“The trick was to focus narrowly… on numbers: lot number, number of bidders, paddle numbers, bid steps.”
I’ve recently jumped into The Billionaire’s Vinegar – The Mystery of the World’s Most Expensive Bottle of Wine – and, I must say, I can’t put the book down!
The aforementioned quote scrapes the surface of British wine critic and auctioneer Michael Broadbent’s process. Born in 1927, Broadbent “was twenty-two before he tasted a top wine”, but started out in the business by simply “taking notes on every wine he tasted. He never stopped.” (page 27)
Neither have I.
Back to the Global Macro Grind…
I have 1-2 pages of hand-written notes of every market day of my working life. I’m not saying that makes me anything other than what it makes me – maniacal about my process. The way that I learn is through repetition. If I write down market prices, risk management levels, and economic data points every day, I have a much higher probability of not missing something.
That’s The Trick.
As far as I can tell (so far), The Trick to this game is not missing when the big things, like Growth and Inflation, are changing. That’s why, in principle, our Macro Models are grounded in Chaos Theory – we embrace the uncertainty that each day brings, because we have no idea what is going to be the proverbial grain of sand that knocks down that perfect pyramid of market expectations.
For the last 3 weeks I have been calling out Growth Slowing As Inflation Accelerates as the #1 risk factor that’s changing on the margin. Changing doesn’t mean the market realizes it instantaneously like a Janet Jackson moment at the Super Bowl. The difference between what’s changing on the margin and when markets are forced to react to it is time.
Get time and price right, and you’ll get mostly everything in the market right. Looking at last week’s Global Macro Performance Divergences, here’s where you didn’t want to be long:
- Small Cap US Stocks (Russell 2000) = down -3.0%
- India’s stock market (BSE Sensex) = down -1.6%
- The Euro (vs the USD) = down -1.9%
- CRB Commodities Index = down -1.5%
- West Texas Intermediate Crude Oil = down -2.8%
- Gold = down -3.7%
Now if you were long the Venezuelan stock market (+8.6% on currency devaluation) or the US Dollar Index (+1.3% after Mitt Romney solidified the Republican base in Michigan and Arizona), you were just fine last week.
Or were you?
The Trick about markets is that the tricks are always changing. Causality and correlation are very often two very different things, but Correlation Risks can sneak up on you like a Chinese Growth Slowdown in the night.
Apparently both the data that we have been discussing since we sold our long China (CAF) position on February 16thand the guys running the joint agree – China’s long-term GDP growth rate looks like it’s going to be a lot lower than the +9-12% it’s been tracking since 2009. China’s Premier Wen guided to a 7.5% number for 2012. Global markets didn’t like that.
In addition to the guide down of Chinese Growth Expectations, here was the Asian economic data that mattered most on the margin overnight:
- Chinese Services PMI dropped to 48.4 in FEB vs 51 in JAN
- Chinese Vehicle Sales are tracking down -3% year-over-year for 2012 YTD (worst start to a year since 2005)
- Australian Services PMI got smoked to 46.7 in FEB vs 51.9 in JAN
I know. That data can be tricky when you convince yourself that the bad January data in Asia was all about the Lunar calendar – until the February data rolls in even worse!
To be fair, some of the data for Asia in February has been as good as you should expect it to be with the calendar shift. But the problem from here isn’t January’s calendar or what your run-of the mill Keynesian economist is going to tell you about rising oil prices not impacting real (inflation-adjusted) growth. For markets, it’s all about time, price, and expectations.
The Trick is to keep moving out there – across countries, currencies, commodities, etc. – and keep risk managing your gross and net positioning to account for multiple durations across multiple factors.
I’m not saying I see everything early. I’m saying quite the opposite really – I really have no idea what I am going to say about a market’s risk parameters until I write everything down in my notebook in the morning.
My immediate-term support and resistance ranges for the Gold, Oil (Brent), US Dollar Index, and the SP500 are now $1, $120.57-123.64, $79.03-79.51, and 1.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
*Interbank risk throws off mixed signals. Last week the Euribor-OIS spread tightened by 4 bps to 61 bps while the TED spread rose 1.6 bps over the same period to 41 bps. What's interesting here is the emerging divergence between the two series. Euribor-OIS continues to improve at a consistent rate, as it has done since the start of the year. The TED spread, however, has flattened out since mid-February and is essentially just moving sideways now. Last week's round two of LTRO was the short-term catalyst the markets had their sights set on (see our Macro Team's note on the matter entitled: "Yea"). While interbank risk was among the most significant factors at the start of the year, the amount of renormalization that has occurred in Euribor-OIS (we estimate ~60% complete) leaves far less room for improvement today than there was back just two months ago.
* High yield rates sank to another new YTD low on Friday. This is both an indication of the risk appetite as well as a reflection of the Fed's policy to pay zero for the foreseeable future.
* Both European and American Bank CDS tightened week over week, again likely reflecting the round two of LTRO.
* Balanced Short-term Outlook - Our macro team's quantitative model indicates that on a short term duration (TRADE), there is equal upside and downside in the XLF (0.6% downside vs. 0.6% upside).
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 5 of 12 improved / 3 out of 12 worsened / 4 of 12 unchanged
• Intermediate-term(WoW): Positive / 4 of 12 improved / 1 out of 12 worsened / 7 of 12 unchanged
• Long-term(WoW): Negative / 0 of 12 improved / 6 out of 12 worsened / 6 of 12 unchanged
1. US Financials CDS Monitor – Swaps tightened for 26 of 27 major domestic financial company reference entities last week.
Tightened the most WoW: WFC, GS, C
Widened the most/tightened the least WoW: MBI, MTG, SLM
Tightened the most MoM: RDN, MTG, AGO
Widened the most MoM: MS, MBI, GS
2. European Financials CDS Monitor – Bank swaps were tighter in Europe last week for 38 of the 40 reference entities. The average tightening was 8.2% and the median tightening was 8.8%.
3. European Sovereign CDS – European Sovereign Swaps mostly tightened over last week. Italian sovereign swaps tightened by 5.8% (-23 bps to 373 ) and Portuguese sovereign swaps widened by 8.8% (99 bps to 1225).
4. High Yield (YTM) Monitor – High Yield rates fell 23.0 bps last week, ending the week at 6.88 versus 7.11 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 6 points last week, ending at 1642.
6. TED Spread Monitor – The TED spread rose 1.6 points last week, ending the week at 41.2 this week versus last week’s print of 39.7.
7. Journal of Commerce Commodity Price Index – The JOC index rose 1.4 points, ending the week at -5.47 versus -6.8 the prior week.
8. Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 4 bps to 61 bps.
9. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system. An increase in this metric shows that banks are borrowing from the ECB. In other words, the deposit facility measures one element of the ECB response to the crisis.
10. 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. Last week spreads widened 4 bps, ending the week at 129 bps versus 125 bps the prior week.
11. 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 rose 53 points, ending the week at 771 versus 718 the prior week.
12. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 2-10 spread widened to 170 bps, 3 bps wider than a week ago.
13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.6% upside to TRADE resistance and 0.6% downside to TRADE support.
Margin Debt - January
We publish NYSE Margin Debt every month when it’s released. NYSE Margin debt hit its post-2007 peak in April of 2011 at $320.7 billion. 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. First, when margin debt gets to 1.5 standard deviations or greater, as it did last 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 2011. The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. In other words, the last few months’ 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 retraced back to +0.55 standard deviations in November, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend runs its course. There’s plenty of room for short/intermediate term reversals within this broader secular move, as we saw in December and January's print of +0.53 and +0.70 standard deviations. Overall, however, this setup represents a long-term headwind for the market. One limitation of this series is that it is reported on a lag. The chart shows data through January.
Joshua Steiner, CFA
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The Implications of a Rollover in Claims for the Card Stocks
The credit card stocks are among the most-correlated names to inflections in jobless claims. We anticipate the claims have troughed and will start gradually backing up towards 380k over the next three to five months, which will create a headwind for COF, AXP, and DFS.
In the charts below we show the long-term weekly relationship between the credit card stocks and rolling initial jobless claims. Note that all three of these charts are over a long time period: from 2000 to present for COF and AXP and since the IPO for DFS.
Why We Expect Claims to Rise
In our note last week, we walked through a quantification of the distortion in seasonal adjustment factors arising from the Lehman shock in 2008. Because the Labor Department uses a five-year lookback to create its seaosnal adjustment, the 2008 shock is still percolating through the data. See our note from last Thursday for more detail.
The seasonal distortion plays out as follows. Claims are understated by the largest amount in the last weeks of February. From now through May, the understatement disappears. Absent an underlying trend in the series, this effect would drive claims higher by about 20k over the course of the next three months. By July, the distortion reappears, this time as an overstatement, pushing claims slightly higher still. From July through year-end, the distortion disappears, and the underlying trend will be reflected in the weekly data.
There's another set of implications for this analysis: the long-term call. Looking at the charts of AXP and COF in particular (since DFS hasn't been public through a full decade), it's striking that the stocks seem to retrace their steps almost exactly from one cycle to the next. This is the natural consequence of failing to accrete TBV over the cycle. American Express in particular is eager to spend cash on buying back stock at multiples to tangible, a process that is guaranteed to reduce TBVPS in exchange for growing EPS.
Keep in mind that claims don't go much lower than 300,000, and right now we're already at 350,000. That's not a lot of room to play for. For the stocks to go meaningfully higher, they need loan growth, multiple expansion, or a very extended stay with claims at 300k.
This reversal in jobless claims should put a lid on upside in these card stocks from now through the end of the summer. Therefore, on the long side you're playing for arguably very little. However, that opens up the possibility of serious downside in the event that gas prices, Iran or any of a number of the other risk factors we're monitoring come to pass. We see the setup for these stocks over the next five months as asymmetrically negative.
Joshua Steiner, CFA
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Positions in Europe: Covered Italy (EWI)
Asset Class Performance:
- Equities: There were plenty of European equity performance swings this week, yet the top performer was Italy’s FTSE MIB, gaining 2.5% week-over-week, and Eastern Europe showed outperformance. Top performers: Romania 2.2%; Ireland 2.0%; Portugal 1.9%; Czech Republic 1.7%. Bottom performers: Ukraine -2.1%; Finland -1.2%; Switzerland -60bps; FTSE -40bps.
- FX: The EUR/USD is down -1.88% week-over-week. Divergences: PLN/EUR +1.45%, GBP/EUR +1.63%; RUB/EUR +1.38%, NOK/EUR +1.28%, CZK/EUR +1.07%; CHF/EUR -0.15%.
- Fixed Income: 10YR sovereign yields continued to move down in Italy and Spain week-over-week, while Greece and Portugal continued higher. Italy fell -53bps to 4.95% -- can the sub 5% level be held? Spain fell -16bps to 4.89%. Conversely, Greece rose 341bps w/w or 197bps Friday/Thursday to 37.65% and Portugal rose 101bps to 13.78%.
Markets continue to make gains on short term hurdles—think Germany’s parliamentary approval of Greece’s second bailout on Monday and the 2nd 36M LTRO of €529 billion on Wednesday. To the latter example, while we think the LTRO is pumping in critical liquidity to the banking system (up from LTRO1 of €489), it cannot cure the solvency issues facing certain banks, nor is there any evidence that this cash is being lent through to corporates and consumers. Much of it still looks to be parked “safely” at the ECB’s overnight lending facility. Markets finished the week giving up some of their early week gains as reality set back in: there are many unanswered questions like if the fiscal union can really work when a similar program, the Stability and Growth Pact, failed so miserably in the past, and if the size and composition of the ESM and/or EFSF are sufficient.
For now, Eurocrats seem resolved to keep the existing Eurozone fabric in place, which is to say to prevent a “default” or exit of Greece and/or Portugal. ISDA, too has been playing ball, ruling that Greece has not had a "credit event" and credit default swap payments will not be triggered. Yet, as austerity takes hold and the region slips into recession, it will be increasingly difficult for governments to shave down bloated debt and deficit levels, and maintain sinking sovereign yields without the magic hand of the ECB. Noting these structural headwinds is nothing new, however this week emerged a great optimism in the press (at least pushed by the Eurocrats at their Summit this week) that the worst is behind us. We’ll take the other side. Witness a revision this week to Spain’s budget deficit, which last year reached 8.5% of GDP versus the original target of 6.0%.
All the while, the goalposts continue to change. This week’s highlight includes further details that the when the ECB swapped about €50 billion of Greek bonds for new longer maturity securities, the switch made the ECB senior to other investors, exempting it from a haircut of 53.5% that all other private holders must take. Obviously this last point will have a huge impact on gaining the critical 95% participation rate on the PSI. Should this rate not be reached, all calculations on a Greek plan to reduce its debt load will have to be revised higher. Back to square one--Yippie!
Another diverging theme this week is the stance of the UK (but also Czech Republic) that it does not want to be part of the fiscal compact. We’ll be touching on this subject in more detail, but it’s clear that to some extent there is an advantage to having one’s own currency, however the problem remains that that Eurozone is the largest trading partner for most European countries, so a slowdown is going to impact topline no matter the currency benefits.
And a continuing theme over the last week remains sovereign bond auctions issuing paper at lower yields than previous auctions. Notable call-outs this week include: Spain sold €1.06 billion due April 2014 with a yield of 2.06% vs above 6% in November 2011; France sold €3.92 billion of 10YR debt at an average yield of 2.91% vs 3.13% on February 2nd; and Italy sold €3.75 billion in 10YR bonds with an average yield of 5.50% versus 6.08% at a January 30th auction.
Finally, as we go into the weekend, it looks like a foregone conclusion that Putin will win Russia’s Presidential election on Sunday. This has severe implications for the modernization of Russia, a theme we’ll reserve for another post.
- Sarkozy gains in polls. With less than two months before the ballot, Sarkozy lags behind Hollande by 4.5 points in voting intentions, down from a seven-point gap a week earlier, according to an Ipsos SA poll for Le Monde and France Televisions.
- Hollande reiterates calls to renegotiate EU Fiscal Treaty and pledges to cap oil prices for 3 months if elected.
- Hollande floats idea of creating 75% tax bracket on super rich if he wins election.
Eurozone M3 2.5% JAN Y/Y (exp. 1.8%) vs 1.6% DEC
Eurozone Unemployment Rate 10.7% JAN vs 10.6% DEC (highest since ‘97)
Eurozone CPI Y/Y 2.7% FEB (exp. 2.6%) vs 2.7% JAN
Eurozone PPI 3.7% JAN Y/Y (exp. 3.5%) vs 4.3% DEC [0.7% JAN M/M (exp. 0.5%) vs -0.2% DEC]
Germany GfK Consumer Confidence 6 MAR vs 5.9 FEB
Germany Retail Sales 1.6% JAN Y/Y (exp. 0.2%) vs 0.3% DEC [-1.6% JAN M/M (exp. 0.5%) vs 0.1%]
Italy Business Confidence 91.5 FEB (exp. 92.3) vs 92.1 JAN (falls to 2-year low on recession)
Italy Annual GDP 2011 0.4% (exp. +0.3%) vs 1.8% 2010
Italy Deficit to GDP in 2011 3.9% (exp. +4%) vs 4.6% in 2010
Ireland Property Prices -17.4% JAN Y/Y vs -16.7% DEC [-1.9% JAN M/M vs -1.7% DEC]
Greece Retail Sales -11% DEC vs -6.4% NOV
Portugal Retail Sales -8.5% JAN Y/Y vs -10.3% DEC
CDS Risk Monitor:
Similar to sovereign yields, Italy and Spain saw CDS declines on a week-over-week basis. Italy contracted -32bps to 359bps and Spain dropped -11bps to 359bps. Interesting, you’d have to go back to AUG 2011 to find Italian CDS at or below Spanish CDS. Portugal’s CDS rose the most at 57bps w/w to 1187bps, but is down -165bps m/m. Ireland rose 14bps w/w to 588bps.
The European Week Ahead:
Monday: Mar. Eurozone Sentix Investor Confidence; Feb. Eurozone PMI Composite and Services - Final; Jan. Eurozone Retail Sales; Feb. Germany and France Services PMI – Final; Feb. UK House Prices (Mar 5-9), PMI Services, Official Reserves, and BRC Sales Like-For-Like; Feb. Italy Services PMI; Jan. Italy PPI; Feb. Russia Consumer Prices (Mar 5-6), and Services PMI
Tuesday: Q4 Eurozone GDP, Household Consumption, Government Expenditures, and Gross Fix Cap – Preliminary; Feb. UK BRC Shop Index, and New Car Registrations
Wednesday: Jan. Germany Factory Orders
Thursday: Eurozone ECB Policy Meeting and Interest Rate Announcement; Jan. Germany Industrial Production; UK BoE Announces Rates; Feb. France Business Sentiment; Jan. France Trade Balance; Q1 France Non-farm Payrolls – Final; Dec. Greece Unemployment Rate
Friday: Feb. Germany Consumer Price Index - Final; Jan. Germany Exports, Imports, Current Account, and Trade Balance; Q4 Eurozone Labor Costs; Feb. UK GfK Inflation Next 12 Mths; Jan. UK Industrial and Manufacturing Production, PPI Input and Output, and NIESR GDP Estimate; Jan. France Manufacturing and Industrial Production, and Central Government Balance; Jan. Italy Industrial Production; Feb. Greece CPI; Q4 Greece GDP - Final
Extended Calendar Call-Outs:
20 March: Greece’s €14.5 billion Bond Redemption due.
April: French Elections (Round 1) begins to conclude in May.
29 April: Potential Greek Presidential Elections
30 June: Deadline for EU Banks to meet €106 billion capital target/the 9% Tier 1 capital ratio.
1 July: ESM to come into force.
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