Tuesday, October 04, 2011

Buy back Tuesday?

We left on Friday with the plan to sell and not buy back until today. So far so good, but do we buy back now? Glancing through the OED, as one does over morning coffee, the page flopped open at the perfect description of this morning's markets.

"A functional disturbance of the nervous system, characterized by such disorders as anaesthesia, hyperaesthesia, convulsions, etc. and usually attended with emotional disturbances and enfeeblement or perversion of the moral and intellectual faculties".  Also called colloquially - Hysterics.

Let's start with the fastest riser up this week's Top Ten chart of hysteria. China. Today we bring you our nomination for the 2011 CDS Darwin Awards. Last year saw those proud owners of BP CDS win in spectacular style, but TMM would like to nominate the recent purchasers of China CDS for this year's CDS Darwin award.

Now, TMM have for some time felt that CDS on debt for countries that can print their own money is a lot like Magic Cards: an obscure game that can be expensively played by 30 year old man-children, who should be doing something else. On that basis we could make fun of most of the sovereign CDS market - US, Australia, Japan, you name it. But TMM feel that those who have pushed China CDS out over the last few months are a special bunch indeed. China has reserves of approximately $3 trillion and a grand total of $1.2bn in external borrowings at the sovereign level. Now, TMM know that China has a lot of NPLs - don't get us wrong - but those are in local currency. Ooooh, but what about SOE borrowings in USD? TMM would like to point you towards creditors to Vinashin, a hopeless Vietnamese shipping company, who appear to be 1) taking a big fat haircut 2) not getting control of the company and 3) now hold busted, useless paper that is not deliverable into sovereign CDS. The bottom line is, if they don't feel like paying you, they won't and your CDS won't pay out. This is EM credit 101: willingness to pay is often far more important than ability to pay. So anyone buying CDS on China is buying something that is collateralized about 2500x with cash and rising. Remember - China doesn't sell its reserves to print money to recap banks, it just expands the monetary base. Just like the Ber-nank.

TMM don't doubt for a moment that China CDS could widen further, much as Pets.com had its day in the sun and BP briefly went deep into the high yield zone. However, as a whole we are calling this trade what it is - deeply, profoundly, ridiculously stupid, poorly conceived and no doubt primarily owned by equity and corporate credit guys who've thought about it for around 2 seconds before putting this trade on, like thick pants, in the vain hope it will stem a haemorrhaging from their posteriors that makes Ebola look like Deep Vein Thrombosis. TMM would like to say to these people's investors that if you want to stop the bleeding caused by a portfolio disease known as tight monetary policy and poor corporate governance, then stop giving your money to credit analysts that can't analyze credit and equities analysts that can't analyze equities - Please! Don't buy China CDS.

Next Dexia -


Note the word CREDITOR in there. The return of bank liability guarantees would be a significant policy response, given that credit markets have been under significant stress in the face of worries about bondholder bail-ins. Markets need an explicit confirmation that governments do not intend to inflict losses on senior bondholders, so this is a positive development. Having said that, this is only one bank, so can't get too excited, but it is a step in the right direction. Of course, this has to increase the probability of France getting downgraded even though, in TMM's eyes, the upside to preventing a bank collapse is significantly better than the downside of a ratings downgrade from less-than-credible agencies.

Back to the mood. The technical picture has yielded cries of  "Bring me a new support, this one is broken" across the city, especially in SPX, with many now ready for the next leg lower. We have even had Battledeathcrosstar Galacticas sighted in various guises. But notable was the way that yesterday's varied positive economic data were pretty much studiously ignored or explained away to such an extent that TMM are beginning to wonder if Alessio Rastani is actually representative of many more than we thought, with all secretly hoping for a recession to serve their own nefarious purposes.

The UK Government wouldn't mind a recession as a justification to its spending cuts (Osborne highlighting the severity of the economic downturn yesterday). Meanwhile the Labour party wouldn't mind a recession to prove how wrong Tory policy is. Every socialist-leaning government in the western world would like a recession as further reason to neuter the banks. On balance most of the blogosphere would like a recession so that they can cheer "told you so". Every holder of Gold ETFs and physical outside of central banks wants a recession to justify their holdings. Sell-side sales folks, rather short-sightedly, seem to want a recession as it means they can scream "not since the last time" a lot and charge wide spreads. Buy side analysts want a recession as they have learnt in 2008 that being contrarian gets you noticed, they just haven't noticed yet that being bearish is now consensus. Is there anyone apart from normal folks with normal jobs, who can't control whether there is a recession or not, who don't want a recession?

Whilst TMM may have been a bit over the top there, the point we are making is that this has to be one of the best flagged and prepared for recessions we have known, accompanied by localised and, in TMM's mind, overhyped short term hysteria. So TMM are indeed going to buy back today, as there is a chance that this may be a beautifully crafted bottom. What one might call a "Pippa Bottom".


Anonymous said...

C says'
I'd like no recession please,BUT do I always get what I want?

No offence TMM as I've noted on more than one occasion ,you appear to have this penchant for trying to be rational/logical and thus finding a case for being contrarian.
Sorry old son,the markets full of dicks that couldn't spell rational never mind do it.So being contrarian is one of those things I prefer to hold for moments of true desperation and this isn't it really. Mr Markets a bit preoccupied with capital preservation and i doubt it cares much whether yesterdays data was just not that bad which I also noted. Indeed quite a lot of data globally hasn't been that bad and if you pushed me to be rational I'd say the worst interpretation of it was mildly recessionary ,but not swimmingly so.Trouble is that's me doing a one hand is clapping with not enough people listening.
On balance be the herd just remembering not to follow them off their most recently established cliff.
Bon chance with the buyback.

Anonymous said...

Oh and I spotted that French 'guarantee' as well and given I hold some bank debt,not there's my eyebrows rose.Trouble is how do I square that with remarks about renegotiating Greek haircuts? Let's be frank here,these Eurocrats couldn't find the same hymn sheet never mind sing from it.

abee crombie said...

30 year old man child... hey wait a minute...

I'm making the shopping list today. At some point the reach for yield will come back in after the momo guys have sold everything.

If you are a long term holder (+5 years, not +6months which seems like the contemporaneous definition) of equities, and you didnt sell in 2008, didnt sell in August, why are you gonna sell now?

I'm looking for signs of bottoming in Hang Sang b4 i get greedy.

Also I think a theme next year will be higher than expected inflation in EM, any idea how to play that? I know brazil has some inflation linked bonds, but any ideas on a more general macro punt

Secret--Sauce said...

Many times have I concurred with the folly of buying such CDSs, often in the context of French banks, but now we can safely add MS, BAC et. al. to the mix. I have no problem with their credit risk (although equity may be another story).

Hysteria is definitely overdone, and a bounce due. The question is today or later.

For is it not written that we are to wait for the Day of Atonement to buy back our positions?

Anonymous said...

C says'
Simply observing what markets do like rather than being rational.Markets do like to test and retest the resolve of directional positions.Which is why technical breaks rarely get away free and clear.
I won't be joining you in a buyback because rallies are to be sold until there is a reason not to.I've banked my short to reset for that because the probabilities after 90% days with double digit drops in large caps don't favour continuation days unless there is a very specific trigger and I have not seen one at this time.

Anonymous said...

never understood why more peopel dont sell CDSs on countries with their own currencies. Where is AIG FP when you need them! There are millions to be made thanks to people who dont understand the power of having your own printer.

Amplitudeinthehouse said...

Just throwing in my couple pounds, I wonder if theres any old timers out there that remember the last time they heard their broker say, 'well, it is a bear market ya know"

Dee Dee Humberside said...

I too am tempted to join the buyback crowd, but I am afraid the A-team is going to stick with its 'only compass' and will pussyfoot around in the face of 3pc upside "surprise" in EZ inflation. Unless these guys get it and capitulate, no equities for this 30y old man child, who'd rather keep playing in US credit (HY and securitized in particular look like decently re-priced, relatively policy/Eurostriches-independent picks on a 12m view)

abee crombie said...

I like the idea of a yom kippur rally!

C - I agree rallys are to be sold, but if you are looking for bargins in equities, and not technical trading, at some point you have to start building your position. If you wait for the trend to change you miss a good chunck of it. I prefer to be cautious like you but at some point you have to grind your teeth and get involved

there are some equity names trading pretty cheap

Anonymous said...

C says'
Abee ..you tell me when you see a building position market and If I agree my teeth will be ground to the gums.
Make no mistake I have not seen that market in equities for most of this year neither do i expect to for quite some time to come.Meanwhile I have problem with trading the market I think I am in and doing so for the most part from the side where I see the bias.
I bought the 'knife' long on the Aug capitulation move adn i'd be happy to do that again.I'm just asking ,give me the capitulation first.This isn't it. Anyway someones got to be out here providing the liquidity to get you and TMM out of positions that you've built ;)

mjm123 said...

You obviously do not understand what China's reserves are. They do not have $3T in equity. There are massive liabilities on the other side of their balance sheet that funded the purchase of those reserve assets. The very simplistic explanation is that they essentially borrow from their citizens at their short term int rate and use those $ to buy US treasuries (mostly). They made a big net interest spread on this for years but now with US rates well below their funding cost they have a huge neg net int spread (which makes pegging their currency very costly). Also, they are short RMB and long US $ (a massive losing bet). So, if the CNY appreciates 10% against the $ the PBOC's net indebtedness goes up by $300B (6% of GDP). I'm not saying you should buy their CDS, but don't use their fx reserves as an argument against buying it.

Leftback said...

TMM have clearly become students of Bottoms over the last few years.

Today is indeed the kind of ridiculous capitulation day that makes US high yield credit (especially) and dividend paying equities irresistible, even while hedge funds and even real money may be throwing the toys out of the pram. This is a classic pre-earnings panic, complete with downgrades and warnings of slashed dividends etc. By and large, this is not going to happen. Earnings season might even see some panic buying.

Europe? We are in wait and see mode there, but a furious squeeze is always on the cards in a heavily shorted market. Europe likely to remain a fantastic trading market for a while with high volatility the rule not the exception. Today's prices probably reflect a 50% haircut, now the question is: can it be worse? More likely not, but for the time being there is no transparency.

Nic said...

Excellent post.
Best comment on twitter today: In 2008 we worried illiquid banks were insolvent, in 2011 we worry insolvent banks are illiquid

Anonymous said...

mjm123, I think you took TMM's 3 trillion reserve argument to the wrong direction. China gov borrowed less than $2 billion from foreigners, and China gov has $3 trillion of foreign currencies in the bank. This is not about the funding cost and balance sheet deficit. My understanding is that China has clost to zero chance to default its foerign gov debt, simply because it has the cash, more than enought to pay back the money.

Internal debt is another matter.

Clive said...

Pippa's bottom - love it!
Pip! Pip! Tally ho! "Fockers" at 1 o'clock high!

"I wonder if theres any old timers out there that remember the last time they heard their broker say, 'well, it is a bear market ya know"

Yes indeed! January 1975 when the FT 30 had fallen 70% plus and then doubled by the end of February!

Anonymous said...

TMM, you dissapoint me. What's with you wanting guarantees from governments on bonds. Let markets clear!

mjm123 said...

My first point is that China's fx reserves are not a source of strength for the Chinese govt, they are actually a huge source of risk.
The second point is that China cannot use their $3T of reserves to repay their govt debt, or be used to recapitalize the banking system for that matter; they can only be used to buy foreign assets. These reserves are not cash hordes, they are actually liabilities themselves (but don't get counted as govt debt). There are numerous examples of countries defaulting that still had huge fx reserves at the time b/c fx reserves cannot be used to fund deficits or repay debt.
THE reason China won't default is b/c their debt is denominated in their own currency and they are the monopoly issuer of that currency and can print all they wish, not b/c of fx reserves. I'm just pointing out a common misconception over what fx reserves really are.

willem said...

excellent comments re: China's fx reserves. This is something I'd like to delve further into, gain a greater understanding of per se. Would you mind providing a resource as to where this view is expounded upon? I've tried Pettis's blog but to no avail. Cheers.

Anonymous said...

What if they gave a recession and nobody came?

Leftback said...

Today has elements of an intermediate term bottom. Sentiment extremes, remorselessly negative media noise, longs throwing in the towel, definite signs of capitulation by some bulls, and very low 10y yields that have now reversed strongly. Most of the ingredients.

I know what Anon @ 5:32 is thinking. Nothing like the Street whipping up a faux recession to shake weak hands out of their positions in income-producing securities and into the slow death of 1% yielding 5y Treasuries.....

Leftback said...

Anti piss-taking bill has protectionist implications. It's probably best if this doesn't get very far:

Currency Piss-Taking Bill Being Discussed

Reminds me of the Buy British campaign, instead of cheap Japanese things that didn't work (this is the 70s, before the rise of China and before Japanese quality) we got expensive British things that didn't work. It wasn't a success. The German stuff was ten times better at twice the price. The French and Italian stuff was beautifully designed and very chic but broke immediately and couldn't be repaired. It was all a bit dire, really.

Anonymous said...

mjm123, in case of external public debt of China, FX reserve helps since 1) gov is the monopoly issuer of RMB; 2) RMB is not freely convertible yet; 3) fx exchange and capital movement are still highly controlled in China; 4) most of the FX are effectively in pboc's hand.

Since I only talked about external public debt, the huge reserve+control over capital movement and transfer would be a pretty effective buffer for an external debt crisis. And could you give some examples of countries defaulting with large fx reserve ?

Anonymous said...

"Significant, but not a game changer", say Bernanke about the 'Twist' -theglobandmail.com/report-on-business/economy/economy-lab.

"We think this is meaningful, but not an enormous support to the economy". Recovery,"close to faltering".

OT expected to lower int. rates by 0.2%. Is BB preparing the market for QE3?

Leftback said...

A few thoughts on various topics.

I think the Twist has been misunderstood, or perhaps not understood at all, especially by those players whose understanding of the Treasury market approximates that of a pond snail (most momo traders, all commodity traders, a vast army of financial media hacks). Allow me to elaborate...

Bernanke knows that a QE3 is to some extent unnecessary at present, as it has already been done for them! Eurostrich activity has triggered enormous panic buying of US Treasuries by European banks and pension funds etc...

This has been a fantastic boon to the US Treasury, which has been able to sell a lot of cheap debt, and to the FED, which owned the short-term Ts and was able to start selling at a profit. The FED can now achieve a couple of objectives over the next few months:

1) Slowly sell 1-5y USTs. This will gradually drive investors out of Treasuries and into higher yield short-term US corporate debt, thereby stabilizing the economy ahead of what is known to be a large debt rollover bulge that is looming in 2012. This will initially look like a mini version of 2009's credit squeeze. We recommend front running this trade by buying junk bonds.

2) Buy 30y USTs and MBS. This FED action will offset selling by other market participants (Voldemort) and prevent the housing market from being smashed by higher mortgage rates. The aim here is simply to keep things stable at the long end.

So, given our base case scenario of a mild US recession only, we don't think the steepener (long front end, short long end) is going to be the best trade in credit, as much as the tightener (long junk, short 5y Treasuries).

Note that this model doesn't predict a lot of dollar weakness, so carry traders would have to jump back to selling the yen, so look for a revival of AUDJPY etc, and only modest strength in the commodity complex and emerging markets, which would only be revived in full by a sizable QE3.

As always feel free to throw rotten tomatoes....

Leftback said...

This youngster is still putting on the spread widener. I think he is a bit late to the party on this one, but it does show the diversity of opinion.

Credit Spread Trades

Dee Dee Humberside said...

Looks to me like there will very soon be a perfectly appropriate soundtrack for this chap


Leftback said...

Or this old chestnut:

Squeeze Box

Dee Dee Humberside said...

You gotta love the fellows at TinFoilHatMagazine.com

"Reverting back to short. The sell-off this morning felt overdone, in HYG in particular. We bounced on Bernanke, but it wasn't with much conviction. Although BAC and MS bounced nicely off their lows, BAC hasn't been able to get green on the day, although MS has, but barely. With such weak performance from ideal short squeeze candidates, it seems clear that we are not out of the woods yet. I think the failure to trade up significantly means we go through the morning lows."

As their namesake would put it: a question of etiquette - as I pass, do I give you the ass or the crotch?

Leftback said...

I think that Mr Cold Steel and the Anonymous Proctologist will be only too delighted to pay Mr Shorty a visit in the very near future. If the European fudge factories are busy overnight we might be in for a gap up at the open.

Some of the tin foil hat brigade might find themselves waking up to a very sore posterior indeed.....

We dumped the last of our Treasuries today, and we're thinking, you know that's a nice bit of business you've done there, for a daft Scouse lad.

Dee Dee Humberside said...

Same as with the parabolic expansion in gold a few weeks back, there will be great opportunities to be long TLTs and the like in the future. This is not it.

Or, for LB: "At the end of a storm is a golden sky, and the sweet silver song of a lark. Hold your head up high, and don't be afraid of the dark"

Leftback said...

That's it, Humberside.

Sing it, Gerry. This one is for battered longs and long suffering Reds fans everywhere:

You'll Never Walk Alone

I think that's me Mam in the video, there....

Anonymous said...

C says'

Dee Dee
Are you an old soul man by any chance? Northern?

Dee Dee Humberside said...

Let's try this fitting anthem for the reflationistas and the inevitably upcoming "everybody else lost even more than we did" quarterly letters

When you write your 10-Q form
Hold your head up high
And don't be afraid of the marks.

When you write in your form
Gold not to the sky
And the sweet SILV thrust in your arse
Sell oooon through the wind
Sell oooon through the rain
Your '10 gains be tossed and blown
Sell oooon
Sell oooon
With hope in your heart
And you'll never sell alone
You'll never sell alone
Sell oooon
Sell oooon
With hope in your heart
And you'll never go bust alone
You'll ne-eee-eee-e-ver go bust alone

Polemic said...

nice ones guys. Financial songs for the terraces.. Now there's a whole new field of fun.

mjm123 .. thanks for your comments. And we get your point and you made us stop and think .. dunno what yet .. but we are thinking .

Right as for les marches , lets hope that Italian downgrades don't screw it all up by tomorrow morning. Thanks for Foxy back .. now wear this ..

mjm123 said...

I read the argument as, "China will never default b/c they have $3T in fx reserves". Whether the default is on domestic or foreign obligations is irrelevant for a CDS event. I agree that foreign borrowings are not the problem, the domestic RMB debt is. And in this case fx reserves actually increase the likelihood of a domestic debt issue b/c, as Pettis says, "financial crises are always caused by mismatched and highly inverted balance sheets, and the central banks accumulation of reserves is exactly that kind of balance sheet". Fx reserves only protect countries from a foreign debt or currency crisis not a domestic one.

mjm123 said...

Most of my knowledge on the inner workings of China's fx reserves have come over time from several books, sell side research notes and presentations, as well as conversations with certain individuals with intimate knowledge of this process. One of which (chief strategist at a major investment bank who used to be head of their fx and his close friend and biggest client was the head of SAFE) I just talked with and briefly discussed this topic. But Professor Pettis does have a couple great posts on this subject, unfortunately it doesn’t delve into detail on the mechanics of the fx reserves.

willem said...

excellent, thank you again.

Anonymous said...

@LB, mjm123,

Along with TMM's posts, your comments are very informative. Thanks

Nemo Incognito said...

mjm, the point we made is that you aren't buying into the probability of China having a general default, you are buying into their USD OFFSHORE BONDS defaulting. That is very different. Those bonds can be redeemed using reserves. Why?

USD Account:
Assets: 3trn
Liabilities: 1.2bn
Net: ~3 trn

Redeem the bonds and no FX changes hands.

Now, RMB account:

Assets: Useless SOEs that couldn't make money without subsidies if they tried, banks that lends to them.
Liabilities: Just about everything.

Which admittedly isn't great. But remember you ARE BUYING USD CDS. If you want to bet on likelihood of China devaluing, selectively letting local governments default, or having insane inflation to make the bad go away by all means go ahead and do it but those are:

1) Onshore bond shorting (hard)
2) Shibor payers
3) CNH options

They are not China CDS.

Nemo Incognito said...

And as for "obviously not understanding what China's reserves are" - bitch please. When you can understand that countries with their own currency and limited external debt are a different game to the Argentinas and Greece of this world let know.

chancee said...

Looking at charts of the early stages of the 2000 and 2008 bear markets I've sometimes wondered, why would anyone have bought those dips? Didn't they know what was coming?

Yet, you can hear history repeating itself right now with people constantly trying to figure out where to BUY. Even with the US and Europe either already in, or headed into a recession. And even with the easy, slow- moving bear market rallies of the dot com crash long gone thanks to all the tradebots. Bear market rallies these days are brief and choppy... always waiting to be sank by the next tape bomb.

And just like last time people always point to some of the data being okay in these early stages. But it's the data from now forward that will reflect what's really happening. It's a self-fulfilling event. -- just my two cents

Anonymous said...

C says'
Chancee...I understand your view.
Indeed I must as I have a tendency at the moment to set up short more than I go long.
However,markets do have two sides and this is why they do not usually go in straight lines .In this case the long side of the argument would say having put in a very high % monthly plunge just prior to the start of a season with a longside seasonal bias they have a rational for buying in this quarter at what they think will be the lower end of the price range.
Earnings season just in front will make that a choppy experience,but then it will be down to having made the right picks.
Essentially you see it's a bottom up view for a buy against my preferred topdown wait and sell .

FWIIW,outside of counter trend rallies I don't see a build and buy market in equity until the Europeans inparticular get their banks fixed.Whilst that remains in flux we are liable to have volatile up and down trading markets. Historically,you don't get true bull markets without the bank/financial sectors being heavily involved.Should be no surprise about that really.