Thursday, June 30, 2011


Its like working in a nightclub.


Turn that bloody month end down, I can't hear a damn thing in here. Seriously, the risk on "choon" in the club is so banging, it appears to have dragged everyone out of the VIP onto the floor. TMM's inboxes are full this morning of "why we have to buy risk" pieces and from a gamut of very respectable sources. Which includes those that have been claiming to have been holding back whilst Greece played out and are now emerging from under their stones, those that have suddenly found their "risk" measure models turning higher (self-fulfilling because the prices they look at have moved up), those that are extrapolationistas and have seen 3 days of bounce and finally those that have been cut from their shorts and have swung long through desperation.

But TMM are firmly covering their ears as, to them, this is far from a risk on anthem but just that month end noise turned up to 11. The Modified Newtonian Dynamics of finance it may not be but we feel our MEN (Month End Noise) theory sufficiently explains most of the phenomena listed in the current spate of "risk on" arguments, even if some purists disagree. Models have been chasing prices higher again too, though one particular bank's new model is taking the buy side by storm, resulting in a lot of people looking at the CHF/RUB cross (Bloomberg figures confirm this)!

Basically, the last 24 hours have, in TMM's mind, killed enough bears to leave it safe for us to go and sell again.

NONONO. Oh Forget it, lets get out of here

Wednesday, June 29, 2011

Kebabs, Sushi and Big Macs

The market's noses are firmly pressed against the shop-glass as never before have so many people's lives been touched by the outcome of a fight in the kebab shop.

Greece combining with Month End madness, rolling into a half year end of poor performance, together with a July the 4th long weekend has produced an intensity of noise on TMM's market TV set that has them wondering if someone has yanked the aerial out.

30yr bond noise appears to have at least a partial explanation for some of the shenanigans earlier this week.

As for month end noise, TMM have been looking for the clues of an oft quoted guestimated $30bio of US equities to be bought for the equity/bond rebalancing but the volumes in cash, where we would assume it to be, have been very light with the futures seeing more of the action, which leads us to presume that the model/CTA community is chasing price and the real money is not involved. Are they bearish enough to ride out a rebalancing or even not need to do one?

The key data point over night, Japanese Industrial Production (see chart below), did bounce back in line with consensus forecasts, which has added ammunition to the PhD community's call for a V-shaped recovery in Japan, and general rebound in the global industrial cycle. TMM take a more nuanced view based upon the fact that for the entirety of TMM's careers, they have learned that the Japanese *always* disappoint, and betting the farm on a Japanese "anything" is a recipe for P&L tears. IP may well be bouncing back, but TMM are unconvinced that the rebound will be anything like as vigorous as the collapse and even if it is, whether the global supply chain being fully operational will result in a significant bounce across the board. Don't get us wrong, there will inevitably be a rebound, but as readers will recall, TMM do not think that this is just about Greece or Japan...

...The reason TMM have been of this view is that the ISM Orders/Inventories ratio and Order backlog measures haven't been providing any particularly dramatic evidence of the supply side being the principal problem in terms of the manufacturing outlook. And to that end, TMM constructed a (very) naive model of the Shoku Chukin survey (see chart below) based upon those lagged components and its lagged self in order to get a sense of the balance between demand issues and supply issues. The model has understated the dramatic moves in the Shoku Chukin, which leads TMM to the possibility that the global slowdown in the industrial cycle is not merely a function of Japan-driven supply side issues. Of course, natural disaster-driven moves are often highly non-linear and TMM are wary of reading too much into this...

...but it looks to us like there is little room for disappointment as far as both markets and the PhDs go. TMM were amused to discover (when bothering to work out the blended consensus GDP forecast for the year ahead) that said community merely track ISM (see chart below). Overpaid, perhaps, as TMM's equivalent model only took about five minutes to knock together... But, in seriousness, there has been little towel-chucking from these guys, predicated on the above discussion. TMM reckon that unless ISM moves back into the mid-to-high 50s that growth expectations are going to have to be revised quite a bit lower... especially in the context of their ISM models suggesting a high probability of a 49 print. TMM are unconvinced that the market is ready for a sub-50 ISM.

Which brings us on to that other important event that is about to get underway: the earnings season. TMM have been very surprised at the lack of earnings downgrades in the context of the macro backdrop and, given their rudimentary earnings growth model (see chart below) is pointing a sharp fall in the rate of earnings growth. TMM reckon earnings are thus going to disappoint.

As a result, TMM are holding on to their negative bias positioning, but the market does appear to be fighting to hang on to short risk positions which makes us think there could be a bit more upside pain through the next 2 days noise before we can return to "normal service". We suspect that this weekend will mark a turn back to the downside and TMM will use the squeeze to convert their light shorts into proper shorts!

Tuesday, June 28, 2011

What's the Plan, Stan?

Summer half year end noise continues to deafen and kill the short-term market favorite trades. So whilst we wait for the cacophony to subside, we will have a quick look at some of the Euro plans that are beginning to appear.

The Management placation plan


It all seems remarkably similar to a headcount reduction edict at any company. Instructions are disseminated downwards that shareholders want to see costs being contained and "something being done". Cutting headcount is always seen as the easiest way to do this and the process is embarked upon along predictable lines.

- Mr Big says we have to cut headcount by 15%
- Headcount or staff costs?
- Headcount.
- So total cost is irrelevant? They just want heads out of the door, even if binning just one senior exec would save the same as binning 10 juniors?
- Yes, apparently so.
- Err, OK then, who shall we get rid of?
- Well, we don't want a PR issue so it's probably best to keep this below the radar, no point in shaking up confidence by letting any of the big boys go.
- So definitely juniors then ... yes?
- Yes, cheap as chips and no one will notice they are gone and if we do need to rehire we'll just call it "staff upgrading".
- Hmm, well I never liked that little sht in audit.
- OK, that's one.
- And what about that cocky arse who you think caught you with **** at the office party?
- OK .. two..
- And that Ph.D MBA CERN fellow, he's always worried me, questions everything, far too bright.
- OK, he's out, three

And so it goes on until the sacrificial lambs are led off to the HR abattoir to be "humanely" put out of everyone else's misery. Finally, a report is made back to the shareholders stating that efficiencies have been undertaken and the slate is clean (P.S.: now please get off our backs). So TMM are now wondering which banks in Europe have already had their straw shortened by dark forces to suit Euro policy, irrespective of financial reality. We feel that listening to the results of the bank stress tests will be as indicative of true talent as the Eurovision Song Contest.

The French plan

To TMM this smacks of protectionism as it will ensure that France's legions of quant structurers will never be out of a job again. They are all to be employed constructing and maintaining the world's most complicated financial product designed to contain the European debt waste. TMM suggest that if 20 years of research by the world's top scientists at the JET project to contain the plasma involved in a fusion reaction has yielded no progress, then expecting a bunch of 12yr olds to achieve Eurodebt containment is absurd. Even so the Germans appear to be happy to throw their support behind it.

Trichet's plan

Trichet's solution is no solution at all. The ECB is not going to play and he himself appears to have turned into a random statement generator that has TMM wondering if he is really the Yul Brynner character from a central bank remake of "Westworld" meets "Duel".

China's plan


U.S. plan

Try not to laugh too loudly.

The Greek Plan

Applying the basic logic that if your sales volumes fall, then to make the same revenue you obviously need to increase prices, TMM have just received a call from a Greek hotel explaining that, due to an "error", the prices agreed for TMM's stay this summer would have to be increased by 50%. TMM were tempted to ask exactly which part of Greek economic history this "error" was referring to but really couldn't be bothered and are looking to rebook elsewhere.

And, finally, the TMM plan

What's the point of setting rules when the rulemakers themselves end up trying to circumvent them. So let's Keep It Simple Stupid. Take the pain, default and "man up". We know what's coming and weaving ever more complicated carpets to try and hide it under is pointless.

Monday, June 27, 2011

Postcard from Europe

Well, TMM have been fairly quiet recently, since their opinions have not changed much and because waiting for resolution in Greece is like waiting for Godot. We still don't love bonds as a long-term trade here, though the merits of a short term deflation trade are not lost on us, as we are also loath to rule out panic buying of USD. We knew the data would get bad, but, suffice it to say, the slope of descent has caught us by surprise, perhaps accelerated by all things Euro. We still like selling AUD/Asia and selling eurobanks. Aside from that, for every seemingly smart trade you have to weigh the indisputable good sense of being in it versus the fact that everyone IS in it and we could see some messy deleveraging if Greek politicians don't come together. To that end we're still pretty heavy cash though we have the kevlar gloves in the draw if things do get exciting.

For now we will leave you with a postcard from Europe that we found addressed to a home in Beijing.

Dearest Papa,

Our grand tour of Europe continues and I must tell you, Papa, that it is just magical. The locals are so delightfully kind to us and have enthusiastically welcomed our entourage into their homes. But, Papa, their smallholdings are so sad, mainly untended and barely fit to support the livestock they keep. Their pigs are far from healthy, being underfed and almost at death's door. I feel so sorry for them, Papa. Please would you allow me to buy them some feed?

We went yesterday to the Island of England to visit the Carriage factory that Grandpapa owns as part of his charity work in the region. On our way we passed through a land commanded by a curious man with a large nose, where people only have to toil for but 35 hours in a week? Can you believe that, Papa? Imagine what Uncle Zu would have to say if his workers in Shanghai were to do the same! Travelling North we crossed the sea and were promptly garlanded upon our arrival. However, Papa, the constant tugging at our garments from the local tradesmen desperate for our charity became so overburdomsome we had to retire. Grandpapa's MG factory has performed wonders for the villagers, with many now able to earn a very basic living. However we were somewhat confused and concerned to see the fruits of their labours lying discarded and unsold behind the workshops. Perhaps we could help by using them as quaint chicken coops in your Imperial Palace farms?

Today we have just returned from the most delightful village of Hungary, just outside Vienna. Their cheery demeanor was so charming I felt I just had to leave them one of your One Billion credit line notes. The joy in their eyes made it well worthwhile and, Papa, I so wished you could have been there to hear them singing your praises from the tops of their churches to St Reuters and St Bloomberg. Their delight was such that they have even promised 20% of their wheat harvest for the next 20 seasons, for your delectation! Oh Papa, would you believe it?

We are next scheduled to visit the old Port of Greece, which we have been warned is destitute and run down. However if we are to travel to and from Europe regularly we are told it is a necessary evil to bear. Perhaps, Papa, you could buy it and return it to its glory days of but 2500 years ago? It would make just such a pretty harbour in which you could moor your Imperial fleet when visiting these lands?

Well, Papa, I must go now as some more local tradesmen are eager to show us their wares, but I will write soon with more tales from this strange land.

Your little Baobao

Friday, June 24, 2011

Austerity Bites

There have been many parodies made with respect to the Greece situtation and the classic film/musical "Grease". "Greece is the Word" has been a favorite, but TMM take their hat off to friends of theirs who have ducked beyond the obvious and instead gone for another great song from that show. Now it is "Austerity Bites" and they have kindly allowed us to reproduce it below (with some very gentle edits). Our most profuse thanks go to you, guys (you know who you are)!!!

Easy credit, had me a blast
Easy credit, happened so fast
The debt mkts, crazy for me
The debt mkts, basically free
Credit rating, driftin' away,
To, uh-oh, those rioting nights

Aborrow borrow borrow borrow, oops

Pay more tax, pay more tax,
Or we’ll sell your back yard
Pay more tax, pay more tax,

A hun, a hun, a hun, a hun
A hundred billion, flushed down the drain
It hasn’t worked, please do it again
We'll save our banks, they’ve nearly drowned
Well they showed off, splashin’ it around
Summer mkts, something's begun,
But, uh-oh, how austerity bites

We’ll sell u more, sell u more,
But we’ll do it right,
Tell the Moodys, tell the Fitch
Not a default in sight
We'll call it voluntary,
Then demand that you’re in
They’ve no choice, but put their country in hock
Come Jun 29th, at 10 o’clock.

Me pay tax? No I don’t pay a thing,
But uh-oh how austerity bites
Pay more tax, pay more tax,
And forget about your pension
Pay more tax, pay more tax
And don’t dare order the venison

We've got to help you; we’ll hold your hand
Just like Dubai did, we'll bury it in the sand
Kick that can, till you’re an old man
Hopefully by then, we’ll have a real plan

Credit ratings, drifting away…,
But, uh-oh how, austerity bites
Pay more tax, pay more tax,
How much dough do you spend?
Pay more tax, pay more tax,
How much? F*ck, this is the end

No, we’ll take your banks down, that's where it ends
But when we’re better, can we still be friends
Then we made our true love vow
Wonder where that money is now

Capitalist dreams, ripped at the seams,
But oh, how austerity bites

Tuesday, June 21, 2011

Qu'est Châteaux Eurobolleaux 2011?

Just as in 2010 the Europeans turned to the US for policy guidance and were offered Little Timmy's post crash STFU policy, 2011 sees them turn once again to the US for help with the same reoccurring problem. Now despite what might have been imagined before the implementation of the US QE2 program about 9 months ago, it hasn't been a complete disaster. In fact, if you were a European observer noticing that their stock market goes up, faith and the price of their bonds goes up, their currency starts to drift off making their exports more competitive and they hardly see much of a rise in domestically led inflation, then you might just rub your chin and say. "Hmm, I wonder".

To TMM it looks mightily like the Europeans are dreaming up a cunning new plan. Not as cunning as trimming their toenails with a scythe as the German's tried last year with their banking regulations, but pretty close. For it would appear that just as US QE is coming to an end, the Europeans are going to be embarking on a second attempt of their own version. Far from EVER calling it QE (or even Qu'Est) it will be deftly disguised as European Himalayan pink salt - a fantastic exotic remedy for the Euro woes. Which of course to TMM means a set of generic structures wrapped and presented to the unsuspecting bond holders as a "cure all".

Sharp observers have pointed out at various times over the past 18 months or so that the ECB's LTROs, SMP and balance sheet expansion in general are essentially just an indirect implementation of QE. Banks merely bought their respective governments' paper and promptly delivered it to the ECB's window in exchange for newly-printed Euros. Of course, that only worked until the ECB realised that they essentially had become Europe's "Bad Bank" and were going to take a bath if and when the Club Med eventually restructures. Naturally, the A-Team panicked and embarked upon brinkmanship with the Eurocrats, in the form of threatening to hike rates to force them into action.

And so it seems that the latest offering from the Eurostriches is to increase the EFSF to 780 Gigaeuros from 440 Gigaeuros. But just as Pink Salt is only salt with some pink, expanding the EFSF is just turd with but more turd added. As we know, the EFSF is capitalised such that the bonds it issues are rated AAA, with the proceeds then used to throw good money after bad lending to the iPIGS. Of course, it's not just the Chinese that are buying the EFSF paper, it's also the European banks themselves, because the risk weighting on these bonds is obviously far lower than that of the Greek government. So the banks then deliver the paper to the ECB window in exchange for newly printed paper... which isn't really that different from the ECB's first "no, it's not QE really" QE attempt. Except this time they've tried to get the Eurocrats on the hook for the eventual payout. Now, the thing is, the ECB's balance sheet is about 1.9 Teraeuros, to which TMM reckon we should add the EFSF's size given it all looks like smoke and mirrors to us, meaning that they just magically increased the money supply by about 15%.

And of course, the longer this goes on, the more privately held debt gets paid down, and the bigger proportion of the remaining debt ends up in the hands of EU institutions. The debt may get larger and larger but the scheme can run on happily until:

  1. The guarantor countries can no longer maintain their own credit ratings due to the guarantees they are making to support an AAA vehicle.
  2. The populations of the guarantor nations realise how much they are in hock for and insist on no more.
  3. Someone stops buying the EFSF issues.
  4. EFSF holdings are marked to market and someone realises that the EFSF haircut isn't enough.
  5. The ECB resigns itself to the money supply increase being permanent (Google "Zimbabwe").
At this point TMM want to raise the alarm because:
  1. Embarking on expanding the EFSF is like mainlining financial smack while snorting woonga and smoking crack. Hooked until an early death. There is no escape unless the debt you own turns good and becomes profitable again. Mr Madoff tried exactly the same thing but apparently borrowing new money to repay existing shareholders whilst hoping those Russian railway bonds that paper your downstairs toilet become redeemable for face is called a Ponzi scheme and is illegal.
  2. Mucking around arbitraging credit ratings has only led to two things in the past. Fat bonuses for the inventors and massive suffering for everyone else. TMM await the calls to "mark EFSF paper to market".

Even if the Europeans do get away with pulling off this issuance trick shouldn't the FSA, SEC and other non-European governance bodies ban the purchase of such obviously dangerous products? And if they were too, would then the only money the Europeans could rely on be the Grey funds that arrive in suitcases whose owners expect their money back in full or else horrible things happen?

But of course the really cunning part of all this is that there is no government or central country running this thing. The ECB is still a quasi-governmental body reporting solely to an unelected parliament in Brussels. Who do you actually go to when the poop hits the prop to get your money back?

Now as for that QE. We have already covered how we think this is indirect QE, but in TMM's eyes, it wouldn't be unimaginable for somewhere down this financial maze of collective (i.e - no-one's) responsibility, someone may notice that just buying Greek bonds for the EFSF with money that has electronically been created will be damn site easier than all this AAA issuance guarantee stuff. No-one would either notice or mind really. We mean hey, Qu'Est the harm it did to the USA?

Friday, June 17, 2011

Hiding behind Greek smoke

Today is largely about option expiries, so we thought we'd take the opportunity to sit on our hands and, instead, have a look at the "Big Picture".

TMM reckon that the current state of the World can be described as follows:

  1. The US: The slowdown is dramatic (more on this below) but positive actual GDP prints, a Pavlovian dog-like response in the form of dip-buying on weakness (learned over the past two years), and a belief in the Fed coming to the rescue have prevented both the PhD and punting community from embracing a negative view.
  2. Europe: Smoke is coming out of the tail pipe, kangaroo-ing down the the road. Going to break down soon.
  3. China: "DON'T TALK ABOUT ANYTHING NEGATIVE!" as China is the only hope the West has. It seems to TMM as though punters are looking through to the peak in inflation and holding onto the soft-landing view - something they sense from the fact that most commentaries on China they receive seem to talk about how too many people are fearful of a hard landing/inflation etc... where is the *real* consensus?

This morning's rumours around a further EUR 150bn package for Greece have TMM shaking their heads at the Eurostriches, as it is no longer about the amounts, so much as the conditionality. The PASOK cabinet reshuffle appears to be something of a wash, and we look to next week's confidence vote for direction, but it doesn't really seem as though either side are backing down from conditionality. TMM trust in the A-Team's ability to screw it up. But given the moves in the credit market this week, it's hard to get overally bearish on the Euro or spreads here without an imminent credit event, especially in the context of EUR trading around it's 100day moving average.

But what TMM find particularly interesting is that many players still seem to view the recent risk aversion as a function of Greek developments. But hiding behind this facia, is the dramatic slowing in global data and, in particular, that of the US. Many have tried to argue that this is simply the result of supply chain-related shock-waves from the Fukashima earthquake, but it is becoming increasingly difficult to justify this view in the face of the recent Empire & Philly Fed surveys, not to mention the jobs data more broadly. Indeed, all TMM seem to see in terms of commentary on the disappointing data is that surely the data can't continue to surprise to the downside indefinitely. That, of course, is a mathematical certainty. But TMM, reluctantly, must quote their arch-nemesis Merv the Swerve: "It's the levels, stupid". Many assets are only correctly priced if the data rebounds, not if expectations are lowered. TMM do not believe markets (or the PhD community) have even come close to capitulating on their growth views in the way they did last summer.

This is striking, because this year's slowdown is far more material than last year's. Indeed, TMM's models of ISM (see chart below, blue line) based upon the Philly Fed (red line) and the Empire State (green line) surveys are consistent with ISM falling to around 49. Admittedely, these (in particular, the Empire survey) overstated the weakness in ISM in 2010 but, particularly in the case of the Philly Fed, have provided a much closer fit since. TMM have barely heard a peep about a "double dip" or indeed, the "R" word. Should ISM print close to this level, we reckon that such talk (and associated market moves) would have to become more widespread.

And this is where TMM reckon there is extreme complacency. There has been a bit of chatter about the potential for QE3, but it is clear from the political backlash - both domestically and internationally - to QE2 that the bar for further balance sheet expansion is significantly higher than it was last year. Perhaps we would need to see a sharp increase in the unemployment rate or, more worryingly, a negative payroll print. In this context, TMM believe that policy is *already* too tight and that the Fed needs to ease. The below chart shows a longer history of ISM & TMM's Philly-Fed based ISM model vs. difference between Fed Funds and it's 6month rolling average (in order to show when policy was being tightened or eased). The Fed have eased policy when these measures fell to 50 on all but one occasion. And TMM would suggest the exception (where the model touched 50, but ISM held above in this case, during the GM/Ford-driven CDS auto-correlation scare in the spring of 2005) is probably just statistical noise as a result of their model being somewhat basic. It is notable that when we reached similar levels last summer, the Fed moved to an easing stance.

So, to sum up, TMM reckon that the Fed will eventually be forced to ease, but the higher bar conflicting with the demonstrable view that policy is already tight mean that the curve needs to continue to flatten. Which is also in conflict with many punters' continual efforts to sell Treasuries. That said, with many assets trading close to technically important levels (the Euro and Spooz, in particular), TMM find it hard to express much conviction here, and wait for either an opportunity to sell a rally in risk assets or sell a break.

Thursday, June 16, 2011

Greek Fudge

The European confectioners are boiling up a new batch of their famous Greek Fudge. Just like last year this is being served up as a Willy Wonka-style panacea for European ills. The ingredients haven't been listed on the box but TMM suspect they are:

- 4 lbs of European Artificial Sugar (Aspartame to get the markets ADHD really going)
- 3 lbs of Buttery Rhetoric, (greasy enough to make you sick)
Flavoured with:
- 1 lb of Greek promises
- Liberal handfuls of Hope and Desperation.

But even if the market does swallow this latest melange it won't satisfy their hunger any longer than a Friday night Chinese takeaway and will cause such indigestion that it will be repeating on them all year until it finally comes heaving back up as an issue in a year's time. TMM are putting a big red ring around May 2012 and looking at 1yr fwd 1 month vol.

But undeniably, the risk regarding an imminent catastrophe is also significantly high, with domestic Greek political situation approaching a potential break point with Tuesday's confidence vote. The ECB remain fiercely opposed to a restructuring that would spark banking system contagion (not to mention result in the central bank itself having to go cap in hand to politicians for new capital...), the fall of PASOK's position in the polls to trail Samara's ND party has clearly emboldened domestic brinksmanship, as has the German's position on private sector involvement. TMM noted a few weeks ago that it seemed to them as though EU policymakers appeared panicked, and the commentary over the past few days has been consistent with this view (c.f. - Wellink's comments regarding a doubling of the bailout fund). On top of that, Irish Finance Minister Noonan has returned to the rhetoric expressed while in opposition regarding imposing losses on senior bank bondholders in Anglo Irish. This isn't just about Greece.

TMM get the sense that markets have moved beyond the actual Greek restructuring to consider the contagion that will likely emerge as a result of the A-Team Fudge boiling. Indeed, we were particularly interested to read of the exposure of US money market funds to European bank CP/CD/ABCP and repo, sitting at something like 44.3% of total assets. While the bulk of this is almost certainly in the "core" European banks, TMM would note that the events of the past few years would suggest that such institutions are likely to reduce their exposure to such paper when faced with potential uncertainty (one only has to recall the ABCP buyers strike in August 2007 and the even more serious wholesale funding run in September 2008). Moody's placing of several French banks on review for downgrade clearly puts this risk on centre stage, and therefore,it is unsurprising to see a resurgence of financial system stress trades in the form of front-end flattening and basis spread widening (see 3m EURUSD basis below). While such moves have often turned out to be speculative in nature, with Libor not moving, TMM find it pretty hard to disagree with these trades in the context of a 0.24%-handle for 3m Libor.

Of course, the above is only half the story, with the global data continuing to disappoint beyond what could plausibly be described as a Japanese supply chain impact. TMM would note that while both the PhD and market community have lowered their growth forecasts, they still sit well above levels consistent with what we have been seeing in the survey data. One of TMM's favourite charts is the lagged 5y5y forward real rate (see chart below, orange line) vs. economist consensus 2011 GDP (white line), and despite the deceleration, the bond market has increased it's growth expectations. Of course, this could arguably be risk premia as a result of the debt ceiling, rather than a true GDP upgrade, but TMM's view is that this is a trade for late July, not now. Under this prism, TMM expect the curve to continue to bull-flatten given the absence of positions and a true embracing of the global growth slowdown.

With the ECB demanding that it gets its money back, the Germans insisting on "private participation" and the IMF offering money to tide the situation over until September on condition the Greeks sort themselves out, whilst the Greeks themselves dissolve their government and riot in the streets against austerity, TMM think the Eurostriches best chances are to shine the silhouette of a bat into the skies over Europe.

Thursday, June 09, 2011

Here There Be Dragons

There has been plenty on the wires over the past few days of the powers being wielded by blogs in bringing various companies share prices to their knees. The response of the companies involved is to SUE. Which is of concern to TMM, not because we feel we are in the same camp as the litigants, but because it seems an asymmetric response to risk and a sign of regulation entering the webosphere.

The asymmetry of response is clear as we have never heard of a company suing an information source for publishing things that result in their share price going UP. The risk of regulation on the web does worry us much more. Not because we feel that it would be a slight on free speech and all the normal moralistic things, but more that we strongly feel that it is vital for the web to contain huge amounts of made up nonsense and complete and utter twaddle. As long as it does, and everyone knows it does, the reader is forced to make judgment calls on the validity of what he reads and take responsibility for the actions he takes based upon it.

Regulation works as long as it is impervious and leak free but partial regulation is much like trying to store water in a net. You only have to look at the fall out from the financial crisis to see how it doesn't work with all casualties blaming all other parties for their own lack of risk management. Whether it was banks blaming regulators funds blaming banks for the toxic paper, the borrower for being allowed to borrow and depositors who thought 7% in an Icelandic bank was risk free. Profit will drive resources to bypass the restrictions whether by developing new products or moving jurisdictions. Where would the fields of finance and law be without regulatory arbitrage?

This is all the more topical as Giethner is warning on the front page of the FT on "light-touch" oversight, which will no doubt lead to "heavy petting" oversight which will lead to the destruction of the remaining financial Himalayan Pink Salt mines.

As we have mentioned many times we feel the importance of doing your own research and taking responsibility for your own actions is paramount, especially in the Thunderdomes of the East. This lesson is being particularly sorely learned by investors in Chinese companies with ADR listings of which a good number appear to be frauds of one sort or another. Just how fraudulent they are is a subject of some debate - as one expert on the matter, John Hempton of Bronte Capital noted "sin has morphology" and just whether these guys have done something along the lines of "aggressive accounting" or listing businesses that entirely do not exist is up for some debate, though TMM are leaning towards the latter.

The problem with these ADRs goes beyond that of most EM investing: you have companies listed in a country where transparency at the best of times is awful and whose managers generally live in that country. That's not ideal - just look at the shenanigans in Asian equities listed in Asia - but it is hardly catastrophic because ultimately if the managers are exposed as frauds they have lost local retail money and that retail money will go completely buts trying to get square. Just look at the Hong Kong minibond scandal.

Equities listed abroad whose managers sit in the local country and cannot be extradited are a whole other ball of wax and have serious adverse selection problems. If you were fraud, would you list domestically? No. Would you get a dumbass whiteboy CFO to legitimize you? Yes. Would you overpay him and let him live in Vancouver / Beijing / etc away from the main city? Sure. It isn't hard to see that Chinese companies that list abroad need to answer one question first and foremost: what are you doing here? Well, probably the same thing Bre-X was.

With all that in mind, you would think the great and the good of long/short, private equity and the like would be halfway competent at avoiding these land mines, right? Oh no they aren't. Just look at the holders list of Longtop Financial before it was suspended and it reads like a grade A list of hedge funds - or perhaps a litter of tiger cubs. To be fair TMM understand the local bank branch colluded with Longtop to fabricate financial statements which is pretty mind blowing to think of in a western context. Kind of like finding a fraud manufacturer having JP Morgan tell them they'd print whatever they liked as their cash balances. Nonetheless, if a couple of funds including one guy sitting by the beach in Sydney can figure you out then what are these guys doing wrong?

TMM think they know why it seems a ragtag group of shortsellers, distressed debt traders and the like are doing better than most on this: skepticism and having to take responsibility for all their research. The China law blog has a good guide on how to actually do diligence on Chinese companies and it comes down to this: assume anything too good to be true is a fraud and work from there with a keen eye to people's incentives. Money apparently does not grow on trees. It seems that people who are doing their own work are working out what makes these businesses tick rather than to work out next quarters earnings (they're in the dock) and continue to win this game. TMM think this may be because they are cutting out the conga line of institutional investing ass-covering that seeks to ensure no one is responsible for anything:

Fund of Funds guys: "The consultant said they were good! I didn't do nuffin'!"
Equity Analyst: "The GLG guy said everyone uses their products and are awesome! Whocudanone?"
PM: "The equity analyst put together a bajillion powerpoint slides and talked me into it! It wasn't me!"

Save the money on GLG consultants and spend some time working out a business' supply chain, how they bill customers and the like. Or, even do something as simple as compare revenue per student at TAL Education and New Oriental Education per student and compare it to GDP per capita. Sometimes this stuff really is painfully obvious - and if your equity analyst does not pick up on this stuff he's a goose.

Looking across some equity research on our desk, TMM can't help but feel that short selling is likely to stay lucrative simply because the whole structure of the broker dealer industry makes it easy. Analysts are so petrified of not getting next quarter's earnings they completely ignore primary drivers of businesses to the extent that they miss out on the business being a fraud. Similarly, no one likes the boy who cries wolf, especially downstairs in the investment banking division.

For those not dedicated to the intricacies of corporate investing TMM can only say that if you aren't doing the work stick to your knitting - trading baskets, ETFs and the like - rather than picking single names and if you do stick to larger cap liquid stocks. Sure every now and then you get an Enron, but most of the frauds we are seeing are thoroughly mid or small cap. Caveat emptor for those not well versed in the black arts of due diligence or forensic accounting.

Wednesday, June 08, 2011

Commode currencies

Sorry for the lack of posts, but unfortunately day-job workload is pretty heavy. We will have to be brief today too.

Bounce Tuesday was a bit of a damp squib and today looks as though the wheels are coming loose again. The Beard has shot a few QE3ers, SPX appears to have confirmed the 1290 break and USDJPY is threatening to apply the red hot poker to a few derrieres. It had been looking equity-led up till now, but at last other assets are joining the fray. Key levels are under threat in various places but especially noticable is the break in European banking stocks.

Last week's thoughts on commodity currencies appear to be playing out. The seemingly bulletproof trading in anything which exports rocks and has a high coupon is softening along with noise about debt ceilings, eurowoes and the general slowing down of data. No doubt with the China "muni" stuff going tabloid your average carry junkie is being jolted awake by bad dreams of mid 2008. The only commodity currency to survive pretty unscathed is NZD, which could be read as indicative of a market that is not actively going short commodities and the associated FX, but just getting out of those monster longs. TMM believe that, outside New Zealand and Japan, it is pretty rare to find anyone who ever actively goes long NZD, with the chosen positions either being short or flat. Therefore, there are minimal speculative long positions to be unwound. TMM would expect any distressed NZD selling to therefore appear through the JPY crosses, when Mrs Watanabe and her Women's Institute carry club have to press the stop loss button. So if/when NZD falls over we will know that these moves are beyond just a commodity positional washout.

TMM note that the trend for the newswires to collar junior desk jockeys at quotable institutions continues. After yesterday's personal comments from a teaboy at SAFE, they managed to collar a clerk at Moody's and have her say that if something happened, something else could happen and finally that COULD mean that the UK's AAA rating MAY be under threat and would you like milk and sugar? Which had the grown-ups at Moody's swiftly apologising and offering to clear up the mess their kid had caused. These guys really ought to be closed down, but more on that tomorrow.

Right - back to work, as we happily watch commodity currencies go down the pan.

Friday, June 03, 2011

Himalayan Pink Salt

But first the NFPs - If we say that growth stocks are going to get hit on slowdown concerns and that feeds on as a theme into global commodities and assume that the USD will get hit vs neutral bases on a "USA is Toast" theory, then surely the neutrals will end up doing best against the commodity currencies (EUR/AUD GBP/NZD, CAD/JPY for example). Stocks should also get carbonised and if they don't, we know that the QE3ers are running the show. If THAT is the case then we should sell anyway because, as we said yesterday, we aren't playing the 2010 QE end game. Phew .. And on to lesser things.

TMM have just had an email from their very nice fitness trainer suggesting that they add a pinch of Himalayan Pink Salt to their water bottle for best rehydration results. Himalayan Pink Salt? What the heck is that? Having checked it out and found that it is just 96% normal NaCl, the rest being gypsum and homeopathic quantities of other pollutants, we really wonder why people peddle this stuff as a cure-all. Whilst we understand the benefits of electrolyte balance to rehydration, TMM will just be adding a pinch of cheap supermarket table salt.

TMM are sure they are not alone in noticing a huge assumed correlation in the health benefits of foodstuffs to the remoteness of their source. The efficacy of such remedies is also assumed to dramatically increase if it can be shown to have been consumed by a small poverty-stricken population of organic tribesfolk. It obviously works in reverse too, as when you actually get to some of these places you find said tribe wearing jeans and smoking Marlboros probably having been sold them by some enterprising villager pushing the unique health benefits. The novelty of such strange products also implies superiority in ownership in belonging to a small club of cognoscenti (which of course is how handbags can fetch $3000+).

So Himalayan Pink Salt ticks the boxes on all levels. The Himalayas are obviously a long way away, both horizontally and vertically, the population roughly fits the profile needed and the bonus is that it's pink, which carries caring references. But most importantly it has a HUGE profit margin for the supplier.

TMM wondered further if this marketing trait occurs in the world of finance. Well yes, of course it does, the financial industry's profits have had their versions of Himalayan Pink Salt at their core throughout history. Successfully finding the next exotic, new and uncommoditised product allows financiers to reap huge profits before the world works out that the product has no benefit or that its active ingredient is available in a much cheaper generic form. We have all seen these things in the past, be they leveraged products that are a sum of vanilla options, or tax structures that use your counterpart's balance sheet or of course all the toxic waste that brought the house down 2 years ago.

What is noticable to TMM is the struggle banks are having to go through to invent and sell its next new version of the Himalayan Pink Salt. The number of term sheets hitting TMM's desk over the past year having all but gone down to zero. Now we know that reams have been written about banks having to scale back risk and we know how the regulator is trying to regulate taking risk out of sight, but without the structured high margin business we wonder how the investmment bankers are going to make their livings as more of them are turning back to selling high volume vanilla products. Basically turning back into brokers from being "investment banks". In a way this lack of the "next big thing" is pretty synonymous with the West's problem vs the developing world. What is the West going to invent next to regain its wealth gradient against the rest of the world which is winning the competition for jobs and income (hello there today's NFPs). In particular the US fast needs its own new Himalayan Pink Salt to peddle to the world. The Apple version, though a damn good effort, just isn't enough.

We dont know what the answer is but we have just worked out that Himalayan Pink Salt is pretty important in making our society tick. We better crampon up and head east.

Thursday, June 02, 2011

HKD Peg: Unbreakable?

There, that's more like it. We had our fingers crossed as we waited for the ISM and were rather chuffed that it came out pretty much where our model had called it. Good Model, pat on the head and an extra bowl of electrons for you.

TMM have only one more thing to say on the matter. Only two things come out of ISM.... and that's Fears and QE3ers. And this doesn't look much like Fear to us, so that kinda narrows it down.

The QE3ers are certainly rampant this morning but, even though TMM are thinking this looks like a repeat of 2010, it probably won't (probably due to observation affecting the outcome). So we would demur from joining the QE3ers just yet. In fact we are more interested in cutting our long held long UST positions, even though Equities look as though they have more downside to go.

More on the QE3ers at some other point, but before we move on, we have recently observed this headline hit the wires (yes, really).


€400bn, perhaps? That woud be a very European solution to the bailout problem. We look forward to the Greek, Portuguese and Irish cucumber crisis payments.

And now for something completely different: the HKD peg.

While a seemingly obscure point, TMM have been watching some action in Asian fixed income markets that has them very amused. But first a few charts:

1) Loan to deposit ratio of HK banks, per the Hong Kong Monetary Authority and the Hong Kong property price index. As you can see, property prices are on a tear and if you look at a few major banks, HKD deposits are beating a retreat.

2) Yuan deposits in Hong Kong (yes, that is a long scale). This is where the deposits seem to be going in Hong Kong - punters in HK see the rise of the Yuan as utterly inevitable and see putting money on deposit in Yuan as the only sure thing around. Now, TMM will be first to say that this is beyond stupid - you have low caps of how much you can convert in a day (~$3k USD), there are plenty of better options for Asian FX carry out there (Indo govvies / Singapore REITs, HK REITs, etc) that do not have liquidity problems and which actually pay positive real rates. Nonetheless, punters are punters and when it comes to deposits in HK they are driving the bus.

3) HK mortgage rates... vs Yuan mortgage rates: Here it is clear that while HKD mortgage rates are rising due to this funding squeeze for banks it is nothing compared to that experienced on the mainland, where the rate hike cycle is truly underway.

So here are the two salient problems here:

HK Commercial Bank: you only make loans on HK property in HKD - unfortunately, your deposits are running away. So what do you do? Make loans in CNY, basically accepting that HK is going to creep towards a CNY peg? Beg and plead with the HKMA to arrange some currency swaps? Or just keep on ratcheting up mortgage rates as your funding runs away to cause rates to level peg with yuan rates? In the meantime, your funding still keeps walking out the door.

HKMA: You are worried about a bubble as real activity is in Yuan but you have a USD monetary policy due to the peg. Do you repeg? Or do you just pester your banks about their loan to value ratios and force them into stress tests without doing anything at all to solve the root of the problem? To date, the latter appears to be the HKMA's attitude.

The sensible answer is to repeg and basically follow CNY monetary policy for better or for worse, because, lets face it, the HKD peg is an anachronism from when HK was a light manufacturing hub that exported most of its products to the US and Europe. It is of course now a financial services hub that is leveraged beta on China and Chinese capital markets activity.

So what is the trade? There is of course the old HKDUSD cross which is one of the more asymmetric trades out there, sadly you pay for it on risk reversals. Another trade though might be Hong Kong banks as distinct from mainland Chinese banks. If HK banks were to become organizations that got deposits, made loans and generally operated in Yuan they would no doubt be as hitched to monetary policy on the mainland as Chinese State Owned Banks and be the recipients of those sweet, sweet 3% Net Interest Margins that Chinese bank analysts know and love. They would also, however, not be natural lenders into all the dumb infrastructure and business lending that Chinese bank analysts know and hate.

Now, TMM may be crazy but if you are making 3% NIMs, not lending to fundamentally uneconomic policy projects and are reasonably well run, you can expect to get a 2-2.5x Price to Book multiple much like higher quality Indonesian banks. As a thought exercise, TMM have seen what the valuation uplift could be for a few HK banks.

In the interim, TMM expect some choppiness in these names as the HKMA girds them for the big inevitable change, but the asset risk is manageable here: HK property may be a bubble but these guys lend to 60% LTV and do not have the type of stuff on balance sheet that Chinese banks do. Going long HK banks and short Chinese ones might not be a bad way to play the HK peg, not to mention a China credit blowup, if you get bored of waiting for what feels like forever for something to happen in the FX market.

Wednesday, June 01, 2011

It must be Chinabollox

May gone. June arrives and, to be honest, TMM are baffled.

So far May 2011 has been uncannily like May 2010 and if we were to follow that roadmap we should soon be moving our attention from European woes to concerns over US growth, which steadily builds to deflation worries and more QE. So far we are running to plan. In the US data is consistently surprising to the downside and in Europe it looks like policy makers are trying to re-implement the STFU policy that worked so well last summer. The lack of official comment has meant the European market has caught the Australian disease of reacting to anything said by a man in a mac - the journalist. Yesterday was a WSJfest and today opened up with a trawl of badly read German newspapers. The related market moves have been remarkable. If anyone were wishing to move markets there could be harder ways than writing an article for "Der Hamburger Sandwich Weekly" on how the IMF is planning to invade Greece disguised as the Portuguese fishing fleet to steal the Greek firstborns to be enslaved in German sandwich shops in lieu of bailout funds - then wait for the resulting selective cut'n'pasting in sales land to cause mayhem.

But with Europe and the US suffering obvious slow downs why are equities doing so well? Why is Euro perking up? Why is Gold coming off as USD falls elsewhere on gloom? The only thing we can think of is that there are two functions. Firstly, the invulnerability now felt by real money who have weathered a catalogue of otherwise disastrous calamities. And secondly, the old favourite of Voldermort and friends being the buyer of last resort of everything. And we mean EVERYTHING.

Now call us cynical, but pinning all your hopes on previous lucky bullet dodging and the China story is a little rash. For one, fortune may favour the brave, but in markets "brave" is only a whisker away from "dead". But more worrying is that we really don't think that China is capable of assuming the position to support the world just now.

Take the Reuters story that $463bn of local government financing vehicle debt would have to be written down or otherwise managed away to China's asset management companies (AMCs). TMM find this amusing because this is the old China banking trick - banks give dud loans to AMCs, so the AMCs can buy the banks' dud loan portfolios. Think Maiden Lane with a fortune cookie at the end. It's not even robbing Peter to pay Paul - it's Paul the schizophrenic junkie robbing from Paul the schizophrenic accountant's wallet. Nonetheless, it is worth trying, as it worked in 1998 when the rest of the economy grew fast enough to cover the idiocy of the State Owned Enterprises (SOE) so all were none the wiser.

The problem now is that those loans to AMCs are still a problem and TMM aren't sure where the next equity injection is going to come from for these banks, given that they can't re-IPO without a nationalization. So, TMM reckon we're about to see a lot of dilution of Chinese bank shareholders. Otherwise the local governments that get their funding from the central government, which is in turn dependent upon SOE dividends, are going to need some alternate sources of revenues (property taxes are already being mooted to be rolled out beyond Shanghai).

One would normally think that new taxes + massive loan losses = stocks down, but in the bizzare world we live in that does not seem to be happening. TMM are puzzled and wonder if this Reuters story of a writedown could be a leak from the CBRC to put pressure on other parts of the government in the leadup to a power transition. Either that or everyone has tuned out to anything that sounds like Jim Chanos.

TMM are enormously frustrated that after a massive balance sheet recession in the US, as well as parts of Eastern Europe and arguably a good chunk of the Eurozone, economics departments of banks do not do credit analysis. It seems that the great and the good (including the US Ex-investment bank) are taking the view that looking into this seriously is beneath them just like the last few major blowups, so TMM really appreciate the work done by the few exceptions (ANZ and Stan Chart) in providing real economic insight, rather than yet another absurdly overfitted PMI or initial claims model.

So all in all, TMM are not buying this "risk on" mood and think that praying to the great God Voldermort to save the world is like a European cucumber farmer hoping that no one checks what he's been doing with his produce.