With the overall SPX index stuck in a range roughly between 880-930 for the
last 3 weeks the question remains which direction this will be resolved. We
think the answer may well be supplied by the energy sector in general and
the AMEX Oil Index (XOI index) in particular. One thing that has been
notable during this consolidation has been the general outperformance of
commodities and material stocks together with a large number of emerging
markets with have mostly managed to break out to new recovery highs.

Typically the US large cap energy producers would participate fully in such
a development but this sector has been disappointingly inert in recent
weeks and has actually lost considerable ground versus the overall SPX
since the March recovery began (see green line on lower chart). In part
this can be explained by the fact that these stocks held up far better that
the rest of the equity market during the rout of late 2008 but with crude
oil now back above its own 200 day ma and seemingly heading for $70 it is
really time that the XOI Index stated to perform better. In this regard it
is notable that the index has today managed to just break through its own
200 day ma for the first time since July 2008. A close above this level
would then set up an advance to test key resistance at the 1000 level. With
the energy sector representing 13% of the SPX a successful breakout by the
XOI would make it substantially more likely that the overall SPX would be
able to follow suit, while a failure to achieve this goal would leave the
market relying on a very narrow leadership base and therefore increasingly
vulnerable to a pullback.


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

A very interesting release that shows how a deeply distressed market starts to
repair itself. Volume is clearly increasing (the key metric in our opinion
since it indicated that buyers and sellers are meeting in the market) but
prices remain under pressure. This can be largely explained by the fact that a
remarkable 74% of all homes sold were subject to foreclosure, and hence the
price level is not necessarily representative of the "true" clearing price of a
non-distressed sale. This is becoming increasingly true of most of the national
sales metrics with the exception of the FHFA data, one reason why for all its
faults we currently prefer this latter measure.

We continue to track this monthly data series and continue to see the same
pattern emerge. Sales remain moribund in the mid 300K range (see blue line
on upper chart using left hand scale) with the April data coming in at 352K
almost unchanged from March and a slight undershoot of the consensus 360K
(remember we are dealing with annualized data so 8K houses really is just
noise). This may prove moderately disappointing but it is hardly
surprising; the "improvement" in conditions for this market thus far has
really been a lack of further deterioration rather than a rebound in
activity, but this does not make it irrelevant in the longer term since
this is how recoveries generally commence.

Of far more interest is the fact that even at this historically low level
of activity inventory data (black line on upper chart, right hand scale)
still dropped 13K units to 297K, their lowest level since May 2001. We are
now well below the 40 year average inventory of new homes (pink band on
chart) and should be testing the 1992 low of 265K by mid summer and
potentially the 1982 low of 246K by the fall. As we have written before it
seems clear that any uptick in sales activity will lead to a rapid
compression of inventory to the point that actual shortages of new homes
appear, with corresponding pricing power for home-builders. It is at this
point that an increase in actual building activity can be expected occur. This
repair process may seem to be moving at glacial pace but it is progressing
along a fairly linear path and given that all prior rebounds in activity have
been very rapid affairs once they actually started in earnest things could look
quite different by the turn of the weather this fall.



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

Long term Treasury yields continue to track higher and both the 10 year
(red line) and 30 year (black line) yields have now comfortably surpassed
our target ranges. There is nothing too surprising in this since our
targets were only rough guesses made several months ago but it does raise
the question as to whether yields will reach a level that proves
problematic for the current rally in risk assets. Fortunately much of the
recent run up in Treasury yields has been absorbed by narrowing spreads in
corporate and agency securities and so has proved far less damaging than it
might otherwise have done. For instance the key 30 year FNM fixed mortgage
rate (see blue line on separate chart) has backed up far less than the 30
year bond yield in recent weeks and remains very close to the key 5% level
and far lower than the rate charged 6 months ago.

It should also be understood that yields at the current level are still
extremely low even for an economy undergoing a difficult recession. In fact
much of the weakness in Treasuries appears to be a result of improved risk
appetites and a subsequent flow of capital out of a crowded "safety first"
asset allocation. In terms of technical targets we would now look to the
round numbers of 4.75% and 3.75% (for 30 and 10 year yields respectively).
Provided yields stay around those levels we do not see any great damage
being done to the incipient recovery but an extension higher could prove
more problematic.



(See attached file: D-USGG30_Index.gif)

(See attached file: D-ILM3NAVG_Index.gif) - D-USGG30_Index.gif -
D-ILM3NAVG_Index.gif

It is becoming increasingly hard to ignore data such as this. One note of
caution we would add is the fact that the BDIY index is tradable, and therefore
there may be some speculative capital seeping into the the very rapid increase
in prices. In any case it is broadly supportive of our thesis that investment
flows will remain strongly pro-cyclical for the remainder of the quarter.

While the Richmond Fed is hardly the most important manufacturing survey on the
monthly calendar today's release is still significant for being the first such
regional survey to actually indicate a positive reading (+4 vs. consensus -7)
as opposed to negative data which was simply better than expected. Note the 3
month absolute ROC (white line on bottom chart) shows that this is the sharpest
"V" shape ever recorded in the 16 year history of the index, and that the 12
month ROC (red line) has also just edged back into positive territory. Frankly
this is the sort of reading that typicaly takes place at the start of a
positive cycle rather than the depths of a deep recession but as ever we'd be
cautious of drawing too many conclusions from a single data point. -
sg2009052640820.gif

May's Conference Board Consumer Confidence Index came in at a much stronger
54.9 than the consensus reading of 42.6, and showed a very substantial
improvement from the April reading of 40.8. This data series has more than
doubled from its February low reading of 25.3 (comfortably the lowest reading
in the 40 year history of this series) and in absolute terms (a better measure
than a precentage ROC due to the unusually low February data) shows the
greatest 3 month improvement (white line on bottom chart) in the history of
this measure at
29.60.
The latter is
important since as we have stated before Consumer Confidence is an excellent
contrary indicator that in retrospect tends to show you the low point of a
cycle. A 40 year low followed by a record 3 month improvement is hard to argue
with as representing a meaningful turning point and so this data series is
giving a powerful suggestion that the March low in the broad equity market will
not be challenging anytime soon. - sg2009052636687.gif

With sentiment turning full circle back towards emerging market equities
(the re-de-coupling trade) and some spectacular gains being recorded in
India this week it is a fair bet that we will see some increase in capital
flows into these markets in the coming sessions. Looking down the list of
major markets poised for technical breakouts Russia (RTSI$ Index) caught
our eye. We have not written about this index since it fulfilled our
prediction of falling by 80% from its 2498 high to its 492 low last year but we
have been monitoring its progress with some interest in recent weeks. At present
the index has doubled from its 2008 low but still remains 60% below its
2008 peak and has just managed to cross the psychologically important 1000
level (there was a failed breakout earlier this month on May 13th). Since
this is a USD index part of the repair has been supplied by the RUB
currency (rate has fallen from 36.55 to 31.64) and a slightly larger
portion by the underlying local equity prices. The recent recovery in crude
oil's price (which has also doubled from the 2008 low) is clearly an
important catalyst for both the RUB and local equity market.

Should the breakout above 1000 gather pace there is little technical
resistance in the way of substantial further gains. The next obvious price
resistance comes in at around the 1050 level. Above this we would be
targeting a 31.8% retracement of the 2008 decline which comes in at 1258,
some 25% above the current index level. While there may be good fundamental
objections to valuations at this target this remains a technically driven
global equity market at the current time and for the first time in many
months and "greed" is becoming as strong a factor as "fear" in the price
setting arena.


(See attached file: D-RTSI$_Index.gif) - D-RTSI_Index.gif

Some interesting data on housing affordability that confirms our own work on
this subject. With refinancing activity running at near peak level this
represents a meaningful suplement to consumer discretionary income.

While today's building permit data (we substantially prefer this to the
Housing Start data that is release simultaneously) showed a substantial
shortfall when compared to consensus (494K vs. 530K) it indicates only a
moderate drop off from the March data of 511K. Since we are dealing with
annualized and seasonally adjusted data this decline is best treated as
"noise" rather than a significant piece of data indicating a reduction of
activity. As to the failure of activity to match consensus this says more
about the failure of the financial industry to understand the particular
nature of this housing cycle than what can be anticipated to unfold later
this year.

The lower line on this chart shows the number of building permits less
total new home sales (one family). As can be seen the index has fallen to a
record low in recent months indicating an unusual unwillingness to
construct new homes in the face of stagnant sales. While this tendency is
visible in all prior housing recessions it is far more pronounced this
time, and is no doubt driven by an understandable desire to conserve cash
balances and to comply with loan covenants. It remains our belief that
housing construction will not rebound until there is clear evidence of a
recovery in sales activity and may still lag this by 60 days or more. This
is also why we believe that new housing inventory is a key metric to watch
with the April data due to be announced on May 28th. Any substantial
further shrinkage in inventory is likely to result in localized shortages
of new homes and it may be that this will be required to occur prior to
builders finally ramping up construction activity.


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

As we had anticipated last week the VXO index has finally crossed the key
30 level in the aftermath of the May expiration cycle. Looking at this
event we have several conclusions to draw. Firstly the fact that expiration
seems to have once more had an outsized influence on both the overall
equity market and level of implied volatility indicates that there is still
a relative lack of true investment (ie medium to long term) capital being
directed to the equity market as opposed to opportunistic trading capital.
Secondly equity volatility along with a number of credit spreads (see our
May 7th note on the Bloomberg Financial conditions Index) have finally
recovered to the level recorded at the time of the LEH debacle, but remain
at a level that would be considered elevated in any normal environment.
There is therefore significant scope for improvement prior to implied
volatility (or tighter spreads) indicating a willful disregard of the risks
currently facing market participants. It should also be recognized that
most recovery rallies of this type only fail once risk measures have
reached an unsustainably low level (say around 20 for the VXO index) and
stayed there for a number of weeks. Of course the process of compressing
volatility back down to a more normal level can be expected to take place
against a backdrop of further gains for the broad equity market. Finally, a
fall in the VXO below 30 indicates a further shift in the risk/reward
between the selling of volatility to harvest premium (a very popular
strategy and generally successful in recent months) towards the tactical
purchase of volatility to substitute actual short and long stock positions.
We would judge these strategies to be broadly balanced at the current level
of the VXO.


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

Despite the generally poor tone of the equity market in recent days the VXO
index has continued to fall over the course of the week. Given that today marks
the expiration of the May option cycle this is an unsurprising event - it would
seem that we have reached the point that participants are far less committed to
rolling protective positions forward and are certainly unwilling to overpay for
doing so. It will be interesting to see if the index can cross the key 30 level
in either today or Monday's session, we certainly believe this is possible.
Meanwhile a lower level of volatility clearly marks a maturation of the current
rally, but we would not interpret the VXO as being problematic unless it fell
to the low 20's or high teens (we reached as low as 16.88 at the close of May
19th 2008). - sg2009051528037.gif

Fed Views Jump in Treasury Yields as Sign of Better Outlook May 13 ...

This story neatly fits in with our view of the FRB's current thinking,
nevertheless as we stated last Friday we see no compelling reason for 30 year
bond to exceed 4.30% or 10 year note exceed 3.30% at the current time.
<>

We continue to monitor chinese New loan and M2 data and while April shows a
substantial cooling off from March's frenetic pace an issuance of 590 RMB (over
$86 Bln) in a single month can only be considered to be expansionary. The 12
month ma for New Loan issuance has now risen to 690.09 RMB (a little over $100
bln). As of April's end Chinese M2 was reported to be growing at 25.95% YOY,
and had reached over 95% of the size of US M2. One of the more interesting
monetary events in many years looks likely to take place late this summer, at
which point China will have a larger total M2 than the far larger
(approximately 4 times in terms of nominal GDP) US economy. We will have more
to say about the ramifications of this development in the weeks to come. -
chinanewloanapril2009.gif - chinam2april2009.gif

While hardly surprising the fact that under 55% of loans were succesfully paid
of at maturity is a telling statistic.

Following another poor Treasury Bond auction (cleared at 4.288% with a
paltry 2.14 bid/cover ratio) the 30 year bond yield has moved to the upper
end of our anticipated range. Given the crowded nature of the current
Treasury marketplace it could well be that we overshoot this level by some
distance although such a breakout would now be more technically than
fundamentally driven. The more generally relevant 10 year note yield has
also followed suit but remains just below our anticipated target range.
With tomorrow's monthly non-farm payroll report now coming into focus it is
fair to assume that the recent spike in yields has moved the market's
target some distance away from the stated consensus of -600K, and we would
anticipate that any number that is not substantially better than this
dismal target will lead to something of a snap-back rally in the long end
of the curve. On the other hand an upside surprise (always a possibility
with this erratic data series) could well lead to a very hurried rush to
the exits. Either way it promises to be an interesting start to tomorrow's
session.


(See attached file: D-USGG30_Index.gif) - D-USGG30_Index.gif

Yet another poor Treasury auction. Yield nearly 4.30% (our target for 30 year
yield) and bid cover ration only 2.14 (anything below 2 considered problematic).

Finally some signs of flexibility are being shown by the ECB. It is interesting
that they have chosen to go down the "CE" road pioneered by Bernanke and the
FRB as opposed to the "QE" road chosen by the BOE. We certainly would agree
with this choice of strategy although at E60 bln. the scale of this operation
is tiny compared to the FRB facility. As has been the case throughout this
sorry cycle the ECB has done too little too late to be truly effective.

After 8 weeks of repair for equities and approximately twice as long for
most credit instruments we have reached an intriguing point in this 2
year-old credit crisis. As of last night most measures of stress (including
the VXO index) are at or slightly lower than the level recorded on the eve
of Lehman’s demise last September (the exception being corporate credit
spreads which remain typically wider), while certain measures such as swap
and agency spreads have collapsed back to normal levels.

This process can neatly be envisaged on the chart shown below of the
Bloomberg Financial Conditions Index (BFCIUS) which measure the total
standard deviation of a range of credit and volatility measures to capture
the overall deviation from a “normal” set of conditions (readers who wish
to learn more about this index should hit FCW <go> on their Bloomberg
terminal) . At Wednesday’s close this index registered -3.084, neatly
straddling the reading on the Friday before Lehman collapsed (-2.699) and
the Monday following (-4.024). We are still a long way from “normal”
conditions, and in fact remain more stressed than at the height of the LTCM
crisis or the 2000-2 recession, and only moderately calmer than the demise
of BSC in March 2008. Nevertheless the rate of repair has been quite
remarkable and the days of a -11.5 total standard deviation (we have not
bothered calculating the precise statistical significance of an 11.5 SD
deviance but it is theoretically about as likely as a Martian reading this
commentary) that we experienced last October now appear to be the sort of
anomaly that is highly unlikely to be repeated. Of perhaps greater
significance is the inference that further progress is still possible in
the near future before the level of stress drops below that appropriate for
an environment that still contains many significant hurdles to returning to
"normality".


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

JPMorgan Chase to Sell $5 Billion in Credit-Card Debt (Update1) ...

There are finally some signs of life in the TALF facility. Over $10bln of
eligible deals have been anounced in the last week.
<>

The last 24 hours have seen some interesting data that confirms the thesis
that we put forward 3 months ago concerning the likely effect of Chinese
stimulus on both their own economy and those of their closest trading
partners. One key such relationship is that between Brazil and China and
the first chart shows how both Chinese (red line) and Brazilian (green
line) PMI have rebounded sharply in recent months, with Brazil lagging
China by approximately one month. Chinese PMI is now above 53.5, indicating
a moderate expansion while Brazilian PMI has recovered to 44.8, which while
still indicates a contraction is a steady improvement from the recent lows.

More impressively the Brazilian trade balance (blue line on 2nd chart) came
in at a much stronger than expected $3.712 Bln (consensus was for only
$3.141 Bln), with the bulk of the improvement coming from far stronger
exports (imports were actually slightly weaker than consensus). Following
the release of this data the Brazilian benchmark IBOV index has risen over
5% to 49,750, within touching distance of our original target of 50,000.
While we do think that the current rally can extend higher in local terms
(we would highlight 57,000 as being a 61.8% retracement of the entire 2008
collapse) it seems likely that from this point on foreign investors are
likely to benefit as much from the strengthening of the local currency
(BRL) as from movements in the underlying local equity prices. The BRL
(third chart) has finally dropped below its 200 day ma and it certainly
seems possible that increased investment flows will see this currency test
the 2.00 level in the weeks ahead.


(See attached file: D-CPMINDX_Index.gif)


(See attached file: D-BZTBBALM_Index.gif)

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

The overall April ISM Manufacturing Index (black line on top chart) came in
at 40.1 this morning, sightly ahead of the consensus reading of 38.4 and a
comfortable improvement on March's 36.3 measure. Since a number of regional
PMI indexes had been reported in recent days as reaching the low 40's
today's data is less of a surprise than the consensus number indicates, but
it is still an important indication that the pace of manufacturing decline
has slowed markedly in recent months. Nevertheless a reading of 40
corresponds to the low point of the 1990-91 recession and is worse than any
recorded from 2000-02 and so we will need to see the recent progress
continued for several more months before the manufacturing sector can be
said to be truly healthy.

Importantly the New Order sub index (red dotted line on top chart) came in
at a near-neutral 47.2, a large improvement on last month's 41.2. Regular
readers will recall that it was last month's New Order reading that really
gave the first glimpse of improvement in the manufacturing landscape. A
reading of 47.2 is still negative, but only to a degree that can be
experienced in "normal" non-recessionary times. As the spread line (green
on lower chart) indicates it will be increasingly hard for the overall ISM
Index not to respond to any subsequent improvement in the New Order sub
index.




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