NOVEMBER 2012: GLOBAL MACRO TIPPING POINT - (Subscription Plan III)

RACE TO DEBASE : The "Race to Debase" Accelerates in a "Race to the Bottom"

The November GMTP issue discusses the Regional Macro Economic Issues in Europe, Japan, China and the Emerging Economcis and BRICS countries. The IMF, World Bank and BIS have all warned of heightened economic and financial risk. The IMF cut the grwoth rate of the advanced economies by 25% taken it down to levels not seen since 2009. The World Bank released a study indicating theat 600 million new jobs must be created over the next 15 years to meet economic and social demands. Meanwhile global growth is falling at rates not seen since the early stages of the 2008 financial crisis.

Currency Wars have entered a new stage has global economies fight for a shrinking piece of export/import demand. Any Geo-Politicl event, an unresolved US Fiscal cliff or unexpected corporate financial failure could be the catalyst to push the world into its first global recession.

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OCTOBER 2012: MONTHLY MARKET COMMENTARY (Subscription Plan II)

RACE TO DEBASE : The Fighting Resumes - The "Race to the Bottom" Monetary Policy Programs Accelerates

THE "UNLIMITED" & "UNCAPPED" SALVO - The macroprudential policy strategy of Financial Repression reached a seminal point last month with the announcement of the Federal Reserve's "Unlimited" QEIII/Operation Twist and the ECB's "Uncapped" OMT. We have moved into the outer limits of Monetary Policy which now forces the accelerated currency debasement of the developed economies against its Asian & BRIC competitors. The 'race to the bottom' has entered another phase which now sets the battle lines for the next set of conflicts.

In case you haven't been keeping score, here is how the "Race to Debase" currently stands. (see right) MORE>>

MARKET ANALYTICS & TECHNO-FUNDAMENTAL ANALYSIS

NOVEMBER 2012: MARKET ANALYTICS & TECHNICAL ANALYSIS - (Subscription Plan IV)

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OCTOBER 2012: TRIGGER$ (Subscription - Plan V)

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	PART I - Understanding FINANCIAL REPRESSION
	PART II - FINANCIAL REPRESSION in Europe
	PART III - FINANCIAL REPRESSION in the US & ASIA
	PART IV - Preparations for FINANCIAL REPRESSION

Password: macro

GLOBAL ERIVATIVES - BIS Report

Q2 Total Gross Notional Derivatives Outstanding: $639 Trillion 11-13-12 BIS -via ZH

Earlier today, the BIS, which has been doing everything in its power today to defend the 1.27 support in the EURUSD since the market open this morning, released its H1 OTC derivatives presentation update. There was little of material note: total OTC derivatives were virtually unchanged at $639 trillion gross, representing $25 trillion in net outstanding (market value), and $3.7 trillion in gross credit exposure. Here the PhD theorists will say gross is irrelevant because Finance 101 said so, while the market practitioners will point to Lehman, counterparty risk, and less than infinite collateral to fund sudden implosions of weakest links in counterparty chains, and say that it is gross (which until a recent revision of BIS data had been documented at over $1 quadrillion) that mattered, gross which matters, and gross which will always matter until finally everything inevitably collapses in a house of missing deliverable cards. Because not even the most generous sovereigns and central banks can halt the Tsunami once there is a failure of a major OTC Interest Rate swap counterparty. And whereas Basel III had some hopes it would be able to bring down the total notional in derivative notionals slowly over the next few years with a gradual deleveraging across all financial firms, the bankers fought, and the bankers won, because the last thing the current batch of TBTFs can afford it admit there is any hope they can ever slim down. The will... but never voluntarily.

Visually:

Click Image to Enlarge

And in tabular form:

Click Image to Enlarge

Some details from the OTC:

Total notional amounts outstanding of OTC derivatives amounted to $639 trillion at end-June 2012, down 1% from end-2011 (Graph 1, left-hand panel, and Table 1). The appreciation of the US dollar against key currencies between end-2011 and end-June 2012 contributed to the decline by reducing the US dollar value of contracts denominated in euros in particular. The overall decline was driven by interest rate contracts (–2%). Credit derivatives notional amounts also continued to decline (–6%). In contrast, foreign exchange contracts outstanding rose by 5% to $67 trillion.

Gross market values, which measure the cost of replacing existing contracts, dropped by 7% to $25 trillion (Graph 1, right-hand panel). This amounts on average to slightly less than 4% of notional amounts outstanding.

Gross credit exposures, which measure reporting dealers’ exposure after taking account of legally enforceable netting agreements, mirrored the decline in total market values, falling to $3.7 trillion, which represents 14% of the total market value of OTC derivatives. Since the end of 2008, gross credit exposures have tended to move in a narrow band of 14–16% of market values. This compares with a range of 19–24% in the mid-2000s. Gyntelberg and Vause (2012) calculate that about half of dealers’ gross credit exposures are covered by collateral.

Since gross notionals in most categories declined (boring) except for FX, here is the breakdown of what drove this rise:

Click Image to Enlarge

Full report link

MONETARY MALPRACE - Moral Hazard & Unintended Consequences

Welcome To The Nuthouse: How Private Financial Fiat Creates A Public Farce 11-13-12 Charles Hugh Smith

Farce #1: “Market value” and “free markets” have become a joke.

Farce #2: Private, self-assigned, fake value is being traded for public money at 100 cents on the dollar.

Farce #3: Printed money is backed by nothing.

Farce #4: We have a “free” enterprise system dominated by monopolies that force people to buy inferior goods and services at exorbitant rates.

Farce #5: High-level financial crimes, no matter how egregious or widespread, are not being prosecuted.

Farce #6: Risk is gone. Now there is only liability borne by citizens.

Farce #7: Productivity has been supplanted by parasitism.

PATTERNS - Arithmetic versus Geometric Progressions

Sometimes a picture paints a thousand words. In the case of this chart, it paints an expectation of around 300 S&P points (to the downside). The strange symmetrical exponentiality of the last four years can only be marveled at in its reflection of greed and fear catalyzed by the machinations of an increasingly impotent central banking cartel. Trade accordingly.

The irony of the coincident timing of the plunge and the pending fiscal cliff decision - which as we noted here, will not be solved until the market pushes the politicians to 'compromise' - should not be lost on those who poo-poo such silly chartist ramifications...

(h/t Ivan The Terrible @SqueezedEquity)

US ECONOMY - Fiscal Tailwinds

Sector Surplus' Is The Key Force That Will Keep The Economy Growing For Years 11-13-12 Goldman Sachs via ZH

RISK - Fixed Income Investor Risk Perceptions

One Big Risk People Have Forgotten Thanks To The Fiscal Cliff 11-12-12

The fiscal cliff has completely dominated the headlines since the presidential election was decided last Tuesday. BofA Merrill Lynch's latest client survey of fixed-income investors confirms that the fiscal cliff is the biggest thing on the market's mind right now:

As fiscal cliff concerns have risen between September and November, many others have waned – especially that regarding  oil prices. In fact, less than half of those who called an oil price shock emanating from a conflict in the Middle East a big concern in September did so in November.

BofA Merrill Lynch credit strategist Hans Mikkelsen and his team say that's the biggest thing that investors are underappreciating:

The one risk that appears to us under appreciated by investors is the risk of higher oil prices - mentioned by only 6% of investors as a major concern - especially as there are significant risks of an escalation of the geopolitical situation in the Middle East.

On the other hand, BofA equity strategists peg the risk of an oil shock owing to a potential military conflict between Iran and Israel at below 10 percent. Here is what they had to say in a recent report on the subject:

Although tighter sanctions and the blockade of crude exports from Iran have reduced the country’s oil exports, Iran is still OPEC’s fourth largest oil producer, exporting about 1 million barrels a day. According to Commodity Strategist Francisco Blanch, a full blown Iranian oil supply disruption could push Brent oil prices up by $20-40/bbl and have twice the impact of Libya on global supplies and prices.

Indeed, the potential fallout from an Iranian strike could be much, much greater given that the oil market is already tight and that 20% of the world’s oil is transported through the Strait of Hormuz. A sustained rise in oil prices above $150/bbl would likely result in a recession and necessitate a significantly more defensive asset allocation. 

That scenario wouldn't be pretty, but given that BofA's equities team labels this a "tail risk" with less than a 10 percent chance of happening, maybe the bank's credit clients aren't so far off the mark.

JAPAN - Deep -3.5% Recession and A Negative Current Account Balance

Japan Plunges Into Deep Recession; GDP Shrinks 3.5% Annualized; Japan Current Account Turns Negative First Time in 30 Years; Watch the Yen 11-12-12 Mish

PE RATIO - The Shiller P/E

An Old Friend: The Stock Market’s Shiller P/E Clifford S. Asness, Ph.D. AQR Capital MAnagement November 2012

In particular, though we will touch on some of the other possibilities, we will focus primarily on two measures at the forefront of today’s argument: A market P/E calculated using standard one-year trailing total earnings vs. what has come to be called the “Shiller P/E.”3 The idea of the Shiller P/E arose from the observation that one-year earnings are highly volatile and probably mean-reverting. Thus, at times of very high earnings, the one-year P/E might look “too low” (stocks too cheap) and when earnings are very low, the opposite can occur and the one-year P/E might look “too high” (stocks too expensive). At extremes, like very bad recessions, earnings can get so low as to approach or pass zero, making the oneyear P/E obviously silly (this almost happened in 2008/09). What the Shiller P/E does to adjust for this problem is simple and effective, if obviously imperfect. Instead of using oneyear trailing earnings, it uses the average of the prior 10 years of trailing earnings (inflation adjusted).4 Ten years is, of course, arbitrary. You would be hard-pressed to find a theoretical argument favoring it over, say, nine or 12 years. However, it struck its creators and many of us as reasonable and intuitive. It extends over one or two typical business cycles without going too deeply into the very distant past. Put simply, one-year P/E’s represent what an investor pays for the last years’ worth of S&P 500 earnings, again a very volatile number. In contrast, the Shiller P/E represents what an investor pays for the last 10 years’ average real S&P 500 earnings. The hope is that this is a more stable measure that is more relevant to long-term future stock returns and earnings. So, what do Shiller P/E’s look like over history up until today?

PE RATIO - Election Year Trends

Post-Election Performance: Dip-Buyer's Dream Or Valuation Slump 11-12-12 Bloomberg via ZH

With the S&P 500 down a staggering 6.5% from its post-QEtc highs, the world and their wealth adviser is beginning to get that Deja Deja Deja Vu feeling all over again. The commission-takers are being trotted out left, right, and center to spew forth every market myth from "money-on-the-sidelines" to "markets-hate-uncertainty"; from "valuation is cheap" and "whatcha' gonna do - buy bonds at 1.5% yield?"; and from "healthy retracement" to "long-term horizon". In today's episode of epic realizations of the truth, we thought we would look at year-end multiple expansion (contraction) seasonals - since we suspect earnings expectations (which are still running dramatically high; even though recently trending lower) - remain exorbitantly hopeful of a fiscal cliff resolution bringing joy and happiness to the world. Fact: post-election-year multiples have on average contracted around 1x versus a 0.6x expansion in non-election years.

The chart below shows the change in P/E multiple for the S&P 500 on average through the year - in election years, non-election years, and the current year...

Chart: Bloomberg

PATTERNS - Climatic Readings Signaling Exhaustion

Climactic Readings Usually Signal Exhaustion 11-09-12 Decision Point

PATTERNS - 2012 v 1987

S&P 500: 2012 vs 1987 10-23-12 Bespoke

There's nothing like a sharp sell off in the equity market during the month of October to bring out the worst of investor fears.  With last Friday marking the 25th anniversary of the 1987 Crash, those fears are even more apparent.  Making matters worse is the fact that the pattern of 2012 bears more than a passing similarity to 1987.

As shown in the charts below, in both years, the S&P 500 started off strong, saw a first half peak in the Spring, and then sold off.  In both years, the market regainged its footing around Memorial Day weekend, kicking off a Summer rally.  In 1987, the S&P 500 peaked in late August and had two successive failed rallies where each subsequent sell off made a lower low.  Likewise, this year the S&P 500 peaked in mid September and has since had two successive failed rallies where the index has made lower lows.

While the patterns between 1987 and 2012 are similar, there are two key differences.  First, the S&P 500 was up considerably more at its peak in 1987 (+39%) than it was at the 9/14 peak this year (+16.6%).  Secondly, in terms of valuation, the S&P 500's P/E ratio is considerably lower now than it was in 1987.  In 1987, the S&P 500's P/E ratio at the low after the crash (14.37) was still higher than it is now (14.28).

PE COMPRESSION - In Process

P/E Ratios Contract 11-08-12 Bespoke

The market pullback during a relatively strong earnings season for bottom line numbers has caused P/E ratios to contract recently.  Below we highlight one-year P/E ratio charts (trailing 12-month) for the S&P 500 and its ten sectors.  As shown, the S&P 500's current P/E stands at 13.92.

We've really seen a pullback in P/Es for three defensive sectors lately -- Consumer Staples, Telecom and Utilities.  This summer we noted the big increase in valuations for the Utilities sector as investors plowed into dividend paying stocks.  But with an increase in dividend taxes on the horizon, we're starting to see an exodus out of the inflated higher yielding names, and it's bringing P/E ratios down with it.  Even with the drop, however, the Utilities sector still has a higher P/E than the Technology sector, which is having its own problems lately.

MARGINS - No Cash Available for Margin Calls

And Now Come The Margin Calls: NYSE Margin Debt At 16 Month High 11-07-12 Zero Hedge

A stock sell off is usually a healthy, cathartic thing: one sells, pockets the proceeds, books a loss, and comes back to fight another day. The big problem, however, is when speculators and traders are already massively overleveraged, and not only don't have a positive Net Worth (defined as Free Credit Cash Account and Credit Balances in Margin Accounts less Margin Debt) but their Margin Debt is so high it commences a toxic loop of selling merely to fund margin calls which usually start popping up in the last hour of trading (and when trading desks put their phones straight to VM), leading to more forced selling, more margin calls, and so on. And therein lies the rub: according to the most recent NYSE margin debt data, the market complacency recently hit such high levels, that speculators virtually went all in, but solely in their margin accounts without holding any cash buffer to pay for potential margin calls. As can be seen on the table below, Margin Debt as of 9/30 hit $315 billion: a jump of $30 billion from the prior month, and the highest since March 2011, just before the market tanked. And confirming that there is simply no cash on hand to pay for margin calls when they start pouring in after today's massive sell off, is the total Net Worth, which in September was the lowest since April. Because with record complacency, and the Fed guaranteeing no further shocks are possible, who needs to hold cash? Today, we will find out: just as soon as the margin calls start coming around around 3PM Eastern...

CANARIES - Micro Weakness Indicating Major Macro Problems

Is Micro Weakness Smelling A Macro Collapse? 11-09-12 Goldman Sachs via ZH

Last week we suggested a reason why the market was unable to hold on to the Bernanke bid. The relative plunge in Goldman Sachs 'bottom-up' Analysts Index (GSAI) suggested that the macro 'strength' that market-savants were so focused on, could perhaps be election-biased (blasphemy). It seems this macro 'strength' divergence (highest since 1996!) from micro 'weakness' reality was enough to get the Goldmanites thinking - and unfortunately for all the cautiously optimistic managers out there, they are not hopeful. As Jan Hatzius explains,  "the GSAI remains closely correlated with other bottom-up measures, including the S&P 500 sales guidance diffusion index; and while one possible explanation is that S&P 500 companies are more exposed to non-US demand than the US economy at large, and the US has been a relative outperformer. But it is unclear whether this accounts for all of the weakness, or whether the bottom-up weakness also holds some additional leading information for the macroeconomic data."

Via Goldmans Sachs' Jan Hatzius:

• Our Goldman Sachs Analyst Index (GSAI)—which is based on our equity analysts' assessment of conditions in the industries they cover—has sharply underperformed the macroeconomic data, to a degree not seen since its inception in 1996.
• Has the GSAI gone off track? We don't think so, as it remains closely correlated with other bottom-up measures, including the S&P 500 sales guidance diffusion index compiled by our Portfolio Strategy group. It seems that the bottom-up message is simply gloomier.
• One possible explanation is that S&P 500 companies are more exposed to non-US demand than the US economy at large, and the US has been a relative outperformer. But it is unclear whether this accounts for all of the weakness, or whether the bottom-up weakness also holds some additional leading information for the macroeconomic data.

Since 1996, we have conducted a monthly poll of the Goldman Sachs equity analysts about business conditions in the industries under their coverage. In general, the resulting Goldman Sachs Analyst Index (GSAI)—a weighted average of analyst diffusion indexes for orders, shipments, and other activity measures—has matched macroeconomic indicators such as the ISM manufacturing and non-manufacturing index quite closely, and has at times even provided leading information. Partly for that reason, we typically release the GSAI two days before the ISM manufacturing index.

Over the past year, however, the historical relationship between the GSAI and the ISM has weakened, and anyone who has tried to use the GSAI to get an early read on the ISM has been disappointed (see Exhibit 1). The October 2012 release was the most striking example. The GSAI fell to 32.9, a reading that historically would have been consistent with an all-industry ISM in the mid- to high 40s. However, the all-industry ISM was broadly flat at 53.9.

Exhibit 1: Relationship between GSAI and ISM Has Weakened

What lies behind this divergence? One possible explanation is that the GSAI has simply become a less useful indicator over time, perhaps because of fluctuations in the sample size or divergence between our analyst coverage and the broader equity market. But on closer inspection, it seems that the weakness in the GSAI can be explained by more fundamental factors. While it has departed from the ISM, its weakness matches other "bottom-up" measures of economic activity quite closely, as also noted by our European Portfolio Strategy team. A good example is the revenue guidance index compiled by our US Portfolio Strategy group. It is defined as the percentage share of S&P 500 companies that guide consensus revenue estimates higher minus the percentage share that guide consensus estimates lower. Exhibit 2 shows that the GSAI has tracked the revenue guidance index closely since the latter was introduced in 2006, and both have weakened in lockstep in the past year. It seems that the bottom-up message from S&P 500 companies and the analysts that cover them is simply more negative than the macro data would suggest.

Exhibit 2: GSAI Still Tracks Revenue Guidance Closely

It is less clear why the bottom-up message is so weak. One reason is probably that S&P 500 companies are more exposed to international factors than the US economy as a whole, and non-US economies have slowed more sharply than the US. Regarding the first point, non-US sales account for 33% of the total sales of S&P 500 companies, but exports account for only 14% of US GDP. Regarding the second point, Exhibit 3 shows that the all-industry non-US purchasing managers index (based on data from our Global Economics group) has underperformed the all-industry ISM index for the US over the past year. Moreover, Exhibit 4 shows that while the GSAI has underperformed the composite ISM sharply, it has actually tracked the new export orders sub-index of the ISM (which is not included in the composite) reasonably well.

Exhibit 3: Weaker Conditions Outside the US

Exhibit 4: GSAI Still Tracking ISM Exports Closely

At the same time, the domestic/foreign split is probably not sufficient to explain the entire micro/macro divergence. Although there is little evidence for a systematic lead/lag relationship between the micro and macro data, and although other measures of overall activity such as the labor market and various GDP-type spending measures also point to decent growth, the micro data do provide an independent read on activity and may be pointing to slower growth ahead. Our forecast remains for a deceleration in real GDP growth to a 1.5% pace in early 2013, despite positive bounce-back effects from both Hurricane Sandy and the 2012 droughts. The main reason lies in the step-up in the pace of fiscal restraint and the uncertainty effects that may already have started to hit capital spending.

It is possible that indicators such as the GSAI and S&P 500 revenue guidance have picked up signs of such a slowdown at an earlier stage than the macroeconomic indicators.

SECTOR RETURNS - Total Return Performance of Obama's First Term

The Returns Of Every Major Financial Asset In The World During Obama's Presidency 11-06-12 Deutsche Bank via ZH

PATTERNS - Global Market Comparisons

Why Global Investors Love The US Stock Market 11-07-12 Mrgan Stanley via ZH

Gerard Minack, Morgan Stanley's head of developed market strategy, created this chart to show how 2013 earnings expectations for Australia's stock market — the S&P/ASX 200 — have deteriorated through out the year.  Australia's economy is largely driven by a mining industry, which has been supplying the emerging markets.  Those emerging markets have slowed significantly.

It's worth noting, however, that the Nasdaq has had net upward EPS revisions.  And S&P 500 EPS revisions have been revised down only modestly.

The lack of earnings expectations volatility is certainly welcome by investors.

Below is the chart from Minack.

• DM EX-US: Developed Markets excluding the US
• MSCI EM: Emerging Markets
• EURO STOXX: Europe