Heavy going

Boy this market is making heavy weather of this counter-trend rally. Feels weak and like it is struggling to get through the heavy resistance up to 1110. Nevertheless I think there could be a quick rally helped by the jobs number up to the 1140 area I suggested last week. Lack of tightening in the Treasury yields in the weaker times in the market makes me think there is no fear so the the least resistance for equities is up. That said I will be flipping pairs trade to short delta at around 1140 and will buy the10s and possibly initiate new index shorts if we are unable to get above 1150.

Weekly pnl review

Flat on the week after trimming my TLT and short Cable on Monday/Tuesday. Plan for next week is that I will fade any rally above 1140 by switching from long delta to short delta on my DTN/SEF pair trade. Will also take any move in the 10 year to the vicinity of 3.40 to re-build my long Treasuries after the recent TLT selling, albeit with a shorter duration. Will consider adding short S&P if there is a strong bounce off the 1140 level suggesting the downdraft of the right shoulder. However given that this pattern seems so obvious I don't believe it will actually happen. Will also continue to reduce short Cable as it seems to be bottoming and GBP vs a trade weighted basket is threatening to break out of its downtrend.

Weekly pnl review

Had a good couple of weeks with a gain of around 2% putting me up just over 6% for the year. Given I have been around 50% cash for most of the year and far too early in a couple of trades I am happy with this. Only change was that I trimmed 25% of my TLT on Thursday in anticipation of the fear dissipating a bit on Friday and reduced short Cable by about 15% today as the dollar looks like it is pausing and it seemed a good time to take a little bit of profit.

Not planning to do much next week unless there is a strong move. All the stocks on my watchlist all look much too expensive. Unlikely to add to shorts unless we get a weak melt up in the early part of the week which might tempt me to at least reduce longs and maybe add something on the short side.

I may also cut my short GBP a bit depending on how DXY looks Monday/Tuesday.

Deflation, hedge funds and the Euro

I have a lot of things going through my mind so please excuse me for being a little rambling in this post.

Couple of things I learned today – a number of hedge funds have de-risked considerably in the last few days. Also the German government will pass the bailout bill comfortably tomorrow as the opposition parties will abstain. So where does this leave us?

The hedgies are now effectively sitting out of the market. As yet volumes are not suggesting that their nervousness has translated into wider selling by individuals and, more importantly, long only funds. Key thing for the direction of the market is how much the market decline fuels redemptions from the liquid long only funds. As fund managers have to be mostly invested they will not yet have had chance to sell much but their hands may be forced by redemptions if fear starts to spread. The next few days will be crucial and hints of wide scale redemptions could be scary for the market given the non-participation of hedge funds.

I am not sure I see real fear yet although LIBOR, Gold and T Bills need watching closely. I can foresee some chioppy action over the next month as hedge funds dip their toes back in the water but also think that each little rally will be faded as there are undoubtedly funds and individuals who feel like they are behind the curve in de-risking their books.

Regarding the EUR the bailout may prompt a short term bounce. However I again think this will be faded in the next couple of weeks as this bailout does NOTHING to address the underlying imbalances in the Euro area. The fiscal austerity which will be needed to create the appearance of fairness for the people of the financing states will cause macro indicators to continue to decline and EUR less than 1.15 seems inevitable.

On a longer term dynamic there have been a number of indicators from US and Europe ex UK that the deflation train is coming to town. Even if this correction does not run much further in the next couple of months I can see some fierce rotation between asset classes. I think that too many investors are positioned far too early for inflation. They made the increased money supply = inflation mistake and have not appreciated the velocity of money.

Despite the efforts of central banks to increase nominal GDP, which is the way they have chosen to “address” the incredible debt destruction ongoing. However despite doubling national debt in the UK and US (and soon Europe) they have barely managed to get nominal GDP positive. This suggests that the velocity of money is still falling as banks keep all the extra money supply as reserves against losses still to be taken. Moreover the uncertainty caused by the poorly planned actions of CBs and Governments is causing the demand for loans to be restrained, even if the banks were in a position to provide them.

Therefore deflation is setting in as the current re-inventorizing cycle comes to an end. The policy makers response will surely, at some point in the next year or so, be to unleash another round of QE. That is potentially when the inflation beast starts to rise and I have no idea where investors will be able to hide

GBP and the election - part deux

OK - so I called the election wrong. Looks like there was a lot more anti-Tory feeling than I had reckoned with. Nevertheless some of those anti-Tories now find the party that they voted for in a coalition with those same people. Therefore my trading call to watch for a long GBP unwind was not a bad shout. Cable noticeably failed to rally on the establishment of the coalition government which makes me think that the market has already twigged that a) whoever is in charge will be a hostage to their terrible fiscal legacy and b) this coalition will be undermined by the left wing members of the Libdems who will look for the first opportunity to grab power away from the current leadership. I therefore remain very bearish on GBP.

Weekly pnl review

Up 2% on the week as TLT and short financials went orbital and GBP weakened although the 2 midcaps which make up 10% of the portfolio both got murdered. Long reality (DTN) vs morality (SEF) was up slightly although US financials proved surprisingly resilient amongst the carnage. Consensus is for a bounce next week in the context of a newly established downtrend. Fear seemed to dissipate, at least in the US later in the week so this is possible, but given the lack of shorts in the market I think another plunge takes place at some point in May before this correction ha run its course.

Only change in the portfolio was a rather fortunate decision to finish clearing up residual long equities (about 3% of the portfolio) on Tuesday.

GBP and the election

It looks pretty clear to me that the Conservatives will win tomorrow’s election. If I was going to guess I would say that they will win with a majority of 30 seats.

Smart money has been pouring into this outcome via a long GBPEUR trade. However I think that this is now a dangerously crowded trade. GBPUSD has weakened in the last few days despite the money pouring into GBPEUR which makes me think there could be a squeeze even in the event that the election goes as expected as the promised bounce in GBP fails to arrive (as everyone and their dog are already long). There could be a really vicious squeeze if the Conservatives do not win outright. I would therefore avoid this trade in the next week. I am short GBPUSD (big) and short GBPEUR, GBPCAD, GBPAUD and GBPJPY in smaller sizes.

In the long run I am very bearish on GBP. It was only good old fashioned jingoism which kept us out of the Euro and our fiscal situation would easily have qualified the UK for membership of the PIGIUNS ® (Portugal, Italy, Greece, Ireland , UNited Kingdom, Spain). Given the disastrous fiscal and economic position of the UK I do not think that the ability to inflate our way out of default should lend support to our currency.

Portfolio

This is the shape of the current portfolio. Will post on my current thinking behind this at the weekend.
Cash 47%
Long equities (mostly in 2 names) 18%
Long index equity (Dividend ex financials stocks) 5%
Short equities (inverse financial ETFs) 9%
Long bond ETF (TLT) 17%
Canadian long bond ETF 5%

Currency exposure is USD 46%, GBP 31%, EUR 10%, CAD 5%, AUD 4%, JPY 4%.

UK Housing

I am trying to sell my apartment in London and I am getting a first hand view of how disfunctional the market has become. We first had a Greek cash buyer who offered the full asking price (which we thought ourselves was too high at 20% over the 2007 peak valuation) but they disappeared with no explanation. We then had an offer at our new reduced price (still 15% above the 2007 peak) which fell through yesterday on account of the person who is buying being advanced another $150,000 by her parents and hence being able to afford a better area. Life is definitely easy for some people.

We now have a new buyer at a slightly lower price who is again a cash buyer bankrolled by her family.

On the other side we are looking at a project on the market for 20% below the 2007 peak valuation which has been reduced twice. It need I am fairly sure that we will lose a bit of money, at least on paper, at some point but it is in a perfect area and near an extremely good state school so has life quality and financial advantages beyond pounds and pence. It also might be a good long term hedge against a monetary over-reaction by the BofE egged on by the next government.

I am not sure what all this means. My initial thoughts are that central London prices are at bubble levels and the lack of "normal" buyers (UK based 20% down types) is symptomatic of the lack of affordability at the bottom of the chain. I have also seen many properties which have been on and off the market a few times as deals fall through and I interpret this as a sign that the banks are unwilling or unable to close deals at these inflated levels (maybe someone has learnt a lesson or two - you can but hope). It would appear that for whatever reason that their is a high degree of instability in the market, like a liquid approaching boiling point and this cannot be a good thing.

Cool air travel stuff

Live radar of all flights above Europe:
http://www.flightradar24.com/

Long reality, short morality

I put on a new position today after I saw the early morning bounce in financial names and C up 8%. I don't even need to read the results having read that their balance sheet was up 8% to $2trn and that the earnings were driven by lower credit loss reserves. Mark to fantasy has started to create bottom line profits. In addition, the lack of read across from the GS problems which surely are just the start of a political witch hunt (ok - so they are actually witches so not sure it qualifies as a witch hunt).

Given the charade that is this rally I do not feel comfortable being outright short so I have gone long 7% of the portfolio in DTN (Dividend stock ex financials) against 5% SEF (short US financials). I figure that at some point reality (cash, dividends etc) might be appreciated more by the market than the pipe dream earnings of the banksters.

Wisdom I have gained

I was answering a question from Thor at Traders Anonymous last night regarding where I learned what I know about trading/investment. I answered that I did not think I was much of an expert but had worked with a lot of great traders and hoped it had rubbed off on me. Thinking about it though, I realised that I had probably learned as much from the mistakes of poor traders than the successes of the good ones.

Please see if you can spot the connection between these people?

1. Trader at a large European IB who had the biggest corporate bond book in Europe. Not content with this he also took massive punts on US interest rates. Despite predicting the large correction in 2004 coming he did not reduce his book, instead he attempted to hedge using cds. He stopped being profitable that year and was forced out a couple of years later, the bank unwinding some positions which would have been massively profitable (he had tens of millions of 5 year cds on the US broker dealers bought at spread of 20-30 bps).
2. Trader at the same IB who, not content with running a profitable CDO origination desk, levered up massively to buy positive carry AAA CDOs (subsidised by poor funding charge allocation by the bank).
3. Trader who bought extremely cheap equity (0-2.5%) protection from unsuspecting investors in European ABS (including Allied Irish Bank if memory serves). However rather than waiting for this protection to pay out, which would have been a great trade, he tried to monetise the theoretical day 1 gain by entering into a large portfolio on which the present value of the carry was shown to massively outweigh the protection payment. The bank let him have his pnl on day1, never considering the possibility that the assets could fall more than 2.5% below par (hey they are AAA!).
4. Brazilian and Swiss hedge fund managers who made massive leveraged bets on mid caps, hedged with large caps and indices. They made hay in the bull markets of 2005-2007 before being wiped out in 2008.
5. Another Brazilian hedge fund who stopped their relatively successful strategy of buying reverse convertibles with floors when equities became “too cheap” in mid 2008. They bought the bargain stocks (C! AIG! Lehman!) and took out the floors on the RCNs on their usual names to get “more return”.
6. Big name prop desk head at big name bank who tried to apply his previously stellar performance in trading relative values in listed equities to investing in private equity based on the same kind of analysis. He wiped out three years of profits in a private equity book which was only 30% of his portfolio.

Lessons learned:
1. If in doubt, reduce risk, don’t try to hedge by adding more positions. It’s no use entering a great trade early if you are not around to see it to conclusion.
2. Short term greedy generally makes you a long term loser and if you don’t assess people’s performance relative to gross as well as risk adjusted capital, they will act in their own interests, not those of the firm.
3. See 2. And don’t fall in love with one product just because it has not hit a bad patch in the last few years. Everything has a spell on the ropes at some point.
4. Earnings multiples matter about as much as the colour of the paper in the Annual Report when liquidity disappears. Never leverage bets on illiquids, even if you “hedge” the market risk with shorts. The shorts can turn round and gobble up your capital in a flight to quality just when you need them most. The NAVs of these two fund went down in almost perfect correlation despite them operating in completely different markets – liquidity tends to be a global phenomenon in a crisis.
5. Not saying that their original strategy would have been a winner in 2008 but sticking to what you know and not getting tempted by bargains in areas you know less about is vital to riding out a storm.
6. Again stick to what you know. Private investment is all about timing and the ability to back and influence the right management. Investing blind and sitting back to await your payday only cuts it in a debt fuelled bubble. There are no shortcuts even for the best trader.

The answer to the connection is that all of them are fabulously wealthy and all (except number 6 who is about level) have cost their employer enormous sums of money. Perhaps the main lesson is that you should make your mistakes with other people’s money.

Banksternation weekly pnl review

Flat on the week. GBP short, TLT and bank shorts went down then up, Equities went up then down. Did nothing except the experimental long GBPZAR. Going too see how we open tomorrow before doing anything. I did not get the feeling there was any genuine fear on Friday as the buck barely moved as financials sold off, even though Treasuries caught a bid.

Fraudman Sachs

There are two key questions for me which draw the line between outrageous ruthlessness and wholesale, management endorsed fraud.

1. Did Tourre genuinely, whether explicitly or implicitly, tell ACA that Paulson would be long the equity in the structure.
2. Were the losses on the deal incurred by GS as a result of a good faith backing of their sponsorship of the vehicle or did they inconveniently run out of negligent idiots to sell the rest of the tranches to.

Northern Rock

Interesting report published recently from the independent valuer of Northern Rock. He looks like he made a good, honest appraisal of how much NR was worth when the UK government took control and how much it would be worth now without government support. C and BAC are you listening?

The shareholders are predictably furious but I agree fully with most of what he says in the report - a bank without liquidity is worth nothing.

http://www.scribd.com/doc/30051240/Northern-Rock-2

Experiment - Is ignorance bliss or is a little bit of knowledge a dangerous thing?

I have only recently been introduced to EW analysis. My knowledge comes only second hand from reading Prechter’s Perspective and from reading Andy T, I-Man, CV et al on Traders Anonymous. After a complete lack of exhaustive study I have gleaned 2 insights – movements tend to happen in 3 and 5 waves and waves tend to retrace to Fibonacci ratios before continuing with trend.

Armed only with this knowledge I am going to experiment with some trade ideas on the GBPZAR cross in which I detect an EW type pattern. Apologies for the bad chart – still trying to work out the technology.



I have 3 scenarios in mind ranked in order of likelihood:
1. The recent move down to 11 completed 4 waves down from the Dec08 high. I therefore expect a retrace from 11 to around 11.8 before commencing a further wave down below 11. A close above 11.7 followed by a close below 11.5 would suggest this is what is happening.
2. The recent move down to 11 completes 5 waves down from the Dec08 high and the recent move off 11 is the start of a new uptrend. A close above 12 would suggest this is the case.
3. The move down to 11 was the bottom of a second wave down from the 13.54 high in Aug09. We would therefore expect a retrace to around 12.3 before commencing a strong P3 type wave down to well below 11.

The confusion between 1 and 2 is caused by the move between the Aug09 high at 13.54 and the Mar10 bottom at 11. There were 2 down waves ending at 11.58 and then 11.68. Given that the second low in Jan10 was higher than the Oct10 low I am not sure whether to count this as one wave or two.

The third scenario looks a bit unlikely as it would imply a blow off top in risk assets, although with the right circumstances in gold prices and UK elections for example, we could see a big move in this cross independent of a risk on blow off. A risk off trend in other markets would probably kill this scenario and given the recent congestion near the highs I see this as high probability and hence scenario 3 is low probability.

However I think there is a limited risk trade for all 3 scenarios so I have gone short ZAR 11,300 v GBP 1,000. Stops are set at 11. At present the plan would be to take half the position off at 11.7 but re-establishing at 12 if we continue up above 11.7. If instead we bounce off 11.8 like scenario 1 I will close the ZAR short at the second visit to 11.7 and initiate short GBP 1,000 v ZAR at 11.5 with stops at 11.8. If we continue to go up above 12 I would stay short ZAR until we hit 12.3 where I would tighten the stops to 12. A close above 12.3 followed by a close below 12.1 would bring scenario 3 into play so after a stop out of the short ZAR at 12 I will initiate a long at 11.8.

Let’s see how this little experiment works.

Market manipulation - surely not

Anyone else see how the 7x bid covered Greek notes today headed South at the same rate of knots as a Greek shipping magnates yacht but one hour after the auction. Its almost like the bid cover number was a made up pile of crap. Unless the Greek fiscal situation took a massive dive in the hour between the auction and the start of the price descent causing a logical reassessment of the required yield. No? Thought not.

Going Concern

Came across a great site today http://retheauditors.com/. She goes into some very impressive detail to undress the incompetent cartel called the big 4. Having worked for one of them I can confirm that the incompetence, deliberate ignorance and concern for legal liability rather than accuracy and transparency is all true.

Ironic that these partnerships issue going concern opinions when they are so clearly living on borrowed time.

Banksternation weekly pnl review

Crap week this week, down 1.5%. GBP rallied on short covering, long bonds sold off and short oil is approaching my $87.50 stop. Expecting more of the same next week but going to hold steady apart from monitoring my oil stop as I think a bucky bounce is due at the end of net week.

Mark to Market

There have been many words, most of them ill informed, written regarding the amendments to FAS157 which have allowed financial institutions to carry their assets at “fair value” i.e. a mark to model price.

Before the amendments were made in 2009 things seemed to work quite nicely, from an accounting perspective at least. An asset would be initially held at cost and would remain there until there was either a transaction at a different value or there was clear evidence of impairment or an increase in value. Due to the accounting principle of prudence, there would be a higher burden of proof for marking up than for marking down. This may have meant that there was a little too much scope for downward earnings manipulation but as far as I am aware no financial system ever collapsed due to overly conservative accounting.

I do not subscribe to the view that mark to market accounting was a cause of the financial crisis. Once the decline in asset values began there was undoubtedly a negative feedback effect of writedowns forcing further sales. However I strongly maintain that the problem was under-capitalisation, not mark to market. If an institution is too highly leveraged to hold the asset to maturity then what possible justification is there for not marking to a tradeable exit price.

The answer of course is that in order to maintain the illusion of solvency in the zombie banks, the FASB caved and allowed objective evidence of value to be replaced by model based mark to fantasy. I have no problem with this approach if accompanied by stringent capital requirements for assets not marked at current trade levels but there has been no linkage established between accounting treatment and capital. Quite the opposite in fact – these marked to fantasy assets increase the optical solvency of the institution and potentially decrease the required capital held.

It gets even worse. In my day job I deal with a number of auditors, rating agencies and independent valuation agencies. Far from being watchdogs, they have become cheerleaders for this new “fair value”, forcing financial institutions to write up illiquid assets which are unlikely to be held to maturity to values where there are no willing buyers in anything like the sizes required. As their “analysis” is often based on “comparative asset values” and they are against liquidity discounts (too subjective!!!!!!) this is causing a spiral in the paper valuation of assets, with no liquid market transactions to back them up. Does this sound familiar?

We appear to have come full circle from the purpose of FAS157 which was amended after Enron’s mark to market excesses to make sure that assets reflected their exit price. What is certain is that the assets of the big banks, in aggregate if not on a case by case basis, are wildly in excess of their exit prices. Let’s hope that they are sufficiently capitalized to see this through or 2008 will look like a walk in the park.

Bob Diamond

Bob Diamond has a reputation as one of the top leaders in finance. I have serious reservations about him. Take a look at his biggest strategic decisions over the past 3 years:
1. Tried and failed to buy ABN Amro, at a price only marginally less than RBS’s ruinous “successful” bid.
2. At the peak of the crisis in 2008, took on 8,000 new staff as part of the Lehman to increase the bank’s global presence.
3. Refused government assistance in early 2009, choosing to take his chances on the bank’s own ability to raise private finance.
4. Sold a solid recurring-fee based business, BGI, to Blackrock at a good price but a good proportion of which went to himself and a select few managers.
5. Continued to be the most aggressive recruiter on the street throughout the crisis.

Every one of these decisions, at least except number 1 which was not so much a decision as a bit of help from the greater fool (I’m talking to you Fred Goodwin) theory, looks good in retrospect.

However many of these look to me like huge gambles which could each individually or collectively have brought the franchise to the brink and makes me think he is doubling up on red repeatedly. The one thing history teaches us is that these streaks inevitably end in tears.

I also can’t help but think of the parallels with UBS and John Costas. There was the transformative acquisition to turn the company into a global power (Lehman/Paine Webber), the constant expansion and recruitment in every market available, the move away from the more staid businesses (sale of BGI/turning the private bank into an extended sale force for the IB) and the self serving nature of some moves (sale of BGI/setting up Dillon Reed Capital Management).

I had a good run buying Barclays shares in 2009 at 50p and riding them up to 150p before I bailed but I would not touch these shares now. I think they will run up (non-appearance of P3 allowing) as they continue to reap the rewards of a lack of competition, weak GBP (reporting currency) and a ridiculously steep yield curve, but think that at some point in the next few years Bob’s chickens will come home to roost in a fairly disastrous way for Barclays shareholders.

Banksternation weekly pnl review

The Banksternation portfolio was up around 0.5% for the week. Closed my PSQ (short QQQQ) position last week after feeling too much cold steel in the melt up. My 2 core equity positions both performed well on broker upgrades but my TLT position (16% of the book) took a hammering on Wednesday and Thursday. I added slightly to it at 88.75. Counting my gains and losses in GBP, while investing in various currencies has slightly flattered the portfolio but after 2009 I will take my gains wherever they come from.

Investment thoughts

I will start to discuss some of my investment ideas but thought that my priorities should be on the record. I have a minimum holding period of a month for compliance reasons. This means my agility is somewhat limited and I have found it VERY difficult making money from the short side.

I am also too poor to trade margin which rules out futures, cash bonds and shorting individual stocks. This pretty much leaves me with the what the ETF universe can provide in terms of instruments to trade bonds, rates, commods and equity indices.
However I think this puts me in the same boat as the vast majority of people so I hope that my ideas and discussions will be from a more relevant slant than most of the blogs I follow, whose contributors are vastly more articulate and experienced than me but also have the ability to trade short time horizons and hedge in and out of core positions.

I find the biggest difference for me is that I have to be a lot more certain of the trend from both technical and fundamental perspectives before I enter the position and do not have the luxury of tentative trades with tight stops to avoid the big losses. Would love to hear from anyone who is in a similar situation so we can compare strategies.

Greek anecdotes

Greece is screwed. They have taken the piss from the moment they entered the Euro, running structural deficits virtually every year since 2002. Their pleas for help from within Europe will be met with an entirely justifiable "nein". Contrast this with a country like Spain which is in trouble as well but ran structural surpluses between 2002 and 2007, as well as having a much larger potential impact on the European economy. Their case for a bailout will be vastly stronger when the time comes.

Greece has to re-finance €50-60bn of debt every year for the next 5 years, this in an economy only slightly larger than Scotland and Wales. The interesting thing is how not if Greece defaults.

A sovereign default is a different kettle of fish to a corporate default. Greece is unlikely to fail to pay a coupon, however much the holders of Greek cds would like that to happen. The default is likely to take the form of a dawning realisation from bondholders and the Greek government that a restructure is the best course for both of them. A cheap money IMF loan might put this back a couple of years, but without a massive scale boost to productivity from within Greece, the interest costs will eventually overwhelm the economy.

Anecdotally they have other issues on top of this. My flat in London was recently purchased by a Greek cash buyer, and the agent told me this is increasingly common. This surely suggests that Greek banks are going to face rising liquidity issues as Greeks try to get their assets out of the country and avoid the tax clampdown promised by their government.

I also saw a story that their tax collectors had gone on strike. That nicely sum up the scale of their problem.

Banksternation blog launch

Am launching this blog to comment on financial markets with a European slant.