I must begin today’s missive with an ebullient congratulations to my good friend Blaine Bell! The wedding in Napa Valley this past weekend was beautiful, the bride radiant and the party atmosphere prodigious.

While my computer did make the trip to Napa, it was used for portfolio management only. Any free time this past week was spent in the lovely company of Rebecca, my girlfriend and the grape vines of Napa. Needless to say I had a tremendous amount of reading to catch up on upon my return to RCM headquarters.

If I could condense this past week’s worth of erudition into a single thought I’d say ‘the more things change the more they stay the same.’ Certainly we have witnessed a significant amount of volatility in 2010.  The ‘change’ component of the above phrase can best be described as nauseating. If you wish to see a graphical interpretation of this 2010 phenomenon feel free to subscribe to our ‘Market Moving Chart of the Day’ located in the top right corner of this page.

As for the ’staying the same’ part of the equation I will simply direct your attention to the following three headlines. In fact, I could have chosen at random any three headlines from the past week and they all sound similar. The basic gist is as follows:

First, a piece of economic news is released that disappoints. However, Wall St. and the powers that be, do their best to put the proverbial lipstick on the ever distending pig… Retail Sales Dip, but It Could Have Been Worse – Briefing. Next, some Fed member chosen to be that week’s puppet (are straws used or is Dictator Ben punishing those who wish to stray?) makes a supposed market soothing comment… Fed’s Hoenig on CNBC says the economy continues to recover modestly, and he still sees 3% economic growth in 2010.  Almost immediately following the sock’s elucidation, a contradicting, real and market troubling story hits the wire…

FOMC minutes from from Jun 22-23 meeting:

The pace of the expansion over the next year and a half was expected to be somewhat slower than previously predicted…

The participants generally made modest downward revisions to their projections for real GDP growth for the years 2010 to 2012, as well as modest upward revisions to their projections for the unemployment rate for the same period…

We are stuck between intense volatility and an insipid news cycle. At times like this I find the best tonic is a revisit with our trusty steed, technical analysis. Below please scrutinize the daily price chart of our favorite index the NYSE Comp..

As you can see, the major uptrend remains intact. Moreover, three attempts have been made to breach this trend in May, June and July to no avail. You may however, remember that everyone and their proverbial brother on CNBC and the like were calling for an epic Head and Shoulders breakdown at the beginning of this month (labeled 3 & highlighted yellow). Naturally you will not be able to find this obvious prediction on the RCM blog site. Rule number one: When CNBC et all call for imminent market demise expect instantaneous market rally. You may recall that when these jokers were calling for new highs on the market we were ‘Stalking the Bear’.

The above chart also suggests a change in trend may be in the offing. The market price has been locked in a downtrend since the April highs moving from the top of the channel to the bottom. However, as the blue, yellow and red Fibonacci Fan lines illustrate, a change in trend has been signaled.  For your convenience I have highlighted with a green box an initial target area for the current rally.  

Allow me to conclude by writing that fundamentally I can see no reason for the markets to rally. We are firmly of the mind that economic growth will not be able to continue without massive government support. Financial regulation will continue to be a hot button right up to the November elections at the very least. Regulation of the GSEs will continue to cause consternation. I will warn that a fourth breach of the uptrend line will be deadly.

However, our credit guru Michael Johnson continues to write, “ Bank CDS & CDX Index spreads point to continued equity market gains. Being short equities as credit improves is dangerous…”  So, until such time as a fourth breach has commenced, the technical picture of the market remains encouraging.

Tags: CDS, CDX index, Credit, economy, Fed, FOMC, GDP, NYSE Comp., retail sales, Stalking the Bear, stock market strategy

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Guest Post by Don Coxe (courtesy of Zero Hedge)

Don Coxe Dissects Gold, As “The Oldest-Established Store Of Value Moves To Center Stage”

…We think that future historians may well report that the moment when gold once again became a store of value was when the dollar began soaring in response to the stench of seared Greece—and gold climbed right along with it. The asset classes that have been inversely correlated since Keynes’s time suddenly united….

… So why didn’t inflation come roaring back when Bernanke doubled the Monetary Base and M-2 was climbing at double-digit rates?

And why didn’t inflation come back when central banks across the OECD were growing their monetary bases and money supplies were climbing? And why did gold take off to record levels when money supply growth began to dwindle and actually turn negative?

… What we believe is unfolding is a rush into gold by individual investors who look at the astronomic growth in financial derivatives—particularly collateralized debt swaps—and government deficits at a time when the effects of demographic collapse are finally being understood. According to some guesstimates we have heard, the supply of outstanding financial derivatives may be in the $70 trillion range, dwarfing the combined value of money supplies and debts. The total value of gold is so minuscule in comparison to the supply of these software-spawned instruments that it cannot be any real help in stabilizing global finances—but it can be a haven for investors seeking to protect themselves against an implosion of majestic proportions.

… So…as a store of value for future generations,

If you can no longer believe in residential real estate,
and you can no longer believe in bank deposits,
and you can no longer believe in the dollar,
and you can no longer believe in the yen,
and you can no longer believe in the euro…
What can you believe in?
How about gold?

It’s so old, it’s new again.

… Among the arguments routinely adduced against it is that it pays no interest—but with interest rates in the zero range, the opportunity cost is minimal.

Read More…

Stock Market Strategy: Follow Up – Credit Check

Michael Johnson (a.k.a Credit Guru) weighs in on recent credit market performance and shifts his stance:

Last Wednesday we turned from tactically bearish to neutral. We went completely bullish Friday morning. The equity market’s ability to ignore the recent improvements in bank and non-financial CDS profiles appears to be faltering…. and this could lead to a sustained equity rally… …Credit market performance so far this morning indicates that the SPX should be trading in the +25pt range….that would match the note we sent out Friday morning

Bears About to be Gored

Summary:

We now believe investors should be Tactically Bullish as well as fundamentally bullish

Bears should be getting nervous…credit market is improving

GS Credit curve has steepened

New Issue Market reopened

Bank CDS Spreads tightening

Credit market volatility decreasing

How many times do you think credit will tighten before the equity markets jump on the bullish bandwagon? It’s probably sooner rather than later…

Gored… As our readers know, during the recent sell-off we have remained fundamentally positive while turning tactically bearish. We have written numerous pieces highlighting the differences between the feared “sovereign credit crisis that will never be” and the onset of the 2007-2009 credit crisis. The fear of Greece and of Euro viability concerns short-circuiting the global economic recovery is wishful thinking by the bears. This is like the bank nationalization argument….politicians will allow the Euro to fail because they know it will cause global havoc….politicians will nationalize the banks because they know it will cause global havoc…investing based on the hope that politicians will make stupid mistakes does not seem appropriate.

However, the ability of FINREG to destabilize the bank’s access to the credit markets is a truly scary, and much more likely to happen, in our opinion. The inversion of the GS credit curve and the widening of larger US bank credit spreads began a week before the overall equity and credit markets began to sell off. In our opinion, the weakness in the money center bank’s credit profiles made it a lot easier for sovereign risk concerns to find a willing audience.

The combination of the sovereign credit crisis headlines along with money center bank credit fears caused the correlation between banks CDS spreads and CDX IG Index spreads to increase. Credit market volatility materially increased and appeared to spill over into the equity markets. Many of the equity market’s worst sell-offs immediately followed large credit market sell-offs.

However, the reason we are becoming tactically bullish at this point is the reduced likelihood that FINREG will be passed with its most destructive portions. This opinion is working its way through many of the money center banks CDS credit curve profiles and credit spread volatility is decreasing. Additionally, continued improvements in nearly every consumer loan asset class will likely force even the most bearish bank analysts to reduce their loss estimates….

Conclusion:

Being fundamentally bullish and tactically bearish has been a relatively solid approach to the recent sell-off in our opinion. However, the recent decrease in credit market spread volatility and the stabilizing of money center bank CDS profiles makes it difficult to remain tactically bearish when we remain bullish fundamentally. We are now fundamentally and tactically bullish. The recent trend in which the equity markets ignore credit market strength is not likely to last.

Tags: CDS, Credit, credit market volatility, credit markets, euro, finreg., gold, GS, Michael Johnson, precious metals, stock market strategy, Zero Hedge

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The Bear is Full Right Now & May Need Time to Digest

The Grizzly we stalked in April and found in May has been devouring pathetic bulls for the last six weeks. The time may have arrived for this satiated animal to take a break.

Please refer to the chart of the NYSE Composite below for a clear picture of the six week mauling. Note the time frame of this chart is longer than previously posted NYSE Comp. charts. I’ve chosen the daily chart as opposed to the 60 min. chart because I’d like to draw your attention to the longer term trend.  Notice the black trend lines bracketing the uptrend in place since last year.  I’ve also highlighted in yellow the recent double bottom reached in the last 2 weeks. This chart clearly illustrates the easy money made on the short side is over for now. Support has been reached at the bottom of the channel and a natural bounce to work off some serious oversold conditions would not be surprising.

I have spent a disproportionate although necessary amount of time over the last 2 1/2 months emphasizing the dangers of holding a long equity portfolio.  However, now that the market trades near the bottom of the long term channel, I feel comfortable discussing issues that may lead to higher equity prices. We are monitoring the following list of developments. Should the developments unfold favorably a market rally worthy of participation may occur:

1) As the November midterm elections draw near, a flurry of government handouts (like the story below) to spur economic growth should be expected. These handouts will be viewed favorably by the markets.

WASHINGTON (Dow Jones)–People hoping to take advantage of the first-time home buyer tax credit would have an extra three months to close their home purchases and still qualify, under a measure introduced in the U.S. Senate Thursday.

To be eligible for the tax credit, home buyers must have a valid contract by April 30, 2010 and close the transaction by June 30, 2010. The Senate measure would allow home buyers until the end of September to complete their transactions.

Senate Majority Leader Harry Reid (D.-Nev.) and Sens. Chris Dodd (D., Conn.) and Johnny Isakson (R.-Ga.) intend to offer the measure as an amendment to the jobs legislation pending in the Senate.

2) I’ll take the thought above a step further and say bad economic news may cease to drive stocks lower. Instead the market may view bad economic news as positive because the threat of a double dip recession will surely drive politicians to create new stimulus. Case in point, today’s bad economic news,  “May Retail Sales -1.2% vs +0.2% Briefing.com consensus” failed to send the markets lower by the close. As I write this missive the NASD Comp. trades over 1% higher on the day.

3) Credit leads equity. This relationship continues to dominate the market place. Michael Johnson of MS Howells & Co. understands this relationship better than most. I affectionately refer to MJ as the credit Guru and his modified list of issues below demands our attention:

 Almost Time to Be Bullish

 We have provided a list of reasons as to why we are in the process of changing:

 1. If GS’s CDS credit curve steepens of so that its 1- to 5 year and 3-5 year CDS credit curves are positively sloped.

2. The re-steepening of money center bank CDS curves should begin to cause both equity and credit market volatility to decrease. Although we have only begun to see a decrease in credit market spread volatility, we expect this trend is likely to grow in the next two weeks.

3. Moody’s announcement, along with an S&P note last week, that they will not downgrade the banks and force them to confront a structural market inefficiency that could stress their business model is a huge positive.  

4. The recovery in Bank Pfd prices indicates that equity prices are likely to stabilize and begin rising again.

5. New issue market appears able to bring deals during periods of market stability

4) Financial regulation (FINREG.) by congress represents a major road block for the equity markets. Fears run high that politicians will make a bad situation worse. While I don’t disagree with these concerns, I do believe that fear often creates opportunity. Equity market participants frequently overreact. Once FINREG. is completed a major uncertainly will be lifted and uncertainty tends to be worse than reality. As time draws closer to the July 4th FINREG. deadline watch for positive market action to FINREG. developments.

Disclosure: Short GS Less than .25% of fund

Tags: bear market, CDS, Credit, equity markets, Financial regulation, finreg., GS, NYSE Comp., retail sales

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As usual European news leads the way with a ridiculous ’shoot in the foot’ decision coming out of Germany…

Merkel will announce, on Wednesday, a financial transactions tax, and a ban on naked short selling on 10 of the “most-important” financial institutions in Germany. Ban also applies to CDS and Euro govt bonds. Will remain in place for an indefinite period of time.

…Neighboring countries have not agreed to implement the same tactics.  Best guess, this ludicrous stance from Germany will only lead to confusion and have a negative effect on Bund prices as rates will rise. Moreover, as we learned in 2008, banning short selling in the shares of financial (FIN) institutions does not stop the decline in share value. In fact, as the record from 2008 reflects, said ban only serves to highlight the precarious position of the financial institutions and leads to more selling.

The idiocy of Merkel’s decision is mind numbing and only proves the current German administration has no understanding of how markets work. I haven’t the time nor the inclination to explain all to these neophytes but I will offer this simple insight: Short-sellers are natural buyers on the way down. They are short term position takers and as stocks drop they buy to cover. Preventing this behavior will obviously result in more erratic price movement.

Well done Merkel, you have succeeded in highlighting the weakest FINs and during a time of extreme volatility, you have accomplished the single worst feat: You have reduced liquidity!  For your actions, we award you with this ‘Larry Summers’ medal of honor.

I find the next news story much more disturbing. The passing of the Volcker rule would add to the cacophony of voices attacking the financial sector. In my last post I wrote, “Make no mistake, as the volume of negative news and behavior towards the FINs grows louder the equity markets will suffer.” The Volcker rule will act like a bullhorn. A quick glance at the price charts of leading FIN stocks will confirm that many in the group have already taken out the lows set during the 1000 point Dow sell off on May 6th. As expected the rest of the market is following….

FT Says Volcker Rule, Given Up For Dead, Is Likely To Pass

As the FT notes, “the political mood is such that a straight vote on derivatives would be close and the Volcker Rule would be likely to pass.” Should the Volcker Rule pass, this will be the beginning of the end for the current casino capitalism system that has gripped Wall Street. And don’t be surprised to see a 10% drop in the market as a last ditch self defense mechanism by the primary dealers.

Read More…

…The final story helps explain the particular negative action today.  Almost all markets are selling off today in unison; Dow, S&P, NASD, NYSE, Transports, Utilities, Commodities etc.. We saw this type of indiscriminant selling during 2008 and it was usually a sign of the carry trade unwinding and margin calls being met. Hard to tell what the markets will do from here. Sometimes this type of selling across the board helps set up at least a temporary bottom. Of course, this action could also lead to a repeat of May 6th or worse….

Carry Bloodbath Resumes With Full Blown Liquidations Imminent

After earlier we saw the decimation of the European currency, it is now Asia’s turn where an impressive bloodbath is now raging. The AUDUSD is in freefall, having moved a massive 300 pips from yesterday’s high to today’s low. At under 50 pips from 0.855, the AUDUSD will likely breach 0.85 at which point the destruction at carry desks will become an epidemic, and full liquidations will soon ensue, coupled with billion dollar margin calls, forcing global asset liquidations at bulge brackets. With the carry collapse pervasive, don’t look to futures to stage any miraculous Fed-inspired ramps tonight: Germany may have well called the Fed’s bluff.

Read More…

Tags: carry trade, CDS, commodities, euro, European, financial, Germany, volatility, volcker, Volcker Rule

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I expressed my belief last week via twitter that this GDP number could be interesting. I suggested the number may be less than expected as the inventory build is coming to an end. Now real intrinsic growth will need to surge in order to satiate the appetite of the GDP prognosticators and I believed that would be a tall order.  Well results are in and the number was in fact less than forecast. I  expect this may be the beginning of a trend…

ECONX GDP Increases for the Third Consecutive Quarter

As expected, growth remained positive for the third consecutive quarter as GDP increased 3.2% in Q1 2010 after rising 5.6% in Q4 2009. The consensus estimate called for a rise of 3.3%. Similar to last quarter, the bulk of GDP growth was allocated between consumption and inventory investment. Consumption expenditures rose 3.6% and contributed 2.55 percentage points to GDP growth. Inventories turned positive for the first time since Q1 2008 and contributed 1.57 percentage points to GDP growth. Construction expenditures deteriorated in both the nonresidential and residential space as investment fell 14.0% and 10.9%, respectively. This was the first decline in residential investment since Q2 2009. Net exports contributed negatively to GDP as export growth (5.8%) increased at a slower rate than import growth (8.9%). Government spending declined for the second consecutive month as state and local expenditures decreased 3.8%. Federal spending was up 1.4%.

Meanwhile, the markets continue to try and ignore the Goldman Sachs (GS) issue. However, I fear the morass (emphasis in the last syllable) is only growing thicker. Hairs are beginning to stand on the back of my neck as the current disregard for the severity of the GS issue creates a déjà vu feeling. I can recall countless talking heads on CNBC down playing Bear Sterns’ troubles in ‘08….

Criminal Probe Launched Into Goldman Sachs

Time for the media circus to go nuts. The AP reports that the Feds have just opened a criminal probe into Goldman: now it is getting interesting. And everyone was thinking that Eric Holder is a toothless puppet (well, that still has to be refuted).

As the AP reports, “The investigation by the U.S. attorney’s office in Manhattan stems from a criminal referral by the Securities and Exchange Commission, a knowledgeable person said Thursday. The person spoke on condition of anonymity because the inquiry is in a preliminary phase.”

Read More…

The following post by Zero Hedge is a must read if one wants to really understand the issues of the Goldman/Paulson case.

Did Paulson Have A $2 Billion Bear Stearns CDS Short In Late 2006? Novel Observations On Abacusgate

…Most relevantly, in what could be damaging disclosure by Fabrice Tourre, the Frenchman notes that as a result of Paulson’s mistrust of Goldman’s counterparty risk, the Abacus AC1 deal was structured in a novel way in which “they would be acting as protection buyer, facing the ABACUS SPV (as opposed to a structure where Goldman is protection buyer as is usually the case).” This little legalistic variation could make a world of difference in an Attorney General’s hands…

…Direct from Tourre E-mail, “As you know, a couple of weeks ago we had approached GSC to ask them to act as portfolio selection agent for that Paulson-sponsored trade, and GSC had declined given their negative views on most of the credits that Paulson had selected….

Read More…

Tags: Abacus, CDS, Credit, GDP, Goldman Sachs, GS, John Paulson, Tourre

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Greek funding update: Deal complete, interest acceptable, funding crisis averted for now….

New Greek €5 Billion 10 Year Bond Prices At 300 Over Midswaps, 326 bps Over 2020 Bund, Comes With 6.25% Coupon 

        Greek debt chief says bids for 10-year bond at EUR14 bln – DJ

DJ reports the Greek government’s offering of 10-year bonds has attracted EUR14 billion in bids, and will close soon, the head of the country’s debt management agency said. In the wake of a new package of austerity measures announced Wednesday, the government earlier launched an offering of 10-year bonds through a group of lead managers that comprises Barclays Capital, HSBC Holdings, National Bank of Greece, Nomura and Piraeus Bank. “The bond offering is going very well, beyond expectations,” said Petros Christodoulou. The government aims to raise EUR5 billion through the offering, but it appears to be heavily oversubscribed. After launch, Greece cut price guidance on the EUR5 billion, 300 basis points over mid-swaps from 310 basis points… “The bidding so far shows that confidence has returned to the Greek bond market,” a senior government official said. “It is a very good development. Everyone is breathing easier now.”

Guest post from Bill H.. His take on the CDS market is dead on and thought provoking, enjoy…

Credit default swap lunacy!

Dubai, Greece and the rest of the PIIGS, now Britain and next the U.S.. Speculators are pushing currencies and sovereign bonds and yields higher and lower almost at will using the CDS (credit default swaps) market. These rocket scientists hedge and or speculate (even attack) currencies with these CDS products and go to sleep at night with a clear conscience. They sleep tight each night not caring what destruction they have caused real people and the real economy and take mistaken solace that if say Greece were to fail “they are hedged”.

I am going to tell you that NO ONE with any CDS product is hedged against anything! First you must understand that if sovereigns begin to default, there will be no end until the last, biggest and most egregious financial entity falls (the U.S. Treasury). These CDS products look good on the books but who can afford to lose and make the winners whole? What currency do you get paid in if you win? My point here is the “counter party risk”. The only way a CDS product could be secure and iron clad is if it were written by a Gold depository and payable in Gold which has been authenticated, assayed and audited as to purity and it actually being there for payment.

We hear that CDS spreads widen for this country or that one. We have even heard this about the U.S. from time to time. But think about how stupid it would be to “insure” against a U.S. default with ANY paper product issued by ANY issuer. When the U.S. finally goes whether it be through default or hyperinflation, the Dollar will ultimately “go away”. So what if you were right? Are you getting paid in Dollars that became worthless? Isn’t this what you were insuring against in the first place? So you win but you receive bazillions of pieces of the very same paper you were insuring against and thus YOU LOSE?

Oh I see…you insured against a U.S. default and will get paid in Euros. This makes all kinds of sense since a U.S. default certainly won’t submarine Europe. This logic works forwards, backwards or in either direction! What I am saying here is that once ANY sovereign default occurs, IT”S OVER! EVERYTHING paper goes boom and in a puff of smoke so does ALL the “supposed” value. EVERYTHING paper blows away and ONLY assets that you can touch, feel and actually USE (manufacturing, farmland, mining) will have or retain value!

THE only true hedge against ANY sovereign default is either Gold or Silver, period. Gold and Silver are real money and will accrue ALL of the “printed” monies’ value over the years. This is a difficult concept to understand but all the fiats that have ever been printed in the past and present really had no value other than “confidence” value. Each Dollar, Pound, Yen, Euro etc. that has come into existence will “spill” its value into the metals upon its demise. I can’t believe that no one has yet (other than Jim Sinclair) publicly explained the stupidity employed in the “CDS protection” scheme.

Credit default swaps are not protection, they are nuclear land mines scattered across the land that will go off in succession after the first one is tripped. OR as Mr. Sinclair says, they will print to oblivion and wipe out all paper values through hyperinflation. Either way if you have wealth tied up in metal or mining shares, you will win in the end. Have you ever wondered why there is no such animal as a credit default swap on physical Gold? Could this be because Gold cannot default? Taking a leap forward, when everything else is defaulting (including and especially CDS products), doesn’t it make sense that fear capital will seek that that cannot default? Now that’s simple logic! Regards, Bill H.

Tags: CDS, credit default swap, eur, gold, Greece, greek, PIIGS, sovereign debt, US Treasury

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After a week of credit market histrionics, Monday morning ushers in a moment of calm…

Greek spreads ease; Portugal under pressure – WSJ

WSJ reports European sovereign CDS spreads were generally tighter Monday, with the cost of insuring Greek and Spanish debt against default falling, although Portugal remained volatile with spreads widening. According to CMA DataVision, Greece’s five-year sovereign credit-default swap spreads—a key measure of credit risk—moved back below 4.00 percentage points in early trading Monday to be quoted at 3.97 percentage points. That’s around 0.1 percentage point tighter than Friday’s close of 4.07 percentage points. That means the annual cost of insuring €10 million ($13.7 million) of Greek government debt against default for five years had fallen €10,000 to €397,000. The pressure on Spain also eased slightly, with the country’s CDS spreads tightening around 0.05 percentage point to 1.61 percentage point, according to CMA. Portugal, however, bucked the trend with the cost of insuring the country’s debt against default for five years rising to 2.34 percentage points, against a close Friday of 2.27 percentage points, according to CMA.

However, this calm is most likely the eye, as opposed to the end, of the hurricane. Speculation runs rampant as to the cause of the Greek tragedy…

 Two Hedge Funds One Bank? Is There A Concerted Effort To “Destroy” Greece?

In the pre-math of the Greek collapse, conspiracy theories are swirling about who keeps blowing Greek CDS spreads wider. The answer, so far completely unconfirmed, is that a large US investment bank (we “wonder” just which US investment bank dominates the sovereign CDS market), and two major hedge funds are behind the CDS “attacks” on Greece, Portugal and Spain. According to Jean Quatremer, and his Coulisses de Bruxelles, UE blog, the plan involves blowing spreads to record levels, and is prompted by the hedge funds’ anger at not having been allocated substantial amount of the recent €8 billion GGB issue, in order to lock in profits from their CDS long exposure. Being thus unhedged with a short bias, their alternative is to continue buying protection else risking to mark losses on their extensive CDS short risk exposure. Read more…

While the previous story sounds plausible and is certainly entertaining, a more pressing and definitive issue plagues Greece….

ZeroHedge: The latest escalation in the Greek crisis comes courtesy of Greek daily Banking News which notes that the latest nail in the Greek coffin comes from formerly major Greek players, Deutsche Bank and Unicredit, which over the past 2-3 weeks have ceased accepting Greek collateral and have pulled out of the Greek repo market altogether….

…Yet even as Greece is concerned about collateral eligibility with the ECB in 2011, the sad truth about its precarious and increasingly non-existent collateral exposure will come much earlier than that. Gradually, the country is becoming financially isolated: if the repo market collapses it is certainly game over as no semi-developed country can continue to exist without this core pillar of the shadow economy. In the meantime the vultures keep on circling.

Tags: CDS, credit markets, Greece

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The equity and commodity markets get rocked as Sovereign debt woes resurface.

The burning question: Will the dramatic widening of credit spreads in Sovereign debt, beginning to resemble the CDS collapse of 2008 in the private sector, lead to a revisit of a 2008 type credit crisis and all the fallout associated with it?…

Greece, Portugal woes intensify – WSJ The Wall Street Journal reports the cost of insuring the debt of euro-zone members with large budget deficits against default rose Thursday, dashing hopes that the European Commission’s qualified endorsement of Greece’s budget plan would calm investor fears. Greece, Portugal and Spain were in focus, with their five-year sovereign credit default spreads moving sharply wider. Greece’s five-year sovereign credit default swap spreads were recently at 4.14%, compared with Wednesday’s closing level of 3.97%, according to to CMA DataVision. Portugal’s five-year sovereign CDS spreads were at 2.09 basis points—their widest level ever—after closing Wednesday at 1.96%. Spain’s sovereign CDS spreads widened to 0.12 percentage point to 1.64%. The moves followed news Wednesday that the European Commission had put Greece under more pressure to cut its deficit; that the Portuguese government sold only EUR 300 million of treasury bills at an auction, compared with an indicative offer of EUR 500 millon; and that the Spanish government had raised its budget deficit forecasts for 2010 through 2012. Spanish and Portuguese stock markets fell sharply for the second consecutive day, with banks leading decliners on sovereign debt worries.

…The jury is still out on the above question but market participants are voting today.  As usual, voting like this is detrimental to long term investment decision making.  I would suggest all take a step back relax and reassess after the smoke of today’s battlefield clears. In the meantime, tomorrow’s employment report may shed some light on the absurdity or validity of  today’s flight into the US$. I stress the word, may, because government released employment numbers are notoriously manipulated.  For those who wish to debate this manipulation issue and wish to cast aspersions about conspiracy theorists please view the following story…

Explaining The Government’s 1.8 Million Job Overestimation In Pictures

Last October the BLS announced it would revise historical payrolls lower by 824,000 on February 5 (this Friday’s NFP release). While this number will not impact the actual January NFP report (a loss of nearly one million jobs in a month would probably even take out the persistent SPY algo that has been hugging the bid for the past 10 months), it will be prorated across all months in the 2008-2009 reporting period. The reason for this adjustment has to do with a huge glitch in the birth-death model, which is exactly the same problem that the rating agencies faced when housing prices plummeted: the birth/death model assumes, in the long-run, jobs are created, not destroyed. Any period of excess volatility in the stock market therefore translates into major prior downward revisions to already disclosed payrolls. And while we know what the current revision will be, the scarier prospect is that the next historical adjustment, due out in early 2011, will be even larger, at least 990,000. This means that the government has overrepresented running payroll data by over 1.8 million jobs over the past 20 months. Read More…

Today, world equity markets suffer, the “risk” trade is reduced and scared investors run into treasuries and the US$.  Meanwhile, the underlying fundamentals of the US$ continue to deteriorate….

Zerohedge: It’s Official: Congress Passes Debt Ceiling 231-195; All Republicans, 20 Democrats Vote Against Raise.  Congress Democrats have just signed off on the US hitting 100% debt/GDP.  About 140% if one adds GSE liabilities which also should be on the budget.

Initial Claims 480K vs 455K consensus, prior revised to 472K from 470K

Continuing Claims rise to 4.602 mln from 4.600 mln

NY Fed’s Dudley says “nothing is on automatic pilot” when asked about ending MBS purchases in March, according to AP – Reuters (The expected end of Q.E. in March has been a major factor in the strong US$ theory since Dec.. Now we see, at the 1st sign of trouble, S&P500 down 3%+ today, the Fed begins to backtrack – surprise, surprise.)

Tags: CDS, commodities, credit markets, credit spreads, employment report, equity markets, Fed, Greece, initial jobless claims, sovereign debt

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RCM Comment: The following explanation, while a little esoteric, offers unparalleled insight into a major component of the credit crisis:

Karl Denninger-

I buy a CDS on GE (a few weeks ago) for a couple hundred basis points ($200,000 per $10 million)The SELLER of that CDS protects against possibly having to pay by shorting whatever he can against that short credit position. This means he buys PUTs, he shorts the common, he does whatever he needs to in order to lay off that risk. He does this because if GE goes bankrupt their stock would presumably go to zero; therefore, if he has a potential $10 million exposure on the CDS he will short $10 million face value of the common stock, or buy enough PUTs to pay him $10 million if the stock goes to zero.

The PUT writer (assuming he buys PUTs), being a market-maker, will in turn short the common to lay off the risk as well. This hammers the stock price which then reflects into the pricing models for the CDS, driving them higher.This cycle repeats; unfortunately credit rating models include market cap as one of their inputs, which causes a credit downgrade (eventually.) That in turn adds more pressure. This cycle is repeated until the company is destroyed.

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Tags: CDS, karl deninger

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Comments by Gary Rosenthal:

It has come to our attention that a piece of legislation traveling through Congress contains a little known section that would retroactively render naked Credit Default Swaps(CDS) unenforceable. In other words, with the stroke of a pen Congress would make contracts previously entered into by two willing parties unenforceable. On what legal grounds can Congress do such a thing you ask? Why, on the grounds that all such contracts are “contrary to public policy”.

Ours is not to judge but to recognize meaningful change ahead of the crowd and to properly position our clients. At Rosenthal Capital Management we work 24/7 to uncover little gems like this in a tireless effort to beat the crowd to what may turn out to be a profound money making opportunity. Clients will remember our January 08 letter in which we outlined the destruction that CDS would likely rain on our banking system in the latter half of 2008. And rain it did. In this light we believe this little piece of legislation may well be the most important piece of legislation that Congress will pass concerning the recovery of the global financial system. The financial landscape is littered with the tattered ruins of once great corporations. Since we were fortunate to anticipate and avoid this destruction we feel confident in our ability to identify where to most advantageously place capital for its recovery. We will be happy to share our favorite ideas with you once we have taken positions with our clients.

Tags: CDS, changing rules, Congress, Credit Default Swaps, legislation

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