Friday, January 30, 2009

Damnification: Global Competitive Devaluations/Wage Cuts ...

Well, we touched related issues some time ago ...

Paul Krugman puts that in the perspective of the U.S. today ...

For lazy people I qoute the Krugman, to get the basic idea:

... Jagdish Bhagwati described the conditions for “immiserizing growth” — a situation in which an expansion in an economy’s production, by driving down the price of its exports, actually reduces its real income. It was a classic demonstration that sometimes individually rational actions can make everyone (at least in one national economy) worse off — although I prefer the terminology of Edgeworth, who noticed the possibility more than a century ago, and talked of nations being “damnified” by their expansion.

I bring this up because the key feature of our current economy, I believe, is that we’re being damnified on multiple fronts.

The paradox of thrift is the best-known example: when everyone tries to save more in an economy in which interest rates are up against the zero bound, everyone’s income falls, and we’re worse off than before. The paradox of deleveraging has gotten currency, too: everyone tries to shrink their balance sheet, and the result is plunging asset prices, which leave everyone worse capitalized than before.

But there’s at least one more form of damnification that has me really worried: the paradox of deflation. An individual company or worker can preserve a business or a job by accepting a lower price; but when everyone does it, we get debt deflation — a rising real burden of debt, which weighs on the economy — and also start to have deflationary expectations built into lending and investment decisions, which further depresses the economy. And once you’re in a deflationary trap, it’s very hard to get out.


ECRI: Weekly Leading Index Slips ...

No comment, take it dry ... my emphasis!

Reuters, January 30, 2009

(Reuters) - A measure of future U.S. economic growth dipped in the latest week while its annualized growth rate inched up but both still indicate the downward spiral of the economy has not stopped, a research group said on Friday.

The Economic Cycle Research Institute (ECRI), a New York-based independent forecasting group, said its Weekly Leading Index (WLI) slipped to 107.3 for the week ending Jan. 23, from 107.5 in the previous week, initially reported as 107.4.

The index's annualized growth rate inched up to negative 24.0 percent from negative 24.3 percent, revised up from minus 24.4 percent. "While the WLI is no longer plunging, it has declined for three weeks following a four-week advance from its cycle low," said Melinda Hubman, research associate at ECRI. "Thus, an economic recovery is not yet in sight."

The weekly index fell due to higher interest rates and jobless claims and to lower stock prices, with the decline partly offset by higher commodity prices, Hubman said.

Italy: Shows The Minister What Customers Should Do?

CNBC's Geoff Cutmore spoke to Italian Finance Minister Giulio Tremonti at the World Economic Forum in Davos in Switzerland, but when the subject turned the .... the interview was abruptly ended. Watch the video here!

Thursday, January 29, 2009

Saut: ... Sometimes Me Just Sits!

Jeff Saut, the respectful strategist at Raymond James, reinforced today:

Indeed, Sometimes Me Sits And Thinks, Sometimes Me Just Sits!

S&P500 violates the 850-855 support area, valid just since yesterday, to the downside... This feels somewhat like a nasty French connection. C' est la vie?

Inflation vs. Deflation

This is the key issue for asset allocation ... We started to focus on this issue in the previous post, pointing to the discussions at Bronte Capital and Cassandra Does Tokyo.

Here we quote Joachim Fels and Spyros Andreopoulos, European economists at Morgan Stanley, discussing the "Could Hyperinflation Happen Again?" at the Global Economic Forum of Morgan Stanley:

According to Philip Cagan’s (1956) classical definition, hyperinflation is an episode where the inflation rate exceeds 50% per month. The historical examples of hyperinflation mostly occurred in the 1920s, when Austria, Germany, Hungary, Poland and Russia experienced galloping price increases. For example, Germany in 1923 recorded an astronomical inflation rate of 3.25 million percent in a single month. Since the 1950s, hyperinflations have been confined to developing and transition economies. Some recent examples include Argentina (1989-90), Bolivia (1984-85), Brazil (1989-90), Peru (1990), Ukraine (1991-94) and Zimbabwe in the past several years.

The root cause of hyperinflation is excessive money supply growth, usually caused by governments instructing their central banks to help finance expenditures through rapid money creation. Hyperinflations have mostly occurred in a context of political instability, adverse economic shocks and chronically high fiscal deficits. Hyperinflationary episodes are characterised by a general loss of confidence in the value of money, a flight into real assets and hard currencies, a surge in barter trade, and a shrinkage of financial intermediation and thus of the banking system.

An important empirical feature of hyperinflations is the high correlation of money supply growth and inflation rates. Money growth and inflation rates are also highly correlated in milder versions of high inflation episodes. Past bouts of high inflation in the UK, Italy, New Zealand and Mexico were preceded and accompanied by high growth rates of the money supply.

It is important to note that in low-inflation and low-monetary growth environments, the relationship between money growth and prices is much weaker or altogether non-existent. Average money growth rates have varied substantially between countries that have experienced relatively low (single-digit) inflation rates. However, countries with sustained high money growth rates have also experienced sustained high inflation.

Against this backdrop, could hyperinflation or high inflation happen again? Possibly yes, under certain circumstances.

First, the rapid expansion of the monetary base that the Fed, the ECB, the Bank of England and others have engineered in the last several months would have to continue and, importantly, would have to feed into a more rapid and sustained expansion of money in the hands of the general public.

Money supply M1 (consisting of currency in circulation and sight/checking deposits by non-banks) has gained momentum recently, especially in the US. We will be watching closely how this measure of money will evolve in the coming months.

Second, governments would have to face difficulties in financing rapidly rising expenditures on the various stimulus and bailout packages through taxes and selling bonds to the general public. In such circumstances, political pressures on central banks to monetise government spending would probably rise. This could be done through central bank loans to the government, central bank buying of government bonds at auction, outright unsterilised purchases of government bonds in the open market or additional lending to banks against government collateral.

Last, but not least, a combination of sustained monetary growth and high fiscal deficits would have to undermine the general public’s confidence in both the government’s ability to service the debt without taking resort to the printing press, and in the central bank’s ability or willingness to resist such pressures. A sudden surge in inflation expectations on the back of such a loss in confidence would induce people to reduce their deposits and cash holdings and pile into real assets. The velocity of money and inflation would rise, and the government/central bank would have to keep printing ever more money to finance government spending.

Clearly, this is an extreme scenario. Governments and central banks would have to jettison their commitment to long-term fiscal sustainability and keeping inflation low, and the public would have to lose confidence in their credibility. Given the reputation that central banks have built up, and given the commitment of central bankers to maintaining low inflation, a return to high inflation or even hyperinflation would seem to us to be no more than a distant possibility.

However, given the size of the current and prospective economic and financial problems, and given the size of the monetary and fiscal stimulus that central banks and governments are throwing at these problems, investors would be well advised not to ignore this tail risk, especially as markets are priced for the opposite outcome of lasting deflation in the next several years. Put differently, we believe that buying some insurance against the black swan event of high inflation or even hyperinflation makes sense and is relatively cheap currently.

Hell ...

Bad Bank/Good Bank Update

Yesterday I touched the "band bank" issue, as I assumed that to be the reason for the party in the equity markets. It looks like the Republicans messed the political bed, Fed did not promise to buy long term treasuries (well, they promised to do so, if they assume it to be necessary), and the "bad bank rumor" looks like hanging in thin air, though ...

Well, here are some other opinions against the bad bank idea:

- Willem Buiter proposes the good bank solution
- The PR dept. of Oppenheimer - Meredith Whitney, here' s the CNBC video coverage, and here is the Oppenheimer' s research note ...
- Barry Ritholtz speaks of Moral Hazard

As I pointed out yesterday, this is raising the question of responsible policies ... and the major question of inflation/deflation! Cassandra, that does Tokyo, wins the responsible policy lottery, and further on covers the issue of inflation/deflation already in two parts ... here's the Part I and here's the Part II.

Latvia: Another Approach To Fix The Problems

No, I am not a genius, the idea is stolen from David Leonhardt at Economix of The New York Times.

The idea is quite simple. The majority of topics discussed here are related to global macro-economics (well, we have focused quite much on "export mania" lately) , and the second key factor of economic development is technology. Well, demographics are key for long term trends. But besides these, Frank Levy, an economist at M.I.T. (Massachusetts Institute of Technology), argues:

...that institutions - unions, the minimum wage, the tax system, accounting conventions and ultimately the tone set by the government - have the power to either moderate or reinforce the underlying market.

Read the full lecture by Frank Levy here, and think how to fix the Latvian problems with that approach!

Fitch: Funds of Hedge Funds

Fitch Ratings, you know - I do not hold very much ...

Well, Fitch Ratings published its quarterly review of Funds of Hedge Funds. Key things in the summary:
2008 worst year in history of hedge funds (HFs) and funds of hedge funds (FoHFs). Cumulative losses (drawdown) reached an all-time high at end-2008.

Global macro and market neutral underlying strategies were the best performers; convertible bond arbitrage and emerging markets worst hit.

Downward correlation of asset prices, credit disruption and liquidity imbalances have virtually nullified the benefits of diversification, such as that offered by FoHFs.

Global equity markets in general have slumped twice the fall of HFs.
The chart courtesy of Fitch (click on image to enlarge).

Well, in this regard it is worth to quote Ben Inker of GMO:

Before getting into the lessons to be learned from the recent past, we should recognize that once the world was in the situation it was in by the summer of 2007, there was no way that portfolio construction techniques could have reduced the size of the overall losses. In 2007, the world saw the most profound bubble in risk assets ever seen, and it is the bursting of this bubble that has led to the enormous loss of wealth we have experienced to date. While we can try to second guess the government policy decisions that have brought us to where we are today, the truth is that most of the money lost in the last 18 months has simply come from overvalued asset classes reverting to the mean. A single institution could have avoided the fall by selling out of all of their risk assets, but if every institution had tried, they would have simply succeeded in hastening the collapse. The world in general is long risk assets. An individual investor selling out or even going short risk only serves to redistribute the losses; he does not reduce them. The only way to have avoided the aggregate pain would have been to have avoided the bubble in the first place, which would have involved changing the way portfolios were invested in the period between 2000 and 2006.

Wednesday, January 28, 2009

Vox's "Global Crisis Debate"

Check out!

About the Global Crisis Debate is partnering with the UK government to collect the views of economists from around the world on what we should do to fix the global economy. The analysis and proposals that appear on Vox's "Global Crisis Debate" page will feed directly into the UK's preparation for the summit of world leaders in London in April. This debate will be featured on the UK government's own web site:

Macroeconomics Moderator: Philip Lane
What macro polices are needed to combat recession and global imbalances?

Institutional reform Moderator: Francesco Giavazzi
How should institutions be reformed to improve global economic governance?

Financial rescue and regulation Moderator: Luigi Zingales
What is needed to strengthen financial sectors in the short and medium term?

Development and the crisis Moderator: Dani Rodrik
How is the crisis different for developing and emerging nations, how should they and the G20 react?

Open markets Moderator: VoxEditor
What should be done to maintain open markets and promote an environmentally sound recovery?

FOMC Statement (Updated @ US Market Closing)

Intra-day reaction, FOMC statement released at 21:15 Latvian time (time in charts), charts courtesy of Reuters. It looks like markets expected Fed to promise buying long term treasury bonds ... but equities are pleased by bad bank rumor (actually Geithner supported that rumor ...)

The original here.

Release Date: January 28, 2009
For immediate release

The Federal Open Market Committee decided today to keep its target range for the federal funds rate at 0 to 1/4 percent. The Committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

Information received since the Committee met in December suggests that the economy has weakened further. Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending. Furthermore, global demand appears to be slowing significantly. Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight. The Committee anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant.

In light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, the Committee expects that inflation pressures will remain subdued in coming quarters. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. The focus of the Committee's policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level. The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant. The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets. The Federal Reserve will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Committee will continue to monitor carefully the size and composition of the Federal Reserve's balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Dennis P. Lockhart; Kevin M. Warsh; and Janet L. Yellen. Voting against was Jeffrey M. Lacker, who preferred to expand the monetary base at this time by purchasing U.S. Treasury securities rather than through targeted credit programs.

Hugh: Latvia Needs To Devalue Soon

Edward Hugh has posted his response to the post "Why the IMF Supports the Latvian Currency Peg" by Christoph Rosenberg at RGE Monitor. It is definitely worth reading the full missive.

But lazy reader can get the excerpt of conclusions here:

So where does all this leave us. Well basically that what we have on our hands is one hell of a mess, and that here there are no easy solutions. Did anyone tell you we lived in an imperfect world? Well what is going on in Latvia is surely as good an illustration that you are likely to find that this is the case. There are no easy, quick fix, policy solutions, and I fully understand Christoph's dilemma in this case.

So while nothing is guaranteed to work, some approaches may be better placed than others, and it is my considered opinion that the best way of addressing the Latvian problem is by trying to kick-start the economy via devaluation, and to then tackle the wage increase problem might by explicitly opening Latvia's frontiers to external migrant labour (as, for example, the Czech Republic have, to some extent, done). Such devaluation, backed by imaginative enough greenfield site support from the government, could attract the FDI, and the migrants to provide the manpower for unskilled positions, with better educated Latvians being able to get involved in some of the higher value work. If something is not done to break the population vicious circle, and the meltdown in internal demand and property prices as young Latvians seek work elsewhere then the outcome is all too clear, and not for that any less tragic, as Krugman suggests.

Of course, some may wish to object at this point that devaluation has the same effect on wages as wage cuts do, and they would be right, but the point is the overall level of economic activity is greater on the V shaped approach (this was Keynes, and is today Bernanke's basic insight). Latvian GDP is about to be thrown, from a period of trying to operate above capacity, to one where for an extended period of time it will operate below capacity. This can never be a good solution. On the V shaped recovery scenario time path of GDP is higher, and the possibility of finding remunerative employment for each and every individual Latvian is to that extent greater. More idle resources will be put to work at a time when there is huge slack in the system, and energy and material costs are at very low levels. Investment (building factories etc, buying machinery and equipment) simply couldn't be cheaper . Putting the resources to work to make this possible quite simply can't be a bad thing, or so I contend, and certainly not if the alternative may be sitting back and waiting till you have a sovereign default coming crashing in on top of you.

I see plenty of work for Latvian parliamentarians (passing much needed laws etc) in the current proposals. I see comparatively few to keep the idle hands of Latvia's valuable human resource base from freezing over.

Let us be clear, of course there is no single clear "cure all" remedy here, but I think we need to say strongly that the earlier attempt to stem the migrant out-flow by being lax on the wage inflation front was to invite disaster (and the disaster of course came), whereas now, excessively compressing wages as the solution will have the impact which was previously feared.

And the Latvian exit strategy is in doubt too:

Finally Christoph has one additional point which really serves as a conclusion and a monument to all this, and that is the idea that Latvia has a clear exit strategy from its currency predicament: euro adoption.

As Christoph says, the Latvian authorities are determined to work to meet the Maastricht criteria in 2012. Certainly entering the euro zone will not do away - at a click of the finger - with the hard lifting necessary to address the competitiveness and high external debt problems (as he suggests in his avoiding the Portuguese trap article, and I go through in my Portugal Sustains post here). But it would offer support to a struggling Latvia and help bring back investor confidence. The point is, at which exchange rate should Latvia enter ERM2? Indeed, it is now apparent - if you read the IMF staff report on the standby arrangement, on their website, that they favoured an expansion of the band to 15% (which basically means 15% devaluation) and it was the EU itself who objected and pushed to retain the peg (see appendix below).

Basically, the EU objected to the IMF proposal for emergency eurozone membership on the grounds that this would sat a precedent in other cases. But I really do feel that the Commission (and the ECB presumably) are being ridiculously pig-headed here. We have an emergency on our hands, and exceptional measures are called for.

Read the full article!

Bad Bank: Final Invitation?

What was the reason for the party yesterday, and continuing today? Financial sector leads the upside, and the only reason, I can see so far is the "Bad Bank Rumor" in the U.S.

"Bad bank" is good for shareholders, but here is a list of opinions, why it is not good for wider public:

- by Paul Krugman
- by Martin Wolf
- by Willem Buiter
- by Felix Salmon

Here is an alternative opinion by Mike Mayo ... Well, obviously existing shareholders of bad banks would party!

If available money is not allocated in an efficient manner, we may start asking questions about responsible policies?

UPDATE: Dean Baker explains the bad bank ...

Monday, January 26, 2009

Saut: Sitting This One Out

Jeff Saut, the respectful strategist at Raymond James has posted his weekly missive, see the latest version here: Last week he suggested this.

His call for this week:

Despite the potential for a trading rally spurred by a surprise banking crisis solution from the Obama administration over the weekend, we stated in last Thursday’s comments that we were “sitting this one out” due to the technical damage that has been done to the major market averages and the fact that we are now into mid-January, where we have long suggested a correction would be due. Moreover, in the past seven trading sessions there have been two 90% Downside Days (1/14 and 1/20). Recent history shows that when two 90% Downside Days occur relatively close together, they tend to be followed by several more 90% Downside Days. Nevertheless, while we are cautious, we think it is a mistake to get too bearish here. As Jim Bianco noted – even if you peg all the financials in the DJIA at zero it would only take another 300 points out of the DJIA, which would still not take it below its November “low.” Further, in past missives we have referenced Franklin D. Roosevelt urging participants to read his inaugural address from 1933 and commenting that it reads like it could have been written yesterday. Interestingly, while we are not predicting it, our friends at “” picked-up on the 1933 FDR theme and included the nearby chart showing a 67% stock market rally in FDR’s first term. And, don’t look now, but crude oil appears to have bottomed.

Jeff was seen also at Bloomberg TV today.

You know, we are more concerned that real economy goes much deeper than priced in by the markets, before it gets any push by fiscal stimulus ... Banks are not much worth, whatever you do?

Consider as a probability!

ISEE Index Alert And Golden Disconnect

Did you notice the sharp rise of ISEE Index last Friday?

And "A golden disconnect story" at FT Alphaville, also happening last Friday?

Is that bullish or bearish? Or disconnect?

Saturday, January 24, 2009

Grantham: 3 (actually 4) Ways To Balance Debt And Asset Values

The admired value investor Jeremy Grantham published his "Quarterly Letter", actually part1 of that. As always, it is worth reading the full letter. However, we recently reminded about the "debt - the mother of all problems". In this regard Grantham writes:

Given where we are today, there are only three ways to restore a balance between current private debt levels and our reduced, but much more realistic, asset values: we can bite the bullet and drastically write down debt (which, so far, seems unappealing to the authorities); we can, like Japan did, let the very long passage of time wear down debt levels as we save more and restore our consumer balance sheets; or we can inflate the heck out of our debt and reduce its real value. (In the interest of completeness I should mention that there can sometimes be a fourth possible way: to somehow re-inflate aggregate asset prices way above fair value again. After the tech bubble of 2000 Greenspan found a second major asset class ready and waiting – real estate – on which to work his wicked ways. This time there is no new major asset class available and, although Homo sapiens may not be very quick learners, we do not appear eager to burn our fingers twice on the very same stove. As a society, we apparently need 15 to 20 years to forget our last burn. With so many financial and economic problems reverberating around the world and with animal spirits so crushed, re-inflating equity or real estate prices way above fair value again in the next few years seems a forlorn hope if indeed it is possible at all.)

So, watch the way we get out ...

Friday, January 23, 2009

SocGen: Eurozone ... Audacity Required Or Doldrums Ahead

Economists at Societe Generale have published their research piece "Eurozone ... audacity required or doldrums ahead", that focuses on the outlook for Eurozone, and some suggestions - what to do? It looks like the link is not working, try to find that reasearch via this site:

Really, what to do? Economists at SocGen Find 3 key recommendations:

1-Consolidate the monetary union, which means putting a stop to any further expansion during the time necessary to rebuild a more harmonised structural
framework for its members, which is crucial for optimising the area’s monetary policy.
2-Improve the eurozone’s growth potential with an ambitious public investment policy in sustainable development; energy research, and technological innovation – the three pillars of development vital for ensuring global economic growth in the long run.
3-Give consumers and governments greater financial flexibility, by purposely favouring an inflationary policy. Europe could only regain economic room to manoeuvre by reducing the public and private debt burden. In the absence of decent
growth in real income, inflation is the only way to achieve this.

In the previous post it was discussed that membership in the euro area is regarded by some as the solution to the current problems in countries like Latvia. Read the full research paper, but the box below tells the opinion of economists at SocGen (click to enlarge) regarding the EMU enlargement:

Latvian Currency Peg: The Looming Divide Within Europe

Zsolt Darvas and Jean Pisani-Ferry published at "The looming divide within Europe" today, as the financial crisis is highlighting the shortcomings of European Monetary Union. Read the full article.

Here are some key excerpts:

Membership in the euro area is regarded by some as the solution to the problem. True, those ten of the twelve new member states that joined the EU in 2004 could by now have joined the euro area, had they met the admission criteria. Indeed, four of them are already members of the euro club. The EU can certainly be criticised for clinging to criteria ill-suited to catching-up countries and the case for reforming them is strong (Pisani-Ferry et al., 2008, Darvas and Szapary, 2008).

Is there therefore a case for speeding up? External stability concerns would suggest early euro-area entry: being inside a large currency area considerably helps small open economies in times of crisis. But the experience of the Czech Republic (not in the euro) and Slovakia (a member since 1 January 2009), two countries that have both maintained macroeconomic stability, shows that euro membership is not the key to stability. Furthermore, the arguments for caution – essentially the need to avoid imposing too low real interest rates to catching-up countries – remain fully valid.

And now key message related to Latvia:

Countries operating fixed exchange-rate systems are caught in a trap now. Given the large share of foreign-currency lending, an abandonment of the peg followed by sharp depreciation would have a devastating effect. However, under a fixed exchange rate, the reduction in current account deficits made necessary by the reversal of private capital flows will probably imply severe recession, unless domestic prices and wages are sufficiently flexible. This macroeconomic dilemma is bound to dominate policy choices, and it would not be solved by early entry into the euro area. Countries in this situation may not need to introduce a floating exchange-rate regime because of the possibility of severe overshooting, but they should facilitate real exchange-rate adjustment – where feasible, a social consensus to cut nominal wages would be less painful than other available options.

Well, this represents one side of opinions. However, Edward Hugh, who represents very much the devaluation camp has this post today. Very interesting message, among other arguments, here:

Also, it only struck me this week how ridiculous it is to have all these Swedish banks giving the advice to stay on the peg, when Sweden itself is not pegged to the euro, and is able to "correct" in a way which Latvia isn't. Sweden again is a country with a substantial economic tradition. There is now quite a debate going on inside Sweden itself about the extent of that country's responsibility for what is going on in the Baltics (see the two differing points of view I have put up in the comments section to the last post). Also note (from the extracts from the IMF report I have also put up in
comments to the last post) the way in which it is now clear that it was pressure from the EU - who didn't want Latvia to throw itself at the mercy of the euro - which has created this ridiculous situation. The IMF seem to have favoured widening the band to + or - 15%, as a first step to entry into ERM2.

What is right?

Thursday, January 22, 2009

(Merrill Lynched) Bank of (Countrywide) America: Global Fund Manager Survey

How do you like this logo? That' s the reality these days ...

Well, the key findings of the monthly "Global Fund Manager Survey", that was published yesterday:

The improvement in global economic sentiment continued this month with particular focus on the US as investors responded to the extraordinary monetary response seen from authorities. Investors expecting a weaker global economy over the coming year more than halved to 24%, from 65% in October. This also played to a moderation of deflation expectations and a sharp rise in long term interest rate expectations: a net 35% of respondents now expect higher long-term yields over the next 12 months (versus only 3% in November).

Improving sentiment led to a modest improvement in profit expectations with a net 55% expecting further deterioration, up from a November low of 71%. The US saw a sharp increase in optimism with only 27% of US PMs now expecting further earnings deterioration compared to 70% last month and a peak of 85%.

A more sanguine picture on the economic and profit outlook is yet to be reflected in any shift in investment positions. The ML (Merrill Lynched) Risk & Liquidity composite indicator has recovered back to September levels but cash levels remain high at 5.3% and asset allocators added to already overweight cash holdings (net 44% o/w).

Allocators are more overweight cash, less overweight bonds and have scaled back regional equity exposure. A net 46% see bonds as overvalued, versus 30% seeing equities as undervalued. Somewhat surprisingly in light of improving profit sentiment, US equity exposure has been cut in favour of GEM and Japan, with China a particular focus. Europe is still seen as the least attractive region, perhaps reflecting a more hesitant government policy response.

Pharma, telecoms and staples remain the three sectors that investors are camped out in with only marginal trimming of positions. Utilities were cut to join tech and energy as neutrally positioned. Pessimism on banks is still plumbing new depths and despite promised pipelines of infrastructure projects, industrials are unloved.

Sterling is now seen as undervalued (net 7% of investors) for the first time since this question began in October 2002. The Euro is viewed as the most overvalued currency, followed by the Yen (a complete reversal of the view back in Oct).

An end to the bear market in conviction requires more conclusive evidence of policy success is reviving US and China growth expectations and/or a genuine reallocation out of bonds. In this regard the pure contrarian global sector trade would be out of US pharma into European/UK banks.

Grain of salt ...

Edwards: ... China Must Surely Devalue

The respectful Albert Edwards, the global strategist at Societe Generale, has been an ueber-bear for years. The key message today:

A new broom sweeps clean. Or at least that’s the hope in the markets. Bloomberg showed recently how the 14% slide in the equity market since Barack Obama’s election mirrors the 12% slide after Franklin Roosevelt’s election in Nov 1932 until his inauguration (albeit a bit later in March 1933). Subsequently the Dow rallied some 75% - link .

I laughed out loud when the highly manipulated Chinese GDP data was released, showing Q4 growth at a 6.8% yoy rate after 9.0% in Q3 and a peak of 12.6% in 2007. That this outturn was bang in line with the median estimate of economists surveyed by Bloomberg makes it all the more unbelievable in my mind. All other economic data worldwide have been surprising massively on the downside and China should be no exception. A few hours earlier, for example, South Korea reported Q4 GDP had declined a hefty 5.6% QoQ, massively worse than a Reuter’s consensus which looked for a contraction of 2.7%! I naively thought that this QoQ decline was already annualized, but it was not. On a US style of reporting, the South Korean economy contracted at a 20% annualised rate in Q4. Asia is in depression. Whatever the heavily manipulated Chinese GDP is telling us, that economy must now be contracting. The Yuan needs to be devalued.

We already commented on China today and Asia yesterday ... Geithner actually surprised me today, see here!

"But just think about the consequences" wrote Edward Hugh ...

Exports: Japan Update ...

Following our thesis of "export-mania", here is the update for Japan... A stable major economy of Japan reports 35% drop in exports over the year to December. Chart of the day, courtesy of Societe Generale.

Adam Smith And Invisible Hand

I was reading the post: "Adam Smith On State Expenditures and Interventions" at Economist's View. And the sentence:

Jacob Viner concluded, unsurprisingly, that Adam Smith was not a doctrinaire laissez-faire advocate.

... reminded me about the mis-interpretation of "invisible hand".

Another post at Economist's View "Creed of Greed Not Supported by Adam Smith" back in October last year has following:

This creed is based on the false view that Adam Smith believed that that personal greed generates the public virtue of economic growth. In fact, Smith would have been revolted by this misrepresentation of his views, as he actually wrote the following:

“Justice [the human virtue of not harming others]…is the main pillar that supports the whole building. If justice is removed, the great fabric of human society which seems to have been under the darling care of Nature must in a moment crumble into atoms….Men, though naturally sympathetic, feel so little for others with whom they have no particular connection in comparison to what they feel for themselves. The misery of one who is merely their fellow creature is of so little importance to them in comparison to even a small convenience of their own. They have it so much in their power to hurt him and may have so many temptations to do so that if the principle of justice did not stand up within them in his defense and overawe them into a respect for his innocence, they would like wild beasts be ready to fly upon him at all times. Under such circumstances a man would enter an assembly of others as he enters a den of lions.”

...The quote found above ... from The Wealth of Nations states that unbridled greed destroys a free market system.

The pernicious view that “economic man” is selfish and rational and that Smith’s invisible hand will clean up the mess has been perpetuated by the Chicago School of Economics. ...

China: GDP Grows 6.8% on Year In 4q2008 ...

Referring to the "Asian Macro Talk" yesterday, the China's GDP release today may be relevant to assess the current situation and the outlook.

Bloomberg reports:
China's GDP Grew 6.8% Last Quarter, Slowest Pace in Seven Years ...
Nouriel Roubini comments at RGE Monitor:
So the 6.8% growth was actually a 0% growth – or possibly negative growth – in Q4; and the Q1 figures look even worse. So China is in a recession regardless of what the highly massaged official numbers claim.

Yves Smith at naked capitalism writes
If you believe the China fourth quarter GDP release, I have a bridge I'd like to sell you.

In order to keep some balance of opinions, the economists at Societe Generale wrote this morning:
Base effects and how China reports economic data largely explains what is going on with today’s figures. China reports nearly all its economic figures on a year-on-year basis so the economic data will look simply awful in the first half of 2009 given very strong base effects from the first half of 2008. Though many are likely to read this as a deteriorating trend, it will not be. We still maintain the view that the Chinese economy is in the process of “troughing out” with the nominal
monthly indicators in an inflexion point ie they are declining at a slower pace in December than they did over October-November. Q1-2009 is likely to represent the low point in growth for this cycle (we are currently forecasting growth of 4.0%YoY to Q1). As China is likely to revise Q3-2008 lower, the Statistician is setting up the numbers for a relatively firm statistical bounce in the second half of the year.

It is not all data manipulation though. Policy will clearly be gaining traction in the second half of this year. Beijing uses much more direct policy tools – such as spending diktat or lending guidance to banks – and these were already having tangible effects in December unlike the indirect interest-rate mechanism of developed economies that depends on an impaired financial system for transmission.

Northern Trust: US Economic Outlook ...

Northern Trust published its U.S. Economic & Interest Outlook on Tuesday, 20th January. The key message by the analysts, in my view, was:

The current economic environment is indeed bleak and there are precious few signs of a recovery. But we believe that if the massive fiscal stimulus package being worked up in Congress is financed largely by the banking system and the Federal Reserve, there is a good chance the economy will begin to grow by the fourth quarter of this year and continue to do so throughout 2010. And if we are correct on this, we also believe there is a good chance that the consumer price index will be advancing at a fast enough pace by the second half of 2010 to induce the Federal Reserve to become more aggressive in draining credit from the financial system. This could set the stage for another recession commencing in 2012, or perhaps some time in 2011. So, the shape of the path of economic activity we see over the next few years is not a “V”, a “U”, or an “L”, but a “W” – down, up, down, up, all within four or five years.

Consider as a probability ...

El-Erian: Investors Must Adapt To Survive

Mohamed El-Erian, the chief executive of PIMCO, famous fund manager and economist, had a nice article at UK's Telegraph yesterday. Here's the key message, in my view:

Going forward, investors should keep a careful watch on four realities that are consequential for the configuration of risk-adjusted returns in various markets.

First, global economic activity has fallen off a cliff since September, and will continue to do so in the next few months regardless of what governments do. Second, many investors have experienced large portfolio losses that will erode their risk appetite for some time.

Third, notwithstanding the headline-grabbing stories of 2008, we are just at the beginning of a messy multi-year phase of institutional change in the financial markets that will ripple through many other sectors and companies. Fourth, driven by a genuine desire to compensate for cascading market failures, governments will intensify their involvement in markets through "unorthodox measures" that have both intended and unintended consequences.

All four factors suggest that conventional mindsets and models will be challenged in 2009, just as they were in 2008. As a result, investors are still vulnerable to costly mistakes, especially as there is no lack of seemingly cheap assets out there. They range from illiquid government instruments to highly leveraged equity products. Yet, only a subset will come back; and even fewer will do so in the first part of 2009.

Read the full article!

Wednesday, January 21, 2009

Latvia In Seismic Shifts by Evans-Pritchard: Latin Europe Meets Teutonia

Telegraph' s Ambrose Evans-Pritchard makes really seismic shifts in Europe. This may be quite true:
A great ring of EU states stretching from Eastern Europe down across Mare Nostrum to the Celtic fringe are either in a 1930s depression already or soon will be. Greece's social fabric is unravelling before the pain begins, which bodes ill.

Each is a victim of ill-judged economic policies foisted upon them by elites in thrall to Europe's monetary project – either in EMU or preparing to join – and each is trapped.
However, given the facts I know, this appears to me a phantasm, but I was not among rioters ... Neither "Ministry of Finance" was the prime target, nor the "blocks of ice" ... I was not there!

This week, Riga's cobbled streets became a war zone. Protesters armed with blocks of ice smashed up Latvia's finance ministry. Hundreds tried to force their way into the legislature, enraged by austerity cuts.

Given the knowledge of " leaked documents" I may be an outsider!

Read the original text, although true in some instances, but you will be impressed by the "epic notion" ...

Equities: Not Falling In Love ...

"Non-conditional" reflex today, reversal to "illusion-ary mean"? Well, financials have been sold heavily this year, KBW Banks down some 43% this year from the peak on the 2nd of January to low, with crash test move by 20% , yesterday. But the "base" for bounce is different (only by some 43%) today...

We watch for "Maginot Line" now, and Dow Jones Transportation (DJT) ... Decisive move above "The Maginot Line" would be technically bullish. Fundamentals appear a catastrophe still, but we may be blind due to lagging effects. Bank equity still has down-side potential fundamentally, but "coordinated equity buys by systemic CEOs" (JPM, BAC ..) may appear consciously bullish... The improvement in financial credit does NOT look good for bank equity via the lens of nationalization. We are more concerned about macro-fundamentals going lower (a much lower base for Obama' s Kiss) than priced in, but DJT should lead...

And beloved Apple beats ... but eBay disappoints?

UPDATE 1 @ 1:00 (23:00 GMT): I do not know, but I believe government bond risk is being repriced as government with Keynesian fiscal expansion + credit of banking system, this however should reduce the credit spreads for financials ... this is no way positive for bank equity, assuming this all happens based on assumption of systemic important nationalization of financials ...

Debt - The Mother Of All Problems

I started to read the "Quarterly Review and Outlook" by Hoisington, an investment management company in the US, and the chart (similar have been produced by other houses too) just reminded me to show the mother of all problems we face now globally ...

Chart courtesy of Hoisington

Saut: The Maginot Line

Jeff Saut, the respectful strategist at Raymond James has posted his weekly missive, see the latest version here: Last week he suggested this.

His call for this week:

Consistent with last Monday’s strategy report, the Maginot Line at 851 (SPX) was broken to the downside last week, leaving us again in cautious mode. While the DJIA was down 3.7% for the week, the real casualty was the D-J Transports with a stunning 9% loss, leaving them only 158 points above their November 20, 2008 closing low of 2988.99. The action of the Transports was especially disturbing in light of the 10.6% weekly decline in crude oil prices. However, if the Transports violate their November lows, without a similar breakdown by the DJIA of its November closing low of 7552.28; it would be a downside non-confirmation that should be interrupted bullishly. In the interim, we are cautious.

Watch Dow Jones Transportation Average index here, as the index made a new bear market closing low yesterday, but has been lower on 20th and 21st November 2008 ... And here is the Dow Jones Industrial Average (DJIA)!

UPDATE 17:10 (15:10 GMT): watch 815-820 area for S&P500, resitance now ... next level Maginot line (850-855 area) ... Cautious. "Bounce" led by crushed Financials, followed by Tech (IBM, Ericsson reported) ...

Intraday US equities charts here!

DBS & UOB Kay Hian: Asia Macro Talk ...

The Asian regional equity strategy team at DBS Bank issued a flash note on Monday, 19 January. It mainly concerns the macro-economic outlook:

Latest consensus GDP forecasts survey (January 2009) reveals more downgrades by the street in the past month. The rate of downgrade was the most severe for Singapore, Taiwan and Thailand, with downgrades of 1.8, 1.3 and 1.2 percentage point respectively. 2009 GDP growth for Asia markets is negative for Hong Kong, Singapore, Taiwan and the US.

We use GDP forecast trend as an indication if negative sentiments has been priced in by the market. The strategy team considers the economic growth levels in 2001/2 as the best case scenario at this juncture as that was the last synchronized global recession recorded . We look for Asia’s GDP growth to be downgraded to these levels as a minimum benchmark. GDP forecasts for Hong Kong, Singapore, Korea and Thailand were lower than the actual levels in 2001, while forecasts for China is 0.1 percentage point away, and Indonesia another 0.2 percentage point away from the minimum benchmark. This suggests that negative sentiments may have already been priced-in in these markets by the street.

However since the US/developed economies are believed to be performing worse than they did in 2001/02 and a lot of indicators are pointing to multi-year lows, a much weaker showing cannot be ruled out for Asia. As investors digest the bad economic data from the last quarter which has been slowly reflected in 2009 forecasts on the assumption that “if trend continues or worsens”, the first set of 2009 data will be important to gauge if there are any signs of a reversal in trend or an improvement in the degree of worsening conditions. We believe this is one of the pre-conditions for equities markets to stabilize in the near term. Eurozone’s flash PMI survey for January will be out this Friday. Our economist believes the sequential month negative changes in the data should improve.

We believe the other pre-conditions for the confirmation of market bottoming are: 1) stability in the global financial institutions 2) easing credit conditions and 3) peaking unemployment rate.

And this morning we have GDP news from Singapore:

Singapore GDP growth in 4Q08 came in lower than expected at -3.7% YoY (-16.9% QoQ saar). Full year average growth in 2008 came to 1.2%, against a previous estimate of 1.5%. The low 4Q08 outcome makes a big difference to the arithmetic of 2009 growth. Even without changing our sequential growth forecast for the four quarters of 2009, average growth would fall below -3.0% (compared to -0.6% previously) thanks entirely to the lower 4Q08 GDP level. Adding in a minor tweak or two to our quarterly profile and we now expect 2009 average growth of -3.3%. That would be the lowest in Singapore history.

Notwithstanding the low growth, we believe that a neutral exchange rate policy is the preferred option for now. In an environment of high volatility in the exchange rate markets, stability is probably the safer route. Statements by the MAS (central bank) this morning corroborate this view. That leaves fiscal policy as the sole means to cushion the downturn. Against this backdrop, we continue to expect an expansionary budget.
Chart courtesy of DBS Bank:

... worst ever recession in Singapore's history in terms of its depth and duration ... may it be even worse than currently estimated by DBS? We fear China may get worse than consensus estimate now ... The "Dry Bulk Shipping" report (see page 2-3) by UOB Kay Hian suggests that it may take longer and also banks may be affected more ...

We Need Some Good News

Here are some links to news to improve the mood:

ECRI's Achuthan talks with Reuters about the role of hope ...
IBM Profit Tops Forecast; Outlook Better than Expected ...
NYT Economix: What Companies Are Actually Doing Well?
NYT Floyd Norris: Remember 1982
Ericsson Profit Beats Forecasts ...
Buffett Buys More Of Burlington Northern ...

at least the headline appears being "good" ...

Tuesday, January 20, 2009

Equities: Financials Crash, Support Broken, Evacuation ...

Have you got your parachute?

UPDATE 1 @ 23:25 (21:25 GMT): heavy day, s&p500 closes 5.28% down, financials crash - S&P 500 Financial sector down 16.7%, KBW Banks down 19.7% for the day ...

Dow Jones Transportation makes new bear market closing low at 2959, however was lower intra-day on 20th and 21st November 2008.
815-820 area for S&P500 is resistance now ...

IBM reports better than estimated EPS after close, guides OK, but earnings conference coming ...

Citigroup (C) cuts dividend to 1c (CNBC says it was pre-announced in November .. i do not know as i do not hold them) ...
It does not look like panic ...

Roubini Suggests Banking System "Effectively Insolvent"

Bloomberg reports:

Jan. 20 (Bloomberg) -- U.S. financial losses from the credit crisis may reach $3.6 trillion, suggesting the banking system is “effectively insolvent,” said New York University Professor Nouriel Roubini, who predicted last year’s economic crisis.

“I’ve found that credit losses could peak at a level of $3.6 trillion for U.S. institutions, half of them by banks and broker dealers,” Roubini said at a conference in Dubai today. “If that’s true, it means the U.S. banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis.”

Losses and writedowns at financial companies worldwide have risen to more than $1 trillion since the U.S. subprime mortgage market collapsed in 2007, according to data compiled by Bloomberg.


“The problems of Citi, Bank of America and others suggest the system is bankrupt,” Roubini said. “In Europe, it’s the same thing.”


Oil prices will trade between $30 and $40 a barrel all year, Roubini predicted.

“I see commodities falling overall another 15-20 percent,” Roubini said. “This outlook for commodity prices is beneficial for oil importers, it’s going to imply that economic recovery might occur faster, but from the point of view of oil exporters, this will be very negative.”

At some stage Roubini will fail, unfortunately he has been right so far ...

Nordea: Latvia Plunging Deeper

Nordea has published its Economic Outlook, that covers major economies in the world, Nordic countries, Baltics and Poland, as well as BRIC countries. The gate to all media here.

Nordea has somewhat more bearish view on Latvia's economy than official consensus at the moment, but still optimistic in my view (click on image to enlarge the 1-pager about Latvia):

Global Competitive Wage Cuts In Cards, Too?

As I was reading the news from the around the world this morning, I noticed an article at Singapore Cuts Government Salaries as Slump Deepens. And you know, we have been discussing the wage cuts vs devaluations quite a lot recently.

So, I asked Edward Hugh in an e-mail this morning:

Global competitive wage cuts? Who is going to win if everyone does?

And the reply by Edward Hugh was as follows:

"Who is going to win if everyone does?"

This is very much to the point. We don't want a race to the bottom, although we might get one.

I also got this brief comment from one reader on the wage cuts thing:

"The consequence of debt deflation is collapse, is it not? Wage decreases are deflation, essentially, in their relationship to debt but are inflation in their relationship to asset prices. Could anybody invent a more unfortunate combination? And devaluation... how do you insure it is only you who devalues? "

I think this sums the whole issue up in a couple of lines. My response was nothing more than platitudinous really:

Well quite. Everyone cannot devalue. The bigger boys have to stand there and take it like a man (if that doesn't sound excessively sexist). Some new emerging economies like India and Brazil could revalue over time, but this is too long term, and their current weight in global GDP too small for this to be of much assistance. And even they can't really revalue at this point. But the four economies I have here - intentionally - are quite small open ones, so really if they could (3 of them can't really, although Latvia would be well advised to bolt and do a runner I think, despite the pain of breaking the peg) they should devalue, since again their weight in the whole situation is small.For the rest, we need to find collective solutions, but again, these would seem to be some way off at this point, since people are still trying to put the fires out rather than discussing how to renew the trees and vegetation.


I would say we have three real theoretical connundra to be working on:

1/ How to bail out the severely damaged members of the eurozone without collapsing the whole structure

2/ How to enable people to restore competitiveness without a massive round of competitive devaluations/ wage cuts.

3/ How to facilitate a recovery - say a new Marshall Plan type programme for emerging economies (only an idea).

Where are those men?