The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Between now and the end of June, traders, wise guys and PMs will try to manipulate stocks higher
to game Q2 performance – especially with May being the worst month for stocks in decades.

This week is option and futures expiration. Normally there is a triple-digit DJIA rally for expiration
week; and Bernanke pours liquidity into the system for expiration week.

If stocks would have declined last week, this week would have been a layup for a rally – as long as no
new negative news surfaced. Ergo, the expiration rally this week might be more tepid than usual.

Another bullish factor for some stocks is the June 25 Russell rebalancing. So, barring ugly news or
developments, the bias for the next few weeks should be to the upside for stocks.

Bonds and the dollar should retrench. If these market movements appear, it is important to remember that
it is nothing more than trading games. It is not the start of some new cycle or a change in fundamentals.

In fact, economic fundamentals continue to deteriorate. Retail sales, auto sales, housing sales, rail traffic
and mortgage applications are receding.

Economic models that have forecast both economic contraction and expansion, like ECRI and Consumer
Metrics Institute, are showing significant declines.

Retail sales unexpectedly declined 1.2% in May. The decline confirms the horrible May Employment
Report and the decline in US Treasury tax data for May.

The May retail sales decline also boosted fears of a double-dip recession.

The consensus forecast on Wall Street and in DC is the US is undergoing a ‘V’ shaped economic
recovery. However, there is no evidence of a ‘V’ bounce in jobs, income or tax receipts.

The main ‘V’ shaped bounce has been in the stock market. And just because the stock market has a ‘V’-
shaped recovery does not mean the economy will have a ‘V’-shaped recovery.

The previous two recessions have had bowl-shaped recoveries while the stock market had a ‘V’-
shaped bounce due to the enormous amount of funny money that was created.

Unfortunately, all that easy credit could not get into the real economy meaningfully due to severe
structural flaws. Instead the record easy credit flowed into the ‘new economy’, financial speculation.

$34 billion Southeastern Asset Management’s “Comment & Analysis on Equity Market Structure”:

• The US equity markets are meant to facilitate investors’ allocation of capital to businesses, thus
expanding production and improving the quality of life in America.

 The markets have strayed from this social purpose, and presently resemble casinos more than
orderly markets. As a result, the economy is hindered, fewer jobs are created, and reasonable
returns for true investors (not traders) are compromised…
 Whereas trading was once a means with which to match long-term buyers and sellers of
businesses, trading has now become an end in and of itself…

http://www.zerohedge.com/article/34-billion-asset-manager-says-market-prices-are-manipulated-accuses-nyse-intellectual-proper

Dallas Fed President Richard Fisher, in a speech on June 3 to the SW Graduate School of Banking
excoriates current Fed and Treasury policies in regard to financial reform and bailouts.
Regulators have, for the most part, tiptoed around these larger institutions. Despite the damage they did,
failing big banks were allowed to lumber on, with government support. It should come as no surprise that
the industry is unfortunately evolving toward larger and larger bank size with financial resources
concentrated in fewer and fewer hands.

As a result of public policy, big banks have become indestructible. And as a result of public policy, the
industrial organization of banking is slanted toward bigness.

As a result, more conservative banks were denied the market share that would have been theirs if
mismanaged big banks had been allowed to go out of business. In essence, conservative banks faced
publicly backed competition.

The system has become slanted not only toward bigness but also high risk.

…sufficient or not, ending the existence of TBTF institutions is certainly a necessary part of any
regulatory reform effort that could succeed in creating a stable financial system. It is the most sound
response of all. The dangers posed by institutions deemed TBTF far exceed any purported benefits. Their
existence creates incentives that will eventually undermine financial stability. If we are to neutralize the
problem, we must force these institutions to reduce their size…

http://www.huffingtonpost.com/simon-johnson/richard-fisher-senior-fed_b_602386.html

In a continuation of the hangover from the end of the home buying tax credit, the June NAHB home builder survey was a weaker than expected 17 vs the estimate of 21 and down from 22 in May. It is now back in line though with the one yr average. Present conditions fell 6 pts to 17 and the Future outlook fell 4 pts to 23, the lowest since March ’09 when it reached 15. Prospective Buyers Traffic fell 2 pts to 14. The NAHB chairman said that while we expected a temporary pull back in the builders’ outlook after the expiration of the tax credit, “the reduction in consumer activity may have been more dramatic than some builders had anticipated.” “Builders still remain very cautious and are aware that several factors could impede the nascent housing recovery, including serious problems in obtaining financing for the production of housing, faulty appraisal practices and competition from short sales and foreclosed properties.”

From Sal & Joe at Themis Trading comes this terrific timeline regarding the events surrounding high Frequency Trading.

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click for ginormous chart

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Hat tip Kate Welling

Way cool!

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click for interactive graphic

The June NY manufacturing survey at 19.6 was about in line with expectations and little changed from May’s # of 19.1 but remaining at a still good level. New Orders rose 3 pts but after falling by half in May. Backlogs rose by 6 pts but remained negative at -1.2. The Employment component fell by 10 pts, matching the lowest since March but it’s just back to the 6 month avg. After 4 positive readings, Inventories went slightly negative at -1.2. Following the selloff in commodity prices, Prices Paid fell to 27.2 from 44.7, the lowest since Dec. Prices Received fell a touch to 4.9 but to the lowest since Feb. The 6 month Business Conditions outlook fell slightly to 40.7 from 42.11, to the lowest since July ’09. Net-net, NY is the first of many regional manufacturing surveys, ultimately summed up by the ISM and the lack of an export orders component in today’s data means we need to see more surveys to get a broader gauge of manufacturing but today is off to a good start.

Looking forward over the next few months in terms of import price inflation, there are two factors to keep a watch on. First is what impact the US$ strength will have in keeping import prices in check and secondly, what impact, if any, will the rise in the wages of Chinese manufacturing employees have on Chinese manufactured goods. May Import Prices, ex all fuels rose, rose by .5% m/o/m and is up 3.6% y/o/y. Headline prices fell .6% m/o/m (half expectations of a drop of 1.2%) but are up 8.6% y/o/y. Thus, the strength of the US$ is not showing yet any influence on keeping import prices contained but it should if the strength is sustainable. Also of note, import prices from China rose .3% m/o/m, the biggest gain since Aug ’09 and with the daily stories of higher wages in China, the trend bears watching.

From Institutional Investor, comes this list of favored HFT names:

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•New York Times – Obama Presses for Aid to Cities and States

President Obama on Saturday implored Congress to provide more aid to states and cities to blunt “the devastating economic impact of budget cuts” by local governments that imperil the jobs of teachers, the police, firefighters and other public employees. In a letter to Democratic and Republican Congressional leaders, Mr. Obama said the “mounting employment crisis” in the states “could set back the pace of our economic recovery.” Proponents of aid to the states, including some Congressional Democrats, governors and mayors, have been urging the president to weigh in on proposed legislation, initially providing up to $50 billion in assistance, which has been derailed in the House and Senate. Mr. Obama did not endorse a dollar figure, reflecting the fact that Democratic leaders were trying to determine what amount could win enough votes in their party, given Republicans’ near-unanimous opposition.

•New York Times – State Plan Makes Fund Both Borrower and Lender
Gov. David A. Paterson and legislative leaders have tentatively agreed to allow the state and municipalities to borrow nearly $6 billion to help them make their required annual payments to the state pension fund. And, in classic budgetary sleight-of-hand, they will borrow the money to make the payments to the pension fund — from the same pension fund. As word of the plan spread, some denounced it as a shell game and a blatant effort by state leaders to avoid making difficult decisions, like cutting government spending or reducing pension benefits. “It’s a classic Albany example of kicking the can down the road,” said Harry Wilson, the Republican candidate for comptroller, who holds an M.B.A. from Harvard.

Comment

Are munis going to go bankrupt?  We addressed this in our May 20 conference call.  The relevant part is excerpted here:

Are Munis Next?

Let’s go to Page 10, which is basically, “Are Munis Next?”

I’ll give you the short course with this.  The answer is, “No, munis are not next.”

The top chart on the left of Page 10 basically shows California and Illinois municipal credit default swaps.  These are the two widest credit default swaps right now.

<Click on chart for larger image>

Can California and/or Illinois Go Bankrupt?

The answer is, “No, they can’t go bankrupt because there is no provision in the bankruptcy code to allow them to go bankrupt.”

If states are allowed to go bankrupt, then what you would be saying is, “We are allowing a bankruptcy judge to become the governor of the state, for him to make the priorities.”  That’s why states cannot go bankrupt.

Well, what if they run out of money?

California and other states have priorities.  In California, roughly 50% of their budget goes to education.

Once education is satisfied, the next dollar has to go to meeting debt service.  That gets you to about 57% of the budget.

So in order for California to default, they would have to come up 43% short in their revenue assumptions – 43% short.

But even if they did come up 43% short, consider the chart below which shows the stimulus bill.  If you want to call this the Municipal Bailout Bill then I don’t think that you would be incorrect in doing so.

<Click on chart for larger image>

$150 billion dollars is the deficit of all of the states in 2010.  We’re spending roughly $135 billion in the stimulus bill. This is a bailout for the states.

So if California needs more money, then what will happen at that point — and this is what they put in their budget earlier this week – is that California could request billions of dollars in stimulus money to be spent on education.  So those billions of dollars, then, could be shifted next up the line to be spent on debt service.

This doesn’t mean that the states have no problems; they have huge problems.  It just means that bankruptcy of the state is not as likely as in Europe.  Rather, they could become a gigantic drag on the federal government.

So will California be Greece?  I think that the simple answer is, “No, they won’t have a debt service problem.  They’ll just drag everybody else down with them.”

Due to forced selling by investment grade managers, Greek bonds are down sharply following the belated downgrade of their credit rating by Moody’s. The selling in turn is dragging down the bonds of the entire region with Spanish yields in particular rising to fresh 20 month highs. This action is a prelude to the biggest event of the week on Thursday, the sale of 10 yr and 30 yr Spanish debt. Spain today sold 12 mo bills at a yield 71 bps above the one a month ago. The equity markets in the area are higher however as it also shrugged off a big drop in the German ZEW 6 month economic confidence outlook # which fell to 28.7 from 45.8, well below estimates of 42. BUT, current expectations (helped by weak euro and export growth) rose to the highest since Sept ’08 and that calmed investors. Signs of banking stress still exist as the 3 mo Euribor money market rate (mostly European banks) spread to 3 mo EU LIBOR is just shy of a record high.

On Monday, Moody’s downgraded Greece’s government bond ratings to junk status of Ba1 from A3.

As legislators debate new regulation for the financial sector, this action yesterday serves as a reminder to the folks in DC that the current regime of ratings agencies has become an unmitigated disaster.

It also raises a simple question: What possible reason on God’s green earth do the ratings agencies currently serve?

Consider the following facts about Moody’s and S&P:

• They are not unbiased observer of credit issuers.
• They do not provide actionable intelligence for bond or equity investors.
• Their positive credit ratings are, as we learned during the collapse, mostly worthless.
• Downgrades and negative ratings are also mostly worthless — but downgrades do have the redeeming quality of providing comic relief, to wit, the astonishingly belated downgrades of Enron, Lehman Brothers, Bear Stearns, Citi, AIG and now Greece. (Good times!)
• Last, they seem to be incapable of providing any sort early warning about potential systemic credit issues with major economic ramifications.

Other than that, they are a terrific group of folks who have done a bang up job paying themselves huge bonuses for previously unimaginable levels of incompetence.

When the Nationally Recognized Statistical Rating Organization NRSROs were created in the 1975, there seemed to be this genteel belief that no management team would willingly risk their entire firm merely to enrich themselves via short term bonuses. And — Of course! — no firm would ever behave so recklessly as to put the entire economy at risk for profit motives. Indeed, market discipline would insure such was the case.

We now know that this idealistic belief system is completely false, and relying on the efficiencies of the market to enforce regulations is sheer folly.