The T Report: Planning, Carry, and Intervention

The market continues to trade with extreme volatility. Yesterday’s decline was deep and painful, only to be followed by an equally vicious rally on rumors of a rumor. This morning has already seen Europe rally, fade, then rally again. The overall theme remains the same, with concerns about Europe being counterbalanced by hopes of central bank action and government policy. Maybe as a bank bull down here, I am reading too much into it, but the whale trade fiasco seems to finally be getting put into perspective. That is good for JPM and the financials and the market.

The fear that the EU is preparing a plan for Greece to exit seemed like the worst excuse to sell off that the market has used. There is a real chance Greece will exit. Without significant concessions from the ECB and Troika, it will be there only option. I would much rather that Greece planned for it rather than just gave it a shot. Any hope of a Grexit not being incredibly disruptive to itself and to the rest of Europe will depend on planning. Real planning, not the typical EU style that assumes the market will do what it would like, but one that puts some stresses on the potential outcomes and works hard to deal with them. Given how much money the ECB and Troika are on the hook for, the concerns of deposit flight in other countries if redenomination risk rises, the EU will have to be very careful what it does. I think that as the EU actually works on some plans (shocking that it hasn’t yet) their concern for their own safety and their ability to really manage the worst case scenario will come into doubt, and they will make some concessions with Greece to give everyone time.

And timing is everything. Lots of people are asking what changed from Friday, or from yesterday afternoon. The answer is very little. But what actually has occurred from 2 weeks ago when the S&P was 1,357. The answer there is also very little. Fears of an imminent Grexit have been overblown. That has been our message. Neither side will have the guts (nor stupidity) to rush this decision. It will take time. Time is key because it does give hope that enough can be done that the exit doesn’t turn into a full blown crisis in Europe and that risk of currency flight in Spain and Italy can be contained. Timing is key, because without imminent catalysts, the oversold conditions and “carry” can come into play. RSI, as simple as it is, remains one of my favorite indicators. So much bearishness has been stuffed into the market, that the ability to rally on next to nothing remains high. We even ignored some okay housing data, which only 2 months ago everyone agreed was the key to a successful recovery.

Shorting credit is expensive. Everyone seems to forget about that. Seeing IG18 blow out from 93 to 123 reminds everyone how cool it is when credit blows out. HYG down from 91 to 87.5 is another great example of how quickly credit moves. Spanish CDS at 540 and still near the record highs posted last week is another example where it blew out from a low of 355 in March, to 555 last week. The problem here with being short is how expensive it is. HYG is paying 7% per annum and the price is rising. The cost to sit short is high, and if you take away the noise around Greece (overdone) and JPM (overdone) the arguments for it to be higher than this are all still in place. Even with Spain, you pay 100 bps running and have a pull to par effect, so you slowly bleed money being short. Add to that, the fear that one of these mash it all together and throw government money (that the government doesn’t have) solutions is enough to get the markets excited and you have the making of a short squeeze. The true “trading float” of Spanish bonds in particular is very small. Most bonds are held in buy and hold accounts at banks and insurance companies. Neither of these groups, overexposed as it is, are buying, but they aren’t selling either, so any improvement in the situation can result in a move disproportionate to the improvement. This is also true, to a lesser extent, in the Italian bond market.

I remain constructive here under the assumption that

• Central banks continue to be extremely dovish and may even take some actions
• Grexit, while likely isn’t imminent and the EU will start trying to sound less arrogant and belligerent towards Greece
• The sell-off in financials, part in Greece, but at least in part due to the whale trade, is over and is reversing as people are able to understand that even at JPM the CIO’s entire book is okay, and that this was not a systematic trade affecting all banks
• Data will continue to be mediocre, but with enough bright spots that the bulls can latch on to something and try and push high
• Sell in May and go away may be a good investment strategy, but selling ahead of a long weekend typically isn’t