From 99 to 1

Well, after a very short time on the beach, it's time to head back to being gainfully employed.

While recently passing by Zucotti Park on the way to my new employer, I choked back the urge to tell them that I was likely in the midst of a transfer from the 99% "unemployed/screwed by Wall Street" back to the 1%.

Not long ago, I was stunned by the unanimity of the view the "Europe will only get worse." Now, I'm equally as amazed that only vague rumors of a 'bazooka' bailout are all that are needed to cause a huge rally. Unless and until dealer capital returns to the market, we can expect these market swings to become the norm.

So, this blog will now become dormant...until the next 'reduction in force."

Benford's Law and Weezer

Credit spreads have spent much of the day wider post JPM earnings.

There are many items to discuss within their earnings release however I feel the most relevant to me, and my livelihood, is their FICC revenues which were down 14% (adjusted for one time costs). JPMorgan spreads (in cash bonds) were ~10bps wider on the day but are outperforming BAC and MS spreads which are ~15bps wider.

Morgan Stanley recently noted, in it's 10Q, that if it's credit rating were to be cut "we may be required to provide additional collateral to certain counterparties." (via UBS credit research).

There are a few data points that highlight how 'cheap' the high yield sector currently is. As of Q2, aggregate leverage has fallen from it's peak of 4.7x to it's current 3.6x. This is where it was in the beginning of 2007. In addition, the covenent stress index is approaching a historic low of 1.8% (all time low = 1.4% in '05). So why is the HY CDX index pricing currently reflecting a 50% cumulative default rate over the next five years? (data via UBS)

Dealbreaker posted an very interesting story about Benford's law. Benford's law posits that there is a natural distribution to all numbers in the universe (i.e. lengths of rivers, the populations of cities, molecular weights of chemicals). This professor had taken 43 financial variables from 20,000 firms and they fit the predicted outcome (of Benford's law) almost perfectly. However, she warns that recently, this same data set is no longer 'fitting' and the deviation is becoming an outlier. She warns that "accounting data seem to be less and less related to the natural data-generating process" and "Benford's law casts serious doubt on the reliability" of this data. No one would label me a quant, but this thesis seemed worthy of note to this layman as a warning that the reported numbers may be more 'adjusted' than we realize.

Today's 'off topic' note - Two weeks ago, the ex-bassist from the band Weezer tweeted that he dreamt he would die the following week of a heart attack in his sleep. Lo and behold, he died the following week of a heart attack in his sleep. ABC new story on this here.

Beer, fried chicken and video games

Again today, optimism seems to prevail as the headlines, to this reader at least, seemed pretty grim. Yet spreads are opening firmly tighter to start the day.

German industrial production was weaker than expected...yet the rest of Europe, lead by Italy of all places, was stronger.

ECB President Trichet used the term "systematic" when discussing the current crisis in Europe.

A German bund auction received fewer bids than the amount on offer and technically failed.

The Chinese tariff bill passed the Senate causing the Chinese official news agency to quickly warn/remind us of the Smoot-Hawley tariff act which many feel lengthened the Great Depression in the 20s and 30s. For an eye opening and exciting read of Chinese offensive capabilities, be sure to read this November 2010 article from Seymour Hersh in the New Yorker.

Many hedge funds are breathing a bit easier this morning on the news that the threshold for 'systematically important' institutions will be $50b. This exempts most hedge funds from the increased regulatory scrutiny that comes along with that 'systematic' label.

The credit strategy group at JPMorgan recently raised their asset allocation in credit to neutral, from underweight, citing attractive absolute yields, inflows into the sector, some "hints at progress" in Europe and ahead of anticipated year end allocations into this "best asset class."

The team at UBS has highlighted a divergence in trends that may be applicable for our equity brethren. They note that while the trend of dividend increases is actually declining (3 straight quarters), the trend in equity buybacks (highlighted by Berkshire Hathaway) has actually remained robust increasing for the last 8 quarters.

For you Red Sox fans...or haters...the finger pointing has begun (in this Boston Globe article). Starting pitchers Beckett, Lester and Lackey were "drinking beer, eating fast-food fried chicken, and playing video games in the clubhouse during games while their teammates tried to salvage a once-promising season." The "consequences were apparent as their body fat appeared to increase and pitching skills eroded."

The animal spirits are happy this morning encouraged by strong comments from Geithner and payroll data coming in above expectations.

While speaking yesterday afternoon, Geithner said yesterday before the Senate banking committee that there was "absolutely" no chance that a big US bank would fail.

Non farm payroll data this morning was both above expectations and included upward revisions to the previously two monthly reports. Tempering that enthusiasm is the knowledge that the current 3 month average growth of ~97k is well below the needed 125-150k needed to keep up with natural population growth.

If you work as a lobbyist, it's likely you pulled an 'all nighter' last night reviewing the leaked draft proposal of the Volker bill. The WSJ highlights the following section as particularly worrisome for fixed income trading divisions : "[trading] must be designed to generate revenues primarily from fees, commissions…or other income not attributable to appreciation in the value of covered financial positions it holds in trading accounts." I've noted repeatedly that you cannot have liquidity without capital. If regulations impede, restrict, or forbid the ability of banks/brokers/dealers to hold bonds (even for a short amount of time), clients liquidity will be impacted. Glenn Schorr (Nomura) cautions that this draft could intentionally be dire "in order to facilitate further discussion during the 60-day public comment period."

In falling markets or dwindling liquidity, one is often forced to sell NOT what one wants but rather what one can. A Goldman piece warns (via FT/Alphaville) that this soon may occur with the French banks; what they can actually sell at the moment is US assets. They opine that the sales could be focused on "(1) aircraft leasing, (2) commercial real estate, (3) equipment financing, and (4) leveraged loans."

Markets can handle both good news and bad news. However, markets detest uncertainty. I'm concerned that the imminent and pending clash between Congress and the White House over potential tariffs on Chinese goods (as result of them being labelled currency 'manipulators') adds yet another healthy and potentially dangerous dose of uncertainty. This opinion piece in The New Republic (via Poltico.com) sums it up nicely.

You'll note that yesterday's rumor of a new round of Euro bank stress tests has been officially denied. Also, Sarkozy and Merkel are meeting this Sunday over their differences about how to implement a bailout package.

OFF TOPIC - I heard this fellow interviewed on NPR this morning and found him to be intelligent, articulate and enthusiastic. He has written a non-consensus op-ed in today's NYTimes titled "This War Can Still Be Won" about his experiences in Afghanistan. He is a Special Forces major who speaks Dari and just spent twelve months embedded with the Afghan army (his impressive bio is here).

Jobs, showers and a point

There seems to be increasing realism in Europe. On one hand, the ECB buying of debt is actually having meaningful impact; perhaps it's fleeting but it's tangible at the moment. In addition, the talk of another round of European bank stress tests has the revolutionary idea of....gasp....using market values for sovereign debt.

The recently conducted Spanish debt auction resulted in yields that were a full 130bps lower than the previous auction. You can thank the ECB purchases for that....but before you yell "Ole!" please recall that Spanish gov't yields are still at historic wides versus German gov't yields.

On the matter of the coming stress tests, I discovered (via FT/Alphaville) a fancy interactive graphic tool here to input your own variables for a customized Euro bank stress test.

For those that watch retail investor behavior for leading but contrary indicators, please know that Morgan Stanley has set a record pace of issuance of structured notes to retail investors that are keyed off of interest rates. When mom and pop capitulate, it (name your sector/security/market) is headed the other way.

Ann Coulter, on the 'occupy wall street' protestors: "I am not the first to note the vast differences between the Wall Street protesters and the tea partiers. To name three: The tea partiers have jobs, showers and a point."

Be aware of Geithner on the tape today at 2pm on the domestic jobs bill and the European crisis.

Hope, hackers and clueless

If I were banned from looking at the screens this morning and simply read of a 3 notch Italy downgrade, Deutsche Bank speaking of "significant and unabated slowdown in client activity" and more proposed legislation of a financial transactions tax, I would think we'd be opening weaker.

But alas, apparently hope, still springs eternal and the risk markets are rallying to start our day. 'Hope' is currently taking form of 'IMF support'.

Eric Beinstein's (JPMorgan) excellent data and research shows that the broad corporate market's negative basis is narrowing to it's tightest level in over a year (with the exception of a brief spike the day of the US AAA downgrade). A narrowing (negative) basis implies that cash bonds are less cheap to CDS. When cash bonds rally vs CDS as they are now, it's usually a sign of sustainable demand for corporate bonds. When CDS rallies, it's usually 'fast money' or the dealers who's time horizon is typically much shorter.

Once again, Costco announced strong earnings. For the majority of this year, the credit markets have viewed Costco as more creditworthy as the US Treasury (comparing the 2 credit default swap spread levels).

Marketbeat/WSJ note that the S&P closed on October 3rd, 2008 at 1099.23. Yesterday, October 3rd, 2011 it closed at 1099.23.

For Warren Buffett watchers, he gave a fairly lengthy interview (here) yesterday. His broad observations started with "our housing-related businesses are as bad as they've ever been during this period. Everything else you name is up. And our railroad carried 200,000 car loads last week, that's the highest total in three years."

While most in our industry view 'occupy wall street' as completely clueless, Erin Burnett at CNN managed to capture and confirm this thesis here. She asks a protester if he knew that the bank bailout package actually made money for the taxpayers and he replied "umm, no" and conceded that that information would change his thinking.

Forgive me for sounding like Chicken Little, but a fairly effective and well known hacker called Anonymous has targetted the New York Stock Exchange. Previously, he successfully took down PayPal and Mastercard. While he, or they, haven't specified whether it will simply be nyse.com or the actual market infrastructure, I believe it warrants notice....so tread carefully on Monday October 10th at 3:30pm. CNBC has the video threat here.

Them there CDSSers

I'd be regurgitating old information were I to cite the drivers of today's malaise in the risk markets. Have no fear, the Fed will "continue to closely monitor developments" according to Bernanke at Congress today. I was really hoping he would stand up and say "this is John Galt speaking."

The New York Fed released a very interesting study about CDS trading. Some of their observations and conclusions may come as no surprise to someone that has actively traded them while other points were long suspected but never confirmed. In what is becoming patently obvious at the moment, the report noted "little evidence that dealers hedge large trades" and that they "typically hold on to risk taken on in customer trades for some time." Also, only 500-100 unique participants trade on a daily basis (in single name CDS) and over half the transactions occur between the G14 dealers. The 'majority' of single name CDS traded "less than once a day" while the "most actively traded changed markedly over our three month sample." All in all, it's a must read.

Dick Bove released an assertive report stating that bank stock declines are overdone and should be bought. You can read his brief rationale here (via Dealbreaker.com).

Waiting For Superman

Greece remains at the fore of the risk markets yet again. This time, the release was notable not for it's content but rather it's honesty and realism. They admit that they are unlikely to meet the deficit targets set only months ago.

As you well know, when credit spreads for a certain issuer invert, it means there is concern about the credit. The most visible and broad intra-day index in the credit markets is the CDX. Their 5yr and 10yr spreads are now the narrowest (i.e. still normal, not inverted) that they've been in ~15 months. Please be aware that the CDX does not contain and banks/finance entities (who's curves have been flat/inverted for some time).

One of the primary drivers of the longer term sustained rally in credit has been strong retail demand for the product. The most recent AMG data shows sustained, but subdued, inflows into taxable bond funds....but if you remove ETFs, that turns to the first (small) outflow in several weeks.

While this observation may be too late to make you any money during this move, it's one to be aware of nonetheless. The CRB RIND index is a commodity index made up of basic commodities (details here) that are not primarily traded on a futures exchange and therefore can be viewed as less influenced by speculators. During August, the regular/normal CRB index rallied strongly causing some to believe commodity prices were moving higher. Astute observers, namely Julian Garran at UBS, warned not to believe the hype and that commodities were still weak and weakening. Alas, he proved right this time as the broader index eventually retreated. On Bloomberg, it is CRB RIND .

The Sunday Times is reporting (via FT Alphaville) that Goldman will be zero-ing out their bonuses and attempting to hold their revenue pay out ratio to an all time low of 35-40%.

As recounted by former Senator Phil Gramm, when Abraham Lincoln first met Harriet Beecher Stowe, he allegedly said "so I finally get to meet the woman who wrote the book that started the Civil War." Her book had humanized the outrage of slavery and moved it from a distant concept/practice to a painful reality that needed action. Senator Gramm went on to say that the movie Waiting for Superman will be the Uncle Tom's Cabin of our generation.

On the beach

Alas I find myself in a similar situation to when I first started writing this blog in the beginning of 2009. Due to decisions made well above my pay grade and across the ocean, I find myself 'on the beach' once again. Before you immediately put my missive on the junk/spam filter watch list, I assure you that I will not be sending many of these. Hopefully only a handful as I have already been re-engaged by several potential future employers.

I'd like to say I'm back due to popular demand. Exactly two friends responded "good, now you can re-start your blog" when they learned of my recent departure from the payrolls of a large bank.

My first observation is a repeat of a long held belief that 'you cannot have liquidity without capital.' Take a look at this graph (Fed data) of US broker/dealer holdings of corporate bonds:

The capital provided to clients as liquidity to trade corporate bonds has fallen off a cliff. The non-capital/agency dealers must be licking their chops. However, it can take a long time for large institutional investors to alter their thinking and trading styles to a more 'patient liquidity' model.

My second observation may be overly simple and perhaps naive. There are few, if any, investors (in any asset class) that believe the European sovereign situation will improve any time soon. In my >20 year career, every single time the entire market felt the same way about a future outcome, that particular outcome rarely actually occurred. While I'm not predicting an immediate positive solution/outcome to Europe, I would posit that a 'positive' outcome would like be the most disruptive to the market. Witness early 2010 when almost every single investor (ex Rick Rieder @ Blackrock) thought US rates were going to rise dramatically. They made salient fundamental and technical arguments for why this was inevitable. Yet, the exact opposite occurred. Back to Europe, be sure to read, or re-read, Michael Lewis's very prescient article from October 2010 about Greece.

Many have observed that Wednesday night was perhaps the most exciting group of games in baseball history. The NYTimes has an article where they write that the odds of those particular game outcomes were 1 in 273 million. In addition, on a more painful and personal level, they note that the odds of the Red Sox making the playoffs, as of September 3rd, were 99.6%.