Sorting the Noise From the Trend

***Charts are at the end of the post, but I hope you have time to read the entire post.


In the last month or so, I've added much more news content then I would prefer, but understanding that news is certainly a short term driver of the daily or intraday fluctuations is an inescapable reality and one that has taken on new meaning in the context of the last 3 years of trade. The news count or buzz is proven to be an important indicator as the market shifts from different biases.

At the same time, there is news that, like Friday is used on low volume days (because of an American and European Holiday with the bond markets closed as well) and ramps the market making price discovery difficult and there is longer term news that is forward looking and is priced in to the markets or in the situation that we are currently seeing in Europe as events unfold so rapidly that it is often surprising, will be discounted in to the larger trend. Thus it's important to distinguish between short term events and those longer term more fundamental items that will influence market direction. This kind of discounting of news is one of the reasons I have said many times that this era is reminiscent of the bear market period of 2008 because then, like now, the institutional investors have a much smaller edge as the news tends to bring fundamental changes that have not been discounted and could not have been discounted as they were unforeseeable; we are seeing a lot of news like that and ultimately the longer term fundamental news will be apparent in the longer term trend (beyond daily and intraday gyrations).

As fast as events have occurred and with me being half incapacitated Friday due to a kidney stone, there's a bit to catch up on and what it means for the market and what is simply fodder for the intraday momentum chasing HFT vacuum tubes.

I'll try to keep this somewhat chronological and relevant.

The ECB (European Central Bank) spent a lot of Thursday and Friday supporting the bond markets of the PIIGS, especially Italy's, where 2 weekends ago they (the ECB) had made some very indirectly, direct threats to not intervene in the Italian bond markets which was a clear message to ouster Berlusconi and after supporting Italian bonds the week before, they let Italy see exactly what a day or to without their intervention would look like should a move to ouster Berlusconi not be set in motion, here were the results as Italian yields not only surpassed what has been the point of no return for Greece, Ireland and Portugal, but moved well in to the impossible to sustain 7+% territory.

Bond Yields on Italian debt came under further pressure this week (as did French due to an inaccurate rating's downgrade story hit the trading floors) as ECB interventions (over 5 in a 2 day period) were completely useless as the market ran well past the level of support the ECB tried to create and why?

As reported by IFR,

"European banks are planning to dump more of the €300bn they own in Italian government debt, as they seek to pre-empt a worsening of the region’s debt crisis and avoid crippling writedowns – a move that could scupper the European Central Bank’s efforts to bring down soaring yields."

With the ECB bidding for Italian bonds, banks have seen this as an opportunity to sell in to a bid,

"With the ECB providing a bid for Italian bonds that might not otherwise exist, board members at some of Europe’s largest bank say now is the time to accelerate disposals. Many are also reversing long-standing policies of buying into new Italian bond issues, denying Rome an important base of support."

Italy going down the same tubes as Greece, Ireland and Portugal (Spain and Italy were always expected to be next), this presents a huge problem for the EU and even worse for the EFSF bail out mechanism that has been an utter failure. Consider Italy is four time the size of Greece, Ireland and Portugal combined. Italy's debt is roughly 25% of the entire Euro area GDP, it can not be saved it if continues down this path.

Nonetheless, the ECB continued with massive intervention through the middle to late part of the week (remember, unlike our F_E_D), the ECB has a restriction on how much firepower they have at their disposal and they have already burned through about half of that, intervention can not continue indefinitely, but while it doe, it creates a false bid for Italian debt, which has caused investors to look elsewhere, namely France which is not eligible for ECB intervention and as such, is now one of the main risk measure used in looking at Europe. Should France go looking for an ECB bailout, it is thought that bond vigilantes who have forced bailouts in Greee, Ireland and Portugal already, will look straight to the last country in the EU backstop, Germany, which may explain why Merkel's CDU political party is seeking such radical reform to the EU which has mentioned voluntary departure by countries to forced departure.

Italy and thus the market at large caught a break on a low volume Friday (for reasons mentioned above) as the short term news of the parliament agreeing to a budget that would force Berlusconi from power took the spotlight, a short term news event that was already well factored in. This weekend has seen the resignation of Berlusconi as he promised one the vote was complete, however, he may not be completely out of the picture. His departure was humiliating and he has already made threats this weekend to bring down the technocrat coalition headed by current Goldman Sachs advisor, Mario Monti. It is worth mentioning at this point that not only was a current GS advisor chosen to form a new Italian coalition government, but a former Goldman Sachs employee is now running the ECB in Draghi.

As per the Financial Times this weekend,

Berlusconi ‘ready to pull plug’ on Monti

Mario Monti and his small band of technocrats are set to take office riding on the hopes of Italy and Europe. But with bond and equity markets breathing down their backs, decisive and unpopular action will be needed to persuade investors not to dump more Italian debt.

So far no eurozone country has managed to regain the confidence of markets once bond yields have crossed the Rubicon of 7 per cent with Greece, Portugal and Ireland all seeking bail-outs soon afterwards.

Treasury faces a test on Monday with an auction of €3bn of five-year bonds.

Yet markets may soon discover that the Bocconi University professor’s room for manoeuvre will be limited by the political realities of a parliament where Silvio Berlusconi’s People of Liberty party remains the largest force.

The public humiliation of Mr Berlusconi on Saturday night – his motorcade chased through the streets and crowds of thousands screaming abuse as he handed in his resignation – reflect the extent of the ex-prime minister’s fall from grace.

But as he defiantly told a party leadership meeting hours earlier, they still retain the “golden share” in Mr Monti’s enterprise, particularly in the senate.

“We are ready to pull the plug,” Mr Berlusconi was quoted as saying.

Briefly interrupting the article, "pulling the plug", would mean Berlusconi's majority party "could" be a roadblock to a coalition government and force elections which likely wouldn't be held until early Spring, giving the market eons in the current pace of the market environment to contemplate the uncertainty, this of course was noted last week as to be the worst possible outcome for Italy, the EU and thus the world markets.

The article continues...

From accounts of Mr Berlusconi’s two-hour meeting with Mr Monti over Saturday lunch it was clear that the 75-year-old billionaire media baron placed his own personal and party interests above those of the nation as he tried, but apparently failed, to extract concessions in exchange for his support.

One condition was that Mr Monti, in implementing austerity measures and reforms, would stick to the contents of the “letter of intent” presented by Mr Berlusconi to last month’s eurozone summit. That would rule out the emergency measures of a wealth and property tax, and possibly an overnight raid on bank deposits, which Mr Monti is said to be considering if Italy is denied access to financial markets.

But on the political fringes there are already those portraying Mr Monti – who is listed by Goldman Sachs, the investment bank, on its board of international advisers – as a tool of the “masters of the universe”, along with Mario Draghi, head of the European Central Bank and former Goldman Sachs executive.

“This is the band of criminals who brought us this financial disaster. It is like asking arsonists to put out the fire,” commented Alessandro Sallusti, editor of Il Giornale, a Milan daily owned by the Berlusconi family

Clearly the short term "good" news has an off-setting "uncertainty" which seems to have effected early opening EUR/USD FX trade.

While Italy was enjoying a brief respite Friday, the new underlying risk gauge, French Bunds (due to the fact that they ARE NOT eligible for ECB secondary market intervention and thus reflect "true" price discovery) have returned to all time record levels on Friday. Unlike Thursday, there was no false S&P rumors to send them to these levels.

While we are on the subject, Analysis from Peter Tchir of TF Market Advisors makes some interesting points in the wake of the (supposedly false) S&P rumors of a possible French sovereign downgrade.

"The S&P report that allegedly downgraded France from AAA is interesting.  The French are angry about it, but what no one is saying, is that when the US got downgraded, treasury prices went higher.  French bond prices went lower because the market doesn't believe they are AAA.  The French can complain all they want, but the market doesn't believe in their credit or their ability to support prices; whereas, for US bonds, no one really cares what the rating agencies have to say.  This is a big distinction, and rather than maybe some angry phone calls between cigarette breaks, the French should figure out how much European risk they can really sustain.

French bond yields are now the widest relative to Germany ever.  There is outrage that there is an "attack" on French bonds.  Seriously, you don't think Sarkozy's willingness to backstop anything and everything (including Dexia) has had an impact on French bond yields.  The bonds are weak because the economy is getting worse, and the French have shown no willingness to do what it takes to remain a safe haven."

As one of the main back-stoppers of the EFSF, France feeling the effect of contagion so early is something that should not be lost on anyone as the crisis continues to gather momentum. As I pointed out in a post last week, the tipping point come quickly and is ushered in by a lack of trust among participants

As for the EFSF, the mechanism the EU created to halt contagion and put the Eurozone on a path to recovery, this is one of the two most fundamentally crucial issues, the other being the ECB which I'll address in a moment.

The only AAA-rated countries left in the EU include: Germany, France, the Netherlands, Austria, Finland and Luxembourg; because of their size, Austria, Finland and Luxembourg are irrelevant to the EFSF. With the German-French 10-year government bond spread at 1.5% the market is voting with its money that France is about to lose its AAA rating. When the US was downgraded, there was quite a bit of confusion, press releases, retractions and then the downgrade, this is why I am skeptical of the S&P "French" rumors being entirely false. 

Since the details or lack of details of the announcement of the creation of the new "Leveraged EFSF", I have been skeptical and critical of the plan for reasons that even a layman can identify. Lets look at what the EFSF actually is, rather then what it has been aptly named, "An empty box of EU wishes".

The original EFSF capacity was EUR 440bn; 150bn have already gone to Greece, Ireland and Portugal, another 40bn has mysteriously vanished, that leaves 250bn left currently. 250bn Euros is a drip compared to the funding needed by Italy and Spain (Spain has largely been skipped by the media, however Spain has major problems- unemployment is at 21.5% and amazingly, McDonald's recently advertised 2700 positions and received 310,000 applications) thus the EFSF desperately needs to be leveraged. Euro zone countries had hoped to increase the EFSF's lending capacity by December, combining bond insurance with investment vehicles.

The EFSF brings up one interesting event and one event that should leave no one in doubt a to just how desperate the EU actually is.

First, late last week (even though I thought this was already a moot issue), the EU apparently left China with a very bad taste in their collective mouths. I knew there was a delegation of Europeans still in China with empty bowl in hand, but I didn't know this issue, which already popped up nearly a month ago, had resurfaced.

Reuters reports that,

The Eurozone Refuses Chinese Demands And Turns Down Bailout Money

China had offered help in return for European support to grant it either more influence at the International Monetary Fund, market economy status in the World Trade Organization, or the lifting of a European arms embargo, said the sources, both of whom have direct knowledge of the matter, including one who has ties to the leadership in Beijing.

Any investment from China would be contingent on gaining a greater say in IMF decision-making and a more rapid path to inclusion of China's yuan in the IMF's special drawing rights (SDR) currency unit.

"The United States and the IMF also attach conditions (when they help financially troubled countries). It is not unreasonable for China to do the same. They can always reject (our demands)," the source said.

Europe granting China market economy status that would, under WTO rules, make it harder for Europe to apply trade sanctions against Chinese imports.

Europe's rejection of China's demands -- particularly the inclusion of the renminbi in the SDR -- was tantamount to "a slap in the face," said the source.

Apparently Christine LaGarde had said the issue of the yuan being included in the MF's SDR was premature and the issue is not expected to be taken up until 2015. Allowing China "Market Economy Status" would mean that countries would have a difficult time imposing sanctions on material that may have copyright infringement or other similar issues (You've seen the $25 Rolex's made in China). So Europe turned down China, which had long ago issued the same demands, apparently the delegation from Europe has made NO progress over the past month in negotiating with China to get funds to leverage the EFSF. This time China took some offense which doesn't bode well for the future.

The STRANGE and DESPERATE action the EU undertook was exposed this weekend.

The TeleGraph broke the story and this shouldn't be taken with a grain of salt or as an interesting aside.

Eurozone bail-out fund has to resort to buying its own debt

Europe's €1 trillion (£854bn) rescue fund has been forced to buy its own debt as outside investors become increasingly concerned about the worsening eurozone sovereign debt crisis.

"The Sunday Telegraph can reveal that target was only met after the EFSF resorted to buying up several hundred million euros worth of the bonds." 

The Target they are referring to was a Euro bond issuance originally slated to raise 10bn Euros in support of Ireleand, after banks saw that the issue was severely undersubscribed, they lowered the target amount by 70% to 3bn Euros.
Sources said the EFSF had spent more than € 100m buying up its own bonds to help it achieve its funding target after the banks leading the deal were only able to find about €2.7bn of outside demand for the debt. 
The revelation will be seen as a major failure and a worrying sign of future buyers strike after EFSF officials and their bankers had spent recent weeks travelling the world attempting to persuade key investors, including China's national wealth fund and Japanese government funds, to buy its bonds. 

Other European Union funds are also understood to have supported the EFSF's bond sale. The failure of the EFSF will increase pressure on the European Central Bank to effectively become the lender of last resort for the eurozone, a move it has strongly resisted.

Again, Peter Tchir of TF Market Advisors puts some perspective on the issue...

Simply bizarre.  I assume by other "EU entities" the EIB bought some?  This is really becoming Enronesque.  Really is almost mind-boggling that they did this, and as far as I know, if it was a public new issue in the US where a company was buying it on the break (or putting in orders) it would likely be in violation of some SEC law.

The ECB is ultimately going to be the lender of ONLY resort in Europe and it is going to have be with full printing capacity as I'm not sure how much can be sterilized in this environment. Unity governments are one thing, and may even be helpful, but the market is looking more and more to the ECB.

In response to this VERY POOR showing (nearly a trillion Euros needs to be raised and this isn't even counting an Italian or Spanish bailout or a French downgrade and they have to resort to buying bonds themselves for their own fund with money from the same said fund so the already lowered expectations; a 70% reduction of issuance is not seen as a failure!) 

Klaus Regling (CEO of EFSF) announced plans to raise money via short-term bills with maturities of less than a year instead. So, lend long, borrow short – even bankers understand this is a recipe for disaster.

This news really must be digested and should not be casually skimmed over. 

Furthermore, the IMF announces, 

IMF warns developed countries may fall in to recession

"Recovery remains in low gear in major advanced economies with elevated risk of falling back into recession"

As a reminder, 

Recall that S&P itself said that it "would likely downgrade the credit ratings of France, Spain, Italy, Ireland and Portugal if the euro zone slips into another recession." Well as of yesterday, the EU itself warned the Eurozone may slump into "a deep and prolonged recession."The result: as of the past few days the EFSF no longer trades with an AAA implied rating; the EFSF is now AA+ at best.

As the EFSF looks more and more like the failure  and many others pointed out that it would be upon the release of the details, more and more the market is now looking to the ECB (European Central Bank) to do something. There are many problems here, but here it is straight from the horse's mouth, as several German ECB members have resigned over the ECB's actions (Germany certainly won't agree to printing and hyper inflation-a subject they are hyper sensitive to), one of the few remaining members, the President of Germany' Bundesbank as well as being one of last remaining German member of the ECB, 

Jens Weidmann had some rain to pour on the "ECB as the savior of Europe parade"

To prevent the crisis erupting into a global economic shock, the ECB has been urged to intervene directly by economists and politicians around the world, including at the weekend by Russia’s Vladimir Putin.

In an interview with the Financial Times JW had the following (come very critical) remarks.

The president of Germany’s powerful Bundesbank has firmly rebuffed international demands for decisive intervention in the bond markets by the European Central Bank to combat the eurozone debt crisis, warning that such steps would add to instability by violating European law.

Only politicians could resolve the crisis, and he rejected the idea of using the ECB as “lender of last resort” to governments.

He also criticised actions taken by eurozone governments as “inconsistent”

Having read the interview, he is specifically talking about how the EU has continuously changed their stance so many times that there's no trust in anything they propose.

“I cannot see how you can ensure the stability of a monetary union by violating its legal provisions,” Mr Weidmann argued. “I don’t see how you can build trust in a system that violates laws.”

Mr Weidmann highlighted the stance being taken by the Bundesbank by arguing governments, not central banks, were mainly responsible for ensuring financial stability. Mario Draghi, the ECB’s new president, has said it is not the ECB’s job to act as lender of last resort, but Mr Weidmann went further, saying such a step would breach Europe’s ban on “monetary financing” – central bank funding of governments.

"We need a debate now about the future architecture of the monetary union – that is, whether one wants to move back to the Maastricht framework, which needs to be improved, or whether there is a willingness and political support to move towards a more integrated union where you delegate national sovereignty on fiscal issues to a European level."

This last statement taken to its logical conclusion hints at a new monetary union where individual countries give up their sovereignty to the ultimate back-stop-Germany. Of course Germany and the CDU party have already been making moves exactly in that direction.

"If there was a political decision in favour of fiscal union, you could of course issue eurobonds at the end of the integration process. But this is not something I’m asking for.....

You would need to delegate your national sovereignty on fiscal policy to a supranational level. I think the true question at the heart of this is: are governments, parliaments, and people ready to accept a supranational level, a European level that assumes the ultimate responsibility for fiscal policy, at least in case of a breach of the rules?"

"In my view, the declaration from leaders at the last EU summit was not clear enough. They talked about minor treaty changes. But this is not a minor change – this is a major change with follow-up changes in national constitutions. Without clear answers, you might not have the basis for a stability-orientated monetary union."

When asked whether the ECB should buy up bonds and keep yields where "they wanted them", he responded...

"We have a mandate and we have to stick to our mandate. Fixing an interest rate for a country is certainly not compatible with our mandate. You would guarantee a certain refinancing cost for a government and you could not argue that this was not monetary financing.

The stated purpose of the SMP is to cope with dysfunctional markets and it’s not to ensure a specific spread for a specific country."

However, one could certainly say recently the ECB has been doing exactly that in Italy and Spain.

From the interview...

"

FT: Some in Washington have suggested the ECB could lend, directly or indirectly, to the IMF, which could then help Italy. Would you rule that out as a possibility?

JW: Again, the crucial point is that the eurosystem is not permitted to lend to eurozone member states – no matter whether this is done directly or indirectly by using the IMF as an intermediary."

"I think the prohibition of monetary financing is very important in ensuring the credibility and independence of the central bank, which allow us to deliver on our primary objective of price stability. This is a very fundamental issue. If we now overstep that mandate, we call into question our own independence."

And on the very issue of trust that I have mentioned so frequently as being the beginning of the end, he addresses the EU's ever-changing stances and inconsistencies, the exact same inconsistencies that are keeping investors far from the EFSF.

"EU governments have decided how to finance the EFSF. They agreed on guarantees for the EFSF and, in their last meeting, on two options on how to leverage the EFSF – by an insurance model or a special purpose vehicle. Instead of working on implementing these approaches, we now have the next idea that is completely out of the realm of what has been discussed previously. I don’t think it builds confidence in crisis resolution capabilities if from week to week, from one meeting to the next, you are questioning your last decision."

And ultimately, what the cure for the disease is...

"What matters is whether there is political will in the countries standing behind the EFSF to honour the guarantees."

And there lies the truth....

So, which Eurocrat will be the first to commit career suicide by implementing the very tough and deep cuts, so called, "Austerity measures" which are fine as proposals are enacted years down the road such as Italy proposed for their retirement age change, but the EU doesn't have years, it may not have months.

Additionally, the major take away from the above is the EFSF has no credibility, thus no funds and as investors come to understand that, they are looking more and more to the ECB, and thus far the ECB is saying, "It's not our problem" and these are the issues that will form the trend, not who took power this week or last week, those are daily swings. The ECB has discovered the real meaning of "Moral Hazard" as we in the US still struggle with it regarding our financial institutions. Should the ECB support a country like Italy, where's the pressure to make them act on needed reforms? However this argument may be very moot as the time needed for those changes to produce effects to counter contagion are not realistic. France, the ECB, what Germany says, how French Bunds trade, what happens with Italy' yields, these are the real issues, not leadership changes when no one in power wants to lose that power to make the changes-just like here in America, "Change you can believe in!"

As for the charts...

Last Thursday's daily wrap looked at the gaps in the major market averages and I basically said they could be filled, that appears to have been the attempt on Friday' low volume market that was likely largely led by momentum chasing HFTs, here are the respective gaps.

 DIA gap filled

 QQQ  gap not filled, not even close.

SPY gap nearly filled.

Tech has under-performed badly recently on a relative basis, here is the DIA (green) vs. the QQQ (red).

The averages themselves...

DIA 2 min showed profit taking/distribution as it tracked sideways, seemingly waiting for the QQQ's to catch up to fill the gap as the DIA had already done.

 Some negative 5 min action as DIA tracks laterally.

The 15 min scale still seems to cap the DIA to a bearish slant, even if the shorter term dynamics seem more positive.

QQQ under performance even in the underlying action

QQQ 5 min

 QQQ 10 min also looking to CAP the QQQ, possibly around the gap fill area if we rally on more short term news.

The 15 min remains ugly

The hourly is really where the trend appears to be going over the next few weeks as the October rally clearly has topped.

 SPY short term Friday action as it travels laterally.

 SPY 5 min

SPY 15 min zoomed in

SPY 30 min at the lows of a leading negative divergence

VXX trades opposite to the market, it is showing short term accumulation

The first significant 5 min divergence in VXX since the 8th.

Longer term on a daily chart, the VXX is also getting ready to make a confirmed crossover suggesting the trend over the next few weeks should see some significant downside.

 15 min Bollinger bands suggesting a highly directional move, just be careful as the last one to the left had a false move up first t the green arrow.

 MY Demark inspired indicators showing a large sell signal on the 15 min timeframe.

The daily demark-styled indicator made some good major calls and is calling this a top.

 Heiken Ashi candles and volume at price suggest a serious halt in momentum on Friday.

 HYG-Credit's longer term 60 min chart also very negative-credit tends to lead equities.

Finally the SKEW indicator recently put out by the CME is showing an increased "probability" of a "Black Swan " type of event. You an see where former lows were in the area of rallies, like the start of October and the red arrows where the market made some significant declines.

Finally, tonight's opening indications

While both ES and the EUR/USD opened higher, they have started giving back some of those gains, as mentioned, around 3 a.m. EDT we should see the Italian bond market open which may significantly alter the shape of the opening tomorrow. Right now ES shows a positive divergence in the very early a.m. hours of Friday morning, and a negative divergence through the later half of the day as do the 3C charts above and now a leading negative divergence which ES seems to be responding to.

The EUR/USD open tonight, it has gapped up and has since closed the gap.

As for the email's, there's definitely a problem coming from Google's groups as I have seen many other users having the same issues over the same time period, we'll see if it is resolved tomorrow, if not then I'll have to find an alternative, suggestions are welcome.