Fin/Inv

Charting is a bit like playing chess. Every technical analyst commands a particular repertoire of technical patterns, instruments, momentum indicators, resistance/support lines, trend biases, trading tools, etc. In the end we all somehow try to anticipate what will happen next - or at least attempt to consider various scenarios of what could happen at what stage if x happens or y will not. From there you plan your next move - and you better anticipate how the market will react to it. If you get married to a particular idea it’s checkmate in three moves or less. Which happens when you fall in love with a particular wave count and refuse to consider other scenarios.

Good analysts know that in many cases they will be wrong and if they somehow manage to survive for more than a few years the lesson learned is not how often you’re right but what you do when you turn out to be wrong (which will happen regularly - get used to it).

When looking at the current chart in the context of all my complementary tools I have very little confidence in proposing what’s next. Frankly - at this stage it seems we are stuck in complete limbo - or what I call ‘end of second wave limbo’. Let me explain:

As you can see there are various ways of how we could count this pain in the ass of a tape. Maybe we completed Minor 2 yesterday (blue) or will do so after a push into 1,128 (light blue). We all know what should come next and it would make any put holders very happy. However, life and especially trading is usually not that easy. If we push higher from here it’s also very resasonable to count the advance as a motive, which would suggest that we are completing Minute {i} of Minor A (green). This would be followed by Minor B, the first half of which would look to the bears like the onset of Minor 3 to the downside. Which would be tantamount to a bear trap clusterfuck of death star like proportions. Not a pretty picture.

I hate second waves - especially in the past year or so - because more often than not they have turned into A waves which were followed by long and painful short covering C waves a few weeks later. Even if you bulked up at the very top (like yours truly) you still suffered from theta burn by the time you figured out you were on the wrong side of the trade. As I said - not a pretty picture.

So, what to do?

Play it long term. You can’t win this one. News do not matter. Good economic news might actually tank this market while bad news might rally it. Too cynical for you? I really can’t blame you - but read this first. The magic word is quantitative easing (i.e. money for nothing and chicks for free) and it’s what has kept this turd of a market melting up and now holding up in the face of a tumbling Euro (and rallying Dollar).

TA does not matter either. I can post all the wave counts I want - it won’t really help you negotiate the mind fucks they’ll throw at you in between. Come on - how many postings and opinions and comments have you digested in the past few months? Did any of them lead to a successful trade? Rarely - and you know one when you see one as the setup is often too sweet to pass up.

Play it long term. You can’t win this one. They will fake you out if you play the small moves. It’s quite simple: Either we’re wrong with Primary {3} or we’re right. If we’re right we’ll bank a shit load of coin as we are among a small minority. Yes, doesn’t feel like it here, but we all exist in our respective monkey spheres. Trust me - 99% of all market participants think the bull market is back - we are crazy to think otherwise. Or are we?

Play it long term - especially if you trade options and hope for P3. If we’re wrong - well, we’ll know soon enough. It might take a few more weeks to get out of second wave limbo but we will. One way or the other. Once we get verification it’ll be too late to jump into the game as things will move rapidly and you won’t be able to get positioned. The pain you are going through right now is the price of admission - deal with it.

Play it long term.

Cheers,

Mole

P.S.: Did I mention to play it long term?

P.P.S.: OR - play it very short term. Ever heard of Geronimo? No? Your loss…

I didn’t have an opportunity to post during the session today but wanted to share a few thoughts with you ahead of tomorrow’s session.

Clearly the bears got burned today and that OPX gangsta style. The tape ramped all day and there was nothing but fear and short covering among the bears. NYSE A/D ratio closed at 4.7, the highest reading since November 10th. So, just looking at the momentum chances are we are already tracing out Minor 2 of Intermediate (1) - or worse

The ‘good news’ for the bears is that we should get confirmation very soon. I’m currently counting a zigzag followed by a flat. Look at that fib I painted from the bottom of my x wave. Traditionally the maximum length permitted for the c wave of a flat is 165% of its a wave. What’s really interesting about this Maginot line (look it up) is that I actually had drawn this fib during the session - way before we touched it at the close - funny how that works out sometimes.

If this is really some type of alternation (EWT speak for a combination of various corrective waves separated by an x wave) then it should stop in its track right now and here. If we push much higher chances are now increasingly pointing towards the Minor 2 scenario. Again, this is merely academic for anyone holding long term puts right now. Just so you know what you are dealing with: A Minor 2 wave can correct almost all the way to the prior high, which would be 1,150.41 - so theoretically we could push to 1,150.40 and the current count would be maintained. The second we run beyond that the entire Primary {3} scenario goes out of the window and it’s back to the drawing board for the bears yet again.

But it’s way too early to worry about that. The Dollar has been digging in its heels and conversely the Euro has been lagging the advance we’ve seen in equities. Therefore the odds still point to either Soylent Orange or Soylent Blue - pick your poison.

Early retracements can be violent and scare off the bears hoping to ride the wave down - and in the end lure them into giving up long term positions. This is part of the game and if you don’t have the brass balls to ride this out then you’re going to be left behind sooner or later.

But yes - we can’t keep running like this forever - would be good to see this thing slow down and that soon. Especially since the time cycle has now shifted downwards again - if we are starting to break away from that and there is follow through to this rally then the bears might be in trouble. I would have preferred to not see a new high for the year in the NYSE A/D department - that’s a bit concerning. Let’s keep that in mind as we run through the rest of OPX week.

Cheers,

Mole

Pressed for time this weekend - let’s get right to it. The battle of the titans looms as we have reached a fork in the road. And as the late Yogi Bera** put it so aptly:

When you get to a fork in the road - take it!

Arguments for the bears:

The Dollar bear squeeze has had the carry traders on the run. But it’s now reaching an inflection point where the Euro baby’s got decide what it wants to be once it grows up - become a bear (i.e. let this turn into a third wave), or grow some brass balls and turn into a raging bull (i.e. the drop we saw since December was a merely a-b-c retracement). Either way, I don’t think this thing is done yet as the divergence painted here on my Euro/Equities chart looks like an equity bull trap me.

Let’s zoom out of the actual Euro futures chart and for a second digest what’s been happening in the past few weeks. We basically retraced seven months of painstaking upside progress in a matter of two and half months. That’s quite a drop and it’s been quite violent. Yes, there is the possibility that it’s only a retracement but it sure ‘feels’ like something else.

Now let’s hear from the bulls:

If I drink my own kool aid I should be anticipating Minor wave 2 snapback in equities here, at least very soon based on the 10-day MA channel the CPCE painted over the past 10 months or so. This is the chart that should make the bears very nervous as the snap back will most likely be very violent. If it comes, let ‘er ride and don’t go short too early. However, once we drop towards the 0.55 range again get positioned for Minor 3 of Intermediate (1) of Primary {3} - it’ll be fun.

Nothing really sensational on my wave counts - everything is still in play. As I said last week - Minor 2 will be confirmed at 1,104.75 - the difference is only intellectual as theta burn and drops in volatility hurt one’s options either way

The orange scenario requires new lows and a drop through 1,045 - if we get it what follows could be very ugly for anyone holding long positions, so make sure you’re properly stopped/hedged.

Next week will be very important - it’s OPX week again plus we are rolling into a potentially bearish time cycle. Which is why I’m a bit skeptical about the bullish scenarios but felt it to be my duty to offer a counter perspective. Expect some volatility, headfakes, and general craziness until the tape decides upon a direction.

Just to remind you guys that Monday will be Presidents Day in the United States (originally dedicated to Lincoln’s Birthday but they have to honor every asshole these days - who’s that Washington dude anyway), so the cash markets will be closed. I think the futures might have an abbreviated session - not sure actually.

Bottom line: Chances are we will pull out of this limbo territory soon as it is now time for the real Slim Shady to stand up:

Cheers,

Mole

** He’s aliiiive - alliiiiiive I say!!!

I keep telling you guys that the news don’t matter. Which doesn’t mean they can’t spike the tape for a few hours - but if you trade on that time scale you’re either a pro and have the inside track or chances are you usually find yourself on Lester’s side of the trade (don’t ask).

Let’s talk about the Dollar - as gmak pointed out this morning, its inverse correlation relative to equities is holding up well and although we don’t trade correlations it’s clear right now that a rising buck presents a headwind for bulltards. So, I wasn’t surprised to see a drop in the DXY this morning after the Greek bailout news made its rounds.

The chicken hawks are ready to buy the dip and the bears should look towards the DXY (or EURUSD) for clues as to whether this is just the completion of an Minuette c wave (i.e. Soylent Orange) or the beginning of a Minor 2 retracement (i.e. Soylent Blue). Well, let’s consult 2sweeties’ DXY oracle - as usual courtesy of retracementlevels.com - I recommend you go and check out the wide selection of statistical trading tools available.

Rule #1 is that we must not breach 78.45, which is the top of Minor wave 1, according to my current count. If we do then it’s back to the ole’ drawing board.

There was no daily long RL right above 78.45, which is why I cheated and set the 100% mark at 78.386. It’s not that I wouldn’t expect a bounce there - it’s just that I probably would not want to go long for more than a day as my wave count would not be clear. Again, if you don’t put any stock in EWT then just ignore this bias and trade what you see according to your own system.

As you can tell the odds are not too great until about 79.171, so it’s possible we drop into tomorrow - be cautious and set your stops if you go long at 79.656. Again, this is assuming you use stops - 2sweeties does not and instead adds positions on the next long RL. For more details I strongly recommend you go and peruse his tutorials - it’s a different trading system than what I’m doing. It’s working fine for 2sweeties and if you have the discipline and the capital it might work for you.

The frequency tab is a bit more accommodating. I see a high frequency of support starting at 79.65 all the way through 78.38. 16% is a strong reading and if you combine the roughly 80% odds at 79.171 with close to 16% frequency I’d say that it’s reasonable to assume a bounce there. IT BETTER! Because if it fails that mark the Dollar bulls (i.e. equity bears) could be in a world of hurt. I’m talking Soylent Green here - not Soylent Blue (see my Sunday analysis for details on this).

Alright - hope this helps my stainless steel rats - always remember that Rome wasn’t built in one day. Give it time - expect snap backs - follow your charts/systems. BE DISCIPLINED - don’t let your bias go in the way of your trading - I know it’s hard and I keep telling that myself on a daily basis.

Cheers,

Mole

P.S.: Thanks for gmak for whipping out a post this morning - really appreciate that considering you are fighting off the Hantavirus and H1N1 at the same time.

I wonder if the boyz are saving their ammunition for the last 5 minutes again. As I pointed out yesterday afternoon - the JPM sponsored short squeeze late Friday was not confirmed by market breadth, the Euro, or any of the momentum indicators I’m looking at. It might actually have been counter productive to the bulls (i.e. VIX ended inside the 2.0 BB) and today’s regularly scheduled ‘Monday Melt Up’ seems to be a non-starter thus far. Yes, the final hour looms ahead and it’s possible that this is only a b-wave of a Minuette degree a-b-c correction.

The bulls need to get their asses out of this downside channel. They tried this morning but didn’t get very far - there is simply not enough participation on the long side. The Dollar is hanging on stubbornly as the Dollar bears may be using this little reprieve to settle/unwind some of their positions.

As the old saying goes: You can fool some of the people sometimes, but you can’t fool everyone all the time.

Again, I would not be surprised to see a late day surprise move by either JPM or GS - but even if it comes - ladies and leeches - before you panic over a few handles to the upside:

THINK LONG TERM!

All the wave counts are still in play - no changes.

Mole out.

Equities remain bid challenged - all $NYMO divergences notwithstanding. A good lesson of not succumbing to recency bias? Maybe - meanwhile sit back and watch the market do its equivalent of Goofy’s Holler:

It’s not all just fun and games at the evil lair however - after all we busy working to separate pig faced bulltards from their ill gotten gains:

I love those Fib extensions in TOS charts (hint hint - T.K.) - if this is not an a-b-c (if it is we’re screwed) then we should be breaching the 1000 mark in a jiffy. Also shown on the chart is the monster divergence between the Euro and equities which developed in late 2009 and finally resolved in late January. I kept harping on that fact for weeks, pointing out that the bulltards could only ignore the Dollar bear squeeze for so long. Hey, I’m trying - not my fault if nobody listens.

This fine chart was posted by brother Jeff Kohler over at OptionAddict.com. Jeff rightly points out that we again are looking at a bullish divergence on the NYSE McClellan (a medium term trend indicator). He’s right - only question here is if the resolution will be the same as during the uptrend. However, I’m willing to consider the possibility, which is why I posted the chart on top. We need to get out of an a-b-c scenario and for that to happen we need to push past the 165% mark (which is how far a C wave ‘usually’ extends) which would occur at (drumrolls) 971.80. If we get past the 990 mark I believe we actually have a chance of getting past that point.

So, we have quite a bit to go until we can pop the Cristal - but thus far I’m liking the ride

BTW, the Dollar is on a tear - so far the retracement levels on the DXY are working like a charm. We are now near a 14% short RL which is 80.7 - either cash out here or wait for 81.7.

I see some dip buyers jumping in - it’s long overdue - if this mark doesn’t hold right now we are looking at some EOD nastiness.

Cheers,

Mole

I really like the developing wave patterns on the currency side of things. The DXY is right on track of tracing out an almost textbook third motive. Admittedly that’s a very early assessment but the first and second waves, as well as the currently evolving third wave look very nice in terms of form, sub-divisions, angle, and velocity. I know this doesn’t look like much to most equity traders, but let me assure you that a bunch of dollar bears are sweating bullets right now.

Where do we go from here? I think it’s up - at least until the 80/81 cluster. But let’s consult our DXY retracement calculator - courtesy of 2sweeties from retracementlevels.com:

As you know I always start with the odds and considering that this may be a third wave I am extra conservative and have placed my 100% mark at 83.44. Based on that the odds for a meaningful reversal are 75.73% at 80.7 and 87.45% one handle further up at 81.75. Now under regular circumstances I’d say that 75.73 would be a decent spot to get positioned for some short side. But again - we might be dealing with a third wave here and if I was planning to go short (which I don’t - only playing the long side) I would wait until at least 81.75. Please bear in mind that this bias is predicated on me having faith in EWT and its wave counts in the first place - if you don’t, then just fade my comment and focus on the odds.

The frequency tab tells a bit of a different story. There seems to be a a cluster of reversals around 80.7 and even a stronger one at 80.06. The next two above (81.75 and 83.44) also have respectable frequency readings above 10%. What to do - what to do?

I think at the current stage of the wave count trading the short side might not be the most profitable endeavor. The main trend seems to have switched to the long side and thus it is here where you should expect to see some nasty surprises - the bucky bear squeeze is on! If you are long since 77, then either take profits at 80 or hold to see 81.7 or 83. The wave count appears to be progressing nicely and we should not fall into the trap of over trading.

If you simply look at the chart it’s quite clear where the resistance clusters will slow the Dollar’s run. Bundle in the odds I proposed and the long side is promising right now. Also, once we get a reversal in the form of another sub-division we might push up hard in a third-of-a-third type scenario. This is the money trade we should be looking to get positioned for. I will keep you guys posted when we are getting close.

BTW, if you’re interested in trading currencies like the pros by facilitating statistical odds head over to retracementlevels.com and pick among various daily calculators:

• EUR/USD
• GBP/USD
• USD/CHF
• USD/JPY
• AUD/USD
• UUP
• UDN

If currencies aren’t your thing then 2sweeties’ got your back:

• Gold COMEX (GC)
• Hang Seng Index (HSI)
• Nasdaq 100 Index (NDX)
• Oil (CL)
• PowerShares QQQ Trust (QQQQ)
• Russell 2000 Index (RUT)
• S&P 500 Index (SPX)
• SPDRs (SPY)
• S&P/TSX Composite Index (TSX)

And those are just the daily indicators. I personally use 2sweetie’s hourly E-Mini S&P 500 (ES) and I wouldn’t even thinking about touching a contract without checking the odds first.

UPDATE 4:00pm EDT: PRSGuitars is back with a vengeance - I’m posting his very interesting chart without commentary as I’m not following this particular pattern.

I would however love to see it play out But again - this is one of those ‘exotic ones’ (at least in my book) I leave to others to follow. But I must point out that the resolution does coincide with my own wave count - so we shall see.

Cheers,

Mole

The Daily Gold blogger Harvey Organ reports that ECB and other Central Banks are terminating the currency swap with the US Federal Reserve Bank as of Feb. 1, 2010. How they are going to unwind the currency swap is something very interesting to watch. It could finally trigger the long expected US dollar crisis: Collapse of the US treasury market and the US dollar itself.

In a currency swap, two central banks print their own currency out of thin air and swap them in a zero interest loan according to the exchange rate. Then after a period of time, they return the loaned currency to each other. For example the FED will loan US dollars to Bank of England (BOE) while BOE loans British Pounds to the FED. Upon the end of currency swap agreement, they unwind the trade by the BOE returning the US dollar, and the FED returning the British Pounds.

The question is how they are going to be able to unwind? The total swap is believed to be as high as US$500B. Some say as high as US$2T. If the central banks merely locked up the cash in a vault, they could easily return the money. But that would defeat the whole purpose of currency swap. Instead of being locked up in a vault, the swapped currency must have been SPENT in some way. Then the question is how do they get the money back if it is already spent, sold out or otherwise given away?

For example I long suspected where did the British get the money to buy US treasuries over recent times? According to latest official data, UK's holdings of US treasuries was up $145.1B in 12 months, while China's holdings went up only $76.4B.

Where did the UK get the money to buy US treasuries? Unlike China which earns US dollar from its trade surplus against the USA, The UK has a huge trade deficit against the USA. It spend US$2 buying US goods for each US$1 it earns selling products to the USA. Where did they get the US dollars to purchase US treasuries? If it was not from trade balance, it must be from the give out by the FED, in the name of currency swap. It cost UK nothing to print British pounds and then exchange for the dollar, just like it costs the FED nothing to print the dollars.

In a sense, FED is secretly buying our own debts through foreign hands, via the currency swap agreements!!!! Now, how is the currency swap going to be unwinded? What magic are they going to pull this time, asn the BOE has already SPEND out the US dollar in buying US treasuries. It does NOT have the money to return to the FED.

Likewise, probably the FED does not have the money to return to BOE either. They must have spent out the British Pounds as well as other foreign currencies, in repeated attempts to sell foreign currency and buy US dollars, to support the dollar, in recent times.

It's going to be fun to watch how the unwinding can be done. If my speculation is right, BOE must sell its holding of US treasuries to raise US dollar to unwind the loan, and the FED must also need to sell dollar and buy British Pounds to unwind its loan as well. Both would be fatal blow to the value of US treasury and US dollar.

Time to run to precious metals as your financial safe haven. Don't run to euro, as the eurozone is crumbling down. Don't run to Japanese yen. Japan has an even worse debt problem. When Japan collases under its debt it must sell US treasuries to salvage its own currency, which will trigger a domino effect leading to the fall of the dollar. The only thing safe are precious metals and commodities.

But unlike most other precious metal bugs I will not tell you to run to gold, or silver. Every one talks about gold as if it is the only safe haven. When every one talks about one thing, be careful. The world is not in shortage of gold. The world has plenty of gold that could easily lasts a couple thousand years if we do not produce gold any more. Warren Buffet famously critized gold by saying that you dig out the metal from the ground, and then dig another hole to hold up, and have to pay armed guards to watch it, what for?

I am also questioning the wisdom of silver investment. Silver bugs have been calling for silver shortage for years. But I never see any solid data to back up the claim of shortage. If there is no shortage, if a precious metal's price is only supported by investment demand, then there is a problem because anything that is purely supported by investment demand, is by definition a bubble, the investment demand could easily turn into investment supply in an instance.

The only good precious metal investment, must be one which is based on REAL industrial shortage, not by the hypothetical investment demand. If there is an industrial shortage, the price MUST go up regardless what investors believe. And price movement due to real shortage, on the other hand, can create solid and reliable investment demand. Such precious metals will provide the best performance way much better than gold.

The only two precious metals I see solid data to support a supply shortage case, are platinum and palladium. Of course my favorite is PALLADIUM. My most favorite mining stocks are Stllwater Mining (SWC) and North American Palladium (PAL), the only primary palladium producers. Russia's Norilsk Nickel (NILSY.PK) is world's largest palladium but they are mainly a nickel producer. South Africa's Anglo Platinum (AGPPY.PK) and Impala Platinum (IMPUY.PK) produces by-product palladium. Watching Platinum Today on related PGM metals news, and KITCO for price movements.


The parabolic price rally of palladium in the past one year, a performance that is far better than gold, silver and platinum, has vindicated my conviction on a palladium bull case.

Why palladium? FOUR things make palladium extremely bullish:

1. Termination of Russian government palladium stockpile sale, due to stockpile depletion.

2. Looming South African electricity crisis could strike again any time, just like two years ago.

3. Launch of ETF Securities physical palladium fund (PALL) in the US market.

4. Long term potential of palladium used in Cold Fusion, make it a must have strategic metal.

I have discussed these points in many of my past articles which I will not repeat. I merely needs to point out that Impala Platinum's PGM Supply Demand data confirms dramatic reduction in Russian palladium supply, as the stockpile sale has ended. There is now a big strictural deficit. Read more detailed discussions on GIM forums.

I do not have to cover the recent launch of ETFS platinum and palladium funds, either.You can see the powerful price surge of palladium recently, and read what fellow SA contributors have to say:

Why Gold ETFs Should Be Afraid of Platinum Cousins
Platinum and Palladium ETFs: Dare They Outshine Gold?
Platinum, Palladium ETFs Are a Home Run
Pent-Up Demand Is Behind Platinum Fund's Success
New ETFs Off to Roaring Start
Don’t Blame Platinum, Palladium ETFs

Sadly, even though people have caught attention to platinum and palladium. There has been absolutely NO mentioning of the end of the Russian palladium stockpile sale, and how palladium rallied from $300 to $1100 in 2000 merely because of a FALSE rumor related to the stockpile sale. Nobody mentioned the South African electricity crisis either, even it triggered quite a rally in PGM prices in early 2008, and another South African electricity crisis is looming again in the near future. Please read the background discussions.

And yet most people don't even know about platinum and palladium. All they know is gold gold gold, silver silver silver.

Let them have gold. I want to have palladium. And I can not own enough stocks of SWC and PAL. I have been predicting and advocating for a super bullish palladium rally for almost two years. No one paid attention until it really happens.

But this is just the start! The real fun will begin when auto makers realize what's going on in Russia and South Africa, and start to panic hoard. If it were not for the foolishness of major industrial user like TOYOTA(TM), GM and FORD (F), rhodium would never see gigantic price swings from $300 to $11000. Shouldn't industrial users acquire and keep a plentifully large stockpile when rhodium was at $300, so they do not need to pay $11000 an ounce a few years later? They never learn.


Full Disclosure: The author is heavily invested in palladium mining stocks SWC and PAL, and own PALL. The author owns silver mining stocks like CDE, SSRI, PAAS but have no interest in ETF funds GLD and SLV, as I do not trust their gold and silver holdings.

I actually meant to post this an hour ago but then received and important phone call. My apologies but right now I’m being pulled in ten different directions. However, I expect things to go back to normal again starting February - so please bear with me.

What I’m seeing right now points towards an inflection point between Soylent Green and Soylent Orange. Since I snapped this chart we’ve pushed up a few more handles but participation is a bit mixed - I’m not ruling out either until I see some follow through in the final hour today.

Highlighted on the chart is the level of pain both bears and bulls have been exposed to in the past three months. It’s been one big whipsaw of hell and it’s wearing everyone out. But let’s also consider the good news here. We bears have been bitching about those ‘damn dip buyers’ swarming in on every drop. Okay, put yourself on the other side of the equation. How about those ‘damn rip sellers’ that have made upside progress an exercise tantamount to clawing your way through a leech infested swamp filled with alligators? It’s always important to see both sides of the equation and believe me - if you’re a retail bull right now you’re not very happy either. The only market participants smiling all the way to the bank since early November are the market makers - boy, did those guys have some fun with all of us

I want to remind everyone to continue being focused on the long term. Obviously we retail traders can neither win the ramp & camp nor the drop & stop games (the latter being my own invention - copyright!!!). And we frankly should not be focused on the short term right now anyway  - which is not only a pain in the ass to trade but is also very time intensive and if you get it wrong once or twice chances are you lose everything you banked previously.

At the danger of sounding like a broken record: Look at this whole thing like a big chess game. Evaluate your options and consider various moves. Project ahead - and consider that the boyz will throw at us truck loads of red herrings, deflections, and misdirections before we see this thing swirl down the collective toilet. Bank on that - and then project out even further. Now you arrive at an Einstein point in time that is probably out at least 9 to 12 months - which will probably be the time needed for all of the tape propping and QE sponsored monkey games to taper out and this turd of a market to collapse under its own morbidly obese weight.

Quick glance at our Dollar odds - these are the short RL odds I posted yesterday. We are now near the 100% RL mark I picked - maybe I was not conservative enough given that I expected a third wave to be in the works. The next one up is 79.24 - if it pushes into that I expect to see at least a quick one day reversal. Would I trade that? Hell no - as I pointed out yesterday, the ole’ greenback is on a run now and carry traders are running around screaming with their hair on fire - deservedly so I might add

Okay, everyone now say out loud:

“Pai’-in”

Gotta love that Cockney accent… if you want to get laid here on the West Coast you better start practicing.

Be smart - shop Evil-Mart

Cheers,

Mole

Good ole’ bucky is bumping its head - I think we are looking at a rough ride before we see further upside:

The reversal cluster shown is based on the recent top as well as a month worth of sideways chop back in August 2009. This range needs to be overcome before we should expect strong/fast advances in the Dollar. What’s pretty apparent visually is also backed up by our retracement levels, again as usual courtesy of 2sweeties over at retracementlevels.com.

I set the 100% odds at the recent peak as advances have been slow as of late and were met with strong selling near the recent top. So, it’s reasonable to assume we will see at least a slight retracement should we push that far anytime soon. Based on that we are currently near a short RL with about 68% odds - not bad but not great either in my book. 77.92 looks juicier with roughtly 83.5%.

The frequency however is spiking right at the current 77.42 RL - so if you are adventurous this is where you might want to start going short ole’ bucky. If I was interested in going short here I would wait for 77.61 - after all we are expecting a third wave to the upside and if that one hits things will unfold quickly. Thus you don’t want to sell too far down as it might get painful if this thing rips higher.

In general I however don’t see a really clean and clear short trade right now - the main trend now appears to be to the upside and instead of going short I am looking for long entries. Perhaps that one has come and gone for now but if we get a drop below 76.5 I would be very tempted to short EUR/USD.

Cheers,

Mole

I’m sure you rats have heard of Ivan Petrovich Pavlov - if you didn’t have the luxury of a formal education let me enlighten you:

While Ivan Pavlov worked to unveil the secrets of the digestive system, he also studied what signals triggered related phenomena, such as the secretion of saliva. When a dog encounters food, saliva starts to pour from the salivary glands located in the back of its oral cavity. This saliva is needed in order to make the food easier to swallow. The fluid also contains enzymes that break down certain compounds in the food. In humans, for example, saliva contains the enzyme amylase, an effective processor of starch.

Pavlov became interested in studying reflexes when he saw that the dogs drooled without the proper stimulus. Although no food was in sight, their saliva still dribbled. It turned out that the dogs were reacting to lab coats. Every time the dogs were served food, the person who served the food was wearing a lab coat. Therefore, the dogs reacted as if food was on its way whenever they saw a lab coat.

In a series of experiments, Pavlov then tried to figure out how these phenomena were linked. For example, he struck a bell when the dogs were fed. If the bell was sounded in close association with their meal, the dogs learned to associate the sound of the bell with food. After a while, at the mere sound of the bell, they responded by drooling.

Now, don’t believe for a second that mental triggers are limited solely to the animal kingdom. Don’t believe me - think you’re purely rational? Alright, let’s do a little experiment:

Think about biting into a juicy lemon!

See what just happened? I personally felt a sour sensation on my tongue and there’s no lemon in sight. The same phenomenon occurs all the time and in various situations. Even when it comes to investing or trading the markets - no matter how smart you think you are. We are all creatures of habit and if we encounter a certain situation for long enough we eventually will get used to it and incorporate it into our mental framework. Case in point? Even we bears have become almost complacent in our anticipation of even higher tape - we’ve been burned so many times that we simply don’t want to touch that hot oven top even one more time. Every time we did - we got burned! So, going short equals pain - right? Of course not - timing if everything. But this type of mental predisposition is exactly what Curtis Faith refers to as one of the cognitive biases - in this case we are talking about a mixture of ‘recency bias’ and ‘loss aversion’.

Some will even miss a stimulus (no pun intended) once it’s gone - which probably explains some of the addict like behavior many traders exhibit once a long term trend turns in its tracks and takes out most or even all of the gains accumulated on the way up. And that is exactly what’s about to happen again - maybe not next week but most likely within this first quarter of 2010:

Yes, Pavlov’s dogs are drooling again

I have not bothered with the wave count for almost a month now - and the simple reason for that was that there was nothing to talk about (plus I was very busy). We needed a strong reversal to place some labels on our map and that came with Friday’s sharp drop to the downside. I’m sure that a bunch of folks betting on an expiry at 1150 still feel the sting today.

And although we might see a snap back on Monday or later this week the wave form in combination with various sentiment indicators dictates that this vapor rally is either over and done, or at least in its last throws. Yes, yes - that’s what I thought back in October and we got served a cold platter of kick ass. But the writing is now on the wall in the form of a looming withdrawal of the Fed IV drip that has kept this market on life support over the last year. Plus consider that avalanche of Alt-A mortgage resets ready to kick Wall Street in its collective groin all through 2010 and 2011. I’m sure you guys remember that mortgage reset chart behind my long term S&P outlook I posted a few months ago.

There is only one question you need to ask yourself today: Where is the real risk here, right now? Is it to the upside or is it to the downside?

Exactly.

Of course the slaughter scheduled for U.S. equities will not transpire in a matter of days or weeks. It will take months to play out - and thus we need to be clever and take into account how we can position ourselves with only minimum amount of risk and with a main focus on the medium and long term. Why? Because by the end of this year I expect the SPX to trade below the March 2009 low of 667. And by summer of 2011 we should be closer to 300, if not lower. An corrective third wave of the magnitude that lies ahead later this year has not been seen in over 80 years - it won’t be pretty and it will ruin the fortunes of many - unfortunately most of them innocent of the unmitigated greed and corruption that has afflicted Washington and Wall Street alike in the past decade. But that’s life - like in war economic crisis mostly affect the working class while the rulers and their cohorts sit things out in relative safety and luxury after having enriched themselves at the detriment of the majority. Is it fair? No, but unfortunately life is not fair - all you can do is to pay attention and push the odds in your favor a little. Which is what we do here - on a daily basis.

Short term we might see some flailing around on Monday or later in the week. Soylent Green is still a possibility and don’t fool yourself into believing that Soylent Orange is a ’shoe in’ - look how far we have come and how little we have dropped last Friday. Yes, it felt like a big victory - but it was nothing but a little drop into the bucket after a ten month long bullish rave party. There is a chance the bulls blow their load and push this thing into 1180. Doesn’t have to happen but if you’re short term oriented - be cautious and make sure you don’t trade the big picture with short term options that drain blood (i.e. theta) faster than bull with a matador’s sword in his heart. Which btw, will be my job all this year

The Investor Intelligence bull/bear ratio closed at 3.36 on January 12th - a new record for the past decade. Again, do you expect this ratio to push towards 3.5 or 3.8 before we turn? Possible - yes - but I keep pointing towards the long term here. I mean - wouldn’t now be a great time to think about hedging yourself to the downside? Option premiums are dirt cheap again and should we experience a correction to the downside the ensuing rip in volatility will be extremely profitable on the horizontal side of the option chain grid. Do I love long term options? No - actually I rarely trade them - but we are now finding ourselves in a very unique moment in time and each battle requires efficient weapons to come out the other end as victors.

I will talk about the Dollar tomorrow - running out of time here. But generally I don’t see anything in the way of the long term uptrend I have ben proposing for the old greenback for months now. It’s been a long time coming but thus far the developing wave form fits this general outlook.

As stated on this Euro/SPX correlation chart - equities can only ignore the dying Dollar carry trade for so long. The thing about a reversing currency carry trade is that it’s all about leverage - at the very tail end a lot of leverage is required to sqeeze profits out of the short end of your trade. When it turns you don’t want to be the last one rushing for the door out. Expect more strength in the Dollar in the months to come - and that will add to the headwind - or should I say shitstorm - that equity traders will encounter all year long.

Before I go a piece of bad news. On Friday afternoon Bloomberg sent me a cease and desist letter in regards to the charts gmak has been posting in the past few weeks. Now, before you bitch and moan about Bloomberg let me point out that this is a very reasonable request and that I was under the impression that gmak had received permission from Bloomberg to post his charts here. It’s quite possible that they are only looking out for their intellectual property and eventually agree that gmak’s posts only serve as advertising of their professional services. As a matter of fact he had been in touch with Bloomberg about this - but as I understand it only on a verbal basis and no written permission was given. So give me a few days to get in touch with their representatives and sort this thing out. Gmak is of course free to post any of his commentary or any of his personal charts. But until further notice you will have to do without gmak’s early morning caffeine boost - sorry - that’s life.

Let me make it also clear that our website, our activities, our products and/or our services have neither been authorized nor endorsed by Bloomberg or any entity otherwise affiliated with Bloomberg.

Cheers,

Mole

I like what I see in the Dollar right now - and I also enjoy equities steadfastly ignoring what looks like the onset of a multi month reversal in the old greenback - at their own peril I might add. Let’s again consult our tea leafs courtesty of 2sweeties over at retracementlevels.com:

Knowing Ben and his growing gang of carry trading Dollar foes I decided to be arch-conservative here and set the 100% mark at 75.35 - very close to the EOY 2009 low. And what do you know - the next two long RLs show quite promising odds at this stage. Me like

Now let’s look at frequency: Yes, we’re currently at the last high frequency RL - everything lower than that is pretty much unprecedented.

Finally, let’s correlate odds and frequency on the DXY chart fitted with an old fashioned fib retracement scale. I don’t know about you but I like those odds right now and the next line of defense isn’t that far off. If you’re long the Euro I would take notice and if you’re short the Dollar - well - good luck!

BTW, if you didn’t get my short call right before the close yesterday then you might want to follow my twitters as there’s more goodness to come in the coming weeks/months. In that context - I too short term profits half an hour ago and might dip into more puts at the EOD. Will let you know over twitter again.

Cheers,

Mole

Yesterday's most recent data from the Conference Board's Confidence Index recapitulates very well the Economic Inquisition purgatory that living in America has become: pain and suffering now, coupled with the promise of salvation and financial bliss at some point in the future. Of course, on a long enough timeline we are all dead, so it is only fitting that the administration, whose slogan had something to do with tangible change, is gradually encroaching on the Catholic Church's turf in an all out war for the souls of America's taxpayers as tangible becomes increasingly ephemeral and, well, intangible (save for unemployment and the wads of electronic cash deposited in Goldman Sachs' employees bank accounts - both of those are all too real). While the CBCC number came in at about the expected reading of 52.9 (from 50.6 in November), all of the "improvement" in confidence came from rosy future expectations, which rose to a two year high of 75.6 (from 70.3 previously). As for the present: current conditions plunged to another record low of 18.8. Never before has the differential between present pain and future hope been so wide.

The impact of this divergence politically is all too obvious. The voting population, which has been extremely patient, and keeps hoping that the future will finally bring something better and in line with oh so many promises, may very soon change their mood and realize that the present is here to stay, regardless of what the Fed manipulated capital markets demonstrate. When that happens watch for some interesting election fireworks on this side of the Potomac river.

Reading between the lines of the CBCC indicates that Obama and CNBC's grand plan to get consumers to spend, spend, spend again has fizzled. Autobuying intentions dropped to 3.8 from 4.5 in November, the lowest read in over a year, when the SAAR was 10.5 million. The double dip in the auto sales will soon be upon us. Furthermore, buying intentions of major household appliances held at a weak 23.7: Cash for Bidets can't come fast enough. Most troubling, however, homebuying intentions have plunged to a near-thirty year low: at 1.9, the percentage of Americans planning on buying a house is the lowest since 1982.

And just in case you thought that shellshocked US citizens will look to get the hell out of Dodge, at least temporarily, to take advantage of that strong, strong dollar and travel abroad, think again. The percentage of Americans planning a vacation in the next six months fell to 35.7, the lowest since April. The David Rosenberg-penned "frugal consumer" is here to stay, which can only mean that both the Fed and the US Government will become buyers of first, last and everything inbetween resort, as the traditional component of US GDP (sorry David Bianco, you are unabashedly wrong in your "consumer is irrelevant" propaganda). Maybe it is time to dust off all those Russian Politics 101 manuals, in our search of how to defeat Soviet Style Communist fiscal and monetary policy, which have so thoroughly penetrated the United States of America itself.

Today, GM disclosed some of its final discounts on its departing brands, namely Saturn and Pontiac, of which, not even billionaires with deep pockets and large egos nor emerging markets wishing to break into the sexy, yet increasingly tricky business of producing cars could not even save.

 

$7,000 (Rebates-To-Dealer) on each car, reportedly on cars going to rental and or service fleets; which, a lot of dealers operate as a way to spin factory incentive monies into their pockets, putting “units on the board” (boosting monthly sales numbers) vying to make their monthly quota.  Note- this is dealer cash, unlike a lot of rebates offered to the public- meaning- they don’t necessarily have to funnel the savings to you, the buyer- they can try to hold some of it as a profit in a deal.  In other words- make sure you ask for these funds if you’re so inclined to buy a new, soon-to-be departed Pontiac or Saturn.

 

These savings could make it easier to move units to customers looking for a four-wheeled-bargain; but I’d be very cautious on buying one of these units- as they may technically be labeled “used cars,” thus putting the original three-year/36 month bumper-to-bumper coverage in question.  The way I’m understanding the deal is- to get the $7,000 a copy (per car unit) the title has to be transferred from the original MSO- the Manufacturers Statement of Origin, or the original title.  I’m not in the car business anymore, but the waters can get murky when rebates, dealer cash and other incentives get before the bottom line.  

 

Most all GM vehicles qualify for the five-year/100,000 mile powertrain coverage which is transferrable to future owners- an incentive for buying a used GM car, that is not only used, but is no longer in production- living in the hearts and minds of people who remember American cars “when.”  But anyway…

 

One car that is saying goodbye is the Pontiac G8, and believe it or not, the G8 has actually gotten many accolades for being a Pontiac that “certainly doesn’t suck,” or the car that “came too late to the party to save Pontiac.” 

 

The G8 is a mid-sized sedan, taking the places of the once-all-mighty Bonneville, Grand Prix and GTO as top Pontiac heap.

 

The G8 is actually a re-badged/engineered Australian-sourced Holden, and unlike the GTO that faded into the sunset a few years ago- this Holden offers a lot of rear-wheel-drive performance for the dollar, competing in the same performance sentence as a mid-sized BMW 5-Series. 

 

Yes, BMW 5-Series. 

 

A little known secret is- the 2009 Pontiac G8 was engineered and tested by the very same engineers who brought you the suspension set-up on the previous generation (E39) BMW 5-Series- certainly not a performance sedan that sucked at all, albeit five years ago. 

 

The Pontiac G8 rides, reportedly handles and zips around the track like a car, costing about twice its $30,000-plus base-price tag.  Certainly the cheapest mid-sized BMW you’ll ever drive.

 

All these deep discounts are fine and dandy if you’re short on the funds to get into a new car, but really, discounts are just drops in the bucket when it comes to a car’s residual or used car value- if you care at all.  There is no free lunch here. 

 

Nothing; not even $7,000, makes up for the fact that these cars will be worthless sooner than later, especially since the nameplates are now officially history. 

 

My friend who vowed to buy the last black-on-black Pontiac G8 with a Tremec six-speed, stating an almost rehearsed “It’s not over…  till it’s over…” looking to re-hash his GTO-days past pulled-out of the notion.  I guess he’s finally moving on, “giving up the ‘Goat’ ” some forty years later.  Yeah, it’s really over.  This cat is skinned.

 

There’s a lot to be said for a nameplate when it comes to cars.  It’s a lot like location in real estate.  It speaks volumes on, and has a lot to do with value.  Or eventual value. 

 

Just look at the Pontiac Silverdome, which cost an inflation-adjusted $220 million to build 35 years ago.  It sold for some $583,000 just a few weeks back.  Finally real estate that valued-out a lot like a new car ultimately does. 

 

Could you imagine if it were the Silver BMW-Dome?  It would have sold for a lot more.  For sure.  

True, the decade is not really over, but no one called 1930 the "last year of the 20's," and given the reflective mood that seems to grip all of Western society whenever a year ending in "9" draws to a close, well, we thought we'd better embrace the trend now so that when some idiot with a pair of glow-in-the-dark "2010" glasses with holes in the zeros for his eyes tries to convince us to watch Roy Scheider over and over again in a celebratory, all-day, marathon screening of "2010," well, we can say we gave at the blog.

Instead, and in conjunction with your many suggestions, we took the opportunity to go back over Zero Hedge's posts and see what moved you, with an eye towards getting a sense of what Zero Hedge wants to read.  The results were quite interesting.  We thought readers would find it engaging both as a sort of "year in review" post, and, perhaps, in finding old material missed the first time around (or before the discovery of Zero Hedge).

Though this is by no means a comprehensive list, and we have omitted a number of "big hit count" posts that may have repeated the subject matter of those listed here, or otherwise be dull (what weighty relevance could our T-Shirt post have?) the list below represents a good sampling of some of the most popular articles, reproduced here in (very rough) ascending order of popularity:

One thing we learned very quickly is that, as often as not, title is a strong determiner of post popularity on Zero Hedge. "Tiny Mauritius Tells US To Shove Its Dollar, Buys 2 Metric Tons Of Gold From IMF At $1,115 An Ounce" was one such.  The news that a small island was buying gold en masse hit all the hot buttons:  Gold.  Banana republics. The dollar as a reserve currency.  (The swimsuit picture might have helped too).

Obviously, the FDIC has been a frequent target of our curiosity.  Along with increasingly obvious signs of an impending nervous breakdown in Sheila Bair's on-camera appearance, the recent dip of the Insurance Fund into red ink prompted "FDIC Discloses Deposit Insurance Fund Is Now Negative," which, while unsurprising to those of us who have been watching for some time, was a good reminder that when you base insurance rates on something other than real actuarial data (like say, the impact those rates might have on a bank's bottom line) you get bankrupt insurance [companies|funds].  Of course, since the FDIC can "literally never run out of money," none of that really matters.  Right?

One thing leads to another, so it's not surprising that "Peter Costa: 'The US Government Will Be Totally Bankrupt In A Year And A Half'" ends up right next to Sheila in the popularity list.  Government spending is, of course, an important topic to Zero Hedge readers.  (Also, you seem to like videos from CNBC.  We aren't sure what to make of this).

We were amused to no end on discovering that a CNBC video re-post was just below "CNBC Viewership Plunges 50% In October" on the popularity list.  To be fair, Zero Hedge has relentlessly hounded the bag of schnitzel that is CNBC on the ratings issue.  This particular post prompted an angry call from a fairly senior executive in CNBC's public relations arm to our never-complaining but often beleaguered (and uncompensated) Executive Vice President of Answering the Hot-line wherein the CNBC exec berated our hero for not calling him directly for comment before printing and accusing Zero Hedge of being a shill for the Fox network.  When asked if the figures discussed in the post were inaccurate CNBC exec reportedly paused before intoning: "Well, that's not the point, is it? You are comparing against our biggest ratings ever at the beginning of the crash!"  Yes.  And?

Huge selloffs often result in the dusting off of some version of "The 'Money On The Sidelines' Fallacy."  As a bit of silver lining lore, it is looking pretty tarnished.  That didn't stop our examination of it from being one of the top posts of the Summer.

A constant and early debate at Zero Hedge was the viability of a philosophy that included a wealth of Deep-dive analysis as a mainstay of our editorial strategy.  Would an audience entertain repeated and highly technical postings day after day and keep coming back for more?  Or would we drive away the interest if we did not dumb down the content.  As "deep-dive" goes, and begging the audiences pardon for the shameless self reference, my occasional pairings with Geoffrey Batt tend to peg the Zero Hedge complexity meter into the red with a combination of legal and financial wonkism.  "Is The Fed Facing Margin Calls From European Banks?" was no exception.  A hybridized subject matter including AIG, the circumventing of banking regulation, margin calls and backstopping by the Federal reserve combined to propel what was otherwise a highly technical post to one of the top 25 in Zero Hedge history, despite it being less than a month old.  Apparently, you Zero Hedge readers don't need "dumbing down" to remain interested.

It would be entirely impossible to catalogue a list of popular (or influential) posts at Zero Hedge without including "Is A Case Of Quant Trading Sabotage About To Destroy Goldman Sachs?" in a prominent spot.  Again, a combination of some classic Zero Hedge hot buttons (Goldman Sachs possibly influencing a young and impressionable U.S. Attorney, High Frequency Trading and the term "market manipulation") conspired to stress our servers.

Gold is a consistently popular theme at Zero Hedge so, in last month's runup, it wasn't hard to make some predictions a la "Is Gold Set To Hit $1,200 Within 24 Hours?"  Alas, we missed our call by 10 days.

Direct intervention in the equity markets by the Federal Reserve is a big "no-no."  But who cares when easy credit from the Fed can be used by primary dealers to go on a equity buying spree? We explored the answer to that question in "An Overview Of The Fed's Intervention In Equity Markets Via The Primary Dealer Credit Facility."  It was another highly technical (and yet highly popular) posting.  Kudos to you, oh, Zero Hedge reader of great complexity thirst.

We loves us some Janet Tavakoli.  So do you apparently, as the widespread interest in "Janet Tavakoli On Why Meltdown Risk Now Is Greater Than It Was In 2007" aptly demonstrated.  But then, who can fail to enjoy a firebrand like Tavakoli when she prompts the likes of Goldman Sachs to distraction?

One measure of Zero Hedge's success is the almost daunting stature of the many collaborators and guest posters our pages attract.  Articles with the likes of David Rosenberg as collaborators are, as one would suspect, intensely popular.  "The End Of The End Of The Recession" was no exception.

Need we insult you by explaining the popularity of "A Zero Hedge Petition: Break Debt Habit, Freeze The Debt Ceiling"?

It probably isn't a surprise that an article about phantom Treasury purchasers would be among Zero Hedge's top posts of all time.  That an article less than a week old would top many others with months of clicking under the belts already is, however, impressive.  Witness the massive click fest that was "Sprott Calls The Fed "A Ponzi Scheme" As Half A Trillion In Treasury Purchasers Are Unaccounted For".

The difference between real and nominal returns is oft ignored when the mainstream media engages in economic analysis based on equity prices.  Hence, our "DOW 10,000!!!! Oh Wait, Make That 7,537" got quite a lot of attention.  Never to be left out of the fun, the mainstream press has seemingly adopted the theme (10 weeks later).  We aren't holding our breath for attribution.

The Swiss Franc was redeemable in gold up until the year 2000.  Whatever else they are, the Swiss are stability obsessed.  Unsurprising, then, that "From Switzerland With No Love - Wegelin Bank Says Goodbye," a review of Wegelin's decision to abandon investment in the United States, drew so many Zero Hedge readers in.

As you might imagine, we hear a number of theories on why the Dollar is in a secular decline.  Still, our own analysis "Here Is Why The Dollar Is Now Effectively Worthless," used the apparently winning combination of QE and reserve analysis to wonder how anyone could ascribe a positive value to the fiat currency any longer.  Like it or not, you apparently enjoyed the discussion, as this post sailed effortlessly into our top ten of all time.

Closely behind was "Thousands Of Rusting Ship Hulls Are A Fitting Tribute To The Speculative Market Bubble," a bit of analysis that seems to have prompted a gaggle of writers worldwide to take a keen interest in satellite photos of idle shipping and GPS tracking sites for the world's mercantile fleet.  Of course, the obligatory flood of copy-cat analysis by more mainstream outlets followed hard upon.

My personal pick for best Zero Hedge post of all time "How The Federal Reserve Bailed Out The World" is also in the top five. I cannot imagine a forum in which this sort of analysis would ever find a public airing, or a place where readers could obtain a deeper understanding of the global interplay between central banks than is exemplified in this post.  Again, the fact that readers had a voracious appetite for the piece is a reminder than depth is not anathema to readership.

There is no way that, after a mere three days (and over the holidays no less),  "Brace For Impact: In 2010, Demand For US Fixed Income Has To Increase Elevenfold... Or Else" should be in the top four.  It is a deep, highly complex and analysis laden post.  True, there are colorful graphs, but even repeated readings by CNBC's color addled anchors could not explain the massive readership that hit this post on the afternoon of Christmas Day while the Christmas Ham (or non-denominational family dinner) was cooking in the other room.  Just, wow.

"Goldman Sachs Responds To Zero Hedge."  Yeah, so that was kind of popular.  Modest prevents us from further comment.

Arguments for the secrecy of the Federal Reserve, and pleadings for its continued independence, are always a big draw.  Still, we were surprised by the absolutely massive response to "Racketeering 101: Bailed Out Banks Threaten Systemic Collapse If Fed Discloses Information."  Massive enough, in fact, to make it the second most popular post on Zero Hedge.  Ever.

Number one "Shadowstats' John Williams: Prepare For The Hyperinflationary Great Depression" probably bears no further comment.

It has been a dauntingly popular year.  We look forward to the next one.  Join us? (Or die).

2010 will be a year of major transformations, punctuated by the following key escalating divergence: i) on one hand, the ongoing contraction of the US consumer will accelerate, because even as the stock market ramps ever higher (and on ever decreasing trade volume a 2,000 level on the S&P while completely incredulous, is attainable, but will benefit only a select few insiders who continue selling their stock at ridiculous valuations), household wealth will at best stagnate (as a reminder, an increase in interest rates "withdraws" much more household net worth, due to implied house price reduction, than any comparable boost to the S&P can offset), ii) on the other hand, China, which is faced with the ticking timebomb of continuing the status quo and hoping that US consumers can keep growing the global economy, or alternatively, looking inward at its own consumer class, and shifting away from its historical export-led model. The one unavoidable side effect of this prominent departure would be a renminbi appreciation, and a logical drop in the US currency, once the US-China peg if lifted (a theme opposed recently by SocGen's Albert Edwards, who sees the inverse as likely occurring). The main question for 2010 and beyond is whether this will be a gradual decline or a disorderly drop. And behind the scenes of all the bickering, jawboning and posturing, this is precisely what high level officials from both the US and China are currently negotiating. This will be one of the major themes that defines the next decade. Another phrase to describe this process is the gradual drift of US into a nation that is aware it is no longer the primary economic dynamo of global growth as China eagerly steps in to fill that spot.

Looking at the aftermath of the financial crisis, the two major consequences that will define US economic trends for an extended period of time, are the increasingly more frugal US consumer, whose savings rate is likely to increase gradually to the long-term low double digit average, and an ongoing outflow from equities into safer assets such as municipals, bonds and loans, as the maturing baby-boomers finds the volatility of the engineered equity market far too risky as they enter retirement age.

So with US consumption-led growth entering its twilight days, courtesy of assets that simply do not provide the kinds of returns that allowed for a savings-free lifestyle, what does this mean for Asia, and China in particular? Bank of America provides a good and succinct overview of the major historical themes that have defined Asian economics, and what the next decade will likely bring.

The essence of the Asian development strategy is to build manufacturing capacity for global demand. High savings rates allowed the needed investment in plants and infrastructure to be financed domestically. This strategy was pioneered by Japan in the 1950s and 60s, copied by the Asian “Tigers” (Hong Kong, Korea, Singapore, and Taiwan) in the 70s and 80s, and by a host of other Asian countries in the 80s and 90s. What changed the game was China’s adoption of the same strategy. Exports have increased nearly sixfold since China joined the World Trade Organization (WTO) in 2001. This had a profound impact on the global economy – but it had an even more profound impact on the China’s own economy and labor market. We estimate that 150 million Chinese workers joined the global labor force and began producing internationally traded goods. (As a contrast, the US labor force is 154 million people.)

The integration of China’s vast workforce into the global economy is what tipped the balance. The transfer of jobs and production from the US, where personal and corporate savings rates were low, to China, where savings rates were high, gave rise to huge imbalances. Within a few years after WTO entry, China’s current account surplus became the world’s largest, mirrored by an even larger US deficit.

Currency appreciation would have reduced wages, profits, and the flow of savings, but China was unwilling to allow market forces to play out. Thus, thePBoC (China’s central bank)  intervened in unprecedented amounts, and the vast flow of Chinese savings was channeled  abroad in the form of foreign exchange reserves – mostly short-duration government debt and bank deposits. Essentially, China was financing its own exports by purchasing short-term debt. The bulk ofthat found its way into US markets, keeping interest rates low and setting the stage for the housing bubble.

And herein lies the rub:

The financial crisis delivered a clear verdict, in our view, on the limits to the Asian growth model. It no longer makes sense to pursue double-digit growth by lending cheaply to the US consumer.

Yet change would require less reserve accumulation or – put another way – allowing the currency to appreciate against the US dollar, to which it is now effectively pegged. China needs to manage this “exit” carefully. Moving too fast risks a dollar crisis, with a disorderly drop in the US dollar and a spike in US bond yields. Moving too slow risks a boom-bust cycle in China, with capital inflows and strong monetary growth rates putting upward pressure on asset prices and inflation.

As noted earlier, the transitioning from the status quo, which worked for many years, but is now no longer relevant for the PBoC, will be likely even more critical than Bernanke's decision on when to finally begin raising rates. Because while the latter is mostly concerned with asset-price inflation (and stoking it every chance he gets), the Chinese decision will determine not only interest-rate policy for the US for decades to come, but will decide how soon the US should prepare to accept the consolation prize of first runner up in the global economic leader category. While on an absolute basis the US Economy is still a clear outlier, the rate of growth exhibited by China makes it a virtual guarantee that the days for US economic hegemony are numbered (even more so with GDP determination which is whatever the Central Committee says it is). The only open question is when will China decide it is finally time to shift away from the export-led growth model to one which prefers its own consumers as the source of growth. This transition will likely be of historical importance: just as the inception of the US vassal relationship with China lead to a historic and unprecedented boom in household net worth, doubling to $60 trillion in the span of a decade, so shall the unwind have a comparable impact to the downside.

It is merely this moment that Bernanke and the administration are doing all they can to prolong as much as possible. Alas it may be too late, as China seems to have finally realized that in the global prisoner's dilemma game, it has taken the constant US defections for far too long enough. And with the benefits of perpetuating the charade at this point outweighed by the detriments, 2010 could just be the year when China decides it has had enough.

For much more observations on the US-China relationship, and what lies in store for both the dollar and the renminbi, below is the most recent China FX roadmap analysis from BofA.

 

• Son of Nigerian banker apparently tries to blow up Delta's EHAM -> KDTW.  (419 BLAM?) [reuters]
• Supposed Delta bomber apparently has al Qaeda ties.  (Explains why he was going to Detroit) [reuters]
• ...and has been known by U.S. officials as a terrorist associate for two years.  (Explains why he was going to Detroit) [AP]
• As they hit 5%, and when they think no one is listening, Freddie whispers that 30-year rates could climb to 6% in 2010. (Rahm: "No big thing.  Just sayin' is all.") [reuters]
• Vice President of Finance for Koss apparently embezzled $20 million.  (Multi-million dollar clothes and jewelery shopping spree may explain WI retail numbers) [reuters]
• Obama tells Americans to count their blessings.  (Actually, we saw that movie already, back when it was called Jimmy Carter) [marketwatch] 
• Whole Foods Chairman/CEO to become Whole Foods CEO.  (Impartiality partially restored?) [ap/nyt]
• Berkshire employee count 8.6% lighter since last year.  (Read: "Buffett downgrades United States") [bloomberg]

One of the key observations of 2009 has been that Primary Dealers, courtesy of their access to the Primary Dealer Credit Facility, and, of course, to the Discount Window, are the critical cog in the Fed's plan to push markets ever higher. In a fashion, the banks that make up the PD community are the designated proxies of the Federal Reserve, allowing it to execute its trading strategy when its own traders at 33 Liberty are having a Starbucks break. As the PDs can pledge any worthless asset to the Fed, for which they get a dollar equivalent of 100 cents on the dollar, the PDs can leverage whatever toxic residuals they have on their balance sheet massively without even using explicit leverage, merely thanks to the Fed's lax standards in accepting practically any collateral. We have had occasional glimpses into what "assets" make up the tri-party repo system that is the backbone of the US financial system, but absent a full blown evaluation and transparency of the Federal Reserve, only the Fed (and specifically its New York branch) and Jamie Dimon really know the state of affairs when it comes to pledge collateral. However, there is some information that we can glean on the broader sense of risk within the Primary Dealer community, which is possible courtesy of the NY Fed's disclosure of the PD's transactions and net holdings by various asset classes. Our focus in this post are the Primary Dealers' transactions and holdings in US Treasuries.

The first chart below summarizes the weekly volume of all treasury transactions. After peaking at about $600 billion weekly, the 6 month transaction Moving Average declined by nearly $200 billion after the collapse of Lehman Brothers. And even as the market has gradually revived, the 6MMA is still about $100 billion below the past 3 year's average. Note the spike in Treasury transactions in the September 15, 2008 week: the $811 billion traded that week was the third highest weekly total ever. In the year since then, the peak has been far lower at $550 billion. It appears that the reduced volume in stock transactions is being mirrored by Primary Dealers in their bond purchases and sales.

A more granular read of the data, with a stratification by various Treasury maturities, indicates that there has been a material shift in the trading of Treasuries with a 3 - 6 year maturity interval in favor of T-Bills, where trading has nearly doubled from the long-term average.

When one looks at net holdings of US Treasuries within the Primary Dealer Community one can notice that since the market peak in 2007, when PDs held a net short position of almost ($200) billion, dealers have built up an almost $200 billion buffer, with the most recent net holdings standing at just over $10 billion. In early June, this number stood at almost $100 billion, and has since declined by about $90 billion.

Digging deeper, one can see that PDs have been accumulating the biggest positions in Bills (essentially as a cash replacement) and also in Coupons with a 6-11 year maturity. Could this be the preferred sweet spot for the PD community, or their clients? The one Bond class that is least desirable is anything with a maturity under 3 years.

Indeed, the Net holding differential between the Sub-3 year Maturity and the 6-11 Year Maturity has recently blown out to a record high. Can you spell steep yield curve? This is how the Primary Dealers are taking advantage of free money graphically. The chart below subtracts the net (lately mostly short) position in sub 3 PD holdings from 6-11 Year Net holdings. The steepness of the holdings curve is only matched by the steepness of the actual bond yield curve.

PD T-Bill holdings indicate that this security class is still seen as a simple cash replacement. Oddly, the fact that PDs still have such historically high Bill holdings indicates that all is far from clear, at least at seen by the PD community. An odd observation: T-Bills hit a record on June 3, when over $90 billion in Net T-Bills was being held on bank balance sheets. Since then this amount dropped to flat by November and has since surged again. Whether this is merely end of year window dressing we should know in a few weeks when the January 1st results come out.

The most obvious observation is that PDs are doing nothing unexpected: they are loading up on the curve, by shorting the near-end and purchasing the far-end. The only question is whether and to what degree they do this for themselves as opposed their clients. And a read of PD T-Bill holdings, especially in the context of TIC data, highlights that there is still either some major liquidity concerns permeating both the International and Primary Dealer community, or just a very rampant case of window dressing as asset managers at both banks and funds get risky-asset buyer's remorse and try to make it seem that they are actually somewhat prudent. Of course, should the Fed be unable to find the much needed $2 trillion in buyers for various US fixed income securities, the "window dressing" approach will seem sadly ironic, as numerous hedge funds implode if indeed there is a massive rush from risky to "risk-free" assets.

As everyone is engrossed by assorted groundless Christmas (and other ongoing bear market) rallies, and oblivious to the debt monsters hiding in both the closet and under the bed, Zero Hedge has decided it is about time to present the ugliest truth faced by our 'intellectual superiors' and their Wall Street henchman who succeeded in pulling off Goal #1 for 2009 - the biggest ever bonus season (forget record bonuses in 2010... in fact, scratch any bonuses next year if what is likely to transpire in the upcoming 12 months does in fact occur).

If someone asks you what happened in 2009, the answer is simple - two things. There was a huge credit and liquidity crunch, and then there was Quantitative Easing. The last is the Fed's equivalent of band-aiding a zombied and ponzied corpse, better known as the US economy. It worked for a while, but now the zombie is about to go back into critical, followed by comatose, and lastly, undead (and 401(k)-depleting) condition.

In 2009, total supply of all USD denominated fixed income, net of maturities, declined by $300 billion from $2.05 trillion to $1.75 trillion. This makes sense: the abovementioned crunches stopped the flow of credit from January until well into April, and generally firms were unwilling to demonstrate to the market how clothless they are by hitting the capital markets until well into Q2 if not Q3. What happened was a move so drastic by the Fed, that into November, the worst of the worst High Yield names were freely upsizing dividend recap deals (see CCU) - the very same greed and stupidity that brought us here. Luckily, so far securitization and CDOs have not made a dramatic entrance. They likely will, at which point it will be time to buy a one-way ticket for either our southern or northern neighbor, both of which, in the supremest of ironies, transact in a currency that will survive long after the dollar is dead and buried.

Back to the math... And here is the kicker. Accounting for securities purchased by the Fed, which effectively made the market in the Treasury, the agency and MBS arenas, but also served to "drain duration" from the broader US$ fixed income market, the stunning result is that net issuance in 2009 was only $200 billion. Take a second to digest that.

And while you are lamenting the death of private debt markets, here is precisely what the Fed, the Treasury, and all bank CEOs are doing all their best to keep hidden until they are safely on their private jets heading toward warmer climes: in 2010, the total estimated net issuance across all US$ denominated fixed income classes is expected to increase by 27%, from $1.75 trillion to $2.22 trillion. The culprit: Treasury issuance to keep funding an impossible budget. And, yes, we use the term impossible in its most technical sense. As everyone who has taken First Grade math knows, there is no way that the ludicrous deficit spending the US has embarked on makes any sense at all... none. But the administration can sure pretend it does, until everything falls apart and blaming everyone else for its fiscal imprudence is no longer an option.

Out of the $2.22 trillion in expected 2010 issuance, $200 billion will be absorbed by the Fed while QE continues through March. Then the US is on its own: $2.06 trillion will have to find non-Fed originating  demand. To sum up: $200 billion in 2009; $2.1 trillion in 2010. Good luck.

As we pointed, the number one reason why 2010 is set to be a truly "interesting" year is a result of the upcoming explosion in US Treasury issuance. Fiscal 2010 gross coupon issuance is expected to hit $2.55 trillion, a $700 billion increase from 2009, which in turn was  $1.1 trillion increase from 2008. For those of you needing a primer on the exponential function, click here. But wait, there is a light in the tunnel: in 2011, gross issuance is expected to decline... to $1.9 trillion.

And while things are hair-raising in "gross" country (not Bill...at least not yet), they are not much better in netville either. Net of maturities, 2010 coupon issuance will be about $1.8 trillion, a 45% increase from the $1.3 trillion in FY 2009 (and the paltry $255 billion in 2008).

Now everyone knows that the average maturity of the UST curve has become a big problem for Tim Geithner: nearly 40% of all marketable debt matures within a year (a percentage that has kept on growing). In fact, the Treasury provided guidance in its November 2009 refunding, in which it stated that it intends "to focus on increasing the average maturity" of its debt after relying heavily on Bill issuance in H2. Once again, we wish Tim the best of luck.

Why our generous best intentions to the US Treasury? Because unless the US consumer decides to forgo the purchase of the 4th sequential Kindle and buy some Treasuries (and not just any: 30 Year Bonds or bust), the presumption that the Bond printer will have the option of finding vast foreign appetite for its spewage is a very myopic one. We already know that China is a major question mark, and will aggressively be looking at pumping capital into its own economy instead of that of Uncle Sam's - at some point the return on investment in its own middle class will surpass that of funding the rapidly disappearing US middle class. That tipping point could be as soon as 2010.

As for Japan - the country has plunged into its n^th consecutive deflationary period. Whether or not the finance minister announces yet another affair with the Quantitative Easing whore on any given day, depends merely on what side of the bed he wakes up on. The country will have its hands full monetizing its own sovereign issuance, let alone ours.

Lastly, the UK - well, with the country set to have zero bankers left in a few months, we don't think the traditionally third largest purchaser of US debt will be doing much purchasing any time soon.

None of this is merely speculation: October TIC data confirmed these preliminary observations. It will only become more pronounced in upcoming months.

How about that great globalization dynamo: emerging markets? Alas, they have their hands full with issuing their own record amounts of both sovereign and corporate debt as well: in 2009 gross EM debt issuance reached an astounding $217 billion, $29 billion higher than the previous record in 2007. Gross EM issuance was particularly high in the last quarter at $73 billion, with October breaking the record for the largest ever monthly gross issuance of emerging market global bonds at $38 billion (January is traditionally the busiest month of the year.) With $81 billion, 2009 was notably a record year for sovereign bonds, while gross issuance of corporate bonds amounted to $136 billion, the second highest level after that of 2007 with $155 billion.

Bottom line: everyone has major problems at home, and is more focused on the supply than the demand side of the equation.

What options does this leave for the administration? Very few, and all of them are ugly. As we stated earlier on, the options for the Fed are threefold:

1. Announce a new iteration of Quantitative Easing. This will be met with major disapproval across all voting classes (at least those whose residential zip codes do not start with 10xxx or 068xx), creating major headaches for Obama and the democrats which are already struggling with collapsing polls.
2. Prepare for a major increase in interest rates. While on the surface this would be very welcome for a Fed that keeps hinting that deflation is the biggest concern for the economy, Bernanke's complete lack of preparation from a monetary standpoint (we are surprised the Fed's $200 million reverse repos have not made the late night comedy circuit yet) to a forced interest rate increase, would likely result in runaway inflation almost overnight. The result would be a huge blow to a still deteriorating economy.
3. Engineer a stock market collapse. Recently investors have, rightfully, realized there is no more risk in equities, not because the assets backing the stockholder equity are actually creating greater cash flow (as we demonstrated recently, that is not the case), but simply because taxpayers have involuntarily become safekeepers for the entire stock market, due to Bernanke's forced intervention in bond and equity markets. Yet the President's Working Group is fully aware that when the time comes to hitting the "reverse" button, it will do so. Will the resultant rush into safe assets be sufficient to generate the needed endogenous demand for Treasuries is unknown. It will likely be correlated to the size of the equity market drop.

If the Fed decides on option three, we fully believe a 30% drop (or greater) in equities is very probable as the new supply/demand regime in fixed income becomes apparent. We hope mainstream media takes the ideas presented here and processes them for broader consumption as indeed the Fed is caught in a very fragile dilemma, and the sooner its hand is pushed, the less disastrous the final outcome for investors. Then again, as Eric Sprott has been pointing out for quite some time, it could very well be that the US economy has become merely one huge Ponzi, and as such, its expansion or reduction on the margin is uncontrollable. We very well may have passed into the stage where blind growth is the only alternative to a complete collapse. We hope that is not the case.

Merry Christmas and Happy Holidays to all readers.

The Obama administration is on the case, don't you worry.  Given that expanding the balance sheets of Government Sponsored Entities, increasing their regulatory caps on assets, and then, when caps could rise no further, permitting them to resort to securitization to move underpriced real estate loans off their balance sheets didn't work, let's relax caps even more, and, while we are at it, give them a blank check drawn on the Treasury.  Bloomberg reports:

The U.S. Treasury Department will remove the caps on aid to Fannie Mae and Freddie Mac for the next three years, to allay investor concerns that the companies will exhaust the available government assistance.

The two companies, the largest sources of mortgage financing in the U.S., are currently under government conservatorship and have caps of $200 billion each on backstop capital from the Treasury. Under the new agreement announced today, these limits can rise as needed to cover net worth losses through 2012.

The Obama administration is “beginning to realize it’s not getting better and it’s not likely to get better” soon in the housing market, said Julian Mann, who helps oversee $5.5 billion in bonds as a vice president at First Pacific Advisors LLC in Los Angeles. “They don’t want the foreclosures now, so they’re saying, we’ll pay whatever it takes to continue to kick the can down the road.”

Translation: This clear, oily smelling liquid I've been using doesn't seem to be quenching the flames.  Hand me that larger jug over there, will you?

It used to be that some alternate reality was the only place we would ever expect to hear this:

Fannie Mae and Freddie Mac now are using a combined $111 billion of the total $400 billion lifeline. Treasury Department officials said they didn’t expect the companies to need assistance beyond what is available under the current caps, barring significant deterioration in the economic outlook.

...and then hear this thirty seconds later:

Under the new agreement announced today, these limits can rise as needed to cover net worth losses through 2012.

The changes mean that rather than needing to trim their portfolios, Fannie (with around $770 billion in holdings) and Freddie (with about $760 billion) can collectively expand them by almost 18% or another $270 billion in 2010.  The Treasury explained:

Treasury does not expect Fannie Mae and Freddie Mac to be active buyers to increase the size of their retained mortgage portfolios.

So.  Let us summarize:

We do not expect the GSE's to grow their portfolios at all, so we are fixing the bloated portfolio problem by easing the portfolio caps to permit a quarter trillion dollar expansion thereof.

We do not expect either of the GSEs to need more help from the Treasury, so we are responding to the underutilized $400 billion "lifeline" the GSE's have with the Treasury ($111 of which is currently used) by expanding it to... infinity.

Oh, and though they have collectively lost nearly $200 billion, we are paying the CEOs around $6 million each.

Great work team!  It's already almost 11:00.  Let's go to lunch.

• In Former Soviet Republics, Dollar trades you on black market. (We score high in Uzbekistan though) [gallup]
• Congress: sucks; Obama: starting to suck; Economy: sucks; Life: sucks.  (Thank god we have experts to tell us these things) [gallup]
• BankAmerrilwide starts Dollar General coverage with a "Buy." (Target price under a dollar?) [dow jones]
• Blackberry outtage slows U.S. messaging to crawl (Inlaws celebrate renewed interest in pre-christmas stories by young guests) [reuters]
• Bernanke enjoys 3-1 "in favor" ratio in Senate.  (Senate also enjoys 3-1 "in favor" ratio in Senate) [bloomberg]
• Blame Canada: Even Canada is finally sick of U.S.'s shit.  China and Russia to buy Canadian dollars (according to Canada). [bloomberg]
• Buffett downgrades Moodys.  ("In former Soviet Omaha....")  [bloomberg]
• Russian oil tycoon Mikhail Khodorkovsky's arrest ruled illegal, continued imprisonment just fine.  ("In Former Soviet courts....") [wall street journal]
• November new home sales hit seven month low.  ("Flip This House" Saturdays on A&E.  "Flip That House" Saturdays on TLC) [reuters]

It is neigh impossible to utter the words "Private Equity" in an introductory paragraph and not mention the firm that defines the industry.  Created by three former Bear Stearns colleagues, Jerome Kohlberg, Henry Kravis and George Roberts, Kohlberg Kravis & Roberts (hereinafter "KKR") has been effectively synonymous with the word "buyout" ever since.  Founded in 1976 with around $30 million in committed capital when the Discount Rate was between 5.25% and 5.50% the firm thrived, even finding success through 1979's crushing 12.00% (and 1981's ruinous 14.00%) Discount Rate environment.  KKR's habit of completing the largest buyout transactions in history goes back at least this far, as it closed what was probably the largest "going private" transaction by that time in the form of the Houdaille Industries buyout in 1979.  The firm even raised its second fund in 1980 with over $350 million in committed capital.  Interest rates, it would seem, were not a condition for KKR's success.

When in February of 2007 KKR acquired TXU in the biggest ever $45 billion LBO (a record which will likely never be surpassed absent hyperinflation truly coming to roost), it looked like KKR could do no wrong. After all, KKR had simply broken its own "largest ever" record, surpassing the $25 billion 1989 buyout of RJR Nabisco.  Well, that reputation might have to suffer, to wit:

The most recent top tick in the "frugal consumer" theme for KKR portfolio company Dollar General. Zero Hedge has obtained the November 25th letter in which KKR does some accounting on the recent DG IPO:

• $1,017 billion initial investment in July 2007
• $120 million sale of equity in November 2009 IPO
• Unrealized gain of $2,171 billion, or an IRR of 42.2%
• ~2.3x Cash on Cash

No mention anywhere in the letter on the apparent inconsistency of cashing out of the "frugal consumer" theme at a time when even the super wealthy, contrary to main stream media's repeatedly flawed data, continue to tighten the belt. Judging by KKR's action, the same goes double for the aspirational, middle and lower classes. However, what is most notable is not the topic of discussion, Dollar General, which KKR truly did an admirable job on, but the implication about how staggering the losses at TXU must be like. Scott Nutall points out that "...as a result of the write-down of the Partnership's investment in Energy Future Holdings [TXU], a portion of the "loss" applicable to this write-down has been netted against the remaining Dollar General capital gain...."

Oops.

Just how big a wash is TXU? If anything, this example once again underscores a comparable theme we have been seeing in the hedge fund world: the flaunting of the survivorship bias as the "losers" get swept under the rug. So many hedge funds are up 50% in 2009, yet after being down 50% in 2008, they are still 25% below their high water mark. And only the most opportunistic ones (see e.g.: Paulson) as well as the most obdurately stubborn and permabullish ones (see e.g.: Glenview) can boast with being in this "admirable" position. But, of course, the HSBC fund performance tracker drops all those which no longer wish to have their P&L grace the ridicule pages of various financial blogs. Very much in the same vein, you will likely never hear what the actual performance of TXU for KKR was.

Doubtless, as interest rates spike in the months and years to come, many private equity firms, perhaps even KKR, will whine loudly about the impossible environment.  In doing so they will remind us all that today's private equity firms, and even today's KKR, are mere shadows of the efficiency creating, sloth eliminating buyout firms of the late 1970s and early 1980s.  True, private equity's "golden age" may return as government intervention in public markets sours a number of public firms and throws them into the waiting arms of the buyout partnerships, but buyout partnerships were only tangentially meant to be tools of regulatory arbitrage (SarbOx being the latest example).  What use are they (and what returns could they command) when that becomes their centrally defining feature?

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After an initial bounce early in the am courtesy of a variety of undeserved and circly jerkular upgrades by the big banks, equities zombied out as the liquidity providers scalped their penny quota for the day. In the meantime the DXY hit another multimonth high, passing and closing above 78, creating massive losses for a whole range of FX trading and correlation desks which have yet to unwind underwater positions. If the dollar continues rallying into the New Year a few banks will start 2010 from a 6 feet under (the water surface) position. Another observation, as Nic Lenoir discussed earlier, Treasurys are getting spooked. The name of the game is, once again, starting the be supply, supply, supply, made ever more dreary courtesy of some "we don't get this whole M.A.D. thing" statement in China. The whole posturing about the trade deficit means that Obama will now do everything to make consumer stay true to their noun. If this means Cash for Chinese Crap, or even Cash for Cash, so be it. Summers is already on it, and Bernanke just ordered another 100 tons of ink.

The single most troubling (and lucrative) piece of news: US CDS hit a 6 month wide of 42 bps. At 22 bps from when we noted this was a screaming, brain death buy at 20 bps, the associated P&L on $500 mm notional is roughly $5 million net of the point lost in roll. The risk averse may consider book half the P. Then again, the risk tolerant shall inherit the earth. Those who take on the Fed and win, shall inherit everything.

T’is bear hunting season. I borrowed this chart to Michael on Friday and it’s becoming so critical that I need to post an updated version:

This is a correlation chart between the S&P cash index and the Euro futures. Quite salient is the massive drop in the Euro futures with an inverse short squeeze in the DXY (more about that below). And the moral of the story here of course is that equities have remained completely unimpressed and have not relinquished as much as an inch (or centimeter for you Euro-rats). Considering how far the Euro has dropped - and assuming a continuation of this correlation - the SPX should be trading at below 1000 right now, not at 1100+.

What does that mean? Well, I’m not sure exactly because the big inflection point all the bears (and deflation proponents) have been desperately waiting for during the past few months was a counter rip in the Dollar (and an inverse drop in the Euro). It took its merry time to get there as Dollar bulls were close to extinction at around 3% for over two months. And then - finally - there it is - a fast rip up. The bears strap themselves in for a fast ride down the equity slide - there you go - better be ready…. aaaannd….

NOTHING.

This is bad. Very bad. You all know I’m not a correlation trader but I do use currency correlations as a bias for short/medium directions on equities. Meaning, on a daily basis I don’t care if the Dollar is down or up if my TA suggests to me that a particular issue or index is going to turn a particular direction. But if I see a chart like the one above in the context of a sideways consolidation in equities then I can’t help but think that the bears have another fast one coming.

When I saw the spike in equities early this morning I thought that the Dollar was probably painting a nice retracement as anticipated. Frankly, I was quite surprised seeing it stretch its legs at 78 today. Not what I expected and it is why I need to second Michael’s call for caution for anyone hoping for a catastrophic drop in equities either right now or perhaps even early January.

The next thing I did was to pull up my DXY odds calculator - again Evil Speculator is proud to have been given exclusive access to this valuable tool courtesy of 2sweeties over at retracementlevels.com.

Alright, as you know the first thing I usually do is to set my 100% odds. And after this merciless short squeeze I decided to play it super conservative and use 79.7, which is near a veritable wall of resistance ole’ bucky would have a very hard time breezing through. However, even then the odds of a turn at 78.42 remain very high at 97.19%. Not that 77.64 at nearly 92% were lousy odds at any measure - but here we are and admittedly the progression upwards has slowed since Friday.

Finally I took a look at the frequency table and on that one we are a bit in uncharted territory right now. 77.64 was where I expected a brief but sharp reversal. Undoubtedly the current short squeeze is pushing us outside the ‘norm’ and thus it’s probably best to stick with the odds. Although the frequency of 78.42 is only registering at 5% its odds are in the 90 percentile. So, ‘chances are’ that this first wave up should be near the roll over point.

Back To The Future

Which brings me back to my first chart. Perhaps I’m relying too much on this particular correlation - and perhaps I should listen to my own advice which is to only use select correlations as a directional bias. But I can’t help but think: We have been consolidating sideways on the SPX - some call it a topping pattern - maybe. At the same time the Dollar has been busting through one high frequency short RL after the other and is now four handles higher than at the beginning of December - that’s a huge move when it comes to currencies.

What will happen when the Dollar decides to consolidate and perhaps drops back to 76 or maybe even 75? Remember that second waves can reverse by quite a bit and if the Dollar starts dropping hard - where does that mean for equities?

Exactly…

Janet Tavakoli Submits:

Now that the crisis is over, and given the special circumstances of the crisis, and Goldman’s contribution to value-destroying securitizations, it is in the public interest to claw back the money paid to Goldman Sachs.  AIG did not need to settle for 100 cents on the dollar in November 2008, and in September 2008, a good negotiator would have refused to hand over more collateral, and should have clawed some back (or insisted it was a temporary loan).  Money should be clawed back before Goldman pays out taxpayer subsidized bonuses.

In late July 2008, SCA settled with Merrill for $500 million on $3.7 B of contracts, or around 13.5%.  On August 1, 2008, Ambac settled $1.4 B with Citi for $850 million, or around 60% on the dollar, but unlike SCA and AIG, Ambac wasn’t on the brink of insolvency at the time. Calyon, a French bank also involved in AIG’s transactions, settled similar contracts with FGIC, another bond insurer, for only ten cents on the dollar in August 2008, yet $13.9 billion of Goldman’s contracts with AIG were settled for 100 cents on the dollar in November 2008 via purchases by Maiden Lane III.  Ambac recently settled similar credit default swaps for ten cents on the dollar ($5 billion in contracts for around $500 million) as Ambac needed capital, and MBIA has made deeply discounted settlements.

This link provides two examples of Goldman’s value-destroying securitizations that were protected by AIG. (You will have to enlarge the image after clicking, and the document is a bit awkward.)  The first section shows the collateral of Abacus 2005-2 (Goldman underwrote and bought protection) and Davis Square Funding IV (Goldman underwrote this CDO, and Societe General bought protection from AIG against it).

Among the many shards of glass masquerading as gems, you will find Tourmaline CDO 2005-1, which went into acceleration in April 2008.  It was managed by Blackrock. Perhaps the Fed’s theory in handing out no bid contracts to Blackrock has something to do with the diligence displayed by a fox watching a hen house.

Parts of tranches of the CDOs that were protected by AIG ended up as collateral of CDOs against which MBIA and Ambac sold protection (to their regret).  This serves to illustrate the interconnectedness of value destroying CDOs.

More from Janet, courtesy of Fox Business News:

 

A list which contains both some quite interesting swans and turkeys:

   1. There is a glaring upside to first-quarter 2010 corporate profits (up 100% year over year) and first-quarter 2010 GDP (up 4.5%). It grows clear that, owing to continued draconian cost cuts, coupled with a series of positive economic releases and a long list of company profit guidance increases in mid to late January and early February, there is a very large upside to first-quarter GDP (up 4.5%) and, even more important, to S&P profit growth (which doubles!). The upside on both counts is in sharp contrast to more muted growth expectations. While corporate managers, economists and strategists raise earnings per share, full-year growth and S&P target estimates, surprisingly, the U.S. equity market fails to respond positively to the much better growth dynamic, and the S&P 500 remains tightly range-bound (between 1,050 and 1,150) into spring 2010.
   2. Housing and jobs fail to revive. An outsized first-quarter 2010 GDP (up 4.5.%) print is achieved despite a still moribund housing market and without any meaningful improvement in the labor market (excluding the increase in census workers) as corporations continue to cut costs and show little commitment to adding permanent employees.
   3. The U.S. dollar explodes higher. After dropping by over 40% from 2001 to 2008, the U.S. dollar continued to spiral lower in the last nine months of 2009. Our currency's recent strength will persist, however, surprising most market participants by continuing to rally into first quarter 2010. In fact, the U.S. dollar will be the strongest major world currency during the first three or four months of the new year.
   4. The price of gold topples. Gold's price plummets to $900 an ounce by the beginning of second quarter 2010. Unhedged, publicly held gold companies report large losses, and the gold sector lies at the bottom of all major sector performers. Hedge fund manager John Paulson abandons his plan to bring a new dedicated gold hedge fund to market.
   5. Central banks tighten earlier than expected. China, facing reported inflation approaching 5%, tightens monetary and fiscal policy in March, a month ahead of a Fed tightening of 50 basis points, which, with the benefit of hindsight, is a policy mistake.
   6. A Middle East peace is upended due to an attack by Israel on Iran. Israel attacks Iran's nuclear facilities before midyear. An already comatose U.S. consumer falls back on its heels, retail spending plummets, and the personal savings rate approaches 10%. The first-quarter spike in domestic growth is short-lived as GDP abruptly stalls.
   7. Stocks drop by 10% in the first half of next year. In the face of renewed geopolitical tensions and reduced worldwide growth expectations, stocks drop as the threat of an economic double-dip grows. Surprisingly, though, the drop in the major indices is contained, and the U.S. stock market retreats by less than 10% from year-end 2009 levels.
   8. Goldman Sachs goes private. Goldman Sachs (GS) stock drops back to $125 to $130 a share, within $15 of the warrant exercise price that Warren Buffett received in Berkshire Hathaway's (BRK.A) late 2008 investment in Goldman Sachs. Sick of the unrelenting compensation outcry, government jawboning and associated populist pressures, Warren Buffett teams up with Goldman Sachs to take the investment firm private. The deal is completed by year-end.
   9. Second-half 2010 GDP growth turns flat. The Goldman Sachs transaction stabilizes the markets, which are stunned by an extended Mideast conflict that continues throughout the summer and into the early fall. While a diplomatic initiative led by the U.S. serves to calm Mideast tensions, flat second-half U.S. GDP growth and a still high 9.5% to 10.0% unemployment rate caps the U.S. stock market's upside and leads to a very dull second half, during which share prices have virtually flatlined (with surprisingly limited rallies and corrections throughout the entire six-month period). For the full year, the S&P 500 exhibits a 10% decline vs. the general consensus of leading strategists for about a 10% rise in the major indices.
  10. Rate-sensitive stocks outperform; metals underperform. Utilities are the best performing sector in the U.S. stock market in 2010; gold stocks are the worst performing group, with consumer discretionary coming in as a close second.
  11. Treasury yields fall. The yield of the 10-year U.S. note drops from 4% at the end of the first quarter to under 3% by the summer and ends the year at approximately the same level (3%). Despite the current consensus that higher inflation and interest rates will weigh on the fixed-income markets, bonds surprisingly outperform stocks in 2010. A plethora of specialized domestic and non-U.S. fixed-income exchange-traded funds are introduced throughout the year, setting the stage for a vast speculative top in bond prices, but that is a late 2011 issue.
  12. Warren Buffett steps down. Warren Buffett announces that he is handing over the investment reins to a Berkshire outsider and that he plans to also announce his in-house successor as chief operating officer by Berkshire Hathaway annual meeting in 2011.
  13. Insider trading charges expand. The SEC alleges, in a broad-ranging sting, the existence of extensive exchange of information that goes well beyond Galleon's Silicon Valley executive connections. Several well-known long-only mutual funds are implicated in the sting, which reveals that they have consistently received privileged information from some of the largest public companies over the past decade.
  14. The SEC launches an assault on mutual fund expenses. The SEC restricts 12b-1 mutual fund fees. In response to the proposal, asset management stocks crater.
  15. The SEC restricts short-selling. The SEC announces major short-selling bans after stocks sag in the second quarter.
  16. More hedge fund tumult emerges. Two of the most successful hedge fund managers extant announce their retirement and fund closures. One exits based on performance problems, the other based on legal problems.
  17. Pandit is out and Cohen is in at Citigroup. Citigroup's Vikram Pandit is replaced by former Shearson Lehman Brothers Chairman Peter Cohen. Cohen replaces a number of senior Citigroup executives with Ramius Partners colleagues. Sandy Weill rejoins Citigroup as a senior consultant.
  18. A weakened Republican party is in disarray. Sarah Palin announces that she has separated from her husband, leaving the Republican party firmly in the hands of former Massachusetts Governor Mitt Romney. An improving economy in early 2010 elevates President Obama's popularity back to pre-inauguration levels, and, despite the market's second-quarter decline, the country comes together after the Middle East conflict, producing a tidal wave of populism that moves ever more dramatically in legislation and spirit. With the Democratic tsunami (part deux) revived, the party wins November midterm elections by a landslide.
  19. Tiger Woods makes a comeback. Tiger Woods and his wife reconcile in early 2010, and he returns earlier than expected to the PGA Tour. After announcing that his wife is pregnant with their third child, both the PGA Tour's and Tiger Woods' popularity rise to record levels, and the golfer signs a series of new commercial contracts that insure him a record $150 million of endorsement income in 2011.
  20. The New York Yankees are sold to a Jack Welch-led investor group. The Steinbrenner family decides, for estate purposes, to sell the New York Yankees to a group headed by former General Electric (GE) Chairman Jack Welch.

As from one Englander to another, so from one massive dollar short to another, we next shift to Steven Englander of BarCap and his daily "Dear USD" hate mail. The man who has been obsessively telling his clients to sell dollars as if he was a subsidiary of Goldman Sachs, must have booked some serious L on the recent, and very much expected, dramatic dollar retracement over the past 3 weeks. In his latest "FX for paranoids and hopeless romantics" Englander does point out one relevant item: that the Fed needs EM countries to keep selling the dollar in order to i) keep commodity prices higher, thereby benefitting these very EMs, and ii) to keep commodity price inflation high, in the absence of other forms thereof (wage, non-commodity price, etc). And that is why, Englander hopes and prays, both for his book, and for those of his clients, that Bernanke will keep on talking big all the while printing more and more dollars as ever more wealth is channeled from the middle class to both Wall Street and abroad.

The report is interesting in that for once Englander, having been discredited by the recent dollar rally, allows for the possibility that the dollar is not a one way train to Hades. For the first time, he discussed the possibility of a eurozone country (Greece) defaulting but staying in the euro - a situtation in which you do not want to be long EUR.

The problems facing Greece have brought the infrastructure of the euro area into focus, as we discuss in “Eventually all chickens come home to roost.” The spirit of the Maastricht Treaty’s “no bailout” provision suggests that this is the tough love that is supposed to be an integral part of the euro, However, few investors believe this is a likely outcome. The collateral damage on the bond markets of the countries seen as having similar difficulties is likely to be immense. Even speculation on this score is likely to lead to significant EUR weakness, as most investors take the view that a bailout of some sort is the most likely outcome (although that certainly does not preclude some tough love, as any parent will be familiar with).

However, even if the tough love provisions were followed, the EUR would not be in the clear. Countries with difficult fiscal situations that did not default could find themselves with pre-

ERM interest rate differentials and post-ERM exchange rate inflexibility. In these circumstances, often an accompanying devaluation helps since it opens some upside to the fiscal offender’s currency and the appreciation risk can take some pressure of rates, but this would not be possible in the EUR world.

The incentives are immensely in favor of fiscal consolidation, tough love, and some exceptional aid, and these would be EUR negative, even in the absence of a default (which we do not expect by any means [TD: no way]), but the FX consequences of a default would be an order of magnitude greater, even if it were thought that the default could be accomplished without an exit from the euro area.

So with that proper Cramerian hedge (being right no matter what happens sure must be nice), the usual DXY bashing ensuses:

Central banks have been disciplined so far in limiting their USD selling. In Q2 the IMF COFER data showed that the USD represented less than 40% of incremental reserve accumulation, but there is little sign that reserve managers are selling enough USD to drive down the USD share in reserve portfolios significantly. Almost all of the drop in the USD share in reserve portfolios over the last 7-8 years has come from valuation effects rather than direct USD selling.

The question is whether this discipline will continue to hold. At present, it does not appear that any major reserve manager wants to be responsible for creating a run on the USD by selling hand over fist. However, while no central bank wants to be the first to sell, no central bank wants to be the last either, so the risk is that if it becomes clear that there is significant official selling, other reserve managers will follow. Putting the two together, there is a potential “bank run” problem. If reserve managers lose confidence in USD strength there is a first-mover advantage in selling it. All know this and it could easily lead to a period of USD strength followed by a sharp fall as people run for the door.

This and the previous item point in opposite directions. The difference is that USD selling can be precipitated by a single reserve manager selling significant USD out of its portfolio, whereas the first risk requires some degree of coordination across central banks.

Full report:

 

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If you have a hedge fund in dire need of some managed account TLC, call this man (and get ready for daily multi-hour explanations on why you put "this or that" trade to people who have yet to complete remedial math); if you have a strategy to front run mutual funds which may or may not end amicably with the SEC in the form of a few hundred dollar settlement, call this man; if you are in the market for some barely occupied property at 740 park, call this man; If you are a CDS trader with special Deutsche Bank sales coverage connections, call this man; if you work for RenTec and feel like borrowing some of their strategies and making a mint, call this man (by the time you get the non-compete subpoena you will be sitting on a beach, earning 20%).

All you need to know about the man who heads the big quant shop, er pardon hedge fund, at the soon to be bankrupt 666 Fifth.

 

 

h/t Leo Kolivakis