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Signs Of The Times

Bob Hoye
Institutional Advisors
Posted Nov 18, 2011

The following is part of Pivotal Events that was published for our subscribers November 9, 2011.

Signs Of The Times:

"Riding a Market Rocket"Financial Post, October 29

Why did MF Global buy Spanish and Italian bonds?

Because: "Europe wouldn't let those countries go down."

Head guy, Jon Corzine wagered that the European portion of the post-bubble contraction could be fixed. He was betting upon both the theory and practice of interventionist economics.

The reason why LTCM defaulted so dramatically in 1998 was because the huge hedge fund was convinced that as the European Community came together credit spreads would narrow. The head guy was John Meriwether.

Spreads were, indeed, narrowing on a cyclical celebration of risk and then on the seasonal reversal in that fateful May – reversed. The crash was outstanding as Mr. Margin and Mother Nature overwhelmed the very best of theories and their proponents.

The book by Roger Lowenstein, When Genius Failed, is a good read on the disaster and the Epilogue includes "The result was a downward spiral which fed upon itself driving market positions to unanticipated extremes well beyond the levels incorporated in risk management and stress loss discipline."

No matter what theories employed, Meriwether's bet was upon the ability of policy makers to continue the cyclical trend of narrowing spreads. With considerable irony, Corzine bet that policymakers could end the trend of widening spreads.

Both failures will be immortalized in financial history.

"MF Global May be Isolated Occurrence"Financial Post, November 1

"MF Global's failure is contained within a relatively small circle of owners and lenders."Bloomberg, November 1

When the sub-prime started its disaster in early 2007 mainstream pundits claimed that the problem was "isolated" or could be "contained". Similar assurances were provided at the start of the Sovereign Debt debacle.

Now another big, but misguided hedge fund has blown up. And because of increasing counter-party risk liquidity is shrinking and that is hitting many sectors.



The wager on the putative abilities of policymakers has been monumental. LTCM bet that they could extend a natural trend of narrowing spreads beyond the best before date. Then, MF Global bet the farm that policymakers could end the recent trend in widening spreads and rising rates for sovereign debt.

These are dramatic examples of a problem that afflicts most markets and participants. As history records, central banks cannot materially change trends in the yield curve or in credit spreads, but the street believes that they can. This error has more subtle implications. The equity-side of portfolio theory concludes that investments in the stock market cannot be timed. In so many words "market timing" does not work.

This contrasts with the widely accepted notion that with appropriate manipulations the Fed can prevent recessions. Many count on this theory, which suggests that central bankers have successfully assumed the proxy of "market timing".

Markets are rich in irony.

Actually, financial history, itself, is a due diligence on every phenomenal scheme ever floated in an exchange, or by financial adventurers in policy. Think academics and central bankers.

And a hundred years of such schemes culminated in the really big, but classic financial bubble of 2007.

It has been the equivalent of 1929 or 1873 to name only recent examples.


This week, yields for the Italian ten-year soared to 7.48%, surpassing the 6.4% reached in the August distress. As those concerns eased, the yield declined to 4.95% and setting new highs has initiated another financial set back.

With this, the post-bubble bond revulsion is threatening another sovereign borrower. With some swings Italian issues can head further up in yield and further down in price. Italy is much more industrialized than Greece.

That there is not a general panic doesn't suggest that policymakers are on the verge of coming up with the perfectly-timed remedy. August - September recorded some highly motivated liquidation, which was ahead of schedule. September into October would have been traditional and with that November could have been described as month of construction leading to a relief rally into January.

Instead, the discovery of financial problems continues with the Italian 10-year trading to 7.48% over night. Italy has been on the long march to join the PIGGs.

The attached chart shows the path. The following chart shows that Spain has started the long march. At 5.90%, rising through 6.50% would be the alert to another crisis.

The third chart (France) shows a double bottom with the key "test" low established with the big "fix" in September. At 3.20%, and in rising through 3.75% France will have joined the march. Through 5.80% would signal a Gallic crisis. Zut alors!


The surge in stock markets to late October got rather excited and suffered a sharp decline. One of the features of a bear market is very sharp rallies that indicate diminishing liquidity.

In October, the S&P jumped from 1075 to 1293 and on the "Alert" dropped to 1215. The rebound was to 1277 where the 200-day moving average provides resistance. The test seems to be failing.

The equivalent big action did not carry into base metals. Copper and the GYX (base metals) accomplished a rally of a little more than a week that ended at the 50-day ma.

Seasonally, this can also be constructive for base metal prices, but problems in the long march in sovereign debt will likely continue to dominate.


Money markets continued under pressure during the month as 3-month Libor rose to 0.444 percent. This key rate had declined to 0.245% in the risk-free days of June and the steady rise has been a continuous warning.

There was some relief at the long end as corporate bond prices and spreads were favourable. This reached its best late in October and have been down and then choppy. It won't take much to turn the price to a downtrend.

Going the other way, the long bond declined from 145.74 to 134.85 as stocks soared in October. The rebound has been to the 142 level.

It could churn around at this level. If it jumps to the previous highs, long treasuries as an asset are still in play. However if the action stalls out as most other asset prices are declining then liquidity concerns will be starting to afflict the long bond.


-Bob Hoye
Institutional Advisors

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