Thursday, May 31, 2012

Headed for Davy Jones' Locker

Yield on 2-yr. Swiss notes
[courtesy ZeroHedge]

Yields on 2-year Swiss notes have gone negative in a big way.  As ZeroHedge points out, you can now pay the Swiss government 26 basis points to borrow your money.

Why would you do that?

You would if your currency is losing value against the Swiss franc.  And right now the currency of almost two dozen European nations--the euro--is sinking fast.  Switzerland is an island of prosperity in the turbulent European waters and historically a safe haven for scared money.  We have observed that capital is fleeing the beleaguered peripheral nations (Greece, Spain, et al.).  Now we know where a lot of it is going.  The Swiss National Bank has said that it will defend the euro (the Wall Street Journal explains here).  But the chart above (remember, bond yields are inversely related to demand) reveals a widespread belief that the SNB will be unable to hold the fort.

[update, 06-01-12--]

Scared money is also finding its way into German bonds; the two-year yield went negative today.  As David Rosenberg at Gluskin Sheff points out, "the front end of the German curve is seeing huge inflows of euros from the dilapidated banking systems in the south." Rosenberg's recap is a useful primer for uninformed castaways curious about what has been happening in the global economy recently.

John Mauldin, in his weekly newsletter, explains why investors are willing to bid bond yields below zero:
"Buying German bonds, even at a slightly negative rate, is actually a cheap call option on the eurozone breaking up. A German bond that became a new Deutschemark-denominated bond would rise in value at least 40-50% almost overnight."

The Euro: now worth $1.24 and plunging.

Wednesday, May 30, 2012

At the Top of His Game

Dr. John's weekly comment is among his best.

"The Reality of the Situation" [excerpts]:

"Remember that these bouts of QE, LTRO operations, and other interventions have essentially had their effect by squeezing interest rates to levels that are so low that investors feel forced to seek higher risk securities in a search for yield. What Bernanke views as a 'wealth effect' is simply the richer valuation of existing cash flows that goes hand in hand with lower prospective returns in the future. This is not wealth creation, but simply a distortion of the time profile of returns that now leaves investors facing dismal future prospects for investment returns. The economic impact of QE has been restricted to short bursts of pent-up demand, but little more....

We'll finally get some economic traction when global leaders have the sense to take bloated, mismanaged banks into receivership, mark down the assets to their actual value, restructure the repayment terms with homeowners and other borrowers, haircut the liabilities enough to make the resulting entities solvent, and then return them to the private market under a regulatory structure that splits traditional lending from securities trading. That prospect is getting closer....

With respect to Eurobonds, investors should understand that what is really being proposed is a system where all European countries share the collective credit risk of European member countries, allowing each country to issue debt on that collective credit standing, but leaving the more fiscally responsible ones - Germany and a handful of other European states - actually obligated to make good on the debt. This is like 9 broke guys walking up to Warren Buffett and proposing that they all get together so each of them can issue 'Warrenbonds.'"

John Hussman's complete commentary for this week is here.

Sunday, May 27, 2012

Quote For the Week, May 27-June 2

Wealth and want equally harden the human heart.
--Theodore Parker

Friday, May 25, 2012

Caveat Emptor

Has this employee in the London office gotten his pink slip yet?

Sunday, May 20, 2012

Quote for the Week, May 20-26, 2012

[America] is a welfare state, but the welfare is for the elderly, not the poor. While our two parties argue over the haves and have-nots, we are blind to what the nows are doing to the laters.
--Lawrence Kotlikoff and Scott Burns, The Coming Generational Storm

Monday, May 14, 2012

Europe Goes Hard-Core

Citi analyst Willem Buiter paints a doomsday scenario.

"A Greek Exit From the Euro Area:
a Disaster For Greece,
a Crisis For the World"

As soon as Greece has exited, we expect the markets will focus on the country or countries most likely to exit next from the euro area. Any non-captive/financially sophisticated owner of a deposit account in that country (or in those countries) will withdraw his deposits from banks in countries deemed at risk - even a small risk - of exit. Any non-captive depositor who fears a non-zero risk of the future introduction of a New Escudo, a New Punt, a New Peseta or a New Lira (to name but the most obvious candidates) would withdraw his deposits from the countries involved at the drop of a hat and deposit them in the handful of countries likely to remain in the euro area no matter what - Germany, Luxembourg, the Netherlands, Austria and Finland...Apart from bank runs in every country deemed, by markets and investors, to be even remotely at risk of exit from the euro area, there would be de facto funding strikes by external investors and lenders for borrowers from these countries....

The funding strike and deposit run out of the periphery euro area member states (defined very broadly), would create financial havoc and mostly like cause a financial crisis followed by a deep recession in the euro area broad periphery. The counterparty inflow of deposits and diversion of funding to the ‘hard core’ euro area and the removal (or at least substantial reduction) of the risk of ECB monetisation of EA sovereign and bank debt would drive up the euro exchange rate. So the remaining euro area members would suffer (at least temporarily) from an uncompetitive exchange rate as well from the spillovers of the financial and economic crises in the broad periphery....

A banking crisis in the euro area and in the EU would most likely result from an exit by Greece from the euro area. The fundamental financial and real economy linkages from the rest of the world to the euro area and the rest of the EU are strong enough to make this a global concern.

Complete paper here.

Sunday, May 13, 2012

Quote for the Week, May 13-19, 2012

The oldest task in human history: to live on a piece of land without spoiling it.
--Aldo Leopold

Friday, May 11, 2012

The Smell of Morgan in the Morning

JPM CEO Jamie Dimon has had better days.

This is more than a wee hiccup.  MainePERS portfolio managers are hurling big time following the disclosure later yesterday afternoon that JP Morgan Chase (ticker symbol: JPM) will be taking investment losses in the second quarter.  How big will those losses be?  The answer (and all you PMs out there, take your ulcer meds first):  no one knows.

JPM is a Top Ten holding in the MainePERS equity portfolio.  Or was.  At the end of the first quarter, MainePERS held 959,294 shares of JPM common stock with a market value of over $44 million.  At that time the shares were priced at about $46 a share.  In pre-market trading this morning, shares are going for around $38.  So in the last six weeks, MainePERS has lost $7.67 million on JPM alone.  The ripple effect on the shares of other Wall Street banks (remember, MainePERS owns 2.5 million shares of Bank of America) compounds the damage.

JP Morgan Chase hastily arranged a conference call with industry analysts at 5 p.m. yesterday, a whiff of panic in the air.  The call coincided with the release of the company's latest 10-Q filing with the SEC.  Scroll down to Page 9 and you will see what the commotion is about:

Since March 31, 2012, CIO [Chief Investment Office] has had significant mark-to-market losses in its synthetic credit portfolio, and this portfolio has proven to be riskier, more volatile and less effective as an economic hedge than the Firm previously believed.

How volatile, you ask?  Is $2 billion vaporized in just six weeks volatile enough for you?  Now, some of that loss has been offset by gains realized through the sale of other securities.  Halfway through the quarter, the net loss for the Corporate unit within the Corporate/Private Equity segment for the whole quarter ending June 30 is estimated at $800 million.  The firm's prior guidance had been for a gain of $200 million.  So that's a billion-dollar swing.

The firm's polished CEO, Jamie Dimon [above], did not hide his displeasure during the conference call. Actually, one wonders why he held the call in the first place.  The 10-Q had been filed and the disclosure made.  The projected loss for Corporate, at first glance, does not appear to be that big of a deal for a firm as big as JPM, which books quarterly profits in the neighborhood of $5 billion.  In the first quarter Corporate showed a loss of $697 million.  That was amply covered many times over by the rest of the company.  So why panic now?

Here's why.  Those synthetic credits are still on the books and may be marked down further.  [Update, 05-17-12:  take off another billion.  And two more.  And two more after that.]  The position is simply too large for the company to disgorge all at once without driving prices down to fire-sale levels.  And now that JPM's hand is exposed, competitors will get in front of the unwind, making the exit even more expensive.  (Bloomberg has the story here.)  The 10-Q says it all:

The Firm is currently repositioning CIO's synthetic credit portfolio, which it is doing in conjunction with its assessment of the Firm's overall credit exposure. As this repositioning is being effected in a manner designed to maximize economic value, CIO may hold certain of its current synthetic credit positions for the longer term.

In other words, Jamie may be stuck in his position, kind of like the Hotel California.  You can check in any time you like, but you can never leave.

Does that make MainePERS stuck as well?

[P.S.--Financial geeks may be interested in this suggestion at ZeroHedge that JPM may be looking at another $3 billion in downside related to the CIO's hedging activities.  "Oh the fun of negative convexity--especially when you ARE the market and there is no one to unwind the actual tranches to."]

[P.P.S.--"I told you so!"  Janet Tavakoli saw this coming two years ago when she warned about "delusional risk-taking and lack of transparency at Too-Big-To-Fail banks," where "ambitious managers strive to pump speculative earnings from zero to hero."  HuffPo has the update here.]

[Lastly, Dr. John Hussman observes:  "Maybe the right question isn't why they lost money on the hedging transaction, but why they apparently have a boatload of questionable assets so massive that they need to use whale-sized leverage to hedge the default risk in the first place."]

Monday, May 7, 2012

Bad Moon Rising

"My view on this is simple - if you've overestimated the long-term stream of cash flows by failing to adjust for elevated profit margins, if the prospective return on stocks is unusually low even on the basis of normalized earnings (as it is today), and if you've set your portfolio up in a crowded trade that takes record-high beta exposure to market fluctuations (as many institutions have now done), you just might be in for some trouble."

--John Hussman, Ph.D. in his weekly Market Comment

Could Dr. Hussman be talking about institutional investors such as (oh, let's just pick one) the Maine Public Employees Retirement System, which is over 60% invested in stocks and whose Top Ten equity holdings include the most "crowded" trade since tulips (Apple), a pharmaceutical giant on the edge of a patent cliff (Johnson & Johnson), and a mega-bank sitting on a ticking debt bomb (JP Morgan Chase)?

Sunday, May 6, 2012

Quote for the Week, May 6-12, 2012

We hang the petty thieves and appoint the great ones to public office.

Friday, May 4, 2012

Where Are the Jobs?

If non-farm payrolls continue to stair-step downward,
Barack had better start packing his stuff.

This morning the Bureau of Labor Statistics released its monthly employment report (or unemployment report, depending on whether you are a glass-is-half-full or glass-is-half-empty kind of person).  Some were disappointed by the numbers.  According to the Establishment Survey, 115,000 nonfarm jobs were added in the U.S. in April [see chart above], the lowest reading so far in 2012 and barely enough to keep up with growth in the working-age population.

The Household Survey told a grimmer story:  235,000 fewer people working at non-agricultural jobs in April compared to the month before.  And if you are not confused enough already, the BLS has another number called the Adjusted Household Survey that shows 495,000 fewer workers month to month.

Whatever the precise quantity of jobs, the quality of jobs leaves much to be desired.  Table A-8 in the household data shows 490,000 more part-time workers in all industries in April even as the overall number of workers declined.  That number is more or less consistent with a data series kept by the St. Louis Federal Reserve Bank showing a gain of 508,000 part-time workers.  The same source records a drop of 812,000 in full-time workers, the largest one-month drop in three years.

The job prospects of one Mitt Romney are soaring.

As for the bank we love to hate, Bank of America filed its latest 10-Q with the SEC yesterday.  Click on the link and scroll down to Page 65 for management's discussion about Credit Ratings.  You will see that Moody's has warned of a possible downgrade to BofA's credit rating, the second in nine months.  The agency's review should be completed by the end of June.

When ratings drop, borrowing costs and demands for collateral rise.  Management quantifies the risk as follows:

At March 31, 2012, if the rating agencies had downgraded their long-term senior debt ratings for the Corporation or certain subsidiaries by one incremental notch, the amount of additional collateral contractually required by derivative contracts and other trading agreements would have been approximately $2.7 billion...If the agencies had downgraded their long-term senior debt ratings for these entities by a second incremental notch, an incremental $2.4 billion...would have been required.

In other words, a potential $5.1 billion loss of liquidity!