With the market “stubbornly” drifting lower and more and more people stuck with the long positions, let’s review the pullbacks. Guest post by Vix and more.
At various times over the past three years, I have been posting a table that I call the VIX and More 2009-12 SPX Peak to Trough Pullback Summary, the most recent version of which can be found in a March post, Putting the Current 2.6% SPX Pullback in Recent Historical Context .
This time around I thought it might be of more value to present the same data, which now includes 17 pullbacks over a the course of a 38-month period, in the form of a scatter plot, with the magnitude of the peak-to-trough drawdown on the y-axis (inverted) and the number of trading days from the peak to the trough on the x-axis.
In the graphic below, I have highlighted the current 6.6% pullback from the April 2nd high of SPX 1422 with a solid red diamond. This pullback now ranks as the 6th deepest in terms of peak-to-trough magnitude and 3rd longest in terms of peak-to-trough trading days. Interestingly, the 6.6% pullback over the course of 30 days is well below the (dotted black) linear trend line for the full data set; the trend line prediction for 30 days is in fact a 9.3% pullback, which I have plotted with a hollow red diamond.
For reference, I have also annotated the top two pullbacks during the past 38 months:
- 21.6% over 109 days from May to October 2011
- 17.1% over 48 days from April to July 2010
Shareholders in Europe’s listed companies will be given a binding vote on pay while those who invest in banks will gain powers to set a cap on bonus levels, under plans being drawn up by senior EU officials. The initiative from Michel Barnier, the EU’s top financial services regulator, would hand bank investors the voting power to curb “morally indefensible” pay and limit the gap between the lowest and highest paid. Banks would also be forced to disclose their top 20-30 earners. http://www.ft.com/intl/cms/s/0/35bcd8f6-9ea8-11e1-9cc8-00144feabdc0.html#axzz1v0L4fkM1
Greece is heading for a fresh general election after its political parties failed to form a national unity government because of opposition from the anti-bailout Syriza coalition. President Karolos Papoulias, who chaired three failed meetings with political leaders in as many days, was unable to bridge differences between Syriza and the two pro-euro parties, the centre-right New Democracy and PanHellenic Socialist Movement (Pasok). A caretaker government will be chosen on Wednesday to oversee the election, expected on June 17. http://www.ft.com/intl/cms/s/0/5aa74018-9e88-11e1-a24e-00144feabdc0.html#axzz1v0L4fkM1
The leaders of France and Germany on Tuesday joined forces to urge Greece to reaffirm its commitment to membership of the eurozone, after François Hollande flew to Berlin for talks with Angela Merkel, German chancellor, within hours of being installed as French president. Both spelt out their concern that Greece should remain a full member of the common European currency, while promising to consider new measures to revive economic growth in the country. But they also agreed that Athens must carry out the austerity programme it has agreed with the European Union and the International Monetary Fund. http://www.ft.com/intl/cms/s/0/fa18437e-9ecc-11e1-9cc8-00144feabdc0.html#axzz1v0L4fkM1
Much more reading below.
- During this important annual event, PIMCO colleagues from around the world debate the major trends that will play out over the next three to five years, focusing not on what should happen, but what is likely to happen. Based on the 2012 Secular Forum discussions, we expect three themes to play out: continued policy and political confusion, overly incremental public and private sector responses and, therefore, greater potential for inflection points.
- In terms of regions, the status quo is no longer an option for Europe. The higher probability outcome – though not dominant – is a smaller and less imperfect eurozone. The journey would be bumpy and expensive; and it would require much more responsive and agile policymaking. Thus, the horrible risk of eurozone fragmentation is not de minimis.
- The U.S. will look good relative to Europe, outperforming in terms of growth and financial stability; but, amid political scrimmages rather than grand bargains, concerns will remain about growth, jobs, inequality, debt and deficits. Financial repression will persist as growth proves insufficient to quickly and safely delever segments that are over-indebted.
- Emerging economies, meanwhile, will continue to outpace both Europe and the U.S. over the secular horizon. Their path of expansion and convergence will be more volatile, especially as some countries undertake needed and tricky transitions in their growth models (including China).
- Portfolio implications: Maintain a sizable quality bias for sovereigns and corporate credits; supplement high-quality equity positioning (low financial leverage, high operating margins, and growth exposure) with dividend streams, where possible, as a means of de facto shortening duration; consider real assets to guard against confiscation risk; expand risk management to include cost-effective tail hedging; and evolve strategies, guidelines, dividing lines and mindsets that have guided investing in the past but will likely be challenged in the context of inflection dynamics.
With the ever increasing number of black swans hitting the world, there is a rapid increase of critique with regards to different models the financial industry uses in determining risk and how to hedge IT. Must read by James Montier on the subject.
The National Rifle Association is well-known for its slogan “Guns don’t kill people; people kill people.” This sentimenthas a long history and echoes the words of Seneca the Younger that “A sword never kills anybody; it is a tool in the killer’s hand.”
I have often heard fans of finanancial modelling use a similar line of defence. However, one of my favourite comedians, Eddie Izzard, has a rebuttal that I find most compelling. He points out that “Guns don’t kill people; people kill people, but so do monkeys if you give them guns.” This is akin to my view of financial models. Give a monkey a value at risk (VaR) model or the capital asset pricing model (CAPM) and you’ve got a potential financial disaster on your hands.
Guest post by Azizonomics.
So let’s assume Greece is going to leave the Eurozone and suffer the consequences of default, exit, capital controls, a deposit freeze, the drachmatization of euro claims, and depreciation.
It’s going to be a painful time for the Greek people. But what about for Greece’s highly-leveraged creditors, who must now bite the bullet of a disorderly default? Surely the ramifications of a Greek exit will be worse for the international financial system?
J.P. Morgan — fresh from putting an LTCM alumnus in charge of a $70 trillion derivatives book (good luck with that) — is upping the fear about Europe and its impact on global finance:
The main direct losses correspond to the €240bn of Greek debt in official hands (EU/IMF), to €130bn of Eurosystem’s exposure to Greece via TARGET2 and a potential loss of around €25bn for European banks. This is the cross-border claims (i.e. not matched by local liabilities) that European banks (mostly French) have on Greece’s public and non-bank private sector. These immediate losses add up to €400bn. This is a big amount but let’s assume that, as several people suggested this week, these immediate/direct losses are manageable. What are the indirect consequences of a Greek exit for the rest?
The wildcard is obviously contagion to Spain or Italy? Could a Greek exit create a capital and deposit flight from Spain and Italy which becomes difficult to contain? It is admittedly true that European policymakers have tried over the past year to convince markets that Greece is a special case and its problems are rather unique. We see little evidence that their efforts have paid off.
The steady selling of Spanish and Italian government bonds by non-domestic investors over the past nine months (€200bn for Italy and €80bn for Spain) suggests that markets see Greece more as a precedent for other peripherals rather than a special case. And it is not only the €800bn of Italian and Spanish government bonds still held by non-domestic investors that are likely at risk. It is also the €500bn of Italian and Spanish bank and corporate bonds and the €300bn of quoted Italian and Spanish shares held by nonresidents. And the numbers balloon if one starts looking beyond portfolio/quoted assets. Of course, the €1.4tr of Italian and €1.6tr of Spanish bank domestic deposits is the elephant in the room which a Greek exit and the introduction of capital controls by Greece has the potential to destabilize.
A multi-trillion € shock — far bigger than the fallout from Lehman — has the potential to trigger a default cascade wherein busted leveraged Greek creditors themselves end up in a fire sale to raise collateral as they struggle to maintain cash flow, and face the prospect of downgrades and margin calls and may themselves default on their obligations, setting off a cascade of illiquidity and default. Very simply, such an event has the potential to dwarf 2008 and 1929, and possibly even bring the entire global financial system to a juddering halt (just as Paulson fear-mongered in 2008).
Market thoughts by Biderman,
A major stock market event will occur later this week when Facebook goes public. Stocks and gold likely will keep selling off until the Facebook offering hits the market. And everything else being equal, I then expect a sharp rebound in stocks and gold after the offering.
I personally will be buying Facebook and gold on the IPO day.
The Biderman Market Theory says all there is in the stock market are shares of stock. Not very complicated. 80 percent of all shares are held by mutual funds, Exchange Traded Funds, hedge and pension funds and family offices. Money flows in and out of those institutions.
Now Facebook will be selling anywhere from $12 billion to $15 billion of new shares in a few days. The main reason stock prices have being going down recently is that there is not $12 to $15 billion in cash sitting on the sidelines waiting for this deal. That means almost all the money that will going into Facebook has to come from the sale of existing stocks or gold. Video below.
Guest post by Steen Jakobsen.
The farther backwards you can look, the farther forward you are likely to see – Winston Churchill
During the ERM crisis in 1992 I was a still a relatively young trader and had the good fortune to witness some of the best risk takers in the world – the Susquehanna group – who had a joint venture with my employer, the Chase Manhattan Bank. I learned more during that ERM crisis in 1992 than I have in the rest of career.
The main lesson I learned is that being short gamma can wipe you out in a hurry. During the ERM crisis, Swedish interest rates touched 500% USD-Deutschmark was moving 10-15 figures in a matter of hours. Everyone was trying to make sense as the uncertainty saw market volatility spinning out of control.
Why is this relevant? Well partly because, despite the 2008 crash, few traders of today really understand risk and risk management. They persist in believing that “Value at risk” – or VaR – offers a true picture of the amount of risk exposure in the market – manage your VaR and you are okay. But times like 1992, the 2000, 2008 – and maybe even 2012 – show us that why VaR doesn’t work. That’s because VaR doesn’t properly quantify or describe the “tail risk”, that small percentage of the time when markets doe what the statistical models don’t account for: go crazy.
In crude terms, VaR explains to you the risk of the volatility on any given day with 95 per cent certainty. But what about the remaining 5 per cent? That’s where the VaR model quickly breaks down, because at times when markets run into a truly volatile patch, pricing becomes downright discontinuous as liquidity dries up – the market moves in astound gaps rather than in the normal step-wise fashion of more normal times.
As the prices jump around, the correlations upon which 90 per cent of VaR is built simply collapse. And if you are caught the wrong way – there is no market and there is no hedge as everything moves quickly and in the same direction.
Fears that the eurozone’s firewall will prove insufficient to shield Spain and other embattled countries against the effects of a possible disorderly Greek exit from the currency union hit European financial markets on Monday. Spanish and Italian 10-year borrowing costs shot up to their highest levels this year and European stock markets suffered their biggest one-day drop in three weeks. German 10-year bond yields fell to a record low, widening the premium Madrid pays to borrow compared to Berlin to a new euro-era high. http://www.ft.com/intl/cms/s/0/517e01a6-9ddf-11e1-9a9e-00144feabdc0.html#axzz1uofkmjQk
Citic Securities, China’s largest broker, has agreed to buy algorithmic trading technology from Progress Software, a Nasdaq-listed company, in the latest sign that rapid automated trading is spreading from western markets to Asia. A race has been under way in the US and Europe among banks and brokers using algorithms to attract business from institutional investors. Such algorithms are either built internally or bought from technology companies. http://www.ft.com/cms/s/0/d7e9b3a8-9da2-11e1-838c-00144feabdc0.html#axzz1uofkmjQk
Asian stock markets, the euro and commodities fell Tuesday on renewed fears that Greece could leave the euro zone after coalition talks Monday failed to produce a government. Both Japan’s Nikkei and Korea’s Kospi slipped 1.4%, while Australia’s S&P ASX 200 dropped 1%. In Hong Kong, the Hang Seng Index was down 0.4%, while the China Shanghai SE Composite fell 0.5%. The euro was down 0.7% late in New York to $1.2824 as fears of a Greek exit from the euro zone became the main concern of investors. The single currency continued to fall in Asia, down 0.1% to $1.2822.http://online.wsj.com/article/SB10001424052702304192704577404932277664936.html?mod=WSJEurope_hpp_LEFTTopStories
More news below.