Canaries Banned from Coalmines (Elephants Allowed)
Guest post by Peter Tchir.
Overnight we are hitting new lows with S&P futures touching 1414, a level not seen since early September and pre OMT and QEX. Nasdaq 100 futures are even worse, hitting levels last seen in early August, right after the “whatever it takes” speech finally got some traction.
Credit indices have been wider than this, even in October, so they are either about to take the next leg down or a sign of hope. I’m going with the view they are about to underperform since IG19 is trading 5 bps rich to intrinsic in a market where single name offers are hard to come by.
Crowded safe trades may be in jeopardy and high yield bonds seem particularly fragile. The total lack of fear about junk companies at low yields, issuing dividend deals while big companies are seeing hits to earnings is a little reminiscent of LCDX in 2007 (as I wrote on Saturday). There is still no obvious catalyst for a sell-off, but there never is. If retail has had enough and real default risk fears spark any selling, I can’t think of many institutions set up to buy rather than forced to sell to protect themselves.
Anyways, I remain with my lowered S&P target of 1,375 – 1,400 but am cutting some shorts here as I was wrong yesterday and underestimated how fast we could bounce into the close (but I was maximum short yesterday, so still remain quite bearish).
Where have all the canaries gone?
One of the effects of the central bank policies is that many of the more obscure parts of the market that you could look to for clues or early warning signs have been eliminated. Sure these markets still exist, but the information from them is so manipulated that it is difficult to get a clear read.
LIBOR used to have some potential to signal funding issues at individual banks. Between Fed lending programs, LTRO, and the lawsuits, I have no clue what to make of LIBOR other than it probably isn’t a whole lot of use as a sign of anything.
The EUR/USD 3 month basis swap was another useful indicator showing the relative strength of US banks versus European banks. Again with LTRO and various central bank global swap lines, this measure has become useless. With banks willing to use central bank liquidity without fear of reprisals or negative stigma, they do, and this rate hovers right around where the governments would like it to be.
European sovereign CDS has become far more difficult to interpret as all these naked bans get enforced. French CDS went from 106 on the 11th of October to 65 today, in pretty much a straight line. I have difficulty thinking of one real reason that France could have done so well – they have funded ESM, instituted some domestic policies that seem dubious at best, have had weak economic data, and are marching to the beat of their own drum in the Euro in a way that indicates willingness to take on more debt, yet they are tighter. This makes it hard to figure out what is going on in European bank CDS. Some traders are using European bank CDS as a proxy for sovereign CDS. While this makes some sense, it isn’t the perfect trade and does skew the meaning of moves in bank CDS, which also rolls into corporate CDS. On the sovereign bond side, the need to borrow bonds to put on shorts remains an issue, so it is difficult to tell how much of the price is real comfort with the credit, LTRO induced non mark to market ownership, and just an unwillingness to take the borrow risk.
US Treasury Yields are very difficult to figure out. The Fed owns over 35% of treasuries with maturities 5 years and longer. Almost everything you would look at and try and infer from the treasury market is skewed by that. Are 5 year rates low because no one expects inflation or because people expect economic weakness, or are the rates so artificial that people could be expecting growth and inflation and rates are still anchored there? This applies throughout the curve, and to the curves themselves. There is useful information to be gleaned from treasuries, but it isn’t as useful as it was a few years ago.
Economic data has even come under attack. In general I don’t believe the data is manipulated, particularly not for political purposes (but there are a growing number of people who do). But I do think they try and cover up their own mistakes. Jobless claims came in at 337k or something (pre upward revision) two weeks ago. There was a lot of concern, and some very good economists spoke to the BLS and came up with the conclusion that one big state had not sent in their quarter end revisions in time. There was some confirmation of this, but then some sort of denial. Missing the deadline would be an honest mistake in my opinion, it shouldn’t happen, but I can see how it could. Then last week, we posted 388k as the number. Now we have data that looks like 369k, 342k, and 388k. Is the reality that had they properly accounted for the missing number, that the claims have been 369k, 365k, 365k? If so, we have okay but steady claims. If the actual data is correct (which I don’t think it is) then we would have seen some euphoric hiring followed by aggressive firing. I find that harder to believe.
No Liquidity and No Canaries is a Bad Combination
The lack of liquidity works both ways, as we saw with the ramp into yesterday’s close, but I think it is more dangerous from the long side right now. Too many people are long (and lately wrong) that I think we see the lack of liquidity tested on the downside much sooner than to the upside. With a lack of canaries, it is easier to get caught by surprise.
Elephants are easier to see than Canaries
If you need a warning sign, let’s stop ignoring the obvious weakness in earnings and outlooks. Again, I don’t think CEO’s are in any better position to see the economic future even 3 months out, but they can get a pretty good handle on next quarter’s earning potential, and I am not seeing anything encouraging here. So I guess rather than looking for obscure signs, we should accept what the pink elephant playing the drums in the tutu is telling us and stop ignoring that.