As 2008 crawls to a close it is time to consider this year's place in market
history. In terms of price decline the year will either be the 3rd or 2nd worst
performance for this index, depending on whether we close above or below
901.72. However in terms of the sheer relentless nature of the decline there is
a case for making 2008 top of the list. According to our search through
historical index performance 2008 is the ONLY year in which we never managed to
record a single YTD up day on a closing basis (our data goes back to 1928).
Even in the terrible years of 1930, 1931, 1932 and 1937 there were at least
brief periods in which the index was up on a YTD
basis.

For those looking to quibble it must be admitted
that the December 31st 2007 close of 1468.36 was very briefly exceeded on
January 2nd on an intraday basis but if 2008 has felt like a long, difficult
year that's probably because it has been one. - sg2008123140981.gif

Attached is a chart showing 10, 20 and 30 day historical volatility for the
SPX. Today's small rally has had a big effect on all 3 of these measures - all
of which indicate that the panic of September-November is rapidly being ironed
out of the market. 10 day volatility is now back in the "normal" zone while 20
and 30 day measures increasingly look to have made definitive peaks. While
panic may have so far been replaced by inertia and indifference this still
represents progress, and perhaps will prove a more stable foundation than a
quicker "snap-back" rally. As with everything else we need to wait for next
week for confirmation and support at 850 remains an important level for this
market to hold in the days ahead. - sg2008123041936.gif

Gold remains very much the lone bright spot in the commodity complex and
has built off a strong (if quiet) Friday session to record further gains
into Monday morning. The metal now looks poised to test the declining
trend-line off the March and July 2008 highs which comes in around $920,
roughly the level at which gold failed in October 2008. A breakout above
this level would clearly be significant and would indicate a possible
retest of the all time high. MACD is strongly positive suggesting that the
bulls have generated sufficient momentum for a realistic shot at overcoming
resistance.

Thus far gold's strength has not been fully reflected in the more junior
precious metals such as silver, in part because the latter also has a
strong industrial metal component. In recent days, however, silver has
started to behave more positively and we would expect to see any further
move higher by gold to be matched by strength in silver. Resistance for
silver can be found at $11.50, $12.00 and $14.00, the latter being a
realistic target for silver in the event that gold forces through the $920
level.



(See attached file: D-SILV_Comdty.gif)
(See attached file: D-GOLDS_COMDTY.gif) - D-SILV_Comdty.gif - D-GOLDS_COMDTY.gif

We are always alert to major changes in hedging policy since they often
coincide with a reversal in the prevailing price trend. Southwest's radical
unwinding of fuel hedges at a time that crude oil and its derivatives are
trading at 4 year lows is therefore worth noting.

At the end of November we noted that the 30 year swaps spread had massively
inverted, falling as low as -60 bp. From our perspective the only possible
explanation was a forced unwinding of positions and the likely suspect was
one or more municipal borrowers, since these are the natural users of
ultra-long duration swaps. The attached story regarding the spill-over from
the LEH bankruptcy shows that our intuition proved correct, and it should
be noted that the swap spread has returned to positive (but still low)
territory precisely as the story has emerged. Besides anecdotal interest we
would be alert to the possibility that the closing out of these errant
trades may mark a turning point for the long end of the Treasury market.
There clearly have been other bullish forces at work beyond the swap unwind
but we suspect that an appreciable portion of demand for long dated T-bonds
has come from this messy and expensive process.


(See attached file: D-USSP30_Index.gif)

+------------------------------------------------------------------------------+

Lehman Roils Muni Swaps as Collapse Forces Payments (Update1)
2008-12-24 14:00:08.25 GMT


(Adds Barclays swaps sales in 24th paragraph.)

By Michael McDonald and Michael Quint
Dec. 24 (Bloomberg) -- Six years after embarking on an
effort to lower borrowing costs using derivatives, New York is
watching those savings evaporate.
The state says it paid bankrupt Lehman Brothers Holdings
Inc. and other Wall Street banks at least $75.9 million since
March to end interest-rate swap contracts that were supposed to
lock in below-market rates. That money and the costs of issuing
new debt to replace bonds linked to swaps gone awry are eroding
the $207 million in savings New York budget officials say the
derivatives produced since 2002.
New York isn’t alone. Lehman’s bankruptcy filing on Sept.
15 triggered the termination of similar contracts across the
country, forcing state and local governments and other borrowers
in the $2.67 trillion municipal-debt market to buy out the
agreements. They suddenly find themselves making unexpected
payments at a time when their revenue is already under pressure
from the worst recession since World War II.
“People are fixing problems right now,” said Nat Singer,
managing partner at Swap Financial Group in South Orange, New
Jersey, and the former head of municipal derivatives at Bear
Stearns Cos. The number of new deals has shrunk to a
“fraction” of the amount a year ago as issuers unwind failed
swaps with Lehman, Singer said.
Bentley University in Waltham, Massachusetts, and a school
district in Pennsylvania vowed never to use swaps again after
losing money. The added costs in New York come as the state
faces a record $15.4 billion budget deficit over the coming 15
months.

Lowering Costs

In a swap, parties agree to exchange interest payments,
usually a fixed payment for one that varies based on an index.
Borrowers may benefit by using swaps to lower interest expenses
or lock in rates for future bond sales.
New York agencies used them to lower the cost of almost $7
billion in bonds sold between 2002 and 2005, according to an
Oct. 30 report from the budget division. The average fixed rate
the agencies agreed to pay Lehman and other banks was 3.78
percent, compared with 4.5 percent if they had sold conventional
tax-exempt debt, officials calculated.
The state failed to comprehend the extent of the risks
involved in entering into the long-term contracts, which often
last more than 20 years, the report said. They included the
likelihood an investment bank would go out of business,
triggering the termination of the agreement.

930,000 Contracts

“One of the main risks with swaps, which is that a sudden
bankruptcy of a counterparty could terminate a swap in
unfavorable mark-to-market conditions, was not effectively
addressed in the existing laws and agreements,” the budget
division wrote in its annual report.
A budget-division spokesman, Matt Anderson, said in an e-
mail that “given the current volatility in the market, we
currently don’t anticipate entering into further swap agreements
at this time.”
Lehman had about 930,000 derivatives contracts of all types
when it collapsed, according to bankruptcy filings. About 30,000
remain open, Robert Lemons, a Weil, Gotshal & Manges lawyer
representing Lehman, said last week. The contracts are worth
billions of dollars to Lehman’s creditors, though their exact
value isn’t clear, he said.
The cost of ending a contract depends on current interest
rates. Since New York and other issuers agreed to pay a fixed
rate to Lehman when borrowing costs were higher, they must pay
the bank to end the deals. The three-month dollar London
interbank offered rate, or Libor, upon which many agreements are
based has tumbled to 1.466 percent from 5.5725 percent in
September 2007.

Swaps Approval

Because they are private agreements, no comprehensive data
exist on how many municipalities are involved in the almost $400
trillion interest-rate derivatives market or the total paid to
exit the contracts. Derivatives are contracts whose value is
tied to assets including stocks, bonds, commodities and
currencies, or events such as changes in interest rates or the
weather.
New York passed a law in 2002 expanding the ability of
state agencies and authorities to use swaps. It was signed by
then-Governor George Pataki, a Republican. New Jersey,
California and other states also use derivatives in their public
financing.
Bentley University entered into swaps with Lehman and
Charlotte, North Carolina-based Bank of America Corp. on $85
million of debt between 2003 and 2006. The school also had to
pay a fee to end the swaps when Lehman collapsed, based on its
contracts with the bank.

Upfront Cash

“It’s going to take awhile for people to get comfortable
again, if ever,” said Paul Clemente, the chief financial
officer at Bentley, who declined to disclose the amount of the
fee. “As far as the future for interest-rate swaps, for me
there is no future.”
Some borrowers also use swaps as a way to generate upfront
cash, an attractive feature as the recession eats into municipal
finances. At least 31 states and the District of Columbia face a
combined budget shortfall of $24 billion this fiscal year, the
Center on Budget and Policy Priorities in Washington, a non-
partisan budget and tax analysis group, said Nov. 12. The
estimate on Oct. 10 was $8.9 billion.
The Butler Area School District in Pennsylvania decided in
August to pay JPMorgan Chase & Co. $5.2 million to back out of
such a deal, more than seven times what it was paid to enter the
agreement, rather than risk losing even more money over the 18-
year contract. The district superintendent, Edward Fink, said he
now thinks it’s inappropriate for school systems to dabble in
such trades, even though they were explicitly backed by the
General Assembly in 2003.

Valuing Risk

JPMorgan said in September it would stop selling
derivatives to states and local governments amid federal probes
into financial advisers and investment bankers paying public
officials for a role in swap agreements.
Borrowers “never put a value on the risks associated with
the swaps,” said Joseph Fichera, president of New York-based
Saber Partners LLC, a financial adviser to corporate and public
sector borrowers. They only estimated the savings investment
bankers and advisers were telling them they would get, he said.
The use of swaps began faltering in February when the
market for auction-rate securities collapsed. States, local
governments and nonprofits sold about $166 billion of the debt,
and as much as 85 percent of that was then swapped to fixed
rates, according to Fichera.

Bond Insurers

The collapse of the auction-rate market left issuers such
as the Port Authority of New York and New Jersey paying weekly
or monthly rates of up to 20 percent. The swap agreements failed
to adjust to swings in the underlying variable rates, leaving
New York and others exposed to higher borrowing costs.
Interest rates on other types of municipal variable-rate
debt also rose this year as investors boycotted bonds backed by
MBIA Inc., Ambac Financial Group Inc. and other insurers that
lost their AAA ratings because of their expansion into subprime-
linked credit markets.
Some borrowers entered into new swaps after Lehman’s
collapse, agreeing to pay higher than market rates in exchange
for upfront payments to help cover the termination fees they
owed Lehman, according to Swap Financial’s Singer. London-based
Barclays Plc, which acquired Lehman’s brokerage, is among the
banks bidding on this business, he said.
“The combined message from all of that is you cannot have
complete confidence in your counterparty,” said Milton
Wakschlag, a municipal finance lawyer in Chicago at Katten
Muchin Rosenman LLP. “People will be taking a hard look at some
of the conventions of the marketplace” after they finish
cleaning up from Lehman’s bankruptcy.

For Related News:
Top municipal bond news: MUNT <GO>
Auction-rate securities news: NI AUCRATES BN <GO>

--With reporting by Christopher Scinta in New York and William
Selway in San Francisco. Editors: Michael Weiss, Robert Burgess

To contact the reporter on this story:
Michael McDonald in Boston at +1-617-210-4639 or
[email protected];
Michael Quint in Albany, New York, at +1-518-426-9921 or
[email protected];

To contact the editor responsible for this story:
Michael Weiss at +1-212-617-3762 or
[email protected].



- D-USSP30_Index.gif

We continue to track both New Home sales and Inventory on a monthly basis
with today's data showing the annual rate of sales falling to 407K, just
above the nadir recorded in 1991 and potentially heading for the depths of
activity reached in the early 1980's, not that the final resting place
makes a tremendous difference given the scale of demand destruction that
has already taken place. We continue to be more interested at the pace of
inventory absorption and this month set another record with inventory
reduced by 28K houses, almost twice the prior record single month's drop.
This means that almost the entire pace of sales for November were accounted
for by inventory, a remarkable statistic that we do not think has ever been
approached before. At the current level of 374K we are still 24K above the
20 year average of 350K but clearly this level will be approached around
the turn of the year. Prior housing collapses have bottomed with inventory
in the range of 250-275K and we remain on track to reach this level during
the first half of 2009.


(See attached file: M-NHSLNFS.gif) - M-NHSLNFS.gif

As we had expected Friday's H.8 data, which covers the week ending December
10th, showed a very large increase in the amount of cash held on commercial
banks' balance sheets. This figure rose by $134 bln. (15.12%) to $1,018
bln. This build-up boosted the percentage of cash and Treasury instruments
up to 22.72%. As the attached chart demonstrates we are about to enter the
"normal" zone marked in pink, which we have argued before is the bare
minimum that needs to be achieved to stabilize the commercial banking
system. It will be interesting to see whether this measure needs to
overshoot up to the high 20's prior to any significant expansion of
commercial bank lending activities, we increasingly suspect that this will
prove to be the case. Even so, at the current rate of cash accumulation
this process could easily be completed by the middle of the 1st quarter 2009.


(See attached file: D-.BANKCASH_Index.gif) - D-.BANKCASH_Index.gif

It has been a year of many records and in its final days 2008 has turned up
another in Crude oil. Today's contango of $8.38 is not only the highest nominal
spread but is also by some distance the greatest percentage of the existing
contract.

We wouldn't look for a more in depth explanation than money flows - clearly
someone had a desperate need to sell today's expiring contract at any price -
but this a reminder that the flows of capital remain sufficient to overwhelm
virtually all markets at the current time. More importantly the "new" February
contract remained above the key $40 throughout the last 2 sessions, suggesting
that support remains intact for the current time. - sg2008121953689.gif

As we had predicted the VXO index has started to collapse right at the end
of the December expiration cycle. We have now broken decisively below the
55-85 "panic" range and are approaching the November low at 45. We expect
to see the VXO fall below 40 before year end.



(See attached file: D-VXO_INDEX.gif) - D-VXO_INDEX.gif

We appear to have definitively turned the corner in Investment Grade
corproate credit with yields falling sharply accross the spectrum. Most
notably the Moody's BAA (red) index fell 26bp yesterday and has now dropped
132 bp from last month's peak. Meanwhile the yields paid for the highest
grades of credit have fallen below those prevalent before this crisis took
hold. The AA index (blue) fell 12 bp to 5.65, its lowest level since
November 2007.



(See attached file: D-USGG10_Index.gif) - D-USGG10_Index.gif

Attached is a chart of crude oil with the continuous current contract (red)
and the continuous 2nd contract (black). On the lower panel is the spread
between these 2 calculated as a percentage of the current crude contract
price. When the spread is positive crude is said to be in "contango", a
negative reading is referred to as "backwardation". As the chart
demonstrates as the current January contract gets ready to expire at
today's close we are currently seeing a record level of contango in terms
of raw price (just over $5.00) and a near record in terms of percentage.
Today's reading of 12.8% has only be bettered once according to our data,
when it reached 15.8% in May 2008. It is quite possible that this record
will be exceeded during today's session since we have recently witnessed
some violent activity on the contract's roll date. As a reminder we have
circled the remarkable spike that took place in September as the October
contract expired. Back then a record backwardation of $20 was briefly
recorded but the resulting spike in crude proved to be illusory.

This time the importance of the distortion is magnified by the fact that
the expiring contract has fallen below the psychologically important $40
level. This fact has been widely reported but has far less significance
than it would in a more "normal" session. The soon to be active February
contract is currently trading at $43.50, a low price but not one that as
yet confirms crude's breakdown below $40.


(See attached file: D-CL2_Comdty.gif) - D-CL2_Comdty.gif

Damien Hirst, of $100 Million Diamond Skull, Sees Prices Slump Dec ...

It is a good rule of thumb that parabolic, speculative markets eventually end
because supply manages to increase even faster than demand. Hirst offers a
simple microcosm of the wider art market and perhaps no other artist managed to
play the current cycle as lucratively. Once more we note the commentary remains
far too optimistic as to the length of time that demand will be subdued,
another reliable sign of the fact that in all likelihood this year's peak will
not be seen for many years to come, if at all for Hirst himself.
<>

While the USD has understandably taking the bulk of participants' currency
market attention today it is important to note that the EUR/JPY cross has
managed to break above its 50 day ma for the first time since August 7th.
This cross has been a good general proxy for risk appetite in recent months
and so this technical achievement adds some credence to the other
improvements in tone that we have witnessed in recent days. Looking ahead
130 looks to be a realistic target.


(See attached file: D-EURJPY_Curncy.gif) - D-EURJPY_Curncy.gif

The AMEX Oil & Gas index (XOI) has edged through key resistance at the
1,000 level creating a new recovery high in the process. With this sector
now the largest industry group in the SPX at 12.3% this is an important
development that increases the odds that the SPX will itself continue to
register gains. Note that the last time the XOI reached 1,000 in early
November the SPX was itself at the 1,000 level, and the fact that it has
reached this level with the SPX still just over 900 demonstrates this
sector's key leadership in recent weeks.

Clearly the XOI needs to build on this achievement and close above the
1,000 level (preferably by some distance) in order for this breakthrough to
gain credibility but an intra-day breakout in an overall down market is
enough to be worthy of comment.


(See attached file: D-XOI_Index.gif) - D-XOI_Index.gif

Yesterday's historic FRB statement really only formalized an unofficial
policy that had clearly been evolving since late September when the FRB
balance sheet first started exploding in size. This is not to downplay its
importance since it has the feel of a "sea-change" event that gives
participants an opportunity to change their minds regarding the balance of
risk/reward in the months ahead, and to the extent that people are now
playing "catch-up" with their asset allocations its effect has the
potential to be quite powerful.

While the language regarding the possibility of Treasury purchases caught the
headlines and has led to a predictable rush into the long end of the curve
(see 10 year yields in Black) we are far more interested in the reaction of
Investment Grade corporate credit. We are pleased to see that our "risk
migration" thesis remains valid since yesterday saw a sizeable drop in the
nominal yields of the 3 Moody's Indexes we track all fell sharply with BAA down
16 bp to 8.48% (lowest since October 9th), A grade down 15 bp to 6.70% and AAA
down 13 bp to 5.16%. While these falls were not enough to reverse the trend of
widening spreads (the BAA to 10 year spread widened to a new high of 6.22% at
last night's close) this is far less important than the fact that nominal yields
have now fallen sharply from their 2008 peaks. We continue to view the IG
corporate space as being far more attractive than Treasuries, short term gains
notwithstanding.


(See attached file: D-USGG10_Index.gif) - D-USGG10_Index.gif

The SPX (top chart) has just crossed its 50 day ma for the first time since
mid September and is threatening to close above this key indicator for the
first time since the start of that month. At the same time the index is
moving above the massive open interest in December at the 900 level (233K
calls, 239K puts) and with just over 3 sessions left this cycle this should
create substantial follow through. Indeed, there is already some sign of option
liquidation and the VXO is right on the edge of key support at the 55
level. As we discussed at length in yesterday's note the coming sessions
are unusually important for this measure and the odds of a powerful wave of
volatility compression have risen over the last 48 hours, which would have
clear bullish implications for the equity market.


(See attached file: D-SPX_INDEX.gif) - D-SPX_INDEX.gif

Attached is a chart of the VXO index showing its 10 week ma from its launch in
1986 though Friday's close. As we have commented before the current sell off
has seen the highest sustained level of implied volatility since the launch of
the VXO and indeed public option markets. However, there are finally some signs
that this may be about to
moderate.
The 10 week ma is an
important measure for the VXO since it approximates 2 monthly expiration
cycles, a reasonable average holding period for an option investor. Clearly an
exploding 10 week ma therefore represents a significant gain in the time value
of premium over that period while a reverse is equally true. While the SPX has
been subject to some violent intraday moves this should not obscure the fact
that this has been a range-bound market for the last 3 weeks, making
time-premium a very important proportion of an option's total
value.

Friday's closing price of 57.78 came in 10.5 points below the 10 week ma and
while it was just enough to keep the 10 week ma rising it will take a close
above 85 next Friday to do the same. This seems quite unlikely to occur unless
the SPX falls below its 2008 low during the next 5 sessions. A sizeable reverse
in the 10 week ma is therefore on the cards and as the attached chart shows
once this line starts to reverse off a radical peak it has historically rapidly
retraced its advance. All this makes the coming week an unusually important
time in the equity market. - vxo10weekma.gif

After stalling for the last 3 weeks the FRB's balance sheet has started to
expand rapidly once more growing by $113 Bln. (5.84%) during the week
ending December 10th (upper chart, black). The lower portion of the
attached chart shows the major sub-categories that make up the balance
sheet and provides some insight into where exactly this massive inflation
of the balance sheet is being directed.

The largest increase in both recent and the current week comes in Reserve
Bank Balances (Green, lower chart) and this largely reflects the
willingness of banks to hold cash on their balance sheets now the deposits
at Reserve Banks are eligible for interest payments. As we have discussed
before the improvement in the ratio of Cash and Treasury holdings on the
commercial banks balance sheet is an important part of stabilizing the
system and we will be monitoring today's H.8 commercial bank data (which is
lagged by 1 week) for signs that this is continuing to occur.

The second largest category is the somewhat mysterious "Other Assets"
category (Blue line, lower chart) which rose by over 15% to $628 Bln. last
week. This category reflects the willingness of the FRB to lend against
"nontraditional" collateral and of course the wish of the commercial banks
to monetize these largely illiquid securities.

We note that the TAF (Red, lower chart) facility has continued to grow
rapidly, reaching $447 Bln this week (up 10%) while Discount Window (Black,
lower chart) usage has fallen sharply. To an extent these 2 categories are
fungible and represent a shift in taste as to which facility offers the
best source of funding during a given period. Gone are the days that
institutions were afraid of the "reputation cost" of using the Discount
window.

Finally we show the growth of Commercial Paper holdings (Maroon, lower
chart). This new category has now reached $308 Bln. since its creation in
late October. During this period total commercial paper outstanding
(Seasonally adjusted) has risen by $351 Bln, indicating that virtually all
the new demand has been supplied by the FRB's facility. Therefore we are
clearly a long way from a healthy CP market but at least in this case the
FRB's efforts are having a tangible effect and with T-Bills currently
yielding zero it is a profitable course to take.



(See attached file: D-FARBCRED_Index.gif) - D-FARBCRED_Index.gif

As the SPX struggles to break out of its "congestion zone" around the 900
level (which is largely a factor of the massive Put and Call open interest
at this strike price) it is important to look to some of the individual
sectors for a clue as to how this deadlock may be broken. Energy is key in
this regard since Integrated Oil and Gas is now the largest single group at
9.64% of the overall index while the entire energy group represents 14.23%.
Attached is a chart of the XOI Index (AMEX Oil Index) that shows a
surprisingly robust performance in recent weeks given the extreme weakness
in Crude oil. The index can be seen to be trapped in a wide trading range
between 750 and 1,000 (coincidentally approximately the same numbers as the
overall SPX Index).

With Crude bouncing strongly off $40 (support we expect to hold in the near
term) the related equities have bounced strongly and are approaching key
resistance at 1,000. Falling trend resistance at the 50 day ma has been
breached (something the SPX has not managed thus far) A breakthrough this
level would be expected to have substantial follow through, and given this
index's SPX weighting would almost certainly take the entire SPX index
comfortably higher. A failure to breach 1,000 on the other hand would suggest
that the SPX will continue to struggle to leave the 900 level behind.


(See attached file: D-XOI_Index.gif) - D-XOI_Index.gif

US commercial paper outstanding continues to grow steadily following its
calamitous fall earlier this year. This week's data shows a growth of just
under 3% to $1,704 Bln. and both the 13 week (red) and 52 week (green) ROC
indicatos are starting to move sharply back towards a neutral reading. It
is also important to note that Top Tier commerical paper yields continue to
fall sharply with 30 day rates now just over 1.25%, down from their October
peak of 5.00%. Tier 2 paper remains highly dislocated with 30 day yields
still above 5.00%.


(See attached file: W-FCPOTOTS_Index.gif) - W-FCPOTOTS_Index.gif

The overnight session has seen an important breakdown in the USD which is
something that we warned to look for in today's Weekly Speculator. We would
view this development positively in the short term since it is largely an
indication of some capital flowing back towards "risk assets". We note that
the USD is particularly weak today against a host of EM currencies
including the HUF, PLN, ZAR, BRL and MXN. Since many of these currencies
have developed into fairly popular short trades the potential for a sharp
recovery in the coming sessions is quite real. For this reason (together with
improving technical indications in the underlying local markets) we continue
to favor a tactical long trade in a number of EM ADRs and ETFs.


(See attached file: D-DXY_INDEX.gif) - D-DXY_INDEX.gif

Attached is a chart of the Bloomberg Global Telecom index (BWTELE) a cap
weighted, USD denominated index of Global Telecom equities. Telecom is
very much our favored sector at present since it generally combines strong
dividend yields with some defensive qualities and historically reasonable
valuations. While US Telco's have led the recovery this process is starting
to broaden geographically and we would anticipate capital to be
strategically allocated to this sector in the coming weeks. We are
particularly interested in what happens in emerging markets where the local
Telco's typically only marginally participated in the foolish run-up in
prices in 2007/8 and therefore seem more likely to be able to lead a
recovery that for instance the commodity related names. Looking at the
index we would note that it managed to keep above its October low during
the November rout and has since climbed above its 50 day ma. MACD has
managed to enter positive territory indicating that momentum is building
behind the recovery. A short term price target of 145/October's high seems
reasonable at the current time.


(See attached file: D-BWTELE_INDEXG8_Index.gif) - D-BWTELE_INDEXG8_Index.gif

As the SPX continues to make good progress the level of implied volatility
is finally beginning to recede. The attached chart of the VXO shows that
this important measure is approaching key support at the 55 level. A fall
below 55 would represent a significant shift in market sentiment but we would
still need to fall below the November low at 45 in order to confirm our
current view that something other than a brief bear market rally is
unfolding. In this regard the massive open interest in SPX Index December
Put options could be a crucial factor in forcing volatility levels lower
between now and expiration (December 20th) . We would pay particular attention
to the strikes at 900 (225K outstanding), 925 (71K outstanding) and 950 (240K
outstanding) since a sustained move by the index through these levels would
place tremendous pressure on put holders to unwind while the rapidly
decaying time period remains in place.



(See attached file: D-VXO_INDEX.gif) - D-VXO_INDEX.gif

Clearly a story to save in the archives. There will come a time that we all
shake our heads at the idea of a 3 month T-Bill auction clearing at one half of
one basis point or 1000 times less than the equivalent paper would have yielded
18 months ago.

For those wishing to play a recovery in EM equities Brazil (IBOV) is our
clear favorite at the current time. As the attached chart of the IBOV Index
shows there are clear signs that this market has established at least a
short term bottom and the index is threatening to cross its 50 day ma (red
line) for the first time since it broke down in June. It is notable that
Brazil suffered far less than other large EM equity markets during the 2008
decline despite its very high commodity related component and the lower
chart shows the IBOV's relative performance against the overall MXEF Index
(green line). We are strong believers in the general rule that markets and
sectors that show relative strength during a steep decline tend to form
leadership in the subsequent recovery (for fairly obvious reasons).

Unsurprisingly the recovery off the October lowers has been driven by
non-commodity names with the local telephone companies being particularly
strong (a growing theme in markets globally). Clearly some stability in energy
and industrial prices would be a major boost to the chances of this market
recovering The one caveat we would add is that the BRL remains weak at the
current time and it is important that this currency does not break down against
the USD since this would extinguish a good portion of equity gains for non BRL
investors. Our initial target for a recovery rally is the November high at
41,000, medium term target is the "breakdown" (blue line) at 45,000.



(See attached file: D-IBOV_Index.gif) - D-IBOV_Index.gif

The Brazilian Real (BRL) has been very much at the center of the explosion
of currency structured products in recent weeks with several large
Brazilian public companies announcing massive "hedging" losses in September
and October. Following the issuance of a massive $50 bln. currency swap by
the FRB this situation then calmed down considerably in November and
appeared to be back under control. In recent days, however, the BRL has
fallen sharply against the USD (note the currency is quoted as in inverse
and so the chart goes up as the currency weakens) and today the BRL broke
down to a new 2008 low. This is clearly a negative development,
particularly if this level is maintained through today's close and
certainly suggests that further forced unwinding may be taking place at the
current time. We would be concerned if a number of other major currencies
followed suit, particularly the MXN, HUF, PLN and KRW (all of which have
weakened without breaking down) and this situation needs to be monitored
quite closely in the coming sessions. A more "naturally" distressed
currency such as the RUB breaking down is interesting but less "systemic"
in our opinion.




(See attached file: D-BRL_Curncy.gif) - D-BRL_Curncy.gif

This week's reading of CS High Yield index shows nominal yield (red lower
chart) steady at 20.78% (up 8 bp from last week) while the spread to 5 year
T-note widened 47 bp to 1925 bp, a new all time high. Clearly the spread's
move is far more a function of the massive rally in the Treasury market
rather than a renewed bout of selling in the high yield space. Nevertheless
there is absolutely no sign of the improvement of demand that has recently
been witnessed in the investment grade arena. As we discussed in the
current "Weekly Speculator" the process of "risk migration" is far more
likely to cross over to the higher quality, high dividend equity names than
move on down the credit curve to High Yield debt.

This can clearly be seen on the second chart which shows the CS HY Index
together with the Moody's BAA index. This week's move has taken the HY
index up to a spread of more than 12% above the lowest portion of the IG
corporate arena and we are yet to reach an equilibrium in this process. With
Hedge Fund redemptions very much a factor for the remainder of 2008 and no sign
of marginal demand for HY credit the gap between IG and HY credit can be
expected to continue to widen in the coming sessions.




(See attached file: W-DLJHYTW_Index.gif)
(See attached file: W-.JUNK_Index.gif) - W-DLJHYTW_Index.gif - W-.JUNK_Index.gif

We continue to see a broad wave of commodity liquidation at the start of
December. While crude's decline to the low $40's has been well documented
copper's simultaneous decline has had rather less attention. As the
attached (log) chart shows copper is now testing key support at the $3,000
level. Should this support fail to hold the loner term chart suggests that
$2,500 is a realistic target. It is worth noting that a number of the large
mining stocks are already trading at prices that were recorded when copper
was in the mid $1,000's and so the metal is currently catching up with the
equity portion of this universe.


(See attached file: D-LMCADS03_COMDTY.gif)


(See attached file: W-LMCADS03_COMDTY.gif) - D-LMCADS03_COMDTY.gif -
W-LMCADS03_COMDTY.gif

Rarely can something so overpriced have been in such demand. The lack of
capacity in the "risk free" portion of the asset universe is another key motor
of the "risk migration" process.

The amount of US commercial paper outstanding continues to recover steadily
rising $11.6 bln (0.71%) to reach $1,651 bln. this week. As the lower chart
shows we are still registering a significant shrinkage on a quarter-quarter
basis but the data continues to suggest an element of demand is present for
this asset class. This is hardly surprising since Tier 1 30 day commercial
paper currently yields over 180 bp more than a T-Bill of the same maturity
level but it is nonetheless a welcome or some degree of "risk migration
into this vital portion of the short term money markets.

(See attached file: D-FCPOTOTS_Index.gif) - D-FCPOTOTS_Index.gif

We continue to see encouraging signs of "risk migration" into the US
Investment Grade corporate market. and this process is finally being felt
in the lower tier of this asset class. The Moody's BAA Index fell 19 bp to
8.84% yesterday, its lowest reading since October 10th and the chart of the
nominal yield (black line) is starting to suggest that a retracement of a
substantial portion of the October blow-out has commenced. Clearly the
spread to the 10 year T-Note (red line) continues to look more problematic
but this has far more to do with the craziness in the long end of the yield
curve (see yesterday's comment) than the attractiveness of investment grade
credit at the current time.



(See attached file: W-MOODCBAA_Index.gif) - W-MOODCBAA_Index.gif

Today's speech by Ben Bernanke contained the following phrase, which has
massively accelerated the already frantic rush into long dated Treasuries

"The Fed could purchase longer-term Treasury or agency securities on the
open market in substantial quantities. This approach might influence the
yields on these securities, thus helping to spur aggregate demand"

We would remind readers that Bernanke originally suggested this measure
during his famous November 2002 speech on appropriate FRB policy in the
face of deflation. In this speech he went into considerable detail as to
how such an operation might be mounted and it is interesting to note that
he suggested buying Treasury bills and notes up to 2 years in maturity. In
other words LONGER TERM than overnight but not actually LONG TERM in terms
of the standard definition of the curve. While he did anticipate that such a
move would influence the entire curve there is little to suggest that
purchasing 30 year bonds at less than 3.50% is on the FRB's agenda even in
these most remarkable times, and there is no obvious reason why this path
would be taken as opposed to directly targeting either long term GSE paper
or corporate securities (both of which were discussed in November 2002) in
the event the FRB wished to "get radical".

It is unfortunate that these comments came out on a day in which T-Bond yields
(black line) were already collapsing in what appears to be a forced purchase of
significant magnitude. Even more telling is the fact that the 30 year
swap (red line) remains inverted (spread in green on lower chart). This
leads us to suspect that there may be one or more municipalities caught in
a poorly devised trade since they are the most likely user of long dated
swaps.


(See attached file: D-USSWAP30_Index.gif) - D-USSWAP30_Index.gif

The 10 year T-Note continues to fall to record yields, a development that
has far more to do with short term capital flows than any considered
opinion as to longer term economic growth rates or inflation expectations.
Attached is a chart that looks at the T-note yield (Black) together with
the Moody's AAA, A and BAA bond indexes. As the chart shows yields of all
grades of corporate credit blew out during September and October while
Treasury yields stayed range-bound. This lack of a "flight to
safety" into the Treasury market was one of the notable anomalies of this
debacle.

The subsequent collapse in Treasury yields therefore seems to be largely
connected to unwinding of large fixed income books (we note that several
CMBS funds were reported to be in severe distress last week) that had used
a short Treasury position as a hedge, together with an element of momentum
that always gets attracted to moves of this magnitude. More importantly
there is finally evidence that the collapse in Treasury yields is leading
to an element of "risk migration" into investment grade credit. As would be
expected this has taken place in the highest quality portion of the space
first, with the AAA index (blue line) falling over 50 bp since mid
November, as has the Moody's A index (green line) The BAA curve (red line)
has fallen far less and remains over 9%. This means that it's spread to
Treasury has widened considerably, reaching 6.28% this morning, the highest
such reading since our data starts in 1962. We would hope to see some
further reduction in IG yields, at least on a nominal basis, in the coming
sessions.



(See attached file: D-USGG10_Index.gif) - D-USGG10_Index.gif

Attached are 2 charts of the SPX index, the first showing the current time
period and the second showing the historic bear market and recovery that
took place from 1973-1975. Both charts show the index price on a log scale
on the top chart an a 1 week RoC measure on the bottom chart. Last week's
gain of 12.03% represents the largest percentage gain since the initial
rebound made in October 1974, a performance made all the more notable for
the fact that it came in a 3 1/2 day period rather than the normal 5 day
week. Had we used a 5 day RoC (from Thursday 11/20 close of 752.44 to
Friday's 896.24) this measure would actually have come in at 19.11% at
Friday's close, the largest 5 day advance since April 1933, at the early
stages of the 1932-1937 rally that saw the SPX rally over 400% over this
time period.

This in itself does not guarantee that we have started the sort of powerful
recovery rally that took the SPX up 53% from October 1974 to June 1975 but
weekly and 5 day advances of this sort of magnitude are extremely rare and
have seemingly been associated with turning points in powerful bear
markets. On the few occasions they have occurred have been followed by
strong but very volatile performance in the weeks ahead.


(See attached file: W-SPX_Index.gif)
(See attached file: W-SPX_Index1.gif) - W-SPX_Index.gif - W-SPX_Index1.gif