Monitoring the Precipice

August 31, 2011

As the month of August has ended, on a suspiciously positive note, lets take a look at some recent undertow, and expectations for tomorrow’s PMI data.  The real story looks quite gloomy, particularly since some much economic data has been falling, quickly.

The chart below illustrates T-Bill rates intraday yesterday as the market was continuing a low volume rally post Bernanke’s comments on Friday.  Note that both the 4W and the 3M T-Bill rates posted negative prints.  Hmmm, I don’t know about you but I find it hard to believe that the stock market is such a good value when so many people are willing to lose 1 bps to own a US T-Bill for a month or two.  Historically this happens just before we go off a cliff.

Bloomberg BTMM 8-30-11 US Money Market Rates

Note the chart below offers a general perspective on sovereign currency risks as measured by the Option Adjusted Spread of the G-8 currencies.  Story seems to be short the Euro and go long everything else.  Guess we can confirm where this disaster is about to emanate from.  Makes sense if the European banks are in as bad shape as many have been reporting.  Funny though, I don’t recall a time where banks distinguished their risks by borders.  I don’t see how the European banking system would not take down the US.

Bloomberg LOIS Currency 8-31-11

And then there is the widely anticipate Manufacturing PMI number due tomorrow.  This will be the first data point to illustrate how much the tail has wagged the dog, and how much real damage the August roller coaster did to the US economy.  I’m also surmising that Bernanke in his infinite wisdom chose to punt to the September meeting to avoid taking action and then have the data come in so anemic.  Note that the Consensus estimate will mean that the economy actually CONTRACTED in August. Any number below 50 represents a contraction.  Also interesting to note that only a handful of economists think we will print a number above 50.  Certainly at least worth a hedge, ay?  Might mean the recession has already begun.  Crazy stuff.

Bloomberg NAPMPMI Estimates Manufacturing PMI 8-31-11

Note that the last time this data came in with estimates this low we were watching the aftermath of Lehman’s failure.

Bloomberg NAPMPMI Estimates and Actual Manufacturing PMI 8-29-11

While the Manufacturing PMI is not as important as its half-brother the Non Manufacturing PMI due next week, it has often been a leading indicator preceding both economic contractions and expansions.  This chart illustrates periods when the two data points were at their widest.  Make your own judgements.  Orange line is tomorrows Manufacturing PMI series.  The white line is next week’s Non-Manufacturing PMI series.  The crossover we are seeing is indicative of past recessions. Since the market is up about 10% from its recent lows, and the DOW is about even to positive for the year, for the market to price a recession in, we need to drop at least about 20%.  And that would be a mild one.  September will be a very long month on Wall Street.  I think we will know better next year how it all has affected Main Street.

Bloomberg NAPMPMI vs NAPMNMI Actual Manufacturing & Non-Manufacturing PMI 8-29-11

No matter how pricy puts look, they are cheap if you are on a precipice.

Leuchtkafer Letter to IOSCO on HFT

August 25, 2011

A rather technical but informative deep dive on HFT.

Leuchtkafer Letter to IOSCO on HFT

_Joseph Saluzzi ( and Sal L. Arnuk (sarnuk-at- ThemisTrading… Read more

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Bond Market is Pricing a Recession, 10-Year Treasury Breaks 2% Yield Intraday

August 18, 2011

Two charts below show a rather alarming and decisive signal from the bond market.  The signal is the stock market is about to crash.  Today the 10-Year Treasury Yield broke 2%.  This follows a 5-Year note below 1% and the 1-Year note below 20 basis points.  Bond holders are not being rewarded much in nominal terms, which generally indicates that deflation is on its way.  The only thing I cannot reconcile is the recent strong performance in TIPs, or Treasury Inflation Protected Securities.  That said the bond market is pricing in a recession, and last time this happened, it took about 6 months for the equity markets to bottom.  Since we are going into an election year next year, which is traditionally bad for markets, and since the world is totally upside down anyway, odds of this being a dramatically terrible selloff in equities is quite high.

A saving grace could be how cheap it is to short US Treasuries.  One would think the carry trade would support asset prices, but we are not seeing that.  Although anecdotally one could guess the strength in the 10-Year and the 30-Year is being supported by a long-short treasury trade. where traders are short the front of the curve and long the mid and long ends, picking up a fairly risk free spread.  When Ben Bernanke committed to keeping short term rates low for two years, he effectively gave carte blanche for the market to arb the spread between the short and and the long end.  I suppose when risk assets get cheap enough, we will see a dramatic selloff on the long bond, as people run back into equity and credit risk.

There may be no better time in our lifetimes to refinance or take out a mortgage!

Bloomberg: 10-Year Treasury Yields vs S&P 500 Index, August 18, 2011

Bloomberg: 10-Year Treasury Intraday Yields, August 18, 2011

Death Crosses?

August 17, 2011

Many pundits have been in “buying” mode, flapping on about looking for the right time to buy.  I am beginning to wonder if anyone has studied to correlation between market performance and television pundits commentaries.  All this talk of equities being cheap, no double dip, and yada, yada, yada, but I have not heard anyone mention that one of the single worst technical indicators is rearing its ugly head.

Take a look at four major index charts below, each with moving averages.  A death cross in technical talk is when a shorter moving average line crosses a longer moving average line.  The most common comparison are the 50 and 200 day moving averages.  When the 50 day moving average falls below the 200 day, it typically hints that a bull market is coming to an end, as the buyers of equities no longer wish to pay ever higher prices for the stocks in the index.  In the charts below the green line is the 50 day SMA (simple moving average), and the yellow line is the 200 day.  The purple line is the 10 day which is not as relevant here.

Looks like the S&P and the Nasdaq have already printed a “death cross”.  The Dow Transports are just about to as well.  The only index not “confirming” a major fall is imminent is the Dow.  I don’t know man, I’m not totally religious on this crap, but 3/4 is fairly hard to ignore.  My advice is to read that last post, the white paper about tail risk hedging.  This looks like its about to get really ugly soon.

*Note, however, this signal showed up last summer, during the first European Sovereign crisis, and the “death cross” that occurred did not confirm an end to the bull market.  One could easily argue, however, that today the world and world markets are on far softer footing than they were a year ago.  I would heed these signs.

Bloomberg Chart: S&P 500 Index with Moving Averages "Death Cross", August 17, 2011

Bloomberg Chart: Nasdaq Index with Moving Averages "Death Cross", August 17, 2011

Bloomberg Chart: Dow Jones Transportation Index with Moving Averages "Death Cross", August 17, 2011

Bloomberg Chart: Dow Jones Industrial Index with Moving Averages "Death Cross", August 17, 2011

In other news, the TED Spread is finally starting to widen.  The TED spread is generally accepted as one measure of risk in the banking system. I imagine this may continue as we approach the end of the short selling ban in Europe in a week or so.  My guess is when markets are free to be shorted, banks may rethink their willingness to take overnight risk with one another.

Bloomberg Chart: TED1 - 1-Month TED Spread as of August 17, 2011

Bloomberg Chart: TED1 - 3-Month TED Spread as of August 17, 2011

Updates and Omens

August 15, 2011

Update on Bank Risk: Looks like Bank CDS narrowed today, however the 3 month TED spread has broken its recent resistance.  Mixed signal, but I’d lean on the widening TED as the dominant indicator.

Bloomberg: BANK - Bank CDS Spreads as of August 15, 2011 (1 of 2)

Bloomberg: BANK - Bank CDS Spreads as of August 15, 2011 (2 of 2)

Bloomberg: TED3 - TED Spread, 3-Month Libor, August 15, 2011

All this on a day where the 3-month T-Bill closed yielding zero percent.  Last time any T-Bills yielded zero percent was just before the most recent bout of stock market bi polar disorder.

Bloomberg: BTMM - Money Market Rates, August 15, 2011

Bloomberg: 3-Month T-Bill Market Rates, August 15, 2011

Oh, and did anyone catch the spazdic Repo rate print at the time of the debt ceiling issue?  Showing the overnight and the 1-week Repo rates below, but all tenors had the same event.

Bloomberg: Overnight Repo Rates, August 15, 2011

Bloomberg: 1-Week Repo Rates, August 15, 2011

In other news, anyone notice that the US is back to the number two safest sovereign credit.  The rest of the world must be really upside down if we are the most sober drunk people in the room.  Note, however, that the party probably won’t last long as the cost of insuring the US’s debt has been steadily rising since it fell post Lehman.

Bloomberg: SOVR - Sovereign CDS Spreads, August 15, 2011 (1 of 3)

Bloomberg: SOVR - Sovereign CDS Spreads, August 15, 2011 (2 of 3)

Bloomberg: SOVR - Sovereign CDS Spreads, August 15, 2011 (3 of 3)

Bloomberg: US 5-Year CDS Rates, August 15, 2011

Lastly, it occurred to me to spend a few moments looking at the US Dollar Index, DXY.  I wanted to see if recent stock market performance was in part attributable the the known current inverse relationship to the USD.  This quickly inspired me to take a look back at the DXY chart, as far as I could go.  A few things stood out.  The last two times the dollar rallied considerably were 1. during the late 1990’s when the US began actually running a budget surplus, and rates were at the top of the cycle. and 2. at the peak of the crisis in 2008/2009 after Lehman’s collapse and liquidity crisis.  Additionally, the dollar rallied last year at the onset of the Eurozone Debt Crisis 1.0.

Bloomberg: DXY US Dollar Index 1995-2011, August 15, 2011

Bloomberg: DXY US Dollar Index 1967-2011, August 15, 2011

It is of interest to note that the most recent bout of risk avoidance did not dent the prevailing dollar weakness, and has not caused a dollar rally, like in 2010 or 2008.  Despite the flows into Treasury Bills over the last few weeks, historic low rates have managed to help keep the dollar massively weak, relative to other global currencies.

Additionally, something else stood out.  The dollar seems to have maintained three prior strength/weakness cycles, peaking in 1969, 1985, and 2001 respectively as illustrated in the chart above.  The rhythm to this cycle has been about 15.5 years.  If this cycle continues, we would be due for a major dollar rally circa late 2016.  It is of interest to note is that the policy decisions in the US best suited to reign in our debt problem today, cost cutting or tax increases (or both), will likely have strong dollar consequences.  What is also of interest to note is that 2016 will bookend the next election cycle.

Bloomberg: DXY US Dollar Index vs S&P 500 Price Performance 1997-2011, August 15, 2011

Lastly, the chart above illustrates the US Dollar Index plotted versus the S&P 500 over the last 14 years.  The chart represents a spread between the DXY and the SPX.  In 2002 the market bottomed into a weakening dollar, having come off of strength in the late 1990’s due to sound balance sheet management under Clinton.  The 2008 market bottomed into a strengthening dollar (but relatively weaker than in 2002), due to prolific balance sheet expansion under George Bush to fight two wars and to launch TARP. This cycle has been a 7 year cycle.  (I did not post a longer series because the nominal price of the S&P obfuscates the spread data with the S&P at lower prices, and I was not sure how to create a log normal series.)  Nonetheless, the 7 year cycle also  culminates in the 2016 time frame, if this were to repeat again.  If these cycles collide, we could have a fairly draconian market plunge, with massive dollar strength weakening the economy at precisely the time the next major recession hits.

There may be a reason the 5-year treasury is yielding 1% these days.  Its probably because we are headed for massive deflation.

Keep an Eye on Bank Risk

August 10, 2011

I’ve been watching the systemic risk rising in the banking sector as denoted by the 5 year CDS prices in Bloomberg.  At first the elevations were slow and steady, and somewhat understandable in the wake of the European Crisis and the looming Debt Ceiling decision.  However, since last Friday, something unnerving is happening.  The cost of credit insurance for major money center banks is beginning to spike.  The good news is in most cases the spike is well below the fear levels promoted by the failure of Lehman Brothers.  However there is one US Bank that seems to be on the precipice of something much more dramatic than its peers.  Consider the most recent CDS price rankings from Bloomberg today, and take a look at the charts of some of the samples below.  I chose the 5 year charts to put the recent risk in perspective.  To be clear, I have not left of the others to warp the perspective, its just that only one really stands out at this moment in time, and it has fallen to the latter part of the list below.

We all know that one bank cannot be stressed and not create more stress for other banks.  This is certainly something to keep an eye on.  And financials are certainly one area to step over if you are picking through weeds for bargains.

BANK from Bloomberg 8.9.11

BANK (Cont'd) from Bloomberg 8.9.11

BANK BAC CDS (5-Year) from Bloomberg 8.9.11

BANK JPM CDS (5-Year) from Bloomberg 8.9.11

BANK WFC CDS (5-Year) from Bloomberg 8.9.11

BANK UBS CDS (5-Year) from Bloomberg 8.9.11

Negative 1 Month Treasury Yields Today (And So Much More)

August 4, 2011

Today’s equity market selloff and concurrent treasury rally were dramatic and unexpected by many.  The strain on the system was so dramatic today that the 1 month Treasury Bill, often used as a cash substitute actually sustained a negative yield for a moment, and was captured here in the Bloomberg screen below next to the “4W” in the US T-BILL YIELD/PRICE box.  Surprisingly, among all of the FX surprises, the Canadian dollar is once again worth less than the US dollar.

Bloomberg BTMM

Money Market Rates and FX from Bloomberg (August 4, 2011)

It’s worthwhile to note that despite the presumed stress in the markets, and despite the odd print in the TED spread in the days before the debt ceiling vote when short term treasuries actually sold off dramatically, today the TED spread barely budged.  As a common indicator of risk in the banking system, this is a good print, at least for the moment, and a sobering data point to suggest that we are not headed into a repeat of 2008, at least at this point.

Bloomberg TED1

1 Month TED Spread from Bloomberg (August 4, 2011)

Looking at credit default swap prices for major banks, its interesting to note that while systemic risk has risen steadily since the 2011 Euro debt crisis reemerged, the too big to succeed/too big to fail banks don’t seem to be bifurcating like they did in 2008 when Bear Sterns and Lehman Brothers were singled out.

Bloomberg BANK

Bank Credit Default Swaps for Safest Issuers from Bloomberg (August 4, 2011)

Lastly, despite all the attention on a US default and downgrade, today the United States was ranked the third safest countryas measured by 5 year credit default swap prices.  This is the highest rank I’ve seen the US in in a long time.

Bloomberg SOVR

Sovereign Credit Default Swaps for Safest Countries from Bloomberg (August 4, 2011)

I read late in the day that there were some technical issues in the treasury market, and these may persist for a time as the Fed essentially wound down some of the liquidity it had been providing in order to avoid going into default if Capitol Hill had not gotten the debt ceiling raised.  This apparently may have led to a massive shortage in t-bills, and also spilled over into demand for other short term treasuries including 2 year bonds which hit an all time record low yield.

It’s hard to tell what is going on now.  Just a week ago short term treasuries were selling off precipitously on fear that the US would default.  Today the exact and extreme opposite happened as more fears were raised that the European debt crisis is spreading, and that leadership in Europe is divided on the proper solutions.  Sometimes separating the noise from the fact helps make sense.  Sometimes the noise creates emotions that lead to new facts.  The proverbial tail wagging the dog.

It certainly remains to be seen what policy responses come out of this, how long such decisions take and how markets react from here.  One thing is for certain, the more obvious the trade or direction is the largest group of people, the more likely the exact opposite trade will be the best way to make money.