prev

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF

Takeaway: US and EU bank swaps moved higher this week, reflecting concerns surrounding weak earnings and a Moody's downgrade of 5 Spanish regions.

Key Takeaways

 

* U.S. and EU bank swaps were wider last week as a spate of blue-chip U.S. companies disappointed on 3Q earnings and/or guidance. Meanwhile, Romney's momentum slowed and Fiscal Cliff concerns are again taking center stage. In Europe, French, Italian and Spanish bank swaps showed the most deterioration.

 

* Perennial laggards Spain, Italy and Portugal saw their swaps widen notably last week. However, the U.S., Japan, Germany and France all saw government default swaps tighten.

 

* Rates on high yield corporate debt rose 14bps week-over-week, the first increase in a long time. The leveraged loan market also reflected that reversal. 

 

* The MCDX, our preferred gauge of municipal default risk in the United States, rose 3bps to 135 bps vs. the prior week. 

 

* Our Macro team’s quantitative setup in the XLF shows 1.5% upside to TRADE resistance and 0.9% downside to TRADE support.

 

Financial Risk Monitor Summary

Short-term: Negative / 3 of 12 improved / 6 out of 12 worsened / 4 of 12 unchanged  

Intermediate-term: Positive / 9 of 12 improved / 2 out of 12 worsened / 2 of 12 unchanged  

Long-term: Positive / 7 of 12 improved / 2 out of 12 worsened / 4 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - Summary4

 

1. American Financial CDS   Money center banks and large brokers saw their swaps widen by ~6 bps on average. Wells Fargo was the only exception in the group, where swaps tightened 1 bp. The median US Financial swap widened bps, and, overall, 20 out of 27 domestic financial institutions widened.

 

Widened the most WoW: AXP, MTG, AIG

Tightened the most WoW: TRV, WFC, LNC

Tightened the most WoW: HIG, C, BAC

Tightened the least MoM: MTG, XL, MBI

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - America

 

2. European Financial CDS – Europe took its cues from America. European bank swaps were wider for 34 out of 37 reference entities WoW. Out of the three swaps that tightened this week, two were German (Deutsche Bank AG & IKB Deutsche Industriebank AG) and one was Belgian (Dexia S.A.). Spanish banks were sharply wider, where the average reference entity widened by 9.2%. This is the result of Moody's downgrading 5 Spanish regions on Monday of last week. Italian and French bank default swaps were also notably wider week-over-week.

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - Europe

 

3. Asian Financial CDS – Asian bank swaps were mixed. Nomura Holdings of Japan saw its swaps tighten by 49 bps to 281 while Matsui Securities tightened 24 bps to 226 bps. Those were the largest movers of the week, both Japanese. In China, the China Development Bank tightened 14 bps to 105 bps. Overall, Asian banks were tighter by an average of 7 bps last week.  

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - Asia

 

4. Sovereign CDS – European sovereign swaps were mixed last week. Italy, Spain and Portugal widened by 30 bps, 33 bps, and 79 bps, respectively, while Germany and France saw their swaps tighten 9 bps and 7 bps. The U.S. tightened by 2 bps and Japan was tighter by 1 bp.

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - Sov Table

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - Sov 1

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - Sov 2

 

5. High Yield (YTM) Monitor – High Yield rates rose 14 bps last week, ending the week at 6.66% versus 6.52% the prior week.

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - High Yield

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 4.5 points last week, ending at 1730.99.

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - LLI

 

7. TED Spread Monitor – The TED spread fell 2.4 basis points last week, ending the week at 19.9 bps this week versus last week’s print of 22.3 bps.

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - TED

 

8. Journal of Commerce Commodity Price Index – The JOC index fell -4.2 points, ending the week at -4.81 versus -0.7 the prior week. The commodity bubble continues to pop.

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - JOC

 

9. Euribor-OIS spread – The Euribor-OIS spread tightened by less than a basis point to 10.4 bpsThe 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. 

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - Euribor OIS

 

10. ECB Liquidity Recourse to the Deposit FacilityECB Liquidity Facility balances ticked lower again this past week. 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.  

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - ECB

 

11. Markit MCDX Index Monitor – Last week spreads widened 3 bps, ending at 135 bps versus 132 bps in the prior week. 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 16-V1. 

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - MCDX

 

12. Chinese Steel Steel prices in China rose 0.5% last week, or 18 yuan/ton, to 3763 yuan/ton. This index has had a solid bounce from its recent lows on 9/7/12, up 12.7% since then. That said, it remains 25% below its August 2011 levels, reflecting ongoing weakness in China's construction market. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - CHIS

 

13. 2-10 SpreadLast week the 2-10 spread tightened to 145 bps, this was 2 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.  

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - 2 10

 

14. XLF Macro Quantitative Setup Our Macro team’s quantitative setup in the XLF shows 1.5% upside to TRADE resistance and 0.9% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - XLF

 

Margin Debt - September: +1.12 standard deviations 

NYSE Margin debt rose to $315 billion in September from $287 billion in August. We like to to look at margin debt levels as a broad contrarian sentiment indicator. For reference, our approach is to look at margin debt levels in standard deviation terms over the period 1. Our analysis finds that when margin debt gets to +1.5 standard deviations or greater, as it did in April of 2011, it has historically been a signal of significant risk in the equity market. The preceding two instances were followed by the equity market losing roughly half its value over the following 24-36 months. Overall 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 September. 

 

MONDAY MORNING RISK MONITOR: RISK RISES ON WEAK EARNINGS AND FISCAL CLIFF - Margin Debt

 

Joshua Steiner, CFA

 

Robert Belsky


Noisy Truth

This note was originally published at 8am on October 15, 2012 for Hedgeye subscribers.

“We think we want information, when we really want knowledge.”

-Nate Silver

 

Within the context of the always-on tweeter-net, I thought that was a really thoughtful quote from the introduction to Nate Silver’s new book, The Signal and The Noise. I’ll be reviewing his framework for forecasting in the coming weeks.

 

Silver says the “signal is the truth” and “the noise is what distracts us from the truth” (page 17). Without having read the bulk of the book yet, I can already assure you that doesn’t hold when attempting to proactively predict Risk Ranges in real-time markets.

 

Our most immediate-term risk management duration (TRADE) is, by definition, noisy. Whereas our intermediate and long-term (TREND and TAIL) work can often be mistaken as truth when the noise isn’t confusing our confirmation biases.

 

Back to the Global Macro Grind

 

Whether we like hearing it or not, we all have confirmation biases. That’s because we are human. At a bare minimum, I think Nate Silver and I agree on that. Thinking, Fast and Slow’s Daniel Kahneman would too.

 

Our risk management day involves grinding quantitative economic realities (data) with behavioral finance (timing). In order to make a probability-weighted forecast (taking a long or short position) we always look back, across durations, before looking ahead.

 

For us, the signal (and the noise) is real-time market prices – here’s what they did last week, across asset classes:

  1. US Dollar Index =up +0.4%, closing up for the 3rd week in the last 4 at $79.65 (bullish on both TRADE and TAIL durations)
  2. EUR/USD = down -0.7%, looking like the upside down of the USD Index (bearish on both TRADE and TAIL durations)
  3. CRB Commodities Index = down -0.3% (down -4.7% from the Bernanke Top, printing to Infinity & Beyond)
  4. Oil (blended Brent and WTIC) = up +2% (WTIC down -4.3% from the Bernanke Top)
  5. Gold = down -1.4%, as it continues to make a series of lower long-term highs (vs the 2011 Bernanke Bubble top)
  6. Copper = down -2.2% (bearish on both TRADE and TAIL durations)
  7. SP500 = down -2.2% (bearish TRADE resistance = 1448; bullish TREND support = 1419)
  8. Nasdaq = down -2.9% (bearish TRADE resistance = 3129; bullish TREND support = 3022)
  9. US Equity Volatility (VIX) = up +12.6% (bullish on both TRADE and TAIL durations)
  10. US 10yr Treasury Bond Yield = down -5% to 1.66% (bearish on both TRADE and TAIL durations)

In other words, there were plenty of signals and noises, across durations, in last week’s closing prices. There is also a confirmation bias in attempting to describe what happened because I, unlike Keynesian policy makers, believe that central planners are the primary causal factor in driving currency values and market correlations.

 

In the private sector, it’s ok to have a confirmation bias – you just have to be right more than you are wrong. If you’re wrong more than you are right, it’s ok - just go work for the government.

 

What do you do when you are wrong? For us, it’s pretty simple – we hold ourselves accountable to the mistake, try to learn from it, and grow. What other people do when they face adversity is up to them.

 

With the SP500 not having an up day in the last 6, what is the truth? Do growth and #EarningsSlowing matter? Or did it from the price where a lot of people thought Bernanke’s money printing meant the “fundamentals don’t matter”?

 

What are the fundamentals?

  1. US GDP Growth of 1.26% in Q2 2012, or consensus expectations of +3-4% growth 6 months ago?
  2. Global GDP Growth of 1.3% (Singapore just reported that for Q3 2012) or +3% as far as the excel model can see?
  3. The worst preannouncement ratio (4:1) of #EarningsSlowing misses since Q3 of 2001, or stocks are “cheap”?
  4. US Technology Sector (XLK) down -3.5% in the last month, or what it’s “up YTD”?
  5. US Financials Sector (XLF) down -1.6% last week on JPM/WFC earnings, or what they are “up YTD”?
  6. Chinese inflation down sequentially to +1.9% (SEP) or India wholesale inflation up sequentially to +7.8% (SEP)?

Some might say all of this doesn’t matter, and all you need to do is know where a 1-factor/1-duration simple moving average model tells you where the market is and everything is either fine. Some might say that all of it matters and is measurable. That’s closer to the Noisy Truth.

 

Our signals say all this noise adds up to us having 12 LONGS and 9 SHORTS for this morning’s US stock market open. Provided that the SP500 doesn’t close > 1448, we’ll likely sell on green bounces, and buy on red corrections closer to 1419.

 

Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1748-1774, $112.68-115.08, $79.34-80.05, $1.28-1.30, 1.61-1.71%, and 1419-1445, respectively.

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Noisy Truth - Chart of the Day

 

Noisy Truth - Virtual Portfolio



Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

Sandy Bayes

“The only safe ship in a storm is leadership.”

-Faye Wattleton

 

US markets are closed today, but rest of world is still open for risk to be managed. US Equity futures are down 8 as the US Dollar (+0.16%) continues on its strengthening path toward popping Bernanke’s Bubble (Commodities).

 

Like Sandy’s progression, the global growth and earnings slowdown is measurable. The closer it gets to you, the more obvious its risk management realities become. Try it at home. Buy a stock in front of a guide down.

 

Nate Silver does a great job simplifying this Bayesian process of managing risk through probability theory on page 243 of The Signal And The Noise: “we learn about it through approximation, getting closer and closer to the truth as we gather more evidence.”

 

Back to the Global Macro Grind

 

Bayes’ Theorum is by no means a silver bullet. It won’t tell you how many trees Sandy will knock down in your yard inasmuch as it won’t tell you the precise day when China will “bottom.” It’s simply a framework that allows us to think flexibly.

 

This is the primary reason why our risk management style is so different than most that you read. Any buy-side fund worth their fees gets this. The sell-side and media at large does not. Like monitoring a hurricane, we probability-weight every decision based on what real-time price, volume, and volatility information we receive (every 90 minutes).

 

Ninety minutes? No, that doesn’t make me “short-term” – that just makes me less likely to make mistakes within the context of the intermediate to long-term cycles that we have already studied. Watch the storm. Risk Happens Fast.

 

Across our core risk management durations (TRADE, TREND, and TAIL), here’s what I saw last week:

  1. US Dollar Index = up +0.6% and up for the 4th week in the last 6 (bullish TRADE and TAIL)
  2. EUR/USD = down -0.76%, and down for the 4th week in the last 6 (bearish TRADE and TAIL)
  3. US Treasury Yield (10yr) = down 1 basis pt to 1.75% (bearish TAIL, which is long-term bullish for Bonds)
  4. CRB Commodities Index = down another -2.7% (down -7.8% since Bernanke’s Top, SEP 14, 2012)
  5. Oil (WTIC) = down another -4.4% to $86.28/barrel in a Bearish Formation (bearish TRADE, TREND, and TAIL)
  6. Gold = down another -0.7% (bearish TRADE and TAIL)
  7. Copper = down another -2.1% (Bearish Formation, down -10% from its #GrowthSlowing high Q112)
  8. SP500 = down -1.5% last wk closing below both TRADE (1441) and TREND (1419) resistance
  9. Russell2000 = down -1.0% last wk closing below both TRADE (831) and TREND (846) resistance
  10. US Equity Volatility (VIX) = +4.3% last wk closing above both TRADE (16.29) and TREND (15.54) support
  11. Russian Stocks (RTSI Index) = down -3.7% leading European Equity decliners last wk (-18.5% since March)
  12. Chinese Stocks (Shanghai Composite) = down -2.9% remain in a Bearish Formation (TRADE, TREND, and TAIL) 

That last point (China) is a good one to qualify. Two weeks ago I heard plenty a pundit say “China has bottomed” without any process or conditional probability backing up their perma-bull proclamation of faith. Bottoms aren’t bottoms, until they bottom.

 

As a general rule, that’s why I like to teach the very basic risk management concept that tops and bottoms are processes, not points. To probability-weight them, you need to have a disciplined process to grind out evidence that risk is actually occurring.

 

Old Wall generally thinks about this bass ackwards. They call it “risk on” or  “risk off”, after the risk occurs. As a practitioner, you can safely assume that risk is never “on” or “off” – instead, it’s always moving. So embrace its uncertainty.

 

Speaking of which, I need to cut this Early Look short to get gas all over my hands and prime my generator. I’d hate to have a risk “on” moment in front of my kids where I didn’t proactively prepare for what’s staring me in the face.

 

Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, Shanghai Composite, and the SP500 are now $1, $106.08-110.66, $79.67-80.35, $1.28-1.30, 1.71-1.81%, 2048-2098, and 1, respectively.

 

Best of luck out there today – stay safe,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Sandy Bayes - Chart of the Day

 

Sandy Bayes - Virtual Portfolio


THE WEEK AHEAD

 

The Economic Data calendar for the week of the 29th of October through the November 2nd is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

THE WEEK AHEAD - Week


Trade Of The Day: JPM

Today we bought JP Morgan (JPM) at $41.41 a share at 3:27 PM EDT in our Real Time Alerts. The company put up a solid quarter and Hedgeye Financials Sector Head Josh Steiner wants to be net long financials if Romney momentum continues to build. A Romney win would be a positive for banks and other financial institutions as he plans on toning down regulation. 

 

Trade Of The Day: JPM - image001


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

next