Merrill Lynch

Frontrunning: January 27

  • Greek Debt Wrangle May Pull Default Trigger (Bloomberg)
  • Italy Sells Maximum EU11 Billion of Bills (Bloomberg)
  • Romney Demands Gingrich Apology on Immigration (Bloomberg)
  • China’s Residential Prices Need to Decline 30%, Lawmaker Says (Bloomberg)
  • EU Red-Flags 'Volcker' (WSJ)
  • EU Official Sees Bailout-Fund Boost (WSJ)
  • EU Delays Bank Bond Writedown Plans Until Fiscal Crisis Abates (Bloomberg)
  • Germany Poised to Woo U.K. With Transaction Tax Alternative (Bloomberg)
  • Ahmadinejad: Iran Ready to Renew Nuclear Talks (Bloomberg)
  • Monti Takes On Italian Bureaucracy in Latest Policy Push to Revamp Economy (Bloomberg)

Frontrunning: January 24

  • Fears Mount That Portugal Will Need a Second Bailout (WSJ)
  • EU to Have No Deadline for End of Greek Talks (Bloomberg)
  • Japan economy predicted to shrink in 2011 (AFP)
  • Japan’s Fiscal Pressure Intensifies as Tax-Boost Plan Insufficent: Economy (Bloomberg)
  • Berlin ready to see stronger ‘firewall’ (FT)
  • Obama Speech to Embrace U.S. Manufacturing Rebirth, Energy for Job Growth (Bloomberg)
  • EU Hits Iran With Oil Ban, Bank Asset Freeze in Bid to Halt Nuclear Plan (Bloomberg)
  • China's Oil Imports from Iran Jump (WSJ)
  • Croatians vote Yes to join EU (FT)
  • Japan’s $130 Billion Fund Unused in Biggest M&A Year in More Than Decade (Bloomberg)
  • Buffett Blames Congress for Romney’s 15% Rate (Bloomberg)

The CDS Market And Anti-Trust Considerations

The CDS index market remains one of the most liquid sources of hedges and positioning available (despite occasional waxing and waning in volumes) and is often used by us as indications of relative flows and sophisticated investor risk appetite. However, as Kamakura Corporation has so diligently quantified, the broad CDS market (specifically including single-names) remains massively concentrated. This concentration, evidenced by the Honolulu-based credit guru's findings that three institutions: JPMorgan Chase, Bank of America, and Citibank National Association, have market shares in excess of 19% each has shown little to no reduction (i.e. the market remains as closed as ever) and they warn that this dramatically increases the probability of collusion and monopoly pricing power. We have long argued that the CDS market is valuable (and outright bans are non-sensical and will end badly) as it offers a more liquid (than bonds) market to express a view or more simply hedge efficiently. However, we do feel strongly that CDS (indices especially) should be exchange traded (more straightforward than ever given standardization, electronic trading increases, and clearing) and perhaps Kamakura's work here will be enough to force regulators and the DoJ to finally turn over the rock (as they did in Libor and Muni markets) and do what should have been done in late 2008 when the banks had little to no chips to bargain with on keeping their high margin CDS trading desks in house (though the exchanges would also obviously have to step up to the plate unlike in 2008).

Fed Back To Its Secretive Ways, Sells $7 Billion In Maiden Lane Assets Directly To Credit Suisse Without Public Auction

Instead of opting for a publicly transparent BWIC in the disposition of its Maiden Lane II assets, the Fed has once again gone opaque - long a critique of the Fed's practices which have required repeated FOIAs in the past to get some clarity on its secret bailouts and transactions - and proceeded with a private sale, without any clarity on the deal terms, in which it sold $7 billion in face amount of Maiden Lane II assets direct to Credit Suisse. The alternative of course would be the same snarling of the MBS and broadly fixed income market that we saw in June of last year. In other words, the Fed looked at the options: transparency and risk of grinding credit demand to a halt, or doing what it does best, which is to transact in the shadows, and avoid capital markets risk. It opted for the latter. As to why the Fed decided to go ahead with a deal shrouded in secrecy? "The New York Fed decided to move forward with the transaction only after determining that the winning bid represented good value for the public." "I am pleased with the strength of the bids and the level of market interest in these assets," said William C. Dudley, President of the New York Fed. Because if there is one thing Bill Dudley and the Fed knows is gauging what is in the best interest of the public... and the callorie content of the iPad of course.

David Rosenberg On The Difference Between The Buy And Sell Sides, And What He Is Investing In Right Now

While part of Merrill Lynch, David Rosenberg was always an outlier, in that he never sugarcoated reality, and could always be relied upon to expose the dirt in the macro and micro picture, no matter how granular or nuanced, and how much it conflicted with other propaganda research to come from the bailed out broker. Then three years ago he moved to Canadian investment firm Gluskin Sheff, transitioning from the sell side to the buy side, yet for all intents and purposes his daily letters, so very appreciated by many, never ceased, in essence making him a buysider with an asterisk - one who daily shares his latest vision with the broader public, in addition to his personal investment team. In one of his last letters of the year, Rosie presents a detailed breakdown of all the key differences between the sell and buyside, at least from his perspective, and also how, now that he manages other people's money, he is investing in the future. To wit: "In my former role as chief economist at Merrill Lynch, I flew all over the world and saw all the legendary portfolio managers from Paul Tudor Jones to Jeremy Grantham to John Paulson to Bill Gross — at least three or four times a year. Now the only PM's I speak to are our PM's. Not that they "have to" agree with all of my calls, but I am here as their economic concierge 24/7. The same holds true for our clients. In my previous life on the "sell side", it was very rare for me to sit down one-on-one with private clients. Today, that takes up a good part of my day — helping our client base make investment decisions that will build their wealth in a prudent manner over time." As for what he likes (and dislikes) we will leave it up to the reader to find out, but will note that Rosie appears to take issue with being labelled a permabear. And why not: he has been far more right than not since the December 2007 start of the Second Great Depression.

The Bull, Bear, And Secular Case From BofAML

While consensus forecasts for next year continuing to be muddle-through mediocrity with a crashtastic defensive bias, BofA Merrill Lynch provides a very succinct outline of the bullish, bearish, and interestingly secular cases for risk assets going forward. The cross-asset class implications are noteworthy and provide an excellent jumping off point for asset allocation decisions. We are not sure the seeming knife-catching perspective of "buying humiliation and selling hubris" will work out, but one thing is for sure, with this volatility, relative-value remains the critical alpha as beta chops everyone up. Once again the bull case relies heavily on government printing presses and the bear case on the reality of debt saturation breaking through.

Cheap Macro Hedges And How VIX Has Always Been A Poor Early Warning Signal

We have time and again pointed to the warning signals being sent from credit markets, FX volatility skews, and equity option volatility technicals (skews and implied correlation) but while the mainstream media is behooven to watching every tick in the 'fear index', the 'simple' VIX has consistently underpriced risk in the face of danger. Furthermore, this implicit optimism, leaves equity options among the cheapest macro hedges across asset classes currently (especially relative to FX, Rates, and Credit). FX options offer the next cheapest hedge with credit already notably stressed. BAML's research group finds Nikkei (Japan), Nifty (India), and ASX200 (AUS) puts attractive as global macro (crash beta) hedges with Copper, IG, and HY credit the least attractive at current levels. So the next time you hear the VIX is up or down or sideways, treat it with the contemporaneous weighting it deserves (or potentially discount its eternal optimism entirely) and remember that while VIX is frequently cited, the availability bias needs to be suppressed when investing.

Guest Post: Psychopathic Economics 101

Psychopaths flew financial weapons of mass destruction (derivatives) into the twin towers of our economy, the housing market and the stock market.  Ten trillion dollars of wealth imploded in a cloud of dust. Ninety-nine percent of the economic experts – financial planners, economists, economic professors, brokers, and investors – missed the largest bubble in history as well as the systemic risk that the bubble posed. The National Board of Economic Research (NBER) (who is responsible for declaring a recession) was 9 months late calling the worst recession since the Great Depression.

RickAckerman's picture

Our good friend Doug B., a financial advisor based in Boulder, CO, has done well for his clients by keeping them heavily weighted in bonds. In the essay below, he explains why he intends to stick with this strategy even though many of his peers expect a rebounding stock market to outperform fixed-incomes in the years ahead.  For Baby Boomers in particular, the deflationary trend that buttresses Doug’s strategy holds stark implications.