Diary of a Financier

From the Trading Desk: Trade Reconciliation (Weeks of August 15 & 22)

In Capital Markets, Trading Desk on Sat 3 Sep 2011 at 08:59

I’m studying the market carefully going into this weekend.

I never really stop watching futures markets, but now that a full quarter has passed since my May entry, “Fivefold Increase in Equity Futures Open Interest: Displaces Cash Markets, Multiplies Leverage,” I’ve had the opportunity to step back and view equity futures’ progression from a broad lens.

Last night, I noticed S&P 500 Futures (SP/) volume & open interest was still waning, while the E-Mini (ES/) has continued climbing markedly. This is a glaring trend. I particularly highlight the ES/ spike in volume & open interest at the recent market bottom:

SP daily- waning volume and open interest.

ES daily- continued climb in open interest, including a recent spike.

In light of this observation, check out the mechanics of cash market manipulation via futures markets, from this recent interview of Michael Greenberger, former deputy to Brooksley Born at the Commodities and Futures Trading Commission (CFTC).

(Not to bring this conversation any more into my comfort zone, but I’m in the middle of reading All the Devils Are Here, which commits a chapter to the struggle between Ms. Born’s watchdog CFTC and Washington DC politicos. The CFTC’s proposed regulation of derivatives was buried by the Alan Greenspan/Larry Summers/Robert Rubin triumvirate. Not only were these guys the champions of deregulation & free markets, but Wall Street’s lobbyists held DC hostage with the old line, ‘if you regulate our profitable derivatives businesses, we’ll move everything to London.’ WGBH’s Nova produced a great documentary on this specific event too. Derivatives, VAR models, CDOs, etc. went on to bury both Wall Street & Main Street. In my opinion, what’s inexcusable is futures speculation–a regulated marketplace–proliferating unchecked. The present, unprecedented spike in ES/ open interest shows the emergence of a [phantom] mass buyer, who quite literally saves the day from a market crash. This isn’t the first occurrence. I try not to play conspiracy theorist, but if someone were to manipulate equity markets, E-Mini Futures are the avenue, since the contract size is so small & the permissible leverage so large.)

Trying to quantify the levitation in the ES/ contracts, allow me to present the numbers:

ES/ Open Interest (# Contracts)
7/26/11-      2.56mm
9/01/11-      3.47mm
Delta=        +35.5%

But, I digress. In other markets, long-dated Treasury bonds pulled back to first resistance (a bit shallower than I had expected), so they’ve resumed their secular ascent without leaving me the opportunity to double-down:

US30 daily- bounced off 1st support, shallower dip than I expected.

In the longer-term monthly fractal, you’ll notice 30-year Treasuries sticking to their historical trendlines in pursuit of their secular bull. In addition, today’s T-bond top is really starting to resemble the setup from 1999:

US30 monthly- sticking to historical trend with today resembling 1999.

Likely attributable to the expectation for “Operation Twist,” the front-end of the Treasury curve is falling from historically wide spreads (flattening), while the back-end remains at alltime wides (steepening). If the bond market has its way–as it usually does–real growth won’t return to the economy for some time:

Front-end Spreads- 10yr-3mo Yield Spreads moving off historic highs.

Back-end Spreads- 30yr-10yr Yield Spreads are staying wide, showing yield curve steepness that forecasts economic growth many years away.

Not much else to report on the Trade Reconciliation front.  At the end of last week, I was traveling, which offered me an opportunity to get some work done in a quiet environment.  I sat down and wrote out all of our equity holdings in the margin of a legal pad.  I had columns assigned Daily/Weekly/Monthly/Notes, and I spent three hours adding a B/S/- (Buy/Sell/Push) to the columns, with a price target & fundamental argument under the Notes.  There were a handful of Buys under the Daily fractal.  There were even fewer Buys under the Monthly.  When price targets were hit this Wednesday, I closed a few more single-name equity positions.  I’m down to a 14% equity allocation, and in retrospect, I wish I were carrying less.

Equities are about to flop like a chunky pitching-wedge into the drink.  Treasuries, Gold & Silver are already resuming their slingshot to the moon, and the US Dollar will have Europe to thank for the coming DXY rally.

Here’s that Trade Rec:

–Romeo

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