Fed-mediated market, has led to nothing but implosion.

Barclays' Joseph Abate adds to the recent confusion over what path of QE (if any) the Fed will decide on at its August 10th meeting, and flatly disagreeing with Nomura which as we noted last week is now convinced the Fed will advise of further loosening in its language, believes that neither MBS roll offs (telegraphed earlier by Jon Hilsenrath), nor lowering the IOER to 0.00% will be sufficient to do much if anything to boost the economy, and instead he believes that the likely path the Fed will take is to allow the Supplemental Financing Program (which currently holds $200 billion in untouchable reserves on the Treasury's book) to roll off, by ending the 56-day Bill auctions, thus pushing almost a quarter trillion dollars into the banking system which can then be used to buy any combination of beta > 5 stocks. The result of this, according to Abate, "would likely push bill and repo rates well into the single digits." Of course with the 2 Year already at almost south of 0.50% one wonders just how much further along the curve does the Fed hope to have its impact felt. Could the Fed merely be trying to steepen the 2s10s by forcing 2s to zero? At this point, nothing would surprise us.

Barclays analyst Jeffrey Meli has issued a report "European bank stress tests: A preview" in which he estimates that if properly executed, the Stress Test, whose results are to be announced on July 23, will require an infusion of €85 billion to replenish capital levels. Specifically, quantifying the amount of capital needed would include €36 billion for Spanish cajas, a number far greater than expected to date, €34 billion for the German landesbanks, €8.6 billion for Greek banks and €6 billion for Portuguese banks. Meli concludes: "Spreads have rallied over the past two weeks, suggesting the bar is no longer set so low that any disclosure whatsoever will cause a rally." So all those who plan on buying the news - beware.

There is a simple reason why all hedge funds with "relative value" or "deep value" in their names will soon be looking to change their moniker: stock picking no longer works, with the only strategy that matters, as implied correlation is now at the second highest level in history, is picking the time to leverage beta exposure and riding the broader market up or down. Alpha is now dead. as Barclay's head of quantitative strategies Matt Rothman says, "Indeed, it was hard to be a stock picker in the market for the last two months as the last two months have seen historically low levels of dispersion in stock returns. As shown in Figure 2, the cross-sectional correlation across all stocks in the market was at its second highest level last month (measured back to July 1950) and recorded its third highest level this month; there have never been to two months back-to-back with anything approaching these levels. To belabor the obvious and put this in perspective, current levels of correlation are higher than in October 1987, anytime during the Fall of 2008, either the run-up or the bursting of the Internet Bubble, or after 9/11. The reason this matters to all stock pickers — fundamental or
quantitative — is because with stock return dispersions at all-time
lows, it is extraordinarily difficult to be picking stocks." In other words, the danger of yet another systemic meltdown (or up), now that everyone is on the same side of the trade (and whoever isn't, is getting steamrolled), is higher than ever in history, up to and including May 6. And he, who has the greatest access to (risk free) leverage wins. Therefore look for all the "investment bank" hedge funds with prop desks and discount window access to once again post record trading days for the current and all future quarters until even they blow themselves up eventually and the Fed can do nothing to prevent it.

From Barclays: "Financial market conditions have deteriorated notably since 1Q10, evidenced by sharply wider credit spreads, cash-derivative basis, declines in structured finance indices, sharply higher volatility and a "flight-to-safety" trade in less risky assets. We believe this market dislocation, while certainly smaller than the dislocations seen in 2008 and early 2009, has impacted broker-dealer revenue generation in terms of client activity levels, trading revenue and investment banking results. Additionally, we believe that 2Q results will be more divergent across the Street, driven more by relative positioning for the moves this quarter." The key reasons for the Barclays cut: "The largest downward revisions are in lower core FICC (-40% seq to $4.49bn, -$1.18 EPS), lower core equities (-40% seq to $1.4bn, -$0.75 EPS), weaker investment banking (-37% seq to $743mm, -$0.39 EPS) and the inclusion of$650mm of UK bonus tax (-$0.90 EPS)." The Q2 financial earning season just got interesting.

In an exclusive report Reuters' Matt Goldstein has uncovered the mystery seller of 75,000 E-Mini contracts during the market melt down. And no, it's not Nassim Taleb as previously reported: the culprit for soaking up ES liquidity (if indeed the selling of 75,000 50x S&P equivalents is enough to throw the market into a 10% tailspin): the "hedging" party is small Kansas-based advisor and asset manager Waddell & Reed (yeah, that was our reaction too). This information is based on an internal CME report which has yet to be disseminated to the general public. Yet the biggest question is not why Waddell trade what it did, when it did, but why did Barclays, which executed the trade for Waddell, stuff the massive order into the pipe, without breaking it up into a thousand child orders first. This is borderline criminal negligence, with Barclays basically begging for their "best executions" practices to be front run by every single algo in existence.

Earlier today we posted the unredacted version of the 5th volume of the Lehman Examiner report, which unhid all the specifics of the unwind related to Lehman's options and futures positions. There was a reason why Goldman et al felt sufficiently motivated to make the data hidden in the first place. The reason: the banks participating in the liquidation made a killing on the unwind. Yet another involuntary gift from the Lehman creditor estate to the big banks who had the inside scoop on Lehman's books all along, and certainly in the days just before the bankruptcy was announced. The market continues to be one for the banks, and one for "everyone else." And "everyone else" still can not borrow at the Discount Window. Although we are confident that that may change soon. At least in the meantime, Anton Valukas scores one for honesty and transparency, and "concludes that an argument can be made that the transfers at issue were fraudulent." Which means Goldman can likely be sued for ripping off Lehman.

Summarizing last week's key economic releases in a few simple charts, as well as an overview of Barclays' macro outlook for the rest of the year.

Yesterday we asked just who the counterparties on Lehman's Repo 105 transactions were. Today we get our answer: the parties that Lehman used exclusively to mask its true leverage ratio were Barclays, Mizuho, UBS, Mitsubishi, Deutsche Bank, KBC and ABN Amro. This is accompanied by disclosure from the Examiner that these Repos, which should logically have been cheaper to Lehman due to the overcollateralization compared to regular matched repo (remember: 105 instead of 100 plus a minor haircut), in fact were pricier, prompting Lehman staffers such as Mike McGarvey to speculate that counterparties may "try to squeeze Lehman." This is quite a critical development ahead of the lawsuit between the Lehman estate and Barclays (a Repo 105 counterparty), which not only refused to bail out Lehman in the 11th hour, but to subsequently go ahead and in the definition of a fire sale acquire Lehman Brothers' North American brokerage operations for pennies on the dollar, coupled with some serious additional trickery on the side. Another oddity: none of the counterparties were US-based. Did US banks know too well about the imminent collapse of Lehman and thus refuse to participate in the Repo 105 window dressing game? Or, much more relevantly, was Lehman terrified by retaliation of its US-based peers, (be it CDS or stock-based) and as a result refused to open up its deplorable balance sheet to them?