The T Report: LIBOR, Spain & Value of Economic Data

Posted by on Jul 9, 2012 in Uncategorized | No Comments

The Economic Data is the Easy Part

If on the morning of May 19th you had been given advance copies of all the economic releases globally, could you have made money?

It’s a strange question, but if you knew the data that was going to be coming out of the U.S., China, and Europe would you have been long S&P at 1,295, or IBEX at 6,566, or Hang Seng 18,951?

Would it have helped if you knew that the Euro would go from 1.278 to 1.23 or that Spanish 10 year bond yields would go from 6.24% to over 75?

Only treasuries and oil seemed to react as expected. The bad economic news has pushed “safe” rates lower and oil has also declined since May. But most other risk assets have done surprisingly well. Stocks remain up since then, and virtually all credit indices, and high yield in particular, are at better levels than on May 18th.

It would be nice to say the market was reacting well to a solution in Europe, but the yield on Spanish bonds and the FX rate make that harder to believe.

So what to do? Can stocks remain strong in the face of so much weak data and little progress in Europe? I ‘m not sure and there is a part of me that is screaming to get out of remaining longs and get short, but I’m not there yet. Last week’s early strength followed by weakness seems like another potential bear trap. We got the rally two Friday’s ago, more because the market had gotten too short than anything particularly exciting out of the summit.

We failed to rally this week on central bank easing, at least in part because all the shorts had gotten stopped out and too many weak longs were set. The market isn’t as short as it was ahead of the summit, but feels once again to be more balanced.

The economic data is likely to be weak, but who doesn’t expect that? The earnings will potentially be weak, but who doesn’t expect that?

As we wait for the headlines to drive the markets, and for data and earnings to confirm the global slowdown, it is worth pausing for a moment and figuring out if you would have made money since May 18th, even if you knew all the data in advance.

Spanish Bank Bailout – Put Up or Shut Up

It’s time to get some actual details, and more importantly, some actual money. Every day of delay means the economy gets worse rather than improves as banks are handcuffed. Every day of delay means that investors don’t believe Europe is really prepared to act, but instead is hoping to bluff their way through it.

Not only is the market running out of patience, but the economy is getting worse. Auto sales, for example are highly correlated with loan availability so having undercapitalized banks, unable to lend, is not helping. I doubt that injecting huge amounts of capital into banks will immediately fix the economy, but I am certain that not recapitalizing the banks will lead to further devastation of economies. Without real action coming out of Europe in the next couple of days, it will be very difficult for risk assets to maintain these high levels.

LIBOR – The start of a new era in banking?

This LIBOR story is only going to get bigger. We are working on a much longer piece focused on LIBOR, but our conclusions are that

  • It is incredibly confusing and complex and the way the banks interact with their regulators and with the BBA, and the method for determining LIBOR make it very difficult to determine a likely chain of events
  • For all the talk about derivatives, the easier case is for lenders. Anyone who lent money on a LIBOR basis lost during the 2008 period because LIBOR was set artificially low. Ignore all the swaps and derivatives, and focus on the lending. Anyone who borrowed on a LIBOR basis won and anyone who lent on a LIBOR basis lost. Some of the banks posting low LIBORs may have lost money because of the setting, but the point of manipulation in 2008 wasn’t to make money but to stay alive. High LIBORs would have caused runs on banks to grow, so they may have taken small losses on carry to avoid that. Complex. Do individual banks pay the price? Can LIBOR be restated?
  • The whole question of what is LIBOR and what does it mean when the money markets for banks are frozen is a question that will likely become a focal point. If there are no trades, can any number be “reasonable”? Barclay’s admitted to guilt, but I think they may have focused too much on the pre crisis period and the crisis period is going to be where the battle heats up.

How many other markets live with “manipulated” settings? Option expiration is a big one? Commodity and VIX futures? What about bond trading. Dealers show each other prices through interdealer brokers, but don’t reflect those prices to all clients. Dealers in fact don’t necessarily show the same price to all of their clients. That is yet another “two tiered” market. Creating CDO’s where the shorts pick the names? I’m sure there are more examples, and I think that as details come out on LIBOR, we will see a renewed focus on regulation and calls that Dodd-Frank don’t go far enough.