It's rare for us to post a gratuitous photo, but this supports our point last week that if the players aren't on the court dunking, key players will be out there selling. It's the only way to get paid...
Little to nothing came of this weekend’s G20/IMF/Worldbank meetings in Washington in terms of a policy response to the Euro/Greek “crisis”. The loudest voices of the Germans, and those that we’re taking our cues from, portend willingness to further aid Greece despite strong winds against such actions from the German populace. Germany’s Bundestag vote on the terms on the facility (originally issued on June 21) comes this Thursday and remains in our minds the lynchpin for the decisions of the other 16 Eurozone parliaments (loosely scheduled in the next weeks, with Slovenia tomorrow and Finland Wednesday) as well as the conciliatory approval of remainder of the EU-27 states outside the Eurozone.
European equity markets rallied today on the belief that the Europeans will throw some sort of bazooka at its fiscal problems, both on the sovereign and banking sides, yet question marks remain on the size, scope, or timing of such a decision. There’s talk that from a calendar perspective, a new framework could be reached at an EU finance ministers meeting on November 4 in Cannes. Regardless, expect the microscope to remain on Europe along with expectations of a near-term solution. We’d expect significant volatility (and greater downside risk) into year-end as investors wrestle with and anticipate additional policy measures that may include a larger EFSF (2-3x its current size of €750B), directed funds to better recapitalize European banks, and stronger fiscal contingency plans for Greece and further down the road for the entire monetary union.
Last week major European equity indices were down -5 to -8%, with the EUR-USD pair falling -2.2%. We’d caution that today’s bounce (European equity indices closed up +2 to 3% and the EUR-USD was mixed) may be short lived. The EUR-USD is in a bearish formation, meaning it’s currently trading below its short term TRADE, intermediate term TREND, and long term TAIL lines. We’d short the EUR-USD on any bounce up to around $1.37 - 1.39 and see immediate term TRADE support (to buy) at $1.34 (see chart).
Risk signals continue to suggest that premiums across the periphery especially (but also in the core – DAX down -28% in last two months) will continue to blow out over the intermediate term TREND, as Eurocrats are likely to continue to attach band-aides to the wounds, yet any new grand policy measures will likely take many months to be pushed through, if they come at all. Again, the market waits for no one.
This weekend German Chancellor Angela Merkel said that Eurozone leaders must erect a firewall around Greece to avert a cascade of market attacks on other European states that would risk breaking up the currency area and German finance minister Wolfgang Schaeuble called for the permanent stability fund, the European Stability Mechanism (ESM), to be possibly issued a bit earlier than its present date of 2013. In any case, both leaders, without giving any details away, lean towards aiding Greece, and therefore have minimized the prospect of Greece leaving the Union anytime soon – which may boost sentiment on the news but may not arrest the slide across capital markets.
It’s the risk signals that continue to worry us: CDS spreads for Belgium, France, and Germany are at or near all-time highs in the last two days. And spreads across the periphery, and despite improvements in Ireland, maintain their direction “up-and-to-the-right” (see charts below). Sovereign yields tell a similar story, with Italy and Spain the main points of interest: both have government 19YR yields inside of 6%, a critical break-out level, yet there’s little confidence that Italy and Spain couldn’t overcome the line, especially should the ECB’s secondary sovereign bond purchasing (SMP) wane in the coming weeks (third chart below).
On the banking side, our Financials MD Josh Steiner has astutely noted that between December 31, 2010 and March 31, 2011 the French banking system increased its exposure to PIIGS by $25 billion; while the German banking system decreased its exposure by almost $11 billion, almost all of which came from reductions in Greek sovereign debt holdings; and Italian and Spanish banks both increased their exposure by $3 and $9 billion, respectively, according to the newest report publish by the Bank of International Settlements.
In short, European banking risks have yet to be addressed concisely by Eurocrats, which adds significant fuel to the fire as sovereign exposures are highly linked across the European banks. Our weekly European Financials CDS Monitor showed that bank swaps mostly widened in Europe last week. 39 of the 40 reference entities were wider week over week. The average widening was 11.3%, or 56 basis points, and the median widening was 23.4%
Expect more volatility into and out of tomorrow as Merkel hosts talks with Greek PM Papandreou and the Greek Parliament votes on property tax as one measure of its austerity program. And expect strikes and rioting in Greece beginning today and possibly lasting throughout the week as Troika inspects “the books” and the Greek state thirsts for its next €8 Billion loan tranche!
POSITION: no positions in SPY or Sector ETFs
On this morning’s opening strength, I cut my US Equity exposure in the Hedgeye Asset Allocation Model back down to 0%. I had been at 6% and all of it was in Utilities (XLU), which continue to outperform every Sector ETF in the SP500.
A lot of people I speak with are focused on the SP500 not having breached its “lower-low” (on a closing basis) of 1119 (August 8th). That, on the margin, is a less than bearish signal, until it isn’t.
Don’t forget that the Russell 2000, Financials, Industrials, etc. have all breached their August 8th lows and have been the leading indicators for all of 2011.
What’s also interesting to point out is that if I stretch my model by a half of a standard deviation point (on my immediate-term TRADE duration), I register support at a lower-low of 1109. In other words, closing there would fit the definition of immediate-term possible.
In the chart below, I show two ranges:
After seeing this morning’s rally fail at my resistance range and with US Equities being in a Bearish Formation again (bearish TRADE, TREND, and TAIL), I’m not going to be betting on some Eurocrat to protect me from the possible. Not here, not now.
Keith R. McCullough
Chief Executive Officer
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This week's notable callouts include growing default risk for both US and EU financials and EU sovereigns. Further, we saw a new YTD high in the TED spread and a YTD low in our commodities proxy, the JOC Industrial CPI.
Margin Debt Falls in August - Don't Get Excited
NYSE Margin debt hit its post-2007 peak in April of this year at $320.7 billion. Let’s put things in context. The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1. While this may sound complicated, the message is really quite simple. There are two important takeaways. First, when margin debt gets to 1.5 standard deviations or greater, as it did this past April, that has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period). We flagged this for the first time back in May of this year.
The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. For those unfamiliar, autocorrelation is simply a statistical term that means that trends tend to continue. In other words, the last few month’s change in margin debt is the best predictor of the change we’ll see in the next few months. This is important because it means that margin debt, which has retraced back to +0.64 standard deviations as of August, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend reversed. We’ve dropped 230 S&P handles in getting from +1.5 standard deviations to +0.64 standard deviations. Bear in mind there’s plenty of room for short/intermediate term reversals within this broader secular move. That said, this setup represents a material headwind for the market.
Financial Risk Monitor Summary (Across 3 Durations):
1. US Financials CDS Monitor – Swaps widened across 27 of 28 major domestic financials last week. 19 of 28 companies saw their swaps widen compared to a month ago.
Widened the most vs last week: JPM, GS, MS
Tightened the most/Widened the least vs last week: COF, PMI, AGO
Widened the most vs last month: C, GS, MS
Tightened the most vs last month: PMI, CB, MMC
2. European Financials CDS Monitor – Bank swaps mostly widened in Europe last week. 39 of the 40 reference entities were wider week over week. The average widening was 11.3%, or 56 basis points, and the median widening was 23.4%
3. European Sovereign CDS – European sovereign swaps were mostly wider week over week, with only Spanish and Irish CDS spreads tightening. Most notably, the German sovereign CDS spread widened week over week by 26%. (Please note: Greek CDS is not shown in the chart because the data was not available. To gauge Greek credit risk, please refer to Greek bond yields below.)
4. High Yield (YTM) Monitor – High Yield rates rose 36 bps last week, ending at 8.20 versus 7.84 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 7 points last week, ending at 1534.
6. TED Spread Monitor – The TED spread made another new YTD high, ending the week at 36.5 versus 35.1 the prior week.
7. Journal of Commerce Commodity Price Index – After treading water for more than a month, the JOC index fell 9.9 points last week, ending the week at -14.3.
8. Greek Yield Monitor – The 10-year yield on Greek bonds rose 244 bps to end the week at 2,363 bps versus 2,119 bps the prior week.
9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1. After bottoming in April, the index has been moving higher. Last Friday, spreads rose 26 bps and closed at 170 bps.
10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production. Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion. Last week the index hit its YTD high to ending the week 106 points higher at 1920.
11. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 10-year yield fell to 1.84, pushing the 2-10 spread to 162 bps, 27 bps tighter than a week ago.
12. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows the following: 5.6% upside to TRADE resistance, 2.5% downside to TRADE support.
Joshua Steiner, CFA
This note was originally published at 8am on September 21, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Greece should default, and default big.”
The day after European stock markets put in their 2011 bottom (September 12th), Bloomberg’s Eliana Raszewski and Camila Russo wrote a Big Headline article titled “Greece Should Default Big To Address Worsening Debt Crisis.”
Notwithstanding this newsy headline being a classic contrarian indicator in its own right (German stocks are up +10% in a straight line since September 12th), Bloomberg was citing a reputable source on the matter. Mario Blejer took over Argentina’s central bank during its epic $95B default in 2002.
Back then, that was considered a Big Default.
Today, what’s another $100, $200, or $800 BILLION dollars? That’s chump change compared to what Madame Lagarde has in mind with what she has dubbed, en englais s’il vous plait, an “infinite amount of resources.” Read: she’s thinking a bazooka 2-3x the size of Hank The Market Tank Paulson’s in 2008. The ECB and IMF central planning for a Euro-TARP is called the EFSF. And it’s Big!
Back to the Global Macro Grind…
Whether it’s that September 13thBloomberg headline (the SP500 is up +3.4% since) or yesterday’s “How To Prevent A Depression” article from the venerable Perma-Bull himself, Mr. Nouriel Roubini, we have a lot of Big Government Intervention here on our plate to process. So let’s get cracking.
It takes an aggressive short seller to know one, and I can assure you that plenty of the bears thought yesterday’s selloff in the SP500 into the close was going to be bearish for both Asian markets overnight and the US stock market Futures this morning.
Bernanke being in a box (he can’t cut or raise rates anymore) is, on the margin, bullish for Americans. No, not the 10% of us who actually traffic on the long side of the stock market casino. I mean the other 90% of us who really couldn’t give a damn about stocks and would much prefer lower prices for gas, food, college, etc. You know, the non-government manufactured stuff.
Bernanke not being able to do much to debauch America’s Dollar anymore will continue to Deflate The Inflation and put pressure on Gold prices. That’s why I cut our exposure to Commodities in the Hedgeye Asset Allocation Model to ZERO percent again yesterday. While commodity price deflation is very bad for Energy and Basic Material stocks, this is very good for Americans.
As for what a Big Default in Greece today or tomorrow will bring, don’t sweat it. That’s not going to happen. It’s already happened in both their stock and bond markets. We don’t need another big “Blue Chip Economist” who has been wrong on his 2011 GDP forecast by 60-70% to remind us commoners of that.
My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1767-1820, $85.69-86.93, and 1188-1229, respectively. Don’t let headlines freak you out at the high or low ends of these ranges. Proactively manage your risk around them.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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