Oct 2, 2016 October Tremors
Pitchforks, torches and sorcery
From a friend, “I’ll tell you what…anybody who is successfully calling the turns in this equity market over the past few months… is a witch, and should be burned at the stake.”
So, logically….
Sir Bedevere – “What ALSO floats in water? ….. A Duck! Exactly! So, logically….If she weighs the same as a duck…she’s made of wood! And therefore, SHE’s a WITCH! Burn her.”
https://www.youtube.com/watch?v=zrzMhU_4m-g [Monty Python and the Holy Grail]
WHAT IS IT ABOUT OCTOBER?
From the latter part of September on, the money market was megaphoning warnings to the entire world. But a belief in miracles kept people from selling what remained of their speculative holdings.
…They were solvent and the collateral was good enough. But the trouble was that once these firms borrowed money on call there was no prospect of the lender getting that money back. They simply said they couldn’t pay it back and the lender would willy-nilly have to renew the loan.
Things got worse and worse. Finally there came the awful day of reckoning for the bulls and the optimists and the wishful thinkers and those vast hordes that, dreading the pain of a small loss in the beginning, were now about to suffer total amputation- without anesthetics. A day I shall never forget, October 24, 1907. –Reminiscences of a Stock Operator
The LA Times reports there’s a been a seismic swarm under the Salton Sea near the San Andreas fault, which vaults the odds of a major magnitude 7 or higher earthquake “over the next seven days as high as 1 in 100 and as low as 1 in 3000.” Seismologists have been expecting a big one, which “happens on average in this area once every 150 or 200 years, so experts think the region is long overdue for a major quake.” Echoes of the October, 2014 treasury melt up, about which Jamie Dimon wrote, “Then on one day, October 15, 2014, treasury securities moved 40 bps, statistically 7 to 8 standard deviations –an unprecedented move– an event that is supposed to happen only once every 3 billion years or so….”
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If the start of this week’s missive seems a bit disjointed, maybe it’s because that’s how markets have been trading. The focus of the week has been squarely on Deutsche Bank. From Barrons: “The storm had been brewing since the U.S. Justice Department was reported in mid-September to be seeking a $14 billion penalty for Deutsche Bank’s alleged transgressions in the mortgage bubble and bust.”
Actually, from last November to February of this year the stock was cut in half, from 30 to 15. Co-CEOs Jain and Fitschen unexpectedly resigned in June of 2015. Keen observers might actually point to those events as a signs of a brewing storm. In fact, one might say a warning was being ‘megaphoned’. In terms of the DoJ fine, DB said ‘we won’t pay it.’ And miraculously on Friday came rumors that the fine had been cut to $5.4B, sparking rabid short covering (still unconfirmed as of Sunday morning, though what is confirmed is that Italy is now charging DB with collusion in falsifying Paschi’s books). In a completely UNRELATED turn of events, Apple’s fine to the EU was cut to $5.6 billion from $14.5 billion. THAT’S A JOKE [insert legal disclaimer here]. But…it wouldn’t surprise me if the ‘back tax’ bill to AAPL does get sliced, because that, mes amis, is how things are <working> in this world. That’s why the guy went into the Apple Store in France and smashed every i-phone with a boule. A BOULE! Because a hammer would have been gauchely American.
It all ties back to the broken window fallacy put forward by the famous French economist Frédéric Bastiat: One comes to the conclusion it is a good thing to break windows [or i-phones], it causes money to circulate, and the encouragement of industry in general. But Bastiat continues, “Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen.” It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.
This is the parable of the broken window or …the 21st century parable of the central bankers. They believe these negative rates are good and that nothing bad can happen from their benevolent window smashing. There is little sense of that which is not seen, the growing pension liabilities, money flowing to financial assets rather than capex.
By the way, S&P downgraded Illinois GO’s one notch to BBB on Friday, just two notches above junk, citing the lack of a budget, $111 billion unfunded pension liability and a growing number of unpaid bills (RTRS). Illinois had earlier in the day announced it will stop doing business with Wells. As one client quipped, “You know it’s bad when a state rated junk won’t do business with you!” (thanks RU) Note that in 2014, Illinois’ current-dollar GDP was $742.0 billion and ranked 5th in the United States. For comparison that’s about the same size as Turkey (but of course with less dysfunctional leadership in the latter). About half as large as all of Canada. But the market ignores it.
In fact net changes on the week were rather small, with treasury and bund yields down a couple of bps, stocks and the euro nearly unchanged. The Eurodollar curve remains linearly locked in cement, with the first ten one-year calendar spreads between 13 and 14.5. Monthly ranges have been only 5 bps. It’s almost amazing that EURUSD is so un-volatile, given the possibility of another intertwined banking crisis. However, what DID move is crude oil; up 376 to close at the high of the week. From Bloomberg: In U-Turn, Saudis choose higher prices over free oil. Just months ago, Al-Falih’s predecessor, Ali Al-Naimi, proclaimed it didn’t matter whether oil prices went “down to $20, $40, $50, $60 a barrel — it is irrelevant.” Al-Falih now says prices, hovering under $50 a barrel, need to rise to encourage long-term investment.
It was Q3 last year when oil made its death plunge to the mid-20’s into the beginning of this year. If oil remains here to a bit higher, then the Fed’s predictions of 2% inflation will start ringing true by Q2. Note that the price of oil is highly correlated to forward inflation expectations, which the Fed regularly cites. YOY Core PCE printed 1.7 last week and appears to be on an uptrend. A small, ironic example of price increases (without of course, any benefit of economic growth) is this: Minnesota is raising Affordable Care Act premiums 50-67% to avoid a collapse in the program.
Crude oil (chart below) potentially is making a head and shoulders bottom. A close above 53 would target 75 to 80.
Unemployment report on Friday. ISM Monday expected 50.2. German holiday Monday. Golden week in China.
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| 9/23/2016 | 9/30/2016 | chg | |
| UST 2Y | 77.0 | 76.0 | -1.0 |
| UST 5Y | 117.0 | 115.0 | -2.0 |
| UST 10Y | 161.3 | 160.5 | -0.8 |
| UST 30Y | 233.7 | 233.2 | -0.5 |
| GERM 2Y | -67.1 | -68.3 | -1.2 |
| GERM 10Y | -8.2 | -11.9 | -3.7 |
| EURO$ Z6/Z7 | 15.5 | 14.5 | -1.0 |
| EURO$ Z7/Z8 | 12.5 | 13.0 | 0.5 |
| EUR | 112.28 | 112.40 | 0.12 |
| CRUDE (1st cont) | 44.48 | 48.24 | 3.76 |
| SPX | 2164.69 | 2168.27 | 3.58 |
| VIX | 12.29 | 13.29 | 1.00 |
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https://en.wikipedia.org/wiki/Parable_of_the_broken_window
