Illinois Still Has a Higher Default Probability Than Spain, Argentina is Third on List (8/29/2012)

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Distressed Volatility is back using the retro blogspot url, for now. My domain was somehow lost, jacked, and parked at GoDaddy even after I paid to renew it on Google Apps two months ago. Hopefully it will be back up soon. Below are links to interesting financial articles and a snapshot of CMA's "highest default probabilities" list (based on sovereign credit default swaps), which showed Illinois one-upping Spain. This happened on May 11 as well. Will Spain's default probability % ever pass Illinois? It is interesting that Argentina is third on the default probability list. The country is dealing with high inflation and energy issues related to the government's economic policies.

Fed Chairman Ben Bernanke will probably move the markets on Friday when he gives his Jackson Hole speech. U.S. index futures are down 0.30%, Japan's NIKKEI index is down 1.08%, and the Shanghai Composite is down 0.34%.

U.S. Economy Contracts If Fiscal Tightening Occurs at End of Year (Fiscal Cliff Scenarios)

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Portugal jan 08_0035
Sagres, Portugal (Source: Dysell)
By now you've probably heard that the U.S. economy will crash into a recession in 2013 if the "fiscal cliff" tightens policy at the end of the year (tax cuts and spending programs expire). Research reports released by the Congressional Budget Office (CBO) and International Monetary Fund (IMF) mentioned that fiscal tightening would negatively affect the U.S. economy (GDP), employment, and the stock market (only in the IMF report) in 2013. I provided their outlooks below.

On August 22, the CBO released an update to their 2012-2022 budget outlook which included post-fiscal cliff economic projections for 2013. The CBO projects that fiscal tightening will contract GDP by 0.5%, increase the unemployment rate to 9.1%, and lower the budget deficit to $641 billion in 2013 (from $1.128 trillion in 2012). They created an infographic that shows their baseline and alterative fiscal cliff scenarios (see below). And I also embedded the CBO's full chart slideshow of their budget outlook via slideshare.

The Global Economic Slowdown Continues; U.S. in Eye of Storm?

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Sovereign debt yielding close to zero percent or even negative has already been pricing this in. And as you can see, the U.S. is off the list, for now. Is the U.S. in the eye of the storm? Or is it a new synthetic emerging market?

Deflated  (Robert Couse-Baker via Flickr)

China bubble in 'danger zone' warns Bank of Japan (Telegraph)
Chinese manufacturing slumps to 9-month low (CNN Money)
China’s Slowdown May Be Worse Than Official Data Suggest (Dallas Fed)
UPDATE: China announces £800bn stimulus to boost confidence (Telegraph)
Limping German firms push economy closer to contraction (Reuters)
Euro zone headed for recession, China, U.S. struggle (Reuters)
Spain Has Serious Economic Issues, Deleveraging and Austerity (Trends, $EWP) (Distressed Volatility)
Italy's GDP Falls 2.5% Y/Y; 10-year Italian, German Yields and Spreads (Trends, $EWI) (Distressed Volatility)
Bundesbank chief says ECB bond buying "like a drug" (CNBC)
UK economy: double-dip recession not as deep as feared (Telegraph)
Dutch housing facing Spain-like slump, says builder BAM (Reuters)
South Korea Key credit delinquency index surges 24 pct over past year (Yonhap News)
Japan Swings to Trade Deficit as Europe Drags Down Exports (Businessweek)
Japanese Economy Signaling a Slowdown (GDP slows to 1.4%) (NYT)

*In other news, North Korea's mineral resources are potentially worth $9.7 trillion: report (Yonhap News).

Annaly Capital Management is Like Gold, For Now ($NLY)

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It seems like leveraged agency MBS REITs (NLY and AGNC for example) are being pitched as the next "sure thing" investment for the next decade. They are publicly traded real estate investment trusts that invest in agency mortgage-backed securities guaranteed by government housing agencies' Fannie Mae, Freddie Mac and Ginnie Mae, and pay out 90% of their income as dividends to investors. Annaly Capital Management (NLY) currently yields 13.24% annualized and has a 5-year net dividend growth rate of 24% (via key statistics). It looks like Annaly's balance sheet is levered 8 to 1 (total assets of 128 billion over $16 billion of equity) and has a debt/equity ratio of 6 to 1 (see quotes from the 8K below).

I'm not going to dig into NLY's financials in detail since I'm not a professional mortgage REIT analyst or MBS portfolio manager, but it seems odd to me how these companies can sustain a dividend payout between 13%-20% (via leverage) with the 30-year fixed rate mortgage near record lows (3.66%) and heightened pre-payment risk. I understand that mortgage portfolio managers can sell off agency MBS for gains, or manipulate their cash flows with interest rate swaps in a rising interest rate environment (which use the TBTF banks as counterparties that could end up blowing up the system again)! Or hold adjustable-rate agency MBS, which is 7% of Annaly's portfolio. But how long can these portfolio managers running $118 billion of agency MBS on mostly borrowed money game a market that is 100% manipulated by the Federal Reserve and backed by government intervention and failed, broke housing agencies? What if deflation sends the 30-year mortgage rate even lower, or the yield curve goes to zero or even inverts in various scenarios?

S&P, Nasdaq Volatility Indexes Hit 2006-2007 Lows ($VIX $VXN $SPY $QQQ), Perma-bulls All In!

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Market perma-bulls and risk managers have pushed the S&P 500 and Nasdaq 100 to new bull market highs and the price of insuring these indexes in the option market to new lows. The S&P 500 and Nasdaq 100 volatility indexes (VIX and VXN) hit lows not seen since 2006 and 2007. And it's all being fueled by monetary policy (printing money and bailouts). So the stock market is now priced like a manipulated synthetic CDO in 2006/7. Good luck perma-bull longs!

The Most Important Financial Links For August 20, 2012

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  • Germany backs Draghi bond plan against Bundesbank (Telegraph)
  • The ECB to potentially target periphery yields via unlimited buying (Sober Look)
  • Lord Rothschild takes £130m bet against the euro (Telegraph)
  • Buffett's Move Raises a Red Flag (WSJ) *Is this directly related to muni credit risk?
  • Buffett Joins Team Whitney; Sees Muni Pain Ahead As He Unwinds Half Of His Bullish CDS Exposure Prematurely (Zero Hedge)
  • Related: Berkshire Trims Municipal-Debt Bet (WSJ, Aug 3, 2012)
  • U.S. Nov soybeans hit contract high on tight supply (Reuters)
  • China worries about social fallout of soybean oil price jump (LA Times, Aug 19, 2012)
  • Why The Fate Of The Global Equity Rally May Rest In The Hands Of Soybeans (Zero Hedge, Aug 9, 2012)

Read Warren Buffett's thoughts on insuring munis in 2008, and his belief recently that more munis could file for bankruptcy as it becomes more popular.

Delinquent Loans in Spanish Bank Portfolios Break Records in June (Charts)

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According to the Bank of Spain, delinquent loans (3-months+) in Spanish bank portfolios hit a new record high of €164.361 billion in June, which has been the trend for years now. But to prove that Spain's financial system is officially in uncharted territory, the loan delinquency ratio hit a record high of 9.42% in June (164.3B/1,743.9B of loans outstanding), a level not seen since February 1994 when it peaked at 9.15% (h/t P&I; view historical data here). Charts on my previous post on Spain's economy explain why loan delinquencies are at record highs.

There's Always a Crisis Somewhere: Social Media, Spain, Munis, Student Debt (Links 8/19/12)

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Source: New York Fed
Muni Crisis:

  • The Untold Story of Municipal Bond Defaults (New York Fed) *the unrated municipal bond market
  • Moody's: Municipal Bankruptcy Is Becoming A Popular Strategy In California (Business Insider/AP)
"To summarize, we expect ... more bankruptcy filings and bond defaults among California cities reflecting the increased risk to bondholders as investors are asked to contribute to plans for closing budget gaps," the report said.

Eurozone crisis:

    Work at Office as Telepresence Robot on Wheels With iPad (Video)

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    Double Robotics built a telepresence robot on wheels that utilizes live teleconferencing on an iPad. So someone working out of the office could roam around their office and chat with people as an iPad face connected to a rod on wheels. Great idea. Watch the video below.

    Spain Has Serious Economic Issues, Deleveraging and Austerity (Trends and $EWP)

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    After writing about Italy's recession, bond yields, and the Italian ETF (down 70% from its peak in 2007) on Tuesday, I looked at economic trends in Spain and the iShares Spain ETF ($EWP).

    Spain's Industrial Production Y/Y Growth ( pdf)
    In June of 2012, Spain's Industrial Production Index declined 6.9% year-over-year (the "adjusted" value was -6.3% y/y, see below). In May, industrial production declined 5.7% year-over-year.

    In Q2, Spain's unemployment rate was at 24.63%, up from 24.44% in Q1. And youth unemployment (16-24) was at 53.3%, up from 52% in Q1. In Q2, Spain's GDP ("advanced estimate") declined 0.4% and 1% over Q1 and year-over-year, respectively.

    So Spain is right in the middle of a recession (ending June 30) which is being fueled by austerity measures and a vicious deleveraging cycle. Keep an eye on the iShares Spain ETF (EWP) to see when it starts, or attempts, to price in an economic recovery. Spanish sovereign debt and bank bailouts, or lack thereof, will be catalysts going forward for at least trades. But Spain's economy is suffering from a significant amount of negative forces that could prevent a recovery even with bailouts.

    LinkedIn, Zillow Are The Only Social Media Survivors Post-IPO Spree ($LNKD, $Z, $FB, $ZNGA, $P, $GRPN, $ANGI, $YELP)

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    This performance makes sense given what happened to jobs and housing. If Groupon's business model wasn't so easy to replicate, it would probably be up there with LinkedIn and Zillow (imo).

    Source: *LNKD, Z, FB, ZNGA, P, GRPN year-to-date

    I added Angies List and Yelp to a 6-month Yahoo Finance chart as well. And check out this chart by Statista showing LinkedIn's year-over-year revenue growth blowing away all of the tech titans in the first six months of 2012.

    Groupon's Gross Billings Decline on a Sequential Basis For the First Time

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    After missing Q2 revenue estimates ($568 million vs. $573 million expected via ThomsonReuters), Groupon's stock crashed 27% to $5.51 today, which is a new all-time low. Groupon is finally profitable though on a GAAP and non-GAAP basis. From Groupon's 8K filing and earnings slides, operating and net income rose to $46.5 million and $28.4 million, respectively, which included stock based compensation and acquisition related costs (GAAP accounting). Excluding these expenses, operating and net income rose to $71.9 million and $53.8 million, respectively (Non-GAAP).

    I put up Statista's infographic on Groupon's earnings below, which included charts of revenue vs. marketing expenses, operating income vs. net income, its stock price, and the most interesting chart of all, gross billings. The chart showed that gross billings declined for the first time on a sequential basis ($1.29 billion in Q2 vs. $1.35 billion in Q1, down 4.4%). They blamed the fall on foreign exchange losses. From the 8K filing:

    Italy's GDP Falls 2.5% Y/Y; 10-year Italian, German Yields and Spreads ($EWI Trends, 8/13/12)

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    First off, Italy's recession worsened in the second quarter of 2012, with GDP down 2.5% year over year. And Italy's industrial production fell 8.2% y/y in June. Here is more info from the Italian National Institute of Statistics on Twitter (@Istat).

    Will Bernanke Announce QE3 at the 2012 Jackson Hole Conference?

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    Read 'The Jackson Hole "fix" is not coming' at for great analysis (a must read blog).

    Source: Medill DC (Flickr)
    QE2 was essentially announced during Federal Reserve Chairman Ben Bernanke's speech at the Jackson Hole conference on August 27, 2010, which sparked a crazy seven month rally in stocks (and backstopped a head and shoulders formation!).

    Below is the portion of Bernanke's 2010 Jackson Hole speech transcript that outlined "policy options for further easing," which involved "additional purchases of longer-term securities" (via Bernanke's Speech in Jackson Hole; Committed to Fighting Deflation - Aug 2010).

    Video: Paul Ryan's Vice President Acceptance Speech (w/ Transcript)

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    Wow, Paul Ryan will be Vice President of the United States if Mitt Romney wins the presidential race. Watch both of their speeches below via CSPAN. Or read the text of Paul Ryan's acceptance speech after the video.

    Getting Busted With Counterfeit Dollars in Mexico (National Geographic's 'Locked Up Abroad' Series)

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    Watch 'Mexico Money Machine' below, which is part of National Geographic's Locked Up Abroad series. It's about a guy who got busted with counterfeit $100 bills in Mexico while trying to smuggle synthetic morphine and steroids back into the United States. I wonder how much counterfeit money is floating around out there.

    Revolving Credit Growth is Getting Tired Y/Y, Consumer Credit Well Below Expectations In June

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    Total consumer credit increased by $6.46 billion in June, which was the smallest expansion since October 2011, according to Reuters. The number was also "well below the $11 billion advance Wall Street economists had forecast in a Reuters poll." When breaking out the number, revolving credit (credit cards) fell by $3.7 billion and non-revolving credit (mainly student loans) rose by $10.15 billion.

    For further review, I put up a 10-year chart comparing the year-over-year percent change in total consumer credit and revolving credit. Consumer credit is still growing annually, but it might be getting tired. You can see weakness clearer in revolving credit, which increased only 0.7% y/y.

    U.S. Hits Debt Ceiling Again Very Soon (James Bianco, Tim Geithner)

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    Source: Bianco Research
    James Bianco, president of Bianco Research, released a chart a few months ago that showed the projected trend of U.S. debt issuance hitting the $16.394 debt ceiling in September. I saw this chart last month at Sober Look. Bianco mentioned that Treasury Secretary Tim Geithner could just borrow again from government trust funds to delay a fiscal crisis. As of August 8 on, U.S debt subject to the limit was at $15.865 trillion. Get ready for news on this subject.

    Here's a quotation from James Bianco's post on The Big Picture on April 30 (with a more detailed chart):

    "Once this ceiling is hit, Geithner can steal borrow from some government trust funds to help fund the government. In 2011 Geithner borrowed enough from trust funds to keep the government going about eight weeks before the debt ceiling had to be raised (see “May 16″ below).

    IYT is Diverging With SPY and DIA Again, Transports Have Been Underperforming the Market

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    One thing I've noticed recently is that IYT, the Dow Jones Transportation Average Index ETF, has been underperforming and diverging with SPY and DIA (S&P, Dow ETFs) during the past 6 months. I had a post on IYT's inverse relationship with SPY and WTIC (crude oil) back on March 1, when IYT's correlation with SPY went sharply negative. I think oil's spike was responsible for bringing transportation stocks down at that time. It's interesting that oil eventually got knocked out because of this, and IYT, which closed at $90.51 yesterday, is still down 2.8% from $93.16 on March 1. But, I will mention that IYT is still outperforming SPY and DIA since the ultimate low in March 2009. It's just interesting that SPY and IYT started to decouple in a major way at the beginning of 2012.

    CHART: Rent Hasn't Declined Y/Y Since the Great Depression!

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    Check out this chart showing the year-over-year percent change in rent inflation since 1914. As you can see, there hasn't been a decline in rent y/y since the Great Depression! In the beginning of the 1920s, rent rose 20% y/y before crashing to unchanged right before the stock market crashed in 1929 (eyeballing the chart below). And then rent declined close to 15% y/y during the depression before spiking to a 5% y/y gain in the late 1930s. It hasn't dipped into negative territory ever since. It's interesting that in 2009, housing prices fell close to 20% y/y, owners' equity in household real estate fell 30% y/y, food prices dipped below 0% for a moment, but rent held on to y/y gains or tested 0%. Check out that chart as well. It's all about the deflation fight. Right? But now some of those who lost equity are without homes, and perhaps underemployed and paying higher rent as a result. I'm guessing the alternative would have been worse?

    Infographic on the U.S. Economy

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    Everything you wanted to know about the U.S. economy is in this infographic produced by (via Business Insider, Zero Hedge).

    Is Waste Carload Growth Diverging With GDP Signaling Economic Weakness Ahead? (AAR Chart)

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    Is the divergence between AAR Waste Carload growth and U.S. GDP growth year-over-year signaling economic weakness ahead? It looks like waste carloads decreased more than 20% y/y during Q3 (quarter-to-date average). The year-over-year change is similar to the 2008 decline before GDP crashed. Waste carloads declined more than 40% y/y at the low. Maybe this time is different. Green movement? This chart was posted on TwitPic by Michael McDonough of Bloomberg Brief (hat tip). He actually created an infographic on on June 9, 2010 that confirmed the economic recovery: "Waste on Freight Cars Gains Most Since '94 Confirming Recovery." Also, this may be of interest "Chemical Activity Barometer Has Been Falling Since April, Leads NBER By 8 Months On Average" (June 26, 2012). However, the weakness in waste carloads could also be related to China's slowdown, since trash was the U.S.'s biggest export to China between 2000-2008.

    Buffett: Muni Bankruptcies Could Increase, San Bernardino's Mayor on Its Bankruptcy (Videos)

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    Berkshire's Warren Buffett, who actively insured municipalities before the financial system and economy collapsed in 2008 (Buffett's Letter on Muni Insurance; Berkshire Insured Detroit Revenue Bonds After FGIC), told Bloomberg TV that muni bankruptcies could increase if it becomes "fashionable and tolerable" to follow large cities like San Bernardino into bankruptcy court to renegotiate expensive city contracts and debts (Bloomberg Video). I found the muni portion of the interview on YouTube and embedded it below. Also watch San Bernardino's Mayor explain why the city filed for bankruptcy in an interview.

    David Faber: Knight Faces Massive Dilution From Convertible Offering... ($KCG)

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    Here are Twitter updates from CNBC's David Faber. Read more at Zero Hedge ("Knight To See Another Day Following 60%+ Convertible Dilution").

    A Comment on CDS & Peter Tchir Says Put CDS On Exchange (Video)

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    First, I replied to this comment on my blog:

    "OK, while it is nice to see CDS prices, how can a little guy buy/sell them? Did not think that was possible. If not, are they more than just interesting?"

    IMF: 200bps Rise in JGB Yields Hits Latin America the Hardest; U.S. Fiscal Cliff vs. Stocks ("2012 Spillover Report")

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    The IMF released an interesting report on July 9 titled "2012 Spillover Report," which analyzed potential spillover effects from the Euro Area sovereign debt and banking crisis, the U.S. fiscal cliff (fiscal tightening in 2013), China's hard landing, and a 200 basis point rise in Japanese government bond yields (JGB yields). It said a rise in JGB yields would affect EM Latin America the most, and then the Euro Area, U.S. and emerging Asia (China).

    The $5 Billion Trade That Destroyed Knight Capital, Down Another 17% In After Hours Trading (KCG) - Update

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    Source: Google Finance
    Seems like it was flash crash-ish.

    "A software glitch caused Knight Capital to erroneously buy $5 billion of stock in a trade that was intended to be executed over five weeks but ultimately took place in just 20 minutes, FOX Business’s Charlie Gasparino reported." (via Charlie Gasparino at Fox Business)

    Knight Capital Down 56% After Software Glitch Causes $440 Million Loss (KCG)

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    Knight Capital Group (KCG) is down 56% at $3 after a software glitch caused a $440 million loss at the trading firm. They are looking to raise capital to support their balance sheet (Reuters, WSJ). Financial tech has reverted back to 1998 and 2002 levels (KCG is testing those lows). Below are KCG stock charts, Knight Capital's statement to the press, an interview with Knight's CEO Tom Joyce on Bloomberg TV, and a snapshot of the enormous volume in KCG's Aug $2.50 puts (42,640 with 687 open interest). Make sure you add financial software, too-big-to-fail credit and Federal Reserve risk mis-management risk to your financial models! First here's an update on Knight Capital's bonds: Knight Capital’s $375 Million Of Convertible Bonds Decline (Bloomberg).

    FED/ECB Statements (August 1-2) - No QE3 and No Action by ECB (TEXT)

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    No QE3 by the Fed + no action by the ECB = bearish for risk assets.

    CHART: Insane EUR/USD Candle Reacts to ECB and Fed

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    EUR/USD pierced 1.228 resistance after ECB President Mario Draghi said the "ECB is ready to do whatever it takes to preserve the euro," sold off at downtrend resistance from May after no QE from the Federal Reserve, and is now dropping like a rock after the ECB's disappointing statement (continued uncertainty about their plan). EURUSD is at 1.21931 -0.47%. The next levels to test are 1.204 and 1.187, see the chart below. The U.S. markets just opened and the Dow is down 0.44%.

    Grantham: "Entering Dangerous Food Crisis"; Profit Margins Weakening Put Stocks at Risk

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    Corn Harvest in Iowa (Wikimedia Commons)
    In GMO's Q2 2012 Quarterly Letter, Jeremy Grantham, co-founder of the $105 billion investment firm GMO LLC, warned that we are "entering a long-term and politically dangerous food crisis" that could last for decades. And towards the end of the note he mentioned that corporate profit margins weakening could be a warning sign for stocks (hat tip PragCap).

    First, here are Jeremy Grantham's thoughts on the "chronic global food crisis" and how to position investment portfolios for this long-term, unfortunate trend.

    "1. Last year we reported the data that showed that we are 10 years into a paradigm shift or phase change from falling resource prices into quite rapidly rising real prices.

    2. It now appears that we are also about five years into a chronic global food crisis that is unlikely to fade for many decades, at least until the global population has considerably declined from its likely peak of over nine billion in 2050."