Archive for the ‘Global Macro’ Category

George Soros on European Fiscal & Banking Crisis and EU Summit on June 28-29, 2012

Monday, June 25th, 2012

Here I present key take-aways from George Soros’ in depth Bloomberg interview on the current European fiscal and banking crisis, Angela Merkel, the Spanish bailout, and Greece leaving the Eurozone.

The video is also below:

Banking & Fiscal Issues

  • “There is an interrelated problem of the banking system and the excessive risk premium on sovereign debt – they are Siamese twins, tied together and you have to tackle both.”
  • Soros summarizes the forthcoming Eurozone Summit ‘fiasco’ as fatal if the fiscal disagreements are not resolved in 3 days.
  • There is no union without a transfer.
  • Europe needs banking union.
    • Germany will only succumb if Italy and Spain really push it to the edge (Germany can live in the present situation; the others cannot)
    • Europe needs a fiscal means of strengthening growth through Treasury type entity
      • What is needed is a European fiscal authority that will be composed of the finance ministers, but would be in charge of the various rescue mechanisms, the European Stability Mechanism, and would combine issuing treasury bills.
        • Those treasury bills would yield 1% or less and that would be the relief that those countries need in order to finance their debt.
        • Bill would be sold on a competitive basis.
        • Right now there are something like over €700bn euros are kept on deposit at the European Central Bank earning a 0.25% because the interbank market has broken down, so then you have €700bn of capital that would be very happy to earn 0.75% instead of 0.25%, and the treasury bills by being truly riskless and guaranteed by the entire community, would yield in current conditions less than 1%.
        • Governments should start a European unemployment scheme, paid on a European level instead of national level.
        • Soros’ solutions, however, are unlikely to prove tenable in the short-term as he notes “Merkel has emerged as a strong leader”, but “unfortunately, she has been leading Europe in the wrong direction”.
          • “Euro bonds are not possible because Germany would not consider euro bonds until there is a political union, and it should come at the end of the process not at the beginning.
          • This would be a temporary measure, limited both in time and in size, and thereby it could be authorized according to the German constitution as long as the Bundestag approves it, so it could be legal under the German constitution and under the existing treaties.
          • The political will by Germany to put it into effect and that would create a level playing field so that Italy and Spain could actually refinance debt on reasonable terms.

Scenario Discussion

  • LTRO would be less effective now
  • At 6%, 7% of Italy’s GDP goes towards paying interest, which is completely unsustainable
  • Spain may need a full bailout if summit is not successful
    • Financial markets have the ability to push countries into default
    • Because Spain cannot print money itself
    • Even if we manage to avoid, let’s say an ‘accident’ similar to what you had in 2008 with the bankruptcy of Lehman Brothers, the euro system that would emerge would actually perpetuate the divergence between creditors and debtors and would create a Europe which is very different from open society.
    • It would transform it into a hierarchical system where the division between creditors and debtors would become permanent…It would lead to Germany being in permanent domination.
      • It would become like a German empire, and the periphery would become permanently depressed areas.

On Greece

  • Greece will leave the Eurozone
    • It’s very hard to see how Greece can actually meet the conditions that have been set for Greece, and the Germans are determined not to modify those conditions seriously, so medium term risk
    • Greece leaving the euro zone is now a real expectation, and this is what is necessary to strengthen the rest of the euro zone, since Greece can’t print money
    • By printing money, a country can devalue the currency and people can lose money by buying devalued debt, but there is no danger of default.
      • The fact that the individual members don’t now control the right to print money has created this situation.
      • A European country that could actually default. and that is the risk that the financial markets price into the market and that is why say Italian ten-year bonds yield 6% whereas British 10-year bonds yield only 1.25%.
  • That difference is due to the fact that these countries have surrendered their right to print their own money and they can be pushed into default by speculation in the financial markets.

On Angela Merkel

  • Angela Merkel has been leading Europe in the wrong direction. I think she is acting in good faith and that is what makes the whole situation so tragic and that is a big problem that we have in financial markets generally – she is supporting a false idea, a false ideology, a false interpretation which is reinforced by reality.
  • In other words, Merkel’s method works for a while until it stops working, and that is what is called a financial bubble
    • Financial bubbles look very good while they are being formed and everyone believes in it and then it turns out to be unsustainable…
    • The European Union could turn out to have been a bubble of this kind unless we realize there is this problem and we solve it and the solution is there.
    • I think everybody can see it, all we need to do is act on it, and put on a united front, and I think that if the rest of  Europe is united, I think that Germany will actually recognize it and adjust to it.

On Investing

  • Stay in cash
  • German yields are too low
  • If summit turns out well, purchase industrial shares, but avoid everything else (consumer, banks)

Conclusion: We are facing conditions reminiscent to the 1930s because of policy mistakes, forgetting what we should have learned from John Maynard Keynes.

Fantastic Michael Burry UCLA Commencement Speech on U.S. & European Financial Crises

Sunday, June 24th, 2012

Below you can view an excellent speech by Dr. Michael Burry, who at one point shorted over $8 billion of subprime mortgage backed securities before the U.S. credit crisis. Dr. Burry openly shares his experiences on divorce, luck, finance, and the future of college graduates at UCLA. As an alumnus of UCLA, Dr. Burry shows that passion, curiosity, foresight, and “working smart” rather than “working hard” can be handsomely rewarded. Michael Burry’s hedge fund, Scion Capital ultimately recorded returns of 489.34% (net of fees and expenses) between its November 1, 2000 inception and June 2008. The S&P 500 returned just over two percent over the same period. Other than Dr. Burry’s subprime short, I am not sure of his performance from 2000 through 2005. Enjoy.

[youtube]http://www.youtube.com/watch?v=1CLhqjOzoyE&feature=share[/youtube]

Burry left work as a Stanford Hospital neurology resident to become a full-time investor and start his own hedge fund. He had already developed a reputation as an investor by demonstrating astounding success in “value investing,” which he wrote about on a message board beginning in 1996. He was so successful with his stock picks that he attracted the interest of such companies as Vanguard, White Mountains Insurance Group and such prominent investors as Joel Greenblatt.
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After shutting down his web site in November 2000, Burry started Scion Capital, funded by a small inheritance and loans from his family. The company was named after The Scions of Shannara, a favorite childhood book. Burry quickly earned extraordinary profits for his investors. According to Lewis, “in his first full year, 2001, the S&P 500 fell 11.88 percent. Scion was up 55 percent. The next year, the S&P 500 fell again, by 22.1 percent, and yet Scion was up again: 16 percent. The next year, 2003, the stock market finally turned around and rose 28.69 percent, but Mike Burry beat it again—his investments rose by 50 percent. By the end of 2004, Mike Burry was managing $600 million and turning money away.”
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In 2005, he veered from value investing to focus on the subprime market. Through his analysis of mortgage lending practices in 2003 and 2004, he correctly forecast a bubble would collapse as early as 2007. Burry’s research on the runaway values of residential real estate convinced him that subprime mortgages, especially those with “teaser” rates, and the bonds based on these mortgages would begin losing value when the original rates reset, often in as little as two years after initiation. This conclusion led Burry to short the market by persuading Goldman Sachs to sell him credit default swaps against subprime deals he saw as vulnerable. This analysis proved correct, and Burry profited accordingly. Ironically Burry’s since said, “I don’t go out looking for good shorts. I’m spending my time looking for good longs. I shorted mortgages because I had to. Every bit of logic I had led me to this trade and I had to do it”.
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Though he suffered an investor revolt before his predictions came true, he earned a personal profit of $100 million and a profit for his remaining investors of more than $700 million. Scion Capital ultimately recorded returns of 489.34 percent (net of fees and expenses) between its November 1, 2000 inception and June 2008. The S&P 500 returned just over two percent over the same period.
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According to his website, he liquidated his credit default swap short positions by April 2008 and did not benefit from the taxpayer-funded bailouts of 2008 and 2009.[13] He subsequently liquidated his company to focus on his personal investment portfolio.
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In a April 3, 2010, op-ed for the New York Times, Burry argued that anyone who studied the financial markets carefully in 2003, 2004, and 2005 could have recognized the growing risk in the subprime markets. He faulted federal regulators for failing to listen to warnings from outside a closed circle of advisors.
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In April 2011, he suggests: (1) Open a bank account in Canada, (2) there are opportunities in small cap stocks, and (3) blue chips may be less attractive than their price-earnings suggests.

Burry left work as a Stanford Hospital neurology resident to become a full-time investor and start his own hedge fund. He had already developed a reputation as an investor by demonstrating astounding success in “value investing,” which he wrote about on a message board beginning in 1996. He was so successful with his stock picks that he attracted the interest of such companies as Vanguard, White Mountains Insurance Group and such prominent investors as Joel Greenblatt.After shutting down his web site in November 2000, Burry started Scion Capital, funded by a small inheritance and loans from his family. The company was named after The Scions of Shannara, a favorite childhood book.


Burry quickly earned extraordinary profits for his investors. According to Lewis, “in his first full year, 2001, the S&P 500 fell 11.88 percent. Scion was up 55 percent. The next year, the S&P 500 fell again, by 22.1 percent, and yet Scion was up again: 16 percent. The next year, 2003, the stock market finally turned around and rose 28.69 percent, but Mike Burry beat it again—his investments rose by 50 percent. By the end of 2004, Mike Burry was managing $600 million and turning money away.” In 2005, he veered from value investing to focus on the subprime market. Through his analysis of mortgage lending practices in 2003 and 2004, he correctly forecast a bubble would collapse as early as 2007.

Burry’s research on the runaway values of residential real estate convinced him that subprime mortgages, especially those with “teaser” rates, and the bonds based on these mortgages would begin losing value when the original rates reset, often in as little as two years after initiation. This conclusion led Burry to short the market by persuading Goldman Sachs to sell him credit default swaps against subprime deals he saw as vulnerable. This analysis proved correct, and Burry profited accordingly. Ironically Burry’s since said, “I don’t go out looking for good shorts. I’m spending my time looking for good longs. I shorted mortgages because I had to. Every bit of logic I had led me to this trade and I had to do it”. Though he suffered an investor revolt before his predictions came true, he earned a personal profit of $100 million and a profit for his remaining investors of more than $700 million. Scion Capital ultimately recorded returns of 489.34 percent (net of fees and expenses) between its November 1, 2000 inception and June 2008.

The S&P 500 returned just over two percent over the same period. According to his website, he liquidated his credit default swap short positions by April 2008 and did not benefit from the taxpayer-funded bailouts of 2008 and 2009. He subsequently liquidated his company to focus on his personal investment portfolio. In a April 3, 2010, op-ed for the New York Times, Burry argued that anyone who studied the financial markets carefully in 2003, 2004, and 2005 could have recognized the growing risk in the subprime markets. He faulted federal regulators for failing to listen to warnings from outside a closed circle of advisors. In April 2011, he suggests: (1) Open a bank account in Canada, (2) there are opportunities in small cap stocks, and (3) blue chips may be less attractive than their price-earnings suggests.

Bank of Spain Nationalizes Bankia – Property Bubble Bursting

Wednesday, May 9th, 2012

According to ZeroHedge, the Bank of Spain has recently nationalized Bankia, the first of many nationalizations that have to occur in Spain because of poor underwriting by the cajas (regional banks/savings and loan institutions) and falling real estate prices. The Spanish housing price graph above shows how much further the property bubble went in Spain, where at one point, more than 15% of the labor force was working in construction.

With a government debt to GDP ratio of 70%, and another 30%+ of municipal debt, where is Spain getting the money to accomplish these bailouts?

By Alexander Lemming, Leverage Academy Associate

Statement on BFA-Bankia

The Board of Finance and Savings Bank (BFA) announced today the Bank of Spain its decision not to buy in the terms and conditions agreed to the securities issued in the amount of € 4.465m who signed the FROB (Bank Restructuring Fund). BFA has concluded that the most desirable to strengthen the soundness of the business project that began with the appointment of Jose Ignacio Goirigolzarri as president is to request the conversion of these titles in stock ordinary. This conversion must be authorized by the Bank of Spain and the other authorities Spanish authorities and community and will be conducted in accordance with the valuation process established in the indenture securities.

The Bank of Spain has worked hard in recent months with the group address BFA-Bankia to specify the measures to ensure compliance with the provisions of the RD-l 2/2012 for the sanitation Spanish financial system. BFA-Bankia late March presented a restructuring plan and restructuring that included measures that would comply with the RD-l, and standardize its financial  position.

After analyzing this reorganization plan, the Bank of Spain also ordered the entity measures complementary to streamline and strengthen management structures and management, increasing professionalization and a divestment program. These additional actions should serve to enhance the soundness of the institution and restore market confidence. The events of the past weeks and the growing uncertainty about the future of the company has made it advisable to go further and raise the providing resources to accelerate and increase public sanitation.

The changes in the presidency of BFA-Bankia is precisely oriented in the direction shown in professional management and allow the group to boost its restructuring program. The new address of the entity must submit in the shortest possible plan of reorganization strengthened that places BFA-Bankia able to cope with a full guarantee its future.

In any case, BFA-Bankia is a solvent entity that continues to function quite normally and customers and depositors should have no concern. (ZHedge)

Italian 10 year Yield Rises Above 7.4%, Country Theoretically Unable to Fund Itself at These Levels (Bankrupt), Prime Minister Offers to Resign

Wednesday, November 9th, 2011

November 9, 2011: After Italian Prime Minister Berlusconi offered to resign yesterday, the credit markets almost sighed in relief. But today, markets were punched in the jugular as LCH.Clearnet increased margin requirements on Italian bonds. Margins were raised because 10 year credit spread exceeded 450 bps, the same point at which Clearnet raised margins on the bonds of other peripheral countries in Europe.
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The pressure is certainly on the ECB and Italy now to find a solution to this debt crisis, as Italy is too large to be bailout out. Yesterday, known for his sex scandals and political corruption, Prime Minister Berlusconi was pressured to leave his post because Italian yields were creeping above 6.5%. According to the Times, “In the end, it was not the sex scandals, the corruption trials against him or even a loss of popular consensus that appeared to end Mr. Berlusconi’s 17 years as a dominant figure in Italian political life. It was, instead, the pressure of the markets — which drove Italy’s borrowing costs to record highs — and the European Union, which could not risk his dragging down the euro and with it the world economy. On Wednesday, yields on 10-year Italian government bonds — the price demanded by investors to loan Italy money — edged above 7 percent, the highest level since the adoption of the euro 10 years ago and close to levels that have required other euro zone countries to seek bailouts.”
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Currently, the Italian 10 year yield has exceeded 7.4%, and the 2 year note has risen more than 10 year rate. At this point, Italy is theoretically unable to fund itself and could theoretically be bankrupt. The margin call on bonds due between seven and 10 years was raised by five percentage points to 11.65%, for bonds due between 10 years and 15 years it was raised by five percentage points to 11.80%, while for bonds that mature in 15 years and 30 years the margin call was raised by five percentage points to 20%. The changes come into effect Nov. 9 and will have an impact on margin calls from Nov. 10, the French arm of LCH.Clearnet said.

Chinese Debtors Offer Fingers to Loan Sharks

Monday, November 7th, 2011

November 7, 2011: Loan sharks have been a problem in the Western World for centuries. From traditional Vegas sharks to payday lenders, the poor have been subject to atrocities by creditors for years, despite government intervention. The situation today is no better for China’s small entrepreneurs. Many businessmen have been forced into bankruptcy recently as local credit has been tightening. Not able to withstand public humiliation, some choose suicide, while others find themselves under the burden of creditors and “tattooed thugs.”

According to a recent Businessweek article, Zhong Mong, a Chinese pharmacy owner, offered his fingers to a group of private lenders because if they repossessed one of his stores, it would be impossible to pay back another 130 small local creditors, many of whom are local friends and neighbors. Zhong had borrowed 30 million yuan or $4.7 million at rates as high as 7% per month to expand his franchise!

Similar to the U.S., small and medium sized businesses account for 80% of jobs in greater China, but these businesses always find it difficult to obtain local bank financing. Other forms of financing are often much more expensive, leading to complications and often default. Since April, at least 90 CEOs have fled Zhong’s city of Wenzhou for the same reason. The 400,000 businesses in the city are facing higher costs because of inflation and soaring black market interest rates because of the sudden credit squeeze. Imagine how fast a business must grow to pay Zhong’s 7% monthly interest…


Black market interest rates have doubled this year, growing faster than local profits. Informal lending has given rise to real estate developers driving prices ever higher, leading to more inflation. Similar problems have also surfaced in the industrial province of Guangdong, to the South.

Wenzhou is home to 9 million Chinese and produces 90% of China’s eyeglasses and lighters. Many residents of Wenzhou take out bank loans at 1% per month and lend out money at 2%+ per month, pocketing the difference. China’s official lending rate is only 6.56%, compared to rates between 20-40% that small businesses are charged here.

Local suicides have prompted Premier Wen to visit the city and pledge to raise bonds to help finance smaller businesses, even if NPLs are higher. Unfortunately for Zhong, it may be too late. He will probably lose his business and will be hired as a paid manager. He and his wife will probably have nothing left.

Japanese Market Plummets 20% in 2 Days on Radiation Threat

Tuesday, March 15th, 2011

The Nikkei slid 14% last night (3/15/11), and recovered 3% to end net 11% down for the day after the Japanese government banned brokerages from selling.  This was after a 6% down day on 3/14 and a poor prior week.  Both the TOPIX and the Nikkei are now down more than 20% for the year on the risk that nuclear radiation will pose a threat to Tokyo.  Traders in Tokyo and Hong Kong said hedge fund selling of Nikkei futures, especially the Singapore-listed contracts , was behind the deepest drop in Japanese shares. Cash volumes on the Tokyo Stock Exchange hit a record for a second day running.

These equity sales were triggered by the explosion of a fourth nuclear reactor 130 miles away from the city, leaking lethal amounts of radiation.

An explosion and fire at the Fukushima Daiichi nuclear plant at 6: 10 am local time prompted officials within a 30-kilometer radius to stay indoors.  This was the message released (translated):

“Please do not go outside. Please stay indoors. Please close windows and make your homes airtight. Don’t turn on ventilators. Please hang your laundry indoors,” Chief Cabinet Secretary Edano said to the residents in the danger zone. “These are figures that potentially affect health. There is no mistake about that.”

According to the Associated Press, about 140,000 people were impacted by the warning.

Soon after the explosion, heightened levels of radiation were detected in Tokyo, 175 miles away.  Radiation levels in Tokyo were 23 times the normal level in the city.

According to ABC News, “The Japanese government formally has asked the U.S. Nuclear Regulatory Commission for help in stabilizing its troubled nuclear reactors in the wake of the country’s massive earthquake and tsunami.  The NRC sent two boiling water reactor experts to Japan as part of a team of aid workers to help in the recovery efforts.”

With this explosion at Fukushima, since the roof did not fall off the rod casing, the pressure is trapped within the vessel around the core, which will allow radi0active material to seep out.  The real risk here is the risk of a meltdown, which could affect the health of millions in Japan and nearby nations.  The fuel rods in all three of the reactors at the Fukushima plant appear to be melting.

The Japanese government reacted hours ago by adding $98 million in liquidity to the market, but this did not alleviate the stress in the market as U.S. 10 year yields jumped and DAX fell 4.5% in Europe. Hong Kong’s Hang Seng Index tumbled 2.9%, China’s Shanghai Composite lost 1.4%, Australia’s S&P/ASX 200 shed 2.1%, Taiwan’s Taiex skidded 3.4% and South Korea’s Kospi fell 2.4%. India’s Sensex shed 0.9% in afternoon trading.  Brent crude fell more than 2.2% to below $112, while U.S. crude dropped to almost $98 a barrel.

$364 billion in Japanese wealth was just evaporated in a matter of 4 hours.   Relying on the Japanese private insurance system is now out of the question.

The document below (LA Blog) shows an overview of the earthquake insurance system in Japan, which certainly cannot cover this mess.

NIRO Japan Eqarthquake

Understanding The Basic Elements of Forex Trading

Thursday, March 10th, 2011

Understanding The Basic Elements of Forex Trading

The foreign exchange market is finally beginning to garner mainstream attention.  The Bank of International Settlements estimates that the average daily volume in the fx market is around $4 trillion, which makes it by far the largest financial marketplace in the world.  Surprisingly, however, many novice investors and traders have never even heard of this market.

Until the late 1990’s, the only players allowed to execute trades in the foreign exchange market were investment banks, hedge funds, and very wealthy private investors.  Since the minimum contract size was generally $1,000,000, smaller traders were effectively denied entrance into the market.

In the late 90’s, however, this all changed.  The advance of the internet and technology led several online forex brokers to open shop and begin catering to smaller investors and traders.  This led to the birth of the retail foreign exchange market.  In this article, we are going to discuss three key elements to forex trading:  Leverage, Margin, and Equity.

Leverage

The idea of leverage in the fx market has been under intense debate over the last several years.  Since the market is decentralized and worldwide, regulation was largely absent from the fx market until recently.  In 2010, the National Futures Association instituted some major changes, one of them being a cap on leverage at 50:1.  This means that an fx trader in the United States can trade on leverage at a ratio of 50:1.  Thus, if a trader has $1,000 in his account, then he is able to leverage that $1,000 into $50,000 and trade much larger positions in EUR USD.  Until the National Futures Association passed this regulation, some brokers were offering traders up to 400:1 leverage, which means that with a $1,000 account, traders were able to control a $400,000 position in the market. Note that leverage is a two-edged sword. It will increase both losses and profits.

Margin

Margin is the life of a trader.  If a trader does not have enough margin, then he cannot open a trade.  Furthermore, if a trader has an open position moving against him, he may eventually not have enough money to act as margin, which means his account would suffer a “margin call.”

Margin is the amount of money required to open a leveraged position.  For example, if Broker ABC offers 50:1 leverage, and Bob the Forex Trader wants to open a position of $100,000, then Bob has to put up $2,000 of margin.  If Bob’s trade begins to move against him to the point where his account equity becomes less than $2,000, Bob will suffer a “margin call,” which basically means that his broker will call for more margin if Bob wants to keep the position open.

Equity

Everyone knows that one of the leading causes of business failure is a lack of initial capital, and trading is no different.  If a trader opens an account with a few thousand bucks and trades heavily leveraged positions, his chances of success are nominal.

Equity is essential to trading success.  The question many new traders have is, how much money do I need to open an account?  Well, the answer to that question is different for everyone, and it largely depends on what your goals are.  If you simply want to get some trading experience, but still have a full-time job, then a person can open an account with a few thousand bucks.  However, if you are trying to generate enough capital gains to sustain a living, then the initial account balance should be much, much higher.

Leverage, Margin, and Account Equity are three essential aspects of fx trading that every trader must be familiar with.

Check out our intensive investment banking, private equity, and sales & trading courses!  The discount code Merger34299 will be activated until April 15, 2011. Feel free to e-mail thomas.r[at]leverageacademy.com with questions.


Oil Should Spike Higher Following Saudi Riots and Nigerian Elections in April – Report Attached

Thursday, March 10th, 2011

The following special report on oil (LA Blog Only, leverageacademy.com/blog) discusses the oil market, providing reasons to be bullish  on the commodity given unrest in the Middle East, Nigerian elections in April, and rising domestic consumption in oil producing countries, including Venezuela, Nigeria, and Iran.  According to the article, the rise of oil prices could easily cause the next recession.   In 2010, soft commodities outperformed energy, but that will certainly change given the political headwinds abroad and continued monetary easing in the developed world.  Therefore, the Bernanke “Put,” combined with political unrest will be to blame for continued sharp price increases in the energy commodity sector.

Emerging market demand, especially in China, which now consumes nearly 10mm barrels of oil per day, will also be driving the demand side of the equation.  Money supply in China was also up 19.7% in 2010, because of the rapid credit growth the country has experienced over the past 2 years.

On the supply side, Middle Eastern youth continue to riot, causing political unrest across the globe.  In Egypt, Libya, Morocco, Saudi Arabia, Tunisia, and Bahrain, youth unemployment is over 20%, which is a severe concern, given the oil wealth of these nations.  The Iran crisis could also re-emerge as the country continues to develop nuclear weapons.  As Iran is mostly Shiite, it poses a great threat to its Sunni neighbors, including Saudi Arabia.  Major risks in the area include that the Straights of Hormuz and Malacca could be blocked in the Middle East if major riots break out.  These two passages account for 32 million barrels of crude transport per day.  The Straight of Hormuz alone carries 33% of oil transport by sea.  Furthermore, one should question how much Saudi Arabia can increase supply, as the country overstated its oil reserves by nearly 300 billion gallons in 2010.  Even if it does increase supply, how will this supply be transported to the West if passages are blocked?

There has not been one year in recent history where Nigerian elections have not posed a threat to the country’s oil supply.  Elections are often bloody, and there is no reason for the upcoming 2011 elections being held in April to be different.

To make things worse, the IEA increased its oil demand forecast by 1.6%.

On December 6th, Brent futures were traded in backwardation for the first time in two years, which means that futures with shorter maturities are more expensive than those with longer maturities (similar to an inverse yield curve).  Backwardation occurs in tight markets, whereas contango occurs when there is oversupply.

What will be the effect of these changes in the oil supply/demand equation?  Well, an increase in oil price tends to affect the economy with a time lag of at least 4-6 months.  An increase an oil price of $10 would cause GDP to fall by 25 bps and S&P earnings to fall by $3.00.

According to the IEA, 4.1% of GDP was spent on oil consumption in 2010.  A sustained price above $100 would mean that the percentage would increase to 5%.  Oil at $120 would mean a percentage increase to 6%, which would be devastating.

Special Report Oil March 2011

Check out our intensive investment banking, private equity, and sales & trading courses!  The discount code Merger34299 will be activated until April 15, 2011. Questions? Feel free to e-mail thomas.r[at]leverageacademy.com with your inquiries or call our corporate line.


S&P 500 2011 Median Target – 1,535, Really?

Friday, March 4th, 2011

Investment bank earnings estimates are truly bullish for 2011.  Applying a 16x-18x multiple to these forward earnings brings you to S&P levels unseen since 2007.  Unfortunately, something not included in these estimates is that for every $10 crude oil increases, S&P earnings fall by $3.  This does not even factor in the fall in consumer confidence when citizens across the globe realize that they are soon going to pay $200 to fill up a mid-sized sedan, once QE3 is unveiled and Middle Eastern governments are overthrown once and for all.  After all this is done for, oil could easily reach $130+ on a supply disruption in Saudi Arabia.

Of course, BofA’s Bianco will not discuss this.  Neither will the analysts at Barclays, who just revised their S&P 500 earnings estimates up from 1,420 to 1,450.

Please view LA’s blog entry to see the S&P earning’s table below.

Predicted
Firm Strategist 2011 Close 2011 EPS RPF Model
Bank of America David Bianco 1,400 $93.00 1,535
Bank of Montreal Ben Joyce 1,300 $89.00 1,469
Barclays Barry Knapp 1,420 $91.00 1,502
Citigroup* Tobias Levkovich 1,300 $94.50 1,559
Credit Suisse Andrew Garthwaite 1,350 $91.00 1,502
Deutsche Bank Binky Chadha 1,550 $96.00 1,584
Goldman Sachs David Kostin 1,450 $94.00 1,551
HSBC Garry Evans 1,320
JPMorgan Thomas Lee 1,425 $94.00 1,551
Morgan Stanley**
Oppenheimer Brian Belski 1,325 $88.50 1,460
RBC Myles Zyblock $88.00 1,452
UBS Jonathan Golub 1,325 $93.00 1,535
Median 1,350 $93.00 1,535
Average 1,379 $92.00 1,518
High 1,550 $96.00 1,584
Low 1,300 $88.00 1,452

200 Years of U.S. Treasury Yields – Short the 30-Year, Ticker: TMV

Friday, March 4th, 2011

The Fed increased the Federal Debt Ceiling dozens of times over the past year, and it seems like it is not over for the Bernank.   The Fed’s balance has been growing every single day as he pumps the economy with more liquidity.  Here is a link to the NY Fed’s POMO schedule: http://www.newyorkfed.org/markets/tot_operation_schedule.html.

In the SocGen chart above, you can see 200 years of U.S. treasury yields.  From the chart, you can see why we are currently in danger of rising yields.  We have a combination of oil shocks and riots facing the world today, with the threat of stagflation.  Almost every emerging market has raised rates over the past 6 months: Singapore, Brazil, India, you name it.  Even Europe, which is in a MUCH worse fiscal situation than the United States, is now “vigilant” on inflation and may raise rates in April…http://www.independent.ie/national-news/trichets-bombshell-makes-bad-situation-even-worse-2565545.html.

According to Bill Gross of PIMCO, “Treasury yields are perhaps 150 basis points or 1½% too low when viewed on a historical context and when compared with expected nominalGDP growth of 5%…This conclusion can be validated with numerous examples: (1) 10-year Treasury yields, while volatile, typically mimic nominal GDP growth and by that standard are 150 basis points too low, (2) real 5-year Treasury interest rates over a century’s time have averaged 1½% and now rest at a negative 0.15%! (3) Fed funds policy rates for the past 40 years have averaged 75 basis points less than nominal GDP and now rest at 475 basis points under that historical waterline.”

In the charts here on the LA blog, you can see (1) the % of investors who own U.S. Treasuries, (2) who is currently buying, and (3) who will buy?  The third chart is in question.  Someone will buy, but at what price and yield?  What will this mean for the U.S. yearly interest burden, for U.S. tax hikes in the future?

One can conclude from these thoughts that yields will have to increase, especially if QE3 is announced in June, and unless the economy booms, so will tax rates.  Here are Mr. Gross thoughts on QE:

Most observers would agree with us at PIMCO that QE I and II programs were initiated and employed under the favorable conditions of (1) and (2). The third criterion (3), however, is more problematic. A successful handoff from public to private credit creation has yet to be accomplished, and it is that handoff that ultimately will determine the outlook for real growth and the potential reversal in our astronomical deficits and escalating debt levels. If on June 30, 2011 (the assumed termination date of QE II), the private sector cannot stand on its own two legs – issuing debt at low yields and narrow credit spreads, creating the jobs necessary to reduce unemployment and instilling global confidence in the sanctity and stability of the U.S. dollar – then the QEs will have been a colossal flop. If so, there will be no 15%+ tip for the American economy and its citizen waiters. An inflation-adjusted “negative buck” might be more likely.

Washington, Main Street – and importantly from an investment perspective – Wall Street await the outcome. Because QE has affected not only interest rates but stock prices and all risk spreads, the withdrawal of nearly $1.5 trillion in annualized check writing may have dramatic consequences in the reverse direction. To visualize the gaping hole that the Fed’s void might have, PIMCO has produced a set of three pie charts that attempt to point out (1) who owns what percentage of the existing stock of Treasuries, (2) who has been buying the annual supply(which closely parallels the Federal deficit) and (3) who might step up to the plate if and when the Fed and its QE bat are retired. The sequential charts 1, 2 and 3 are illuminating, but not necessarily comforting.

What an unbiased observer must admit is that most of the publically issued $9 trillion of Treasury notes and bonds are now in the hands of foreign sovereigns and the Fed (60%) while private market investors such as bond funds, insurance companies and banks are in the (40%) minority. More striking, however, is the evidence in Chart 2 which points out that nearly 70% of the annualized issuance since the beginning of QE II has been purchased by the Fed, with the balance absorbed by those old standbys – the Chinese, Japanese and other reserve surplus sovereigns. Basically, the recent game plan is as simple as the Ohio State Buckeyes’ “three yards and a cloud of dust” in the 1960s. When applied to the Treasury market it translates to this: The Treasury issues bonds and the Fed buys them. What could be simpler, and who’s to worry? This Sammy Scheme as I’ve described it in recentOutlooks is as foolproof as Ponzi and Madoff until… until… well, until it isn’t. Because like at the end of a typical chain letter, the legitimate corollary question is – Who will buy Treasuries when the Fed doesn’t?”

So, how do we short Treasuries at Leverage Academy?  Using TMV, Direxion Daily 30-Year Treasury Bear 3x Shares.  Actually, this security should not be used for prolonged periods of time, but has tracked treasury yields fairly well on a daily and weekly basis.  You can always maximize your return on your treasury short by using longer dated securities.

What can the House and Senate do to address the U.S. deficit?  We can only hope that they will act to preserve our currency’s status, otherwise global inflation will continue.  According to Reuters, “the Republican-controlled House of Representatives will hold off on raising the government’s debt limit until Washington is closer to exhausting its $14.3 trillion credit line, sometime after mid-April, party leader Eric Cantor said on Wednesday.

There is often a pitched battle in Congress over allowing the government to borrow more money, but if Congress does not take that step, Washington risks a default on its debt that could damage U.S. access to credit markets, force suspension of government payments, and close federal offices.

The U.S. Treasury Department estimates the debt ceiling could be reached between April 15 and May 31.

“We really don’t know exactly when the date will be that we’ll have to act,” Cantor said on MSNBC’s “Morning Joe.”

“You know, we’re waiting for April 15 and tax revenues to indicate exactly when the date is that the ceiling needs to be raised,” he added. The must-pass debt limit increase may be leveraged to rein in future spending, Cantor noted.

Cantor spokeswoman Laena Fallon later said the majority leader was not suggesting the House would act on April 15, a date both symbolically important to tax-conscious Republicans and practically important to the U.S. Treasury as the deadline for income tax payments.

“April 15th isn’t a date certain for consideration of the debt limit. But the revenues that come in from tax day will provide a good indicator in relation to when Treasury might determine when we will reach the debt limit,” she said.

Some Republicans, including Tea Party conservatives, have said they will not vote to allow the United States to go deeper into debt without agreement on controlling spending with Obama and Democrats.

“Along with that vote, we’re going to see a lot of things put in place, whether they be process reforms as far as the budget is concerned, spending caps, whether we can demonstrate that we are tightening the belt this fiscal year,” Cantor said.

“Those are all the kinds of things we’re going to have to do prior to seeing that that vote happens,” he added.

The Republican-run House has passed a budget bill for the current fiscal year that includes $61 billion in spending cuts, but the majority Democrats in the Senate say the cuts would endanger the economic recovery.

A debt limit increase would also have to be approved by the Senate and signed by President Barack Obama. (Editing by Jackie Frank)”

Check out our intensive investment banking, private equity, and sales & trading courses! The discount code Merger34299 will be activated until April 15, 2011. Questions? Feel free to e-mail thomas.r[at]leverageacademy.com with your inquiries or call our corporate line.