WTI

• Expected dip in mortgage delinquencies: peak in 2010, then fall. 3Q2009, delinquencies were at 6.25%, 3x historical norm
• UC Rusal likely to be able to list on HK Exchange before the end of year; looking to gain additional capital to finance a massive amount of debt
• Strong demand in Asia, Opec production cuts, excess inventory in the US: WTI is trading les than Brent, Dubai crude
• First Bangladesh derivatives trade: FX options denominated in the taka against the dollar. HSBC used historical spot, forward data to construct product, given the absence of implied volatility
• Fiscal Stability Improvement Act

Commodity History Lesson

Commodity History Lesson

• Boom: 2003-08; oil less than $10/barrel in 1999, to $150 in mid-2008.
• Super Cycle: main drivers of upward trend in commodities remain in place: pent-up demand in emerging markets and supply constraints caused by a lack of investment over the past 20 years, including a rise in resource nationalism
• September: traders speculated on winter demand, but storage grew stronger due to a weak economy. Spot price ended up being significantly lower than 1-mo futures.

Nomenclature

• contango: price of a commodity where future price is higher than the spot price, or a far future price higher than a nearer future price. Represents the price of storage
• Standard in equity markets. Normal for non-perishable commodity which has a cost of carry (example: interest paid on a margin account). Perishable commodities are not in contango, since eggs delivered today are not the same eggs in 6 months
• contango: surplus; backwardation: shortage
• Oil storage trade: buy at spot, sell future, store oil for delivery, pocket the difference

Back Office Repo Dust Off

• Trade: go long financials day after Dubai announcement, as the exposure is most likely limited, and shares will regain as that information comes to light
• UAE established an emergency liquidity facility for local and foreign banks in the area; will assist in the likely debt restructuring of Dubai World
• Berezin (GS): cautionary tale of credit-financed construction booms
• Electricity in the US: "demand response" paying customers not to buy power when they need it the most. Instead of building a power plant that you only use for 50 hours out of the year, why not just pay people to not consume during those 50 hours? Equivalent to selling options.

Fed's first steps in exit strategy

• support of the financial system since 2007 has added $1tn of excess banking reserves; should the banks start lending these reserves, massive inflation
• repo: repurchase agreement - allows a borrower to use a financial security for collateral for a cash loan at a fixed rate of interest. Equivalent to a cash transaction plus a forward. Difference between the forward price and spot price is the interest on the loan.
• reverse repo: counter party view of a repo
• FOMC: add reserves to system by purchasing UST, and then after a specified time remove them
• reverse repo: Fed sells UST to deals for cash, with agreement to buy them back at a higher price, which will gradually remove reserves from dealers

Dubai goes bust

• Dubai World's restructuring and "debt standstill" on $22bn debt, including $4bn due Dec 14th. (definition: Mechanism by which a country agrees to cease payments on its debts until a restructuring agreement has been negotiated with its creditors) sends markets into turmoil: little information plus low volumes due to holidays compounded the situation.
• Dubai World: one of the emirate's biggest and best known companies
• Nakheel: most trouble subsidiary - asked to extend maturity from Dec to May 2010
• Investors feel misled about implicit state guarantee; typical of the way things work: top-down and in a vacuum
• Perspective: put 40bn in context of 1,000bn of toxic assets in the US and Europe
• 2nd order effect: preparing for a fire sale of prime property in London and NYC

I will sell anyone insurance on sovereign debt

• Cadbury signals it is open to a 17$bn bid by Hershey
• Signals of an impending asset bubble: inflation (cost of goods rising), caused by a rise of base commodities due to near-zero interest rate speculation: focus on consumer price indexes
• Abraaj Capital (Largest PE in ME): sellers are become more realistic about valuations, ready to start buying
• European government subsidies for 'green' manufacturing expected to give the area a significant boost
• Coca-Cola looking to triple bottling in China to serve rising middle class
• Marked increase in sovereign CDS volume for industrialized nations. US: 10bn, Japan 15bn, Russia $101bn

Central Banks seeking exits

• Bernake speaks on dollar: Fed expects to keep rates 'near zero for an extended period', as there is low resource utilization and low expectations for inflation; traders question if he will move beyond talk
• Japan GDP at 4.8%, stronger than expected, fueled by domestic demand
• UK: 6th largest economy by nominal GDP (2.6tn). 61 million people. London (7.5m).
• GM: $8.1bn outstanding, will pay back 1.2bn ahead of schedule. In fresh losses after emerging from bankruptcy
• Eurozone companies having trouble, as the high euro has decreased sales, compared to countries not on the euro (UK, Switzerland)
• Baltic Dry Index: cost of moving grain, steel, etc by sea. Can't be seen as a reliable indicator, as significant capacity was added in the boom, and new capacity remains underutilized now in the recovery, distorting costs
• Japan: weak JGB (Japan Government Bonds) auctions; looking to raise new debt, high yen makes economy uncompetitive, debt/GDP ~ 2, rapidly aging population decreases tax revenues and requires more pension payouts from the state: uh-oh.
• Foreign ownership of treasuries: 33%, JCB: 7%
• Since the LIBOR market is liquid again, central banks are looking to unwind 'monetary loosening' policies.
• Jean-Claude Trichet: European Central Bank president: December will be the last auction of 1-year notes (introduced for crisis); one-month, one-week still common. Free money for too long will promote asset bubbles.
• Federal reserve has stopped buying treasuries; Bank of England unlikely to extend 200bn pound quantitative easing
• spread between 3-mo libor and overnight: down to 20 bps, levels at before Lehman

Staggered maturities of high yield debt

• Congress proposing legislation which would end the Fed's supervisory role and limit it's ability to be an unlimited lender of last resort. Large bailouts would have to be deliberated, but critics say not letting the organization work fast enough would be a disaster
• Record levels of corporate financing activity are more than making up for sluggish M&A, syndicated lending. Gains made by flow business (contrasted to proprietary trading). Largest in Europe: DB, Credit Suisse, Barclays Capital. US: Goldman, JP Morgan
• OTC derivatives market on the upswing: rate and FX derivatives: investors positioning themselves for an uncertain economic outcome
• NYSE average daily volume: 3.5 billion shares
• 2,700bn commercial mortgages due in the next five years (peak 2011)
• 1,500bn leveraged finance debt (peak 2014)
• In contrast to previous credit cycles: speculative grade debt maturities are staggered: lenders have more time to work though exposures, but system will take a longer time to clear out

$7000bn debt due by 2012

• banks reluctant to lend: corporate bond market has new importance
• speculation for more M&A activity (cadbury and Axa Asia-Pacific) is bad for bond market. When Kraft issued it's takeover bid: stock down 6%, but CDS up 35% (!!)
• This week's G20 meeting: stimulus programs will remain until economic recovery is entrenched
• Dollar: 15-month low on trade-weighted basis
• Banks looking to refinance $7000bn of short-term debt expiring in the next 3 years. Will have to pay up as interest rates will most likely rise in the coming years
• average debt maturity in the US sank to 3.2 years in 2009, less than half the long-term average. CDS spreads lower for the next 3 years, jump 30% at 3-5 year range
• short term debt was exasperated by governments guaranteeing the new loans during the crisis

S&P 500: 80% companies report Q3 profit above forecast

• Expectations are that Kraft will go hostile with takeover of Cadbury
• S&P 500: 80% companies report Q3 profit above forecast; highest since started tracking in 1994. Usually beat by 1.9%, now 14.9%. Only 58% beat revenue forecast, which means that increased profit was a result of cost-cutting instead of sustained growth, leading to increased volatility.

Who would believe Ford is profitable

• US Institute of Supply Management: index of national factory activity 55.7 (oct) from 52.6 (sept); clear sign of improving economy. Caveat: too much improvement, Fed will raise rates
• Ford: posted net profit, primary as a result of 'cash for clunkers'
• Oil: previously 2 benchmarks: Brent (Europe) and West Texas Intermediate (US). Saudi Arabia to now price in terms of Argus Sour Crude Index (Gulf of Mexico).
• Most profitable commodities businesses: GS, MS, Barclays. RBS following UBS, Lehman, Bear Stearns in getting rid of commodities division.
• ChiNext: market debut, all 28 stocks gained 76-210%, fell 10% soon after as they reached daily down-limits
• Australia and Norway have already rasied rates; market sentiment shows that investors are bracing for a rate increase as well, although well into the future
• Middle East construction begins again - people willing to trade in double digit profit margins for longer term stability

Low dollar feeds risky global asset bubble

• European dark pool liquidity has increased 5x since the start of the year; Oct: only 1.2% of total trading
• Reinsurance companies: very few catastrophic events, bond markets have recovered strongly. Munish Re: world biggest reinsurer
• TSE now offering co-location, to match US HFT
• Bank of England debating to continue quantitative easing; action has boosted asset prices but secondary effects in the market are unclear
• New technology has released natural gas locked in shale rock, of which the US has a surplus. LNG producers have sent the excess to Russia, which has produced a surplus there amid the slow economy
• US banks: 'skin the game' legislation: retained unhedged 10% of the credit risk in a securitization. Lack of investor interesting in anything non-prime has made the banks keep 12-15% of a deal
• Risky asset bubble (equities, oil, commodities) driven by falling dollar. Borrowing in dollars (short dollar) alone gets your nearly 20%; total returns for investing those proceeds in risky strategy yields 50-70%. One big common trade: short the dollar to buy any global risky assets
• Central banks in Asia / LatAm are fighting currency appreciation
• Fed is artificially keeping vol low by massive asset purchases - expect to go away soon

Better recovery than expected

• US economy returned to growth in the Q3; 3.5% was stronger than expected
• Unemployment still at 9%
• Latin America weathered the crisis well: resulting in rapidly appreciating currency and influx of capital that could encourage future bubbles
• House income fell 3.4%, while expenditure rose 3.4% - people acting on credit
• DB posted it's best quarterly net profit ever at E$1.4bn

Savings and Loan all over again?

• BNP and SocGen consider 'life assurance sales' to be an important part of their business, while most other banks are divesting insurance business to raise capital (Lloyds and RBS have large insurance businesses are in dire need of capital, and are likely to sell)
• China's sovereign wealth fund: mining, energy, and real estate
• 2007 to Jan 2009, $1500bn flowed into US money market out of more risky assets

Summary of the Savings and Loan Crisis (1990)

• Greenspan cut rates, promised to keep them low, openly lent to banks
• Banks borrowed at 3%, bought longer dated treasuries at 6%. Recapitalized, provided liquidity to other areas
• Equity and emerging markets went up, bond yields fell. Recovery by 1993
• Greeenspan started to tighten in 1994
• Banks were very highly levered, 10YR collapsed (yields soared), no more liquidity
• Mexican tequila crisis

Today:

• Banks are loading up on government debt. Governments are already starting to raise rates? Could this all happen again?
• 2 YR notes were in record demand at the latest auction - investors do not see an economic recovery anytime soon - keep rates low

The Big (Quantitative) Easy

• Two biggest European rescues: Lloyds (43.5%), Royal Bank of Scotland (70% state owned).
• Rights issue 99% subscribed - investors have confidence in the banks to repay state loans
• Regulators suggesting that bank compensation be given in shares, which gradually mature, as to avoid excessive risk taking
• Verizon wireless: owned 55% Verizon Communications, 45% Vodaphone
• Amazon: IPO in Dec 1999, it gained 6,000% in 30 months; subsequent bubble lost 94% of value. All and all, has still beaten the S&P 22%.
• 10-year bond reaches 3.5%, attributed mostly to supply (deficit of $1,400bn - 10% GDP), and lack of demand as investors look for more yield in equities and corporates.
• Foreign ownership of JAP debt at 6%, compared to 50% for the US
• JAP: Aging population is no longer saving, which means the country can no longer run a large deficit without excess domestic savings
• quantitative easing: buy distressed assets, wait to be repriced

Soros on regulation

• China: tightly regulated foreign investment; just allowed investments to resume - signaling they believe the economy is back on track
• Dubai: total debt of 80bn held by the royal family. Looking to refinance shorter term loans as longer term debt in the current favorable credit conditions
• Iron ore gradually moving to the spot market, as it had been done purely by annual negotiations previously
• Brazil: imposing tax on foreign inflow to moderate currency appreciation. IMF says that more fundamental solutions are necessary, but these take a long time time to implement, while a tax, although flawed, complex, and 'porous', may be the best immediate response

Soros: financial markets always present a distorted picture of reality. Instead of developing towards equilibrium, they develop towards bubbles. Bubbles are not irrational, as it pays to follow the crowd for awhile: no amount of regulation will fix this.

• Regulators (as Greenspan said previously) need to accept that bubbles can't be recognized
• Money supply in addition to credit has to be controlled - govt should be able to impose tighter margins due to economic color
• Prevent systemic risks by making large institutions report their larger positions, to make sure not too many people are one side of a trade
• Since the government can't credibly withdraw its 'too big to fail' insurance plan, it must instead actually make sure banks don't use this last line of defense: by reducing leverage, eliminating proprietary trading
• Regulation isn't needed now, but later. Banks are 'earning' their way out of the recession, and it is profitable for them to do so, and only reduce their profitability once things have stabilized.

Europe export recovery in jeopardy

• Rats leave the sinking boat: CIT CEO resigns
• 20% of hedge fund managers found to intentionally misstate their fund size and/or earnings history (holy crap!)
• European Central Bank (ECB) is concerned about euro appreciation; Europe's export-led recovery will stagnate; past material changes to the euro exchange rate have only occurred when the US Fed and other central banks have intervened

Don't need a rating agency to sell bonds

• US wants to retrofit coal fired plants for cleaner emissions. TRADE: which companies are doing this?
• JPMorgan has 40% of its profit from London; currently questions about future management makeup
• Google and Apple are no longer sharing board members - a sign of more contention (Apple does not want to sell a device that requires Google's network services to function)
• Companies prefer bonds to bank loans: in some cases, it's riskier to borrow from a bank than the bond markets. Banks used to fund working capital, but those markets froze up, so companies are looking to use longer term bonds to settle immediate cash needs (example: GE financing arm)
• If companies start hiring, central banks will need to raise interest rates to stem inflation, which will remove one of main drivers for a recovery
• Citi: first US institution to offer banking in Philippines (remittances)
• Other big banks looking to Asia for growth. HSBC head moved from London to HK
• EMEA: Europe, Middle East, and Africa
• Moody's Global speculative grade default rates: 12%, low of 2% in 2008. Predicted to come back down to 3%; US Junk is up 50% this year
• Russia looking to be the best preforming this year as oil has risen and global recovery seems apparent
• Vanilla ABS is back; Lloyds and Volkswagen. European privacy laws make it hard to publish data on the contents of these structures . Investors aren't asking for more loan level information than previous, but demanded a larger subordinated cushion

Nickname for Argentinian bonds: Mistresses

• Citi pays $600k fine for using derivatives to escape taxes
• Argentina defaulted on $95bn of debt 8 years ago - largest sovereign default in history; blamed it's problems on the IMF; ultra low interest rates are causing some investors to take a look
• IMF predicts contraction for Saudi Arabia, followed by growth. TRADE: pick up cheap oil companies on thesis worldwide demand will again rise?
• Companies buy tailored derivatives because such products precisely match the risks to be hedged and avoid messy accounting problems; in this way eliminating OTC derivatives is not the key - what is needed to avoid systemic risk is proper reporting of exposures and the reporting of transparent prices
• a weaker dollar is the right kind of recovery: shrink current account deficit, and an export-led recovery is the best growth strategy
• last year: anyone borrowing in YEN to buy AUS would have lost 45% in 3 months.
• Telefonica increased its dividend 22%. Too soon?

Andrew Hall is my hero

• Citi sells Phibro to Occidental Petroleum, since they couldn't pay their star trader Andrew Hall as the government still has a 34% stake in the company
• Trade deficet recuded to 30.7bn, due to greater exporting of services and less oil consumption
• Canadian jobless rate from 8.7 to 8.4, signaling recovery
• Cheap dollar is what the US needs; we're able to close to the trade gap by exporting more while making external consumption less attractive. Export based countries are trying to weaken their currency against the weakening dollar, but doing so will only drive inflation
• Trade-weighted dollar has recovered back to levels before the crisis
• Investors are looking to take physical delivery of commodities. This is stupid. How can you exploit this? Sell vol?
• Who wants to be trading commodities in Wall St where a regulator is going to set your salary? -- head of oil trading at a big commodities bank
• Vitol, Glencore, Trafigura, Gunvor, Mercuria instead of GS,MS, Barclays, or DB
• Bernanke: interest rates may rise earlier than expected; US 10YR up to 3.39
• US is entering earnings season

Liquefied Natural Gas

• UST called for all 'standardized' OTC derivatives; big manufacturers, transport and resource companies have complained since the original reform plans would require large margin accounts for outstanding swaps. In the past, companies were allowed to purchase loans from banks or use their assets as collateral. Provisions have already been made to exempt participants who do not own 'substantial positions' in swaps
• Europe: argument between exchanges and banks over dark pools (crossing networks: price only published after trade). Exchanges argue that the pools are subject to regulation
• CIT: more insurance than debt
• Bermuda looking to be center for catastrophe (very extreme events with sizable losses) bonds
• LNG: prices fell most of 2009 as recession hit demand; cool summer led to less electricity demand. Storage will hit 3,800bn cubic feet - highest ever. AUS looking to be the new leader of LNG (Chevron, Royal Dutch Shell, ExxonMobil - investing $38bn). Likely to surpas Qatar (current largest) in 2020 - China will be largest customer
• BG Group (UK), ConocoPhillips (US), Petronas (Malaysia) have all signed steals for coal bed methane extraction in Queensland

Sell correlation

• global equity markets loose ground as US equity market figures provoked doubt on the strength of the economy rebound: surprise slowdown in manufacturing
• manufacturing activity > 50 -> signals expansion
• CDS question: who is providing insurance on CIT? TRADE: short those who may be holding CIT insurance if you believe CIT will go bankrupt
• KKR (Kohlberg Kravis Roberts) merged with their public fund listed in Amsterdam, may be soon listed in the US
• Topix: Tokyo stock Price Index, based on float rather than market
• TRADE: Correlation(developed, emerging, commodity, currency) - how can we sell correlation? Betting that a correlation (crisis) won't happen soon
• Spending surged on consumer durables as a result of a cash for clukers program
• IMF: Countries with large trade surplus (China) need to spend in order to sustain growth and accept the appreciation of their currencies
• recovery spread trade: long emerging markets, short developed
• Ben Bernanke: financial institutions should pay higher premiums so being 'to big to fail' is less profitable - Glass-Steagall: bank holding company can't hold other financial companies - repealed by Gramm-Leach-Bliley 1999 - going back to separation (commercial, investment banking)
• Small businesses: 50% workforce, 38% GDP

• To address a budget deficit, Russia is looking to sell a partial stake in some closely held companies, such as OAO bank
• A CIT (vendor financing, asset-based lending) bankruptcy would be the 5th largest of all time; they will go to bankruptcy court if bondholders don't agree to new terms; government deems they can fail without impacting the economy
• 
  

Cheap Debt

• FX markets were tested by the financial crisis, and investors found deep liquidity to realize their macroeconomic views. 3.2T dollars traded daily; spots about 30%, swaps 50%, fowards the rest
• On a purchasing-power basis, the BRICs are a larger economy than Europe
• Highly rated US companies are stockpiling cash from heavy bond issuance, while junk grade are paying down debt

GSCI Ex-US

• G20: US wants to reduce European (UK and France) seats at the IMF, to give a larger vote to developing countries (India an China)
• IMF: formed to stabilize exchange rates and facilitate development though highly leveraged loans. Currency code XDR : special drawing rights, currency basket (USD,EUR,YEN,GBP). Sold part of their gold reserves to make up for budget shortfall
• Zhou Xiachuan (China Central Bank boss): international monetary system too volatile; dollar should be eventually replaced by XDR. Could be more stable, but lower growth
• Stupidity is back: Twitter valued at $1bn
• S&P GSCI (GS Commodity Index) looking at ex-US index, due to pending trading regulations
• JP Morgan Chase represents 30% CDS market - same % when it was first created 16 years ago. CDS only really being used by the largest banking institutions
• Liquidnet released 'Supernatural' - help Euro customers find dark pools. Dark pools are estimated at 8% of Euro trade volume.

California is too big to fail

• The Chicago Mercantile Exchange (CME) and Citadel abandoned plans for a CDS trading platform, as the interest is no longer there from the bank holding companies acting as the major counter parties
• California's largest debt sale of 8.8bn (last year 5bn) in short term notes, less than 3 WEEKS AFTER IT STOPPED ISSUING IOUs will pay 1.25-1.5% opposed to the anticipated yield of 2-3%. This shows investors are actively going after yield, and risk will be under priced

Citi looks to shrug off the govt

• Citigroup: Still has $10B of risky assets. US govt owns 34%. C planning perhaps a $5B equity issuance to reduce govt. stake.
• Impact of news on FX rates: concern over trade dispute between China and US led people back to USD, taking away from EUR.
• Treasury sold $15B of bills a week
• Gas futures: 7.5 year low
• Judge tossed out SEC settlement with BOA/Merrill bonus issue. SEC usually settles, but in this case the essentially the shareholders are being asked to pay the fine. This poses questions about broader government involvement.

Optimism

• Natural gas is down 75% from last summer's highs, simply because supply exceeds demand. Underground storage containers hold 17% more gas than a year ago.
• TIPS returned 8.7% y/y.
• It's unclear that the ban on short selling financials did anything to lessen the impact of the crisis, according to a Columbia University report.
• EU regulators are considering limiting OTC derivatives contracts, in favor of only standardized derivatives.

It's all about the currencies

• EUR is at the highest level against USD since inception at 1 EUR = 1.46 USD. Most likely will have the side effect of making European exports less attractive to foreign buyers. This could subject the EUR to higher inflation, as it would be difficult to raise interest rates in the current environment of economic recovery. Combination of a strong currency and low supply of credit (banks unable to lend) could push to higher volatility.
• Weak USD shouldn't worry US, as we're not consuming (e.g. mortgage payments) in EUR.
• Investors worried about weak currency look to FX, gold, commodities baskets.
• On average, the year following the steepest declines in USD, stocks/bonds outperform commodity baskets - so it may be too late to catch commodity upside
• James Gorman takes over Morgan Stanley from John Mack. Adamant about focusing on institutional securities rather than more wealth management
• Inverse ETF: (short ETF, bear ETF): use derivatives to short a basket, index, etc. Do not require a margin account, as is usually the case for shorts
• Leveraged ETFs are typically 2:1. Maintaining constant leverage is silly, as it requires a tremendous amount of trading, for no real benefit.
• SPDR: S&P Depository Receipts
• Depository Receipt: security traded on a local exchange that represents an equity share in a foreign corporation
• Program trading: Aug 31 - Sept 4th: 30% of NYSE volume, 785 MM shares/day