"Sell on Friday and go away
Don't buy again til next Tuesday"
Wishing you all a none too terrible month/quarter end and hoping that your Octobers not be red.
We leave you with the commisioner for EU policy -
The Eurocrats have certainly succeeded in making this plan to leverage the EFSF via the European Investment Bank (EIB) appear complex and thus fulfil the requirement of "pulling the wool over the eyes of electorates and the media", but there are a few problems with this particular implementation that in TMM's view make it a non-starter. As TMM have noted before, bailout complexity can be useful in addressing problems without political or electoral opposition, and they recommend readers take a look at Phillip Swagel's excellent account of the US Treasury under Hank Paulson. The key paragraph from that Brookings piece is:
"At Treasury, two additional lessons were learned: (1) we had better get to work on plans in case things got worse, and (2) many people in Washington, DC did not understand the implications of non-recourse lending from the Fed. This latter lesson was somewhat fortuitous, in that it took some time before the political class realized that the Fed had not just lent JP Morgan money to buy Bear Stearns, but in effect now owned the downside of a portfolio of $29 billion of possibly dodgy assets. This discovery of the lack of transparency of non-recourse lending by the Fed was to figure prominently in later financial rescue plans."
And this is where this plan falls down: it does not involve non-recourse lending. To see this, the plan diagrammatically looks like this (please excuse TMM's Noddy paint skills!):
So the leverage in this case would come from the SPV issuing bonds to the Eurozone banks which they could then repo with the ECB. As a result, the SPV, as a wholly owned subsidiary of the EIB, would have to be recapitalised by the EIB should its capital become depleted. And there are three serious problems here from what TMM can see. Either (i) the SPV is not guaranteed by the EIB, in which case its credit rating would be something like single-A, and therefore there would be few investors willing to buy its bonds, (ii) it would be guaranteed by EIB, and therefore in the case of it requiring more capital, EU members would be compelled to inject more and (iii), the UK is joint equal largest shareholder in the EIB (see chart below). The latter two possibilities are clearly very problematic as the leverage effectively comes in the form of more explicit exposures to EU governments - i.e. France and Germany lose their AAA ratings. But that is not all... The UK will also lose its AAA-rating. This just isn't going to fly in this form and TMM suspect the Dambusters will ruin the A-Team's attempt to build a Dam in front of the rest of Europe.
In TMM's view, the leverage HAS to come from the ECB, just as it did in the Fed lending programs like the Bear Stearns bailouts and TALF etc. And the lending *has* to be non-recourse, in order for losses beyond the initially capitalised 20% to accrue to an entity in such a manner that the EFSF bond and the SPV itself get a AAA rating (and therefore attract demand from SWFs). TMM think, therefore, that the structure needs to look more like this:
The trouble is, that the Bundeathstar really don't want to do this, and the Panzer tanks are firmly blocking the ECB lending to such an SPV. But, as mentioned yesterday, TMM get the impression that the Germans have overplayed their hand (for example, they don't have any friends at the G20), and unless they really are about to leave Europe, they are going to be forced to accept some such plan. The key thing with the above is that it maintains the cloak of complexity for the public, while showing markets where the money comes from, thus avoiding the need to put the plan to electorates. Because action is needed *now*, and there just isn't time there just isn't time to vote on this. Europe is unlikely to change its history of doing what it likes, regardless of voters' wishes.
There was an interview on the BBC on Monday that has shocked not only those it intended to, but those it probably didn't too.A young man purporting to be a "trader" appeared on BBC news being asked his opinion of the current crisis. The interview can be seen here:
Now whilst TMM are fully supportive of anyone explaining to the BBC how the real world works outside UK politics and social issues, the content and style of this young man's outburst were so stunningly dreadful that TMM have been forced to consider things are not as they seem. Having dug a little deeper we found this trader to be fairly opinionated on his abilities judging by the content and title of his web site.
But TMM are completely baffled as to how he ended up on the BBC, and after much head scratching and worry are considering the following:
1) Said trader had escaped from a lunatic asylum and was holding the producers family for ransom his demands being that he lets the world know how mad he is.
2) He is Sacha Baron Cohen's next character to be launched.
3) The BBC really is so completely clueless about any subject that has numbers involved in it, that they actually thought he was an "expert".
4) And this is the one TMM are most convinced of...
This man must have been a stooge, set up by Ed Balls to appear just when he was trying to launch a new round of "really it wasn't our fault last time but if it was we've seen the light, spend our way to more votes" policy to highlight just how satanic and parasitic anyone involved in finance is.
Whilst the BBC presenters were of course shocked that someone could be so heinously evil as to wish depression on people, their highlighting of the fact rubbed in it nicely. The clincher was the line that governments didn't rule the world, Goldman Sachs did. Now whilst a few may suspect as much, you certainly don't go blurting it out on TV unless you are about to go on about the Illuminati, UFOs, crop circles and astrology. But then that would just confuse the BBC too much as they struggle with where to separate truth from fiction or more importantly, emotion.
Whether this man is for real or not, whether or not the interview was a spoof (nope, its not April 1st) just let it be shouted from the roof tops - TMM and everyone they know in the field of finance think him a disgrace and only wish he was "trader" enough to own a Bloomberg Account (which he doesn't) where we and our like could message him to tell him such.
Of course, as TMM know all too well... Great traders trade. Bad ones run courses.
TMM have been chatting amongst themselves this morning having convened feeling non too happy for various individual reasons. Normally, the mood waves tend to cancel out, but today a set of troughs have interfered to create a rogue wave of grumpiness. To try and understand what has caused this we thought we'd get on the TMM therapist couch and answer ourselves some questions from the red tape recorder behind the "in case of emotional crisis break glass" glass.
So here we go...
In HAL voice:
"Can you hear me TMM...?"
"Yes, we can hear you."
"How is your P/L TMM?"
"Its a P , but it should be bigger."
"Why do you feel like that TMM?"
"Well look at what's going on in the world, there is so much of what we've always believed would happen happening yet we are fighting so many twists and turns in the shorter term that fading short term news and emotion just adds to our own."
"So are you telling me, TMM, that the space-time reference frame is interfering with your P/L?"
"Err... Yes, we suppose so."
"Well why cant you just put on a long term trade and walk away?"
"Because of the pressure to have stuff on."
"Just when the world is busy talking 'stuff off'?"
"Yes. Look at Asia. That is a 'stuff off' story that is so obvious that its obviousness had become clouded in unobviousness."
"What do you mean?"
"Well, the Emerging Market FX complex has seen a massive unwind of leverage yet the underlying local paper hasn't really budged. We would just sell that normally."
"Well, why haven't you TMM?"
"Because EVERYONE expects it to fall as it's so obvious and so must have front run it and yet it still hasn't fallen and so if it hasn't then the front runners will have to cover and and and..."
"I can see you are confused TMM, just relax..."
"Just think clearly now. DO you KNOW that the world has front run a sell in underlying Asia?"
"Well, we haven't got figures, but if the CTA's are all over it then EVERYONE must know about it!"
"OK... well, let's leave that and come back to it later. Is there anything else troubling you?"
"Ahhhh yes... this is very common."
"You mean we're not alone in having that dream of being chased down a dark alley only to come out of the other end into blazing sunshine, but it isn't sunshine it's a nuclear flash and it's coming from the old home we lived in as kids? Oh... and there's this big whale and helicopter in it too somehow?"
"No, that's completely normal. It represents the current turmoil of indecision by the Eurocrats, but the growing positive newsflow pointing towards a cobbled together solution that, though eagerly anticipated, turns out to be a complete disaster destroying all the stability that you have known through your life. Oh, and that whale is a reference to Fat Tail risk that you are trying to hide from, but can't. And that helicopter... was Trichet wearing a beard at the controls?"
"Yes he was! Ah right, well at least understanding it makes me feel better."
"Yes, so your long DAX belief and faith that the Europeans will come up with a solution are being challenged by your concerns of the fat tail risk of europe collapsing in a Yugoslavian style cataclysm."
"OH I seeeee."
"And are you at one with yourselves over the US?"
"Well no not really, we're all twisted up over that too."
"Do you think you need a twist operation?"
"We think probably not and it's priced in anyway. But whereas QE3 proper has been off the table given inflation expectations, things might be changing in some respects."
"Have you asked why you feel that way?"
"Well one of our metrics for the Fed to expand its balance sheet is inflation expectations, and in particular the 5y5y forward breakeven. And the Fed's version of that is close to the 2.5% level. And in 2009 and 2010, when we moved below it we got QE1 and then QE2."
"Hmm I see. You are in quite a state arent you? Why don't you take some time off and give yourself time to reflect?"
"Time off?!?! Are you mad?! Do you know whats happening in this industry?! If you so much as blink you'll be packaged up and HR'd off to spend more time with your family. Love 'em as we do we cant afford that!"
"Ahh... Yes.. Depressing isn't it?"
"Yes it is. What should we do?"
"HMMMMMmmmmm... Well as I see it, you are struggling with the problem that the usual narrative for a really bad year has worked out thus far: (i) sell the rubbish (Eurobanks, China property, finance and cyclicals everywhere), (ii) sell the liquid hedges and try to scare the carry monkeys (AUD, ZAR, Itraxx crossover), and (iii) start dumping core conviction positions ($Asia, US tech), but on (iii) we seem to have taken a pause. You see, for (iii) to really, really make sense you need to have a full blown systemic crisis and funding squeeze and per a previous post there will be no funding squeeze."
"Err yes... That about sums it up."
"So... feel any better?"
"Well, I really wouldn't worry... There's a lot of it about"
"Can you give us something for it?"
- Why are they called the Pirate Party?.......
- Because they "Aarrgh!".
TMM never thought they'd get the chance to use one of their favourite jokes topically though in this case "because they'll force the Greeks to walk the plank" may be as apt an answer.
Now other brewing things.
First, Adoboli and UBS's now $2.3bn rogue trading loss. The latest news on this front is that Adoboli traded equity index futures and "hedged" these positions with forward-starting ETF trades, in a manner remarkably similar to Jerome Kerviel. However, UBS, unlike Societe Generale, did not pick up the fact that in some cases, the false trades did not appear to have counterparties (Kerviel, in such cases, allegedly said they were mistakes and then booked a different trade). The FT reported over the weekend that these trades dated back to October 2008. TMM are astounded that Adoboli was able to run such a record of false trading in such a similar manner, despite the events of January 2008. UBS's risk controls are clearly even worse than TMM thought on Friday.
TMM noted the similarities between Leeson, Kerviel and Adoboli's starting in the Back Office and then moving to the trading floor, and thus their expertise in the risk management and settlement systems allowed them cover their tracks for long periods of time. But the similarities don't just end there. It is generally very difficult to hide trades that require settlement in the next couple of days, or exchange margining, especially in the aftermath of Leeson's famous 88888 "error" account. However, Leeson's losses were not all in the error account. There was also a fictitious trade for 7.78bn Yen, where Leeson "sold" some options to generate the appearance of cash in an account, but this was an OTC trade. Kerviel also worked on the Delta One desk, trading equity swaps, ETFs and so forth, with OTC hedges against equity indices. And now, Adoboli is alleged to have done the same.
TMM reckon that there is now sufficient evidence that the risk controls with relation to OTC trades is woefully lacking, partially because of the underinvestment in systems over the past 20years (that TMM witnessed firsthand at several of the banks they have worked at in the past). Often ill-fitting trade templates have made booking non-standard trades into systems difficult and in some cases impossible (TMM remember a trade being booked in Microsoft Outlook at one of their previous employers), but this is a different issue entirely, as the Adoboli trades were pretty vanilla. What astounds TMM is that the back office did not pick up the fact that these trades would not have been confirmed with the alleged counterparties. Clearly, by the time these have been picked up, both in the SocGen case and the UBS case, it was too late and weeks/months after the trades had been booked.
But it's not just the actual confirmation with counterparties that can be the problem here. In the absence of clearly marked exchange prices, OTC trades are usually valued using internal models taking market inputs from broker pages etc. One of the more bizarre instances of rogue trading TMM have heard of was an internal trade between an options market maker and another trader on a different desk. After a few weeks of both traders posting a profit on said trade (marking against their own curves/surfaces), the middle office was eventually alerted but it turned out there was a lot more exposure from the guy mismarking the book with the rest of the Street. Of course, the problem here was having adequate internal marks, but the products themselves were not particularly sophisticated. TMM struggle with the need for these products to be OTC in the first place (given their simplicity makes them easily Exchange-mutable), other than to add margins to the banking cartel, but given that they have been involved in several rogue-trading losses now, it seems obvious to us that regulators need to apply more pressure upon banks to move these products on-exchange. That way, under-resourced back offices would be able to concentrate on the exotic trades, thus reducing the risk of rogue trading more broadly. As John Hempton says, there will always be criminals, but you can minimise the risk of such actions generating large losses and, to TMM, migrating vanilla derivatives on-exchange seems like a pretty sensible solution here.
And now, onto Europe. Schaueble & Weidmann's comments with respect to leveraging the EFSF have sparked rumours that Timmy G has lost his job running Europe for being too direct and suggesting the obvious. Very Un-European. Geithner last spotted trying desperately hard to steer the Eurostriches in the direction of the finishing line.
The usual imminent Greek default rumours have been spreading this morning, with tomorrow's EUR 769m coupon payment a point of focus, but TMM reckon it is a bit more subtle than that. Evidently, the Troika are becoming less enamoured with the Bubbles, and the view that Greece has to be cut loose is gaining more traction in policy circles. The problem, as Merkel stated last week, is that there is no current way to shield everyone else from the consequences. Much like demolition engineers trying to figure out where to stash the charges in order to avoid the building falling on top of those around it. TMM find it encouraging that the Eurocrats at least understand this (unlike the Paulson Treasury's belief that the fall-out from the Lehman default would not be large). That means that while the sabre rattling appears confrontational, like the Greeks being asked to walk the plank, that there is a good deal of double-bluffing going on here. We would need to see the rest of the PIGS backstopped to a degree that markets would not immediately attack Italy, Eurozone banks recapitalised to the extent that they could cover the theoretical losses of Italy defaulting, and capital controls imposed to prevent domestic bank runs.
The Greeks, for their part, have realised they have lost the upper hand that they had as recently as July. Still running a primary deficit of something like 3% (see chart below), the domestic consequences of a unilateral default in terms of a "sudden stop" would be significant. And TMM find it interesting that Venizelos spent time talking about the need for a primary surplus to shield the country, as well as reiterating Greece's need to reform and consolidate, as well as the cabinet meetings aimed at producing more fiscal measures in order to meet the deficit targets necessary to receive the next loan tranche. TMM reckon (though this could be their famous last words!) that the Greeks are unable to take the drastic unilateral default step without running a primary surplus, which TMM reckon should happen sometime next year.
Of course, not running a primary surplus is not a complete barrier to unilateral default. As many have pointed out, governments can only continue austerity as long as the population will allow it. With no elections until 2013, there is some political cover, and while there have been riots and protests, these have not been to the degree that they threaten implementation. Such moments come when riots become "serious" rioting, i.e. - a lot of people die or the armed forces get involved. Think Arab Spring. We are not there yet, but there is certainly plenty of potential for the situation to develop to that point.
But for now, TMM are sitting on their long US equities, but are worried about the actions the Eurostriches may have on their DAX position. Meanwhile, we note Asian Air Traffic Control has given landing permission to a large Pink Flamingo.
To which the market is replying:
But TMM is thinking:
There has, however, been one phone call made that makes no difference at all:
"Hello Mr Osborne. This is Dr King. Mervynflation and our expectations thereof are running like Usain Bolt on speed, but as policy bias appears to be moving from monetary to fiscal, it's not my problem and I suggest you raise taxes".
Now then, on to something that has been sticking in the craw of TMM for some time and has them jumping up and down in frustration every time a headline on European funding is waved in front of them as example of "the massive US$ funding crisis that European banks are suffering". The sheer frenzy that journos and punters whip themselves into reminds them of this scene.
TMM reply "there isn't a funding crisis - there are more dollars floating around than you can imagine" and here we put our case as to why and try to debunk some of the recent hysteria over "funding" headlines, messages, emails and cut n pastes from the "Hero Zedgers" that appear to confuse simple issues. We want to clear a few things up.
Forgive us for starting with old material, but for completeness, in the early days of the crisis, as USD funding markets shut down, leveraged institutions in Europe and elsewhere were forced to use the FX Forward market to borrow Dollars in significant size, driving the Cross-Currency Basis sharply negative. In the case of EURUSD, this basis is the difference between exchanging a stream of US 3m Libor coupons and a stream of EUR 3m Euribor coupons, and is quoted as the number of basis points deducted from the 3m Euribor stream. If 3m Libor and 3m Euribor were both riskless and there were no relative liquidity preference for USD over EUR, then this difference would be ZERO and the FX Forward would be priced as the difference between the two deposit rates. However, that is the world of textbooks, academics and arbitrage, something TMM have rarely found to be useful in their careers. But we digress, the point here is that the more negative the basis moves, the more people are willing to pay for USD through the FX Forward market.
Since 2008/9, cross-currency based funding has reduced significantly as banks and hedge funds de-levered their balance sheets, and the advent of QE led to the explosion of the Fed's balance sheet and a sharp increase in the excess reserves of foreign banks' US subsidiaries accounts with the Fed. This means that cheap and abundant USD funding has been available to those large international banks lucky enough to have an account with the Fed, but smaller ( and usually peripheral European banks) in need, have usually had to utilise the FX Forward market to borrow dollars.
With the European situation deteriorating, the 3m Cross-Currency Basis (see chart below) has once again moved sharply negative, but in contrast to 2007-8, TMM's mates in the forward market report more USDs than pieces of Lego in the overnight and tom/next markets, while term prices are moving largely on the back of broad-based risk aversion. This is an important point - early on in the crisis, FX Forward and basis markets were a leading indicator of trouble precisely for the reason that such large funding exposures had been built up in the 5years prior. This just isn't the case anymore. By early-2009, the large part of bank cross-border funding exposures had been unwound as European banks sold EUR/USD in order to pay down the losses on those US assets. And, as above, central banks have provided significant amounts of liquidity and liquidity back stops in the form of FX Swap lines - simply put, the amounts traded in this market just aren't that large anymore, because generally, banks do not need to tap it for USDs.
Yesterday, TMM's IBs lit up in excitement at the ECB's USD Auction Allotment showing that two banks had borrowed the princely sum of $575m from the ECB. The below chart of the facility's usage should put this into perspective. Today's ECB marginal lending facility showed a jump to EUR 3.4bn borrowed, from the usual few hundred million a day. More excitement. I don't think anyone would be particularly surprised that a few peripheral banks might be having a tiny(!) bit of problem funding, and were forced to go to the ECB facility to pay 2.25%. But let's be realistic- versus assets earning yields of 5% or more, this is hardly going to force them to go bust. But that is a different point entirely. TMM's main point here, is that this number often bobs up and down because of technical factors such as:
This stuff just happens, it is not unusual. Of course, were the amount to move rapidly higher then it would certainly signal something more serious, but as of now, TMM are unconvinced.
Next, while historical data for European CP issuance in the US is sketchy, due to the primary nature of the market, as a proxy, the below chart shows 30day Natixis Commercial Paper, which should be a reasonable approximation to the rates that European banks are paying directly on CP in the US. It has certainly moved higher over the past two months, but as a reality check, 0.45% for one month unsecured money is hardly a sign of severe funding stress.
As a comparison, the below table shows the current implied US $ funding rates from the FX Forward Market vs the ECB $ Auction and the above direct US $ CP issue assuming different rates of Euro funding - unsecured (Euribor), EUR Repo market, EONIA, the ECB's 7 day MRO, the LCB's LTROs and the ECB's main refinancing rate. The ECB $ Auction works out to be about 1.1% (1week US OIS +100bps), but in reality is a bit more expensive than that due to the need to post collateral for the 12% haircut. The point below is that generally, market Dollar funding costs are just not high enough for banks to need to tap the Fed/ECB swap lines, with only the 3m Euribor-based rate being really higher than the ECB auction rate.
Graphically, looking at the 1M implied funding rates, it's not really obvious that these are particularly extraordinary, and only at the kind of levels seen last December. The Orange line shows the rate implied from Euribor, the yellow line implied from the ECB's LTRO, the whte line implied from Eonia, the green line implied from Euro repo and the pink line the Natixis US CP rate. The chart makes clear the distinction between unsecured borrowing in Europe and swapping it (orange), and accessing the ECB's LTRO and swapping it (yellow) and the secured repo-based borrowing (green) and the better-quality banks that are still able to access the Eonia market (white line) and US market direct (white line). As we have hit the level at which it is becoming attractive to access the ECB's US $ Auction facility, TMM would not be surprised to see the allotment here move higher should current market rates prevail, but would not read anything into it other than the fact that it may well be cheaper to tap than the market itself...
A slightly longer term chart:
Unless the allotment spiked dramatically into tens of billions of Dollars TMM does not think there really is a Dollar funding crisis in Europe.
Today is the fifth birthday of this Blog. Macro Man couldn’t have picked a more torrid 5 years and perhaps one day a lump of magnetic material will be dug up from a bog, analysed and found to contain the financial equivalent of the iridium that pointed to an explanation for the death of the dinosaurs. The Macro Man diaries could be pawed over by academics of the future to then be held up in business schools, philosophy, psychology and history classes as proof of how NOT to run an economy, financial institution, monetary system, political system, society or world.
Or, more likely, held up as an example of how in the past people had nothing better to do with their lives than invest man-years developing complex technologies so that they could waste more man-years filling them with complete rubbish, (if they don’t find Facebook and Twitter first).
In the past five years we have spectacularly seen the western hegemony go from boom to bust. The complexities of economic theory proved, E=MC2 like, to be nothing more complex than a meld of "live within your means" and "if someone else is willing to do your job for less, you are screwed", leaving us at this very moment unemployed with the debt collector at the door.
Today's story is once again that the debt will be paid off by a massive infusion of money from China, the type O universal money donor to all the type AB universal money recipients of Europe.
"Nothing changed there over the last 5 years."
Meanwhile the second wave banking crisis appears to have come to fruition. The mighty French banks that appeared unscathed by the 2007/8 sub-prime mortgage disaster are currently suffering from their own sub-prime sovereign disaster. To the point that the vigilantes are marking BNP's market cap at EUR29bio... This, for a company that has 50bil of tier one capital, made E7.8bio profit last year, had assets last year of 3.1 trillion and most importantly, is the pride of a government proved to be interventionist in the protection of its national treasures and whose demise would make Lehman Brothers look like a Buckingham Palace tea party, TMM think that it has all gone too far and refer you to Andy Haldane’s superb speech. Especially the part:
“Asset prices are guesses about the future. Faced with uncertainty about the future, market participants form these guesses using their own heuristics. One such heuristic is the “popular narrative” – a simple story that aims to make sense of reality. Risk on/risk off is precisely such a popular narrative. The effect of popular narratives is to increase psychological contagion in financial markets. Simple stories generate market mood swings. The greater the uncertainty, the more compelling the simple story and the greater the amplitude of these mood swings...
...All of these behavioural elements have come together in today’s financial markets – disaster myopia, intrinsic uncertainty and deep trauma. This may help explain why risk-takers have their foot poised on both brake and accelerator, why risk capital is in stop-start mode. That implies a risk of heavy and persistent financial congestion in the period ahead. With hindsight, Roosevelt’s fear (of fear) in 1933 was well-founded,
economically and psychologically. It may also be being repeated."
Roughly paraphrased as "MAN UP!".
This is particularly apt today where simple story 1, the “we are saved” FT story, has been replaced within a couple of hours by the “we are doomed” story written by a proven euro shock jock trying to whip up panic over BNP using the well known and innocuous ECB/FED swap lines.
TMM urge the market in true scouser style to please “CAAAAALM DOWN”. Which is really not their job as it should have been enforced by a stern hand and clip around the ear from the Eurocrats. But, like a ginger haired teacher in a Peckham Comprehensive school, they appear to have lost complete control of the class.
The rest of the world is steadily losing patience with the lack of European control too. The US’s Timmy G is being airlifted in to sit in on the EU finance ministers gathering in Poland on Friday which to TMM smacks of early 2010 when he taught the Eurostriches the one trick of STFU which worked so well throughout the summer of 2010. Unfortunately it is now completely inappropriate and is having the wrong effect. Now they urgently need to be taught how to speak again, but with one voice. So TMM are hoping that a new era of SWOV will be forthcoming.
That’s enough of the heavy stuff. Normally at school on your birthday you get a cake and are allowed to play games so to celebrate we would offer up the chance to expand TMM’s glossary of TMMisms and invite suggestions. The top 5 will be added. More if thought apt. We know this is pretty pathetic but as we don't have any TMM T-shirts, mugs or financial bailouts to hand out its the best we could come up with.
With the G7 having once again pulled off another spectacular impression of a wet sponge, the market is now feeling like Neville Chamberlain declaring "I have in my hand a piece of paper..."
But they are not as naive. So thanks G7, your commitment to solving a problem that unfortunately has time dependency attached to it has left today's markets looking like a work by Hieronymus Bosch.
Observe the French banks in the background of the work providing the back lighting for the rest of the scene as periphery debt holders jump from the cliff (top left) as the battle at the gates of Fortress Europe are fought. The rest of the symbolism is pretty obvious though TMM invite your own observations.
But through TMM's less medieval eyes we see the picture slightly differently and can sum it up as:
But with the G7 sailing on by, it looks like the markets are going to be left alone to sort their own problems out rather than counting on any lifebelts being thrown in by the CBs or policy makers in the short term. TMM hope that the need for self help rather than spoon feeding will result in a little more introspection rather than the mad dash from bad headline to bad headline. This morning's news flow really hasn't been that bad as the Europeans do seem to be trying to show a little more unity than usual, and official expectations of the Troika outcome are being flagged as positive. TMM hope that it's worthy of Prokofiev's cheery "Troika" that they can't get out of their minds every time they hear the word. But for today we are back to "price" once again being the news...
Global Terror + SNB + Hope(G7+HIA+ECB+UKQE) = Relief
Which suits TMM just fine.
TMM have, as you may have detected, been erring between tentative equity buyers in the style of "on the one hand" hedge me calls analysts, to outright "so excited we cant pee straight" buyers. Of course, the SEWCPS signal is usually a sure indicator of unreasoned stupidity, so we thought we d better have a closer look and see if it is justified.
And that brings TMM onto the DAX, which has taken a very large pummeling in recent weeks. Obviously, the imposition of short-sell bans in Europe, preventing the EuroStoxx future from being used as a hedging mechanism has played a large part in its under-performance as "hedgers" moved to short the DAX instead. TMM use the term "hedgers" loosely, as it seems to them that given the wild cheering on their IBs and email messages the past couple of weeks to the move lower in the DAX, that there are a great deal more players short the index than merely hedgers alone. Indeed, TMM's sales coverage has highlighted a lot of interest from macro hedge funds in being short, meaning that there are a significant number of "Tourist Traders" in that market. The trouble with this is that the DAX is a lot less liquid than the EuroStoxx. Now, TMM have learned very painfully in the past that when trying to get out of positions that are illiquid when everyone else is positioned the same way that the door isn't big enough and you get Pink Flamingo-ed.
Now, TMM admit, positioning is not a sufficient trigger for reversals, and neither are valuation-based arguments - which as many point out - are vulnerable to becoming value traps. But for completeness, TMM reckon it is worth considering what the downside in DAX could be. As with all models, the below (very) naive model for the YoY change in EPS for the DAX (based upon lagged ISM, IFO, CPI, PPI and Wage growth) is meant only to be illustrative from the macro level, rather than fully explain earnings growth or margins or any particular specifics. [Stats Geeks: the large tech-related write-downs in 2001-3 make it not particularly meaningful to look at YoY % EPS growth when modelling, but looking at the straight change in EPS growth should eliminate the root unit problem in the regression.]
The last model print in the chart assumes that IFO falls 4pts this month to 102 (which seems reasonable given the falls in the PMI etc), and the final three lines are rough forecasts of the underlying variables for a Mild Recession (e.g. 2001-3), a Mid-Cycle Slowdown (e.g. 2005) and a Global Financial Crisis-style Hard Landing (e.g. 2008/9).
Translating these into more meaningful %age changes and the implied Earnings yields under those scenarios, and making the exceptionally conservative assumption that the current DAX price discount ZERO fall in earnings (while it clearly does)then in a GFC-style crisis, this would imply earnings falling nearly 87%, leaving an earnings yield of around 1.4% (vs. Bund Yields at 1.89%). Now, TMM tend to think this model is perhaps too pessimistic, given that in 2008/9, earnings actually only actually fell about 60%, and that would leave the earnings yield sitting around 5.8%.
Either way, the point of this exercise is to demonstrate that the DAX already pricing in a pretty dire macroeconomic outcome. In fact, TMM reckon that it is hard to argue that the DAX does not already price in EPS falls of some degree, and thus the above numbers understate the actual Earnings Yields in such scenarios. And thus, it is pretty hard to argue that the DAX is anything but exceptionally cheap in this framework, with a forward P/E of just 7.3x.
Now lets look at the background. Interestingly news-flow has begun to improve, with the German Constitutional Court ruling and Italian fiscal packages voted through, the US economic data stabilising, a US Jobs Plan in the offing and the potential for a G7 policy response that is likely to target the recapitalisation of Europe's banking system (judging by recent leaks), all falling onto a market that has been up until recently been wrist slittingly suicidal. The technical picture is also supprtive of a run higher with dojis/island reversals in various equity markets and even a soothsayer signal in the DAx itself, we reckon that the conditions are in place for a more dramatic rally.
SO, are we still at SEWCPS levels? Yeah... why not...? Where's the fun in life if you can't jump around like a 9 year old at the sound of the ice cream van coming down the road*?
* TMM have a friend whose dad told them at a very early age about the tune the ice cream van plays: "Well they play it when they have run out of ice cream and have to go back to the yard". Masterful parenting.
A reading from the Book of Genesis, Chapter 7, Verses 1-24:
7:1 And the European said unto SNB , Come thou and all thy house into the ark; for thee have I seen righteous before me in this generation.
7:2 Of every clean currency thou shalt take to thee by sevens, the cash and the debt: and of currencies that are not clean by two, the cash and the debt.
7:3 Of foul peripheries also by sevens, the cash and the debt; to keep them alive upon the face of all the earth.
7:4 For yet seven days, and I will cause it to rain upon the speculator, forty days and forty nights; and any value in your currency that I have made will I destroy from off the face of the earth.
7:5 And SNB did according unto all that the European commanded him.
7:6 And SNB was two hundred billion short when the flood of CHF selling was upon the earth.
7:7 And SNB went in, and his sons, and his wife, and his sons' wives with him, into the ark, because of the flood.
7:8 Of clean currencies, and of currencies that are not clean, and of foul peripheries, and of all the debt that creepeth upon the earth,
7:9 There went in two's and ten's unto the SNB ark, the cash and the debt, as the European had commanded SNB
7:10 And it came to pass after seven days, that the flood of CHF were upon the earth.
7:11 At six hundred billion short, the SNB, in the second month, the seventeenth day of the month, the same day were all the rules of monetary policy broken up, and the taps of QE were opened.
7:12 And the rain of CHF was upon the earth forty days and forty nights.
7:13 In the selfsame day entered SNB, and Hildebrand , and Jordan, and Danthine, the sons of SNB , and SNB's wife BOJ, into the ark;
7:14 They, and every Central bank after his kind, and all the policy makers of their kind, and every creeping regulator that creepeth upon the earth after his kind, and every foul politician after his kind, every bid of every sort.
7:15 And they went in unto SNB into the ark, cash and debt and two of all the structures, wherein is the breath of life.
7:16 And they that went in, went in cash and debt of all ratings, as the European had commanded him: and the European shut him in.
7:17 And the flood of CHF was forty days upon the earth; and the levels increased, and bare up the Ark, and it was lift up above the earth.
7:18 And the flood of CHF prevailed, and were increased greatly upon the earth; and the Ark went upon the face of the world.
7:19 And the flood of CHF prevailed exceedingly upon the earth; and all the high debts, that were under the whole heaven, were covered.
7:20 Fifteen trillion upward did the CHF prevail; and the mountains were covered.
7:21 And all debt died that moved upon the earth, both the foul periphery, of Greece and Italy and Spain, and of every creeping crisis thing that creepeth upon the earth, and every speculator.
7:22 All in whose balance sheets was the leverage of shorts, of all that was in the deflationary land, died.
7:23 And every bearish substance was destroyed which was upon the face of the ground, both hedge funds, and day traders, and the creeping blog things, and the foul bears; and they were destroyed from the earth: and SNB only remained alive, and they that were with him in the ark.
7:24 And the CHF prevailed upon the earth a hundred and fifty days.