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APRIL 2012: MONTHLY MARKET COMMENTARY - (Subscription Plan II)

The European Central Bank's (ECB) unprecedented use of a three year, low cost LTRO (Long Term Repurchase Agreement) policy initiative may have removed some of the short term pressures from the EU Banking crisis, but like the Greenspan PUT, the unintended consequences are not yet fully understood. One is the moral hazard which is fostering financial "games" to be played with reckless abandon. Some of the mischievous and cunning games are frankly questionably as being even legal! But then, nothing is illegal if the regulators and those organizations charged with surveillance are not bothering to investigate. Extend > Pretend > Bend is the new approach. MORE>>

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>> LONGWave >> VOLUME & VOLATILITY December 12th, 2011

EURO EXPERIMENT :  ECB's LTRO Won't Stop Collateral Contagion! Released December 27th, 2011
I would argue that the problem short term is a shortage of real collateral and that US dollar cash, versus 'encumbered' cash flow, is now king. It is clear that the rampant advancing Collateral Contagion will quickly eat the futile LTRO attempt like ravenous wolves. A well circulated Tweet from PIMCO bond king Bill Gross said it all: " What does LTRO stand for? 1- A shell game; 2-Cash for trash; 3 Three-card Monti; or 4. All of the above." Here is the stark reality of what forced the ECB to offer unprecedented three year loans at absurd rates and most alarmingly, the acceptance of collateral that no other financial institutions will accept. The ECB has sacrificed its balance sheet in yet another EU "kick at the can". MORE>>

EU - IMF Increases Firepower by $430B

IMF Nearly Doubles Its War Chest for Crisis 04/20/12 WSJ - The International Monetary Fund, the world's emergency lender, announced pledges by many of its member nations to nearly double its lending capacity to more than $700 billion, creating what officials dubbed a "global firewall" aimed at containing the euro-zone debt crisis.

On the LEFT: Who OWNS and NEEDS the funds. On the RIGHT & BELOW IS Who is fundng it.

G20 doubles IMF's war chest amid fears on Europe 04/20/12 Reuters

Mr. Draghi is hamstrung in part by the ECB's mandate to keep annual inflation at 2%. It is far above that target now, at 2.7%. Additional stimulus measures could also spark furor among the ECB's conservative wing, led by Germany, that worries about the inflationary risk of abundant bank loans and easier monetary policy.

ECB LTRO - Spanish & Italian Banks Credit Suffer

LTRO Bank Credit Spreads Widen 04/20/12 Zero Hedge

... and which banks do you think these are? Spanish and Italian.

From mid-March, the difference in credit risk between banks that took LTRO loans and banks that decided not to become stigmatized and subordinate their existing senior unsecured bond holders has now more than doubled. Another day of decompression today has pushed the so-called LTRO-Stigma to 142bps - its widest in 5 months and worse than at any time since LTRO1 was undertaken. Since we first noted the disingenuous commentary by Draghi on 'there is no stigma' and suggested this trade on the back of the early recognition of the implicit subordination and unintended consequence of self-loading and self-referencing banks buying their own sovereign debt locking them into a vicious circle with one another, the spread has more than doubled (meaning anyone who TRS'd this deal likely would have seen this spread doubling result in a doubling of P&L) and reflects very closely the market's movements during the crisis period heading into the announcement of the new fiscal compact and the LTRO scheme. This time around, there is less collateral and a banking sector that knows what it means to shake hands with the devil

CENTRAL BANKING LIQUIDITY PUMPING - Japan's Turn Again?

The War For The BOJ's Balance Sheet Gets Real 04/20/12 Zero Hedge

Strategists have been seeing imminent BOJ easing in the form of yet another Y5 trillion LSAP any second now. Yet at the end of the day, just how much capacity for expansion at the BOJ is there. Below we show the balance sheet of the Japanese central bank as a percentage of total GDP.

At 30% of GDP it is 50% greater than the Fed's. Which means two things:

1) all those years of modest monetization have done absolutely nothing to stem the deflationary tide, and the result is that if politicians win the war for the BOJ, the next easing episode will not be a gradual one, but will be full on Fed-like "sturm und drang" which will result in some major shifts in the precarious balance within the Japanese economy, as Andy Xie explained a month ago; and

2) judging by the relative size of the Japanese and US central balance sheets, who do you think will ease first?

RISK - Three Central Spheres

Goldman On The Three Risk World 04-19-12 Zero Hedge

Three key issues remain at the heart of current markets: the strength of the US growth cycle; the sovereign and financial risks in the Euro area; and the risks of ongoing deceleration in Chinese growth. Goldman has created proxies for these various risks and the sensitivities of different assets to those risk factors.

They further note that looking at those three proxies over time confirms what general qualitative commentary has also spelled out. From late November to early February, the market relaxed about all three risks, as better global data and the impact of the LTROs on European financial risks provided a strong tailwind. From February until mid-March, China fears reappeared and the market downgraded its views of China significantly while still relaxing about European and growth risk. Since then, both European – and to a lesser degree – US growth risks have re-emerged, but at the same time there are some very tentative signs that the market is becoming a little less worried about China.

Goldman, however, remains increasingly cautious on them all:

1. Europe seems increasingly in the hands of governments, not the ECB, raising volatility;
2. Unspectacular growth trajectory in the US continues as outlooks adjust down; and
3. Even thouigh China's risk has stabilized they have avoided active exposures 'given the muddiness of news'.

REAL DISPOSABLE INCOME - Salary & Wage Compression - Fewer Quality Jobs

Wages and Consumption Are Both in Long-Term Downtrends 04/19/12 Charles Hugh Smith

ROLLING OVER

PERSONAL INCOME FAILLING

(Dispite MASSIVE Government Transfers Being Included in this Number)

WHY? INFLATION & WAGE ERROSION

(Fewer QUALITY Jobs Available)

GLOBAL GROWTH - Shipping Traffic Indicators

Global Trade set for a Downturn? 04/16/12 Reuters

The World Trade Organization dealt a blow to the hopes of anyone hoping that the global economy might be showing signs of improvement in the coming months by announcing last week that it expects the rate of growth in global trade to fall again to only 3.7% from 5% — significantly below the 20-year average growth rate of 5.4%. That might not be the end of the story: “severe” downside risks could put a further dent in growth rates.

As this chart indicates, traffic through the Suez Canal in Egypt – a key cargo transportation route – has nosedived in recent weeks and months. Currently, Suez traffic is only slightly better than flat compared to year earlier levels. Unsurprisingly, perhaps, the trends in global GDP growth tend to mirror those in traffic transiting the Suez canal; it is logical that trade volumes would flag during periods of contraction or sluggish growth, as is most vividly illustrated by the close correlation between the two indicators at the height of the financial crisis from late 2008 through 2009.

The Suez indicator isn’t a perfect one, of course. Estimates are that perhaps 8% of the world’s trade in goods travels the length of the canal that links the Mediterranean Sea – and Europe and North America – and the Persian Gulf leading into the Indian Ocean and ultimately the Pacific Ocean. On the other hand, given the otherwise scattered global trade routes and the difficulty gauging what cargoes are traveling on them, capturing 8% of global trade is enough to at least provide an indicator of what’s afoot. Certainly, in this case, the Suez traffic seems to provide support for the WTO’s bearish forecast. As recently as 2010, the rate of growth in global trade, as measured by the WTO, was a whopping 13.8%, more than double the 20-year average growth rate.

SPAIN - Non-Performing Loans

The percentage of bad loans on Spanish banks' balance sheets rose to 8.16 percent in February according to the Bank of Spain, its highest level since 1994. That datapoint is worrisome to investors already troubled by Spanish banks' large investments in government bonds and high use of funding from the European Central Bank. This comes on the heels of a mounting number of reports that experts now believe some kind of large-scale bank bailout is inevitable, and that the government will probably have to ask for money from international lenders—EU countries, the ECB, or potentially even the IMF. So far, the IBEX is off nearly 3.5 percent today.

SPAIN - Bank Runs versus LTRO Flows

The Run On Spain 04/17/12 BI

1. First, deposits are vanishing as the economy contracts and what money would-be investors hold flees the country. This has an important consequence for sovereign debt, too, since domestic banks have been the primary buyers of Spanish debt recently. Unless asset growth from Eurosystem funding can keep pace with deposit flight, banks will no longer be able to keep up these purchases. In this cynical scenario, the value of bonds will decline, yields will rise to unsustainable levels, and Spain could become insolvent.
2. Second, the Eurosystem is increasingly becoming the vehicle for supporting Spain, making it more likely to embrace a Spanish bank bailout in the future. If the Eurosystem's assets stand to be lost, it will be less likely to allow a series of private defaults to occur. No matter how much banks try to pump up their capital, the unfortunate reality seems to be that they're going about it in an unsustainable way, particularly if there is no third LTRO.

Spanish Banks Gorging on Sovereign Bonds Shifts Risk 04/17/12 Bloomberg - For lenders in so-called peripheral countries -- Spain, Portugal, Ireland, Greece and Italy -- profit also was an inducement: They could borrow at 1 percent to buy government bonds yielding between 6 percent and 13 percent.

• Spanish, Italian and Portuguese banks are loading up on bonds issued by their own governments, a move that shifts more of the risk of sovereign default to European taxpayers from private creditors.
• SPAIN +26%: Holdings of Spanish government debt by lenders based in the country jumped 26 percent in two months, to 220 billion euros ($289 billion) at the end of January, data from Spain’s treasury show.
• ITALY + 31%: Italian banks increased ownership of their nation’s sovereign bonds by 31 percent to 267 billion euros in the three months ended in February, according to Bank of Italy data.
• GERMANY/FRANCE -50%: German and French banks, meanwhile, have cut holdings of those countries’ bonds, as well as Irish and Greek debt, by as much as 50 percent since 2010 in some cases.
• That leaves domestic firms on the hook for a restructuring such as Greece’s last month and their main financier, the European Central Bank, facing losses. Like Greece, governments would have to rescue their lenders with funds borrowed from the European Union. “The more banks stop cross-border lending, the more the ECB steps in to do the financing,” said Guntram Wolff, deputy director of Bruegel, a Brussels-based research institute.

“So the exposure of the core countries to the periphery is shifting from the private to the public sector.”

SPAIN - Non Performing Loans- Corporate, Consumer & Residential

LTROver 04/17/12 Zero Hedge

Corporate loans are tracking unemployment in their surge higher...

The residential and consumer loan delinquency data in Spain seems questionable at best. Consumer and residential delinquencies are flat, despite a surge in unemployment. I recommend taking this data with a giant grain of salt, given what one would normally expect. Markets are doing exactly that, which is why Spanish banks trade at less than tangible book value; a bit less than 1.0x for BBVA and Santander, around 0.5x for the domestically-focused Cajas. Note: Caixabank recently purchased Civica at around 0.35 times book value.

ECB LTRO - Failing Fast

LTRO Bank Stigma Widest Since LTRO Announcement 04/16/12 Zero Hedge

Since we first suggested in early February that investors should be underweight LTRO-encumbered banks relative to un-encumbered banks, and summarily dismissed Mario Draghi's lies with regard any stigma associated with LTRO loans, the spread has increased from around 50bps to almost 140bps today. The move today has taken LTRO Stigma (the spread between banks that took LTRO loans and those that did not) to the widest it has been since the announcement of the LTRO program. So while financial spreads in absolute terms are not back to their very early January widest levels quite yet - the differentiation between the encumbered and unencumbered is gaping wide. Perhaps this helps to explain why a further indicator of funding stress - the 3Y EUR-USD basis swap - is deteriorating rapidly (at a similar velocity as was seen heading into the crisis epicenter last year) meaning European banks are increasingly willing to pay a higher premium for USD funding - not a sign of a healthy market in any way.

The rapid deterioration in the 3Y EUR-USD basis swap is worrisome as it indicates European banks are increasingly willing to pay a premium to access USD funding (obviously post LTRO in this case).

The LTRO Stigma (lower pane) has reached levels not seen since the initial announcement of the LTRO program as banks that face the ECB's implicit encumbrance notably underperform those that chose not to dance with the devil.

EU BANKS - Failed To Take Action

Liquidity Isn't Capital 04/16/12 Zero Hedge

As Barclays notes today, the major financials alone look set to need over EUR120 billion in capital to bring their credit risks down to acceptable levels to be able to openly access capital markets once again. This means a median 30% of current equity market capitalization has to be raised.

As Barclays notes today, the major financials alone look set to need over EUR120 billion in capital to bring their credit risks down to acceptable levels to be able to openly access capital markets once again. This means a median 30% of current equity market capitalization has to be raised.

BUNDESBANK & TARGET2 - How Long Can Germany Finance this Debacle?

What is the origin and meaning of the Target2 balances? Deutsche Bundebank 03/15/12 - This has considerably changed the Eurosystem’s role as a liquidity provider. Whereas before, it provided only the bare minimum of central bank money, the Eurosystem has now largely taken over the liquidity functions of the interbank market and other cross-border capital flows. The total volume of refinancing transactions has risen from approximately €460 billion on the eve of the finan-cial crisis to over €1,100 billion at last count, and the average maturity of the transactions has spiralled from a few weeks to almost three years. The share of euro-area peripheral countries in the volume of refinancing operations has concurrently climbed from one-sixth to around two-thirds. The continued net outflow of liquidity from the peripheral countries has caused them to accumu-late combined Target2 liabilities in excess of €750 billion. Zur problematik der TARGET2

Oh, and where is the money coming from you may ask? Danke Deutschland!

GLOBAL TOTAL DEBT - Rollovers & Interest Payments

To QE3 or Not to QE3 04/17/12 Jeff Gundlach

EU - Spanish & Italian Deterioration NO Longer Able to BE Hidden

Mark Grant On The Dangerous Road Ahead 04/14/12 Mark Grant via Zero Hedge

We are just at the beginning of a great divergence where credit assets, risk assets, decline in value and where Treasuries head in a quite separate direction as driven by U.S. data in part but, more significantly, by the travails in Europe.

• SPAIN CDS: The CDS for Spain reached an all-time high on Friday reflecting the financial issues in Spain as the Spanish bond yields creep higher held back, in part, by the threat of intervention from one of Europe’s stabilization funds.
• SPAIN / ITALIAN LTRO LEVELS: We have just been presented with one very red flag signaling the seriousness of the issues in both Italy and Spain.
  • Spain just announced that its banks borrowed $415 billion from the LTRO funding while net borrowing stood at almost $300 billion and accounted for 63% of the net borrowing at the ECB.
  • For Italy the number is $354 billion in LTRO borrowing and they are not that far behind Spain in needing aid. The actual debt to GDP ratio, which I detailed on March 29, is 133.8% for Spain, not the official 79% number, and is getting worse as their economy shrinks and as the country guarantees ever more bank debt to be used as collateral. It is not much better in Italy as the combined national debt and their share of the debts at the ECB and the EU peg Italy’s actual debt to GDP ratio right at 200% and while Italy’s ability to self-fund is appreciably better than Spain; their funding needs are becoming appreciably larger as the country sinks into recession.
• EU BANKS: The one other area I am becoming quite concerned about are the banks; in particular the European Banks. Of the twenty-five largest banks in the world there is only one that does not need to raise additional capital to de-lever to a 20x leverage and a 5% of Tangible Capital Ratio and that is Citigroup which has a current leverage of just 13 times and I also point out that Wells Fargo with a 14 times leverage needs a minor amount of capital to accomplish these goals. At the far other end of this scale is Deutsche Bank which is levered 62 times and would need a massive amount of new capital and tremendous shrinkage to accomplish these goals. The assets of DB are also equivalent to the entire GDP of Germany so that the bank could devour the country if Deutsche Bank were to hit the wall. Then the most leverage can be found at Credit Agricole at 66 times which would also swamp France, given its size, if asset values continue to decline or if Spain or Italy need to be bailed out and the contagion worsens.
• QE ON HOLD: For the moment both the Fed and the ECB are not engaged in Monetary or Quantitative Easing. This has been the driving force for both equities and for bonds for the last four years. Yields have been lowered, spreads have compressed but I think we are now in the early stages of a massive reversal where stocks decline and where yields rise and a widening takes place between Treasuries and every other asset class.
  • In my view, during the next several months, the situation will continue to deteriorate and so I continue to advise taking profits in both equities and bonds and re-deploying the money.
  • I would stick with various structures that float or step-up and I would avoid bullets as losses will accumulate both from the absolute rise in yields but also from the widening in spreads.

“It is in the uncompromisingness with which dogma is held and not in the dogma or want of dogma that the danger lies.”

SPAIN - Clear Market Message

dshort

ITALY - Industrial Production Suggests Budget Problems Ahead.

Global Macro Monitor

GENERATIONAL CYCLES - An Analytic Perspective

When Does This Travesty of a Mockery of a Sham Finally End? 04/16/12 Charles Hugh Smith

1. The credit expansion/renunciation cycle. a.k.a. the Kondratieff cycle. Credit expands when credit is costly and invested in productive assets. Credit reaches excess when it is cheap and it's dumped into malinvestments, and as collateral vanishes then credit is renunciated/written off.

This is inexact, but obviously the postwar cycle of expansion has ended and is now rolling over into the collapse/renunciation stage.

2. The generational cycle of four generations/80 years described in the seminal book The Fourth Turning. American history uncannily tracks an 80-year cycle of crises and profound transformation: 1860 (Civil War), 1940 (world war and global Empire) and next up to bat, 2020, the implosion of the debt-based Savior State and the financialized economy.

3. The 100-year cycle of inflation-deflation described in the masterful book The Great Wave: Price Revolutions and the Rhythm of History. The price of bread remained almost constant in Britain throughout the 19th century. In contrast, the 20th century has been characterized by inflation--the U.S. dollar has lost approximately 96% of its value since the early 20th century.

Another characteristic of this cycle is wage stagnation: people earn less even as costs of essentials rise, a dynamic that inevitably leads to political crisis and upheaval.

The end-game for inflation is destruction of fiat currencies, i.e. hyper-inflation or complete loss of faith in paper money. This is of course "impossible," just like World War I, the Titanic sinking, the global meltdown of 2008, etc. Impossible things happen with alarming regularity.

4. Peak oil, which does not mean the world runs out of oil, it simply means oil production no longer rises to meet demand and eventually declines even as new fields are brought online.

All this surplus energy in North America sounds wonderful, but that doesn't mean the world as a whole has escaped Peak Oil. Even if these projections turn out to be accurate, that expansion of production will not replace the loss of production as supergiant fields in Mexico, the North Sea and the Mideast enter the depletion phase. Yes, technology can extract more oil, but technology is costly. The days of cheap natural gas may have arrived, but the days of cheap oil are numbered.

MARKET LIQUIDITY - Why Volumes are Drying Up and HFT Is Exploding

Why The Market Is Slowly Dying 04/14/12 Zero Hedge

What happens in a world where the very core of the capital markets system is gradually deleveraging to a point where maintaining a liquid and orderly market becomes impossible: large swings on low volume, massive bid-offer spreads, huge trading costs, inability to clear and numerous failed trades?

ANALYTICS - Initial Jobless Claims

The Market's Best Indicator Continues To Work Perfectly 04/14/12 BI - The blue line is the S&P 500. The red line is the inverse of initial jobless claims. For over 5 years, they've moved in virtual lockstep, and they're doing it again. Lately the improvement on initial jobless claims has stalled out, and the rally in the S&P 500 has stalled out. It alone is a good reason to think that fundamentals, not central banks, are what's driving this market.