Seven crap banks failed a crap test

"Seven crap banks failed a crap test" was our favourite summary of Friday, but TMM, ever positive, have put on their rose-tinted spectacles to bring you today's piece.

Figure 1. - TMM at work

Firstly, the release comes on the back of a run of positive European data - PMIs, IFO, and even UK GDP have been well-ahead of consensus (the things a weak currency can do for you...). This, along with a run of weaker US numbers has led European indices to outperform, the Euro has recovered 8% off its June lows, and risk has been put to work more generally. Even the Shanghai Composite has stopped falling.

In the main event, quite a bit of ink/pixels have been spilled across The Street discussing the assumptions, rigour and implications of the Stress Test. It seems that the general consensus is that, in spite of the Sturm und Drang, it's more or less a non-event (aka "damp squib"). 7 out of 91 banks failing with EUR3.5bn of new capital needed was the headline that led to a number of unimpressed punters, but underneath the surface the tests were actually more positive in the amount of data opened up to the public. Indeed, this data has allowed a number of analysts to run their own tests, and show that if the bar had been set 1% higher, 24 banks would have failed, with about 27bn Euros of new capital needed; mere chump change as far as the market is concerned, and on the margins, probably a small positive for Europe.

So where do we go from here, now that the excitement is more or less over? TMM thinks that we all, including Mr Market, go back to sleep for the rest of the Summer. Goodnight and good luck! See you after Labor Day.

If you can't inside trade, make sure you know who does

Well it looks like news is gradually leaking out of further stimulus measures in China. This is not any particular news to Team Macro Man because we have been watching this announcement getting front-run silly in the high yield and *GASP* equities market for a few days now. Just look at the price action in Chinese steel names like Maanshan:

This is nothing compared to the rubbish that has been going on in the high yield space where China property bonds have been trading up about four points in a day. In all fairness, it started about a week and a half ago with steel traders: prices ticked up slightly and it seemed that all the liquidations of minor metals like Nickel and Zinc started to reverse onshore with speculative builds in warehouses.

While it would be fair to say that places like Hong Kong are finally taking some measures to prosecute insider trading, those who get in trouble are very much more the exception than the rule. So, if you aren't a tycoon who is immune from prosecution or a prince-ling then how do you trade these markets? It's one thing to swim with the sharks, it's another thing entirely to do so without the relatively reliable fuse wire steel cage that is the SEC.

The answer? Be a spiv. We TMM started out trading high yield and other very lightly-regulated markets, we quickly learned that some clients seemed to be just "too good" and would have to be priced accordingly. Now, without the informational advantage afforded to others we have learned to watch the tape for the kind of moves that are a trademark of someone buying the bejeezus out of the market, knowing something you don't. For Kovner it was the Russians, for TMM it's anyone with a red phone. So when things break out on NO news and policy is uncertain - just chase it.

There really is no point in the kind of deep dive financial analysis that has made the likes of of Jim Chanos a fortune if the rules of play aren't the same.
In cases, like this recent one in Indonesia - whether it was a screw up by the auditors, as claimed, or just behind the scenes shenanigans, one thing is for sure: if the auditors don't get fired and the worst thing you can get is a $55,000 fine for managing to "misplace" a few hundred million dollars, then companies really don't have any incentives to behave in ways that are expected elsewhere in the world.

The West's current financial reforms are doing nothing to flatten the global regulatory gradient as G20 purport to want. If anything, it is steepening, leaving financial markets with a choice of where to base themselves:

The West:Or the Thunderdomes:

Mr Whippy

A tad volatile after Ben yesterday so we are a little busy today in our real jobs, but feel free to help yourself to an ice cream...

Elvis is Alive!

One of Team Macro Man's favourite pastimes is chuckling at the tin foil hat brigade and their most vocal leaders, the "bullets n Gold" brigade, but when reading this article this morning they couldn't help but wonder if Bloomberg had hired the authors of this site to the editorial staff:

"Deutsche Bank is marketing a tail-risk hedging index that gains in value when investor expectation of stock-market volatility increases, according to material the bank sent to clients. The so-called Equity Long Volatility Investment Strategy, or ELVIS, uses derivatives called variance swaps linked to the S&P500 that bet on the index’s volatility."

But (very poor) jokes aside, TMM is struck by the number of products that have recently appeared allowing suckers investors to "hedge" against tail risks. The news that the CBOE is developing such a product is perhaps the ultimate contrarian signal that the cult of the Black Swan... sorry, err... "propriety portfolio convexity hedge overlay to our alpha strategies" has reached its zenith. Indeed, the usual Wall Street product cycle starts with bank structuring desks creating some utterly useless exotic option structure designed to perform in the conditions of the last crisis period which is far too complex for the purchaser to value, resulting in said bank ripping the poor (or naive?) punter's eyes out. And market veterans will attest, the next crisis is usually caused by an "unknown, unknown", usually resulting in said derivative structure not performing in the way it was expected. In fact one of our maxims is "Correlations work really well.. until you put the trade on". Add to that the fact that the guys that sold it to you are the only ones that will buy it back - and TMM are exceptionally sceptical of any trade ideas with the words "structured" or "exotic" in. But we digress, the Exchanges, in their attempts to keep market share, often try to launch an exchange-traded version of these products, right as focus on them peaks (anyone remember SONIA futures, house price futures & Credit Default Swap Index futures?). You know when the Vampire Squid creates John Paulson an exotic way of getting short China that the credit bubble is about to burst... TMM suspect ELVIS is about to leave the building (sorry, we could not resist that one...)

Speaking of John Paulson, Apple's blow-out earnings are something of a gift to the reflationistas (Paulson, Einhorn et al) as it bails them out, somewhat, against their Gold & BAC holdings, as does the fact that, despite what appeared to be pretty poor earnings numbers, equities staged a remarkable rebound after holding the technically important 1050 level. Perhaps it was just a short squeeze, perhaps it has been misconceptions? TMM was surprised to read that so far, earnings beats are ahead of historical norms, and revenue beats are their highest since 2004. TMM expects punters to begin talking about the potential inverse Head & Shoulders pattern that would target the 1075-ish area.

The other big worry on punters' minds is the European train crash which, since Timmy G advised them to follow the "shut the f*** up" strategy, has surprised on the upside, with the data decelerating a lot more slowly than many expected, the Greek budget & current account data showing reduced insolvency and illiquidity risk (and aiding rebalancing), while EMU bonds appear only to have repriced to a new equilibrium around EONIA+110bps rather than continuing to collapse. The heavily stage-managed leaks of the stress test scenarios and pass/fails almost seems choreographed out of 1500 Pennsylvania Avenue.

But back to China. TMM has been struck, in recent days, by a creeping re-enthusiasm for a reacceleration of Chinese growth (just as the last of the economists had downgraded their forecasts...). Copper and the Aussie Dollar, refused to plumb new lows in the recent equity sell-off, and TMM received reports of sector rotation out of the Financials into Commodity names. Scattered mutterings are also trickling through that steel mills in China have begun raise their ex-factory prices. The chart below shows scrap Iron & Steel prices at Turkish ports, and appears to have bounced since late-June.

The Shanghai Composite (first chart below) also has been showing signs of perkiness as talk (whether real or not) of further stimulus, along with buying from domestic insurers has dragged the index 10% off its lows. But it is not just the locals that have been buying - in the rush to push money East, foreigners have been piling into any exposure they can get, such that some ETFs are trading at large premiums to NAV! (see second chart below):

While none of the above is enough to persuade TMM to abandon their view on "short-term high volatility within summer ranges", a break above 1100 in SPX would be pretty bullish when put in the context of the above. However, if we were to consider the recent moves as just big positions squeezes, then a move higher in risk would fit with a squeeze of the general beliefs we saw in our poll two days ago.

Roll Over Beethoven

Team Macro Man can't help but notice that the common theme of the summer thus far - gappy, trendless markets with no clear theme aside from slower (but not that much) growth may be coming to an end. Squeezes are happening across the board, indicating either some serious conviction on the part of some parties, or that positioning has got a touch too one-sided, with the winners doubling down and those bruised by the last few months' price action limping off into cash. Price action in commodities remains an amplified version of life outside of it, with one house allegedly deciding to corner the market for Freddo Frogs and Body Shop products. The wife and kids will NOT be pleased. Similarly crowded action in Yen crosses has led to more volatility as more observers expect Japan to go thoroughly Network on us.

Throw in a few more improbable events:

• Greek Current Account moved into surplus for the first time since 2005 - something the optimists will point to as evidence that things are improving, and something the bears will point to as increasing the probability of a restructuring & devaluation, given the lack of need for external funding. This could be the first candidate for TMM's new Flying Donkey Award.
  
  
  
• Some heavy volume early in Eurostoxx, which is either someone trying to freak everyone out or someone who is actually freaked out (and has a spare EUR 1.6bn). Who knows?

• And Gold taking a good look over the edge with everyone wondering whether they are going to jump. Two Gold bulls deciding to double up.

• Has anyone seen a Eurocrat recently? Or have they all escaped down a secret tunnel to join their Euros in Switzerland before Friday's well-timed 6pm (European Time) bank joke test announcement. That maximises the head start they get on the markets before they open on Monday morning and find them missing.

• The early whisper for The Vampire Squid's earnings is $2.04 vs expectations of $2. Now, in TMM's book, that's a $1.00 miss against the usual "Consensus plus a Buck".

Yesterday's poll was interesting too, thank you. So much for fat tails. Either this blog's readership is not representative of the market (to be fair, which passive equity manager would be reading this), or we are well out of court. Nice distributions around current levels with a bias to the "stress" side of things again (EUR/USD to dip, SPX to fall), but we were most taken by the disappearance of the Gold bugs, with only 15% thinking we will be above 1250 at the end of August, the same number as think we will be below 1050. Y'all out buying bullets...?

And all Team Macro Man can say is that it may be a Summer of going nowhere, but it's going to be a hairy journey getting there. The end of the week probably isn't going to be the snoozer that the Summer has been so far.

Computer says "No"

Just when you think bureaucracy can’t get any more idiotic... it does. After a day of mind-numbing stupidity at work resulting from a “computer says no” mentality worthy of an email post on this site, one of TMM's members went home to find out their car insurance had run out that very same day. Fine, no problem, we'll just ring them up and ask them to start it off again tout d’suite. "Ah no sir, even though yesterday your renewal quote was for X amount, as the policy has now expired it will count as a new quote and the price will be... wait for a moment, please, caller... 1.5 times higher". Huh? So you're telling me that in the space of 12hrs, your perceived risk of me crashing has gone up 50%? “No sir, I m not saying that at all. The computer is”. So thats twice in a day I have been sandwiched in a logic vacuum between two thinly spaced slices of stupidity. I think I have discovered the Casimir effect of stupidity and its all to do with virtual particles of stupidity arising in logic vacuums.

Which reminds me of the McDonald’s behind Harry’s on Boat Quay in Singapore which a few years back was running a half price 50c offer on cheeseburgers. Now, TMM is not saying they were regular customers of such establishments but “needs must” and every now and again a reminder of the splendid culinary delights of the West were needed to temper the wonderful local specialities. As such, one of TMM's members asked if they could do hamburgers at the 50c price too. “No sir, only cheeseburgers”. So after a complete failure to get anywhere with a growingly heated logical debate, he walked out... And then walked back in again:

TMM: “Do you cook burgers to order?”

Attendent: “Yes Sir”,

TMM: “Good , then I’ll have two cheeseburgers please... Without the
cheese”...

Attendent: “Certainly sir”.

We know how in markets logic and what the computer says often seem at odds. Just take the Euro/Everything rally we have been seeing. The mind may say "Yes" to running Euro shorts but the computers of risk management and the computers of trend models have all said “No”. Well actually its been more of an “Abort Abort Abort” + red flashing lights and that klaxon noise. The CFTC figures have seen some massive turnarounds in underlying USD positions over the past week with a swing from 3.6 Bln long to 5.4 Bln short. And if you are a European who dashed out to buy Gold with your Euro savings you are now down about 12% from the highs and feeling a bit Edward the Second'ed, as it has nearly filed the gap on the Gold/Eur chart 915 area from the beginning of May. TMM knows it behaves like carry (or is supposed to), but the policy mix is now very deflationary. It's very hard with a UK budget like that and up coming Eurausterity to claim that your currency is at imminent risk of debasement. Not to mention other silliness in the precious metals - recent action in Aquarius Platinum is due to BP-like safety controls leading to possible cuts in world production of 5-6% if South African regulations are ammended. And Platinum and Palladium are... down to flat. Either we are thinking a few too many steps ahead, or some decoupling between the Platinum group and Gold is in the offing.

But it wasn’t a surprise to see the markets spin on a dime and say bonjour to Monsieur Toilette on Friday, for it was the mythical 16th of July and you can't say we haven’t had any notice that Friday was going to be the 16th of July. Now as to why the 16th of July is such an important day, TMM is sure that there are an awful lot of things that could be found to correlate to it, but we are massive believers in “Correlation does not imply Causality” so instead we will leave it to someone else to decide that hedgehog deaths in Nigeria divided by sunspots is the root of it all. In fact, TMM remembers back in the early ‘90s when work being done on the correlation of USD/DEM to Oil prices (then a popular theme) threw out the lovely result that in fact you would be better trading USD/DEM against “Icelandic Fish Catches”. Strange but true. Ironic really, as who would have thought that 15 years later we would actually be trading the modern version of USD/DEM against “Icelandic Fitch Crashes”.

But now that we have even mentioned the 16th of July it will, of course, be even more important next year as, even if you don’t believe it, next year it will remain in the back of some of our readers' minds like some survivor bias ghostly influence. Which brings me on to another bizarre quantum like function of markets. If say Mr Large Hedge fund or Voldemort type character were to buy a gazillion payout of a binary one touch option from one bank and then sell it to another bank , one would think that the market was now net flat and the relevance of the strike of the binary should be irrelevant. But it won't be because you can be pretty darn sure that the hedging processes that both banks employ will not exactly match out over the duration of the option and on run up to expiry you will at best have wobbles as the timing of gamma hedges between the banks mismatch or, at worst, a full out slugging match between the 2 banks to protect/drive the barrier. So a market that should be flat, isn’t and the passing of the trade has left ghostly entanglements.

But enough rambling and back to today's markets. It feels as though the summer holiday season has kicked in big time today and yet we are still of the opinion that the “Market does very little ‘til the end of August” view is not widely held and the fat tails are still loaded, but just to test it we would be most grateful if you could share your thoughts with us in our “Where will it be at the end of August poll”. In the meantime, TMM are going to go back to writing code that makes computers say "YES".

EURUSD:

GOLD:

SPX:

2s10s:

I'm still only in Saigon... Every time I think I'm gonna wake up back in the jungle

One of the more fun things about doing macro in emerging markets is that, historically at least, the crises and manias come hard and fast, and the monetary cycles have about as much subtlety as Wagner coming out of a helicopter - at least you know when to run.

Certain members of TMM have recently been doing trips back to Vietnam, a market with which the market quickly fell in, and out, of love with in 2006 and early-2007, only to go down hard with emerging market equity flows drying up, and currency devaluation which made it one of the worst performers in the World.

Vietnam's recent economic history is best summarized in the chart below (green - M2 growth, white - Dong/USD exchange rate, red - inflation, yellow - GDP growth, orange - current account deficit as a %age of GDP):

As can be seen, Vietnam is no stranger to Chinese levels of base money growth or old-school LATAM inflation. What happened in the mid-2000s was as much a demographic phenomenon as anything else - a very large number of people were hitting peak consumption years and imports picked up accordingly.

The only problem was that FDI was high, but barely enough to keep up and was not able to generate quite enough exports to plug the gap, though that has begun to change. By late 2006 and early-2007, Mark Mobius, Marc Faber and the gang were telling everyone to pile into Vietnamese equities on the back of the great fundamentals - growth, cheaper than China etc etc... Around that time, EM equity analysts - particularly in Vietnam - sounded like this guy:

The fun could not last, of course - a surge in inflation (fuel & food are big parts of CPI-baskets in EM) and a deterioration in the balance of payments soon took its toll on the Ho Chi Minh exchange, taking it down more than 70% from the peak by March 2009. Add in the depreciation of the Dong over that period and that's an 82% loss. By that time, the only foreign investors engaged in the market were closed-end funds who simply could not get out, and more private equity-orientated investors who didn't have margin calls to meet. Since then, foreign investor activity has been pretty limited at best.

There's nothing that TMM likes more than something non-consensus, so going back to Vietnam was something one of the team had to do. Dennis Hopper's Apocalypse Now character isn't running research anymore and the ratio of Wall St to Main St guys you see in your hotel is a lot more healthy than in 2006, and these kinds of announcements are positive - ultimately, TMM is not what an improving current account are made of, it's boring Korean corporates that build the factories that generate hard currency that are. and those guys just keep on coming, look at the FDI numbers:

Problems remain, however, and the government deficit continues to be monetised - i.e. money is still being printed like it's going out of style. A screenshot of onshore government debt yields makes Indonesia look pretty tame:It may sound crazy, but TMM is thinking that with notional independence of the Central bank and a nascent global recovery, it might be possible for the country to get inflation under control as the need for China-style credit stimulus abates. The Big Mac Index or any measure of PPP makes the Dong look pretty interesting.

Could it be time for Team Macro Man's favourite gag trade - Long Dong Silver?