We're down, but how far?

General economy

• Fears major economies are slowing down, sending sovereign debt down to record lows
• global acknowledgement of a slow recovery combined with little inflation means central banks will keep rates near zero
• Fed chose to reinvest cash from maturing MBS; did not decrease size of its balance sheet
• YEN gains on USD as carry trades exited
• Agreed that Japanese economy is in a slowdown; debate is to which degree
• US purchase of previously own homes falls 27.2% in July (15 year low) - increased supply of unsold homes
• Ireland downgraded to AA- with a negative outlook

deals

• BHP Billiton placed hostile bid for Canadian PotashCorp. Potash: K2CO3, KCl (fertilizer)

Flash Crash

Economic announcements :

* Thursday: New jobless claims: consensus of 448k, have been essentially flat for the past few weeks

* Friday: Retail sales

* Gold above $1250 for the first time (UK credit rating, hedge against weaker euro, inflation)

* Monday: Bernanke cautiously optimistic (US recovering at a "moderate" pace)

* Fitch warned UK faced "formidable" challenge to keep its AAA rating

* FTSE Eurofirst 300 down 1% to 979.44 on sovereign debt contagion concerns

* EU finance ministers are moving ahead with plans for a bank Levy; currently being resisted by the UK.

* RBS nearing the close of selling its commodities and private equity business (expecting 4bn)

* May 6 'flash crash'

Not so much risk appetite

* Prudential made a failed bid for AIA; nearly 800MM in management fees wasted

* Only 41k jobs created in the US in May, far fewer than expected

* Michael Gordon (BNP Asset Mgmt): Blames exchanges for encouraging high frequency traders; do not help the market ascertain a company's value, don't provide a service

* ECB purchased E750bn government bonds (Greek, Portugal, Ireland); ignored Spain and Italy, who's yields have increased (widest since mid 90s)

* Belgium debt difficult to auction; had to go to 100+bunds compared to 50+ previously

Dampening of Investor Risk Appetite

* geopolitical pressure Asia, Europe

* uncertainly in financial regulation reform

* Gulf of Mexico oil spill

* AIA: AIG Asian insurance business, may be worth $25bn instead of $36bn originally sought

* Decay of infrastructure - $40,000bn needs to be spent over the next 25 years (emerging and developed markets)

* Germany reveals 95bn in spending cuts, cutting 15,000 public jobs

* Much larger than expected factory order increase of 2.8% (revisited up to 5.1%); shows weaker euro is having an effect boosting growth

Updates on Greece

Greek Crisis

• Spain, Italy spreads over Germany highest since 1999
• Expectation that Greece will face a managed default; Spain, Portugal would follow suit
• BNP Paribas has 6.1bn in Greek debt
• Greece, Spain, Portugal, Ireland and Italy: $4tn in public/private lending 2009
• European banks were insulated from initial credit crisis, regulators didn't create additional capital requirements. With the Greek crisis, these banks are now suffering. Debt (most of which comes due in 2012) will be difficult to refinance as they'll be stretched for capital

'nanke vs Berlin

Bernanke testified to financial services committee

• time to consider how to start tightening credit
• large amounts of reserves -> less liquidity in fed funds rate; it's become a less reliable indicatior of the short-term money markets
• reverse repo: US central bank borrows from short-term lending markets, removing liquidity, using its own securities for collateral
• Could also increase the interest rate paid on reserves; banks would be less likely to lend

Berlin Bail out

• Germany, others prepared to lend to Greece or buy sovereign debt
• Greece has 28bn in loans due in April,May
• PIGS: Portugal, Ireland, Greece, Spain: for the past years, they have incurred debts in a currency that was far stronger, and at much lower borrowing costs, than their old national currency. Now the bill is due.
• Ireland: cut public spending dramatically, keep corporate taxes down: long-term gain from short-term pain

Bloomberg News Radio

• Volcker
• cause of financial meltdown: not prop trading. not hedge funds.

no doc loans (lending without doc)

went into securitization

underwriter paid to underwrite, (keep churing it out) sales to sell

inventory build - couldn't get rid of it

teaser rates in subprime lending

low interest rates - some other complacency

retail investors: will get hurt when rates rise in FI mutual fund

where are real prices? bought 1tn of mortgages - don't know real interest rates

bank of england stopped QE

ECB stops program at the end of year - problems with Greece

congress doesn't like the Fed being the market maker

start to unwind reserves

400bn up to 2tn in reserves

allow rates to normalize - what is the fair level?

I'd probably sell some Euro puts, too

• 50% of Greek debt set to mature before 2015; UK is 32%.
• France next? Borrowing at 8% GDP; only countries higher are Spain, Greece, Ireland
• US Equity: eurozone sovereign debt overshadowed encouraging corporates
• Possible positioning for a European Central Bank rate cut? Current intention is to keep rates steady.
• 2007: 90% default of ABS CDOs (total market: 186bn); most toxic of assets; result of bad underwriting
• Past few weeks have seen a shift out of the euro and into the dollar; by worries of the eurozone being able to fund their deficits
• 7.6bn shorting the euro
• Germany, France most well positioned to bail out Greece. Unlikely; Ireland has enacted its own reforms to dig itself out of its hole. Impact on European banks would be massive.
• US: 1600bn projected deficit; Moodys will downgrade from AAA if economy doesn't grow; Credit traders give 5% chance of default in 5 years
• Average maturity of US Debt: 4.2 years

create a fungible, liquid market for longevity risk

• life insurance: hurt by young people who die too early and haven't paid enough premiums
• pension funds: hurt by older people who live past expectancy

Who is working in Europe?

Europe Problems

• Portugal had troubled debt aution
• Spainish economy in trouble (18.8% unemployment, up 5% from last year)
• EU unemployment: 9.6%, (4% Netherlands, 22.8% Latvia)

• Markit 5-year sovereign debt CDS higher than comparable corporate debt! Nuts!
• 2009: 900bn equity raised globally; 41% increase from 2008; emerging markets were 60% of volume
• Jan: 8.8bn leveraged loans sold to investors; compared to 39bn in all 2009. Prices have rebounded from low .64 (Dec 2008) to .93
• Institute for Supply Management Index: up to 58.4 from 54.9; highest since Aug 2004; well ahead of expectations; led by strong economies (France, Germany)

Trading at a fraction of a penny

• existing home sales plunged 16% M/M; however prices stabilized, of which first-time buyers (urged on my housing stimulus) were a major factor; muted reception
• FOMC meets Tuesday (1st of 2 day meeting - announcement Wed 2:15); 8 times a year. It would be insane to see a rate hike until QE is completed
• Greek issued 11bn of debt at 6.2%; CDS at 329bps. Good idea for the buy and hold investor
• Obama's crackdown on banks is simply a buying opportunity
• Exchanges looking to quote in 1/10 of a cent in order to compete with dark pools

Prop trading isn't a big deal

• Benanke vote questionable; missing key Democratic support. Market would increase inflation expectations if he's not reelected
• Obama: "American people will not be served by a financial system comprised of just a few massive firms". Planning to ban proprietary trading, divest internal hedge funds. Banks would more prop trading into asset management
• Top 4 lenders hold 35% of deposits; up from 5% in 1998
• Flow business: bank as a counter party to clients
• Prop trading: 1.4% of BNP Paribas, 4.3% at DB, CS
• UC Rusal finally priced on HK Exchange
• Inconsistency: want banks to lend, but also reduce risk

Obama Regulatory Changes

2009 in review

• Best performing hedge fund strategy last year was convertible arbitrage: find anomalies between bond price and equity; short sellers preformed the worst
• Emerging markets gained 37.9% for 2009

Platinum ETF/ETN

• ETFs: depend on arbitrage mechanisms to guarantee its price tracks with NAV; during market turbulence spreads can widen
• ETN: unsecured debt; backed only by credit of issuer. has a maturity date. pays the amount specified by the tracking index at maturity less fees; can be shorted. Tax efficient, considered as a prepaid contract (e.g. forward)
• PGM US Equity traded at premium to tracking index, as the ETF didn't have a mandate to issue more shares, investors bid up; Difficult to execute because of the high borrow cost of the ETF

News

• SP500-ex financials expected to post 8% in Q4
• Historically: stock market has delivered higher returns with lower volatility when US unemployment was high
• BRICs contributed to half of global growth between 2000-2008.
• reconfirm Bernanke

Obama Regulatory Changes

• Mr Obama called for banks to be banned from running their own trading desks and “owning, investing in or sponsoring” hedge funds and private equity groups.
• Will take 3-5 years to debate, modify legislation
• Banks can hold no more than 10% of deposits (must lend!)
• Paul Volcker (chairman of the economy recovery advisory board)(80s, former Fed reserve chairman - before Greenspan, inflation was ridiculous, put fed funds rate to 15%, unemployment soared, inflation gone)
• Tim Geithner: treasury secretary
• TALF: term asset-backed securities loan facilities (ending Mar 31st): Fed lends cheap money to investors (hedge funds) to buy asset backed securities

Greece

All about the Fed

• Fed purchased CDO assets from AIG during the crisis, so that CDS contracts on the CDO could be terminated. The Fed made the controversial decision to pay the CDS contracts in full, as a way of injecting money into the banking system, and criticized as a 'back door bail out'
• Those assets have increased $29.6bn to $45bn; a paper profit difficult to realize since the CDO market is still illiquid

News

• I really can't bring myself to care about Cadbury
• Citi reports 7.6bn loss; excluding 1-time items, 1.6bn loss in 2009, 27.7bn loss in 2008; however 70% of revenue outside the US; most saw this as a buying opportunity, shares went up 2% on the news

Greece!

• Promises to cut deficit of 12.7% GDP to 3%; won't happen
• Falsified financial figures for years
• Doesn't have monetary tools (policy, currency depreciation) to combat deficit
• Unit labor costs (along with Ireland, Italy, Spain) up 23% compared to Germany, making them uncompetitive
• Borrowing much more as a % GDP than Ireland, Spain
• Could default: removed from EU, would make the weaker remaining members much more vulnerable; significant political upheval
• Could bail out: fast-track merging the EU into a more cohesive group; easier to dictate future policy.

Risk On

Risk On trade

• "risk on" trade: bought stocks, sold dollars for other other currencies. "risk off": sell stocks, buy back dollars
• when equities go up, a sign of investors taking on risk, dollar, yen go down
• carry trade high yield currencies: Australian, New Zealand dollar

General news

• since mid-december, euro has fallen
• 2009: broad brush investment theme; 2010: selecting bets more carefully
• American Airlines, Delta competing to partner with JAL (just cut 1/3 of its workforce); could be the largest bankruptcy outside the financial sector
• Possible Paris bond trading exchange in the works; set for next year
• Resurgence in European high yield (~10%, 20% yield at peak) paper; 30-40% growth compared to 15% investment grade
• Platinum: first physical platinum, palladium market
• Swiss Re transferred $300m to Berkshire
• Banks expected to be less profitable as quantitative easing ends, decreasing trading profits and available leverage
• Greek 10-yr +270bps to the Bund
• Will the European union allow the euro to suffer to help Greece, or play hard and allow Greece to suffer?

CDS premium and default probabilities

• Use of a CDS for limit exposure to a government is becoming more popular; new regulations have created the demand

• People's Bank of China raised reserve requirements 0.5% (sooner than expected) - implies that interest rates will rise
• Cheveron missed earnings
• Greece under-estimated / under-reported debt as % GDP; prime minister admits corruption problems
• Fed paid record $46.1bn to the Treasury in 2009; net income of $52.1bn - also a record
• Fed has about $2bn on its balance sheet it needs to unload; could loose value as it's sold
• Economies that serve China: Taiwan (industrials), Brazil (commodities)
• Largest iron ore player: Vale of Brazil, Tio Tinto, BHP Billiton
• Short sell on Chinese exchanges

FT: Myth of BRICs. Yes.

The story at home

• Business, governments looking to issue debt while rates are still low; US bond market had its second busiest day on record. At the end, it's a belief that the market will recover and interest rates will rise
• Dollar moving lower (non-farm payroll data), 1.45 to the euro
• *Earnings Season!* Alcoa reported today, earned 0.01; expected 0.06
• Intel, JP Morgan report Thurs, Fri. Expecting earnings growth of 184% y/y
• Consumer discretionary not expected to rebound as significantly

Myth of BRICs (FT: Tasker, Peter 11-Jan)

• emerging market IPOs have been at double cash value of developed market IPOs
• NO CORRELATION between GDP growth and stock market returns. Countries with high growth potential are not good investment opportunities unless valuations are low
• Macro: emerging markets have under utilized savings and human resources; no motivation to raise returns on existing capital when you have easy access to additional capital
• China bubble: apartment prices 15-20x salary; 50% GDP is fixed-asset investment
• Shanghai index has halved; still too rich

Figuring out the macroeconomics

• Arnold's last budget needs 6.9bn from the fed for a 19.9bn deficit; previously printed 3bn of IOUs (15-Jul-09), at 3.75% - specifies 8.5bn of cuts; no new taxes
• New UK law: 50% tax on earnings over £150,000; companies are accelerating the payment of dividends
• Chinese exports rose (17.7%) for the first time in 14 months; brings new pressure to appreciate currency (year on year comparisons inflated due to previously low numbers). After consecutively good numbers, will most likely issue an appreciation
• Fri: 85,000 jobs lost; Eurozone hit 10% unemployment; S&P ended up 0.3%
• Dec Fed: moderate growth, tame inflation; contrasted to more bullish private sector. Most worried about commercial real estate, reluctance of companies to start hiring
• Fed has already purchased 1,700bn bonds; 10-yr treasury up to 3.9 from 3.2 as a reflection of Fed stopping purchasing; For 2010, the market will need to find a place for 2,000bn of new issuance
• Most likely won't end in March; if the Fed has to buy more it will make the eventual unraveling more troublesome

• US Yield curve is the steepest ever. Gap between 10 Yr and 2 Yr 286 points. Usually a signal to go long equity
• Fed signaled not expecting changes for 2010; suggesting low growth, continued unemployment
• Think about the bond dynamics - massive purchase of short term securities