The European Central Bank's (ECB) unprecedented use of a three year, low cost LTRO (Long Term Repurchase Agreement) policy initiative may have removed some of the short term pressures from the EU Banking crisis, but like the Greenspan PUT, the unintended consequences are not yet fully understood. One is the moral hazard which is fostering financial "games" to be played with reckless abandon. Some of the mischievous and cunning games are frankly questionably as being even legal! But then, nothing is illegal if the regulators and those organizations charged with surveillance are not bothering to investigate. Extend > Pretend > Bend is the new approach. MORE>>
The Global Markets have reached the point of waht can be best labeled as "Elevated Risk". Analytics measurements including Fundamenal Analysis, Techncial Analysis and Risk Anlysis all are independently signalling this along with warnings. This months report lays out the Risk Assessment, Risk Levels as determined by our proprietary aggregated Global Financial Risk Index, changes in Tipping Points and the Macro Risk-On, Risk-Off Drivers.
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The market action since March 2009 is a bear market counter rally that has completed a classic ending diagonal pattern. The Bear Market which started in 2000 will resume in full force when the current "ROUNDED TOP" is completed. We presently are in the midst of of a "ROLLING TOP" across all Global Markets. We are seeing broad based weakening analytics and cascading warning signals. This behavior is typically seen during major tops. This is all part of a final topping formation and a long term right shoulder technical construction pattern.
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Latest Public Research ARTICLES & AUDIO PRESENTATIONS
EURO EXPERIMENT : ECB's LTRO Won't Stop Collateral Contagion! Released December 27th, 2011
I would argue that the problem short term is a shortage of real collateral and that US dollar cash, versus 'encumbered' cash flow, is now king. It is clear that the rampant advancing Collateral Contagion will quickly eat the futile LTRO attempt like ravenous wolves. A well circulated Tweet from PIMCO bond king Bill Gross said it all: " What does LTRO stand for? 1- A shell game; 2-Cash for trash; 3 Three-card Monti; or 4. All of the above." Here is the stark reality of what forced the ECB to offer unprecedented three year loans at absurd rates and most alarmingly, the acceptance of collateral that no other financial institutions will accept. The ECB has sacrificed its balance sheet in yet another EU "kick at the can". MORE>>
04/15/2012 4:59 AM
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"BEST OF THE WEEK "
TIPPING POINT or 2012 THESIS THEME
HOTTEST TIPPING POINTS
SPAIN - The Reason CDS' Have Suddenly Exploded Upward
During March alone, the LTRO expanded by 433.236 billion but main refinance operations shrank by 87.821 billion. In March alone, 301.424 billion was parked right back with the ECB.
Please consider Spain -The Consolidated Balance Sheet of Banco De Espana
ECB system-wide lending in March went up by 39.690 billion euros. ECB lending to Bank of Spain alone jumped by 75.168 billion euros. Thus, lending shrank by 35.478 billion euros elsewhere. What did Spanish banks do with the money? They parked it in sovereign bonds are now underwater on the purchases. If you were looking for specific details as to why CDS rates for Spain hit an all-time high, there you have it
Spain CDS On Track For Record Close 04/13/12 Zero Hedge - Spanish CDS, at 493bps, have just pushed above their previous record wide closing levels (though remain a few bps below their record intraday wides at 499bps from 11/17/11). The Spanish bond market, which we have numerous times indicated does not reflect the economic realities since it is so dominated by LTRO-buying and government reach-arounds, remain 45bps off their record wide spreads to Bunds. BBVA (430bps) and Santander (415bps) are also close to their record wides back in late November as their stock prices plummet.
As Spanish CDS surge and bonds shrug off the very recent gloss of a 'successful' Italian debt auction,is the increasing dependence between Spanish banks, the sovereign's ability to borrow, and the ECB. As ING rates strategist Padhraic Garvey notes this morning, the bulk of the LTRO2 proceeds were taken down by Italian (26%) and Spanish (36% of the total) and the latter is even more dramatic given the considerably smaller size of Spanish banking assets relative to Italy. The hollowing out of the Spanish banking system, via encumbrance (ECB liquidity now accounts for 8.6% of all Spanish banking assets), is a very high number - on par with Greek, Irish, and Portuguese levels around 10% where their systems are now fully dependent on the ECB for the viability of their banks. His bottom line, Spain is not looking good here and while plenty of chatter focuses on the ECB's ability to use its SMP (whose longer-term effectiveness is reduced due to scale at EUR214bn representing just 3% of Eurozone GDP), consider what happened in Greece! The ECB did not take a Greek haircut and so the greater the amount of Greek debt the ECB bought, the greater the eventual haircut the private sector was forced to take. By definition, every Spanish bond that the ECB buys in its SMP program increases the default risk that private sector holders are left with. Only outright QE, a promise not to default and a willingness to expand the ECBs balance sheet with ownership of the entire stock of Spanish debt if necessary (in the extreme) would be enough to cause a material positive effect from ECB intervention but it is clear from the massive compression in German yields (and weakness in Spain) that the market remains nervous amid an ongoing preference for core. Of course the cycle of crisis, as BNP noted, from crisis to complacency is becoming more chaotic and less sustainable.
2- Sovereign Debt Crisis
SENTIMENT: Still Too Complacent, But Changing (As the Fed Wants & Needs)
CITI: Reasons To Be Worried 04/11/12 BI - Citigroup just published and distributed its Global Equity Quarterly report to clients. Robert Buckland, Citi's Chief Global Equity Strategist, recommends being underweight U.S. equities since he sees better opportunities elsewhere. Nevertheless, Tobias Levkovich, Citi's Chief U.S. Equity Strategist, sees the S&P 500 closing the year at 1,425. The massive 112-page report included each regional strategists' favorite charts. Levkovich's pick – the Panic/Euphoria model – is one we see over and over. But it's a good one. Last October, it predicted a 98 percent chance of a double-digit return in stocks, and it was right.
Investors sentiment is no longer depressed, per Citi's proprietary Panic/Euphoria model.
Citi's own Economic Surprise Index is rolling over.
The firms Cyclical Expectations Model is rolling over.
Margin pressures are building.
The election cycle is inevitably going to start bringing more uncertainty, especially as it relates to taxes and spending cuts in 2013.
On this note, Levkovich hits on a point he's made before about the significance of the election:
Furthermore, we suspect that more uncertainty with respect to the upcoming US Presidential/Congressional elections will develop in the next few months, especially as investors begin to consider the reality that tax cut and spending programs will expire at the end of 2012 alongside the sequestration process that will account for 3.4% of GDP in 2013 if nothing gets enacted. We would further point out that who wins the elections will probably have inordinate influence on the direction of four areas of the market (financials, health care, energy and defense) that collectively account for nearly 40% of the S&P 500’s market cap. As such, one has to recognize that some near term market performance risk is increasing.
Bullish Sentiment Collapses 04/12/12 BeSpoke - Investors have been extremely skittish throughout this entire bull market due to the bad taste left in their mouths from the crash during the financial crisis. This skittishness has caused investors to head for the hills at the slightest hint of a pullback, and we saw this once again over the last week. With the S&P 500 down more than 4% from its bull market highs, AAII Bullish Sentiment fell from 38.17% down to 28.14% over the past week, or 26.28%. (AAII Bearish Sentiment rose 49.5% as well.) Over the last five years (which includes the financial crisis and the current bull market rally), AAII Bullish Sentiment has had a weekly drop of 25% or more 19 times.
33 - Public Sentiment & Confidence
US FISCAL CLIFF: December 31st Post Election Cliff Looms
If there are no changes to current law, 2013 promises to bring a big wave of fiscal tightening. This is due to the fact that spending cuts are kicking in at the same time that the Bush tax cuts are due to expire. According to a chart from Nomura, it's theoretically possible that fiscal contraction could knock 5% off of GDP. But at least then we'll be cutting the debt, right? Not so! A chart in Richard Koo's latest monster presentation shows what happened in Japan when they tried fiscal consolidation during their long balance sheet recession. Both times the economy got dramatically worse, and the deficit EXPANDED. Not only did things get bad, but the theoretical benefit didn't happen either. Figuring out a way to defuse the 2013 fiscal bomb is critical.
CENTRAL BANKS - Monetary Policy Can't Solve the Growth Problem
Spain (and less so Italy) has decompressed to its worst levels of the year (5.96% yield and 425bps spread on 10Y) has now lost all of the LTRO gains as the curves of these liquidity-fueled optical illusions of recovery bear-flatten (as front-running Sarkozy traders unwind into the sad reality - most specifically for Spain - that we described in glorious must read detail here). Divergence and decoupling remain sidelined also as Deutsche Banks' Jim Reid notes the 4-week rolling beat:miss ratio in the US macro data has fallen to 24%: 73% (3% in line) from a recent peak at a string 70%:30% on February 29th. His view is still that in a post crisis world, especially as severe as the one we've just been through, Western growth is going to continue to be well below trend for many years and with more regular cycles. With Spain teetering on the verge of a 6% yield once again, we are still off the record wides from late November but not by much as the vicious cycle of sovereign-stress-to-banking-stress-to-banking-stress re-emerges in style. The European situation is still incredibly political and while we'd expect much more intervention down the line, expect the discussions and rhetoric to be fairly tough. The ECB last week indicated that they felt the recent widening in Sovereign spreads was more due to sluggishness in the pace of reforms. They are therefore unlikely to intervene in a hurry. So if Europe does need further intervention it is likely to need to get far worse again first.
US macro data is missing expectations more and more as US decoupling myths get exposed as seasonal adjustment folly...
And Europe's vicious cycle re-emerges as Yields...
And Spreads break to near record wides once again...
The eurozone crisis has returned with a vengeance after Spain’s mounting woes pushed 10-year bonds yields back to the danger line of 6pc and the Madrid bourse crashed to its lowest level since the 2009.
A disastrous debt auction last week was taken as a sign that Spanish banks have exhausted their LTRO money and can no longer prop up the Spanish state through this back-door funding, leaving the country nakedly exposed. Other buyers are scarce after the EU imposed a 75pc haircut on investors in Greece.
The Madrid bourse fell 2pc, led by banks. Short positions on Banco Santander jumped to 11.12pc of the total share base. Funds have built an extra 237m short positions in the past week alone.
Professor Jesus Fernandez-Villaverde from Pennsylvania University said the fiscal austerity imposed by the EU is deeply misguided. "Trying to cut the deficit from 8.5pc to 3pc in two years during a recession is a recipe for disaster. The Germans are crazy," he said.
The kind of dismal position Spain finds itself in currently has not ended well with 13 defaults since 1500 A.D. and he suspects its going to take a lot of bilateral aid and ECB financing to prevent another one.
Analysts expect to hear about two major themes this season:
1) higher energy and input costs and
2) weakening demand from the emerging markets and Europe.
Alcoa unofficially kicks off earnings season next Tuesday and it'll certainly set the tone more than ever. Currently, analysts expect the aluminum giant to report a 0.1 percent decline in earning per share. So goes Alcoa, so goes the rest of the stock market?
According to FactSet's data, analysts slashed the earnings estimates of for nine of the 10 major sectors.
Seven of the 10 major sectors are expected to see earnings decline year-over-year. The materials sector is expected to see the worst with a 14.5 percent decline in earnings.
As usual, Apple will be a big as the iPad maker accounts for nearly 4 percent of the market capitalization of the S&P 500 index. It is expected to be the largest contributor to earnings growth for the index. Excluding Apple, S&P 500 earnings are actually expected to fall by 1.6 percent.
While Alcoa unofficially kicks off earnings season next Tuesday, 25 companies have actually already reported Q1 earnings. Of them, 76 percent have beaten analysts' estimates.
Also, 105 of the S&P 500 have provided earnings guidance for the Q1 season. 67 of them, or 64 percent, have issued guidance that fell short of analysts estimates. However, this is an improvement from the 75 percent warnings rate going into the Q4 2011 earnings season.
As always, traders will be looking at how actual earnings do versus the expectations. Furthermore, they'll be listening for any clues regarding the outlook for the company and the economy as a whole.
It's quite possible the companies will announce earning declines, but see their stock go up if their language is relatively optimistic.
However, it has been years since investors have seen earnings decline. This could prove to be a shock to the system.
21 - US Stock Market Valuations
DARK POOLS & INTERNALIZATION - So Much for Opaque Markets
Some 37% of U.S. stock trading takes place away from exchanges, according to research firm Tabb Group. That’s up 3 percentage points from 34% just one month ago and “up dramatically from 15% in 2008,” Tabb Group says.
Dark pools account for only a small part of that jump. The much larger fraction comes from another growing area of off-exchange trading called “internalization.”
With internalization, big institutional investors match buy and sell orders internally, using their own inventory of stocks. Internalization has become one of the most controversial practices in the stock market in recent years.
Some critics say it has created an unhealthy trading environment because it separates most retail orders from the rest of the market. Firms that use the practice, for their part, say it helps guarantee fast response times and good prices for investors. But, just as is the case with dark pools, few investors have any idea about what goes on behind the scenes at internalizers.
Indeed, the story of Pipeline illustrates how investors, even large institutional firms, are often in the dark about what happens to their buy and sell orders on Wall Street. Pipeline misled its clients for years about the activities of its trading affiliate, Milstream Strategy Group, which interacted with the vast majority of orders on Pipeline, the SEC said. A senior official with the SEC’s enforcement division told the Journal that steps Pipeline took to misinform clients stood out starkly to investigators, following its probe. “Our fundamental point is that there’s a deception here,” said George Canellos, director of the SEC’s New York office and a lead investigator in the Pipeline case. “There’s no getting around that fact.” Pipeline officials didn’t admit or deny wrongdoing in their settlement with the SEC. But a Pipeline spokesman told the Journal, in an interview, that the firm had misinformed clients. Though the Pipeline investigation appears to have its own unique circumstances, it sent tremors through the trading world in October when the settlement became public, in part because it tapped into embedded fears regarding what investors can’t see in the fast-moving electronic markets.
What also seems clear is that the Pipeline matter, and separate investigations into how high-speed traders interact with exchanges and other investors, are adding to scrutiny of how murky markets work.
21 - US Stock Market Valuations
CORPORATE MARGINS - 2013 Margin Expectations Not Credible
At the end of January we first discussed the rolling over of corporate margins and sure enough the consensus for 2012 margin compression has turned our way with only 42% of the S&P 1500 now expected to increase net margins YoY. What is simply 'incredible', in the words of Morgan Stanley, is the jump from 2012 to 2013 expectations of net margins as this chart so well indicates. In 2013, 89% of firms are expected to miraculously rediscover their pricing power and increase net margins. Our word for this is 'magic'.
21 - US Stock Market Valuations
TRADE DEFICIT SHRINKS - Bad News Since it Always Leads Contracting GDP
24 - Shrinking Revenue Growth Rate
UNION PENSION UNDERFUNDING - More Accounting Gimmicks Hide the Stark Reality
The shortfall in US labor union pension funds is huge and growing rapidly.
The latest data, from 2009, from the PBGC showed that these multi-employer plans were 48% underfunded with $331bn of assets to support $686bn of liabilities - and it has hardly been a good ride for those asset values since then.
Critically, as the FT notes today, recent changes by FASB has enabled Credit Suisse to estimate shortfalls more accurately and it paints an ugly picture. The critical difference between reality and what is being reported is the ability for firms to use actuarial 'facts' to discount liabilities or compound assets at a 7.5% annual growth rate - as opposed to the sad reality of a financially repressed investing environment where returns swing from +20% to -20% in a flash forcing all funds into market timers and not long-term buy-and-hold growth players.
These multi-employer pension schemes cover over 10 million people concentrated in industries with highly unionized workforces such as construction, transport, retail and hospitality but of the shortfall only $43bn lies with firms of the S&P 500 - leaving the bulk of the burden on small- and medium-sized businesses once again.
It seems the number and size of unfunded (implicitly government) liabilities continues to rise or does this force pensions to follow Ben's path and increase exposure to hedge funds (which are underperforming in this serene rally so far this year) in an effort to meet these hurdle rates?
Either way it appears this under-appreciated drag on the real-economy as one after another small-, medium-, and large- (Safeway faces shortfalls larger than its market cap) businesses will need to eat into earnings to fund this shortfall.
25 - Pension - Entitlement Crisis
EARNINGS WARNINGS - Sony Cuts 10,000 - "Worst Ever Loss"
Here is a number for you: 70% That is roughly how many economic reports have missed their mark in the last month. Why is this important?
Markets don't run in one direction indefinitely - either up or down. The economy is a reflection of real employment, when you consider that 70% of the economy is made up of personal consumption, and ultimately the stock market is reflection of the economy. Therefore, while the markets and the real economy can detach from time to time, especially when driven by successive rounds of liquidity injections, reality will eventually play catch up with fundamentals. "Reversion" is the only truth that we can count on
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
While 'Apple is the market and the market is Apple' has been the mantra for much of the last few weeks, the last few days suggest a regime change. Apple is currrently trading down three days in a row (which is unusual in itself), having dropped the most in these three days since the middle of December. However, unlike the previous times when Apple dropped, the S&P 500 is ignoring it for two days in a row - something that has not occurred since mid-January and the largest divergence with Apple down 1.2% and the S&P 500 up over 2.1%. Are the professionals using the gap-fill market pump to sell into strength?
Quite a divergence for Beta 1...
and 3 down days in a row (red arrows) and two divergence days in a row (orange ovals) are unusual...
APPLE - If This Doesn't Bother You - Check Your Pulse!
Analysts see Apple shares continuing their unparalleled ascent. Currently worth around $586 billion, if Apple can get to around $590 billion, it would be worth as much as all of the companies in Europe's most debt-laden countries -> the combined market caps of all of the publicly traded companies in Spain, Portugal and Greece combined.
YTD performance of an equal-weighted S&P 500 relative to the normal cap-weighted S&P 500 has now reached its lows as the last 3 days have seen significant weakness of the equal-weighted (as large cap AAPL has dominated cap-weighted performance). Furthermore, as the chart shows, the 250bps of outperformance since mid-Feb coincides perfectly with AAPL's disconnect and parabolic rise...
The EURCHF may be the tipping point for a new round of financial instability. I see this tipping into the dark side. I see this happening before week’s end.
There is evidence that money continues to poor into Switzerland. Six month T-bills are now trading at -25%. That the short end of the curve is trading at negative levels is not all that surprising, but the Swiss two-year went negative earlier today. There is only one thing that can make the 2-year go negative. Demand. Hot money is getting converted into Francs, and then it is pushed forward in the swaps market.
The swaps and bond market are showing that that money is coming into the Franc in a significant way. But the EURCHF has not touched on the magical 1.2000 level and there has been no reported Swiss National Bank (SNB) intervention. This does not add up.
1) Some very big (and ballsy) prop desk/ hedge fund is shorting the CHF to the market and using the negative cost of money as a carry trade to fund other investments. This is a beautiful trade as one is “guaranteed” not to lose money on the short CHF position because the SNB has “guaranteed” that the Franc will not exceed 1.2000.
While this is possible, I consider it unlikely. The negative cost of money may look attractive on paper, but there is no real guarantee from the SNB that the peg will last for the next two years. Money is cheap and available in other currencies all over the globe right now; there is no need to gamble the house to save another ½ percent on funding costs. If the peg were to break, that ½ percent savings would turn into a 20% loss. The risks and rewards of shorting the Swissie just don't justify it.
2) The SNB is involved with “sub rosa” intervention in the currency market. It may be using one or more banks (to make it look like commercial buying interest) to bid for Euros above the 1.2000 peg rate. Alternatively, the SNB may be offering EURCHF FX options to market makers.
I think #2 is happening. The SNB is quietly doing its best to avoid a visible and splashy round of intervention. If true, the SNB will have to back off in the near future and allow the Franc to trade at the 1.2000 peg. At that point it can be as aggressive as needed.
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