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Poll of the Day Recap: Rig Her Up, Flash Boys!

As most of the financial world knows by now, author Michael Lewis appeared on 60 Minutes last night to promote his new book “Flash Boys: A Wall Street Revolt.” What made the headlines was Lewis’ remarks that the U.S. stock market is rigged to hurt average investors to the benefit of high frequency traders, stock exchanges and large Wall Street banks.

 

“The insiders are able to move faster than you and play it against orders in ways you don't understand,” according to Lewis.

 

So, we asked in today’s poll:  Do you agree with Michael Lewis' assertion that "the market is rigged?"
 

At the time of this post, 72% responded YES the market is rigged; 28% said NO.

 

Besides stating that the market was clearly and obviously rigged, many who voted YES said it’s the only way to win, and can’t remember a time when the stock market wasn’t rigged. Here are some noteworthy comments

  • As someone works with HFT managers and firms I know that they are laughing all the way to the bank.
     
  • Just look at the action in the market for the past 2 ½ years or so, it is clear as a bell. One would have to be blind not to see it.
     
  • Stocks in the junior sector I own show constant signs of predatory trading, manipulative moves, naked shorting, bid stack kills, spoofing, etc.  It's endless, perverse, and aggressive.  This never used to exist like this.
     
  • 60 Minutes didn't even address the futures markets and how the computers are manipulating orders on those exchanges.
     
  • Ethics, morals and values have no place in the US system anymore (if they ever did) and the means to exploit and yes, steal are so technologically advanced that the system has 99% of us in near complete subjugation.
     
  • The playing field isn't on the level...  HFT isn't the problem, though... it's only a symptom.  Every leaked market moving "news" item gets to some before everyone skews the price.  Every monetary intervention or expectation of monetary intervention skews price.   This thing is so rigged, we wouldn't know a free market price if it hit us in the head.  Price isn't set by supply/demand...it's supply/denomination/demand.
     
  • It’s all a big game of regulatory and representative capture.  Insider and rigged trading is alive and well.
     
  • It’s not the only thing that is rigged in this market!  Please, this market will eventually blow up.

On the opposite end, NO voters said the market is not “rigged” in the normal statutory definition, and that, “it is what it is. Just like Vegas.”

 

Another NO commenter explained, “Rigged assumes you must lose. Impact HFT doesn't not mean you lose, it simply means you should adjust your risk premium slightly, much like one would do for insider trading in other countries that allow it.  Don’t ignore the liquidity that is provided by these HFT firms and the value it has for all investors.  Should those who invested millions for a faster way not be able to benefit when they are not breaking any rules? Embrace those like IEX who provide an alternative to traditional exchanges.  Let the market solve its own problem, you just need to spread the information.”

 

As for Hedgeye CEO Keith McCullough, he believes Michael Lewis is merely making hay out of an old issue — five years too late — for monetary gain.

 

“Michael Lewis has jumped the populist topic shark,” according to McCullough. “The stock market is rigged for the average monkey who hasn't evolved. Lewis takes the side of “horse-and-buggy whip” old Wall Street traders at the advent of the car engine. Note that Lewis had 0% content on the SEC's read-through on evolution.”

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BWP: Closing Best Idea Short & Stepping to the Side

We added Short Boardwalk Pipeline Partners (BWP) to our Best Ideas list on 12/2/2013 at $26.34/unit.  After cutting its distribution by 80% in February 2014, BWP’s unit price collapsed (down ~50%), and we feel that our short thesis is largely played out.  With this note we are removing Short BWP from our Best Ideas list.

 

In our view, BWP neither is fixed nor cheap – thus we simply move to the sidelines instead of turning outright bullish. 

 

At 18.2x 2014e EV/EBIT and 10.3x 2014e EV/EBITDA, it is certainly screens as inexpensive relative to other pipeline MLPs, but not absolutely.  BWP’s re-contracting risk is significant for several years, particularly in 2018 and 2019.  2014 could be peak earnings for the core businesses, though the out years are naturally difficult to predict.  We also remain concerned with the Company’s high leverage, which looks to be stuck around 5.0x EBITDA; BWP may need to issue equity in 2015 to strengthen the balance sheet.

 

But from a risk/reward perspective, the setup is no longer asymmetrical to the downside.  What’s already happened (and is priced-in to some degree): narrowed basis differentials crushed BWP’s transportation business; narrowed calendar spreads crushed BWP’s storage and PAL businesses; its G&P ventures (Marcellus and Eagle Ford) have disappointed; it cut the distribution 80%; it guided 2014 below the Street;  consensus has soured on Bluegrass’s prospects; and it got kicked out of the Alerian Index.  We’re concerned that the next catalyst/announcement from BWP could be one to break the losing streak –  repurpose an under-utilized asset?  LNG export investment or deal?  A Loews tender offer?  

 

Staying short here is not compelling, in our view; our time and effort will be better spent looking for the next BWP.

 

Research Recap:

Short BWP - New Best Idea (12/02/2013)

Best Idea Short BWP December 2013 (12/10/2013)

Reducing BWP Fair Value to $10/Unit (2/10/2014)

 

Kevin Kaiser

Managing Director

 


European Banking Monitor: Risk Falls on Russia/Ukraine

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .

 

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European Financial CDS - It was another week of broad-based tightening for EU financial swaps, consistent with the falling risk associated with the Russia/Ukraine situation. Sberbank of Russia also posted another large w/w improvement (-23 bps to 318 bps).

 

European Banking Monitor: Risk Falls on Russia/Ukraine - 1. banks

 

Sovereign CDS – Sovereign swaps mostly tightened over last week. Portuguese sovereign swaps tightened by -8.0% (-17 bps to 191 ) while Italian sovereign swaps widened by 0.5% (1 bps to 135).

 

European Banking Monitor: Risk Falls on Russia/Ukraine - 1 sov a

 

European Banking Monitor: Risk Falls on Russia/Ukraine - 1. sov b

 

European Banking Monitor: Risk Falls on Russia/Ukraine - 1. sov c

 

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 widened by 2 bps to 15 bps.

 

European Banking Monitor: Risk Falls on Russia/Ukraine - 1. euribor

 

Matthew Hedrick

Associate


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.



MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT

Takeaway: What is the risk monitor and why do we use it?

We use our weekly risk monitor primarily as an intermediate/longer term risk management tool. We look for early sings of inflections in bigger picture indicators so that we don't find ourselves flat-footed at times of major inflections. We try and keep the sensitivity "setting" low enough to avoid numerous false positive signals, but high enough that we don't actually miss the important signals. Anyone who's been involved in markets and risk management knows what a tricky balancing act this can be. 

 

Along these lines, the bottom line is that there's very little being signaled on the risk front right now. Systemic interbank risk measures are all benign. Commodity price inflation, which had been a rising issue through the first ~10 weeks of the year, is now showing signs of cooling off, at least based on the CRB index price. One of the few areas of ongoing pressure is the 2-10 yield spread, which compressed a further 5 bps last week to 227 bps. In our experience, the trend in place tends to remain the path until you see the risk environment inflect. As we're not seeing any real inflection in risk at the moment, we wouldn't be surprised to see the general upward trend continue for the short/intermediate term trend.

 

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 3 of 13 improved / 2 out of 13 worsened / 8 of 13 unchanged

 • Intermediate-term(WoW): Negative / 4 of 13 improved / 5 out of 13 worsened / 4 of 13 unchanged

 • Long-term(WoW): Positive / 5 of 13 improved / 2 out of 13 worsened / 6 of 13 unchanged

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 15

 

1. U.S. Financial CDS -  Swaps widened for 16 out of 27 domestic financial institutions. Overall, however, the moves were generally small with the exception of the bond guarantors, MBI (+31 bps w/w) and AGO (+30 bps w/w). The global US banks were mixed with Citi the worst performer at +3 bps and JPM and GS at -2 bps.

 

Tightened the most WoW: GNW, JPM, WFC

Widened the most WoW: AGO, MBI, TRV

Tightened the most WoW: MBI, GNW, UNM

Widened the most MoM: ACE, TRV, SLM

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 1

 

2. European Financial CDS - It was another week of broad-based tightening for EU financial swaps, consistent with the falling risk associated with the Russia/Ukraine situation. Sberbank of Russia also posted another large w/w improvement (-23 bps to 318 bps).

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 2

 

3. Asian Financial CDS - There was substantial w/w tightening across Asian Financials last week. Indian bank swaps were tighter by 16-34 bps, while Chinese banks tightened 8-9 bps.

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 17

 

4. Sovereign CDS – Sovereign swaps mostly tightened over last week. Portuguese sovereign swaps tightened by -8.0% (-17 bps to 191 ) while Italian sovereign swaps widened by 0.5% (1 bps to 135).

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 18

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 3

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 4

 

5. High Yield (YTM) Monitor – High Yield rates fell 0.7 bps last week, ending the week at 5.70% versus 5.71% the prior week.

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.0 points last week, ending at 1,855.

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 6

 

7. TED Spread Monitor – The TED spread rose 1 basis point last week, ending the week at 19.5 bps this week versus last week’s print of 18.49 bps.

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 7

 

8. CRB Commodity Price Index – The CRB index rose 0.8%, ending the week at 305 versus 303 the prior week. As compared with the prior month, commodity prices have increased 1.2% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 8

 

9. 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 widened by 2 bps to 15 bps.

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 9

 

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index rose 16 basis points last week, ending the week at 2.66% versus last week’s print of 2.50%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 10

 

11. Markit MCDX Index Monitor – Last week spreads tightened -1 bps, ending the week at 66 bps versus 67 bps 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: ALL QUIET ON THE RISK FRONT - 11

 

12. Chinese Steel – Steel prices in China rose 0.3% last week, or 10 yuan/ton, to 3,275 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 12

 

13. 2-10 Spread – Last week the 2-10 spread tightened to 227 bps, -5 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.5% upside to TRADE resistance and 0.9% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: ALL QUIET ON THE RISK FRONT - 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


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