Category Archives: Economy and Meltdown

The Most Ridiculous Forecast You Will See In A While

With Apple apparently building a lower-cost iPoor model and now accepting iLayaway payments, the question of margins is once again front-and-center. However, the market as a whole is in a world of its own in its consensus view of what US companies are capable of producing next year. As Morgan Stanley notes, 58% of firms are expected to raise their margins YoY through 2012, and then consensus sees a stunning (record-breaking) 76% of firms will raise margins in 2013. If that eye-watering buffoonery is not enough to raise some doubts at the market’s implied ebullience, then a reminder that we have seen this divergence from GDP growth and margin growth before – as, simply put, the squeezing of costs to improve margins inevitably plays out down the chain (aggregate supply and demand lags) and increases the load on government as safety net living-standard-provider-of-last-resort. The bottom line is simple – margin expectations must fall and given the dour outlook for top-line growth in a stagnating global economy, that will expectations correction will drop straight to the bottom-line. Of course, prices will be nominally defended by a herd of talking heads expecting moar multiple expansion.

 

The incredible consensus view of margin-expanding companies in 2013

 

Excluding energy and financials, incremental margins are expected to expand to 15.9% in 2013 after contracting to 5.8% in 2012

 

and we have seen this kind of wild (one-sided – demand vs supply) divergence before… the solid green arrow shows the consensus expectations surging while GDP consensus is sideways to lower…

 

Charts: Morgan Stanley

Another V-Shaped Stock Recovery – But Rates And Credit Ain't Buying It

From last Friday, the S&P 500 had decoupled somewhat (trading in a 10 point range) from credit markets (which had widened notably) while spot VIX had caught up (and over-taken) stocks. Today saw HYG (the high-yield bond ETF) trade sideways to lower all day long, catching down to its credit derivative market cousins, as VXX was the lever of choice to ramp stocks to test the week’s highs once again (and scratch a few more stops). However, while AAPL made it up to the lows of the last swing down amid thin volumes, the last hour saw mid-dated volatility being bought which pushed VXX higher and reverted it towards rates and credit un-exuberance. Treasuries ended the day green once again and the USD drifted higher (though most of FX traded in extremely tight ranges). Silver rose further, Gold trod water, and oil played some catch up to the precious metals. Tech outperformed (thanks to AAPL) but financials (apart from some early vol) did nothing – despite Mario Monti’s call that “the crisis is over.” Another low-range, low volume, mediocre trade size, close-near-the-open day in stocks with bonds bid – and futures fade after-hours.

 

They tried to lever HYG but its call-caps were done, so once again they shifted back to VXX and it was compliant (interest rate complex did not play along)…

 

S&P 500 futures stage another V-shaped recovery to unch on the week – taking out a few more stops then fading back to VWAP for the close… and the infamour 8amET turnaround story…

 

 

AAPL filled the gap from the 12/28 lows and VWAP (and faded into the close)…

 

Treasury yields continue to slide – so much for the great rotation (oh please make it true, it was such a nice meme there for a day or two…)… yields dropping each day this week

 

 

Equity markets remains alone relative to credit this week…

 

Low range day but cross-asset-class correlation picked up with stocks reverting to their ETF cousin’s view of the world into the close…

 

It seems once again, given the range-bound week, that the algos are running out of leverage (VIX limited given the term-structure, HY limited by call constraints, rates limited by POMO, and USD limited as world plays ping-pong with verbal intervention)… I guess we ‘hope’ for magical earnings…

 

Charts: Bloomberg and Capital Context

 

Bonus Chart: Gold and the S&P 500 have recoupled from 1/4/13 – moving tick for tick this afternoon…

 

Bonus Bonus Chart: Some 2011 Debt Ceiling Deja-Vu in VIX Term Structure...

 

Bonus Bonus Bonus Chart: The breadth today was very weak…


Crossing Through The "X Date" – What Happens After The US "Default"?

Call it “X Date”, call it “D(elinquent/efault)-Day“, call it what you will: it is simply the day past which the US government will no longer be able to rely on “extraordinary measures” to delay the day of reckoning, and will be unable to pay all its bills without recourse to additional debt. It is not the day when the US defaults, at least not defaults on its debt. It will begin “defaulting” on various financial obligations, such as not paying due bills on time and in full, but since this is something Europe’s periphery has been doing for years, it is hardly catastrophic. 

As a reminder, the technical definition of default is being unable to pay the interest or maturity on one’s debt – for the US this is not an issue (at least not for the near term), as the revenues brought in by taxes more than cover cash interest requirements. It is, however, the day past which the US government will slowly but surely have to begin shutting down non-vital services and cut spending for non-core services, as it is forced to begin prioritizing who gets what from the remaining money. In short: it the day when America has no choice but to live within its means (no wonder the crank spending to infinity “Magic Money Tree” brigade – the same that has no idea that IRR on government “investments” is always below zero, is screaming bloody murder).

And while we have done the full analysis some 18 months ago when the US found itself in the exact same place, it is time for a refresh of precisely what the next steps are if, some time after the second half of February, there is still no debt ceiling resolution, and the “catastrophic outcome” (in the words of Tim Geithner) becomes reality.

First, as everyone knows, the US hit its debt ceiling on December 31, and has since been utilizing some $200 billion in Extraordinary Measure to stave off X Date. The exact same thing happened on May 15, 2011, when for three and a half months, until August 2, the government used the same delay tactic. Alas, this time around there is only 1 – 1.5 months in “extraordinary” dry powder time, because, as the Bipartisan Policy Center politely puts it, “February is a “bad” month for the federal government’s finances” and “Fewer measures available” (one does wonder just what month is “good” for federal finances when the US government is burning over $1 trillion a year but that’s a different story).

The $200 billion in “Extraordinary Measures” are summarized as follows:

In other words, the government will basically defund yet more retirees in exchange for another IOU. And how long will this strategy go for? Not too long. As the chart below shows, the drama will end some time between February 15 and March 1, depending on inflows, and the calendarization of expenditures:

Once the $201 billion, consisting primarily of plundering the government retirement G-fund, runs out, the Treasury has two options:

  • Remaining cash on hand (including any leftover funds from the emergency $201 b)
  • Daily cash inflows (federal revenues received each day)

Since there will be virtually no cash on hand, absent some much more drastic measures, such as selling the Treasury’s gold, Jack Lew will have to make do with spending what he makes: i.e., tax revenues.

And here comes the rub, because should we get to T+1, we will be in history territory, as “There is no precedent; all other debt limit impasses have been resolved without reaching the X Date. Treasury has never failed during a debt limit impasse to meet a payment obligation.” No precedent?  Kinda like the Fed injecting $3 trillion into the stock market…

None other than the Chairsatan has chimed in: “[Going past the X Date] would no doubt have a very adverse effect very quickly on the recovery. I’m quite certain of that.”

So what will happen, assuming the world does not end? Simple: prioritization. To wit:

If we reach the X Date, Treasury might either prioritize payments or make full days’ worth of payments once they receive sufficient revenues to cover all of a day’s obligations.

  • Interest on the federal debt would likely be prioritized in either scenario.

Scenario # 1: Pay some bills, but not others

  • Treasury might attempt to prioritize some types of payments over others. Prioritized payments would be made on time, others would not.
  • Uncertain legality (no precedent)
  • Unclear if it is feasible, given the design of Treasury’s computer systems

Scenario # 2: Make all of each day’s payments together once enough cash is available

  • Treasury might wait until enough revenue is deposited to cover an entire day’s payments, and then make all of those payments at once.
    • (For example, upon reaching the X date, it might take two days of revenue collections to raise enough cash to make all of the payments due on day one. Thus, the first day’s payments would be made one day late. This, of course, would delay the second day’s payments to a later day.)

The issue, under scenario 1, is that the Treasury would have to choose and sort between 100 million monthly payments, and that roughly 40% of the funds owed for the month would go unpaid. As the chart below shows, of the 20 business days between February 15 and March 15 2013, there is a $175 billion deficit, 40% of the total outflows of $452 billion.

Specifically, the Yes/No option means that should the government pay these bills:

It won’t be able to pay these bills:

For those who enjoy micromanagement, here is the two week daily cash flow forecast from February 15 to March 1, showing inflows and, mostly, outflows, in the period under discussion. Keep in mind that should the debt ceiling not be resolved in this 15 day period, the same cash flow analysis, usually done by bankruptcy consultants at the corporate level, will have to be extended on a month to month basis:

Yet the reality that while manageable, payments will quickly become problematic, especially for Social Security, Medicare, Medicaid, Defense, military, etc, as group after group scrambles to demand priority in order of payment.

In effect, the US will become one ongoing bankruptcy assignment, where the various impaired unsecured creditors will demand a right of superpriority. It is unclear which bankruptcy court they can voice their objections to, however.

* * *

But perhaps the biggest threat for the US when it crosses the X Date is not so much the debt interest, nor the prioritization of payments, but the roll over risk of some $500 billion in debt maturing between February 15 and March 15! That’s right – recall that when it comes to the US debt, it is the ever greater frontloading of short-term maturities that amplify the interest rate risk facing the country. And while interest rates are likely to explode across the curve, what is virtually assured is that the rolling of the half trillion in debt will become impossible due to lack of funding, and the inability to find buyers of matched short-term debt to roll the retiring paper, in an environment in which suddenly it is unclear if even 4 week Bills will be money good. And for all those predicting a failed Treasury auction, this will be your time to shine, as it is unclear if even full direct and outright monetization of ultra short term debt by the Fed will be enough to get piggyback buyers on paper whose rate of return is so low as to not justify the risk of exposure to a real deal maturity non-payment default.

What else will happen? the BPS has some other ideas:

Additional borrowing costs for the federal government from delay in increasing the debt limit

  • Additional rating agency downgrades are possible
  • S&P downgraded last summer and reaction was not severe
  • But there is uncertainty about effects of another downgrade since many funds are prohibited from holding non-AAA securities

Market risks beyond the X Date:

  • Treasury market, interest rates
  • Potential for serious equity market reaction (401(k)s, IRAs, other pensions)
  • Our economy
  • The global financial system

No guarantee of the outcome; risks are risks

In other words: while it is not the end of the world, what would happen on Day 1 (2, 3, etc) is the sudden realization that the game is, indeed, over, and that little by little everyone’s head will have to be pulled out of the ponzi sand.

* * *
Finally, and perhaps most disturbingly, because realistically Congress will come to a compromise, even if it means 2-3 days of payment defaults, even if it means the early onset of the sequester, which together with the payroll tax cut expiration, would mean recession for the US as explained previously, is the final chart in the BPC presentation, which shows just how much the US debt ceiling will have to be increased by to get the country through the end of 2013 and 2014. The answer? See below:

That’s right: we are looking at 2 more years of $1 trillion+ deficits, which means by January 1, 2015, there will have been 6 years in a row of $1 trillion deficits.

Sadly, “Banana republic” does not even come close to doing this country justice.

Source: Bipartisan Policy Center

Yet Another Long-Term Mean Reversion Chart

As the S&P 500 pulls within a few percentage points of its nominal all-time highs, despite macro-uncertainty and micro-delusion, perhaps (as UBS’ Peter Lee notes) a longer-term perspective is warranted. For over 80 years, the S&P 500 (or its proxy) has cyclically reverted to it its logarithmic trend-line growth. The last time the market pulled away from this bullish up-trend was in 1982 (and the previous period of cyclical reversion took 32 years from 1942 to 1974) and suggests the S&P 500 could well revert to around an 850 level within the next year or so. Perhaps Lee (the anti-thesis of JPM’s Tom Lee) needs to read some Birinyi to really understand how to extrapolate? Still, an 80-plus year trend-line perhaps offers some color.

 

The 80-Year S&P 500 Log Chart Trendline…

 

Chart: Bloomberg

All Aboard The Gold Repatriation Train: First Germany, Next: The Netherlands?

While moustachioed managers, contrary to the far better insight of their superiors, and mainstream spivs are trying to talk down Germany’s somewhat stunning shift in thinking – i.e. to repatriate its gold – as nothing but political pandering (or cost-saving); it seems, just as we predicted, the rest of the world are seeing this crack-in-the-confidence-armor the same way we have suggested. As we noted here, the first party to defect from the prisoner’s dilemma of all the bulk of global gold being held by the Fed, defects best (then the second, or even the third perhaps) and sure enough, via RTL, we see the Dutch CDA party has requested that Holland’s gold supply be repatriated. Who next?

The Dutch government says it has 612 tonnes of gold – with a value of around E24 billion – and is thereby in the top 10 of countries with gold reserves. The bulk of the Dutch gold reserves is in America and, to a lesser extent, in Canada and the United Kingdom. The rest, about 10 percent, is in Amsterdam.