The T Report: Writers Block – 2 Pages of It

Posted by on Oct 4, 2012 in Uncategorized | No Comments

Central Banks versus Rest of the World Day 1,038

What is there to write? The Fed has done its thing and the market is still trying to digest what QE means in the short term. The ECB has indicated what they would like to do, but so far has not actually done anything. Every day we seem to rally on some headline that Spain is about to get money, and fade on some story that they might not ask yet. It is almost disturbing the 100’s of billions of global market cap that are created and destroyed on every Spain headline.

Yet, here we are for now. The single most obvious headline the market can glom on to is the Spanish bailout.

Away from the Fed and ECB, there is continued optimism that China will enact stimulus of its own and that somehow the BOE and BOJ will see all their QE dreams actually help the economy.

The part I find most ironic, is that China seems more willing to accept some form of business cycle as part of free markets than many of the “capitalist” countries.

The U.S. is Not Spain

There were some pretty funny comments and views about our debt level last night during the presidential debate.

Over and over we were told that we shouldn’t be borrowing from China. That borrowing from China is bad. I’m not sure how they feel about lending to us and maybe that should also be a focus, but guess that wasn’t the agenda last night.

We were also told that the U.S. isn’t Spain. I have to admit that reminded me of 2010 when the Greek Finance Minister proudly proclaimed that speculators would lose their shirts. If he meant throw out their old shirts because they could buy fancy new ones with their bets against Greece, he was right, otherwise it was just an arrogant statement without any basis in reality.

While I’m not saying the U.S. is Spain, it was funny that no one pointed out that the biggest lender to the U.S. government is the Fed. That at some point, the Fed could become the biggest owner of mortgages backed by Fannie and Freddie, which are in turn backed by the U.S. government.

I am not sure why it bothers me so much, maybe it is just that I’m not used to it, but we seem to be in pretend mode. Let’s pretend that our bonds are super desirable because of the faith the world has in us, and not because we have an unlimited buyer who continues to buy and telegraphs that intention to any momentum player that wants to join in. For now the strategy is working, but we seem to be on a path where we rely ever more on the Fed yet are less willing to admit it. That without the Fed we would be piling up another $200 billion or more of debt each year (cost savings on rates and refund of coupon).

I am trying hard not devolve into a rant, but somehow this dynamic of blaming China, wanting to export, talking about jobs, but not the debt, and treating it as normal for the Fed to own almost 40% of our longer dated bonds just feels like a situation that will end badly. Maybe it is years away, but some of the people pointing out legitimate issues, are treated much like those who talked about sub-prime in 2005. A great many things can be done to avert any problems, but recognizing that there is a problem and trying to avert it is the first step and we seem a long way from that recognition.

Mixed Signals in the Credit Markets

If all you could look at was CDS, you would think credit was in great shape. CDS indices, particularly investment grade corporate are doing extremely well. European CDS has lead equities there two days in a row. IG19, the current on the run US investment grade index, is now trading about 6 bps rich. This is very reminiscent of March right before the whale trade blew CDS sky high.

If all you could look at was fixed income ETF’s, you get a different signal. HYG, JNK, and LQD are no longer seeing growth in shares outstanding. Maybe this is a healthy switch from “beta” products like the ETF’s into managed mutual funds where managers can generate alpha in these low yield environments, but my guess it is just that people are running out of money to add. The big rotation and reallocation from massively underweight to reasonably weight is over. The price performance of the funds this past week also shows signs of weakness.

It looks like fast money is “chasing yield” and slow money is going to wait and see.

Earnings versus Economic Data

Diffusion indices leave a lot to be desired in terms of how much information they really convey. We have seen some better numbers, but I remain skeptical. On the other hand, earnings are real. At some point a stock will trade on something other than QE, or OMT, or YMBJ, and earnings will matter. I am not seeing any indication that earnings will be good (at least not good when S&P is at 1,450). More importantly, it seems like warnings are the far more likely outcome of any earnings call. Maybe QE can push multiples higher, but with so many investors long, and no impact on earnings from QE, I continue to believe we have run out of steam here.