Was it Greece? Was it a fat finger trade? Was it high frequency trading? Was it quant funds run amok? No one knows for sure, but it was ugly to say the least. I believe the selloff was very, very real and a matter of no one left to buy the dip. We fell within 1.5 points away from all trading being halted and we miraculously reversed course and rebounded some 700 points. Some think it was the Fed or the plunge protection team, I would say that is not farfetched either.
The one thing this was definitely not was a fat finger trade, like originally reported. When trades are entered for equity orders they only use numbers, not letters so the whole “B” versus “M” argument is a bit irrelevant and merely makes a good news story. I believe this whole thing was a perfect storm of a hugely overbought market, yes it is and was overbought, mixed with Greece contagion fears sprinkled with a bit of tight orders by HFT or quant funds and no one left to buy, anything. All liquidity was sucked out of the market and when that happens, well you saw what the results are.
I believe this is only the beginning and things will get much worse. It was also odd to see mining stocks remain in the green along with gold. If this was a trading error these stocks should have tanked as well, but they did not. This tells me that the selloff was more than a bad trade or order imbalance and any other ludicrous reason the media can come up with. It was selling, real live selling from people who know what it is like to lose 40-50% of their money and did not want to repeat that again. Watch fund flows to verify this, I bet we see more bond fund inflows in the very near future.
Even if you were short it was a tough market for you, especially option traders who saw the bid/ask spread widen to levels I have rarely seen before. I am long VIX August and September calls and it took an hour to get pricing back to normal and there was no premium being given for being in the money. It was amazing to see the selloff today as I jokingly went to my wife’s office and said the market is crashing, it was down only 280 at the time, and when I turned it to CNBC to show here it was down 400 and moving fast to the downside. It was breath taking and luckily I was hedged, but the talking heads on TV and perma bulls that you talk to probably told you that hedging was not important and the market now only moves up, it doesn’t, sorry to tell you.
I always find it odd that when the market tank there is talk of manipulation, but if the market goes up for 8 straight weeks that is normal, come on now. I do not believe anything about today was manipulated, except for the massive rebound that “just happened” all of a sudden. No one seems to be really looking for the cause of this, in a serious manner I mean, and are chalking the decline up to a fat finger event, etc. I am a bit more inquisitive though and while I do not have an answer, I have some theories.
I have heard rumors that the overnight repo market in Europe is frozen, I do not know if this is true yet, and if you notice the overnight LIBOR has been creeping up and is close to the 1 and 3 month rate, this might mean the rumor of the repo market is true. On top of that the risk of contagion is extremely real, I wrote about that a week ago in the “Greece Does Matter” post, and the next up is Portugal followed by Spain, Italy and France who owns tons of PIIGS debt, $781B to be exact. After that it is anyone’s guess to who is next, but it is more than likely going to be the UK. What is happening in Europe should be a lesson, in advance, for the US who, ever since Obama has come into office, seems to think the European way of doing things is better than our system, it is not.
The reason for the debt crisis is the massive debt these countries accumulated to give away free health care, massive pensions, paid vacations and other luxury things to their populations. Clearly following the European lead is not a wise move, but that will not stop our politicians who are immune to market downturns because, A) they are all wealthy and B) they are paid very well for what little work they do. We are the next Europe and we will suffer the same issues they have now if we do not get our act together. I am fairly certain that the funding crisis which is a rumor today will be public knowledge in a few days and is one of the main reasons for our selloff today.
If Europe cannot fund itself, other than through the printing press, today will seem like good times moving forward. This is bigger than Greece and it is 10 times bigger than Lehman, we are talking about countries now, not banks. Essentially, we decided to save the banks at our own peril and we are now seeing the results of this action. We should have let them fail, all of them, because we now run the risk of major countries failing. Was Goldman Sachs really worth it? I think not.
What really stood out today was gold, it went up and is on the verge of a tremendous break out. Are gold bugs really that creepy now or is it that we knew something in advance? For those of you wondering, it is the latter. Gold is now the new reserve currency, period. We may suffer from deflation when this funding crisis escalates, but that will quickly turn into inflation, very, very fast. When dollars come into high demand and they are not available we will see this deflation, but remember, we have Helicopter Ben at our disposal. He will literally get into his helicopter and drop dollars all over the country. This will seem like nothing as the dollar stays strong, but that will be very short lived.
After the dollars are dropped inflation will be swift and unlike anything we have seen before. You see, even though Ben flooded the banks with dollars over the last 3 years none of those dollars made it to us, the people who spend them. Instead the banks bought treasuries, also a good option for investors right now, and this time the dollars will bypass the banks and hit us directly, think Bush stimulus instead of green energy stimulus from Obama. Putting that money in our pockets will mean people will spend, that is what Americans do, don’t ask me why. There is where inflation begins and that is only the start. I am not sure what they will do after that, but I am confident it will involve more spending and giving us money, thanks china!
There is where the problems will really begin because there will be a global funding crisis at that point. This means that no one will buy our debt so we can buy iPods. Ben will have to print it, literally print it to get it into our hands. Inflation is a funny thing and very misunderstood, but I assure you that we will not enjoy it, we will at first though if we pay off our personal debts. In the end we will merely be left with tons of worthless paper and sky high prices. What happens next is a mystery to even me and I am a doom and gloom guy, but it is not going to end well. This is why you must own gold, in your possession, because it will get that bad. The worst case scenario is the value of said gold drops, but it will still be better than holding only USD’s. I think the biggest risk is not owning it versus owning it at this point.
Perhaps this was a one day event though, I doubt it, and everything will be fine. Tomorrow we will receive news that the government hired tons of people and private companies hired more temporary workers, we know the number will be good because Obama already scheduled an 11 AM press conference to go over the jobs report. However, those who continue to think temporary jobs and government jobs are a good thing will be very disappointed to learn it is not. I believe that we will open up much lower, working off unclosed sell orders, and we will rebound some tomorrow, who wants to be short into the weekend.
The real show might be next week, depending what happens over the weekend. I am not sure of the near-term outcome or what will happen, I am holding my shorts and VIX calls though, but we did get a glimpse of what will happen longer term today. I do not know about you, but I did not think it looked pretty. As far as believing some trader pushed the wrong button, come on we can do better with our excuses than that.
I have been delinquent in really looking at some of the technicals, mostly because the economic data has just been so bad that I really never thought we would get to this level. Honestly, with the economy still shedding, depending on which numbers you want to look at I prefer the real numbers, but, 263K jobs a month and credit contracting at a record pace and a whole host of other nasty things I could rattle off who would have thought we would be sitting at Dow 10,000?
I think it is safe to assume no one thought we would be at this point, even just a few months ago very, very, few people thought we could see the market at this level. However, now we are right back at the levels where we were right before Hell was unleashed last year and the S&P 500 is about to hit major resistance right in this range and the Dow will have reached its 50% Fibonacci retracement at 10,300, or so. Therefore, we are right at the peak of where the technical equity rebound can take us on its own and the weak dollar is horrible for the US for anything longer than a short-term basis.
I would have to say that after the weak dollar rally and the retracement has hit its peak we will need real substance to sustain this rally and it is simply not there. Without government stimulus and government transfers we have horrible GDP growth. Intel, as I have repeatedly said, was a story about Asia and a weak dollar, not about a US recovery. This is confirmed by Dell saying the US PC demand is still weak, but the pundit dismissed Dell and refused to look under Dell’s press release, so you are left in the dark unless you are doing your own homework.
Clearly multinational firms are going to do well, but how well are they really going to do? Johnson and Johnson missed on the top line and they are a well diversified consumer defensive company. It is my belief that we will see more weak top line revenue growth, except from firms doing business in Asia or have international sales, thanks to Helicopter Ben. I firmly believe that Banks are still bad bets because of the lack of mark-to-market accounting rules. I know, JP Morgan had markup’s today, please, when you can mark securities to fantasy land of course you’re going to have markup’s. What surprised me is they only took $400M in markup’s and not $4B.
With real estate still in the tank, which is reflected in every piece of data shown by the government and even industry shill’s, there is no way banks are making money on their real estate holdings. With commercial real estate defaults up 7 fold YoY to $22B, from $7B last year (the really “bad” year), how in the world are things better? Not to mention junk bond defaults which are projected to hit 14% in the near-term. I simply do not buy a V shaped recovery or even a robust recovery for that matter and this is most evident in the employment numbers, which is a leading indicator for credit recessions.
Retail sales are a joke considering some 8,400 stores were closed over the past 12 months, many of which were the worst performing stores I might add. So, if you dump your losers and keep your winners do you think your sales comps will go up? Hmm, I am pretty sure they will. Of course, was this advertised on any of the media outlets this morning? Nope. Do you really think another 530-550K initial claims report tomorrow is going to be bullish? Either do I, but I am sure this cost cutting method will be embraced by CNBC as gross margins will improve.
As much as I want this to be over, believe me I do since I suffer as much as the next guy, there is no way that it is. Declining income, declining credit, increasing defaults, rising unemployment, declining spending and then throw in shrinking corporate revenue that pretty much proves there is not much of a recovery. I admit the data is getting better, but nowhere near where the talking heads claim we are at for a recovery. Sometimes I sound like a broken record, but a rising stock market is not a reflection of a healthy economy. The other major misconception that needs to be never, ever, mentioned again is how great the market is at forecasting the economy, it is not and never has been, it’s a myth. Otherwise, in 2007 the Dow would have been at 7,000, not 14,000 and there are about 100 other examples.
It has been perhaps the longest year of our lives where we witnessed the absolute collapse of the banking system, to the largest bailouts in history, one of the largest market declines in history, historical political elections, the largest stimulus in the history of our country, and the list actually goes on. There are a lot of history making events that happened over the last year and with those history making events we were promised change and a brighter tomorrow. However, what has really changed? Absolutely nothing, for the most part.
We are expecting the political establishment to address us in the upcoming week to tell us what a great job they have done in ‘saving’ our system and way of life. While they are patting themselves on the back and congratulating each other they know that they have merely postponed the inevitable. No matter how hard they try to hide the facts we know all is not well and we know that there is no way the epic stimulus packaged saved any jobs or created new ones. What our leaders have done is nothing short of criminal as they allowed us to go deeper into debt bringing our long-term liabilities to upwards of $55 trillion dollars.
The Banking System
Next they will tell us how the bailouts, no matter how distasteful, were necessary to preserve the way we live, which is so fatally flawed that defending it is impossible. The sad reality is that the banking system is just as insolvent today as it was last year this time. How could I make such a statement with the market screaming and banks climbing to 52 week highs? Simple, look at the economic facts:
Defaults have increased substantially year-over-year. If defaults broke the bank last year then surely twice the level of defaults must have inflicted horrible damage to the balance sheets of banks. However, mark-to-market is gone and mark-to-fantasyland is here and if they don’t have to mark the assets down or include SIV’s and the other BS then everything is fine. They merely postponed the inevitable problems to a future date.
Unemployment was nowhere near where it is today last year. If you really think we are at 9.7% ‘real’ unemployment then I have a nice CDO to sell you. The reality is we are closer to 17% real, real, unemployment according to how the government used to calculate the unemployment rate. This will lead to more defaults in credit and is the nexus of our problems.
Defaults across the board are sky high and will likely get much worse. Of course, as long as you get to market things to fantasyland does it really matter? No, not until it ultimately blows up on us, which it will.
Everything they told us they were going to do, they did not do. Banks will hold those toxic assets forever because they are worthless. Why participate in the PPIP if you have to sell the assets at market value versus holding onto the assets at fantasyland value? It makes no sense which is why the PPIP was scaled way down because no one wants to participate, except for the FDIC and Federal Reserve which is surely holding a bunch of that garbage.
The Fed is encouraging risk by allowing Goldman and the remaining investment commercial banks to borrow at the discount window and speculate driving earnings through the roof. At the same time the Fed is simply trying to re-inflate the same credit bubble that got us here to begin with. One wonders why anyone would think more debt is the answer to our already overwhelming debt load is the answer.
As far as banks are concerned, I would not touch them, period. Yes, they have the backing of the US government, but the bottom line is you have no idea what their assets are really worth. From a personal point of view I also wonder about their ethics, or lack thereof. When they came to Washington, hat in hand, for their bailout which Congress was ‘pressured’ to give, more than likely to save their largest campaign contributors, they received it, no questions asked. Now that these same banks are ‘healthy’ and allowed to pay back their TARP funds, presumably so they can receive their annual bonuses, while at the same time hiking their banking and overdraft fees from the very people who bailed them out.
The Federal Reserve refuses to tell the American people which banks received any special loans and what was taken in for collateral for those loans, if anything. We already know the banking system is fragile and that banks were in jeopardy of failure so there is little reason to not tell us who got what and how much. Of course, let us not forget that we have had 89 bank failures this year which means that the bailout was, in my opinion, a failure. Not to mention that by the time these failures end, some predict 1,000 bank failures, it is clear that only the Citi, BoA, and Goldman Sachs will be the only survivors left which leads us to an oligarchy banking system with only a very few big players left, who just happen to be the most politically connected I might add.
Even politics have not changed at all, with the exception of grander spending projects. Washington is still polarized and, from my perspective, we went from an inept president, who was utterly clueless, to another inept president who is equally as clueless. Even more disturbing is the fact that Congress is, mostly, the same as it always has been. When looking at the list of Congressmen and Senators you see that very, very, few are new names and the names you recognize have been there for decades. How in the world do you get change when you elect the same people every election? That has always bothered me about politics; you want change so you vote in the 18th term congressmen? We get, at the end of the day, what we deserve.
I realize that speaking against our newly elected messiah is a one way ticket to being called a racist or, somehow, anti-American, but, frankly, nothing has changed. The Patriot Act is still alive and well, lobbyist are ever where, Iraq is still alive and well, Afghanistan is getting worse, spending is even more out of control and we are all still polarized between two parties who only care about campaign contributions. Nothing, and I mean NOTHING, has changed and to think otherwise is simply being delusional. If we now have a transparent government why are all the questions people want to ask always having to be pre-approved? Sorry folks, I am just pointing out the obvious here.
For all intents and purposes the country was blackmailed by the banks to bail them out so they can continue business as usual. It is perhaps the greatest heist in history and did nothing for the American people except tack on trillions of new debt. To make matters worse the industry is at it again coming up with a new securitized product for life settlements, perhaps the sleaziest way to make money. Life settlements basically buy life insurance policies from those who will die soon. They buy the policies for 40% or so of face value, pay the premiums and collect the difference when the person dies, only in America. Goldman Sachs, always ahead of the game, is even starting an index so you can bet on whether people, as a group, will live longer or shorter than expected, I always knew they were vampires, but this is taking it to a new level.
So as we come up on the 1 year anniversary of the Lehman Brothers collapse and we watch the politicians pat themselves on their backs, for doing nothing, we really need to ponder what has changed. As you think about where we were to where we are today you will see that nothing has really changed except for some accounting gimmicks that really never should have changed. Even though the industry and politicians threatened a complete collapse if they were not given money or unless the accounting rules were changed is complete hogwash. Elizabeth Warren who chairs the Congressional Oversight Committee over the EESA is not even convinced that a total collapse would have happened if we just said no to the bailouts.
To think anything has really changed is simply a matter of people not doing their homework or just buying what they are being told by the media. Based on the above, fairly quick, but accurate analysis, it is clear that things are still the same. We simply just postponed everything until a future date and that future could be tomorrow or 10 years from now, who really knows. What I do know is that we must vote out our leaders faster than every 10 or 20 years, when they die of old age in office that is simply just too long.
This week should be fairly busy with market moving data points and bond auctions which will help gauge the economic recovery that we are told is happening now. The biggest data point, in my opinion, to watch is consumer spending which economists expect to grow at 50% of June’s rate. June delivered a ‘strong’ .4% increase in spending and July has a medium estimate of a .2% increase.
I have no idea which way the number will come in as the bar is set fairly low and people are out spending for back to school items. I believe there is a case for either an upside surprise or very dismal results. In general, I believe spending will continue to decline as unemployment appears to be on the rise again, but July may surprise us to the upside as sales and deep discounting of products is attracting consumers. However, discounted products squeeze profit margins and employers are getting more out of their existing workforce, mainly because people need to keep their jobs, but lower profit margins make it impossible to keep people employed.
The Case for an Upside Surprise
According to Bloomberg purchases, excluding automobiles, dropped .6% as of August 13th. They went on to say that retail sales slipped .1% in July which leads me to lean towards an upside surprise in consumer spending. Mostly because of pent up demand, we love to spend money, along with deep discounts and kids just a couple of weeks to get ready for their first day of school are a recipe for a surprise. Frankly, the ingredients are there for people to spend more as they are told the economy is recovering and stocks are up.
Perhaps June’s numbers were so bad because people where saving money for July and August to buy their kids new clothes. If that is the case then we definitely could have a, albeit short-term, surprise to the upside which will surely cause the market to add 100 or so more points to its overbought averages. If we do get an upside surprise I am sure it will be a one-off event as people really are hurting.
The Case for a Downside Surprise
While people are told things are better, they know better because they live in the real world and not in statistics. Unemployment has been creeping up over the last two weeks and many people have lost access to emergency unemployment benefits which means hundreds of thousands of people are absolutely broke. For those who are employed, their falling home value and massive stock market losses from last year make them feel especially poor.
Not to mention, their credit card bills just went up by 2% and they either closed some credit cards or the credit card issuer closed the account for them. Either way, they have less available credit to buy things which will and cash, frankly, is in short supply. However, the kids got to have the new Nike’s or Guess jeans or whatever is cool and obscenely expensive nowadays and who are parents to say no. There is also the likelihood that people blew their money on a new car with the cash for clunkers program. A surprise to the downside would mean that the Dow would probably come off a good 50 points as it, inexplicitly, does not go down now, ever.
The End Result
No one has any idea what the number has in stored for us and I am much more interested in the unemployment numbers that will be out Thursday. Contrary to popular belief, I believe unemployment is a leading indicator for our current problems as this is a credit led recession, unlike other recessions we have had in recent decades. I am sure that the markets will blow off any bad news and continue to trade in the top end of its current range. Frankly, the markets behavior make no sense to me as it is so overbought right now and, regardless of what they say publicly, no one has a real explanation for its rapid and sustained gains.
The really good news is that I have also noticed that the crowds picked up at stores in the last month which means they may be out spending money. However, I am willing to bet the average transaction size is much smaller than it was last year at this time. Either way the numbers come I am sitting out of equities with only 25% exposure, the risk/reward ratio is just not attractive, and am looking for a sharp decline in September or October when liquidity returns to the market. While I could be wrong on the timing, I am not wrong overall as the markets have 4%+ GDP growth and a lot of very, very, good news priced into it right now.
This has been our main concern for some time, in the residential market, as Prime and Jumbo loans are getting ready to reset in the coming years. This, of course, is if they have not reset already because once the LTV, loan-to-value, reaches a certain point the interest rate automatically can reset. I am going off of memory, but I believe the LTV is about 120% or so that causes these loans to reset. We are there and then some.
Here is a disturbing figure, 1 in 8 homeowners are either delinquent or entering the foreclosure process in America, according to the Mortgage Bankers Association, MBA for short. That is pretty scary to say the least and with unemployment initial claims increasing over the last few weeks this number may increase. The good news is that sub-prime loans are being foreclosed on at a lesser rate than before, eventually everyone will be out of their homes and this number will go to zero soon.
However, we are talking about prime loans, these are fixed rate conforming loans with 20% down and good credit. This, my friends, is a major problem and one that we knew was coming for some time now. What this means is much more bad news in the coming months as many of these loans are securitized. However, the intervention of the government will more than likely lessen the impact of the growing problem, but it will drive the deficit higher, so much for Obama cutting his $1.8 trillion dollar deficit last night.
Here is what Jay Brinkmann, MBA’s Chief Economist, has to say:
“The rise in prime fixed-rate foreclosures can largely be attributed to unemployment” he said.
The delinquency rate for mortgage loans on one-to-four-unit residential properties rose to a seasonally adjusted rate of 9.24 percent of all loans outstanding as of the end of the second quarter of 2009, up 12 basis points from 9.12 percent the first quarter of 2009, and up 283 basis points from 6.41 percent one year ago, the MBA said in its National Delinquency Survey.
The delinquency rate breaks the record set last quarter. The records are based on MBA data dating back to 1972.
So, nothing to see here, just move along as I am sure the media will spin this, somehow. I suspect they will point out that the sub-prime loans are not defaulting as bad anymore, they can’t go beyond zero, and completely ignore the prime mortgage problem. However, add this to commercial real estate, which is down 36% year-over-year a much further decline than residential real estate collapse, then the problems just keeps growing. Again, unemployment is the problem and until that turns we will continue to see further deterioration of the credit markets.
To illustrate this point, corporate defaults are through the roof this year, which is why I sold my high yield funds last week. According to the Financial Times corporate bond defaults reached 201 this year with $453B of debt. Compare that to last year where we had 126 defaults with a total of $433B and I think you can see the problem. The current default rate on high yield bonds is 8.58% this year, so far, and is expected to climb to 14.53% in 2010 taking out the prior record of 12.54% defaults in 1991 when junk bonds blew up big time.
As you can see, everything is fine, no problems at all. The markets are sure to continue its steepest market rally ever rising 49% since march, outpacing the 1929-1933 44% rally. I guess the new normal of a high unemployment, revenue-less, earnings-less, and growth-less recovery means that the markets can have the greatest percentage gain ever, in only 5 months, and should continue forever. I am kidding of course, this thing looks ugly and makes me question what is really going on.
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