Wednesday, March 18, 2009

A Big Day

Big day today.

Contrary to Macro Man's expectations, equities put in a very good day yesterday, with the SPX breaking and closing above the 767 level. Perhaps the feel-good was stoked by the unexpected rise in housing starts; if so, Macro Man remains sceptical, as that data is a rather flimsy foundation for a recovery.

Perhaps, also, the rally was stoked by a belief that the Fed will do something at tonight's meeting. Certainly, the Fed has lost its leadership in the global easing league table. While Bernanke has long been touted as an expert on the Great Depression, and the Fed was the first CB to publicly contemplate quantitative easing in this cycle, they've basically done nothing for several months. (OK, they've been preparing for the TALF, but hey- what have you done for me lately?)

As a consequence, the growth of the Fed's balance sheet has stalled. In the meantime, the BOE, SNB, Bank of Israel, and BOJ have all embraced some form of QE. So is the Fed going to bring shock and awe tonight, or is Bernanke going to do nothing, sit there like a deer caught in the headlights, and pray like hell that the TALF works where every other Fed program has failed? If the latter, equities may face their sternest test of the "recovery".
Nevertheless, markets clearly seem to "want" to trade this recovery. The few equity longs of Macro Man's acquaintance are crowing, dollar bears are emerging, yawning, from their winter hibernation, and thousands of virtual trees have been killed with all the e-ink spilled about China's incipient rebound.

And indeed, there are a few interesting-looking charts. Oil is trying its damnedest to break out; June WTI, pictured below, has driven through both trendline resistance and the 55-day moving average CTA trigger level. Frankly, Macro Man has more sympathy for this move than the equity bounce, as the long-term supply/demand dynamics of the energy market are considerably more bullish than those for equities.
Elsewhere, some of Macro Man's sacred cows appear to be en route to the abattoir. He has long favoured playing SGD weakness, and it appears that he has quite a bit of company. There's been quite a squeeze at the very short end of the SGD yield curve, with overnight rates trading as high as 55% yesterday. Ouch! The chart below, showing tom-next forward points, illustrates how unusual this is. Ultimately, this squeeze should prove cathartic ahead of next month's MAS meeting. In the meantime, it's just another indication that the pain trade takes no prisoners.
Finally, AIG. Macro Man has been alternately amused and bemused by the reaction to the AIG bonus disclosure. On the one hand, you have popular uproar, complete with buffoonish Congressmen grandstanding in front of the TV cameras. When a Senator starts advising people to commit suicide, that's usually a pretty good sign that popular hysteria has taken hold.

On the other hand, you have community of financial market professionals, aghast that Congress could contemplate breaking the sanctity of an employment contract and comparing the AIG hearings to the McCarthy HUAC hearings. It's surprising how many people seem unfamiliar with a concept that is part of daily life for members of small investment partnerships, namely netting risk.

Simply put, no matter how well an individual trader does, if the firm performs poorly and does not earn sufficient revenues to cover its expenses, you don't get paid, regardless of whatever agreements you might have. It's not pleasant and it might not be fair, but that's life. (Disclaimer: Macro Man lived through three years of this early in the Noughties.)

Now under ordinary circumstances, employees of large firms don't have to worry about netting risk. But it seems quite clear that these are not ordinary circumstances. One argument put forward by finance pros to justify the payouts is that AIG needs to retain key staff to maximize shareholder (e.g., taxpayer) value moving forwards.

Two thoughts come to mind on this one. The first is that cash bonuses are no guarantee that staff will stay; Macro Man knows that if it were him, he'd be looking to get the hell out of Dodge the moment the bonus hit the bank account.

The second is a quote from legendary baseball GM Branch Rickey, informing the star player (Ralph Kiner) of a woeful Pittsburgh Pirates team that he was on the trading block: "We finished last with you, we can finish last without you." Well, AIG lost $66 billion last quarter with these invaluable staff members; it seems reasonable to expect that they could achieve a similar result without them.

All of this makes Macro Man appear to occupy a place of the political spectrum further to the left than his usual ideological residence. So to put things right, he has a compromise, market-based solution. Don't seize the bonuses via a one-off excise tax. Instead, pay them in the amounts contractually-mandated, and use normal tax treatment. But pay them in stock, and allocate shares on the basis of the average AIG share price in 2008: $27.57.
So someone receiving a million-dollar bonus will receive 36,269 shares of AIG. Current market value: $34,818. This should appease the baying masses and also introduce an incentive to these valuable employees to right the ship as quickly and successfully as possible. Oh, and at the same time, introduce these guys to another concept well-known to hedge fund types: the high water mark.

If and when AIG were ever to surpass the high water mark of the stock allocation price, that would be a very big day indeed, for both the employees and the taxpayer.


Anonymous said...

You commie and your damn left foot!

Har, I couldn't help but laugh when I saw the news that Geithner would deduct an equivalent sum from the next bailout. The absurdity of it all! You would have to hit their wallets if you actually wanted to inflict some pain. Everybody knows Uncle Sam won't let AIG go under, so whatever funds are necessary will still be forked over. And on top of that Geithner confirms AIG's continued status as a monetary black hole. Ahahahaaaa...

Anonymous said...

Like the idea of paying comp in AIG stock. However, and I'm no tax expert, won't this generate significant capital losses that can be used to offset capital gains? Granted, capital gains are quite thin on the ground these days and AIG stock ain't going to pay down the mortgage on the house in Montauk but it still has some "value". The fundamental issue as you point out is how to change the mindset of - "even though the firm lost big time, my own group did OK and therefore I deserve to be paid".

Great blog by the way.

Anonymous said...

xlnt column!

who's this swiss miss CONF1 bond thing breaking out

on long bond seasonal chart(US) it starts making a double bottom with april and goes up for rest of year

seems like the stock market has come in high on short covering to fomc decision last few times, and sold beginning the morning after, could be coincidence as it sold all the way til a week ago tues.

Anonymous said...

Inventory is running out. Soon we should going to see the production pricking up a little. Yes we won't recover since it isn't ending and the consumption will never go back to pre-recession level. But there is some mini-bull in a big bear market.

John said...

Great solution to the AIG bonus situation. Concerning the tax consequences Of anonymous @11:35. It would trigger capital losses only AFTER the value of the stock was reported as income at the price of 27.00.Also the income received would be taxed as ordinary income in the year of receipt. When sold if no gains to offset would be limited to a deduction of 3000 a year. People would beg not to get their toxic bonus. Great idea!

JJ said...

While I understand your reticence to believe in teh equity rally, I think you may have picked the wrong technical level to watch - I am more focused on 800 which is recent resistance and 50d MA.

Anonymous said...

MM - don't you think it would be prudent to see Obama and the House and Senate members return all the campaign loot that they all took from AIG? I think Dodd took in 103k and Obama 101k from them.

stock trader said...

they are all criminals as far as I'm concerned. Obama and company are putting a nice spin on the situation by publicly demanding AIG bonuses be returned, it will never happen though

Anonymous said...

Macro Man, what does the spike in SGP O/N rates mean? Is it simply short covering ahead of possible QE from the Fed? It seems like funding pressures are coming back, the TIC data released Monday showed that foreign banks sourced $120bn from their US subsidiaries. In comparison, between August 2007 and August 2008 foreign banks sourced $500bn from US subsidiaries. 1/4 of that total in 1 month is a HUGE figure. The TIC data flagged funding issues well in advance last time. It feels like a bomb is about to go off somewhere in the financial system.

Macro Man said...

Anon @ 12.03, Actually, inventory/sales ratios have screamed higher, which suggests to me that businesses are likely going to need to see a sustained recovery in demand (which would organically push those ratios lower) before re-stocking. It looks like a ways away to me.

JJ, you may be right. I have seen short-term technicals in equities like Mr. Magoo this year.

Anon @ 12.58, obviously any donations made post-conservatorship, if any, should be returned forthwith. As for donations made while AIG appeared to be a going concern, I don't think it's a moral imperative to return the donations (they were received in good faith), but it would be a nice piece of realpolitik to do so, if the money is still available from the relevant campaign organizations.

Anon @ 1.45, it means that there is a large short SGD spot position that that needs to be rolled (ie, re-borrowed.) A lot of HF and CTAs roll all their positions to the quarterly IMM date, and then as that approaches, roll to the next date. Given the size of maturing positions , as well as current spot positions (which need to be rolled each day), there is a large demand to borrow SGD at the moment, and the MAS is not providing liquidity...and watching the specs squirm.

I don't think it necessarily tells us much other than that there is a large short SGD position, and the MAS is squeezing the shorts' goolies for a bit so as to prevent a total "free-money" play on a SGD NEER depreciation next month.

wcw said...

I don't think you need to be so cruel as to pay in AIG stock, especially when you have the Solomonic option of paying in participation rights to the CDO/CDS mess AIGFP created itself: Maiden Lane Whatever-Number-We're-At. Et voila -- you get a million bucks "worth" of the waste material you created yourself.

Strikes me as just about right.

Anonymous said...

MM, from past 60 years, every time PMI was below 40, inventory's contribution to GDP was around -5%. Currently the available inventory number is about above 0 due to the lagged reporting time. But you can bet that inventory is dropping to -5% right now but we will only see the numbers in the second half of this year. PMI will grow fast following the bottom of inventory as history showed. PMI could go above 50 this year before it drops below 40 again later (as in 1980s). But I see that equity market is betting on production activities pick up and unemployment slows in the near future (3-4 months I presume). A few days ago in a conference, at least some people in some still healthy big financial companies agree on this projection. But we'll see. People are really cautious toward any optimism.

Anonymous said...

you are a smart man.

Macro Man said...

Anon @ 3.33, obviously, at some juncture, inventory rebuilding will start again. But that's an H2 story, rather than a Q2 story, as I have heard mentioned in some quarters. So if markets are rallying on the basis of an inventory-related uptick in production over the next few months, colour me sceptical.

Macro Man said...

wcw, as you may be aware, Credit Suisse has adopted that very measure, creating a $5 billion turd-holding vehicle in which senior employees' bonuses are fully invested. Outsides can buy in too, if they cannot find any other dodgy paper in which to invest. It's really quite a sensible idea.

Sadly, the complexities are, in all likelihood, beyond the ken of the public and indeed the policymakers. So I stick with the stock suggestion!

Anonymous said...

QE, holy polony USD getting killed, what a move

Anonymous said...

buh buh buh bonds, bad to the bone!

well, i've been harping that we needed a strong long bond to save the housing market!!

gold 50 above the lows, loves the printing presses turning on and weak dollar i guess


Macro Man said...

Deac, check next post. I prefer oil!