The black hole of (de) leveraging by Ektoras

As Krugman stated falling home prices lead to the feared phenomenon of “debt deflation.”
By common sense when businesses get into financial trouble, they sell assets and use the proceeds to pay their debt. Such selloffs are self-defeating when everyone does it: if everyone sell his assets at the same time, the resulting plunge in market prices undermines debtors’ financial positions faster than debt can be paid off. So we get into a vicious circle. The severe economic slump is some moments away. The same goes for the property market all over the world. Debt deflation at these moments is the real threat and unfortunately key financial players are highly leveraged.
The current U.S. financial crisis is similar to what happened to Japan back in the late ‘80s. Keep in mind that the Japanese crisis lasted almost a decade. The response to a Japan-type financial crisis was supposed to involve a very aggressive combination of interest-rate cuts and fiscal stimulus, designed to prevent spillover effects to the real economy.
What we currently face is aggressive rate cuts and push of funds into the private sector. Results show that the funds were not led to the right companies or at least it was not given the right way. There were no Tax reliefs at all.
In a few words, humanity is under heavy Deleveraging. The problem is not deleveraging itself. The problem is that nobody knows when this will end because nobody really knows the real leverage levels. It can be stated that the black hole of leverage will swallow everything before it disappears..
Overall, supporting the economy with government funds seems to be a good idea BUT governments should proceed to other actions in order to relief the corporate struggle. Just throwing money will not lead anywhere..the black hole will destroy everything. Central bank governors and Governments Should get the big picture. They just focus in specific aspects of the crisis and in the long run this may be the reason of the upcoming economic meltdown. Taking decision under panic is the worst thing that can happen. We should learn from the Japanese economic crisis and act in accordance. Of course there are differences but there are a lot of indications which show that we will be led there..

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The next day (or there will not be one?) by Ektoras

The market is crashing.. What did you expect? At this moment there are many reasons for the markets to collapse. May be we don’t want to realize it but it is just right in front of us. The real economy will suffer. The next thing that one should expect now is that debt coming from shipping companies will not be repaid and that banks that are heavily exposed to the emerging markets, and do not have a well established network, will face major loses.
The situation in the Shipping industry is really bad. One after the other, shipping companies shut down and things are about to get worse as the global economic slowdown really affects the world demand for commodities. The Inflows will diminish and the losses will increase dramatically. Hence, banks will not be paid for their shipping loans and will have to write them off or sell them with major loses.
On the emerging markets front now, unfortunately things are about to get even worse. The local currencies have declined against the US$ and the Euro, there is no liquidity in the market and on the top of that people are afraid of the banking system and they massively withdraw their savings. The funding gaps that will be created will be disastrous and the mother companies either will pay a high price to cover them or they will not cover them at all! The picture gets even more complicated if we add the fact that banks are not in position to borrow/lend money in the interbank market. Moreover the government intervention is not going to help, to this end, as it is not very likely that the governments will allow the banks to take risks and grow with its money.
We should realize that companies do not face losses.. they just try to survive under the destroy of capital. Finance returns to its roots and a new banking era starts.. In any case, in the long run banks will survive and will bring reality to their standards- not their standards to reality. After all, banking is the second ancient profession!

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F is also for Forex (FT Alphaville)

F is also for Forex

Oct 24 10:11
by Izabella Kaminska

The forex markets are seeing an unwind of epic proportions this morning,

Latest key rates include:
$£ 1.5516

$Y 93.35

$Y 93.35

The great British Krona’s decline is perhaps best reflected in chart form: More…

The forex markets are seeing an unwind of epic proportions this morning,

Latest key rates include:
$£ 1.5516

$Y 93.35

€$ 1.2798

The great British Krona’s decline is perhaps best reflected in chart form:

Regarding the carry trades that may have got us into this trouble in the first place Denis Gartman of the Gartman letter put it nicely yesterday:

Perhaps we have entered a new era of forex market volatility that shall be with us for a very long while, but we suspect we shall never, ever, EVER see the likes of this punishing unwinding of this hugely important cross position again in our lifetime. Certainly we hope never to see its likes again.

Adding to that we must not forget the ‘Great Emerging Market’ forex debacle featuring the Polish zloty, Hungarian forint and the South African rand all heading for their biggest weekley declines EVER. At the last count:

• The Zloty’s weekly decline is an impressive 16%

• The Hungarian forint’s decline is a slightly less impressive 14%

• And the “commodities trade” South African rand is down nearly 17% in the week

In Addendum - Wasn’t it the fall of the mighty denarius that actually brought down the Roman Empire?

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The rising default wave (FT Alphaville)

The rising default wave

Oct 24 09:10
by Sam Jones

From a Fitch report out Wednesday (emphasis ours):
Fitch believes that the toxic combination of economic and funding pressures has set in motion the beginning of the next cyclical peak in high yield corporate defaults. More…

From a Fitch report out Wednesday (emphasis ours):

Fitch believes that the toxic combination of economic and funding pressures has set in motion the beginning of the next cyclical peak in high yield corporate defaults. In fact, a surge in corporate defaults has already taken place. The par value of U.S. high yield bond defaults alone has increased to $25 billion year to date through September from $3.5 billion for all of 2007, and including bonds affected by Lehman Brothers Holdings Inc.’s bankruptcy filing and Washington Mutual Inc.’s collapse, pushes the par value of corporate bond defaults above $100 billion, a level comparable to 2002 defaults…

…already.

Fitch believes that recent events are among a number of worrisome factors that suggest that the coming high yield default wave may be the most severe on record.

A few other select snaps from the report:

Impaired credit access will remain an issue for speculative grade companies years beyond the current crisis.

Consumer retrenchment more problematic than telecommunication meltdown.

Defaults tend to spike roughly one year following a meaningful contraction in corporate profit growth.

Roll on 2009, year of the corporate default.

From a strictly old-world point of view, this is going to be painful: corporate defaults always hurt.

What will make it all the more so this time, however (as compared to during the 1990s) will be the effect this has on the CDS markets. The pricing models on which CDS markets trade have not been tested through a major recession. Synthetic structured finance, to boot, offers the possibility of a damaging positive feedback loop, with ructions in the CDS markets forcing further deleveraging from banks, causing further credit contraction, and more corporate defaults.

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Bernanke Bailouts Not Working, Banks Hoarding (the Financial Ninja)

Bernanke Bailouts Not Working, Banks Hoarding

Click on the chart to marvel at the carnage.

Bottom line, Bernanke pumps in liquidity and the banks continue to hoard it. The Bernanke bailouts are not working, yet...

I'm encouraged by some of the recent improvements in the credit markets, but it isn't enough.

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Comment By Ektoras

A good friend whose opinion I respect wrote a comment that deserves space in the front page.

My only additional point is that he has been saying these EXACT same things for more than 6 months now...

Ektoras Wrote:

This is just the beginning. I believe US will get out of the recession much faster than Europe. This will take at least 3-5 years. Europe will face a longer but milder recession. Unfortunately the New Europe dream is under attack. The FDIs are going to die, Inflation will increase by at least 15% in most of these countries, growth won't be around for many years and people will keep living under panic. Major Banks are going to fail since the financial system is COMPLETELY OUT OF BUSINESS. More or less the same goes for Europe. The only -but vital- difference is that Europe has a strong social, politic and economic structure.
Banks are out of business. You don't have to be a nuclear scientist to get it...You buy high you sell low...what follows next? Bankruptcy.
The only reason people believe that the system won't collapse is because they cannot imagine what follows next. It is impossible for people to imagine a second great depression even though they have read about it in the past.
On the political grounds now, New Liberals should be punished. New Liberals would include the republicans in the US, the imposers of the "dead end" economic policies in Italy, the populist right representatives in Greece, the national social right politicians in Poland, the liberals in Germany and so many others.. They should not be punished for imposing their thoughts. They should be punished because they were arrogant.
On the financial grounds, humanity, initially, needs to see how to get over the crisis and then punish all the "useless, arrogant, short sighted and constantly conspiring" finance people. Everybody in the market knew what was about to follow BUT nobody was strong enough to admit it..Maybe this is because everybody would reveal the secret after the bonus payment.. How short sight policy..
Even the entry level employers were chosen under doubtful criteria. These are things that people should expect when the system blindly trusts "top university" alumnus. Alumnus who have never been tested for their global views and entrepreneurship mentality they ought to have. Introducing so many quant people in the system would lead to these results. The economy needs economists and people who are in position to explain what the F**k is "inflation", “growth” and “stagflation”.
The irony of the whole story is that moderate people, Keynes supporters and people who used to believe in the European fundamentals of social governments, workers rights, Unions, moderate monetary policies were criticized as inadequate..Now they are here to save the New Liberal politics.. “Socialism saves Capitalism”…what an irony

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The CDO unwind waiting to happen (Bloomberg)

The CDO unwind waiting to happen

Are the days of CDO carnage behind us?

Apparently not. Bloomberg reported on Wednesday:

Oct. 22 (Bloomberg) — Investors are taking losses of up to 90 percent in the $1.2 trillion market for collateralized debt obligations tied to corporate credit as the failures of Lehman Brothers Holdings Inc. and Icelandic banks send shockwaves through the global financial system.

The article is referring to synthetic CDOs: that is, CDOs which are not backed by tangible collateral (RMBS, CMBS, for example) but CDS contracts which reference some form of collateral.

In this case, CDS on corporations.

All of which may sound dreadfully esoteric. Until you ratchet up the numbers. On Friday last week, Barclays analyst Puneet Sharma put out a report on a possible synthetic CDO unwind, and what can be expected to happen to the market as we move through a recession in the coming months.

In graph form, here’s what would happen to the ratings on prime and high-grade tranches of the trillion dollar synthetic CDO market:

Huge, disastrous downgrades: exactly mirroring the structured finance downgrades from ABS CDOs which have brought the financial system to its knees already. Don’t forget, moreover, that these CDOs aren’t backed by dodgy subprime collateral, but are supposed to reference the investment grade corporate world. More proof that it’s not the collateral which is to blame, but the structuring. The medium is the message, and all that.

We guess the impact of this might make itself felt in three ways:

Firstly, there will likely be the mark-to-market losses on the CDO notes themselves. As the Bloomberg article noted, in some cases this is equivalent to a 90 per cent loss on capital. The question here then, is who is holding these notes? Hedge funds were certainly big buyers of synthetic CDOs. But guess what - banks are also holders too. And by and large, banks synthetic corporate CDO holdings haven’t been written down.

Secondly, trouble in the synthetic CDO market will - just as with ABS CDOs - have huge regulatory capital impacts for banks. Shama at Barclays produces another set of graphs to demonstrate:

Downgrades of synthetic CDOs, in other words, will have a devastating caustic effect on banks’ capital ratios - with the potential to completely offset government recapitalisation actions.

Thirdly - crisis for synthetic CDOs will suck money out of the banking system in other ways. Synthetics are “unfunded”. In a normal asset-backed CDO, the cash raised from selling bonds is used to buy assets, but in a synthetic CDO, the cash raised from selling bonds is not used up front: as a protection seller, the CDO collects premiums on CDS contracts which only cost it money in the event of a default (when the CDO must make good on its protection). Of course, depending on what is happening to the spread on the various CDS contracts a synthetic CDO might hold, the CDO might also need to make margin calls. Here is a quick diagram of the generic structure:

The point here is that the “collateral” account of synthetic CDOs usually takes one of two forms: a bank deposit, or a similar cash-equivalent holding: a money market deposit, for example. As spreads widen, and collateral posting (the red line in this diagram) comes into force, synthetic CDO SPVs will be drawing money out of banks and money market funds to meet their obligations. Given that there are quite a few synthetic CDOs out there, the effect shouldn’t be too insignificant.
______

There’s one other point too: synthetic CDOs almost always have a super senior swap written on them. You can see it in the above diagram, technically sitting “outside” - above - the structure. The swap effectively offers the arranging bank protection against its position. The question is, who writes these swaps? LSS conduits, for one (another layer of SPV fun - backed by CP), insurers do (monolines and AIG, for example) and other banks do.

Complicated all the above might be. The long and the short of it is that the synthetic CDO market has used derivative technology to build a huge amount of leverage. With recession now biting, the whole house of cards is dangerously close to collapse.

The CDS markets should feel the impact when it does. One way synthetic CDO managers can offset losses- or rather, crystalise them at acceptable levels - would be to buy protection in the market to sterilise their portfolios.

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Quote of the day

Quote of the day

Oct 23 14:12
by Stacy-Marie Ishmael

Jim Reid, Deutsche Bank:

It’s a depressing world when the only safe haven at the moment is a country that has recently nationalised its two largest mortgage companies, bailed out the world’s largest insurance company, More…

Jim Reid, Deutsche Bank:

It’s a depressing world when the only safe haven at the moment is a country that has recently nationalised its two largest mortgage companies, bailed out the world’s largest insurance company, is spending $700bn buying toxic assets, is injecting $250m into its largest banks after high profile failures and is about to go on a fiscal expansion the likes it has never before seen in its history.

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It can get worse (FT Alphaville)

It can get worse

Granted, this was written by UBS’s Jeffrey Palma on Oct. 21, and things have deteriorated since then.

Year to date, global equities are down 36.2%, on a total return basis, the worst year ever since MSCI World began in 1970. Before that, 1974 was the worst returning year, when equities fell 24.5%.

At today’s prices the MSCI World is back to its September 2003 levels, erasing 61 months of gains so far. This is more than the gains erased at any other time since the 1970s. In 1990 the index erased 24 months of gains, and then a further 15 months of gains in 1992. Between 2000-2003 the index erased its prior 53 months of gains.

Peak to trough things have been worse in the past. From their October 2007 peak, global equities are now down 43% in price terms compared to 48% between 2000 and 2003.

On the plus side, that means equities are trading on an average price/earnings ratio of 11.1 — the cheapest PE since 1982, according to UBS. FT Alphaville notes, however, that might not be so good when you consider the stocks are at their lowest level since before 1970 (as above).

On the other hand, over 50 per cent of companies are now offering dividend yields above 3 per cent — greater than the long-term average of 2.8 per cent since 1974, UBS says.

Opportunity to buy then? Not quite.

There’s still the coming recession.

In previous earnings cycles, global earnings have fallen 30-40% from their peak. So far EPS is down around 15%, suggesting earnings weakness is likely to persist well in to next year.

What’s worse is that while analysts are just starting to revise their earnings estimates for 2008 (almost over anyway) downwards, 2009 and 2010 still have a long way to go.

… while 2008 numbers have come down significantly, 2009 and 2010 estimates still look too lofty. As a result, forecasts for growth in these years will need to fall sharply.

What’s an investor to do then? Palma has the answer:

Stay defensive. Against an uncertain landscape we retain our defensive sector allocation, as investors continue to manage cyclical risk. Our largest overweights are in Consumer Staples and Telecoms as we encourage investors to search for yield and companies with stable earnings and less relative downgrade risk. These sectors are trading at a premium to the market because of these characteristics, but we don’t expect a reversal while uncertainty prevails.

Not surprising then that UBS have Campbell’s Soup on their preferred stock list.

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Russia not so strong says Fitch (FT Alphaville)

Russia not so strong says Fitch

Oct 22 15:05
by Izabella Kaminska

The great emerging markets sell-off continues with Hungary, Turkey, Poland and Argentina taking starring roles. Ukraine and Belarus meanwhile are both in talks for IMF loans. But how are things looking for Russia?

Not so good according to Fitch: More…

The great emerging markets sell-off continues with Hungary, Turkey, Poland and Argentina taking starring roles. Ukraine and Belarus meanwhile are both in talks for IMF loans. But how are things looking for Russia?

Not so good according to Fitch:

…despite the sovereign’s strong balance sheet and liquidity position, the impact of the global financial crisis and sharp drop in oil prices has brought Fitch’s long-standing concerns over Russia’s relatively weak banking sector, commodity dependence and heavy private sector external repayment schedule to the fore, exposing weaknesses in Russia’s economic and credit fundamentals. “Trends in external refinancing and oil prices and measures being taken by the authorities to support the private sector will have an adverse impact on the sovereign balance sheet.

Russia’s exceptionally strong sovereign balance sheet underpins its rating, notably the buffer provided by foreign exchange reserves of USD531bn - the third largest in the world. This allows the policy authorities to provide the Russian corporate and banking sector with US dollar liquidity and financing without imperilling its own credit quality.

But:

Russia is also facing a second negative external shock - the recent sharp fall in commodity prices - which combined with falling inflows of foreign capital, will lower economic growth and pressure the credit quality of Russian banks and companies.

So while Russia’s sovereign status is likely to withstand any shocks, the private sector remains exposed. Shares have responded accordingly.

The fear is that the Russian private sector, which borrowed heavily from international capital markets to fund aggressive expansion at home and overseas, could make Russian markets very vulnerable.

Fitch estimates Russian banks and companies face some $80bn of medium- and long-term amortisation next year and the CBR estimates that total foreign debt payments due in the final quarter of this year are up to $40bn.

Already gas giant Gazprom, which only today reported a record Q1 profit of $10.1bn, said it may have trouble obtaining new loans and refinancing debts.

Bloomberg writes:

Gazprom and its subsidiaries have $55 billion in outstanding bonds and loans, according to data compiled by Bloomberg. The company is scheduled to repay $6.6 billion next year and $12.5 billion in 2010, the data show. The energy producer has already said it’s reviewing its spending program amid tightening credit markets and lower revenue expectations. It has laid out plans to spend more than $30 billion this year on new projects as output drops at mature fields in western Siberia.

Among those banks “aggressively” expanded into foreign markets is VTB, Russia’s second biggest lender. It owns banks across western Europe, including Germany, Austria and the UK. Today VTB said it plans to spend some $500m supporting its foreign units writes Reuters.

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Defaults, revisited (FT alphaville)

Defaults, revisited

Oct 22 13:20
by Sam Jones

On Tuesday we noted the current chaos in fixed-income and CDS markets which seems yet to have worked through into equity.

With severe recession now firmly on the horizon, bond markets are anticipating a huge surge in default rates. More…

On Tuesday we noted the current chaos in fixed-income and CDS markets which seems yet to have worked through into equity.

With severe recession now firmly on the horizon, bond markets are anticipating a huge surge in default rates. The broad consensus is that junk rated credits will fare, relatively speaking, worse. One commenter noted on the site yesterday:

…there has been rating deterioration across the board over the last decade, it has been more pronounced in sub-investment grade. Investment grade is still typically single and A, but sub-investment grade now means single B whereas it used to mean BB.

And indeed, it’s the itraxx Crossover index which is seeing some of the most dramatic moves right now, compared to the investment grade iTraxx Europe. The Crossover is currently at an all time wide:

The big moves in the iTraxx crossover index are interesting when seen historically, rebased against moves made by the iTraxx Europe:

Relatively speaking, the iTraxx crossover and iTraxx Europe indices have diverged quite markedly - to the casual observer it looks like there is something of a correlation crisis at work. Either one of the indices was mispriced or one of them is mispriced.

1. It may be that, looking backwards, just as too many AAA structured finance bonds were thought too safe (and thus paid too little) so investment-grade corporates were “overrated” and are now being proved to be actually much riskier. The investment grade iTraxx Europe, which has never existed through a recession, is thus adjusting to a more historically accurate correlation between it and the junk-grade crossover.

2. The IG index also contains a large number of financials: you might consider what’s going on in this whole sector an idiosyncratic event, and thus likely to pull the IG index out of historical line.

3. Or it may be that the iTraxx Europe is the correctly priced index, and it’s the Crossover which will have to adjust.

The crisis in financials has indeed been behind the “disproportionate” rise in the iTraxx Europe, but to tackle point 2, the trouble in that sector is not an idiosyncratic issue but a systemic one: one which will spread.

Defaults/rising default risk in financials should be seen as a precursor to a wave of defaults elsewhere. Only in the coming months will the real effects of the crunch start to be felt on the broader economy, and with it, the broader corporate universe: to which the iTraxx Crossover is most exposed. Assuming then, some kind of historical correlation between the two indices still holds, the Crossover will move much wider yet.
_____

There might be a third take. A bit of a get out, but no less relevant. The modelling and pricing assumptions around CDS and CDS indices - both iTraxx Europe and Crossover - are totally inadequate in the current crisis.

Default modelling has relied on historical data going back, typically, over the past twenty years. The last banking crisis like this that we faced was in 1930.

The pricing of credit is broken.

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CDS REPORT: European emerging sovereigns under pressure (FT Alphaville)

CDS REPORT: European emerging sovereigns under pressure

Oct 22 12:17
by David Oakley

European emerging market credits came under pressure on Wednesday as risk aversion continued to plague the financial system.

With the International Monetary Fund considering bailouts for Ukraine, Turkey, More…

European emerging market credits came under pressure on Wednesday as risk aversion continued to plague the financial system.

With the International Monetary Fund considering bailouts for Ukraine, Turkey, Hungary, and Serbia, these countries’ credit default swaps widened further because of the growing perception of risk in investing in these so-called high-yielding nations.

Ukraine, which is expected to seal a deal of between $10bn and $50bn with the IMF soon, has seen its CDS price rise to record levels, with bid-offer spreads very wide, reflecting the illiquidity in this market.

The latest CDS bid-offer spread on Ukraine was 1,793bp to 2,093bp. Every 1bp is equal to a cost of 1,000 euros to insure 10m euros of debt over five years.

Nigel Rendell, senior emerging markets strategist at RBS Capital Markets, said: “You can drive a bus through these spreads, they are so wide - and a bendy bus at that.”

Other countries that have seen CDS prices rise sharply this week include Hungary, which is trading at around 520bp, up around 50bp since the start of the week, Serbia, which has a price of around 450bp, and Turkey, which has a price around 700bp.

Traders are no longer quoting CDS prices on Iceland, which has in effect defaulted and is also awaiting on the IMF to help kickstart its hobbled economy.

The IMF is considering rescue packages for all these countries, which have high current account deficits and weakening economies.

Separately, the iTraxx Crossover index, which is made up of 50 mainly high-yield credits and is considered the best gauge of sentiment, was trading around 780bp, close to the Tuesday close.

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Argentina Default Looms as Pension Funds Seizure Roils Markets (Bloomberg)

Argentina Default Looms as Pension Funds Seizure Roils Markets

By James Attwood and Bill Faries

Oct. 22 (Bloomberg) -- Argentina's planned seizure of $29 billion of private pension funds stoked concern the nation is headed for its second default in a decade.

Investors say President Cristina Fernandez de Kirchner's decision may further hurt markets already reeling from slumping commodity prices and slower growth. The retirement system, set up in 1994 to help bolster capital markets, owns about 5 percent of companies listed on the Buenos Aires stock exchange and 27 percent of shares available for public trading, data compiled by pension funds show.

Argentine bond yields soared above 24 percent before the announcement late yesterday, and the benchmark Merval stock index tumbled 11 percent. The last time the government sought to tap workers' savings to help finance debt payments was in 2001, just before it stopped servicing $95 billion of obligations.

``It's the final of many nails in the coffin from an institutional investor perspective,'' Bill Rudman, who helps manage $3 billion of emerging-market equity at WestLB Mellon Asset Management in London. Argentina is ``disappearing into irrelevance.''

The government's proposal to take control of 10 funds, including units of London-based HSBC Holdings Plc and Bilbao, Spain-based Banco Bilbao Vizcaya Argentaria SA, still needs congressional approval. Fernandez said yesterday her decision is ``in a context where the biggest countries'' are taking steps to protect their banks because of the global financial crisis.

``Instead, we're taking them for our retirees and workers,'' she said during a rally in Buenos Aires.

Borrowing Needs

Argentina's borrowing needs will swell to as much as $14 billion next year from $7 billion in 2008, RBC Capital Markets, a Toronto-based unit of Canada's largest bank, said yesterday.

South America's second-largest economy hasn't had access to international capital markets since its 2001 default. Holders of about $20 billion of defaulted bonds rejected the government's 2005 payout of 30 cents on the dollar, and Fernandez has said she's considering proposals to offer a new deal.

The cost of protecting Argentina's bonds against default soared yesterday, as five-year credit-default swaps based on Argentina's debt jumped 2.38 percentage points to 32 percentage points, according to Bloomberg data. The contracts to protect against or speculate on default pay the buyer face value should a borrower fail to adhere to its debt agreements.

The proposed takeover ``makes the chance of default in the short-term less likely by inflicting immense damage to the long- term credibility of the government and the financial system with its own people,'' said Paul McNamara, who helps manage $1.2 billion of emerging-market assets at Augustus Asset Managers Ltd. in London.

Investment Mix

Amado Boudou, the head of Argentina's social security administration, said yesterday the government will keep the same investment mix for the funds, with 60 percent in bonds and 10 percent in stocks. He called the privately run system an ``enormous error.''

Currently, about 55 percent of the 94.4 billion pesos ($29.3 billion) held by the private pension funds is invested in government debt, according to the pension regulator's Web site. A takeover would allow the Fernandez administration to write off the sovereign bonds held by the funds, said Javier Salvucci, an analyst with Buenos Aires-based Silver Cloud Advisors.

``It's a short-term fix that may cause more fiscal and macro pain in the long haul, which has been typical of the last two administrations,'' said Will Landers, who manages $5 billion in Latin American equities at BlackRock Inc.

Volume Quadrupled

Since the pension system began in 1994, trading volume on the Buenos Aires stock exchange has quadrupled. The funds were net buyers of domestic equities for a third straight month in September, investing about $144 million, according to Deutsche Bank AG. They have about $4.1 billion in domestic stocks, strategist Guilherme Paiva wrote in an Oct. 15 note.

The government's plan is ``one additional factor to count against Argentine assets,'' said Vinicius Silva, an emerging market strategist at New York-based Morgan Stanley, which recommends that emerging-market equity investors have a ``zero' weighting in the country.

Nestor Kirchner, Fernandez's husband and predecessor as president, began tightening restrictions on private pension funds last year, requiring them to keep more investments in the country to sustain economic growth. The rules forced the funds to ``repatriate'' about $3 billion in mostly Brazilian assets, Sebastian Palla, chairman of the country's pension fund association, said in February.

Fund Sales

Foreign emerging-market funds sold about $250 million in Argentine stocks through August this year in the biggest outflow since 2000, according to fund flow tracker EPFR Global in Cambridge, Massachusetts. The Merval is down 51 percent this year compared with 39 percent for the Bovespa in neighboring Brazil.

Bond markets also have tumbled. Yields on the government's 8.28 percent bonds due in 2033 have almost tripled to 24.69 percent from 8.83 percent a year ago.

Seven years ago, as the government tried in vain to stave off a debt default, it pressured the pension funds to participate in bond swaps that pushed forward repayment dates. That December, strapped for cash to pay salaries, it ordered the funds to transfer $3.2 billion in bank deposits to state-owned Banco de la Nacion.

The latest move is ``much, much worse,'' said McNamara at Augustus Asset Managers Ltd.

``It's not just shoving a little bit of debt in at the edge, it's taking over the whole system,'' he said. ``It does even more damage to the concept of encouraging people to invest in the domestic financial industry.''

To contact the reporters on this story: James Attwood in Santiago at jattwood3@bloomberg.netBill Faries in Buenos Aires wfaries@bloomberg.net

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Dancing the Gas "Troika"

Oct 22 09:58
by Izabella Kaminska

Talk of a natural-gas alliance is officially back.

Following high-level talks in Iran, Qatar and Russia are to forge a so-called “Gas Troika”.

This sort of chatter has been around before, everytime causing a corresponding level of panic about a potential Opec-style grip on natural gas prices. More…

Talk of a natural-gas alliance is officially back.

Following high-level talks in Tehran, Iran, Qatar and Russia are to forge a so-called “Gas Troika”.

This sort of chatter has been around before, everytime causing a corresponding level of panic about a potential Opec-style grip on natural gas prices. Witness, the Times today:
We need not worry that Russia is about to join the oily club. Today’s visit by Abdullah al-Badri is a formality, but the talk of a gas cartel is a different matter. A combination of leading gas exporters, no matter how tentative, could pose a serious economic threat to Europe. We should first discount the hoopla from Gholam Hossein Nozari, the Iranian Oil Minister, who proclaimed yesterday that the talks between Russia, Iran and Qatar had reached ‘a consensus to set up a gas Opec’.

Or the WSJ (our emphasis):

Iran, Qatar and Russia have agreed to form an OPEC-style organization for gas-exporting countries, Iran’s oil minister said Tuesday after a trilateral meeting in Tehran.

That’s all very well, but there is an important distinction to be made between a “gas troika” and an Opec-style cartel. A true Opec-style union is many years aways. In fact most gas market specialists would say it’s currently almost an impossibility.

For one, nat gas does not trade like oil. It is locked to specific pipeline routes and/or transported in liquefied form as LNG. Both are contracted out in long-term deals, leaving very little to trade in an effective spot market.

Without a viable spot market it would be very hard to control day-to-day prices. What’s more natural gas prices are extremely seasonal, and can spike on a day’s notice if there’s a cold snap.

While you can trade the arb between Europe, the US and Asia, on the whole each market also follows its own, very unique, fundamentals.

All that said, a close cooperation between the three, which collectively represent some 56 per cent of the world’s known reserves according to the BP Statistical Review of World Energy, could make a difference in deciding long-term contracts and future investment strategies. But, these sorts of decisions would still take years to feed-through.

For the time being, Russia’s best policy to control prices is still the old, hardly subtle, tap-turning.

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Oil Dip

Oil dip

Oct 22 07:57
by Tracy Alloway

Crude oil prices have fallen to about $67 a barrel from their record summer highs of about $146, as concerns of slowing economies filter into the commodities market. But, even with that drop, the market is signalling further declines, More…

Crude oil prices have fallen to about $67 a barrel from their record summer highs of about $146, as concerns of slowing economies filter into the commodities market. But, even with that drop, the market is signalling further declines, according to analysts at Merrill Lynch.

ML analysts are looking at WTI crude oil options — where the number of implied vol for OTM puts is trading at much higher levels than for OTM calls. In other (English)words, more downside.
As of last close the options market is pricing in a probability of crude oil prices being in the $45 to $55 per barrel range by Dec. 16, 2008 that is seven times higher than the one based on past historical returns over a similar timeframe (see below) — that seems incredibly bearish given that Opec appears hellbent on cutting production this Friday.

Oil cartel divided over level of cuts

Oct 22 04:54
by Tracy Alloway

Opec is expected on Friday to decide to slash production as the oil cartel faces its biggest test in more than a decade. Newly released data reveal that the cartel’s vastly divergent economic circumstances will make the divided group’s decision of how much to cut even more difficult. More…

Opec is expected on Friday to decide to slash production as the oil cartel faces its biggest test in more than a decade. Newly released data reveal that the cartel’s vastly divergent economic circumstances will make the divided group’s decision of how much to cut even more difficult. Consultants PFC Energy calculated that Opec countries need next year’s oil prices to be anywhere from $10 to $100 to keep their import expenditures and export revenues in balance. Estimates by energy ministers of how much Opec will have to cut range from 500,000 barrels a day to 2.5m.

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Economic Crisis

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Overnight Dollar Libor Declines to 1.28 Percent (BLOOMBERG)

Overnight Dollar Libor Declines to 1.28 Percent, BBA Says

By Gavin Finch

Oct. 21 (Bloomberg) -- The London interbank offered rate, or Libor, that banks charge each other for overnight loans in dollars fell to 1.28 percent, below the Federal Reserve's target for the first time since Oct. 3.

The rate dropped 23 basis points, or 0.23 percentage point, according to the British Bankers' Association. The cost of borrowing for three months also declined 23 basis points, to 3.83 percent, the BBA said today.

To contact the reporter on this story: Gavin Finch in London at gfinch@bloomberg.net

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European weather map (FT)

European weather map

Published: October 20 2008 21:35 | Last updated: October 20 2008 21:35

Stormy conditions prevail across Europe’s economies after the arrival of a full-blown banking sector crisis this month sent confidence plummeting and threatened widespread-economic damage.

The FT’s latest European economic “weather map” shows the extent of the deterioration since July and April. In July the continent’s economies had largely avoided a credit crunch but were being hit by sudden and steep rises in energy prices, compounded by the effects of a strong euro. In October, inflation is ebbing and the euro has softened.

The weather symbols were compiled by Ralph Atkins, Frankfurt bureau chief, and draw from official data as well as his own analysis. Click on a period to see the forecast.

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Valuations Need To Fall Further for a Sustainable Rally

Last week we discussed Robert Shiller’s S&P500 trailing 10-year price earnings ratio that has averaged 16.3 since 1881 and the fact that it had dropped to 15 as of October 10^th. While we saw prices increase last week and a rise in P/Es, what does the longer-term future hold?

In our next chart, we show annual trailing 10-year P/Es from 1920 to August 2008 using Dr. Shiller’s data. As we see from this chart, every major recession has resulted in P/Es falling below 10 for an extended period of time - lasting decades, not years - typical of secular bear markets. Click to enlarge:

At 15 last week, the P/E was back to just below the long-term average, but this was a daily drop, not an annual P/E. It will take many more months (possibly a year or more) to get back below 15 on an annual basis, meaning we probably won’t see this occurring till 2009 or even 2010.

After that, it could take a few more years to get back to single digits like we had during the last major recession in 1981-1982. In other words, markets and economies will need a long rest with P/Es below 10 before they will be able to mount the next sustainable bull market. A similar situation occurred during the Great Depression into the early 1950s, as we see from the chart above.

Could we get another cyclical bull market rally lasting a few weeks, months or even years as we saw between 2003 and 2007? Very possibly, but as we learned, more often such rallies are short-term and often end abruptly and rather unexpectedly. There are also the raft of fundamental financial challenges facing a sustained U.S. economic recovery like the crushing levels of debt, rapidly deflating derivatives and housing bubbles, falling Treasury sales and mounting government deficit as a result of more than $2 trillion in bailouts so far.

But that doesn’t mean you can’t make money trading the powerful reactive rallies embedded in every secular bear market. This is a trader’s market where it's important to set tight stops and take profits off the table regularly, not a time to buy and hold for the long-term, as the so-called pundits would have us believe, if we are in a true secular bear market.

found at: http://seekingalpha.com/article/100666-valuations-need-to-fall-further-for-a-sustainable-rally?source=feed

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Lex (FT) on The crunch stole Christmas

The crunch stole Christmas

Published: October 20 2008 15:04 | Last updated: October 20 2008 20:55

If investors are to be believed, Santa’s sack will be light this year. Share prices of Mattel and Hasbro, the two big US toymakers, have fallen by a third since August. Third-quarter numbers released on Monday from both manufacturers prompted downgrades to earnings expectations in spite of solid sets of topline growth. Has Christmas been cancelled?

Some caution is natural. After 15 years of declining prices for toys, 2006 and 2007 were notable for rises in average product prices. New mechanisation and computerisation techniques had allowed the creation of must-have robotic playthings, handing their manufacturers a rare degree of pricing power. Yet with consumers retrenching from all discretionary spending, it is hard to see too many parents forking out for Hasbro’s $180 FurReal Friends Biscuit animatronic puppy, or Mattel’s $60 Elmo dolls.

Christmas is always a nervy time. Shares in the toymakers tend to perform best in the first half of the year, when the fourth quarter turns out not to have been so bad as feared, and the following year’s line-up starts to prompt excitement. Toys have historically proved relatively recession proof, thanks to parents’ perennial desire to see happy faces on Christmas morning. More than half of Hasbro’s products sell for less than $20; more than three-quarters of Mattel’s for less than $25. Retailers know the pull of toys and discount hard-to-lure customers – Wal-Mart has announced a top 10 for $10 deal.

Currency headwinds lie in wait next year, and ambitions to make mid-teen margins are likely to stay long-term goals for now. But demographics, international growth and well established brands remain on the toymakers’ side, suggesting a future of steady, if unexciting growth. With Mattel now trading on a lowly 10 times prospective earnings, the spirit of Scrooge may have gone too far.

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Libor fixes: credit and phase transitions

Libor fixes: credit and phase transitions

From the BBA:

LIBOR OVERNIGHT STERLING RATES FIX AT 4.76875% VS 4.68750%

LIBOR OVERNIGHT DOLLAR RATES FIX AT 1.51250% VS 1.66875%

LIBOR OVERNIGHT EURO RATES FIX AT 3.57250% VS 3.66125% More…

From the BBA:

LIBOR OVERNIGHT STERLING RATES FIX AT 4.76875% VS 4.68750%

LIBOR OVERNIGHT DOLLAR RATES FIX AT 1.51250% VS 1.66875%

LIBOR OVERNIGHT EURO RATES FIX AT 3.57250% VS 3.66125%

LIBOR THREE-MONTH STERLING RATES FIX AT 6.11625% VS 6.16000%

LIBOR THREE-MONTH DOLLAR RATES FIX AT 4.05875% VS 4.41875%

LIBOR THREE-MONTH EURO RATES FIX AT 4.98625% VS 5.02000%

So far no huge crashing to earth in Libor rates. There are some big movements - the reduction in three month dollar funding rates, for example, is certainly a large move (undoubtedly a result of JPM’s multi-billion interbank three months ops on Friday).

But relative to the velocity of the upward moves in Libor several weeks ago now, these are incremental baby-steps.

Indeed, what happened to Libor - or more broadly, perceptions of market risk in September (measured by the Libor-OIS spead) looked like something of a crude phase transition:

That is to say, there might be something more to the over-used “frozen credit markets” metaphor than at first meets the eye. Here’s a crude graph of how water freezes:

The dotted green line is ice. In its pure form, water makes an instantaneous transition from its liquid to its frozen state: a phase transition. More usually a seed crystal - a small piece of solid-form material (ice) develops around an impurity and tips the balance: as if by magic, the inter-molecular structure of the liquid reorganises itself to match that of the single seed crystal’s “solid” state.

Back to the market: might LEH have been something of a seed crystal to a market already cooled to a critical point?

And to flip that around, are we now seeing that suddenly frozen market only slowly melt?

More broadly - to add to this wild series of flailing stabs in the dark - how might describing markets in terms of thermodynamic physics work in terms of characterising “Black Swan” events as phase transitions?

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Welcome note

Welcome and thank you for reading this.

This blog is a result of some free time and as a result.. if that free time disappears... the updates could stop.

I will do my best to let you know if that happens.

On a side note... I anticipate that the vast majority of the articles here will be copied from other web-pages (notably the excellent ft.alphaville site) and I will try and add my opinion (or not if I feel I am covered by theirs)

I have the out most respect for these great journalists and I value their opinions and insight.

Enjoy !!

Nikolas

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