Wednesday, October 05, 2011

Beware Bears Bearing Maps

Wowza. That was interesting. China CDS apart, the response to our calling for a turn in risk in the markets was most informative. TMM's "comments rule" played out again where bullish posts are either met with no response or a stream of disagreement to the point that we think we proved one of yesterday's observations - "On balance the blogosphere wants a recession so they can say 'told you so'". TMM received similar ribald jibing in their work environments too. Now such biased response certainly does not mean that TMM will be right, and with a 2 horse race of bottom or no bottom. A 50/50 outcome is all we should expect. But if price reflects information and expectations, and expectations as detected by our mockery meters are pretty extreme, then where do we go from here? Who is the seller who is more stupid than you who hasn't been exposed to stories that are so tabloid they are on the back of cornflakes packets?

Many comparisons are drawn between today and 2008. Back then, the discovery of a new land of economic doom had all the financial cartographers mapping the landscape, but such mapping appears to have given today's financial navigators a false confidence that their 2008 GPSs of financial crises are to be followed blindly today. But TMM, just like any good navigator, suggest that the 2008 GPS is an assistance to traditional navigation methods, never to be trusted fully and to be used together with a wily local knowledge and a healthy respect for the uncertainty of what lies ahead. Things are only ever obvious with hindsight. Especially new things.

Our point is that the observation itself has feedback into the price and so the outcome will never be exactly the same again. Most of the price moves of 2008 were on a shock of the new, if you think you have an accurate map then there should be no shock and so price moves will not behave as many expect. Not only does this feedback occur from the punters side but also the policy makers, who, having seen the disaster of 2008 have learned their own lessons. This last point is hard for many to believe and indeed the intransigence and lack of discernable action from Europe would support that disbelief, but TMM really do trust that the lessons of 2008 HAVE been learned and will not be allowed to happen again.

Let's dig a little deeper. As mentioned above, TMM find it particularly interesting that the "default" view as to the natural path of events is "this is 2008". We remember vividly back in the summer of 2007 that many were of the view that "this is 1998" and that rate cuts would fix the problem. TMM would argue that traders minds are usually framed, as far as crises go, on the last crisis they experienced. So "This time is NOT different" is more the norm than not, from an expectations standpoint.

The trouble with this view is that ALL crises ARE different. But they DO share one common element: the inability of markets point in time to distinguish between a liquidity problem and a solvency problem. To wit, once upon a time, shortly following a financial crisis in one part of the world, credit markets began to seize up as a basket case economy with a large amount of debt started to have problems. It entered an IMF programme, but kept missing its targets. Meanwhile, financial conditions globally tightened, PMIs began to fall sharply and ISM printed below 50. Equity markets fell sharply, and speculation grew about US Investment Bank exposures to this country and a certain systemically important financial entity. Then that country defaulted. Markets panicked, and the equity prices of several investment banks fell as much as 70% from their peaks a month before.

How did it end? Ring-fencing of that certain stressed systemically important entity, liquidity provision by the Federal Reserve and a 30% Q4 rally in the S&P500. For those that haven't guessed already, this was 1998. And it turned out to be a liquidity crisis rather than a solvency crisis.

And this is the point TMM are trying to get across. In a crisis, you just DO NOT KNOW whether it is solvency or liquidity. Now, TMM believe that European banks are insolvent *conditional upon* the PIIGS collectively being insolvent. Clearly this is the case for Greece, but for the others, this is unclear - and, particularly in the case of Spain and Italy, a function of the rates at which they can borrow. So while the ECB provides a liquidity backstop, they have the room to adjust. Of course, the missing ingredient is growth, Europe already looks as though it has slid into recession. But nothing is certain.

While we're on the subject of differences with 2008, TMM would note that by July 2008 - a full two months prior to the Lehman default - the World had entered recession. This is clearly not the case now, though growth has indeed slowed, there are signs the US and UK are picking up, just as they began at a similar time in 1998.

So is the *real* Black Swan (a 30% rally in SPX) the outcome in which things start to look like 1998? Greece defaults, the UK & US embark on further QE, the EFSF leverages up alongside the IMF to provide liquidity to the rest of the PIGS, or the ECB continues to cap yields on Spain and Italy on a conditional basis, growth expectations gradually rebound and the next bubble is born...

...Beware Bears bearing maps.


CV said...

I agree with the sentiment here. The US economy is likely in a recession but it will be very short and shallow one (perhaps just even stationary rather than an actual recession). All liquidity measures are shooting up strongly which augurs very well for risky assets 9-12 months out. This is especially the case as headline inflation will moderate going forward due to the recent puke in commodities.

The key question is obviously whether the new low reached yesterday was indeed the LOW. However, is the pain trade really up from here? I would doubt it but I would interested to hear other views here.

As for China, well ... I think the key here is that there was too much OPTIMISM in the first place and now everyone seems to be in the hard landing camp. I stick to what I know and people on the ground are pointing out that, for now, China is prepared to sacrifice short term growth in order to clean up off balance sheet lending and flush out overlevered property developers. Make no mistake, if it turns into 2008, they will ease quickly, but this is the point isn't.

We are no where near 2008, so people looking to China and EM for the rescue are banking on too much.


Marcf said...


congrats on your content these days, I enjoy it. I used to use you as a contra-indicator but lately I am in phase and relate to your analysis and outlook.

I am rather bullish. The main macro reason is what you mention. The sovereign crisis is NOT the subprime crisis. It is one thing to short subprime and force some banks to barf it is quite another to take on the printing presses of the world central banks. Don Quixotism. Of course a more cynical analysis says that some people made a lot of money on the way down and are about to make some more on the way up. Vol is all that counts after all. I think we may be witnessing the impact of internet time noise and trading on markets with much more maniacal trading. There is a lot of headless chicken hysteria going around.

I think the memory of 2008 is still hardwired in many investors memory and so the knee jerk reaction to anything is "oh my gawd the sky is falling AGAIN", it is related to your "i told you so" blog syndrome. The policy mistakes of 1932 were not repeated, we are also not on the gold standard (meaning QE , forget the politicians they are irrelevant). Of course timing the bottom is hard.

Finally the counterpoint is of course that QE2 being finished we are reverting to a more natural level, not propped by asset inflation. We will see. However that the hard deflationary dynamics that are brought about by a liquidity crunch are NOT present today is in evidence everywhere but the chickens are running around, if anything the closest we have seen was the lack of US funding for EU banks, which was solved by other means and, imnsho, may have been a concerted attack.

Skippy said...

Thanks for the posts over the past couple of days and the contributions. Much appreciated.

Having been on the short side and had the S&P move down to a level (intraday) that, in my humble opinion, is largely priced for a recession, it is hard to argue with your view.

The reason I remained on the short side until recently is that while some markets had priced a fairly severe growth/risk outcome (e.g. DAX at book value and the 10 year at sub 2%), EM, commodities, and the S&P had not. That potential contradiction appears to have largely resolved itself.

Having said that, if a rally is underway it might still be a counter-trend rally rather than a bull market rally. It has paid to fade every 'hope' rally over the past 18 months.

Afterall, another key difference between 2011 and 2008, is that there are very few conventional policy tools still available for the major economies. In 2008, central banks cut official interest rates agressively and fiscal policy was eased. In contrast, fiscal policy is now detracting from growth. Indeed, the policy prescription in Europe - austerity and bailouts have made matters worse, not better.

Clearly this is no longer a surprise - but even if the EU banks are rapitalised tomorrow it is not going to resolve the growth problem in Europe.

The counter-trend rally may be sharp, but my gut feel is that it will not be durable and one to fade.

ntwsc said...

Thanks cpmppi.
I love it when you talk BBBM.

Secret--Sauce said...

Not so sure that it was so decidedly anti-bullish. A certain Lefty certainly adds heft to the bullish camp (probably the result of hanging out with other lefties occupying Wall St.).

Still, one hour of market action does not a rally make. Time will tell.

As regards onyx fowls, how about a US-Sino trade war starting tomorrow at noon? Contrary to yesterday's ruminations of a certain currency piss-taker, I think it would be good for the US economy. Look at the US experience in 1929, or Japan in 1980, when we were constantly told they would own all of Hawaii, Manhattan and every N. American golf course within the year. Didn't quite work out that way.

Corey said...

GOOBER - Getting Off On Bearishness Expecting Recession. That late session rally really torched some of those GOOBERs. May they continue to feel the heat.

GOOGGETS - Getting Off On GOOBERS Getting Edward The Seconded.

Whats that the contest is over? I need to get back to thinking of trades instead of TMMisms? Sorry, keep up the fine macro, hope you're right.

Hotairmail said...

The 'solvency problem' versus 'liquidity problem' much cited (by Merv amongst others) is to me a rather moot point.

They have clearly attempted to solve the solvency problem with liquidity - both by lifting the value of assets and through the inflationary devaluing of debts.

It is a solvency problem. Is the solution insoluble?

Leftback said...

Nice one, lads. The call yesterday and the post today were indeed timely. The 1998 analogy is a good one, and will be tested very soon!

For the nippers (youngsters), here is the historical background on the Asian Contagion:

Asian Contagion

I think everyone knows the consequences in hedge land - the classic LTCM Story. An object lesson on the dangers of excess leverage in what are normally calm and highly liquid fixed income markets, not to mention tremendous self-aggrandisement:


Interesting footnote is that LTCM was eventually bailed out by Wall St., not the US government, and Bear Stearns declined to participate. Speculation has it that when the time came for Bear Stearns to be bailed out, their brethren were only too happy to see them go down.

Note that the lessons of LTCM were not learned!

Secret--Sauce said...

You see, to be quite frank, TMM, the fabric of the universe is far from perfect. It was a bit of botched job, you see. We only had seven days to make it. And that's where this comes in. This is the only map of all the holes. Well, why repair them? Why not use them to get stinking rich?

Leftback said...

Here are the charts from 1997-1999. Some elements might be familiar to market watchers.

Note the 25% decline in SPX and the modest VIX surge in 1997 for the Asian crisis followed by the big honking increase in VIX (into the 40s) for the Russian crisis/LTCM in 1998 and a second slightly lower VIX spike afterwards.

1997-1999 SPX and VIX

Thereafter, a monster rally into EoY and selling vol all the way.... not saying this is what will happen but that's why they play the games, innit?

viking said...

Beware bloggers talking book

Ben said...

Love the blog, always provocative. Respectfully, though, I remain in the 2008 redux camp. The primary reason is that the LCTM bailout did not require the will of the people in any way and bailout fatigue was not yet a diagnosed illness. Now, you could call me naive and say that an ECB bailout doesn't require the will either, but I don't think the German populace are going to swallow this pill on the first offering. A TARP vote replay leading to a bailout seems about the best case scenario for the bulls IMHO and we've got a ways down to get there.
Lastly, the whole China/copper crash seems only tangentially related and presents it's own potential deflationary tidal wave.
Keep up the good work,

Anonymous said...


Leftback said...

As the Geordie darts commentator might say: "Double Top"?

Double Top?

No. Obviously not. LB is always wrong, after all. No chance of mean reversion....

It's much more likely that 30y yields will go to zero, junk spreads will widen to 25%, China will go from 9% growth to -10% OVERNIGHT, and the repo market will seize immediately leading to a TOTAL crash of CRE, REITs going to ZERO, banks shuttered, and tumbleweeds blowing quietly through the streets of our cities, the silence broken only by the occasional electric cars driven by the Tin Foil Hat Brigade as they venture out from the shelter to forage and barter silver bars for Twinkies, ever wary of small bands of vicious Hedge Fund Zombies roaming the landscape looking for alpha.

chancee said...

It's true that history rhymes but doesn't repeat. But the weight of the historical 'event' always has to be considered. Even though lessons have been learned from 2008 and governments and banks alike have instituted policies to help prevent such calamities again, the mental scars on traders, hedge fund managers, and retail investors are still vivid. So in this case, it is hardly a matter of referring to a 'chart pattern' or a 'map' and extrapolating the future. It is the real knowledge that your book can be cut in half in the blink of an eye. Your retirement savings can be wiped out overnight. So, while we don't have the buildup of leverage in the system and some of the conditions that led to the 2008 scenario, we now have something equally as bad... the knowledge of just how bad it can get. We didn't really have that before. As evidenced by the lack of proper tail risk during 2008.

Long story short.. people will sell first, ask questions later. And that will provide the framework for a 2008 type event. Probably also why when you look back through history at events of the 2008 magnitude, there is very often a similar type event a few years after. Traders may have a contrarian gene at work, but the general public does not.

I simply don't think the '30% black swan' is in the picture because while some of the data is 'better', it's all still bad. I'd say about ten or fifteen percent up in the S & P and lots of people will start pointing this out. For the record, I think we're in more of a 2007 type of environment here. I think shades of 2008 will appear in 2012. When else?

Leftback said...
This comment has been removed by the author.
Leftback said...

Bust A Move

willem said...

Phenomenal post. Nothing unusual about post-crisis volatility in the data and participants swoon from panic to euphoria overreacting because of the all too familiar feeling of what happened in '08. That "observation" in and of itself greatly decreases the odds of a repeat of those outcomes.

abee crombie said...

regarding the CDS and the 98 crisis, wasnt it conventional thinking at the time that russia would never defualt and devalue at the same time. thats politics in the east

to say that china is default free, we you never do know. I would feel better writing CDS on Australia, US, Canada, UK etc.

I still think a 2008 crash is possible, though not likely. Why? HFT and 100% correlations.

Marshall Jung said...

My simple thought was that 2008 would only repeat if and when all the people who got their hair burned off in 2008 are no longer around to apply the brakes tho those that were not around during 2008.

Thanks for the hard work TMM. This is the first blog I open in morning, every morning.

willem said...

Claus - re the pain trade, I think that positioning is such that many participants do not realize just how far the consensus has leaned to the bearish side. Yesterday being the perfect example, I think there is a massive constituency of players that are desperately wanting to get long risk assets on the slightest sign of positive news, this makes sense as with ZIRP and twist many don't have much a choice do they? How many times have we all heard lately "If the credit markets look better" "If the data improves" etc. etc. then we'll get long. My sense is this could easily drive the black swan move as referenced in this post.

Per China, my boots are definitely not on the ground there but with food prices coming down in a big way, seems that inflation should be falling rapidly and easing of credit conditions could be much more palpable now, if needed to stem an unwanted collapse in the real economy driven by a (somewhat) wanted slowdown in r.e. development.

Maybe the US is on the verge of recession, or maybe we're all just not used to the massive volatility in the data that comes with post financial crises fear that drives both investors and real economy folks/firms. The really ugly picture is being painted by the sentiment data, but should we expect anything different with the onslaught of bad news from debt ceiling to sovereign downgrades to EZ bailouts? If I were running any type of real economy small business and reading about all that is happening recently, you better believe that I would put off hiring/firing/expansion decisions for now. And i think THAT is exactly why this time IS different (although I cringe whilst typing that). We must know that psychology is much different now and thus the inputs to the cycle are different and the data outputs are going to be much different. the rules of the game have changed.

As for market participants, in my view, the fact that we're so readily aware of those recent events specifically means that it is already 'priced in' per se. Not saying that things only look great from here, but i agree firmly with this post that blindly laying over charts and data to recent events is not the way to determine the most probable outcome from here.

JG said...

Can't can't c*nt't see it. 30% kickback in yer face rally at this point? ok just because the dumb money can't see it either doesn't mean it's going to happen. Bottom is perhaps more live than dead ahead but it's still to be spanked. Junker, Skankel, Sokozy to be faded. I'm long BUNGA BUNGA bring back Gaddafi and leave Berlineupforsomeofmyactionsconi to fook alone. Reality is one big SHORT.

Leftback said...

JG must be drinking some impressive moonshine. Interesting comment.

At times like this, when the market is and has been dominated by FEAR of losses, LB ponders the way that market participants tend to forget the other kinds of FEAR.

1) FEAR of being stuck in moribund fear trades.
2) FEAR of missing the big-ass rally.
3) FEAR of losing money in fear instruments.
4) FEAR of worthless put options and CDS.
5) FEAR of under-performance of one's benchmark.

Just watch all of those come into play during Q4....! This isn't going to happen in a day, but once it begins it can be quite powerful.

ntwsc said...

Funny you should mention that, LB, I'm just about to embark on my halfprice hardback of The Fear Index.

Not my usual bedtime fodder, doncha know.

Nic said...

Hehe looking good MacroMan ;)

Dee Dee Humberside said...

To Willem 7.21

It's true that real economy folks are likely (and rightfully) very cautious given the ongoing noise and pretty dire macro backdrop.

But that argument itself has become quite consensus (you heard it a lot from the MSM in the debt ceiling debate, stuff like "how do you expect *job creators* to get on with it if everything else around them is a circus)

This humble punter believes there is an interesting counterpoint to this, and it's that those guys were running pretty lean ships in the first place, and there is just not that much inventory/jobs/future capex to slash as a result of that. The downside is capped by the very fact that the upside was meh in the first place.

I am not sure about equities, but US credit (HY esp.) and the pooled/tranched stuff is at some point going to respond to this. There simply wasn't the type of buildup you typically see entering into a recession for corporate defaults and/or housing & commercial real estate to experience a collapse to 2008 places. Ditto EPS (lower, but no crash), but I am sympathetic to the view that multiples may need to contract, hence a more wait and see approach there.

2012 ... it's another story. But for now on, JNK and HYG it is. (and perhaps some IYR, but there are cleaner ways to play this from the secured bond side)

JG said...

Battin - Luxembourg finest, if you ever find yourself in this jule of Europes crown or should I say eurocrat waystation - its my shout for sure!

Don't think it's as simple as 1,2,3,4,5 there's a whole lot of flip side to those points. Your Q4 discounts falling sandles and black birds.

JG sees a cascading paradox of swift down drafts and counter trend rallies mingled with fear of the flying sandle and occasional boot, but its the black bird that one must fear most...

Leftback said...

No straight lines for sure in this business, JG in Luxy, except for those white ones on the mirror...

JG said...

LB, Ahh wouldn't it be so simple if it was always one long straight rack, but I concur only mushrooms and acid to guide players in this game. I'm long the USD waiting for a better entry into EUR before we go back to the LUF. Yes I'm waiting to go long Junker, for now its a short.

Dee Dee Humberside said...

JG I am typically early, and the Q1 2009 re-test was a major pain in the arse after we jumped the gun on Junker in late 2008.

But my little shop "holds" stuff - if that ever makes sense in this day and age - so at some point, you have to turn the mute button and trust your bottom up guts.

Just don't get too fancy with duration and you'll be more than fine at the 1-2Y horizon. If anything, for the inventory and buildup reasons mentioned above, I find it even more difficult today to imagine Corporate Armageddon (last time around, I could at least envision a chain of events that would blow up the 2007-style balance sheets. Not so much here).

ntwsc said...

Hands up any real economy small business type folk here then.

Mine's up, and I mean real.

Anonymous said...

Was it not a couple weeks ago we had this discussion, wherein we all agreed, that when its up the political class to 'save' the real economy things are going to look pretty damn dicey? The fact that yesterday's rally took of on a rumor of a rumor of some sort of eurocrat action said it all. If you really want a sustained rally have Merkel say something positive and then shut her and every other politician up for 6 months.

Dee Dee Humberside said...

And "PPIP can't work", and "TALF is the act of a desperate man", and "what the hell does Bernanke think his little QE adventures are going to achieve" were all popular memes at the 2008/09 turn.

Again, the point is not that we are heading to Dow 36000. But negativity IS everywhere, prices ARE low, and richly yielding fixed income in a world where the Bond is sub 3% ARE nice opportunities, if only for a quarter or two.

Leftback said...

Steve Jobs has died. We will not see his like again.

Thanks, Steve, not for the iPod, the iPad or the iPhone, which are brilliant, but for the Mac. A real game changer for users as varied as scientists and graphic artists. Jobs re-imagined the computer, and liberated us all from the hegemony of IBM and Wintel boxes.

willem said...

Dee Dee H.,
excellent points all around.

The comments/debate are in very good form today.

speaking of markets mispricing potential scenarios as highly probable, typically insightful John Kemp has some interesting thoughts on crde.

Chris of Stumptown said...

Mebane Faber had a nice graphic up charting depth and length of bear markets. By any stretch this would be among the shortest and shallowest if it were to stop here. Of course this may presume it's own conclusion in a way, since if you define a bear market as down X percent, of course the day you hit it everything is worse by definition.

Nonetheless credit drives the show and bank credit to end users is bound to contract. It is maybe too early to tell but maybe this is starting to show up - small business surveys are showing banks tightening again in the US. I would like to know about bank credit in Europe. Can anyone enlighten me?

longshorttrader said...

I'm preparing to hedge myself for the possibility that markets behave in the manner you describe in this post, over the next 2-3 months; however, I've seen just as many comparisons to the 1998 market as I've seen to 2007/2008; My data set could be wrong.

As a result, I don't think that "everyone" thinks this is 2008 for US equity markets.

For those of us who fear of a 2007/2008 like equity markets (or something worse), we are more disturbed by the similar progression of events, such as short selling bans, politicians' rumors/denials, Bank CEOs claiming everything is OK, hedge fund redemptions, commodities correction, etc. Not to mention bank shares trading like pump n dump penny stocks.

Hate to sound so cynical, but if I were long, I'd precisely want to perpetuate the myth that everyone thinks this is 2008 all over again.

With all that said, everyone might think that everyone else thinks it's 2008 all over again, and therefore buy the dip.. and I'm ready to hedge myself to that self fulfilling, self reinforcing possibility.

PPM said...

The relevance of past history should be debated by first considering the ways in which the surrounding circumstances differed or were similar, as between the present and past history. My view is that the scale of the credit bubble today blows away all prior instances of the credit cycle, unless we go back to the '20's. Hence, the severity of the associated deleveraging will be greater, and of longer duration. In fact, the credit bubble is probably without modern historical precedent. Yes, we had loose lending standards, and an explosion in high yield/junk volumes. Those have happened before. But the world had never seen ABS, MBS, ABCP, CDO's and all of the other 1000:1 leveraging mechanics that were employed over the last 20 years. The required correction, which began in 2008, has been delayed and delayed, as sovereigns stuck their fingers in the dikes and (a) took on all of the existing risk themselves, and (b) then continued to added debt at the same velocity as would have happened the credit bubble continued expanding at its pre-08 rate, to prevent a liquidity implosion. You guys are losing the forest for the trees by getting bogged down in charting and attempting to interpolate macro conclusions from short run micro trends, IMHO.

Anonymous said...

C says'
I have stated on more than one occasion that we have a market looking over it' shoulder.Elsewhere I labelled it the systemic event that hurt no one as an allusion to the fact that behaviourally huge numbers of people at already prepared and preempted it. Simply put looking back at 2008 is has mistaken as it is to look back at 1998 IF you think they are your guidelines for this market.There is allsorts of crap written about history repeating,harmonizing..blah blah blah.Sounds wonderful,but it's crap.There is no substitute to looking at the here and now.The here and now we are in and have been in for over a year is a seesaw of opposing goals setting off the needs of the bond markets that fund so much debt against those of the political class and there market arms who need to control factors such as growth etc etc.
We're swinging between the needs of the two which is why our markets have been so choppy and probably will stay that way for the foreeable future.The problem is the swings are of such magnitude they hurt to be on the wrong side of them.

More recently we have a plunge that was a function of the preceding sideways market.A market that had not been so narrowly concentrated would have had a much more drift down feel to it .Instead the normal choppy moves were forgone for a plunge.That now puts' us in a qtr where we can argue that price has actually outstripped what we know from the economic data. Indeed we know that because central banks are still not seeing it the same way as price for one thing.

At this juncture though the market got itself geared up for a move down based upon a key Euro date for Greek shot hits the fan.Dressed up ,but hold on the clubs shut the door until Novemeber and it's like a cinderella moment because the clock is also ticking doen that same week to rate decisions ...fooook cinderellas got to miss the ball and run for home...that's what the markets did this week and on some fronts they also managed to get themselves oversold in the immediate term on we all know what...or of you're safe haven you got overbought cinders'

CV said...

Thanks for the response Wilhelm!

Vasastan said...

The thing that to me feels as though it's not currently priced into equities is a Chinese (formal and informal) credit crunch, with accompanying slowdown in everything from construction to consumer goods.

Now, I know from my track record that I am not the smart money in this region, or even in the two categories below (dumb money, mollusk money) - still I am worried that many of the things that have sold off the most are in the class "things people in China invest in".

Was trying to get some indication from this:
Fancy mug sale

...but since the results seem evenly divided between well over estimate, on estimate, and unsold, at most the results seem neither disastrous nor stellar.

Any comment from someone closer, smarter, or both?