Core meltdown

Well, that got ugly in a hurry.  Curiously, however, yesterday's risky asset selling never really seemed to reach a panicked crescendo; it was more of a drip-feed of supply into the market all day.  In that sense, it wasn't like a disaster movie or a Bond flick where the infuriatingly calm female voice intones "core meltdown in 30 seconds".   No, this was more of a Glencore meltdown, a slow descent into the void.

For clearly Glencore's travails have gone tabloid and are the new nexus of market weakness, with China's economic slowdown forgotten in a retail frenzy of Air Jordans and iPhone 6s's.  The company's swift descent into the maelstrom is the closest thing we've seen  seen to the financial crisis since the...err....financial crisis.  The familiar pattern...

Over-leverage during the good times -->  See underlying price of key asset(s) tumble  --> Share price comes under pressure as investors worry about leverage --> Devise plan to recapitalize and "sort everything out"  --> Market calls BS, equity and bond prices dump

....describes Glencore's downfall every bit as much as it did, say, Merrill Lynch's.  Certainly the price of Glencore bonds is reminiscent of crisis, be it the GFC or the biannual Greek meltdown/bailout.


source: https://twitter.com/ericbeebo/status/648516702960025600?lang=en

On a positive note, it does not seem as if Glencore carries the same systemic risk that so many financial institutions did seven years ago, most notably AIG.   Macro Man was chatting with a mate yesterday who speculated that the company's notional derivative exposure must be "in the trillions."   Macro Man's philosophy is why guess when you can look, so he did, and was pleasantly surprised by what he found.   If the company's financial statements are to be believed, the company's gross and net derivative exposure is actually quite small, and they've actually unwound about half of their book since the end of last year.

                                                  source: Glencore

That will come as small comfort to those unfortunate souls long the bonds in the chart above, of course, nor those long the equity or bonds of other commodity players, large and small.  For better or for worse, Glencore can serve as something of a morality tale of the post-crisis era, and not just because they IPO'd at the ding-dong highs of the commodity market, joining others like GS (1999) and Blackstone/KKR (2007) to cash out at the best possible time.

No, Glencore's story is one of succumbing to the temptation of the luscious fruits on offer in ZIRP-world, and the doubling of the firm's gross and net debt profiles between the end of 2011 (its first year as a public company) and 2013.   Now, this probably says as much about how management's incentives were skewed as soon as somebody else was holding the equity bag as it does about the ultra-permissive borrowing climate that's prevailed in the world of QE, ZIRP, and central bank forward guidance.  But still- adding $27 billion of gross debt is pretty punchy no matter how you slice it.

The outcome leaves the Fed in exactly the type of conundrum that curmudgeons like your author have been concerned about vis-a-vis ultra-easy monetary policy and the misallocation of capital.   Does it react to market woes deriving from Glencore by delaying the policy shift that it's indicated it wishes to get on with?  If so, isn't that kind of like delegating the chairmanship of the FOMC to Ivan Glasenberg, which doesn't seem like such a hot idea given the performance of his firm?

On the other hand, there is some legitimate stress out there.  For many of us, credit market liquidity has been a primary concern in the brave new regulatory regime, with the inability of dealers to take any principal risk rendering the market considerably more volatile...and prone to over-shooting well beyond the apparent fundamentals of the market or an underlying security.   That's all well and good if you're a long-term investor with a multi-year horizon, but in the modern climate of five minute macro, it's properly frightening for those caught long (and wrong.)  Using HYG as a proxy, high yield isn;t in proper meltdown mode yet....but it's not too far off.



As equity-focused readers have noted, biotech has gotten slammed recently, even more so than in the 'rotation, rotation, rotation' shank-fest in the .  Obviously, this is a sector quite popular with a lot of equity guys, though their performance recently does raise the question of whether they actually generate any alpha, or simply buy the thing that goes up the fastest (and not sell it when it goes down the fastest!)


Regardless, the Fed really needs to sort out its communications strategy, which has descended into farce.   You know the stream of verbal diarrhea from governors and regional presidents has become counterproductive when two Fed-heads hit the tape an hour apart giving conflicting messages.  Yes, each person around the table is special and wonderful, etc.   At such a sensitive time, however, too many cooks spoil the broth (one used to be able to say there were too many chiefs and not enough Indians- is that still allowed?)

Either way, the Fed really ought to sort itself out sooner rather than later...or we might end up with a proper core meltdown, just like you see in the Bond movies.  



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winginit
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September 29, 2015 at 7:43 AM ×

Nice stuff. Hope I didn’t miss it above but very important when it comes to Glencore is their rating.

Re Stock market. I wouldn’t be surprised if this is a day for the dip buyers (I too will be ready). But light won’t come until US open/EZ afternoon.

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Anonymous
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September 29, 2015 at 7:55 AM ×

But it's not just Glencore. It's Noble, Shell pulling out of Alaska, Alcoa split, CAT, China coal miner laying off 100k, Cargill dumping its hedge fund, Nidera's "rogue trader". Just need one of the other FTSE's to cut it's Div now.

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Unknown
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September 29, 2015 at 7:56 AM ×

Glencore also has a lot of quasi derivatives in the form of offtake agreements and long-term contracts. The accounting for these is not consistent with the accounting of derivatives so can create phantom assets/liabilities (hence profit/losses)/on balance sheets (never looked much at Glencore as always been obvious black hole accounting wise - not saying valuations just unknowable). This issue of long-term items not being consistent with derivatives is common across a lot of industries and some firms have no doubt 'arbitraged' it

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Anonymous
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September 29, 2015 at 7:58 AM ×

And that is just the last 4/5 days.

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September 29, 2015 at 8:31 AM ×

imo, there is nothing the fed can sort out in its communications, its much deeper than that and cannot be solved with a few nice words. US data will keep rolling in and happily confirm that cyclical turn we have been positioned for. I know MM will not be glad to read it but EVEN IF fed hikes they will quickly reverse and go into easing mode...and it does not have much to do with the eq market performance. That is just the icing on the cake.

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Anonymous
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September 29, 2015 at 10:40 AM ×

there's so much reflexivity in the 'recovery' so far that its very difficult to make fundamental arguments for why the market should recover

In the same way, its hard to make arguments for the market to go lower

I think this is a very low conviction space for all concerned, which is helping de-risking / lower tape

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Anonymous
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September 29, 2015 at 11:44 AM ×

FT: I think the FED has stumbled in its communication policy; they warn of hikes, then they don't hike but come out in force in the following few days to reassert that they will hike soon; compound that with the EM SNAFU and you get a lot of (suddenly) risk averse investors (and punters).
Carl will be right, of course, but I think he showed up a bit early to deliver his market eulogy.
As of this morning, I'm 100 % long ready to go to 150 if we have a final capitulation.

The service ISM will be interesting; I'm not convinced if payroll stats are reliable in real time but if they are, we should see a dip in job creation. The problem is that the birth/death model is a heavy ship to turn around which is why payrolls are so lagging....

Precious metals: I'm still long (and wrong) with stops not so far...I know they are commodities and investors are more concerned with getting out than getting into something else. I also know that PM's ignition sequence tends to be a tad slow;
Still, I'm surprised by how savage the selling has been since the end of last week considering the context.

Probably old school thinking.....

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abee crombie
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September 29, 2015 at 11:51 AM ×

Was listening to Cramer last night and I think he summer it up nicely, anyone who needs debt in this market is getting killed ( mlp, rollup, oil and gas /commodities. ) but while I hear the point and do think credit is full of a lot of crappy business models, and black boxes, I am not sure this is the big one as NICO wrote

1 I don't think credit guys are the smartest. Distressed guys do thier work, but imo, investment grade is just index following. And what happens when they realize the bought a turd like glencore or pbr for 0.5% of the fund. The sell, no questions asked.

2. Lots of pe money still on sideline. I think they will fund a chunk of mlp needs. I don't think mlps are broken.

3 if high yield gets really crazy, the fed will end up buying some. Asset reflation is the only bullet the fed has. They are not going to stop. And the world is still awash on money. This might take a while to occur but a massive drop on asset prices should do it.

Either way, I'll let hy show me before I jump in with 2 feet.

Thinking of shorting insurance Co for tail hedge. Thier assets are mostly corporate bonds.

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September 29, 2015 at 12:16 PM ×

On Fed communication, just yesterday, three contradictory comments from Dudley, Evans, Williams. Awkward.



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Nico G
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September 29, 2015 at 12:31 PM ×

bah Abee, if you are confused like everyone else just shorten your (from investing to trading) timeframe i went long for a change this morning and locked 2% on stoxx. I originally wanted to trail that long into quarter end but too many tape bombs are still in the way, not comfortable. I do plan on going solid long when/if we do see a liquidation meltdown so far there has not been much pain

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washedup
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September 29, 2015 at 1:27 PM ×

abee - u listening to cramer now? C'mon!!!!

I am very bullearisheutral - seriously no f@#ng clue - will wait for something to tell me something - kind of envy u guys for having conviction because big moves seem almost assured, so with the right stops I feel there is $ to be made.

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Leftback
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September 29, 2015 at 1:34 PM ×

Agree with comments on Fed communication. Way too much jawboning. Well stated by many. They could really all learn from Rajan at RBI and just shut up until they do something. Keep quiet and then make a big move that actually matters. ["Rate cuts should not be seen as goodies that the RBI gives out stingily after much public pleading."] Btw, has there been any real news on a diagnosis of Yellen's absence seizure/s last week (it was definitely not a stroke, by the way)?

Not far removed from the peace and relaxation of the summer hammock, we are now at about 85% long equities, which is close to as long as we ever get. The hammock time definitely served its purpose, as we are outperforming our benchmarks by about 4% YTD. This is in spite of the fact that we have really had a bit of a stinker this year, mainly b/c of getting some FX movements wrong and falling foul of the EM sell-off, despite being more or less spot on about rates and US growth....

Nico, I don't think we see another capitulation sell-off with vol spiking to VIX 50, or even a retest of the August lows (b/c this is becoming consensus now), instead we will probably just get more grinding down here as we carve out a bottom. Sentiment is very extreme here, and in the short term a relief rally into (and perhaps through) earnings season seems probable.

HY has obviously been weighted down by credits in the energy space, and my guess is that it will move in lock step with the price of crude for some time going forward. Brent/wti is the first thing I look at every day now, as it is the main inflation driver and hence the key to all 5-minute macro, longer term reflation trades and most if not all of the global equity indices.

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washedup
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September 29, 2015 at 1:43 PM ×

I will say this to your comments Left - an oil rally here is about as expected as a screen door on a submarine - in the meantime oil fundamentals have been quietly getting better - I've been a big bear on oil for 15 months (I hope you remember our debates as fondly as I do!) but I am really beginning to question that thesis with recent data points.
Just food for thought.

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Booger
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September 29, 2015 at 2:12 PM ×

Parsing the Fed, I suspect Yellen was trying to say in her speech last week: "we still expect to be hiking this year, if things remain sweet which they are not". Unfortunately she had the coughing attack just before she could utter that last bit. LB, based on my internet research of medical symptoms, she appears to have had a transient ischemic attack (TIA) not an absence seizure.

On EM: I think the EM turd cannot be expelled until China devalues some more. It could however rally suddenly to kick you in the nuts shorting from current levels. I am still waiting for the double poo to go long.

On Spoos: Despite the minor bearishness recently, we are still only 10% below all time highs. Bears have been spanked repeatedly and mercilessly for the last 5 years (probably the way nico likes it). Recency bias favours JBTFD. But we should not be too anchored to recent settings. I reckon despite the recent settings, 1300 is fair value on spoos and an overshoot to 1100 is not improbable. DAX has been very good to daytrade on both sides recently. Short Spoos is currently my preferred high conviction medium term trade. I just wish it would hurry up and die or melt up more quickly.

On risk trends: These appear to have changed with the China devaluation of the Yuan. Based on this simple and magical thinking, I think it will not be reversed until the Chinese devalue some more.

We may see spoos correcting up a bit to 1900 again, but I think the writing is on the wall for a further move down. The market sold off with the Fed not hiking (normally bullish), and they are still talking hawkish to appear credible/tough, which is sending it down further. If they do actually raise this year it would likely crater EM and spoos.

The only way I can see risk trends reversing here is if they started talking seriously about easing, negative rates or QE4. But they have been doing the reverse in the last week so I reckon spoos will have to take it a bit more before they do a 180.

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Gnome of Zurich
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September 29, 2015 at 3:35 PM ×

This market looks more and more like a 1980s replay: Oil & petrodollar bust with corresponding banks and EM disaster, much disbelief in the equity bull market, a few junk bond sector boom & busts but overall improving picture for the consumers, not at least thanks to the oil collapse. Only the interest rate trend goes into the other direction, which complicates the analogy...

Euro PIGS banks now look like terrible bargains: balance sheets have been strengthened, credit is growing again, new bad loans are retreating and Draghi has their back. I really don't get the current sell-off.

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Nico G
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September 29, 2015 at 3:36 PM ×

yeah yeah Boogie i like it rough

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Macro Man
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September 29, 2015 at 3:55 PM ×

Booger, I really think you're barking up the wrong tree if you think another China deval a) will happen any time soon, and b) will calm things. I also happen to think your 'fair value' estimates for the SPX are way too low, sceptic though I am of QE/ZIRP.

You all know my view: the worst possible thing for markets is what we are getting- policy uncertainty from 'the world's central bank', combined with more flip-flops than the Algarve in August.

Do I think we melt up if/when they hike rates? No, certainly not immediately. But if/when 6 months pass and the US doesn't fall into the abyss, I could easily see a rip-snorter as markets embrace a return to normalcy.

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Anonymous
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September 29, 2015 at 4:02 PM ×

Euro pigs banks were making money on high yield bonds, btp etc. That's gone now and they ain't really lending. So how they make coin?

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Nico G
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September 29, 2015 at 4:31 PM ×

Euro pigs banks are BANKRUPT. They have been since 2008.

'more flip-flops than the Algarve in August' bless English humour

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C
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September 29, 2015 at 5:15 PM ×

Why are Euro pigs banks still bankrupt? Haven't they recapitalised? Thought their assets would have appreciated over the last couple years also

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Eddie
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September 29, 2015 at 5:35 PM ×

Booger, sorry for nitpicking again but how do you arrive at 1300 fair value for Spooz? Grantham mumbled 1120 last time I checked and I won't mention Hussman here...

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DownWithTheBeanCounters
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September 29, 2015 at 6:00 PM ×

Any chance that the Fed consensus is correct and we do start to see wages rise in the US as labor market slack abates?

US consumer confidence was a +tive shocker this morning. I drove the family to Charles City IA two weekends ago. Round trip gas cost was $40. That was also a positive shocker (prices aren't down much in Chicago for a variety of unfortunate reasons).

US real world stuff looks ok. Markets definitely do not.

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Bruce in Tennessee
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September 29, 2015 at 6:08 PM ×

Not far removed from the peace and relaxation of the summer hammock, we are now at about 85% long equities, which is close to as long as we ever get.


...Lefty, as you know, I enjoy your posts. But be careful here. Sometimes we develop a thesis, and then we rationalize it all the way to the poor house. Perhaps a cup of coffee, a yellow pad, and a pencil...listing the pros and cons and giving it a good rethink. I hope you are right, though, and make scads of money with this idea. I am betting the other way.

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washedup
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September 29, 2015 at 6:29 PM ×

US macro data is ho hum but clearly +ve - its the european data that continues to impress me - I think (with a due nod to the opacity of Chinese statistics which make it impossible to say anything with confidence) EZ may actually be growing at the same pace, if not slightly faster than China, which was unthinkable to me a few quarters ago.
QE is bogus and a complete failure when it comes to any real economy impact, but never underestimate the beneficial impact of currency weakening in a beggar thy neighbor world. Of course if the former achieves the latter....

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CV
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September 29, 2015 at 6:40 PM ×

Great post MM, especially the point about non-financial corporate bond liquidity, etc etc. We must watch this carefully.

Meanwhile, I think the problem with the discussion here is the lack of imagination. Spoos is a great example. Imagine for example that the reality is somewhere between(!) a return to 666 and a rocket ship to 2200. It's possible you know. One of the key themes since 2012 has been divergence across asset classes, equity sectors etc. I think this will continue, and if you fade the extremes in either direction, you will do well.

Funnily, I find myself labelled here as an uber-bull (with LB) despite running a sizeable cash position due mainly to my apprehension that corporate credit is a time bomb. Maybe it is a sign of the times, I don't know, but I guess that I DO have to accept the bull mantle when I look at the coming six months.

I think it will be oh so easy. I think the world will keep spinning, and I think that passive/stupid(?) beta chasers will do very, very well simply buying the FTSE, the MSCI World, MSCI EM and EZ.

Finally, Nico ... . I don't materially object against your critique of the teflon QE markets actually. But if you want to short something, I cannot for the life of me understand why you be running that trade in Europe. Just my five cents ...

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DownWithTheBeanCounters
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September 29, 2015 at 6:52 PM ×

I'm impressed with the Gyropeon data too and puzzled by your follow on washedup. Ben B was very aggressive with unorthodox monetary moves and what do you know? The US economy outpaced those helmed by more diffident CBers. Now Mario D has a bid in and what do you know?

Yurp is amazing when it comes to inventing innovative ways to blow up positive economic momentum (who'd have guessed it would be Germany Inc. cheating with the EPA?), but man do those markets look cheap.

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Anonymous
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September 29, 2015 at 8:50 PM ×

Are global capital flows a big negative for assets?

Trade surpluses are exploding upwards in China and Europe with Japan moving back from strong deficit to neutral (thanks to the Yen). The U.S. is accommodating a lot of this in the non-petroleum trade balance, which is sinking fast. The U.S. needs to find some job producing investments to make or unemployment is going to move in the other direction. Saudi Arabia and other oil exporters are also accommodating the surpluses in China/Europe.

The Saudi deficits lead them to sell assets, which means less demand for risky assets. Does the positives of the European surpluses outweigh the negatives of the U.S./OPEC deficits? The capital account outflow from China is a clear negative as trades are unwound as a result rather than built up. When speculative capital flows into China, PBOC buys Treasuries, former Treasury investor buys something more risky, etc. Now this all goes into reverse with speculative outflow from China.

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Nico G
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September 29, 2015 at 8:54 PM ×

CV

my core short is spoos (longest timeframe), i take profits much faster on Europe (swings). Today i did a quick 2% trip long from auction, happy to be out, will repeat tomorrow, just trying to be opportunistic. I agree that Europe is the least damaged good here simply because it has not shot up in 2009-2015 like the rest of the world (and for good reasons!). Still on one correct timeframe Europe has always more beta than the US if you want more bang for your bear buck Europe will deliver, Dax first and foremost.

i am afraid we might come to Correlation One when everything moves together anyway. There are tons of liquidation out there me think it is only the start, so i am not too sure about your 6 month timeframe it might take more for leverage to trim down before a sound and healthy bottom is found. Well that cash position of yours will be there to average at lower levels wink wink

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Macro Man
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September 29, 2015 at 8:55 PM ×

There are clearly net asset sales from the oil guys, Brazilians, etc. The China story is a little more nuanced I think. I don't think we're seeing a massive change in China's net international investment position; rather, the private sector is exporting capital, replacing that held by the public sector. This is one reason I think PBOC is going to defend the exchange rate and is willing to burn reserves; they realize that this is a natural evolution in China's NIIP.

The upshot is that Chinese holders of Treasuries (PBOC) are being replaced by Chinese buyers of property and equity (Mr. and Mrs. Wu)

What it does add up to is much less official buying of UST paper than has been the case in a long, long, long time.

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washedup
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September 29, 2015 at 9:11 PM ×

MM fully agree on treasuries - in fact I really think 10 Y are much more interesting than a long equities idea - punters have rather thought-lessy piled into UST in this risk off episode - a bit of a turn in the tide and continued Chinese intervention and you could end up at 2.50 for the 10 yr by thanksgiving - seems like a long way off but thats what we used to spike to 2 years ago.
Also beginning to see the potential for some FED dollar weakening intervention or swap lines with EM banks if this carry trade unwind that the market is so paranoid about comes to fruition - just because they haven't done it in the past doesn't mean its impossible - I did;t expect them to refer to dollar strength in their statements at all, but clearly they are increasingly concerned about that as a source of financial contagion. Note that would also be bearish UST.

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Anonymous
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September 29, 2015 at 9:19 PM ×

Anon from 8:50 here again:

Before, Chinese and non-Chinese invested in a Chinese asset (RE, bank deposit, etc). Any surplus balance of dollars was recycled by the PBOC into USTs and the sellers replaced the USTs with marginally riskier paper.

Now, Chinese and non-Chinese liquidate the Chinese asset (RE, bank deposit, etc) and buy a like asset overseas. Any deficit balance of dollars is met by PBOC of USTs and the buyers of the USTs had to sell something marginally riskier or lever up.

To me, it looks like the direction of the private flows matters a lot given the official mechanisms. Reserve accumulation suppresses risk/spreads like QE and reserve drawdowns are likely to do the opposite.

I would think that risk assets are hit hardest/first by this process. Oh the humanity if USTs lose a bid at the same time (I don't think it is likely, but the correlation to the downside would be a major swan of some color).

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washedup
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September 29, 2015 at 9:35 PM ×

@anon - "Oh the humanity if USTs lose a bid at the same time (I don't think it is likely, but the correlation to the downside would be a major swan of some color)."

Truer words were never spoken - in fact, one reason I have no compelling cause to distinguish this equity selloff from the other ones we have had in this bull run is precisely the behavior of govvies, and what that implies for pent up horsepower later - I would note that we have already seen a slow motion version of this YTD which is why cash has outperformed the stocks plus bonds idea - but yes I would very get very bearish (Nico bearish) if that correlation u allude to starts to develop.

Basically if CB assets are getting inflated because the market rushes to them at the slightest hint of trouble, in what sense are they losing the market battle? Only with pressure on treasuries would they be truly cornered.

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abee crombie
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September 30, 2015 at 12:40 AM ×

MLPs are getting killed. It's gonna be huge tax loss selling pressure from the retail base, if not already. I'm getting smoked. All hands away for now, this is a falling knife. But they have assets. Keep selling. It will make my come back trade of 2016.

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JohnL
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September 30, 2015 at 2:16 AM ×

Looks like MLP's are leading the pack. Yeild reach is getting smoked by the look of it.

https://goo.gl/9MFySo

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abee crombie
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September 30, 2015 at 4:32 AM ×

This is a market of stocks, not a stock market. I'm not sure how many guys here trade individual stocks but from the lists I scan I see so much carnage already its scary. According to GaveKal, 48% of stocks are already down 20% from their highs. And now with Biotech kicking in the can, we have only the internet names and a few consumer names holding up the pack.

Conceptually, HY is a put option in the capital structure, hence where the relationship between VOL and HY spreads comes in. Today if one were to judge which two markets have the most liquidity/market structure problems, you'd say HY and Vol trading. I dont pretend to know the outcome but this seems to be a space to watch. I'll try and bring some analysis on HYG tom when I'm in front of my terminal.

Nico, I'm not so much confused here as I am just kicking myself for not having more cash when things are collapsing as they are now. I didnt think mREITs and MLPs would have gotten killed so much before S&P broke 1850, doh! I like the first 10min of Cramer as he does a good job talking about the single name movements in the markets I may have missed. Yeah he's nutty but he knows how to play the MoMo game very well, so now is actually the time he is valuable.

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Nico G
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September 30, 2015 at 6:40 AM ×

abee what can i say? i advocated caution all year long to the point of becoming MM resident PPT (party pooper tenuous). Even if one had no taste for going short, seeing the spoos repeatedly fail at 2100 was a good invitation to trim longs especially when Apple and some other beauty queens we started to be sold

as you said, one wonders where spoos would be if those monster cap darlings were not holding up the pack. I only trade indices now, but wonder if dispersion strategies on single names VOL would work here, short gamma on the champions long gamma on a basket of others

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