Market Found its Mojo

Well I was half right yesterday I guess (or half wrong, if you prefer, but given my oft bearish disposition, I’m going for the optimist’s view on this one). The GDP number came in worse, it was due to a bigger inventory draw down and the market looked through that (Box tick for me). The consumption side was a positive however and that provided a fillip to the market and it certainly got off the fence this time (I lose points on this one). The Fed comments about some signs of recovery certainly helped too and the market feels far surer of things today than it did yesterday.
Usual stuff happened as risk assets rally, bonds sell off. Asia helped too as Japan comes in with a MoM Industrial Production number of 1.6% vs expectations of 0.8% and a previous number of -9.4%. We’re back up at pre crisis levels!!



That’s only the MoM % change however; if we look at the actual index, let’s hold off on the uber- enthusiasm for the time being.

While I’m bearish overall, you can’t ignore the price action of the market and I’ve been pretty happy to advocate standing on the sidelines the last couple of months. This is not uncommon amongst the PMs I speak to, on average I would say they are 50% gross invested. I do think we’ll see a great selling opportunity in equities, I just don’t believe it is yet and as I always find it hard to push a trade I don’t believe in (because if it goes against you, where’s your conviction?), I’m not prepared to jump on board the rally train. As I’ve said before, I just think the market is pricing in too much of a recovery. Ignoring bad news is one thing but rallying 5% off the back of it is another. Just as the market couldn’t bounce to save its life back in Feb., it can't go down at the moment. I think we need to be somewhere in between those two with a more tempered view of the world.

YAWNARAMA

This market can’t make up its mind. In fact I’m not sure it even has a mind at the moment. It’s sitting on the fence and just when you think it’s going to move one way or another; it does a swift about turn. Yesterday the BAC & C news took us lower but the consumer confidence number buoyed us in the afternoon. I’m always pretty sceptical of confidence surveys, the sample is usually small (in the Consumer Confidence Survey, it is 5,000 households. That’s 10 times the size of the U of Mich confidence survey sample…but still small) and who really pays attention to these forms when you’re filling them out? I get that such things can be self perpetuating and if consumer confidence is high, they may spend more etc, but it’s a pretty fickle number and next month if the markets take a lurch down, I’m sure people will be less upbeat. Anyway, enough rambling, the market paid attention to the number yesterday, up we went and that’s what counts.

With Q1 GDP later today we may get some movement but I’m not holding my breath. -4.7% is the consensus estimate. Will anything happen either way? I’m not sure the momentum is there to push much higher and if we get a surprise on the downside, and it’s due to continued inventory destocking and not weaker sales, I imagine the market will look through that and it will be a bit of a nothing done. Ditto the FOMC meeting tonight, the ammo there is spent.

Bloomberg is talking about at least 6 banks having to raise more capital…and despite it being the most read story on Bloomberg, the market is apathetic in its response. Biggest print of the day to be the lunch order...

BAC and C Need More Money?? But Didn't Ken Lewis say...

The markets are still struggling for direction. As I mentioned last week, the earnings just haven’t provided that bit of uumph we were hoping for. While we’re down today and things such as the misses from US Steel, Daimler certainly haven’t helped the tape. The real reason in my view is the worry surrounding BAC and C having to raise more capital. The Journal has the leak and it’s not pretty, especially when you consider this is as a result of the Stress Tests which as we know, weren’t very stressful. Plug in some realistic scenarios and the numbers would become increasingly sobering. Now while Ken Lewis did again and again state that BoA would not need to a capital increase, surely not even the most trusting of souls could have believed this…right? Still, there is a disconnect between the market and reality at the moment, so if Ken Lewis says so, why not run with it. You’ll get burned eventually (soon), but in the interim, you can make some money.

Both Macro Man and Zero Hedge talk today about FX vol and in particular Yen Vol. Now JPY has rallied which is usually a surefire risk aversion sign, yet vols haven’t really rallied. In fact all risk assets have sold off, the resource currencies, beta equities are down and the defensives have a bid as do bonds, but there hasn’t been much of a move in the VIX. Zero Hedge recommends buying FX vol and I don’t disagree (as it’s simply a risk proxy and I am bearish) but I would say this about vols in general; I don’t think we’re going to get back to anywhere near the lofty levels we had in Oct/Nov 08. In February and early March, when the market was falling out of bed, VIX didn’t get much above 50. During that period, while I thought we were due a rally (nowhere near this sustained admittedly), the signs of capitulation that you would ordinarily have looked for, i.e. elevated vols, just weren’t there. So while I think the market goes lower, and may well break the previous lows, I don’t expect vols to rally anywhere near the previous highs. For one I think the market is long downside protection but also the shock factor has been removed from the market. We know what we’re dealing with now (if not yet quite how to deal with it) and the issues that appear are reoccurring ones, not new themes so the panic levels aren’t as high. So while I’d be long vol here, I’d put on a call spread and finance it by selling some say, 50 strikes. I’m not an options guy by trade so if someone has more insight, I’d love to hear it. That’s just my thoughts.

They Tried to Make Me Go to Rehab but I said "No, No, No"

“Hello, my name is ABC Bank and I’m undercapitalised” Cue clapping and welcoming support from other Banks. It is often said in order to overcome your problems, you first have to admit you have one. The SCAP methodology released on Friday was another great example of pretending things are better than they are. Now, it’s not hard to be cynical about the White Paper, but it is hard not to be. There are plenty of things you can poke holes at…my personal favs include

- Each participating firm was instructed to project potential losses on its loan, investment, and trading securities portfolios etc. The report goes on in the same vein. The institutions we asked to provide etc. Erm, so the Banks are providing the estimates and the Fed and co are taking them at their word. How many times in the last 18 months have we heard banks come out and say they were well capitalised. This is definitely the last time we need to raise capital. We don’t need to lower our marks, there’ll be a H2 recovery and we’ll get out of these positions.

- I think most would agree that the Adverse scenario could/should well have been the base case scenario.

- The loan portfolios are valued at amortized cost instead of mark to market…as a result “The economic value of loans in the accrual book is reduced through the loan loss reserving process when repayment becomes doubtful, but is not reduced for fluctuations in market prices” No prizes for guessing which holds the greater value.


- The baseline scenario assumes no further losses above current marks!

One thing that also struck me was in the preamble on the website where they say over 150 people were involved and that the process was extensive. So we’re talking circa 8 people per bank. The banks submitted their projections in early March and we’re getting the results May 4th. Now as I’ve said before, I’m not an accountant, but 150 people “scrutinising” 19 banks, which are mired in toxic assets, does not seem that extensive to me. In order to follow up on my hunch, I did some primary research…and asked an accountant friend of mine*. Now if you consider, to conduct an audit on a global bank takes at least 1000 people multiple months. 8 people over two months seems like they may be short of some manpower. Now you wouldn't necessarily have to have an audit when conducting a stress test - the key link to the audit is that the opening balance sheet is accurate (which is clearly questionable for these banks). Models are simplified so they can be reviewed and understood quickly so you would not need as many people as in an audit and those you do have would be far more experienced. In any case, the fruits of my research estimate it would take 40-50 people two months to stress test a large global bank.

It was surprising to me (perhaps I should stop being surprised by this sort of stuff) the market reaction to the White Paper. A bit of a sell off and then a rally back. The cover ups continue and so does the rally.

And another thing…I was also pretty surprised (note to self, see above paragraph) by the reaction of the credit card companies post Amex figures last week. They pretty clearly showed ongoing deterioration. Charge off rates jumped to 8.5% and the outlook was for another 2-2.5% increase in Q2. Looking back, we’ve had 4.3% Q108, 5.3% Q2, 5.9% Q3 and 6.75% Q4. It showed that card spending has fallen heavily and the beat was of low quality. There was a big gain from Mastercard and Visa settlements and the core US card services business actually came in at a loss of $25m vs $523m last year. The market didn’t seem to care though, there was a headline beat and the stock bounced 20%.

So in summary…a hocus pocus stress test methodology and the market goes up. Poor numbers and macro extrapolation from AXP, COF etc figures and the market goes up. What does it take to get the market down…as bad case of flu. Bizarre…

*This accountant does not work for Friehling & Horowitz

CT Scan: Results Unclear

I'm in Connecticut this week. Trying to look at and make sense of the markets is tough at the best of times but the combination of the trip over and now getting in midway through the European session has thrown me a little.

Add into the mix a few strange moves and the whole thing becomes more nebulous. Look at oil for example, now admittedly it had come off fromthe $55 level with the equity market slide. But there were big builds across the board yesterday in the DOE data and it's bounced back. You can probably rationalize it with the $ sell off and equity rally but I guess my point is this stuff is getting harder to call.

CAD was unch to small better while the other resource currencies, AUD & NZD rally. Now Canadian Leading Indicators posted a poor number yesterday but in thelast couple of quarters, the main driver for this currencies has reallybeen risk appetite with economic data taking a back seat.

The earnings season has not yet given us the direction we hoped for. As of this morn, 134 companies in the S+P have reported with 90 beating expectations at the EPS level. You have to factor in the marketreticence to believe the beats from the financials and most of the 90that beat have come through with a 0-20% beat. Actual EPS so far for Q1is c $12, extrapolate this and it gives you $48 for the year (estimates are around the $40 level I believe) which puts the market on c18x. I think most would agree however that earnings are likely to get worsebefore they get better so extrapolate at your peril! I continue to believe the results of the Stress Test will be key to the market beating a discernable path, one way or the other.

VW/Porsche is all over the press again. I can't bring myself to care to much about this because frankly, as was proved last year, there are people who know what is going on in this one (very few of them) andpeople who don't (most of the Investment community). Being in the latter camp, I have zero edge and prefer not to play a rigged game so my care factor is pretty close to zero.

Lastly, the UK budget was a bit of a nothing done from what I've seen. I agree with Willem Buiter's assessment of increasing the top rate ofincome tax to 50% as a populist measure which will raise minimal marginal revenue...unless you're in the tax avoidance business. Maybe today, the cold callers at Welbeck Solutions will actually have someonetake their calls!

GadZEWks!

The markets were roiled yesterday…light on volume and light on news. Worry ahead of a big earnings week and Hal Turner’s supposedly leaked Stress Test results conspired to produce the worst day for the SPX in 7 weeks. I think it was instructive how hard risk assets took a pasting on the back of a specious rumour from a spurious source. Not to say the story is wrong but the references to non Stress Test banks (e.g. HSBC) certainly called into question the veracity of the post.

However, I think the moves was saw served to tell us that people are worried up here at these lofty levels. There was certainly a feeling of, well this rumour may not be right, but there’s a good chance it’s not too far off the mark…in which case, a market dirtnap is around the corner.

A lot of noise is being made about the rising credit card delinquencies reported by BAC. This should be no surprise and I mentioned this last week post the AMEX figs and the Capital One charge off rate. The credit card issue is not going away anytime soon and will only worsen as the crisis continues to make its way from Wall St to Main St, as will cars loans, student loans etc.

The government bailout programs make the news again today ahead of TARP Tzar Barofsky’s report. NYT has got the report it seems and reports it’s going to criticise TARP and say PPIP is open to fraud and needs taxpayer safeguards before it is initiated.

In other news, the ZEW posted its first +ve number in almost 2 years (July 07 to be precise). More green shoots!! The market however, feels less inclined this week to focus on the good (or less bad) news than it has been for the last 6.

I’m in the US Weds-Fri so thoughts could be less daily and more if I get the chance.

Slow News Day

There’s not much going on this morning. Many market participants seem to suffering the effects of an indulgent weekend promted by the strong performance of the weather. Even Euronext slept through its alarm this morning. Markets, having rallied in the US post the European close have drifted back with a sell off in general in risk assets.

GBP is faring not so well today either. This is annoying for me. I travel Stateside on Wednesday and when cable was trading at 1.50 last week I was in better cheer. We await the budget later this week and Darling has admitted that the Govt won’t recoup all their bailout money. No surprise there but it has knocked the pound somewhat. I guess the Darling comments and the $ safe haven status in this market fade we’re seeing are combining to accentuate this move…and make my trip that bit more expensive. The Euro’s not faring much better against the greenback amidst worry of ECB discord but EURGBP is rallying hard.

We have some home sales numbers later on the week, and durable goods on Friday but outside of those, the week should be defined by earnings with a quarter of companies in the S&P 500 reporting this week. Personally, I think the highlight will be the unveiling of the Lions squad tomorrow although admittedly, its impact on the market will be negligible to nil.

I really didn’t come across anything that interesting or thought provoking over the weekend or this morning. Mind you, I was a little preoccupied. I think the market pause is due and deserves to reverse but no change there. I did find one article on Zero Hedge listed as must read. It’s probably done the rounds already but it does highlight the erm, questionable nature of the “beats” from the banks last week.

Here’s hoping for more activity in the coming days.

GAMMA!

I’m going to use the word GAMMA instead of Second Derivative. I think it makes me sound smarter and certainly more conceited. Second Derivative is just so hackneyed these days. It is the catch cry of the crowd. I haven’t had a taxi driver say it to me yet, but it will happen soon for sure…and when it does, I’m going to bring out the GAMMA dog just to show him who the Daddy is. So the GAMMA of the Jobless claims number yesterday continued to improve. The Continuing claims number however was pretty stinky, taking the US over the 6m mark.
The housing numbers were poor too and having seemingly plateaued somewhat in the previous weeks, questions must now be raised about the future GAMMA of these numbers.
In much the same vein as the last few days the market couldn’t really make up its mind, yo-yoing about with a last hour rally for the second day running only to give it back overnight.

I saw an interview on Bloomberg with David Tice, Chief Strategist for Bear markets at Federated Investors. It may not come as the greatest surprise in the world to discover that he is…bearish! The S&P could trade down to 325 he warned. Now I don’t have an exact figure for the S&P earnings estimate, but it was about $40 the last time I looked so I suspect it’s around $35 now (Earnings estimates have been folding faster than Superman on laundry day for the past 18 months).
So at $35, the SPX is on 25x, at $40, its on 21x. Given the average is 15x, we’re in a recession so it should probably trade closer to 10x and earnings estimates will continue to come down, a 325 number doesn’t sound wholly implausible, albeit admittedly on a back of the envelope calculation.

I read an interesting piece on the IRA today I won’t go into the details of it because well, I’m not an accountant, so couldn’t really even if I wanted to but the broad brushstrokes are this: the Q4 FDIC banking report understates the health of the banking system due to an accounting process which doesn’t include the operating losses from WaMu for Q3 and for Wachovia and NatCity for most of Q4. If these were included, IRA reckon instead of the Industry post a $10bn profit, it would show at least a $10bn loss.

Now you can call me a sceptic for not taking what the banks/govt/management say at face value but a guy I used to work with often said, and I think this is apposite…”Just cos your paranoid, doesn’t mean they ain’t watchin’ ya” Bon weekend all. SP

Can We Please Just Have Some Direction?

Having treaded water for most of yesterday, the market took inspiration from the AMEX figures and climbed 2% in the last hour of trading. Unsurprisingly financials led the way, up 5.5%. We’re fallen a bit since and are now back to the levels of where we went home yesterday. This market is really struggling to move one way or the other.

While AMEX was up 12%, it is interesting to note the write off rate rose to 8.8 percent in March from 8.6 percent in February and 8.1 percent in January. Some of the AMEX losses were offset however by the sale of previously written off loans to a third party. The number coming out of Capital One was particularly ugly. The February annualized rate of 8.06% jumped by over 1% month-over-month to 9.33%. This is a worrying trend not just for the individual companies but also for the credit card securitisation market. Given that credit card delinquencies tend to rise with the unemployment rate, which has further to rise, we can expect these numbers to maintain their bearing.

Elsewhere, China fell for the first time in six days after posting a Q1 GDP figure of 6.1% vs consensus of 6.2%, the weakest in almost a decade. Also, China is no longer a currency manipulator. Fact. A backtrack from the Administration on this one. Given everything that’s going on, it’s probably not the time to be accusatory and pushing through exchange rate reform. In real terms, and this seems to have been important in the decision, the RMB has appreciated while many other emerging currencies have depreciated.

So where to for the market? We have JPM reporting today and Citi and GE out tomorrow. These, along with the housing starts and jobless claims will be the highlights and potentially give us some much needed direction.

One interesting thing I did read this am was from DB’s Jim Reid who noted the similarities in equity markets now to those seen at like points in 2007 and 2008. In 2007 the S&P 500 bottomed out on March 2nd and rallied 13% into mid July before approaching these lows again a month later. In 2008 the Q1 low was on March 10th before a 12% rally into mid May, which was then followed by a subsequent fall of -37% into year-end. In 2009 the low (so far) was seen on March 9th before the current 26% rally. So these three rallies started from a similar date, and although the percentage rise has already been far higher in 2009 the actual increases in points have been similar. In 2007 it was a 180 point rally to 1553, in 2008 a 212 point rally to 1427 and so far in 2009, a 175 point rally to 852. When you get to these lower levels the percentage swings are probably going to be higher. So March has been the start of a 2-4 month rally over the last two years without it impacting the longer-term trend. So will it be a history repeating sell in May and go away or are we now breaking the cycle? I’m going with the former. SP

About Turn

So yesterday, no sooner had I sent a piece out saying that the path of least resistance appeared upwards, when out came some worse economic numbers and down we went. Given that the markets were being led by financials and the basics, a lower PPI saw the inflation trade sectors sell off and GS put paid to the financials rally. When the smartest guys in the room try to sell you something; caveat emptor. Risk assets in general sell off although the safe haven of gold failed to catch a bid, the lower PPI winning over its qualities as a place to hide.

So the question of the sustainability of this rally is yet again posed. The market sold off a couple of percent but nothing major (and since writing has now rallied back). A few things I’ve seen read over the past days have started to get me very worried about the outlook for the market. I, like many/most believe this is a bear market rally and it won’t be long before we head back south. Even if the rate of deterioration of the economic data is slowing (although things don’t go down in a straight line forever, bounces do occur, often of the moribund feline variety), this isn’t going to be a V shaped recession, it will be U or L shaped. So we could stabilise but not recover, so to speak. The peak earnings of yesteryear become confined to history and a not so belle epoch emerges where the standard is lower earnings, not buoyed by excess leverage. However, the longer term view is just that, and much can happen contra to that before it pans out. It was difficult to see perhaps, what would be the catalyst that would bring the market back to earth. Q1 earnings perhaps? Very possibly. One thing that sticks out for me as a real banana skin for the market, is the stress test results.

This is all over the press today and we’re seeing an about turn from the Administration on it. The WSJ and NYT are today talking about some of the results of the Stress Tests being made public. This could be down to GS forcing their hand by raising capital to pay off the TARP money. The logic being this, if you are strong enough, you tap the market and pay off your TARP money, if you’re not, you don’t. So the banks that aren’t raising money must be in a very bad position, they get smacked and this causes fear and uncertainty in the markets. There was talk before of giving some aggregated information on the stress test results but that was never going to cut the mustard as the outliers would skew the results. We don’t know what or how much is going to be disclosed but according to these articles, it is something which has been debated by the regulatory agencies for a number of weeks now. If the news was good, I can’t imagine it would take so long to work out what to say. Just as a potential example, KBW, expects Wells Fargo (which posted pretty good numbers, right?) to show $120 billion in "stress test losses", meaning losses under the assumption of a supposed worst case of recession through the first quarter of 2010 and unemployment reaching 12%. To put it in perspective, as of year end, Wells had $1.3 trillion of assets and shareholders equity of $99 billion. So, should these losses materialize, all is not Wells, it is insolvent.

I think it’s interesting to note too that GS is not planning to pay back (any time soon) the $28bn it borrowed from the credit markets and which is backed by the Federal Govt. Funnily enough, this didn’t come with conditions attached capping executive pay.