Dudley to market: remain calm, all is well

Where to begin?  How about with Bill Dudley, who gave a speech yesterday essentially saying "nothing to see here, please disperse" when it comes to bond market liquidity (or lack thereof.)  To say that the argument was uncompelling and smacked of complacency is an understatement; for example, Dudley's analysis focused on dealer-to-dealer transactions in the Treasury market while ignoring client-to-dealer transactions.  Moreover, by focusing on measures (such as deviation from fitted yield curve) that he himself admits were distorted by the Fed's zillion dollars worth of asset purchases, Dudley essentially rendered his argument tautological.

Unsurprisingly, other analysis comes to a different conclusion such as the chart displayed in this article showing how daily yield moves in excess of 1 standard deviation are at historic highs since the implementation of Dodd-Frank.

Dudley wrapped up his argument with the usual "even if liquidity has declined, it's a small price to pay for financial stability."  That's easy to say, but there is of course no guarantee that the deterioration of liquidity has conferred (or coincided) with overall financial stability...and that's without pointing out the logical fallacy that maintaining ample market liquidity and financial stability are somehow mutually exclusive.

As for those who've been bulldozed in the least liquid segment of the corporate sector, where price becomes news, here's a succinct summation of Dudley's message to you:




Moving along, focus today is on the ISM, where despite the published consensus forecast of 50.7 the whisper number is below 50.  Yesterday's execrable Chicago PMI number has surely fed the tide of negativity.  Given the weakness in other regional surveys, the market's pessimism would appear justified, though the historical correlation between the regional reports and the national figure are relatively modest.

While it would appear unlikely that the Fed would move policy with the ISM below 50, no one actually expects a move in October anyways, given the S&P 500's audacious failure to rally.  Putting things into context, however, it's important to recall that manufacturing is a relatively small (if visible) portion of the US economy.   A composite measure of the manufacturing and services ISMs, weighted 30/70 to reflect their relative importance, suggest things are nowhere near as bad as the usual prophets of doom might suggest.


Obviously, things can change....but right now Macro Man isn't seeing the sort of deterioration that would serve as a legitimate cause for alarm.

Speaking of which, there have been some fairly bearish viewpoints espoused in the comments section recently, and Macro Man was amused to see Carl Icahn star in a video expressing a similar sentiment.  Your author was shocked, SHOCKED to see Mr. Icahn, who owns many billion dollars worth of corporate equity, recommend steep corporate tax cuts as a solution to the current malaise.

The fact is, however, that corporate profits are generally doing just fine, thanks to a whole host of advantages that companies enjoy which Joe Sixpack does not.  Macro Man has touched on this before, but profits (and market expectation of future profit streams) do an excellent job of defining the secular cycle in US equities.  The current state of play, quite simply, does not suggest an imminent collapse, nor that this is 'the Big One'.  If anything, the time to make that argument was 6-9 months ago, which was exactly the point when Macro Man was fuming about the lack of volatility in the market.



History suggests that when earnings expectations are pointing up and the market's pointing down, it's the market, not expectations, that tends to correct.  Perhaps this time really will be different.  Macro Man cannot shake the view, however, that while we have moved into a higher volatility regime for the foreseeable future (thereby reducing the ex ante Sharpe ratio of holding risky assets), the ultimate resolution will be higher, demonstrating this to have been a correction rather than the start of a new bear market.
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23 comments

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Nico G
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October 1, 2015 at 9:33 AM ×

"even if liquidity has declined, it's a small price to pay for financial stability"

Dudley the Oxy moron King

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Nico G
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October 1, 2015 at 9:33 AM ×

"even if liquidity has declined, it's a small price to pay for financial stability"

Dudley the Oxy moron King

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Eddie
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October 1, 2015 at 12:49 PM ×

www.wsj.com/articles/third-quarter-earnings-theres-no-place-like-home-1443637223

"In the second quarter, operating earnings per share at S&P 500 companies excluding the energy sector grew by 8.9%, by Thomson Reuters’ count. But figures from S&P Dow Jones Indices show that overall earnings under GAAP (again, excluding energy), fell by 2.9%. It is, of course, companies in trouble that tend to see the sharpest differences between operating earnings and GAAP, and right now the trouble is overseas."

I guess this tells a bit about earnings quality right now.

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Adrem
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October 1, 2015 at 1:14 PM ×

When can you take over from Dudley? Can we raise a petition?

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Nico G
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October 1, 2015 at 1:48 PM ×

leading indicator DAX is down 2% from day high, and in the red. You guys be careful this October

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Anonymous
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October 1, 2015 at 2:23 PM ×

watching IG spreads here...

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Anonymous
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October 1, 2015 at 2:33 PM ×

FT: Dax from an elliotist perspective we had 5 clear waves up and are now experiencing a healthy correction which should end just before or after ISM

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Eddie
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October 1, 2015 at 3:46 PM ×

Nico, could you pls elaborate why you think GIPS banks are bankrupt?

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Mr. T
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October 1, 2015 at 5:00 PM ×

Nice post MM. The fed communications are like talking to my daughter. I think I know what they are saying and then all of a sudden I realize I have absolutely no clue whats going on. Maybe thats a good thing in the long run - decreasing the signal to noise ratio to a point of uselessness is the way to start the process of them losing celebrity status?

I too want to see this vol resolve itself to the upside but have very little conviction. It might seem like an eternity of watching red every day but if this is a bear or even a slowdown its probably still early. We have not seen a single quarter of crap earnings, we have not seen a quarter yet with energy names ex-hedging, price decks for commodity strips are all still well above market rates etc. I suspect the weakness in AAPL is informed selling and we are going to see some real retrenchment in the consumer space.

I bit too early on some higher-beta names. The macau gaming stocks have turned into a slaughterhouse, but like a moth to the flame they still seem like a decent way to play TWINE, which fits well with a "slowdown with a secular growth background" baseline.

Good luck out there guys

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Anonymous
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October 1, 2015 at 5:13 PM ×

Today's Atlanta Fed GDPNow forecast for Q3 FELL from 1.8% last est to 0.9% NOW (far below 2.5% Blue Chip avg forecast)!

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Nico G
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October 1, 2015 at 5:29 PM ×

Eddie

non PIGS:

the book of DG, SocGen etc is a time bomb and doomed is every other bank who OTCed billions with them. Nothing has changed since 2008 there is barely any accounting, derivatives are not marked to market and the leverage has thus even increased courtesy of ZIRP induced mad quest for yield

PIGS:

just add hundreds of billions of bad loans and RE losses that again are not accounted for

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Anonymous
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October 1, 2015 at 5:47 PM ×

nico-"derivatives are not marked to market ", absolutely not true...fx rates and equity books are marked to market and end of month independent valuation as well
some credit derivs may be marked to model but you are way off in you assertion here

doesn't mean i disagree with you general views- i have been bearish all year in the us and have started covering short deltas in the us by buying europe ...and actually skewed bit long there..trading around( easier said than done ) but we aren't going to see a blow up because of banks are not marking stuff correct

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Nico G
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October 1, 2015 at 6:51 PM ×

i meant complex derivatives, not vanilla 'i scream'. And even then when the mark to market is not all right on the listed side you end up with a Tom Hayes and the big whale and Kerviel etc

simply put, i would never ever buy shares in an investment bank where monster IQs can decide to hide billions of loss at any given rough time. It is 100% casino and you are playing against people much smarter than you whose design is to enrich themselves no matter the risk for their firm's balance sheet

at 23 year old i traded a multi billion book on Italian single stock options - vanilla and exotic - for a top french shop. I had the upmost respect for auditors who with banks were big employers at our school. They showed up and asked question so dumb i was absolutely shocked. This is when you realise how easy it is to cheat when both your management and your auditors lack basic understanding. When i say basic i mean the first Greek, not the smile of your exotic book

anyway

on the PIGS side we had Esparto Santo not so far ago... and you had to laugh each time Santander posted a quarterly profit... while sitting on hundreds of billions of RE inventory none would buy at 'their' price. Profit on what? Total casino


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abee crombie
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October 1, 2015 at 7:03 PM ×

While we are getting somewhat of a relief rally, HYG still points downwards. Mr Crobmie did some digging into the index and found that the communications sector has been the biggest contributor this month, away from usual suspects materials (steel) and oil/gas. Take a look at sprint, Altice, Tmobile, Dish and even cable vision (who is being bought by altice). The telecom sector makes up a bigger part of HY than Oil and Gas at about 22%. however outside communications, oil/gas and materials, Financials and Consumer plays have held up relatively well this month, so unlike what I thought I might find, the selling in HY has actually been pretty discriminate and not panic across the board.

But as long as HY is in the dumps, vol is gonna stay elevated and the risk will be to the downside.

Ive had a feeling HY would be the source of the next financial downturn but I didnt think it would happen before the REAL economy has turned. That is what I missed. Bc I do agree with MM, that the US economy isnt so bad and corporates are doing pretty well. So to have a turn in HY means either 1) the risk premium went up and equity multiple should go down and or 2) the HY market is expecting a slowdown in earnings, which could be possible given the whole China/EM story. But aside from Oil and Gas, most HY companies are doing OK. So a credit led selloff is not something to take lightly

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abee crombie
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October 1, 2015 at 7:13 PM ×

Re PIIG banks. While I do sympathize with Nico, having had my experience with auditors, and from looking at some spanish banks "foreclosed assets" they have on the books at who knows what price (though in fairness most are generating gains on disposal, which means thier marks were lower than FMV) and those foreclosed assets as a percentage of sh equity are a big piece, I tend to agree with anon 5.47. I think the recent oliver wyman stress tests were a lot more detailed than most give credit for. That said, PIIG banks are now having a hard time making profits, much like US banks, given razon thin NIMs.

Euro banks are a good leading indicator for the index but I think as an investment, much like US banks are, they are a trade. The preffereds are better IMO, unless you think asset quality it truly crap. But unfortunately those banks preffereds havent sold off.

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Anonymous
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October 1, 2015 at 7:21 PM ×

FT@Nico
Bollocks....I grant you the Kerviel episode wasn't one of SocGen's finest moment but having worked as head of CCY options desk there for 6 years I can tell you if the derivative books had a chance to blow off, it was on the 2008 "stress test".
Now, if you tell me there is zillions in non performing loans under the blankets, I don't know about that, but that crap about "derivatives will take down the financial system" is just that : crap

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washedup
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October 1, 2015 at 7:30 PM ×

I am not worried about derivatives taking down the financial system - I have a derivative to protect me from that!

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Anonymous
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October 1, 2015 at 7:44 PM ×

FT@wash: guns?
:)

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Nico G
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October 1, 2015 at 8:46 PM ×

FT

i never said derivatives would take down the financial system, but they might take down your investment.. The post for Eddie pertains to investing in European banks shares. What do you get for your money? Noone knows. for every cent in transparent retail banking there are +10 or -50 cents at play in the investment branch operated by guys who care zero about shareholders' return and only focus on their March bonus. Am i wrong?

i worked at the other shop... the conservative guys who always looked at Socgen's pool of polytechniciens' arrogance with horror.

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washedup
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October 1, 2015 at 9:16 PM ×

@FT nah Mrs washed would never allow that (and would gladly take away everyone else's if given half a chance).

I was merely pointing out the big paradox in those apocalyptic trades - I kind of laugh when I see some rich DBs (doc@#e bags, not Deutsche Bank!) preparing for apocalypse by 1) buying GLD and getting themselves exposed to state street, or 2) buying physical gold and stashing it in some vault in geneva with no clue how they'd access it if cut off or 3) buying some random nuclear bunker property in Nebraska that a million scenarios would allow them no way to get to.

I find it surprising no one thinks of the obvious - developing deep relationships with ur friends and neighbors - actually i am sure they have, but everyone is too busy earning paper money and measuring their di@#s with it to have time for that stuff.

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Anonymous
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October 1, 2015 at 9:42 PM ×

FT@ wash good point; I'm an optimistic with a touch of cynicism....at the end of the day, family, friends and neighbors is what makes life bearable and sometimes interesting....still, I buy house and all kind of insurances and a small gold stash (not in a bank vault) seems like a nice hedge.....

@Nico: as a matter of fact, some of them, although arrogant, were rather in touch with real life and honorability; I once failed to exercise JGB options in Japan (in my defense I had been there for less than a week before expiry and the "procedure manual " stated "automatic exercise") My boss at the time, a famed polytechnician, handed instantly his resignation to Antoine Paille who, of course, refused it (the damage was less than 10 M$ which in itself was incredible as everytime I computed the potential cost for my following 3 years there, it was in the hundreds.....but when I got there JGBs had been in a 3 figure range for a few monthes and the book was light). Anyway, they are not all bad :)

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Anonymous
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October 1, 2015 at 10:24 PM ×

@Nico - I'd like to run some ideas by you. Please email me @ blueberry.trading@yahoo.com or how to get in touch?

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Anonymous
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October 1, 2015 at 10:34 PM ×

FT : even bucket shops are watching this blog.....time to get long for wave 5

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