Catastrophic Success

By John Mauldin

400 Billion Yellow Aspirins
The US Government Is in the “No-Money-Down” Mortgage Business
Crash Alert?
Is Social Security a Ponzi?
Catastrophic Success
Europe, and Breaking the Light-Speed Barrier

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Breathes there a man with brain so dead
Who never to himself hath said,
“Social Security looks like a Ponzi Scheme?”
- With apologies to Sir Walter Scott

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Today we look at Social Security. In the US, Texas Governor Perry touched the third rail of Social Security and called it a Ponzi scheme, which of course immediately made him the leading candidate in the “shoot the messenger” category. Behind the rhetoric, we look at some actual numbers. No, not the unfunded liabilities, that’s too easy. Let’s look at what a heartless, uncompassionate man President Roosevelt was when he started Social Security (and that’s what many will call me after reading this!). Behind the tongue in cheek, there are some very real issues that do not get addressed when we talk about Social Security, but that need to be part of the discussion. And of course, we must start off with the results of the FOMC meeting, which has me feeling not at all amused. What are they thinking? Apparently, they are seeing the results from another, alternative universe. There is a lot to cover as I head off to London, where I will finish this letter.

But first a very important announcement. I am very excited to be able to introduce my readers to a new mutual fund offered by my friends Altegris Investments. This fund is a blend of five commodity trading advisors or CTAs. Normally, to access a CTA you be to be an accredited investor, with all the net-worth requirements and limited liquidity. But Altegris has figured out how to wrap a mutual fund around CTAs and create a fund of commodity traders with all the usual aspects of a mutual fund (daily pricing, liquidity, etc.).

I have long been involved in the commodity-trading advisor space (some 20 years) and am a proponent of CTAs as a way to diversify portfolio risk. I have written a detailed report on this fascinating sector in relation to the fund, and it is available for free at http://www.altegrismutualfunds.com/landing/mauldinreports1.aspx, along with more information on the fund (including the offering memorandum and important risk disclosures, which are also included at the end of this letter).

The fund has been very well received since its launch and has grown rapidly to over $1 billion. There has been very active interest in the professional community, as advisors and brokers are looking for simple and realistic ways to diversify their clients’ portfolio risk, as well as a way that is truly noncorrelated to typical stock funds and many other asset classes. Whether you are a professional or individual, you really should take the time to research what I think is a very solid fund. My partners at Altegris have decades of experience in the CTA space, with the largest database of CTAs and long-term relationships with many of the managers (I actually started my investment career in the commodity fund space, so have more than a passing knowledge of the arena). Given the potential for volatility in the global markets, I think it makes sense to have some exposure to funds that can go both long and short (depending on their models). I urge you to read my report.

http://www.altegrismutualfunds.com/landing/mauldinreports1.aspx

400 Billion Yellow Aspirins

My mother used to tell me, “John, if you can’t say something nice, then don’t say anything at all.” So let’s see if I can find something to nice to say about the FOMC announcement. How about: “At least they didn’t cause TOO much damage”? As Rich Yamarone tweeted immediately after, they announced they would buy 400 billion white aspirins and sell 400 billion yellow aspirins. This was not something that should have been done, but thankfully they only did some $400 billion and not a few trillion, which could have really screwed (a technical economics term) things up.

With Operation Twist as part of their new mix, they announced they would sell short-dated and buy long-dated treasuries. This sent the ten-year yield down to 1.72% (yields were already dropping), although as I write it is back up to 1.79%, which without the recent action would be the all-time low. The 30-year is below 3%, at 2.85%, which makes those of us who have been predicting such an event for many years finally right. I think I will just savor the moment and not make any more predictions for a week or so. It was a long time coming. It would have gotten there anyway, even without this Fed action. Which makes what they did impotent and pointless. More below.

However, such low rates are not cause for merriment but for thoughtful pause, as low rates might be good for the government and for those looking for mortgages, but they threaten to wreak havoc on pension plans, as the bond portfolios on which they are built are paying less and less, and that means they are becoming more and more underfunded, and stocks are not helping. The problem pension fund trustees have is that lower yields require them to raise their assumption for future liabilities, which must be discounted at a lower rate. Lower bond yields, like falling share prices, increase funding gaps.

While few are mentioning this aspect, Spencer Jakab of the FT sent me this note: “A sensitivity study by Credit Suisse done in mid-August shows how big an impact this can have. The underfunding for S&P 500 members was then an estimated $390bn. A 25 basis point fall in discount rates would have inflated the deficit to $435bn – about the same as 4 percentage points of investment underperformance this year. In August alone the deficit among the broader S&P 1500 widened by some $75bn, Mercer Consulting found. Slumping equities and bond yields brought the deficit from 12 to 31 per cent since April alone.”

Not to mention what low rates do to people who are trying to live off their savings. How can you survive on 1% yields from a small income portfolio? That means you start reaching for yield in places that are not as safe or liquid, which is precisely what we do NOT want our retirees to be doing. Wrong, wrong, wrong. An unintended consequence of this Fed policy is that retirees are being put at serious risk. And it is an important consequence. So many retirement plans were formed ten years ago, assuming they could safely withdraw 5% a year. Now that is difficult, at least if we’re talking “safely.” There is going to be a plethora of schemes to entice retirees with “safe” higher-yielding investment programs. Please, remember that there are no free lunches. If you are getting above-market yields, you are taking above-market risks.

Now, let’s look at what the Fed is actually likely to do. They have indicated their actions will occur over the next nine months. This also means they will sell most of their short-term treasuries and increase their duration, but not necessarily their risk. It is still US government debt. These projections are from Bridgewater.

Treasuries the Fed will likely sell:

	What the Fed Has	Likely Sales
0-1 Years	$138	$138
1-2 Years	$156	$156
2-3 Years	$221	$106
Total	$515	$400

On average, $400bn at 1.5-year maturity
Treasuries the Fed will likely buy:

	Eligible Total	Eligible Outstanding	Eligible New Issue	Likely Purchase
6-7 Years	$353	$179	$174	$140
7-10 Years	$581	$383	$198	$160
10-30 Years	$521	$395	$126	$100
Total	$1,455	$957	$498	$400

Rates have already moved in anticipation, as seen below.

One has to go out beyond 5 years to get more than a 1% yield. Who is buying this stuff? Any pension plan doing so is locking in low returns and underfunding for that period. This is just a disaster in the making in the pension and insurance world. If you couple that with a recession, a Muddle Through Economy, and a secular bear market, it is a prescription for a pension-funding train wreck of epic proportions, which means that the large companies will have to start writing checks, which will be a hit on earnings.

Note: Adding to pension concerns about the stock market, the ECRI weekly leading indicator has been down for six of the last seven week. More evidence that we are in for a real slowdown, if not a recession, sooner rather than later. This just in from the Wall Street Journal:

“Providing fresh evidence of weakening global trade, FedEx Corp. said Thursday it is cutting capacity and trimmed its full-year earnings forecast amid weaker demand, mainly due to slowing sales of consumer electronics made in Asia.

“The news comes as a slide in Asian air cargo traffic that started in July has shown no immediate signs of abating. The slowdown extends to the makers of perishable foods, high-end apparel and automotive and industrial parts that fill the holds of planes flown by FedEx and rivals such as United Parcel Service Inc. and Cathay Pacific Airways Ltd.

“‘The consumer just doesn’t have an appetite’ for spending more, Chief Executive Fred Smith said during a post-earnings conference call. As a result, he added, ‘we don’t anticipate a significant peak [shipping season] this year.’” –Bob Sechler of the WSJ

But that’s just it. What happened with QE2? The money went into commodities and stocks (for which Bernanke again took credit), giving us inflation and a good feeling. But the economy, in terms of jobs, hours worked, incomes, and GDP, went south or sideways. Where was the carry-through? I somehow don’t remember that the stock market was part of the dual mandate, yet Bernanke listed its rise among the results of QE2. My bet is that with QE off the table, that will come to be seen as a temporary rise. A sucker’s rally.

And now that we have used that QE bullet, where are we? The stock market is tanking, as are commodities. Bond yields are making new lows. The dollar is getting stronger. Can someone tell me why we went through this exercise? It seems we are right back where we were, yet with even more uncertainty. And now we start something that my Dad would call a piss-ant (a small, rather noxious and foul variety of Texas ant) program called Operation Twist, which has no real hope of doing anything that will help the dual mandate. It simply creates the illusion the Fed is doing something.

I said at the time of the 2^nd QE that the main problem I had was that we were wasting a bullet that we would (and now do) need when the next liquidity crisis came. And we have now kicked inflation up. As Rob Arnott wrote me in a private message, when you look at the next four months, which will “drop off” the year-over-year rate of inflation, it’s not pretty. Core could easily run up to more than 2.5%. The Fed may have handcuffed itself at the very time we need some liquidity. QE2 was a very bad and ill-conceived move, as is the current one. It is not smart to mess with Mother Market. (Can anyone say Fisher for Fed Chair?)

The US Government Is in the “No-Money-Down” Mortgage Business

The Fed was very clear in its statement that it wants mortgage rates to go down. But anyone with a pulse knows that the problem in the housing market is not that rates are too high. Dropping rates another 25-50 basis points is not going to help all that much if you can’t get the 20% down you need to finance a house, let alone get a nonconforming loan or, God forbid, a jumbo loan. With banks feeding into the market “REO” homes they get from foreclosures, it will be several years until we get close to a bottom in housing. But new homes are being built. So what gives?

This week I went to a fund presentation on new-home construction and sales. I was invited by a very knowledgeable real estate consulting firm (John Burns), and I was interested to know, how do you raise money in this market for new-home “spec” construction? The numbers and the company sales history they presented looked very impressive, but I could not figure out how they were closing the rather significant number of homes per development they did. No one else I knew of was close, from what I have seen (I watch these things). When the person who presented sat down, I looked at the mailer they send out by the millions. They send it to apartment renters. It says, “Why would you rent an apartment when you can buy a new home for $699 a month with NO MONEY DOWN?” And at very low rates, I might add.

These are starter homes, smaller but quite nice. (Note: a lot larger than the houses I grew up in with three siblings!) But they are on the outskirts of town, and that triggered a thought in the back of my head. Joan McCullough had tipped me to this.

“Are you using USDA financing to get the no-money-down?” The short answer was yes, along with FHA (3% down) and VHA. And what, you may be asking, is USDA financing? And how do I get some?

The USDA is the US Department of Agriculture. They currently have $24 billion they can use for government-guaranteed financing of homes (up from $12 billion last year). This is not Fannie or Freddie, this is the good old US D of A. As in farms and stuff (and food stamps and housing and… basically they got all these odd mandates long ago, when congressional agricultural committees wanted to expand their power). From Real Estate Economy Watch:

“Founded in 1949 to spur home sales and development in rural areas, the US Department of Agriculture’s popular direct and guaranteed rural housing loans today are one of the few places in America you can still get a mortgage with no money down at competitive rates.

“Borrowers don’t have to be lower income; in fact they can make slightly more than the median. To qualify for the government guaranteed loans, borrowers can earn up to 115 percent of the median income for the area. Nor do they have to buy in a rural area. They can live relatively close to a major urban area or in a popular resort community, however qualifying areas were recently redrawn to comply with the program’s rural mandate.

“Best of all, no down payment is needed to get financing through approved lenders, which makes the USDA program more attractive to borrowers who qualify than FHA.” (emphasis mine)

And there are actually subsidies available, so that you might not need to make the entire payment. Now, you can’t use this to buy a McMansion. You have to be in a rural area, which has come to be defined as outside the city limits (except in certain areas). There are income limits. The program does attempt to help lower-income families, and I am not trying to be snarky here, but these are government-guaranteed loans (read: taxpayer-guaranteed) at 100%, being handed out in areas where in the city homes are going into foreclosure and need someone to live in them, yet right outside the city you can buy this cute new home. Which is a situation more or less guaranteed to keep home values down in the rural outskirts, yet we want first-time buyers to snap these up!

The intention here is all well and good. And the buyers are seeing it as a way to reduce their monthly payment, and a house is still the American Dream. And, over time, it will be. If they stay in them long enough and don’t need to move, etc. I just think the unintended consequences (there are those words again, as we’re talking about a government project) are likely to be larger than anyone thinks.

I invite you to go to http://www.rurdev.usda.gov/Home.html. Look around. Notice that 4 of the first 5 press releases on the home page have the words job creation in their titles. Plus a lot of other current buzz words, like energy, environment, etc.

This whole side trip got started with our analysis of the Fed and its recent actions. Let’s quickly return, before moving on to Social Security. This week’s action is not useful. It falls under the category of “Let’s do something to show we know there is a problem.” It will provoke suspicion or opposition among those of a conservative monetary bent, probably hurt small and medium-sized banks (as it drives down the yield curve, which bankers depend on to make money), and lower interest rates for savers.

Crash Alert?

This is from my good friend Art Cashin today (he’s head of floor operations of UBS, and you see him all the time up on CNBC). I thought it should go here, after the market action of the last few days. Just as a heads-up.

“The Thursday/Monday Syndrome – We had suggested yesterday that we should probably explore the history of what old fogey traders refer to as the Thursday/Monday syndrome. While it would be pretensions to say that was prophetic, it was, to say the least, serendipitous, for yesterday’s action looked like the perfect first step in a Thursday/Monday setup.

“We had intended to give you a more thorough history of the syndrome with lots of analytical examples starting with the classic one – October 1929. Unfortunately, events are moving too fast this week, so we have neither the time nor space to wax poetic on the topic. So, you will just have to rely on my recollections of 50 years of watching markets and hundreds of nights studying market history.

“The classic Thursday/Monday syndrome starts with the kind of action we saw yesterday. The markets open under pressure and selling accelerates in swelling volume. By early afternoon, there is a virtual stampede of selling. Then, later in the session, stocks stabilize a bit based on some reassurance. On Thursday, October 23, 1929, that reassurance came in the form of Richard Whitney bidding ‘205 for 10,000 steel’ on behalf of the bankers’ rescue pool. (Read a terrific account in the chapter ‘The Crash’ in Fredrick Lewis Allen’s marvelous and essential ‘Only Yesterday’.)

“The action on Friday (and Saturday in the case of 1929) is uneven, often ending choppily steady or somewhat weaker.

“Then on Monday, the trapdoor opens with liquidation and margin calls bringing tsunamis of selling.

“Is that what’s going to happen? Who knows? If it were that easy, kindergarten kids could do this. But chance favors the prepared mind. Old fogeys will guard against undue risk and exposure. Some may even get out a special shopping list. They will set their basket right, put in silly bids and hope some panicky soul throws a bargain in. Recall the story of the floor messenger boy, who, in 1929, according to legend, bought White Sewing Machine with his silly bid of one dollar when all other bids canceled.

“One final note on the syndrome. Not infrequently, the Monday massacre spills over into Tuesday morning – a capitulation bottom in mid-morning resulting in a massive reversal to the upside.”

Is Social Security a Ponzi?

Breathes there a man with brain so dead
Who never to himself hath said,
“Social Security looks like a Ponzi Scheme?”

- With apologies to Sir Walter Scott

Governor Rick Perry has been getting slammed of late for his comment that Social Security is a Ponzi scheme. Note: This is NOT an endorsement of Perry or any other candidate; it is a segue into the more important issue of Social Security.

Perry is not saying anything that has not been said for over 20 years. I seem to remember that back in my younger days (as in the ’80s) I actually published a book on Ponzis. The classic Ponzi is where you get money from one group and then find another group to pay the “returns” to the first, and so on, until you run out of people and the game is up. The difference between a Ponzi and Social Security is that SS is legal and is done in full view of the public with everyone knowing the deal.

As long as each succeeding generation is willing to pay and is large enough, SS can go on. But now we have trillions in unfunded liabilities. All Perry is suggesting is that we admit the problem and fix it. Not exactly radical or suggesting we end Social Security, as Romney and the others claimed.

(Side note. I found that use of the attack mode disgusting and totally devoid of the leadership I want to see on that stage. It was trying to create a “gotcha” moment. Why not turn it into a teaching moment, to say how you would fix Social Security or admit you have no clue as to the true nature of the problem? Afraid to touch the third rail of Social Security? Then get out of the race. You have no ability to lead this country through what will be a crisis presidency if you can’t even admit to some basic, obvious truths. And how will you even get to the real problem, Medicare?)

Most of the “fixes” are some combination of increasing the retirement age, raising the cap on how much is subject to SS taxes, and/or some form of means testing. Social Security can be fixed if the political will is found to do one or all of those. Some comments on those choices:

First, there is some resistance to means testing, as it would be an admission that Social Security is a form of welfare and not a “savings account” that is in some hidden lock box. By now, anyone with a neuron firing knows there is no lock box and the Social Security funds are an entry into a government accounting book that don’t really exist except as an IOU. Politicians of all stripes have used the Social Security money to pay for other government expenses. Those funds were even counted to offset the deficit, although now that Social Security is no longer in a surplus, that has gone away.

Isn’t that what Ponzi did? He took money from one group, telling them they would get it back later, and then spent the money with another group, telling them the same thing.

OK, think using the term Ponzi is harsh? Some Republican theme? Then let’s quote uber-liberal Paul Krugman from 1996:

“Social Security is structured from the point of view of the recipients as if it were an ordinary retirement plan: what you get out depends on what you put in. So it does not look like a redistributionist scheme. In practice it has turned out to be strongly redistributionist, but only because of its Ponzi game aspect, in which each generation takes more out than it put in. Well, the Ponzi game will soon be over, thanks to changing demographics, so that the typical recipient henceforth will get only about as much as he or she put in (and today’s young may well get less than they put in).”

Let me say, I am all for Social Security. While I supplement my mother’s income, her Social Security check is very important to her. Not enough to live on, but every bit helps. (I have friends whose parents’ sole income is Social Security, and I totally get how small it is in today’s world.)

I also have seven kids. Hopefully, most or all of them will not need Social Security when they retire in 40-50 years. But some might. I want it to be there for them if they need it. But if we don’t properly fix it, it won’t be. I want it fixed.

I turn 62 next month. I am eligible for Social Security. I have paid in a lot of money over the last 45 years of working, for the last 20 years at the max level (with some off years here and there). Am I “due” something? Based on the current law, I am. But I must confess that life has been good of late (there have been times when I thought I would need every penny of Social Security!).

I think Social Security should be means tested. We should recognize it for what it is, for what Krugman called it: a redistributionist scheme. And a good and necessary one from the perspective of civilized society. Means testing would go a long ways to “fixing” the problem. But it doesn’t get us there.

We need to raise the retirement age, and by more than a few years. And this is where I get called a heartless (insert expletive)! “How could you want us to work until 70 or even later? How can we do that? Is that fair?”

Let’s use as our model that icon of the left, the King of Compassion, President Franklin Delano Roosevelt (FDR). He created the Social Security Act in 1935. He put the retirement age at 65. From today’s perspective, that seems about right, if not a little early. But what did it look like back then? I refer you to a report from the US Senate in 2006 on life expectancy in the US. Interesting reading, but for our purposes we will scroll down to page 26 and the detailed life-expectancy tables. (http://aging.senate.gov/crs/aging1.pdf)

In 1900, the average life expectancy was 47 years (shockingly, the life expectancy for black males was only 32). By 1930 it was 59, which, if they kept such records then, would have been what they were looking at when the designed Social Security. In 1935 it had risen to 61.

So FDR set the retirement age four years above the average life expectancy. So much for compassion. He (they) assumed you would work into what was for them advanced old age. Today, 62 does not seem all that old (at least from my vantage point!). Look around – there are lots of people in their 60s and 70s with very active lifestyles.

Why is that? Let’s fast-forward. In 2003 life expectancy was up to 77. Today it is 79 and change. Life expectancy has been rising more or less steadily rate at about 1 year for every 4 years of the calendar. So that means that in 40 years life expectancy, if it continues as it has, will be around 90. Under today’s laws one could retire at 62 or 65 or 67 and, if you just lived an average lifespan, get far more in benefits than you paid in. Remember, 90 will just be the average.

So when someone suggests that we move the retirement age to (gasp!) 70 in a few decades, I just smile and think back to what FDR would do. If Social Security had been set up to track life expectancy in 1935, when it was formed, then retirement would be set at 83 or 84 today! Not exactly the golden-years concept, is it?

Catastrophic Success

But then we come to what I call Catastrophic Success. Advances in medicine and biotech in the next 10 and then 20 years are going to radically alter life expectancy. Alzheimer’s disease will be gone. I will tell you about a potential cure for cirrhosis of the liver (and all kinds of cirrhosis) in a future letter. Heart disease? Soon be something that can be dealt with. Diabetes? Will be controlled or gone.

And cancer? There are numerous approaches, but I am following one that will be in human trials next year and that, in numerous mice studies, shows the potential to be a silver bullet for cancer in general, and relatively inexpensive (not a public company).

I could go on and on, but the point is that this Boomer generation is not going to live up to its part of the generational Social Security bargain. We are not going to die on time in anything close to the actuarial certainty the government now assumes (nor do the private pension funds!). Short of a Soylent Green-type debacle, Boomers will not only break the deal, they may destroy it, if we do not tie Social Security to the average lifespan.

Health care will soon be a Catastrophic Success. Wildly successful from the point of view of the individual, but a catastrophe from the point of view of Social Security. And we are debating whether to raise the retirement age from 67 to maybe 70 at some distant time in the future?

We need to be raising the retirement age by one year every four years. That means in 20 years the retirement age needs to be five years higher. I can hear the screams and moans from those 45 and under. 

“What a heartless [insert expletive] Mauldin is. How long does he think I should have to work? It is all well and good for him,” etc.

I want the Social Security system to be there for my kids in 40 years. And not dealing with the rapid age increase is one way to make sure it is not. OK, I will offer a way to retire earlier. If you agree to forego any new medical treatments introduced after, say, 2014, then I will say you get to retire at the current SS levels. Like that trade? I didn’t think so.

Think I am being overly optimistic about lifespan? I am not even close. I am having a small private dinner in a few weeks with Mr. Optimistic Future himself, Ray Kurzweil (among other books, he wrote The Singularity Is Near – a very important work on the waves rolling toward us from the future). We will talk of many things, and I hope to get him to contribute to my next book, The Millennium Wave, which is all about how the world will look in 20 years. If we stay on his track, then shortly after that time (by 2032) we will be regenerating the entire human body. Ray (and many others) see a path to humans living to 150 and beyond, in good health, with younger bodies. It doesn’t make you immortal. You can still look the wrong way and step in front of a London bus or climb the wrong mountain and fall off. (Note: Ray does see a path to immortality of a sort, when we can download our minds into machines and then reverse the trip. But that’s a whole different level of discussion and farther down the road.)

I am talking to scientists who are doing the human trials on the first real regeneration of a human organ, the cardiovascular system. How about a 50-year warranty on your new heart and cardio system? Then it’s on to the next organ system. One down, 203 to go. (Start with cardio, as it’s the easiest to deliver the targeted stem cell to.) Sadly, it will be done in Asia and not in the US, so we lose tens of thousands of high-paying jobs and don’t get to train a cadre to physicians on how to do it. Nothing against Asia, but this is US-developed technology … that would take five years to get through the FDA. For the management team of the company doing the work, who really do hate the concept of people dying from old age, that’s too many deaths as a result of waiting. And there is still a long way to go before we get true regeneration. We (as in those of us over 60) won’t have time for 20^th-century regulators to get in the way. The clock is ticking.

(Side note for those of you who don’t want to live a very long time: I am sorry your life is so boring. I see nothing but wonder and new worlds to explore and cultures to find and tens of thousands of books to read. Ask me in a few thousand years how it’s going. I’m in no hurry to knock on the gates of the Other Side. We get there soon enough.)

Social Security as it is set up today is close enough to a Ponzi scheme for government work. That can be changed, but we have to have the will to do so. Let’s hope that not just Perry can decide to lead us there.

Europe and Breaking the Light Speed Barrier

Heads up, you Junior Rocket Man Kids (remember those days?). Physicists are doing amazing things. My son Trey and I got a private tour this summer of CERN, the great physics lab in Geneva. Very cool. But Wall Street is also legendary for the number of physicists it hires to work on high-frequency trading programs. Evidently, they have figured out how to get trades done 190 milliseconds in the future. Is the race on to see who can cross the one-day mark? What is the speed of light when compared to the speed of money?

“Nanex: On September 15, 2011, beginning at 12:48:54.600, there was a time warp in the trading of Yahoo! (YHOO) stock. HFT has reached speeds faster than the speed-of-light, allowing time travel into the future. Up to 190 milliseconds into the future, or 0.19 fantaseconds is the record so far. It all happened in just over one second of trading, the evidence buried under an avalanche of about 19,000 quotes and 3,000 individual trade executions. The facts of the matter are indisputable. Based on official UQDF/UTDF exchange timestamps, there is unmistakable proof that YHOO trades were executed on quotes that didn’t exist until 190 milliseconds later!” (http://www.nanex.net/Research/fantaseconds/fantaseconds.html)

Going forward in time is cool, and the same day I got the above notice I read that the physicists at CERN and in Italy have found subatomic particles that move slightly faster than the speed of light, making it possible to travel back in time (only a few nanoseconds, but it’s a start):

“But now it seems that researchers working in one of the world’s largest physics laboratories, under a mountain in central Italy, have recorded particles travelling at a speed that is supposedly forbidden by Einstein’s theory of special relativity.

“Scientists at the Gran Sasso facility will unveil evidence on Friday that raises the troubling possibility of a way to send information back in time, blurring the line between past and present and wreaking havoc with the fundamental principle of cause and effect.

“Researchers on the Opera (Oscillation Project with Emulsion-tRacking Apparatus) experiment recorded the arrival times of ghostly subatomic particles called neutrinos sent from Cern on a 730km journey through the Earth to the Gran Sasso lab.” (http://www.guardian.co.uk/science/2011/sep/22/faster-than-light-particles-neutrinos?newsfeed=true)

Now, just in case you buy this (and if you did, contact me about a bridge I have), let me attempt to disappoint. First, as my curmudgeon PhD from MIT and VC friend Bart Stuck writes, “I think they both had time-stamp errors.” I can’t vouch for the Swiss and Italians, but I would bet the keys to the kingdom that there is a computer glitch at the NYSE. High-frequency trading (HFT) is distorting the markets. It is enriching a few pockets (and that of the exchange), and I simply do not see how it is in the interest of the public to allow it.

I also know that fighting HFT is spitting into the wind, as faster tech comes along every few months. If you force the HFT funds to put their servers across the street (losing the time advantage of not being co-located with the exchange servers – milliseconds count!), it will only be a few years until technology has given the edge back to them. In ten years, when artificial intelligence and connection speeds are far more advanced, how will human traders compete? Hire yet another AI to fight back? Wire yourself into the system (already being done, by the way, in rudimentary ways)?

The only way to effectively end HFT is for the exchanges to stop giving incentives for such trading. I can see the profits for the traders and the exchanges. I just don’t see the benefit to the rest of us. The SEC should step in and settle some hash over missed time stamps. If a small broker-dealer has a wrong time stamp, they are all over us, and you can bet there are fines. Something is wrong here. If one trade can go “back to the future” then how many more? Really? A one-off or a symptom? And to finish this on a light note, here’s a cartoon from my favorite cartoonist, Gary Larson.

It is getting close to time to hit the send button. It has been good to be home for almost seven weeks and let my body recharge, and spend more time with my kids and grandkids. Life is not easy for all of them at times. Poor Lively (perfect angel that she is) was getting a “spanking” as I left for the airport. I can’t imagine her doing anything naughty, but her mother (Tiffani) thought otherwise. Two of the adult kids needed some help. It is never the same two at the same time. And on and on.

This trip should be fun. I love London. And I’ll be in Malta with my European partner, Niels Jensen of Absolute Return Partners. I will be hosting CNBC Squawk Box on Wednesday in London. Then it’s on to Dublin and lots of meetings, as I try to get a handle on the crisis there (my first trip to Ireland). And a little time driving through the Irish countryside, on our way to Galway. Then to Geneva to be with friends and clients for two days as I turn 62. First, dinner with the always fascinating Lord Alex Bridport (the only lord I know, so I love applying that title) and then a birthday dinner hosted by Herwig van Hove of Notz Stucki. And then it’s back home to Texas.

In four weeks I head to Cape Town, South Africa, where I will speak at the Momentum Wealth Investment Summit, and then, back in Texas, I’ll speak November 6 for a charity fund-raising event sponsored by Hedge Funds Care, a wonderful group that raises money for children’s causes. You can learn more by going to http://www.hedgefundscare.org/event.asp?eventID=74. I hope to see you there!

Have a great week and enjoy the weather if you can. The forecast for Europe is beautiful.

Your wondering if he’ll find his Irish ancestors analyst,

John Mauldin

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CREDIT UPDATE – THE EMERGING MARKET CONTAGION

By Martin

“If you don’t have a functioning financial system the world economy won’t be revived. All the major economies have their responsibility to assist at a pace which is required to clean up the balance sheet of the banking system and to ensure that credit flows are resumed.” - Manmohan Singh

Contagion we have in Emerging markets:

Source CMA:

The trend in Ukraine:

No more Viagra ((Pfizer (PFE) long-term rating cut to A+ from AA- by Fitch; Outlook Stable) for China, as one stimulus after another is getting pulled out – this time around, it is not like Haier Electronic Group as we discussed previously with subsidies for home appliances. Instead, loan approvals are getting withdrawn:

China’s Squeeze on Property Market Nearing ‘Tipping Point’ – Bloomberg – 23rd of September:

“The squeeze on China’s property market may be reaching a “tipping point” that drives growth lower just when exports are under threat from a global slowdown and investor confidence is plunging, said Zhang Zhiwei, Hong Kong-based chief China economist at Nomura Holdings Inc.

Land transactions in 133 cities tracked by Soufun Holdings Ltd., the country’s biggest real-estate website, fell 14 percent by area in August from a month earlier. Prices of new homes declined in 16 of 70 cities last month compared with July, according to government data.”

Pop goes the real estate bubble in China, from the same article:

“Property construction is a mainstay of investment that last year drove more than a half of economic growth while land sales contributed 40 percent of revenues earned by local authorities that have amassed 10.7 trillion yuan ($1.67 trillion) of debt.

A funding squeeze on developers risks a “domino effect” as companies needing cash cut prices, forcing others to follow, Credit Suisse Group AG said yesterday.

“We’re reaching a tipping point where land sales are dropping much faster than before, developers are losing more access to bank financing, and housing prices are showing weakness,” Nomura’s Zhang said in an interview in Beijing yesterday.”

And Bloomberg to add:

“The price of land in Beijing slumped 76 percent in August from a month earlier, while in Guangzhou it plummeted 53 percent, according to Soufun. Land auction failures surged 242 percent in the first seven months of this year because of government curbs on the property market, the Beijing Times reported Aug. 3.”

A Chinese Subprime crisis in the making?

“Some developers have turned to trust firms for financing, usually in the form of loans that are repackaged into investment products and sold to retail investors. The debt is typically funded by banks or investors themselves, according to Samsung Securities Asia Ltd.”

Worst Asia Currency Drop Since ’97 Spoils Debt – Source Bloomberg:

So, no safe haven anymore even in Asia as its redemption/liquidation time for some global macro players.

Source Bloomberg – Kyoungwha Kim and Jiyeun Lee – 23rd of September:

“The Bloomberg-JPMorgan Asian Dollar Index slumped 4.3 percent this month, heading for its biggest loss since December, 1997, led by a 9.6 percent decline in South Korea’s won. Korea Exchange Inc. prices show the yield on 10-year government debt soared 27 basis points, or 0.27 percentage point, to 3.82 percent, from an all-time low on Sept. 14. The yield on similar Indonesian debt jumped 68 basis points this month to 7.47 percent, after touching a record low on Sept. 9.”

And EM for Global Macro players is a crowded trade according to Bank of America Merrill Lynch research, hence the liquidation we started to see and mentioned in the post “Markets update – Credit – Anterograde and Retrograde amnesia“:

Emerging Markets, which until recently had been preserved from the onslaught, have been affected as well by the revised growth picture published by the IMF, cutting its forecast to 4% from 4.3% in June 2011 – Source Bank of America Merrill Lynch Research:

So Australia and Australian banks please beware:

And given commodities based countries are in the frontline in relation to a Chinese slowdown, it is of no surprise that commodities based currencies are taking a beating in the process:

AUD/USD, 2008 until the 22nd of September picture – Bloomberg:

Canadian dollar is exposed as well:

And my good credit friend to comment:

“The equity market finally realized what the credit market was” flashing” for a while… and reacted accordingly. But the race to catch back with the credit market has still a long way to go…and the path may not be a straight line. Bottom line, equities will go lower as the new “norm” of slow economy worldwide will be accepted…

Which means lower prices for commodities (goodbye Canadian dollar and Australian dollar carry trade), higher US dollar (a higher US dollar and slower growth will be the poison pill for the international US corporations)…”

No more safe havens, even in Switzerland, as the country now flirts with deflation, Japanese style:

Source Bloomberg.

Like Japan, Switzerland is suffering from currency appreciation, tipping it towards deflation in the process, with 30 year Swiss Government bonds yielding less than Japanese 30 year bonds, with a yield at around 1.30%. The Swiss National Bank is warning that its Consumer Prices may decline 0.3% in 2012.

As a follow-up on our last post where we discussed the sell-off in Emerging Markets currencies, we now have 4 countries trying to prop up their currencies, namely, Russia, India, Argentina, and now Brazil. According to Bloomberg in relation to Brazil:

“The central bank sold 55,075 currency swap contracts in auctions, which was equivalent to selling dollars in the futures market. The last time policy makers entered the derivatives market to weaken the dollar was in June 26, 2009, according to the central bank. Yesterday’s measure marked a reversal of a 28-month-old strategy of buying dollars to weaken the currency.”

Brazil Sovereign CDS climbed 23 bps on the 22nd of September to 219 bps according to CMA. No, inflation is not the immediate threat, deflation is. US treasuries returned so far 1.7% in September, 8.9% gain year to date. And my good credit friend added on this:

” ‘No more risk free assets’ may result in a big re-pricing of all asset classes.

When there is too much debt in a system and when everybody is reluctant to erase the debt, the only solution is to deflate the value of the debt and the capital in order to bring them in line with the value of the assets or collateral… The trend will be “to deflate”, because we are in “deflation” … even if nobody wants to hear it.”

Ratio MSCI EMERGING MARKETS/ MSCI WORLD:

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Loud Rumors of Greek Default

by the trader

As Europe is enjoying Saturday evening we are getting multiple loud rumors of Greece defaulting. A default is necessary, the only question is how much bankers are willing to loose/sacrifice. Below some early Saturday rumors. The night is loooong.

From Telegraph; German and French authorities have begun work on a three-pronged strategy behind the scenes amid escalating fears that the eurozone’s sovereign debt crisis is spiralling out of control.

Their aim is to build a “firebreak” around Greece, Portugal and Ireland to prevent the crisis spreading to Italy and Spain, countries considered “too big to bail”.

Greece needs a decade to regain competitiveness by Reuters.

Greek Default Gets Louder by Ekathimerini.

…and here is BBC’c quick guide to the different scenarios.

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Germany Demands "Managed" Greek Default And 50% Bond Haircuts In Exchange For Expanding EFSF, Peripheral "Firewall"

by Tyler Durden

Back on July 21, the same day as the Greek bailout redux hit the tape, we speculated that the biggest weakness in the Second Greek Bailout is that the EFSF would have to be expanded to well over the current E440 billion (which even at its current size has not been fully ratified in Europe, and based on recent events may not be implemented until 2012 thanks to Slovenia and Finland), or about E1.5 trillion (and possibly as much as E3.5 trillion). The reason this is a "problem" is that it would have to come exclusively at the expense of Germany which would have to pledge anywhere between 50% and 133% of its GDP (as France would have long since been downgraded and hence unable to participate in the EFSF at a AAA rating). We also assumed that the debt rollover with a 21% haircut would not be an issue as it should have been a formality: on this we were fatally wrong - the debt rollover plan has imploded and means that the entire Greek bailout has collapsed as some had expected. And now that it is clear that contagion is threatening to sweep through the core, it is back to Germany to prevent the gangrene, no longer contagion, from advancing beyond the PIIGS. However, in order to prevent a full out revolution, Germany's economic elite has said it would agree to an EFSF expansion and hence installation of European firewall, but at a price: a "controlled" default by Greece and 50% haircuts for private bondholders (as German banks have long since offloaded their Greek bonds).

This means that "Lehman" is indeed here: just like back in 2008 Paulson et al thought they could contain the adverse effects of a Lehman bankruptcy, while the financial system ground to a halt 4 days later when money market funds broke the buck, so now Greece is somehow expected to remain in the eurozone even as it files bankruptcy. How or why they think the market will buy any of this is beyond stupefying, but we are sure all those armies of lawyers who never have a practical sense of what actually ends up happening in the real world, and who are poring over tomes of EU and EUR charter to see if they can file Greece without expelling it from the Eurozone, certainly has something to do with it.

So as part of this new strategy, here are the three key components of the plan to "firewall" contagion, via the Telegraph.

Sources said the plan would have to be released as a whole, as the elements would not work in isolation.

First, Europe’s banks would have to be recapitalised with many tens of billions of euros to reassure markets that a Greek or Portuguese default would not precipitate a systemic financial crisis. The recapitalisation plan would go much further than the €2.5bn (£2.2bn) required by regulators following the European bank stress tests in July and crucially would include the under-pressure French lenders.

Officials are confident that some banks could raise the funds privately, but if they are unable they would either be recapitalised by the state or by the European Financial Stability Facility (EFSF) – the eurozone’s €440bn bail-out scheme.

The second leg of the plan is to bolster the EFSF. Economists have estimated it would need about Eu2 trillion of firepower to meet Italy and Spain’s financing needs in the event that the two countries were shut out of the markets. Officials are working on a way to leverage the EFSF through the European Central Bank to reach the target.

The complex deal would see the EFSF provide a loss-bearing “equity” tranche of any bail-out fund and the ECB the rest in protected “debt”. If the EFSF bore the first 20pc of any loss, the fund’s warchest would effectively be bolstered to Eu2 trillion. If the EFSF bore the first 40pc of any loss, the fund would be able to deploy Eu1 trillion.

Using leverage in this way would allow governments substantially to increase the resources available to the EFSF without having to go back to national parliaments for approval, which in a number of eurozone countries would prove highly problematic.

The arrangement is similar to the proposal made by US Treasury Secretary Tim Geithner to the eurozone at the September 16 EcoFin meeting in Poland. Gathering turmoil in financial markets has convinced Germany to begin work of some kind of variant of the US plan, despite having initially rejected the notion as unworkable as threatening to compromise ECB independence.

In other words, Germany will be humiliated to appear weak after conceding to Geithner's proposals even after everyone in Europe already took turns at mocking the tax cheat. Which is why Germany has decided in turn to humiliate Greece, and in the process initiate a chain of events that will bring the end of the Eurozone, albeit, mercifully, much faster.

The proposal would be hugely sensitive in Germany as its parliament has yet to ratify the July 21 agreement to allow the EFSF to inject capital into banks and buy the sovereign debt of countries not under a European Union and International Monetary Fund restructuring programme. The vote is due on September 29.

As quid pro quo for an enhanced bail-out, the Germans are understood to be demanding a managed default by Greece but for the country to remain within the eurozone. Under the plan, private sector creditors would bear a loss of as much as 50pc – more than double the 21pc proposal currently on the table. A new bail-out programme would then be devised for Greece.

And with incompetent hubris bringing us here, we are happy to see said hubris is still front and center. Because if Europe really thinks there is such a thing, quadrillion sin USD FX swap lines notwithstanding, as a "managed" bankruptcy, then it fully deserves to ride into the sunset, battling the windmills of evil shorters and vile bloggers, on the much suffering back of Don Quixote's Rossinante.

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There Will Never Be A “Good” Time For Greece To Default

By Peter Tchir

I have been a proponent that Greece should default sooner rather than later for a long time. At first most people argued that Greece would never have to default. Now many people argue that Greece should default, but now isn’t a good time. The argument goes that Europe needs time to prepare for the default or the risk of contagion is too high.

My view is that Europe needs to let Greece default. Europe needs to abandon the existing perimeter and fall back to a more defensible position. Europe doesn’t need to collapse, but it does need to retreat to a core, stronger position, where it can dig in its heels and defend itself. Battles are not lost because every soldier is killed, battles are lost when morale gets so low that the soldiers give up and flee for their lives. Wars are won when isolated, broken units, are captured or killed. I think Europe has to take the pain now, or risk further pain.

My argument against “waiting for a better time” is that it may never come. Europe has squandered the last year. Europe was in much better shape to deal with a Greek default last year than they are now. Contagion was a concern back then in regards to Ireland and Portugal, now it is a reality. Only the darkest of the doom and gloom crowd believed that contagion could really spread to Spain and Italy, yet now that risk is palpable. Banks were more worried about fighting Dodd-Frank, and raising dividends, and creating almost record bonus pools, not trying to convince employees that the firm’s are solvent.

Contagion in many ways has already hit. The EU stocks are down over 20% in the past 12 months in most cases. Germany has performed better than the rest, but that is a very large drop and the market in Europe as a whole are in a Bear Market. The U.K. with its proximity to Europe, and Japan with the earthquake are also lower, but the U.S. stock market has remained relatively unscathed (despite what you might be reading this weekend about how our sell-off is overdone). China and Brazil are experiencing some troubles in their own stock markets. In spite of the hype of the BRIC’s coming to the rescue, they may be too busy taking care of themselves. It is worth noting that the EUR/USD exchange rate was 1.36 on September 30th last year, and is 1.35 now, so it is not all about exchange rates.

The credit story is more bleak and stark. Credit has clearly picked the safe havens, the next Greece, and those in between. Italy and Spain are now trading almost where Portugal was a year ago. How much easier would it have been for Italy to withstand a Greek default when it’s 5 year bonds were trading at Bunds + 134 instead of Bunds + 407. CDS has blown out across the board, including the allegedly cash rich China, but there is a “basis” swap element as the CDS trades in a currency different than what the country uses (ie, all Eurozone CDS trades in dollars).

It is hard to look at the data and note with that the bold steps of letting Greece default, had been taken last year when countries were in better shape. It is also clear, that the contagion has occurred without a default. Portugal has clearly moved to the plagued group and Italy and Spain are trying to fight it off.

Last September, the Eurozone and the U.S. had just posted 2nd quarter GDP growth of about 0.9%. This year, both the Eurozone and U.S. only had 0.2% growth in the 2nd quarter. At the risk of being ridiculed by proper economists, you cannot guarantee that GDP growth will be even worse or in contraction if we wait any longer for Greece to default.

It also worth pointing out that at the time, the ECB was only an amateur at overpaying for bonds. It has since purchased even more bonds well above the current market price. All that purchasing power would be nice to have now, but it has been spent. They can always spend more, but the ECB would be much stronger if it wasn’t sitting on such a big inventory of losing positions, that clearly did little to stem the crisis.

What about the banks? Don’t we need to wait so the banks can be stronger?

It doesn’t take a rocket scientist to see that the banks squandered a year to improve their capital base. BAC wasn’t selling cheap options to Warren Buffett when their stock was at 13. The SocGen CEO wasn’t on TV trying to convince investors that they had no funding or capital problems when his stock was at 42. The banks are even worse off than most of the countries, but why should anyone assume that waiting will make it easier for them to digest a Greek default.

To me, it seems that a lot has already been priced in and that the contagion is occurring whether we want it to or not, so we may as well let Greece default now and figure out how much has already been priced in and how to really stop the contagion from spreading to Italy and Spain and to banks that deserve to be saved. Let’s just admit it is gangrene and that it has already spread farther than is safe, but it is still better to cut off an arm to save the body. If we keep waiting it may not be possible to save the patient. The patient is getting weaker by the day, and being blind to that is just as big and just as dangerous as letting Greece default now.

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Record Correlations + Record Low Mutual Fund Cash + Soaring Dispersion = Recipe For Redemption Driven Disaster

by Tyler Durden

The topic of surging market return correlation (and the death of alpha on broader terms) is nothing new to long-term Zero Hedge readers: every time the market appears poised to crash, stock and sector correlations reach new highs while return dispersion drops as fundamentals and technical are broadly ignored, and only the roar of the thundering herd matters. And while whether a spike in volatility is a precondition to correlation jumps, or simply a coincident factor, is unknown, in recent weeks an equity correlation of 1.000 has been matched by a jump in volatility not seen since the days of September 2008. What this has done is to make return dispersion for the hedge fund community higher than historical associated with comparable episodes of palpable market fear, exposing a broad rift between the outperformers (very few, mostly macro hedge funds) and underperformers (many, long-biased primarily). Curiously in the (massively levered) mutual fund community everyone is broadly underperforming with roughly the same intensity. Which means that while in the past one’s returns could suck, at least so would everyone else’s, the past month has accentuated the ability of funds to generate alpha (and even beta) lead to broad reallocation of capital by fund LPs. The will force the en masse selling of winners to satisfy margin calls, exacerbated by record low mutual fund cash "dry powder" positions, and sets the groundwork for even more volatility as all traditional hedging strategies fail. So what is an investor to do in such a confusing environment? Pray... is the short answer. As for the longer one, there is not much that can be done according to Goldman, which in its latest weekly chartology has little if any words of encouragement for both clients and market speculators alike.

From Goldman’s David Kostin, who first describes the latest record surge in correlations:

Correlation of market, sector, and intra-sector returns has soared to record levels as macro themes continue to drive equity market performance. Investors believe a high correlation environment is associated with low return dispersion. However, stock volatility has been elevated and a high volatility regime typically corresponds with high return dispersion. A high correlation and high volatility situation suggests mixed dispersion of returns. Indeed, dispersion of equity returns at the market and sector level has been slightly above average compared with the past decade.

The 3-month trailing daily return correlation among the ten major sectors hit 0.94 last week, the highest in more than 20 years, more than two standard deviations above the ten-year average and a level approached only once before, during the aftermath of the financial crisis in February 2009 (0.91). The sector correlation averaged 0.67 during the past decade and 0.58 over last 20 years (see Exhibit 1).

Correlation of returns across all 500 constituents in the S&P 500 index stands at a record 0.75, 3.1 standard deviations above the ten-year average. Intra-sector correlation of stock returns within each sector equals 0.78, a new high, and 2.8 standard deviations above the ten-year average of 0.49.

As for what hedge funds can do in this kind of market, the answer sadly is, not much

Three strategies exist for investors to combat a high correlation market: (1) Nimbly trade the macro news, although this approach involves high risk given the volatile global political and economic environment; (2) identify thematic characteristics that will drive relative performance, although sharp reversals have meant few strategies have delivered consistent returns; and (3) use a long investment horizon to capture perceived mispricing, although this approach requires a patient capital source to allow time for the disparity to close.

Translation: nothing in the hedge fund arsenal works in the current investing/speculative environment, where redemption requests in many cases soar after just a month (if not week) of underperformance.

What’s worse is that anyone expecting a moderation in correlation will be disappointed based on a realistic appraisal of what is coming:

The news flow for the balance of 2011 will continue to be dominated by geopolitical uncertainty on three continents led by the European sovereign debt crisis, ongoing budget negotiations in Washington, DC, risk of US recession, and slowing pace of economic activity in China. The trading backdrop certainly appears conducive for global macro funds to outperform given the key market drivers are primarily macroeconomic related.

Making matters even worse is that in addition to already much discussed margin calls sapping investor cash, mutual funds are levered to record levels as we noted first months ago:

And as the redemption requests start piling in, the slow money will be forced to proceed with a rapid liquidation of winning holdings (as gold experienced last week, assuming of course that the CME margin hike had not been leaked).

But are mutual funds really going to see a spike in redemptions? You betcha:

Global macro hedge funds have posted strong returns in 3Q and YTD. These funds have nimbly traded the treacherous environment with the typical macro fund returning 4% in 3Q with 2/3 of macro funds returning between - 1% and 9%. Macro funds have returned an average of 8% YTD through September 16th. These returns are impressive considering the huge price swings in equities, commodities, interest rates, and currencies in 2011.

S&P 500 index has outperformed both long/short equity hedge funds and large-cap core mutual funds YTD as of September 16 (-2%, -4% and -4%, respectively). Relative returns of long/short hedge funds was slightly better in 3Q (-4%) versus -8% for S&P 500 and -9% for mutual funds.

The painful 7% plunge in the S&P 500 this week has pushed the 3Q and YTD returns for the S&P 500 to -14% and -9%, respectively, as of September 22nd. Mutual funds have lagged the market, falling 15% in 3Q and 11% YTD. Just 30% of large cap core mutual funds has outperformed the S&P 500 YTD. We estimate long/short hedge funds have returned -12% in 3Q and YTD.

For style advocates, just 34% of large cap growth mutual funds and 46% of large cap value funds have beat the Russell 1000 Growth and Russell 1000 Value benchmarks, respectively, YTD in 2011 as of September 22nd.

The paucity of outperforming mutual funds and long/short hedge funds is surprising given dispersion of stock returns at the overall market and within sector level has actually been above the ten-year averages (see Exhibit 4).

As noted previously, correlation of returns is extremely high but the dispersion or range of stock returns is large in absolute terms. For example, during the past 30 days, while the S&P 500 returned 1%, the best performing stock in the S&P 500 (GR) surged 47% while the worst performing stock (NFLX) fell 37%. The range of returns represents the potential alpha generating opportunities that existed for both long-only mutual fund and equity long/short hedge fund managers.

We fully expect that the investing community will proceed to sell all of the best performing stocks imminently as this last bastion of cooperative game theory falls apart.

Yet in all this gloom there is some bad news: job prospects for FX traders and analysts have never been better, as macro has emerged as the only strategy (modestly outperforming the market if still negative) that matters.

Looking ahead, a normal return dispersion climate should mean security selection matters. But it is hard for a portfolio manager to focus on the nuances of stock selection when the prospects of a US recession keep rising and the outlook for the European financial system seems more precarious, not less, on a daily basis. Simply put, the macro is overwhelming the micro.

The biggest loser? Last year’s biggest winners – quant, HFT and algo traders (who are now much deservedly demonized on every down day and broadly ignored when the market trades higher), and their CEOs who suddenly find themselves without a compass or GPS in the most treacherous market seen in years if not decades, and with BODs intent of finding scapegoats. For the prime examples of this look no further than Goldman’s now former Global Alpha and ever more correlation (Insert Greek Letter Insert Number) prop desks blow ups (the irony of course being that if UBS had followed the stipulations of the Volcker rule, its CEO would still be in his chair). These are just the beginning, as the true severity of record correlation and investing leverage are gradually disclosed.

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