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Friday Review: Market Paints Tape, Credit Event Looms

  • Written by Syndicated Publisher 1 Comment1 Comment Comments
    December 10, 2011

    Today was paint the tape day. Make it appear that markets were expressing their support of the EU summit and that confidence has been restored. Looking purely at the SPX today it was a smashing success. The Dow recaptured 12,000 they are probably proclaiming on CNBC. Oh joy. What does that even mean by the way?

    Look closer though at other asset classes and today was nothing but the old “lipstick on a pig” trick. The same which can be said for the EU summit. As an example of the efforts made to show confidence Zero Hedge put out the following tweet early in the trading day.

    “Trading desks reporting forced by ins in fnancials citing rule 204 even with pre-borrow.”

    Rule 204 is from the SEC and is meant to address the failure to deliver aspect of short selling. In other words today the SEC told brokers to close out any shorts (buy to cover) in financials that have a failed settlement. Why today? Is there a reason the financials need to be bid up today?

    Remember, “this is a credit driven event that equity will be forced to acknowledge.” I’ve said countless time to wrap your head around this trade. Understand it and what the basis for the trade is because the mainstream media does not. In an effort to explain daily price action they will make up excuses. They will be wrong and they will misguide you. This trade is driven by the events in the credit and currency markets. The ES can fight it but only for so long.

    The question becomes has the credit event changed? Have currencies signaled a change?

    Credit Event

    One key measure of stress within the credit markets is the demand for US Dollars as measured by the EUR basis swap. When the central banks expanded their swap lines last week the market rejoiced and the EUR basis swap rose (less negative means less demand for USD). For a few sessions the EUR swap continued to improve slightly until Tuesday when it reversed course (from -109.25 to -116.50). It deteriorated further on Friday courtesy of Zero Hedge’s Bloomberg shot below.

    The central banks failed to quench the thirst for USD.

    Another measure of stress in the credit market involves the negative yield as it relates to the leasing of gold. Reader Rob has been pointing this out and the drop in rates has been rather precipitous. In other words I will lend you my gold and pay you interest if I can borrow your US Dollars.

    Another piece of anecdotal evidence as discussed numerous times relates to the loss of confidence that resulted when MF Global when bankrupt. The exchange which was meant to be the backstop between counterparties and guarantee a trade has failed to such. The CME has tried to offer a few hundred million to help with the $1.2 billion in customer capital that has vanished but that’s it. As Jon Corzine so “eloquently” stated before Congress “I don’t know where it is.”

    Below is an excerpt of a Jim Sinclair interview on King World News. The interview is in the context of buying gold as a hedge which I am not supporting or discouraging but the context of his words as they relate to confidence are spot on.

    “How can you have your money anywhere, Eric, and expect and feel certain that this money will be returned to you when you see the inner workings of finance and Wall Street through the eyes of the collapse of MF (Global)?  Totally shocking.

    We are in the midst of a crisis which is so complex that the public generally doesn’t understand it.  This event is so complex that I’m not sure professionals reporting on it or possibly even a good deal of the management of companies operating in it totally understand it.  The derivative is ahead of the client.

    So in the Lehman case the banks just took out Main Street.  When MF Global went down, that broke the mechanism.  The sharks will eat the sharks now because in the case of the clearing house, what you are taking out are the traders and investors who had confidence that a clearing house meant their money was safe and segregated from misuse by the management of the clearing house.  You lose confidence in that, how do you settle trades?

    Today it’s not a question of will your investment come out correctly.  Today it’s a question of whether the money you put into the investment will ever come back again, regardless of what the quotation is.  The only money I can count on is the gold I own.  Everything else depends on the system.”


    Huge divergence today between equity and the currencies. AUD/USD up .45%, EUR up .25%, USD (DXY) down .25% while the ES was up 1.7% and the TF (Russell futures) up 3.25%.

    Look at the intraday chart below of the ES (SPX futures) versus the EUR/USD. Today’s entire move was not supported by the EUR nor any other currency. The simple truth behind the US equity markets is if you can ramp the futures you can ramp the market regardless of other asset classes.

    So it may appear all is well but credit nor the currencies are in supporting such group think.

    Bottom Line

    Stay focused on this trade. Traders talk about being mechanical in their actions. Let this thesis be the same for you. Days like today are difficult but ask yourself has the credit event changed? Has it improved? Are the currencies supportive of higher equity prices?

    The action this week by the ECB and EU Leaders was an epic failure. Rather than offer solutions they in fact retreated. They didn’t even announce another summit let alone some rumor to buy more time. The danger now lies when investor sentiment makes that final shift these leaders will be in a position of weakness. Perhaps it will force their hand at Euro Bonds or a smaller EU but that road travels through a crisis.

    This weekend may be the start of downgrades by the rating agencies. The media and market will tell you to ignore it. That the implications are negligible. Tell that to the repo market where the collateral posted by those downgraded will generate less marginable debt. Tell that to investors who are seeking safer debt to invest their capital. An already strained interbank lending market is about to get even tighter.

    If I am wrong in this trade thesis I will know when I see improvements in credit. When I see the demand for USD fall then it will be time to step aside. I see the contrary though. I see credit deteriorating and entering a truly dangerous phase. This weekend’s Macro View will highlight what may very well be the final stage in the credit crisis.

    Images: Flickr (licence attribution)

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