Lehman

Bond Model: Sell Signal


Sunday, July 15th, 2012

 

by Guy Lerner, The Technical Take

Our bond model has issued a sell signal.

The bond model is based upon intermarket variables including inputs from commodities and utilities.  The model first issued a buy signal on March 30, 2012.  Since that time the Vanguard Total Bond Market Fund (symbol: BND) is up 1.9%.  This ETF also closed at a new all time high on Friday.  The i-Shares Lehman 20 + Year Treasury Bond Fund (symbol: TLT) is up 15% since March 30, 2012.  The out performance of TLT is thought to be due to Operation Twist, as the Federal Reserve has been actively buying at the long end of the yield curve to push down interest rates.  From March 30, 2012 to July 14, 2012, the SP500 loss 3.7%.

It has been my contention that the buy signal back in March was an early sign of economic weakness.  This has turned out to be the case over the past 3 months as important data inputs, like ISM and unemployment,  have been softer than expected.  I don’t believe we are in recession (personal data), and at best, the US economy has stabilized with growth being below trend.

From a technical perspective, TLT looks like one of the best charts in my Chart Book.  See figure 1, a weekly chart.  Price must remain above the 128.52 key pivot point (support level) to avoid being a double top.  Considering that our fundamental model has issued a sell signal, I would suspect TLT will struggle going forward.

Figure 1. TLT/ weekly

 

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The FED and LIBOR – The Biggest Manipulator of Them All


Thursday, July 5th, 2012

 

by Peter Tchir, TF Market Advisors

The Fed does everything it can to keep Libor low

This chart says it all.

The Fed cannot affect LIBOR directly, but in general LIBOR trades in line with Fed Funds. You can see that historically as Fed Funds was changed, LIBOR responded appropriately. There was typically some small premium to reflect the “credit risk” of banks versus the Fed, but it was relatively small, and fairly stable. 3 Month LIBOR would deviate a bit as rate cuts and hikes were anticipated in the market, but in general, it was a fairly stable game.

That all started to break down in 2007. We saw the first real signs of LIBOR deviating from its normal spread to Fed Funds in the summer of 2007. The Fed responded by cutting the “penalty” rate for using the discount window, and in fact encouraged banks to use the discount window (I still can’t shake the mental image of someone sitting in a dark basement with a green eye-shade doling out money to banks that request it). Then the crisis got worse. Bear needed to be rescued. Facilities such as the Term Auction Facility that had been put in earlier were increased in size. The Fed backstopped some portfolios that JPM acquired as part of the Bear Stearns deal.

As the crisis re-ignited in the late summer of 2008 and peaked after Lehman and AIG, the Fed took step after step to reduce borrowing costs. The Fed was blatantly clear that it wanted borrowing costs to go down. They had the obvious tool of reducing Fed Funds to virtually zero, but when LIBOR didn’t follow, the Fed took further action. The Fed did not want bank borrowing costs to be high.

They increased dollar swap lines so foreign banks could borrow. The Fed stepped into the commercial paper market so banks wouldn’t have to use money to meet drawdowns on revolvers. TALF was another creation to take pressure of bank lending.

The FDIC allowed banks to issue bonds with FDIC backing (so not quite Fed program, but who is going to quibble).

Fears that MS and GS and GE would topple the banks were alleviated by making them banks.

The list goes on. The Fed has done a lot and trying to control LIBOR as a key borrowing rate is one of the things they have worked on, both directly and indirectly.

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Killing Vampires, Werewolves, and Zombie Banks (Tchir)


Thursday, June 7th, 2012

 

by Peter Tchir, TF Market Advisors

We all know how to kill a vampire and a werewolf. For vampires you need to either trap them in sunlight or drive a wooden stake through their heart. For werewolves, you need a silver bullet. Or at least you did before the Twilight series came out. But killing a zombie bank isn’t necessarily as easy.

We all get caught up in the moment. Every tick down in the stock market adds to the fear and anxiety. Every tick up sends waves of relief through the economy. The reality the stock market and economy move at dramatically different speeds, and that is the case for bank failures as well.

While it is true that occasionally banks or companies default overnight or in very short order, that isn’t the norm. Even Lehman was a known problem for ages. Its debt traded very wide off and on for a year ahead of the eventual default. It was on the cusp when Bear Stearns got saved. Lehman got saved that time without a dime being given to it. It squandered its chance and failed to raise money in the 6 months after Bear, but it did last a long time.

Weak banks can linger for a long time, especially if someone is willing to provide them liquidity at non market (stupid) rates. Rescap affectionately known as Rescrap, although not a bank is a great example.

A solvency problem can’t be solved by liquidity, but if there is a lender willing to provide as much liquidity as it takes, and rates that make no sense for the risk, the default can be pushed off for a long time. It can be delayed much longer than we think and in some cases, avoided all together. While Rescap finally met its fate it should probably have met in 2007 or 2008, MBIA seems to have turned the corner.

MBIA has lasted this long because it didn’t require much funding and time has given it the chance to earn carry and avoid payouts.

While neither Rescap nor MBIA are banks they are decent examples of how long it can take to play out.

In the U.S. only Lehman and Washington Mutual failed. At the last moment Bear Stearns and Merrill were “saved”. Others have lingered along in various states of disrepair for a long time with full government support.

That is the key when looking at the crisis in Spain or at Bankia in particular. A solution of lots of fresh equity capital tomorrow would be ideal. But just because we don’t see capital injections tomorrow doesn’t mean it is about to default or go into full unwind mode. Unlimited 3 month LTRO and other ECB and Spanish facilities can keep it alive for quite some time, so expecting it to be an immediate catalyst to a huge down move is as likely to be true as those that hope for some magic plan from the ESM to make it all better.

Time is the key, and horrible headlines aside, it is easier to kill a vampire or werewolf than it is to kill a bank with an unlimited supply of cheap money.

Central Bank Activity

Our scorecard from yesterday continues to fill in. We didn’t get global swap lines, but we did get a China rate cut, so +1. We didn’t get a rate cut, so -1/2, but they did mention some members had voted for a rate cut, so take that as a zero, with a running total of +1.

Unlimited 3 month LTRO, wasn’t on our list but call that a +1/2. 3 year would have been better, but the focus on unlimited was good. So we are at +1.5 so far in total.

Away from that, the ECB didn’t really do much else, but Germany or someone floated a rumor that the EFSF or ESM could lend to some Spanish entity other than Spain which could then recapitalize the banks. I don’t know the source and it is so convoluted that it is unlikely to work, yet convoluted enough it seems likely some politician is really looking at it. Call that +1/2 max, but when coupled with further rumors that ESM will either get a banking license or have a lots of ECB support, lets call all the rumors and “wink wink” signals as a +1 in total. That gets us to 2.5.

The ECB did put it back on the politicians, but not as belligerently as they could have so only -1/2.

Extremely dovish Fed comments added back at least +1, giving us a current total of +3 heading into Bernanke’s testimony.

After yesterday’s comments, by Yellen in particular, it is hard to imagine anything other than an actual announcement by Ben doing a lot for the market and he could easily undo the work done by Yellen.

Still Targeting May 11th Prices

In addition to the central bank push encouraging risk on, and the overreaction to the Spanish banking crisis, I was surprised that the Spanish sovereign debt auction got done. I suspect that the banks were told to buy and some CDS short covering bids were put in, but it is still a minor positive and far better than pulling the auction.

I was also surprised just how short the market seemed to trade. I thought we were oversold, but the market traded even more short than I would have guessed.

I think the banks can be a catalyst for yet another leg higher. Clearly I’m getting nervous back up at these levels, but I think we can achieve the May 11th prices. Everyone again seems to be fading this rally or too bitter that we are moving up on a Chinese rate cut. No one has embraced the trade off the lows and too many funds seemed to have gotten whipsawed that the pain of this up move isn’t quite over.

Look for a continued bounce in HY and EM debt denominated in dollars. U.S. treasury rates aren’t going up any time soon, the search for yield will resume, and high yield will benefit from a sluggish, but stable economy, and EM will benefit from the “reflation” trade the central bankers so desperately want to see happen.

 

Copyright © TF Market Advisors

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How Many Times Have We Heard That This is the Death of Bonds?


Friday, June 1st, 2012

 

by Guy Lerner, The Technical Take

I know they don’t move much, but in these turbulent times, just getting your principal back from an investment is a winning proposition.  I have been bullish on bonds since March 30, 2012, and at the time, I suggested that this was an early sign of economic weakness, and on April 23 I wrote: “A topping equity market appears to be a sign of an economy that has peaked as well.  This has been heralded by strength in bonds.  Most likely, this is signaling further quantitative easing as the Federal Reserve intervenes in the bond market to prop up the economy and the equity markets.“

So fast forward to this week, and we note the following.  The calls for the death of bonds has been pre-mature.  Once again!  How many times have we heard this over the past several years?  Yes, they are boring, and yes, the market is very distorted courtesy of the Federal Reserve.  But since April 30, the Vanguard Total Bond Market ETF (symbol: BND) is up 1.42% while the SP500 is down nearly 7%.  The i-Shares Lehman 20 + Year Treasury Bond Fund (symbol: TLT) is up nearly 13% in this time period.  Of course, hindsight being nearly 20/20, this suggests the Fed is continuing its purchases at the long end of the curve, and in all likelihood, the next round of quantitative easing will target these maturities as well.

For the record, figure 1 is a weekly chart of the TLT.  Note the breakout to new all time highs.  Even to the equity bulls this must mean something.  Right?

Figure 1. TLT/ weekly

 

Copyright © The Technical Take

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Run, Don’t Walk (Hussman)


Monday, April 23rd, 2012

 

by John Hussman, Hussman Funds

We currently estimate the prospective 10-year total return on the S&P 500 at about 4.5% annually, in nominal terms, based on our standard valuation methodology. This may not seem bad, relative to 2% yields on the 10-year Treasury bond, provided that investors actually consider either figure to be an adequate 10-year investment return, and provided that they view 4.5% annual returns as adequate compensation for securities that have several times the volatility of a 10-year Treasury bond (especially when yields are low), and provided that investors ignore the fact that prospective market returns tend to enjoy a significant range over the course of the market cycle, so that “locking in” present prospective returns must necessarily forego any higher prospective return that might be observed in the coming decade. Even given robust growth in GDP and corporate revenues, a move to prospective returns of just 6% at some point in the next two years would likely leave investors with no return (including dividends) in the interim (see Too Little to Lock In).

Wall Street continues to focus on the idea that stocks are “cheap” on the basis of forward price/earnings multiples. I can’t emphasize enough how badly standard P/E metrics are being distorted by record (but reliably cyclical) profit margins, which remain about 50-70% above historical norms. Our attention to profit margins and the use of normalized valuation measures is nothing new, nor is our view that record profit margins have corrupted many widely-followed valuation measures. As I noted in our September 8, 2008 comment Deja Vu (Again), which happened to be a week before Lehman failed and the market collapsed, “Currently, the S&P 500 is trading at about 15 times prior peak earnings, but that multiple is somewhat misleading because those prior peak earnings reflected extremely elevated profit margins on a historical basis. On normalized profit margins, the market’s current valuation remains well above the level established at any prior bear market low, including 2002 (in fact, it is closer to levels established at most historical bull market peaks). Based on our standard methodology, the S&P 500 Index is priced to achieve expected total returns over the coming decade in the range of 4-6% annually.” Present valuations are of course more elevated today than they were before that plunge.

Suffice it to say that every P/E multiple is simply a shorthand for proper discounted cash-flow methods, because there are countless assumptions about growth, margins, return on invested capital and other factors quietly baked inside. Like price-to-forward operating earnings multiples, even our old price-to-peak earnings metric has been rendered misleading due to historically high profit margins. Of course, we knew that was happening even before the credit crisis began, and believe that numerous widely-followed valuation measures remain distorted by record profit margins here.

On the economic front, the recent uptick in new unemployment claims is consistent with the leading economic measures and “unobserved components” estimates that we obtain from the broad economic data here (see the note on extracting economic signals in Do I Feel Lucky?). Indeed, it will be difficult to get the expected flat or negative April employment print if weekly new claims don’t rise toward about 400,000 in the next few weeks. We’ve seen “surprising” weakness in some of the more recent regional surveys such as Empire Manufacturing and Philly Fed. A continuation of that trend would also be informative.

As I noted a few months ago, “examining the past 10 U.S. recessions, it turns out that payroll employment growth was positive in 8 of those 10 recessions in the very month that the recession began. These were not small numbers. The average payroll growth (scaled to the present labor force) translates to 200,000 new jobs in the month of the recession turn, and about 500,000 jobs during the preceding 3-month period. Indeed, of the 80% of these points that were positive, the average rate of payroll growth in the month of the turn was 0.20%, which presently translates to a payroll gain of 264,000 jobs. Notably however, the month following entry into a recession typically featured a sharp dropoff in job growth, with only 30% of those months featuring job gains, and employment losses that work out to about 150,000 jobs based on the present size of the job force. So while robust job creation is no evidence at all that a recession is not directly ahead, a significant negative print on jobs is a fairly useful confirmation of the turning point, provided that leading recession indicators are already in place.” (see Leading Indicators and the Risk of a Blindside Recession).

The upshot is that while I expect a weak April jobs report, we should hesitate to take leading information from what remains largely a short-lagging indicator. We’re already seeing deterioration in economic data, but it remains largely dismissed as noise. An acceleration of economic deterioration as we move toward midyear would be more difficult to ignore. My impression is that investors and analysts don’t recognize that we’ve never seen the ensemble of broad economic drivers and aggregate output (real personal income, real personal consumption, real final sales, global output, real GDP, and even employment growth) jointly as weak as they are now on a year-over-year basis, except in association with recession. All of these measures have negative standardized values here. My guess is that we’ll eventually mark a new recession as beginning in April or May 2012.

Emphatically, however, our concerns about the stock market continue to be independent of these economic expectations, as the hostile investment syndromes we’ve seen in recent months have historically been sufficient to produce very negative market outcomes, on average, even in the absence of economic strains (see Goat Rodeo and An Angry Army of Aunt Minnies). As always, I strongly encourage investors to adhere to their disciplines – including those following a buy-and-hold approach – provided that they have carefully contemplated the full-cycle risk and their ability to stick to their strategy through the worst parts of the investment cycle. What I am adamantly against is the idea that speculators can successfully “game” overvalued, overbought, overbullish markets – particularly in the face of numerous hostile syndromes, near-panic insider selling, speculation in new issues, and broad divergences in market internals, all of which we are now observing.

In the absence of hostile syndromes like we observe today, we generally have more equanimity about market prospects – recognizing the average outcome, but also emphasizing the wide range of individual outcomes associated with a given set of market conditions. The majority of our past market comments are filled with reminders that our expectations are based on average return and risk characteristics, and should not be taken as forecasts about any specific instance. At present, the outcomes that have historically emerged from similar conditions are so uniformly negative that too much equanimity would be misleading.

One way to gauge your speculative exposure is to ask the simple question – what portion of your portfolio do you expect (or even hope) to sell before the next major market downturn ensues? Almost by definition, that portion of your portfolio is speculative in the sense that you do not intend to carry it through the full market cycle, and instead expect to sell it to someone else at a better price before the cycle completes. With respect to those speculative holdings, and when to part with them, my own view is straightforward. Run, don’t walk.

Notes on banking and monetary policy

Banks continue to report seemingly pleasant earnings, as long as one doesn’t look under the hood at the drivers of those reports. Two drivers have been particularly important this quarter. One is the further reduction of reserves against future loan losses, which shows up as a positive contribution to bank earnings. For example, a decline in loan loss reserves was the source of about one-third of the earnings reported by Citigroup. The other driver is something called a “debt valuation adjustment” or DVA. You might recall that as a result of European credit strains last year, investors sold off the bonds of major banks. In the world of bank accounting, the debt was therefore cheaper to retire, so – I am not making this up – the decline in the value of the bonds was booked as earnings. Of course, the value of bank debt has recovered somewhat since then, as investors have set aside concerns about Europe (which we doubt is a good idea). One might expect that since banks booked DVA as a contribution to earnings last year, we would see the opposite effect this quarter. But one would be wrong. As Peter Tchir noted last week, “Morgan Stanley no longer includes DVA in its ‘continuing operations’ headline number. It was a loss of $2 billion this quarter. With 2 billion shares outstanding, that would have wiped out the gain. What bothers me, is that in Q3, when it was a gain of $3 billion, it was part of continuing ops.” It was the same story at Bank of America, prompting one analyst to observe “one-time items are to be ignored when negative, and praised when providing a ‘one-time benefit.’”

Tyler Durden of ZeroHedge has started referring to the Federal Reserve as simply “CTRL+P” – which is brilliant, because it really captures the full intellectual content of Fed policy in recent years. Keep in mind that when the Fed engages in quantitative easing, it purchases Treasury securities and pays for them by creating new base money. From an equilibrium perspective, the U.S. government has financed its deficit in recent years partly by issuing new Treasury debt that was bought by the public, and partly by printing money that is now held by the public (corresponding to the Treasuries bought by the Fed). Of course, the Fed can “unprint” the money, so to speak, by reversing its transactions, and selling those Treasury securities back to the public. But the Fed’s ability to do such massive selling without disruption is unproved, to say the least.

Some have asked why the Fed will ever need to reverse its transactions. Couldn’t the Fed just leave the monetary base out there and perpetually roll the Treasury portfolio forward? The answer depends on what sort of inflation we would like to observe, particularly in the back-half of this decade.

To put some structure on this question, I’ve updated our Liquidity Preference chart (1947-present), which illustrates the close relationship between nominal interest rates and monetary base per dollar of nominal GDP. Currently, the U.S. monetary base amounts to 17 cents per dollar of GDP – a level that is consistent with contained inflation only if short-term (3-month Treasury) yields are held below about 10 basis points. For more on the relationship between the monetary base, interest rates, nominal GDP and inflation, see Sixteen Cents – Pushing the Unstable Limits of Monetary Policy, and Charles Plosser and the 50% Contraction in the Fed’s Balance Sheet.

Think of it this way. The willingness of people to hold a given amount of base money, per dollar of nominal GDP, is intimately tied to the rate of return that they could get on an interest-bearing security. Higher interest rates reduce the demand for zero-interest cash. So if there is upward pressure on interest rates, and the Fed leaves the money supply alone, how do you reach equilibrium? Simple – nominal GDP becomes the adjustment variable. If there’s not enough real GDP growth to absorb the excess base money, prices rise to do the job.

Likewise, expanding the amount of base money per dollar of nominal GDP puts downward pressure on Treasury bill yields and short-term interest rates, but really only if there are no inflationary pressures in the system. Clearly, if inflationary pressures are present (suggesting that the monetary base is already too large), an expansion in the monetary base won’t produce lower interest rates. Rather, it will accelerate those inflationary pressures as nominal GDP is forced to keep up with the monetary base – even if real GDP isn’t growing at all. All hyperinflations are built on this dynamic. That said, it’s worth emphasizing that untethered money growth is invariably a reflection of untethered fiscal deficits (the central bank just buys the government debt and replaces it with money). So significant inflation is ultimately not a monetary phenomenon as much as it is a fiscal one.

In any event, the simple fact is that the Fed can sustain the current size of its balance sheet, without inflationary pressures, only to the extent that people (and banks) are willing to sit on idle, low or zero-interest money balances. In an environment of credit concerns and an increasingly likely implosion of the European banking system (where the fresh leverage taken to pursue the “Sarkozy trade” is now turning into leveraged losses), the short-term willingness to hold idle but “safe” cash balances is quite high. So in the event of additional credit strains, the ability of the Fed to go further out to the right on the Liquidity Preference curve is nearly unconstrained.

The problem is that this policy is inconsistent with any economic environment except one where credit is imploding and the Fed is running the whole show in setting short-term interest rates. As the Fed increases the monetary base, it becomes a greater and greater challenge to reverse those actions in the future. Getting into the position may be as easy as hitting CTRL+P, but getting out of the position promises to be a disruptive nightmare – not to mention the effect that these policies have in distorting financial markets, rewarding reckless lenders, punishing savers, and misallocating capital.

Notably, any exogenous pressure on short term interest rates to even 0.25% (on the 3-month Treasury yield), would effectively require the Fed to move back to the pre-QE2 monetary base in order to forestall incipient inflation pressures. Of course, the Fed could delay that outcome by boosting the interest it pays to the banking system for holding idle reserves. Then again, the Fed already has a balance sheet leveraged more than 50-to-1 against its own capital. So upward interest rate pressure would begin to induce capital losses on the Treasury securities the Fed has accumulated at low yields. Raising interest payments to banks would further strain the Fed’s balance sheet, producing an insolvent Fed while providing a fiscal subsidy to the banking system at taxpayer expense.

Needless to say, I don’t expect that all of this will end very well, but given that the full historical record captures inflation, deflation, recession, expansion, Depression, credit expansion, and credit crisis, we are prepared to respond to a wide range of possible events, without relying on the hope for perpetually high profit margins, endless monetary interventions, absence of major sovereign defaults, stability of the euro-zone, or avoidance of what we view as an oncoming recession. For now, both market and economic evidence remain negative, and we remain accordingly defensive. That will change, but we emphatically view present conditions as being among the most negative subset we’ve observed in the historical record.

Market Climate

As of last week, the Market Climate continued to be characterized by rich valuations and a variety of hostile syndromes (generally related to overvalued, overbought, overbullish conditions, and other variants that capture a general syndrome of “overextended market coupled with a loss of supporting factors”). This places market conditions among the most negative 1% of observations on record, particularly on a 6-18 month horizon, though shorter horizons are clearly negative as well here. Strategic Growth and Strategic International Equity remain tightly hedged. Strategic Dividend Value continues to be about 50% hedged, which is its most defensive position. In Strategic Total Return, we raised our exposure in precious metals shares to about 12% of net assets in response to recent price weakness in that sector. The ratio of gold prices to the XAU is now nearly 10-to-1, which is close to a record high. Historically, gold stocks have been treated as having “insurance” features, and their negative correlation with other stocks was accompanied by premium valuation multiples. At present, many precious metals shares have higher yields than most S&P 500 stocks, and are also significantly depressed relative to gold prices, which suggests a relative margin of defense even if gold prices were to decline substantially. This sector still has substantial volatility, which is why our exposure in terms of net assets is not aggressive (though we would likely increase that exposure on significant economic weakness). Overall, we’re comfortable shifting to a moderately higher exposure in this sector, recognizing that we may observe additional volatility as market conditions change. Strategic Total Return continues to hold a duration of just under 3 years in Treasury securities, and a few percent of assets in utilities and foreign currencies.

 

Copyright © Hussman Funds

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Garbage In, Garbage Adjustments, Garbage Out (Tchir)


Friday, April 20th, 2012

 

by Peter Tchir, TF Market Advisors

It is hard to ignore the fact that this year is shaping up a lot like 2011 and 2010. I’m not a big fan of seasonal patterns, so what else could it be. Could it just be that all of our adjustments are a total mess?

I understand why we attempt to “seasonally” and otherwise adjust numbers. We crave smooth data. It makes charts look better. It puts a number into context, but what if the adjustments are just horribly wrong? The magnitude of the adjustments is large, so even a small mistake could have a huge impact.

Did the plunge in the economy in the months following Lehman cause adjustments that consistently make the Dec-Feb period look better than it should. Did the rebound, which really started in March 2009 affect those adjustments so that they reduce the jobs by too much? We have gone through some violent shifts in the economy since at least 2008. Industries like homebuilding, which had a huge seasonal component, are far less important in today’s economies. So much has gone on, and so much has changed, are the adjustments overwhelming the data and giving us bad reads? I have only picked on payroll, but I am becoming convinced that much of what we see as growth, followed by decline, is just bad data in the first place, further messed up by bad adjustments. We pretend like 50,000 difference in a month is meaningful (when even BLS says that is in their confidence error), when the data shows that probably anything within 250,000 of the real job growth would be a lucky guess.

As you get ready for next week’s deluge of data, it is worth keeping in mind. Expect bad data.

One last rant, I find it interesting that every American has to basically fill in the same forms, in the same way for their taxes, and yet the half a dozen money center banks, thriving on Fed support, each report basically everything in their own way, making it very hard to compare bank to bank or quarter to quarter. Couldn’t the SEC, Fed, OOC, or FDIC insist on a consistent summary format for reporting earnings?

Markets are a little better on the back of German confidence. Those rallies rarely last.

I would be shocked though if we don’t get some commitment to commit out of the G20 and IMF this weekend, so although I think we will fade a little from here, we should see some strength into the European close as everyone gets ready for more “firewall” money. This meeting highlights the ascent of China and the decline of the U.S. as it is Chinese money “coming to the rescue”.

Credit is very quiet this morning. IG, MAIN, XOVER, and HY are virtually unchanged. High Yield bonds remain well bid, HYG and JNK remain strong, but HY18 continues to struggle. TIPS have continued to do very well in spite of how “transitory” inflation is.

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European Nash Equilibrium Collapses – Bank Bailout Stigma Is Back At The Worst Possible Time


Tuesday, February 7th, 2012

In all the excitement over the December 21 LTRO, Europe forgot one small thing: since it is the functional equivalent of banks using the Discount Window (and at 3 years at that, not overnight), it implies that a recipient bank is in a near-death condition. As such, the incentive for good banks to dump on bad ones is huge, which means that everyone must agree to be stigmatized equally, or else a split occurs whereby the market praises the “good banks” and punishes the “bad ones” (think Lehman). As a reminder, this is what Hank Paulson did back in 2008 when he forced all recently converted Bank Holding Companies to accept bail outs, whether they needed them or not, something that Jamie Dimon takes every opportunity to remind us of nowadays saying he never needed the money but that it was shoved down his throat. Be that as it may, the reason why there has been no borrowings on the Fed’s discount window in years, in addition to the $1.6 trillion in excess fungible reserves floating in the system, is that banks know that even the faintest hint they are resorting to Fed largesse is equivalent to signing one’s death sentence, and in many ways is the reason why the Fed keeps pumping cash into the system via QE instead of overnight borrowings. Yet what happened in Europe, when a few hundred banks borrowed just shy of €500 billion is in no way different than a mass bailout via a discount window. Still, over the past month, Europe which was on the edge equally and ratably, and in which every bank was known to be insolvent, has managed to stage a modest recovery, and now we are back to that most precarious of states – where there is explicit stigma associated with bailout fund usage. And unfortunately, it could not have come at a worse time for the struggling continent: with a new “firewall” LTRO on deck in three weeks, one which may be trillions of euros in size, ostensibly merely to shore up bank capital ahead of a Greek default, suddenly the question of who is solvent and who is insolvent is back with a vengeance, as the precarious Nash equilibrium of the past month collapses, and suddenly a two-tier banking system forms – the banks which the market will not short, and those which it will go after with a vengeance.

The WSJ has more on this very subtle but so very critical shift in the European bailout game theory equilibrium:

A group of top European banks is disclosing that they didn’t borrow money under the European Central Bank’s bank-lending program, fearful of being perceived as bailout recipients.

The broad participation in the program, known as the Long-Term Refinancing Operation, fueled a sense of euphoria among many bank executives and investors that the worst of the Continent’s two-year banking crisis was over. In a second batch of loans in late February, analysts expect the ECB to distribute as much as €1 trillion in additional funds, partly because the central bank is making it easier for banks to borrow.

But some bankers and observers are starting to warn about unexpected fallout from the ECB’s loan program. A top concern among banks is that the receipt of central-bank lifelines could subject them to potential political or regulatory interference and sully their ability to declare themselves free of any outside help. That sentiment has the potential to damp demand for future ECB loans, at least among the Continent’s strongest banks.

In other words, the market is finally waking up that the LTRO, more than merely carrying the upside of a mechanism preserving the status quo for a brief period of time, also has the downside of implicit stigma associated with any and every bank that is found to use it. And the punchline here is that the second a European “Jamie Dimon” emerges and starts touting their lack of need to use LTRO cash, the whole plan collapses. It appears that Deutsche Bank, the bank whose assets are 80% of German GDP, is just that equilibrium collapse factor.

It isn’t yet clear how many banks declined to borrow but the list includes Deutsche Bank AG and Barclays PLC. While the ECB doesn’t divulge which banks borrowed, most companies are expected to disclose the information as they release annual results this month.

“The fact that we have never taken any money from the government has made us, from a reputation point of view, so attractive with so many clients in the world that we would be very reluctant to give that up,” said Josef Ackermann, Deutsche Bank’s chief executive, explaining to analysts last week why the German lender didn’t borrow from the ECB.

Mr. Ackermann said Deutsche Bank still is scarred from its experience borrowing from the Federal Reserve in the first phase of the financial crisis in 2008. U.S. regulators encouraged banks to borrow under the cloak of promised confidentiality, but when the banks’ identities were subsequently disclosed by the Fed, the recipients were dubbed bailout recipients. “We learned a lesson,” Mr. Ackermann said.

Other bank executives privately have voiced similar opinions. Some of that sentiment is likely to surface publicly in coming weeks as banks report annual results and executives face questions from investors about whether they borrowed from the ECB.

English banks are also suddenly scrambling to portray themselves as healthy:

In the U.K., the Financial Services Authority informally encouraged the banks to tap the ECB loan program, although the regulator also made clear that the decision was up to the individual banks, according to executives with several British banks. The goal of the FSA, shared by other European regulators, was to promote broad use of the facility and reduce any stigma associated with borrowing, said people familiar with the matter.

A number of top British banks, including Barclays, Standard Chartered PLC and Lloyds Banking Group PLC, opted not to borrow from the ECB, according to people familiar with the matter.

Beyond the implicit, there are explicit risks associated with being bailed out:

“Those heavily reliant on ECB funding run risks of interference as a price for continued support. This may come to be seen as a form of nationalization,” said Simon Samuels, a European banking analyst at Barclays Capital. He said bank executives are likely to worry that regulators will view their dependence on ECB funds as a sign of a broken business model and will pressure them to restructure operations.

Such concerns are peripheral for banks that potentially were going to have trouble refinancing maturing debt at nonpunitive prices. Virtually every major French, Spanish and Italian bank borrowed billions of euros from the ECB, according to bank disclosures and people familiar with the matter. Among those was Banco Bilbao Vizcaya Argentaria SA, Spain’s second-largest lender by assets, which borrowed €11 billion, the bank’s president told analysts last week.

Some healthy banks also pounced on the opportunity for inexpensive three-year funding. HSBC Holdings PLC was among those that borrowed even though it didn’t need the money, according to people familiar with the matter. Any profits the British bank reaps from investing the borrowed funds will be segregated from HSBC’s bonus pool, one person said.

Yet all these considerations pale before the reality that any banks that borrows even €1 on February 29 will suddenly be perceived as a lower-tier performer, when faced with banks that parade with their “fortress balance sheet.” And as everyone knows, bail outs only work when everyone agrees to be bailed out. Otherwise, it is a shortcut to collapse. Because the last thing Intesa and UniCredit and STD and a whole lot of not so healthy banks will want on March 1 and onward is to be put in the “bailout recipient” category when so many others clearly no longer need the cash…

It appears that European banks, in their vain attempts for short-term capital gains, may have just sealed the fate of the entire financial sector.

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Fed Swap Lines Jump 59% In A Week As Japan Shows Its Hand


Friday, December 30th, 2011

It seems that it is not just the Europeans that are USD cash starved heading into year-end as the Swiss and Japanese gorged themselves on two-week maturity FX swap lines during the last week. The total outstanding under the Federal Reserve’s USDollar Liquidity Swap Operations jumped from $62.599bn to $99.823bn – or more than 59% during the week ending 12/28. Admittedly, the size of the additional Swiss draw-down, $320mm more compared to $75mm the previous week, is a drop in the bucket compared to the ECB’s additional $33bn this week. However, the more-than-$9bn additional draw-down by the Bank of Japan perhaps helps explain why USD-JPY cross-currency basis swaps eased so much this week (as the desperate need for USD through this counterparty-risk-exposed form of funding reduced by around 12bps or more than 25%). Perhaps it is time to take a closer look at some of the Japanese banks as while the stigma of borrowing from these lines is talked down, clearly there are funding/liquidity needs that are rising dramatically.

From the Fed’s website, the scale of the jump in the swap lines is evident for Europe and Japan.

While the velocity of the initial moves is not quite as historic as the Lehman moments, it is starting to gather pace – now above the pre-2008-crisis starting levels.

And the rise (an improvement) in the USD-JPY basis swap up to the 12/28 break is very notable as banks preferred to spend a little extra (58bps for 15-days versus 32bps for 3-months) and avoid the longer-term currency exposure (and counterparty risk) of the basis swap in favor of the Fed’s visible hand.

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Goldman Reports Massive $0.84 Loss Per Share, Prop Trading Loss Of $2.5 Billion


Tuesday, October 18th, 2011

via ZeroHedge.com

Topline bloodbath Summary: Net revenues in Investment Banking were $781 million, 33% lower than the third quarter of 2010 and 46% lower than the second quarter of 2011. Net revenues in Financial Advisory were $523 million, up slightly from the third quarter of 2010. Net revenues in the firm’s Underwriting business were $258 million, 61% lower than the third quarter of 2010. Net revenues in both equity underwriting and debt underwriting were significantly lower than the third quarter of 2010, reflecting a significant decline in industry-wide activity. The firm’s investment banking transaction backlog increased compared with the end of the second quarter of 2011. Net revenues in Institutional Client Services were $4.06 billion, 13% lower than the third quarter of 2010 and 16% higher than the second quarter of 2011. Net revenues in Fixed Income, Currency and Commodities Client Execution were $1.73 billion, 36% lower than the third quarter of 2010. And so on. As for the number everyone in #OWS is looking for, “The accrual for compensation and benefits expenses (including salaries, estimated year-end discretionary compensation, amortization of equity awards and other items such as benefits) was $1.58 billion for the third quarter of 2011, a 59% decline compared with the third quarter of 2010. The ratio of compensation and benefits to net revenues for the first nine mo nths of 2011 was 44.0%. Total staff levels decreased 4% compared with the end of the second quarter of 2011.” In a nutshell: for the first time in probably since the Lehman crisis, Goldman reported a massive loss in its prop trading division of $2.5 billion, and also based on LTM accured comp benefits and the total staff at period end of 34,200, average compensation amounted to $358,713/employee.

P&L breakdown:

And the carnage visually:

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Short Selling Rises Most Since 2006 in September – Just Ahead of Rip Roaring Rally of October


Monday, October 10th, 2011

It almost never fails does it?  Just as investors position themselves for zig…. instead zag happens.  Apparently we just saw the largest increase of short selling since 2006 in September – which worked out nicely for about 1.75 days in October, before this face ripping rally of 10%.  One can be sure part of this move upward is those newly placed shorts covering – indeed we saw such a vicious move last Tuesday in the closing 45 minutes, I have to assume many of those positions were harpooned that day.

  • Investors are increasing bearish trades around the world by the most in at least five years, convinced the lowest valuations since 2009 will prove no barrier to losses after $11 trillion was erased from equities.  Borrowed shares, an indication of short selling, climbed to 11.6 percent of stock last month from 9.5 percent in July, the biggest increase since at least 2006..
  • Trades that profit when Chinese equities decline have reached a four-year high and bearish bets in the U.S. are the most since 2009, exchange data show.
  • Slowing economies are spurring short sellers after indexes in 37 out of 45 major countries tumbled 20 percent, the common definition of a bear market.
  • “The Lehman collapse is way too clear in people’s minds,” said Henrik Drusebjerg, who helps oversee $230 billion as senior strategist at Nordea Bank AB in Copenhagen. “They don’t want to get burned as much again. They know either they get some protection or get out altogether.”
  • About 4.1 percent of NYSE shares have been borrowed and sold, up from 3.5 percent at the end of July, data from the bourse shows. U.S. short sales are rising at the second-fastest pace on record after the 2008 financial crisis, according to exchange data dating back to 1995.
  • Short selling, where traders borrow shares and sell them, hoping for a decline, is increasing even as equities approach the cheapest valuations on record. The MSCI All-Country World trades at 11.8 times reported profit, compared with 11.9 in the five months after Lehman’s collapse. The measure’s average price-earnings ratio since 1995 is 21, data tracked by Bloomberg show.
  • The bond market indicator that has predicted every U.S. recession since 1970 now shows that the economy has a 60 percent chance of contracting within 12 months. The so-called Treasury yield curve, adjusted for distortions caused by the Fed’s record low zero to 0.25 percent target interest rate for overnight loans between banks, shows that two-year notes yield 20 basis points, or 0.20 percentage point, less than five-year notes, according to Bank of America Corp. research.

And the last time this happened?

  • Bearish bets last increased faster in March 2009, the same month the S&P 500 began a bull market that doubled its value.

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