Rounding Error, Short Squeeze, And Cost Of Recap

Via Peter Tchir of TF Market Advisors

Job report definitely better than expected, but if 50k comes from the striking Verizon employees coming back to work it is less impressive.  Underemployment continues to be weak.  It also seems strange that strength in hiring came in services; whereas, employment in the ISM Services report was weak.  Anyways, not a bad report, but nothing overly exciting in a country this large.  I was trying to find out how many cities over 20,000 people the country has?  How many people per city got jobs?  I think if we reported the number on that basis, 100k would still bring tears to the eyes in a country that has seen jobs ravaged.  It's not even worth talking about the quality of the jobs or what they pay.  I have heard that this number takes the double dip talk off the table.  I am not sure why it would do that.  It indicates we haven't double dipped yet, but certainly doesn't take it off the table.

The rally has been strong across many products, but once again has all the signs of a short squeeze rally.  The weakest and most beaten up sectors and names have performed the best.  Anything that was a "hedge" tool, has also outperformed.  In credit, IG17 is trading at 138 which is about 8 bps rich to intrinsics.  That means that the index is outperforming the single names in CDS by a lot.  At this stage either single names will snap tighter or the index will revert as the "arbs" come in to close this gap.  Since the underlying bond market remains tentative (LQD is tighter on a spread basis, but lower in price, and stable on shares outstanding), I think it is likely that the indices will underperform single names.  Now is a good time to reset shorts in index.  The fact that price action has been one of the biggest factors in the price action is not a great sign.  That rationale can turn quickly and leaves a lot of weak longs in credit.

Dexia.....Dexia was going to be saved.  Then it was going to be good bank/bad bank.  All banks are going to get recapitalized.  Lots of rumors, lots of noise, and little action.  Why so little action?  Because little Dexia that was largely off the radar screen, has 570 BILLION EURO of assets.  It isn't that little and the risk some country or countries have to assume is not de minimus.  In fact the risk is large and figuring out who should bear what risk and who should take losses is not simple.  What we have seen over time, is that Europe is great at making announcements, but poor at following through.  And I'm not blaming them, what politician really wants to throw away a couple hundred billion of taxpayer money?  In reality, the only fact that we know for sure is that Dexia stock has been halted for almost 24 hours and its last price was 0.85 euro per share.  As bank shares have rallied on the recapitalization stories, has anyone bothered to ask what price the shares will be at after the recapitalization?  How much dilution with the governments want for their money?  Will it be punitive?  Before getting to excited about the prospect of government infusions for banks, investors should spend a few minutes figuring out if governments and citizens will want to take their pound of flesh as the cost for more infusions?  The governments may want to protect creditors of banks and prevent banks from failing, but it doesn't mean that they want bankers to be rich.  Maybe they will use AIG as an example of what a bailout should cost shareholders.

Anyways, this rally seems overdone.  European stocks and credit are sluggish today.  The data, while not bad, seems priced in already, and being long because "Europe gets it" is risky, because even if they finally get it, do they still have the resources to fix it, or a system that is simple enough to let them agree on how to fix it?  I am dubious, and at 1080 was willing to give some benefit of the doubt to the EU, but at 1170, I am happy to bet against them.

HY seems more attractive than stocks for a long in any case.  HYG experience a solid flush earlier this week and may be more resilient if we get another leg down.  Though for all the talk about low default rates, Friendly's filed for bankruptcy and the market seemed very willing to believe that EK and AMR were both on the verge of filing.  When default rumours aren't dismissed easily, there is probably a real nagging concern just below the surface.


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