Thursday, September 2, 2010

Bond trader: "Unprecedented" Treasury Volatility

I wanted to write an update early today because I am busy tonight.

I will start with a chart and then share a conversation with a credit trader that I had yesterday.

Let me first start real quick with a chart on bonds because this is what we talked about.

Folks, the volatility we are seeing in the treasury market over the past week is truly historic. Let's take a look at the 10 year the last few trading sessions:

My Take:

As you can see the 10 year is moving a full point per day in either direction at times.   This type of volatility has never been seen before according to my c friend that I have in the credit markets.

In 30 years on the street he told me that he has NEVER seen moves this big on a daily basis in treasuries.  It's unheard of to see moves like this and he added that it's not a good sign.

My friend explained that the bond market is getting extremely speculative and  traders are loving the volatility. 

He also added that this is not a "healthy" situation.  In fact, he is horrified by the price action.  As he put it "this is not going to end well". 

I'll be honest:  I have never heard him so bearish over the longer term.  He has no answer as to how we ever get out of this.

I brought up the idea of a "reset" and he pretty much hammered me on this.  He said "how do you reset?".  I sat for a second and thought about it and I then threw him a few scenarios.

I offered explanations like inflating out of the debt with a currency devaluation, a new world currency, or a 50% cut in government spending where the debt gets defaulted on etc.  He didn't buy any of it.

In his view, all of the answers ended up with the same result: Failure.  The way he sees it from what I gathered, he basically believes this plays out just like the plot in the 1980's movie "War Games" where a computer and a boy play a simulation game of nuclear war between the USA and Russia.

The two played the game several times and it always ended in the same way:  One side launches the nukes and the other side then retaliates.  The end result is always the same: Total nuclear destruction of the planet.

The trigger that started the war was irrelevant because it always ended with the same result.. 

In my friends view the same thing will happen with our economic system:

No matter what the economic trigger is, the end game never changes:  Systemic failure and chaos.  He just didn't see how any of my scenarios could rationally "work".  He put holes in all of my "reset" solutions. 

In the end I agreed with him which is sad because I really want to find a way out this mess and I am still hoping for a miracle.  The reality is a solution is a long shot at best.

We also concluded that nobody really has the answer as to how this plays out.  This is why you are seeing large hedge fund managers retiring(more on that later)..

You can read a million blogs on the financial markets that will claim that they have this all figured out.  The reality is they really don't. 

We have never dug a hole like this so deep before so how can anyone actually predict how we come out the other side?

As my friend said:  "We are in uncharted waters".  I think this is why you are seeing bond prices at near all time highs at the same time gold is also near all time highs.

The way I see it, most investors really don't know if the US dollar will explode into a hyperinflationary event or soar as the Japan scenario continues to develop.

The market is telling you it doesn't have an answer by taking bonds and gold to new highs at the same time.

The Bottom Line

He ended our conversation with a question that I thought was a good one:  " Jeff, What I want to know is what is the big money doing?".   He added "When guys like Druckenmiller are walking away it's time to be nervous".

His point was if he is if guys like Druckenmiller are willing to walk away from their billions in fees, then it's fair to assume that they don't understand how the game works anymore, and if this is the case, you can then assume they are also asking themselves if the game can actually still work moving forward.

I think this is an excellent point and it's why my friend asked the question about the big money.  He believes some of them are asking themselves questions like this:

What do I do with my billions if the system or the USD is going to fail? 

We finally finished up our conversation by offering up solutions to the question like moving to Asia, buying farmland etc etc. 

As we ended the night discussing this, we came to the same conclusion on this question that we did with all of the others:  "Nobody has the answer".

I am guessing this will all end in a way that no one can predict because we have never been through anything like this before.  We have never seen a country that held the world's reserve currency potentially default.

Like they say....."There is a first time for everything". 

I'll be back with a writeup on the big jobs report tomorrow.

Disclosure:  No new positions taken at the time of publication.

Wednesday, September 1, 2010

The Volatility Continues

Stocks soared today as the ISM data came in stronger than expected.   In a nutshell here is the number:


The growth here is hardly impressive.  I think the market breathed a huge sigh of relief that the number didn't collapse like virtually all of the data has throughout the summer.

The ADP jobs number came in worse than expected but the bulls seemed to be too busy buying stocks today to notice:

"This morning, ADP, a payroll processing firm, put out its latest employment report. It isn’t good. Between July and August, private employers shed an estimated 10,000 workers; economists expected an increase of about 20,000 jobs.

Moreover, ADP revised down July’s increase from 42,000 jobs to 37,000. Over the past six months, private employers have added 37,000 jobs per month, according to ADP’s estimates. To put that in context, the economy needs to add 100,000 to 150,000 jobs a month just to keep up with the country’s growing population, and there are currently 14.5 million unemployed persons looking for work."

My Take:
I can see why Druckenmiller decided to get out his hedge fund.  This is a brutal tape if you are trying to trade on a daily basis.
The rally started off strong but the volume again was light and it tended to lose steam in the afternoon. 
The bulls and the bears have both been humbled by the tape this summer.  The market continues to trade in a range as the world waits to see what the economy and the Fed decide to do in the coming months.
I wouldn't be surprised to see the volatility continue this week.  Jobless claims are out tomorrow and we then get the jobs number on Friday.
I am sure Wall St is not looking forward to the jobs number after seeing the ADP report.   I expect it to be bad but it's all about expectations.   You have to also expect the number to be goosed in some way like every other data point that has come out of Washington lately.
The accuracy of new economic data has gotten so bad that I am starting to pay more attention to the revisions versus the newest numbers because it's the only data point that you can count on.
All I can say is I am glad I am not trading this market.  You are just asking for a whipping as these robots all trade with one another.
I wonder what the volumes would look like if you took the HFT's out of the game?  I am sure it would be pretty horrifying.  
The Bottom Line
From a macro view nothing really changed today.  The economy continues to show signs of weakening and the jobs numbers continue to look ugly.  Any positive news that we have seen recently has shown tepid growth at best.
Remember folks you need job creation of over 150,000 a month in order to see positive employment numbers.  We are not even close at this point.
I will keep it short today because the big news will be Friday.  I will close with some Davidowitz bear porn.

Tuesday, August 31, 2010

Wall Streets Bond Obsession Continues!

Stocks remained on ignore again today as money continued to soar into bonds.  I have a feeling you are going to hear this line a lot from me in the oncoming months after I caught this piece:

Bonds Bubble Inflating Faster than Dotcom:

"Analysis from one Wall Street strategist shows that the pace of money flowing into bonds is faster at this stage than the infamous dotcom bubble of the late 1990s. And that's not necessarily bad news for those Treasury investors.

Almost two years into the bond flight, about $550 billion has poured into U.S. bond mutual funds and exchange-traded funds, according to BNYConvergEx Group Chief Market Strategist Nicholas Colas. Using inflation-adjusted figures, investors had put $499 billion at this same stage of the Internet bubble. Colas selected December 1996, the month of Alan Greenspan's "irrational exuberance" speech, as the estimated start of the bubble in equities. For bonds, he uses the collapse of Bear Stearns in March 2008."

Quick Take:

The article then explains that the tech bubble still had a lot of legs before it blew up:

""We all know bubbles can last longer than anyone thinks possible, and the money flows give us a sense just how much more cash may be waiting in the wings," said Colas, in a note to clients today. "In total, U.S. equity stock funds logged some $840 billion in new capital from Greenie's warning to the peak of the NASDAQ, and over $1 trillion before money actually stopped flowing into stocks. So that $550 billion in new bond fund money may have some more company soon, if the 1990s period is any guide."

My Take:

That last line is the money quote.  I have been discussing the idea of shorting treasuries after this move.  After finishing this article I am starting to think maybe my shorts should be focused on stocks instead.

The numbers above tell you that this move into bonds is basically only half over if you compare the bond bubble to the tech bubble back in the late '90's.

If history repeats itself then stocks are in a great deal of trouble here.   Before I get into that lets talk a little bit about bonds:

Owning bonds in a lot of ways is just like owning a stock.

Investors tend at times focus too much on bond yields versus the actual return on thebonds if  the demand for them rises.  TLT(which is a great barometer of how bonds are doing) has soared recently as money piles into the bond market:

Take Continued:

If you bought TLT when this bond bubble really started rolling in March at 87 you have made a killer return of about 25% in a span of 6 months.

If you go back a little further you can also see how this move may still have some legs:

As you can see we are still far below the highs of 123 that were seen when the stock market collapsed back in 2008.  This means that the money flows are likely to continue into bonds as Wall St sees so much more room on the upside.

What's startling to note here is the volumes in which money is now flying into bonds versus 2008.  As you can clearly see, the flight into bonds today is blowing away the volumes that we saw back in 2008 when it appeared the whole banking system was about to collapse.

This my friends is hard evidence that this flight into bonds has morphed into a speculative bubble versus a fear trade.

I mean think about it: If this was a fear trade then how could the volumes be so much higher then they were back in 2008 when it appeared the financial system might collapse?

The Bottom Line

We all know that Wall St has always been about making money.   Where they made it never mattered.  They will flock to anything that can turn a nice profit especially in an economy that's as bad as this one is.

Wall St is also famous for walking away when a game is over as they look for the a new bubble to blow.  It appears that stocks have become "passe" as the big money rolls into bonds.

When the Fed dropped rates to zero I figured Wall St would eventually  find a way to exploit it.  Ironically, you never would have guessed it would have been in bonds because rates were at zero.

I say this because zero rates made bonds very vulnerable to dropping in value because the consensus view during usual times would be that the Fed would only hold rates this low for a short period of time.  They would then raise rates as the economy recovered which would then push the values of the bonds down.

Wall St quickly realized after the stimulus was over that the Fed could not raise rates because the economy was basically screwed beyond belief.  

Once they came to this conclusion the trade was easy.  You have to hand it to Wall St:  They will always find a way to exploit various vulnerabilities in the economy. 

It doesn't matter if the economy is good or bad.  150$ oil anyone?

So now that we see the new game you need to ask yourself how can you profit from it?

The way I see it you could still pile into bonds.  Japan's 10 year bond dropped to 1% during their meltdown.  Why couldn't the same thing happen here?  If it does the bond trade will still work.

Another way to play it is to short the stock market.  It's clearly obvious by looking at the volume of money flying into bonds that Wall St has decided to pump the bond market versus the stock market.

Strange isn't it?  We are so used to it being the other way around.  This is not the first time this has happened.  I had an old banker friend tell me the stories about how Wall St basically bailed on the stock market in the 1970's when the stock market flat lined at DOW 1000 for a decade.

The traders all bolted to the credit markets because all of the money was being made in bonds because their yields were outperforming the returns in stocks. 

Ironically, the move into bonds this go around is for the exact opposite reason:  The move has been triggered by higher bond prices/falling yields versus lower bond prices/higher yields.

It doesn't matter to Wall St as long as the game is profitable. 

I think the stock market over the coming years is in deep trouble.  Stocks are now facing even more headwinds as Wall St flips into bonds. 

Facing a collapsing economy was bad enough.  Now they have to fight the good fight without the support of many of their old friends from the street!

The reality here is stocks now face a double edged sword when more weak economic data is released: 

On the one side investors will sell stocks because earnings will fall which will hurt values. 

On the other side economic weakness will likely push Wall St into selling more stocks and piling even more into bonds because the game will look increasingly profitable as the economy continues to fall off a cliff.

This will be a brutal 1-2 punch for stocks.  You can be sure that it will eventually put them on the canvass.

IMO, it's time to start focusing on the short side in the stock market moving forward as the bond bubble blows. 

Let me also say that the bond bubble isn't any different from any other Ponzi scheme.

This one will burst too and I am afraid it will be the last one when it's all said and done because there will be no economy to fall back on. 

For the near future however, the bond game still has plenty of tailwinds as the economy continues to worsen.

Disclosure:  No new positions at the time of publication.

Monday, August 30, 2010

Is Main St "Walking Away" From Wall St.?

The stock "strike" continued today after a 1 day hiatus as investors piled back into bonds.

There was no real catalyst catalyst today.  I think it's important to note that the volume was very light.  One must take into account that Wall St may decide to take advantage of the last weekend of the summer and head to the beach.  Not sure I buy that(more later).

I find it ironic that a Category 3 Hurricane now looks to potentially threaten New York City this Labor Day weekend as we get prepared to change seasons.

I say this because Wall St will most assuredly face it's own hurricane this fall  as the economy appears to be coming to a standstill. 

I think what few investors that are left in the stock market realized on Friday that Ben Bernanke is pretty much out of bullets at this point.  The markets were hoping for a Bazooka and Bernanke showed up holding a squirt gun.  Stocks liked it but t bonds sure didn't.

Let's remember:

Stocks rallied 70% last year thinking that "the worst was behind us". 

Main St appears to be catching on that this isn't the case. 

They are slowly learning that they were sold a bunch of goods as a combination of fuzzy math from the government, fraudulent "mark to myth" accounting standards, and front running robotic traders all combined to create an economic recovery that turned out to be about as real as Santa Claus. 

Main St increasingly now believes  that "the worst is most assuredly ahead of us".

They have responded to this by running for cover and piling into treasuries as they prepare for the Economic Storm of the Century.

Wall St has responded like they always do:  They have have cranked up the PR machine to full throttle as they toss their puppets back onto the financial media in an attempt to suck Main St back into stocks.

To date it hasn't worked.  Treasuries continue to soar as Main St wakes up to the fact that they have "been had".  Main St's confidence in Wall St is now all but lost as a result of all of the constant games and misinformation. 

Main St's confidence in the government has also collapsed to an all time low.  When you see GDP revisions of 33% like we did last month can you blame them?

Main St. is now aware that the dreams they were sold by Wall St. have turned into a nightmare.

The public now resembles a group heroine addicts that are trying to face reality after coming off their most intense high. 

The reality they are facing is not pretty: 

-  Their homes have dropped in half is some cases. 
-  20% now find themselves jobless. 
-  Most have also seen their life savings drop by 50% twice in the past decade, and they are now petrified that it might happen a third time as the market threatens to drop below 10,000 once again.

As a result of all of this pain its becoming more and more evident that Main St has come to the conclusion that they have had enough of the stock market.

Wall St tells Main St to buy stocks because their money is earning zero in treasuries.  Main St now responds by saying "No thanks.  At least I know it's there". 

Main St has learned some hard lessons during this historic downturn.  They now understand that there is risk in buying stocks just like they learned that there is risk when you buy a house.  No investment is guaranteed to go up.  Anyone that tells you so is likely selling you some type of Ponzi scheme.

The habit of buying and holding stocks was an extremely hard habit to break because it worked so well the past 30 years.  Millions of baby boomers made fortunes along the way as the economy flourished based on the strong tailwinds of a flourishing financial industry, technology, and an unprecedented housing boom.

It becomes very difficult to "walk away" from old investment habits that brought this country the longest period of prosperity in history.

The problem is the world changes no matter how much we don't want it to.  Economic history is is nothing but a series of booms and busts.  The longer the boom, the more powerful the denial of the bust when it inevitably arrives.

The problem is when the bust comes it cannot be avoided.   Eventually the reality of the bust is accepted but history has shown us the music can go on for a couple of years before we all succumb to it. 

The last period of exuberance that we saw like this was in the 1920's.  The collapse hit in 1929.  As you can see by this great graph that's updated daily by Doug Short, stocks didn't bottom from the 1929 crash until 34 months later:

As you can see above, we have managed to hold this bounce a lot longer this go around thanks to a generous Fed.  However, despite their heroics(or stupidity as I like to say), the market still remains 30% below the lows.

Let's also not forget the psychology involved here as well. As I said above, the longer the boom the more powerful the denial of the bust.   We just completed a 25-30 year boom whereas the 1920's boom only lasted for about 8 years.

Therefore, the acceptance of the bust will become that much tougher for people to realize.   As a result, finding the lows of this depression should take longer to reach than the 1930's.  We shouldn't be surprised at the stubborn resilience that we have seen in the stock market.

The Bottom Line:

I think Main St. has finally realized the magnitude of the nightmare we find ourselves in.  The flight to bonds over the past several weeks was the first clear symptom of panic that I have seen since the rally.

I also get concerned when you start seeing selling on days like today where there is no bad news to speak of.  You tend to see days like this in downtrends.  I remember seeing weeks like this when the tech bubble burst.

Let me once again repeat and put today into perspective:  The volume was anemic so you can't read to much into it. 

The question that needs to be asked is why has the volume been so low recently?  Is it because Wall St is vacationing in the Haptons OR has Main St decided to "walk away" from stocks?

This week it's probably a little bit of both.  If we see the trend continue after Labor Day then it's time to really get worried.

The hurricane that approaches New York next weekend will pale in comparison to the economic "Katrina" that we will likely see this fall.

In the meantime, while we wait, one thing is pretty clear:  Main St has lost confidence in Wall St.  It remains to be seen if they can ever get it back in our lifetimes.

Disclosure:  Sold part of my PTTRX position.