Saturday, October 31, 2009

Killer Chart By BNP Paribas

As usual, the analysts at BNP Paribas have chosen the Killer Chart in their "Number Cruncher". Although the French affairs are not that bad, but Eurozone gets hard to reflate, except the trading rooms ...

Click on picture to enlarge, courtesy of BNP Paribas.


Thursday, October 29, 2009

Another Text-Book Case - US GDP 3q2009 Flash Estimate

BEA reports today:
GROSS DOMESTIC PRODUCT: THIRD QUARTER 2009 (ADVANCE ESTIMATE)
Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 3.5 percent in the third quarter of 2009, (that is, from the second quarter to the third quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP decreased 0.7 percent.
Let' s look beneath the headline:
1.66% contribution from cars via government stimulated Cash For Clunkers
0.5% from government stimulated Housing
...government itself contributed 0.48% to the growth.
So, the headline of real GDP was improved by analyst miss on deflator, which was reported 0.8% vs 1.3% estimate... err, nominal GDP (that serves the nominal debt) was smaller than expected?

Markets of risky assets liked it today....

And here are compilations of opinions by WSJ Real Time Economics and NYT Economix ...

Wednesday, October 28, 2009

Is Goldman's "Hope" Fading?

While the ring was pulled rightly, and the Merton' s dividend yield provides some comfort so far, the question about depth of correction remains.

The conventional wisdom of equity markets was nicely described by the analysts at Goldman Sachs last week:

Most earnings growth is not paid for when it occurs during the Growth phase, but when it is correctly anticipated during the Hope phase, and when investors get overly optimistic about the future growth potential during the Optimism phase. The Growth phase sees the highest rate of earnings growth, but the second lowest rate of return over the cycle.

The phases are related to the economy. Generally, the Despair phase is associated with a recession. The output gap troughs and the unemployment rate peaks during the Hope phase, while the Growth phase sees sharp improvements in both variables. Investors’ real required return rises during the Despair and Growth phases and falls during the Hope and Optimism phases.


Click on picture to enlarge the graphical depiction, courtesy of Goldman Sachs.

The question now remains - is the "Hope" already over?

While looking at Western markets and applying the "conventional wisdom" of Goldman Sachs, or even the approach of "Triunity Theory", it is not that clear... However, the fading of "Hope" in Asian and Latin American markets appears to be very likely.

The underlying fundamentals and the "damaged technicals" of Dow Jones Transportation Average also questions the "Growth" thesis. On the Asian side of the pond the life is still ticking up...

Monday, October 26, 2009

Bylov: Global Intermarket Perspectives

Jan Bylov, chief analyst at Nordea Markets, is a "rare specie" among analysts, as he is looking himself at all asset classes and uses inter-market approach in analyzing the markets. He writes in the summary today:

Stocks – Fortunately, downside fear feeds the upside

In the real world – away from the classroom – few things are as they were supposed to be, and often perspective and philosophy are more important than micro insights. Now, reading and talking to many types of market operators we continue to be met the attitude that “this recovery just cannot be true” and clearly people continue to search for evidence why valuations, EPS, net income, sales or the likes eventually will cause markets to turn down again. Obviously, they may be right but we also should remind ourselves that all experience informs us that when people fear the downside then the upside potential hasn’t been exhausted! Further, investors are still met by an encouraging impression as bond yields are low and ranging, a weak US dollar providing global liquidity, commodity prices only edging higher, leading stock indices trending higher and central banks holding back their exit strategies. Consequently, the ongoing bull market will remain intact until the occurrence of a reaction which exceeds the June setback in both time and size. We are structurally bullish.

Bonds – In the absence of central bank action

As markets moved away from “systemic breakdown” in March/May and major central banks during the summer ensured us that interest rates would stay low for an extended period then little has actually occurred in both money and bonds markets; interest rates and yields have traded within well-known levels. Now, in the absence of major central bank action then statements, research reports and news paper articles have caused four yield “waves” without really commencing a new overall directional trend… in spite of investors perceiving that the risk/reward ratio obviously favours yields breaking higher eventually. Stereotype perceptions are a dangerous thing, and we continue expecting prolonged trading ranges in yields, and that the yield direction will oscillate between the popularity of two transient investment themes: 1) “supply fear and political discipline” and 2) “hesitating central bankers”.

Commodities – Buying pressure intensifies

Global commodities have been stable from June until early October benefitting a continued global economic recovery. However, measured in various currencies commodity indices have broken upwards or are pressuring to break higher! Speculative buying (and rising Open Interest in futures) also appears to be intensifying and with no extreme positioning evident (gold aside) then additional buying potential remains from this source too.

Currencies – Carry & momentum… not valuation

The global recovery in asset prices and economic activity is showing no real evidence of faltering – not least nourish by the anecdotal evidence that people remain occupied with why the recovery will falter ultimately. Therefore, the post March global recovery continues to support cyclical currencies as opposed to non-cyclical currencies, and to this script we can add global central bank divergences. This environment and the investment theme of “global central bank divergences” still support the carry and currency momentum in LatAm, Asia, commodity and cyclical sensitive currencies (SEK and NOK included) – not least with no market action suggesting that a short squeeze having commenced in USD. Clearly, any valuation concerns/considerations have little success. Finally, we hold on to our May -09 carry basket strategy of long BRL, TRY, RUB funded by CHF and CAD, and protective measures should slowly be tightened.

Below is the Dow Jones-UBS Commodity Index Total Return in USD, EUR, JPY, click on chart to enlarge, courtesy of Nordea Markets.

Looking At Classic "Text-Book Recovery" In Oil Prices

Economists at Societe Generale, while writing about oil prices that may have an impact on monetary policy, have made interesting commentary and charts.
... the latest spike in oil and most other commodity prices has pushed up raw material costs sharply. While certain observers may look at these trends as nothing more than normal cyclical adjustments, this is far from being the case.

Monitoring commodity market trends in the light of
the position in the economic cycle strongly shows the anomaly of the current recovery in comparison to past ones. There is indeed no example in the past four exits from recession during which commodity prices have inflated so much so soon, even in 1974! Oil prices are now above $80 a barrel, or 75% above their level in April, corresponding to the trough in the OECD leading indicator. This is more than 65% above the average price trend of past recoveries. Interestingly, markets do not seem troubled by such a development.
Charts below, and also the accompanied text, do not specify the commodities under consideration or index, and, very likely, assume the changes in prices for different currencies. The chart on the left side appears to be likely measured in USD, the right one - in EUR. But the assumptions were not confirmed so far...

Click on chart to enlarge, courtesy of Societe Generale.

This one should just add some curiosity to the recovery story, and should reveal also the self-reinforcing positive feedback loop. Think of momentum trade that loses the support from economic surprise ...

UPDATE: These "Commodity prices" in the charts are "Oil prices" ... a look at DJ UBS Commodity Index Total Return is by far less stellar, look for next post ...

Thursday, October 22, 2009

Inflation In Eurozone and US

Inflation or deflation? Well, expectations may drive it ...

The quantitative strategy team at Societe Generale wrote in the note yesterday:
Global markets have moved in harmony over the past few weeks. With no significant dislocation, the drop in the dollar and the equity markets' upbeat performance pretty much sum up the action.

Rising US inflation expectations were in part responsible for these moves. We highlighted two weeks ago that inflation expectations were undervalued when compared to buoyed equities and increasingly expensive precious metals. After leading two weeks of sustained rally, long-term inflation expectations are now fairly priced.

Despite the rise of market inflation expectations, our aggregated inflation risk factor has been trading in a relatively tight range since June 2009 after periods of inflation fears (summer 2008) and deflation worries (September 2008 till March 2009). So we remain between a high- and a low-inflation regime: the debate on the future shape of the recovery therefore remains open.
Click on chart to enlarge, courtesy of Societe Generale.
Interestingly, the economists at BNP Paribas looked at the ECB's assessment for inflation in the Eurozone yesterday:
With broad money growth collapsing and excess capacity likely to exercise downward pressures on wages and prices for another while, the ECB’s conclusion that risks of deflation in the eurozone are very limited extensively relies on the observation that inflation expectations are ‘well anchored’. But available measures of inflation expectations have a number of limitations:
  • First, at the current juncture, they are providing mixed indications, with business and consumer surveys (which however have a shorter horizon than other measures) decisively more downbeat than expectations derived from market or analysts’ surveys;
  • Professional forecasters’ inflation expectations are partly conditional on the assumption that the ECB will do what it is needed to comply with its mandate. Excessively relying on these expectations may lead the central bank to be complacent to possible shocks (‘paradox of credibility’);
  • While useful to provide a rough guide to trends in inflation expectations, market-based measures are not necessarily a precise indication of market participants’ inflation expectations. In particular, it is very difficult to disentangle the risk premium required to hold inflation, following the impact of the financial crisis; and
  • Last but not least, inflation expectations tend to respond to actual inflation. Persistently low inflation rates (our but also the ECB’s expectation over the next few months) could lead to a sudden fall in inflation expectations such as that feared by Mr Kohn in the US. We see this as the predominant risk at the current juncture.
Against this backdrop, the ECB’s current assessment that expectations are ‘well anchored’ may well be challenged over the next few months, revealing that risks of deflation are higher than currently suggested by the central bank.
But who knows? At the end of day forces of nature will win the wishful thinking ... Will currency help to reflate the US?

Wednesday, October 21, 2009

Get Ready For Parachutes

... cracks appear on the surface, but wait for decisive move below 1080 for S&P500 ...
They will try to do it right ...

Koo: Monetary Aggregates Behave Totally Different ...

I know, the out-smarts on the Wall Street will say that all bears should retire. Richard Koo, chief economist at Nomura and one of respected experts of Japanese balance sheet recession, wrote in the note yesterday:
Under normal circumstances, a given percentage increase in the monetary base by the central bank should produce an equal percentage increase in the money supply and in private-sector credit. But this relationship no longer held in Japan starting in the 1990s or in the US from 2008, as a shortage of both borrowers and lenders caused the money multiplier to fall to zero or even turn negative at the margins.

During such phases, central bank liquidity can help address certain financial problems, such as a dysfunctional interbank market. But it should not be expected to stimulate the economy. The fact that private-sector credit declined in Japan and the US despite large injections of liquidity by the Bank of Japan and the Federal Reserve suggests that these funds never reached the real economy because there were no willing borrowers or lenders.

Click on chart to enlarge, courtesy of Nomura.
Similarly, a reduction in the supply of central bank liquidity during such phases will have only a limited impact on the economy and the markets because a shortage of liquidity is not a constraining factor on the economy to begin with.
Bonus reflation in trading rooms and fear of currency debasement leads the monetary indicators and the life on the Main Street.

Tuesday, October 20, 2009

Merton And Dividend Yields

I spent the day focusing on Merton model and high dividend yields among staples, health, telecoms and utilities, as I prefer defensive tilt in my portfolio at the moment. Below 1080 for the S&P500 it would appear wise to raise cash from cyclicals, as economic surprise of green shoots, that counts only one way, has clearly rolled over ...

I still miss the euphoric exhaustion, if ever happens ...

Monday, October 19, 2009

Another Strong Opinion By Christopher Wood

Christopher Wood, the strategist at CLSA Asia-Pacific Markets, had another masterpiece of strong opinion in his appreciated "Greed & Fear" publication, that deserves to be quoted:

The above is a critical tactical point since in GREED & fear’s view policy in America has now become the key variable for Wall Street since the US, like China, is now an increasingly command-driven economy where government initiatives are driving such growth as exists. Investors in Asia are used to viewing China’s stock market as at least as policy driven as earnings driven. Investors should now do the same when looking at America. Investors will, for example, become nervous if they start to think that the Fed will actually end next March its programmes of buying US mortgage agency debt and mortgage-backed securities, as it has said it intends to. Remember that the Fed has so far bought US$925bn of US agency mortgage-backed securities since it began in January the related programmes of quantitative easing and so called “credit easing”.

We just miss the Mr. Lenin in play ...

Euroland Versus US In The House Of Goldman Sachs

"Global Economics Weekly" at Goldman Sachs was focusing on the differentiated global recovery last week, the US versus the Euroland in particular. Certainly, there are people who do not make any difference, but for me the chart below tells quite a lot ...

Click on chart to enlarge, courtesy of Goldman Sachs (note the scale does not start at zero).


Bylov: Global Intermarket Perspectives

Jan Bylov, chief analyst at Nordea Markets, is a "rare specie" among analysts, as he is looking himself at all asset classes and uses inter-market approach in analyzing the markets. He writes in the summary today:

Stocks – Earnings season and year-end buying

The US earnings season continues to surprise on per share basis, net income and sales. Clearly, this is motivating all those disbelievers of the global recovery, but it also appears reasonable to ask whether the ongoing year-end buying is occurring based on an improved macro background or not. As economic surprises apparently peaked this Autumn (see page 2) current stock buying appears more related to year-end buying due to Western equity allocations having been way too defensive and that investors embrace a sense of Goldilocks from low bond yields, a weak US dollar providing global liquidity, relative stable commodity prices, leading stock indices edging higher and central banks holding back their exit strategies. With the “surprise effect” probably peaking a 2010 extension appears related to support from absolute macro levels, but the ongoing bull market will remain intact until the occurrence of a reaction which exceeds the June setback in both time and size. We are structurally bullish.

Bonds – Euribor futures faltering

New yield lows in bonds and new interest rate lows in money market futures contracts are difficult to maintain. This not least illustrated by 3M money market futures in EUR and CHF breaking down from recent weeks’ trading ranges. Clearly, this suggests that traders sense that the odds for both ECB and SNB hiking in 2010 are rising – no matter that Australia is the only major central bank having hiked. With Fed, ECB, SNB and BOE still talking rather than walking the recent rise in yields and interest rates appears more related to perceptions and risk allocation towards cyclical assets rather than intensifying evidence that central bankers are providing tougher rhetoric for removing monetary accommodation! Overall, Bunds are edging higher and we continue expecting prolonged trading ranges in yields, and that the yield direction will oscillate between the popularity of two transient investment themes: 1) “supply fear and political discipline” and 2) “hesitating central bankers”.

Commodities – New highs… measured in USD and GBP

Industrial metals are underperforming precious metal, and new recovery highs are only observable when global commodity indices are calculated in the most disliked currencies of USD and GBP. Therefore, the absence of commonality still advocates that global commodity prices remain relative stable. Stability should support a continued global economic recovery!

Currencies – Valuations versus central bank divergences

The performance by world currencies in combination with currency style (i.e. carry, momentum and valuation) continue to support our perception that the price discovery is ruled by the never ending US dollar collapse theory and the central bank divergences of the world. Few challenge the idea that emerging markets are leading us out of recession indicating that ordinary people in emerging countries are puling out USD from their mattresses and exchange these savings into local currencies. Currencies that are characterized by momentum (LatAm & Asia) and economic prospects advocating continued carry (i.e. central bank divergence) as these countries hold the best odds for future interest rate hikes. With investors sensing a Goldilocks scenario any valuation consideration is neglected – not least exposed by the already extreme large speculative short USD positions. We hold on to our May -09 carry basket strategy of long BRL, TRY, RUB funded by CHF and CAD, and protective measures should slowly be tightened.

Historic performance of four main asset classes below, click on chart to enlarge, courtesy of Nordea Markets.

Friday, October 16, 2009

Reading Paul Kasriel - What Might Milton Friedman Have To Say?

Paul Kasriel, the chief economist of Northern Trust, has published the latest "U.S. Economic & Interest Rate Outlook" today. There are couple of interesting things related to Milton Friedman in the report. As Paul Kasriel writes:

Friedman’s inflation monetary phenomenon was related to the growth in the money supply held by the nonbank public, not the monetary base. After all, the monetary base soared in the early 1930s, albeit not to the extent that it did in the past year, even as the M2 money supply contracted at double digit rates...
See chart below, click on chart to enlarge, courtesy of Northern Trust.

Milton Friedman did not judge the growth in the monetary base in the early 1930s to be inflationary and it is doubtful that he would judge the recent explosion in the monetary base to be inflationary either given the lack of response in the broad money supply.
More interesting, in the course of "failed states", there are opinions related to government spending and deficits:

... The more funds the government acquires, the more productive resources it controls and/or directs. Given a finite amount of productive resources at any point in time, the more resources under the control of the government, the fewer resources will be left to be used by the private sector. As you will see the importance of it in a minute, the economy’s long-run potential growth rate basically is related positively to the growth in the labor force and the growth in the productivity of that labor force.

Let’s assume that an increase in government spending will be used to acquire resources for the provision of health care for retirees. Retirees, by definition, are no longer part of the labor force. Although a healthier senior population might result in lower golf scores for this cohort, it does nothing to increase the productivity of the current labor force. Thus, this increase in government spending does not positively affect the long-run rate of growth of the economy. It could conceivably negatively affect the long-run rate of growth in the economy. Remember, that the more resources controlled by the government implies fewer resources controlled by the private sector...

Only hope remains with us to believe that governments of "failed states" are wise enough....

Thursday, October 15, 2009

Let Them Retire In The Name Of Sweet Spot?

There is a clash of opinions out there, and the digitality of outcome makes people nervous, except those who know what will happen instead of what should happen.

Well, I made a cynical story out of Chinese pig farmers last month, and China is very likely blowing the bubble. It looks like Chinese farmers prefer copper over the rubbish consumer electronics?

However, Mike Shedlock went on to dig deep as possible into leading economic indicators, including the ECRI' s WLI.

Paul Krugman took over the awesome takedown to state:
I’d add that this is a really, really bad time to be relying on conventional indicators.
However, ECRI was quite quick to defend itself and reply:
Perhaps the intensity of the attacks today have more to do with the fact that so many (including hedge funds and investment advisors like Michael Shedlock) have missed the nearly 60% market rally since the spring, which makes it so hard to accept that ECRI’s leading indexes were correct once again.
Well, the difference is at what people look and where they are ready to put their money. That' s the questions of economic sustainability and value. This is quite well described by "The Daily Reckoning" under the "Roach and His Bearish, Pessimistic Attitude":

I would also ask the optimists what has changed in the global economy over the past year to make them so...optimistic. How does a huge increase in government debt do anything but provide a short term boost, masking long term structural problems? How can more debt solve problems caused by too much debt? How do they expect ultra low interest rates - which encourage consumption and discourage saving - to correct the imbalances?

I'm guessing the answers would have something to do with faith in governments and policy makers to get us out of this mess. The fact that they didn't see the mess coming doesn't seem to register.

Roach's analysis is far more realistic. He writes that, "This [government attempts to 'fix' things] is the same dubious script the world followed in the aftermath of the bursting of the equity bubble in the early part of this decade. And look how that ended. With far more excess liquidity currently sloshing over into asset markets, there is great temptation to erase the memories of the Great Crisis. Therein lies a pitfall for the markets - as well as for a still unbalanced post-crisis world.

Well, one should ask, even if the cyclical recovery of couple quarters is inevitable, is it worth to pay the premium for cyclical rebound, if, assuming the outlook for macroeconomic balance, it is not sustainable in long term?

Richard Koo, the chief economist at Nomura, wrote in the note yesterday:

It has been my practice in the past to focus more on the direction of economic activity than the absolute level. Given the dramatic changes in the level of activity during the current recession, however, I think we need to consider the possibility that past rules of thumb are no longer operative.

I concur wholeheartedly with Bank of England governor Mervyn King’s warning in August that we should focus on the level of economic activity and not the rate of growth. After all, there is no proof that improvements in familiar leading economic indicators will once again signal recovery.

People expected the worst after the Lehman shock, and sentiment improved sharply in response to massive government support measures. However, it will take a long time before the level of real economic activity rises enough to boost capex and employment. I therefore think it is dangerous to ignore the level of economic activity and focus exclusively on whether it is rising or falling.

Click on chart to enlarge, courtesy of Nomura.
Momentum feeds on itself, and do not underestimate the positive feedback loop ...
So, let them retire?

The Economist Writes "Baltic Brinkmanship"

The Economist.com has a story about Latvia on how outsiders, including the very own government, are wrestling with Latvia' s problems.

Merrill Lynch(ed): Global Fund Manager Survey

Bank of America Merrill Lynch published their monthly Global Fund Manager Survey yesterday. "The picture" looked like this in September. Key conclusions from the new October survey:

Bullish on equities, but no euphoria
The October FMS shows equities remain in a sweet spot: investors believe double-dip risks are receding, inflation is distant and risk appetite is rising (to +44 from +40). But bullishness is still not euphoric: the equity overweight (+38%) is below
danger levels (+50-55%), hedge fund’s net exposure remains low and investors
remain stubbornly underweight global banks.

New highs for profit expectations
Two-thirds of investors view a double-dip recession as unlikely (vs. 47% last
month). But two thirds also expect growth and inflation to be "below-trend". With
inflation and interest rates low, a net 72% expect higher corporate profits, the
most bullish reading on profits since December 2003.

Cash has left the building
The lack of a September correction (and perhaps also large corporate issuance) has forced investors to sharply cut cash balances from 4.1% in September to 3.7% in October. Asset allocators cut cash to 7% UW, the lowest cash allocation in 5 years. This benefited equities: the net % OW rose from 27% to +38%.

Europe rising from the ashes
Investors remain OW Emerging Markets. But Europe is the favoured developed market. 11% of asset allocators are OW, a massive shift from -40% in March. A
net 30% of global PMs view EU as the most undervalued region. In contrast,
panellists are giving up on Japan fuelled by perception of ¥ overvaluation.

Investors are still UW global banks
Despite strong performance in recent months investors turned more bearish on
global banks in October. Technology remains the favoured global sector; while
positioning in energy, industrials and materials all increased at the expense of
consumer sectors, with discretionary now the least loved global sector.

Dollar sentiment cracks but yet to plumb '08 lows
A net 20% of investors see the $ as undervalued, a sharp drop from September
but a long way from the 50% undervalued readings of spring 2008. In contrast
readings on yen overvaluation are extreme by historic standards and suggest
Bank of Japan currency intervention would have some success.

Pain trades galore
For uber-contrarians the October FMS offers the following trades: long T-bills,
short EM equities; long Japan, short EM or EU equities; long consumer disc.,
short materials; long utilities, short tech; long UK, short EU equities.


I was looking for the microscope to see all those trillions of cash on sidelines. Well, if seriously, there should be no less cash on sidelines even if equities are 20% higher, except the case we see heavy new issuance.

Wednesday, October 14, 2009

Reading Hoisington's Ponzi Finance

These are two different worlds - real time action in equities and the deep deflationary thoughts at Hoisington. This time the quarterly review and outlook is labeled "Ponzi Finance". Everyone is advised to read the entire report. However, I will quote the opinion on the "USD debasement effects":

The inflation outlook from the monetary and fiscal standpoint looks truly deflationary, yet some believe that dollar weakness will reverse this circumstance and create inflation. This is unlikely. First, our imports are about 13% of GDP, and even if the dollar were to halve in value, the price of imported goods would not only have to compete with U.S. producers, but also their price adjustment would have to offset the other 87% of factors included in the pricing indices. Second, unlike the 1930's a 50% decline in the dollar would be difficult to engineer. Fisher recommended to Roosevelt that the U.S. should exit the gold standard, which he did in April of 1933. That was a fixed exchange rate system, and within three months the dollar lost more than 30% against the gold block countries and fell to 60% of its former value within the next five months. This spurred our exports and provided some price inflation (2.9% per year, GDP deflator) for the next four years. Then, in 1937 the tax increases (the next policy mistake) reversed the positive growth rate of the economy and drove price levels and economic activity downward again. However, even with that small period of price increases the overall price level never recovered from the 25% decline that occurred from 1929 to 1933, and thus deflation reigned. Today the declining dollar is a good thing in terms of our trade balance, but the modest change will be insufficient to offset the negative forces of insufficient domestic demand.

Next year the core GDP deflator will fall to zero, with the possibility of negative levels.

Ooops! Dow Jones re-knacks 10,000 mark, what a festivity at media outlets!

Tuesday, October 13, 2009

French Keynesians Or Why The US Fights The Secular Force

This is a topic I wanted to write already months ago. Last time I touched this issue was, I suppose, this one in August.

Now I have got the time and an excellent research note from the economists at Societe Generale they wrote back in mid-September. Here is the quote in full:

Higher savings needs higher income and flatter income distribution.

Another secular force that helps to explain long-term movements in savings is the income distribution. Recently, distribution statistics of 2007 income became available, revealing the most skewed income scales in the US since the 1920s, or in some cases even exceeding the 1920s. For example, the top 10% of earners (incomes above $109,630) took in 49.7% of total US income, the highest on record. The top 1% of earners (incomes above $398,909) took in 23.5% of total income, the highest ratio since 1929. These peaks tend to coincide with secular troughs in savings trends.

The peaks in income skewness – 1929 and what is likely to be 2007 – tell us that there is something fundamentally unsustainable about an excessively uneven income distribution. The key lies in the fact that consumption distribution tends to be far more stable. Maintaining steady consumption shares as income shares shift dramatically can only be achieved via expansion of credit from the rich to the poor. This can continue only up to a point, until middle-class incomes can't support any additional debt.

Click on charts to enlarge, courtesy of Societe Generale.

Cross-sectional data also supports a strong relationship between savings and income distribution. France, with one of the flattest income distributions in the western world happens to have one of the least-leveraged household sectors.

The other side of the story is that the top earners in periods of uneven income distribution have tended to invest their excess savings in very inefficient ways. For example, in recent years the savers have financed the excess expansion of housing stock via purchases of mortgage bonds and other indirect investments into the financial sector. Had those inefficient investments never been made (or had the savings been channeled into more productive investments), the savings transfer and a build-up of debt would not have gone on as long as it did.

The moral of the story is that at some point an uneven distribution of income becomes unsustainable because there is no-one left to consume. In the end, the market tends to force an adjustment as it did in 1929 and in 2008. Though these adjustment periods are painful for everyone, the wealthy suffer disproportionate income losses. These include not only lower pay, but also capital gains losses which can wipe out accumulated income earned in previous years. When 2008 figures become available, we are likely to see a significant reversal of fortunes.

If historic relationships continue to hold, the anticipated secular rise in the savings rate will likely be accompanied by a flattening income distribution. Whether these will be market-driven or policy driven trends remains to be seen. However, there is little doubt that deleveraging of household balance sheets requires not only higher incomes overall, but in particular for the middle-income households with highest debt burdens.


Correlation does not mean causality? Well, let's put all, including foreign, resources to fight the secular forces of "Mother Nature"?

Monday, October 12, 2009

Fed Praying The Reflation Trade Is Not Slipping Out Of Hands?

Anonymous commenter reminded me about the reflation in the context of Fisher's Debt Deflation over the weekend. Irving Fisher wrote:
Assuming, accordingly, that at some point of time, a state of over-indebtedness exists, this will tend to lead to liquidation, through the alarm either of debtors or creditors or both. Then we may deduce the following chain of consequences in nine links: (1) debt liquidation leads to distress selling and to (2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes (3) a fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be (4) a still greater fall in the net worth of business, precipitating bankruptcies and (5) a like fall in profits, which in a "capitalistic", that is, a private-profit society, leads the concerns which are running at a loss to make (6) a reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to (7) pessimism and loss of confidence, which in turn lead to (8) hoarding and slowing down still more the velocity of circulation.
The above eight changes cause (9) complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.
So, the focus seems to be on "Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise ...". And any weakness in corporate profits is not in cards, as it is better to sink the state than give up in fighting the deflation?

The economists at BNP Paribas wrote on USD carry trade and inflation last week, with a summary:
Owing to the risk of succumbing to deflation, the G3 are expected to maintain their super-low interest rate regimes.
The effects of these regimes could spill over into the emerging economies via carry trades shorting the dollar, possibly resulting in a renewed surge in commodity prices in the event that emerging economies overheat.
If a currency like the dollar, the global standard for settlements, is shorted in massive carry trades, the macroeconomic impact would dwarf that of the yen carry trades, as the dollar could plunge and commodity prices could skyrocket.
The US could then go from facing deflation to facing surging prices from imported inflation and, if this were to rekindle problems plaguing the US financial system, the Fed could again be faced with the dilemma of having to choose between stabilising prices or stabilising the financial system.
However, Fed should be praying that they are in control of, especially, food and energy prices (what they usually are not, as they exclude exactly the food and energy inflation from their focus on core inflation). The economists of BNP Paribas wrote in explanation:
There is a risk that, at some stage, the dollar could plunge and commodity prices could skyrocket. At that time, the macroeconomic impact would dwarf that of the yen carry trades. The US could then go from facing deflation to facing inflation due to dollar carry trades swelling to the point of triggering imported inflation. And with this imported inflation eroding real purchasing power in the US, thereby becoming a constraint on the economy, there is a chance that problems plaguing the US financial system could be reignited. The Fed would then be faced with the dilemma of having to choose between stabilising prices or stabilising the financial system. This is one risk scenario currently facing the FX market.
We have short memory? Will we notice the rise in food prices? Car makers, very likely, will...

There is much more of the alike discussion at FT Alphaville...

Bild.de: Knackt der Dax die 6000er-Marke?

There is no reason to be bearish, as Bild.de speculates:
Knackt der Dax die 6000er-Marke?


Who said that tops are usually marked by false breaks?

Bylov: Global Intermarket Perspectives

Jan Bylov, chief analyst at Nordea Markets, is a "rare specie" among analysts, as he is looking himself at all asset classes and uses inter-market approach in analyzing the markets. He writes in the summary today:

Stocks – The power of Goldilocks

Earnings season has begun well while macro economic surprises apparently peaked during September. Now, in absence of a new and stronger macro economic theme why are investors and speculative futures traders responding by buying so heavily? Well, we maintain that the dominating reasoning is found in that fact that most investors have been disbelievers of the recovery and hence underperforming severely! Consequently, with Goldilocks of low bond yields, a weak US dollar providing global liquidity, stable commodity prices, leading stock indices dominated by higher reaction lows and central banks holding back their exit strategies then underweight investors facing year-end are being pressured to allocate more capital towards global equities! The bull market will remain intact until the occurrence of a reaction which exceeds the June setback in both time and size. We are structurally bullish.

Bonds – Walking or talking!

Aside from Australia who recently hiked the official interest rate no leading central bank has yet walked the walk but rather talked the talk, and interestingly Fed’s liquidity operations are still causing investors to load up bills and short duration bonds… no matter the talk of governors! Volatility in treasuries is much bigger influenced by the anecdotal evidence from numerous research reports/opinion makers on an intensifying global debate about the timing and tools necessary to normalise the unusual historic monetary accommodation. A path which also includes a fight between central banks’ independence versus policy makers daring to reduce deficits. For now, leading central banks are talking the talk and postponing their exit strategies as they fear the Japan scenario and the public uproar about the government deficits. Just “talking the talk” should support bond prices and Friday’s selling was probably as much about asset allocation towards equities as it was about Fed talking! We continue expecting prolonged trading ranges in yields, and that the yield direction will oscillate between the popularity of two transient investment themes: 1) “supply fear and exit strategies” and 2) “high real yields and hesitating central bankers”.

Commodities – Precious metals the only real mover

Gold is breaking up from an 18-month range advocating a continuation of its long-term bull market! Now, aside from precious metals global commodity price remain quite stable in all major currencies, and they haven’t been able to produce and maintain new recovery highs since June. This stability should remove a concern to a continued global economic recovery!

Currencies – Central bank divergence

We have revised the overall dominating transient investment themes of the US dollar: 1)“the US dollar collapse theory” (unchanged) and 2) “central bank divergences of the world". Theme 2 has been altered as anecdotal evidence from numerous research reports/opinion makers suggest an intensifying global debate about the timing and tools to normalise the unusual historic monetary accommodation. A path which also includes a fight between central banks’ independence versus policy makers daring to reduce deficits. The global perception of central bank divergences continue to see an escalating and historic extreme short position in USD and GBP! Now, the current Goldilocks scenario continue to favour cyclical risk and rejection of historic valuation considerations as investors remain overwhelmed by the desire for carry and the feel-good factor of momentum! We too hold on to our May -09 carry basket strategy of long BRL, TRY, RUB funded by CHF and CAD, and protective measures should slowly be tightened.

Historic performance of four main asset classes below, click on chart to enlarge, courtesy of Nordea Markets.

Sunday, October 11, 2009

UPDATED: Classic "Text Book Recovery" Of US Housing

While reading the latest "bear warning" on "gigantic error of pessimism" from ECRI, one should have noted that US Weekly Leading Index "was pushed up by strong housing activity".

It just happens that Calculated Risk has compiled some facts and opinions on the policy of supporting house prices. It is definitely worth reading the original post in full. I excerpt here some key messages:

As Representative Frank notes, the policy of the U.S. appears to be to support asset prices at almost any cost. This includes:

- The FHA insuring "bad loans" for buyers with a high probability of default.
- The first-time home buyer tax credit (the FTHB makes no sense from any other economic perspective).
- Delaying foreclosures, first with moratoriums and then with "trial modifications".

We could probably include the Fed buying GSE MBS to lower mortgage rates, and other policies like increasing the "conforming loan" limit to $729,750 in high cost states.

Intentionally encouraging loans with high default rates (insured at taxpayer expense), and the FTHB tax credit (especially allowing buyers to use the credit as a down payment) have stimulated demand. And delaying foreclosures has restricted supply.

Well, there are some other games in play too. First of all, I really appreciate the "earnings recovery" story at banks, some of "organic drivers" are listed by Calculated Risk. However, at the end there comes the sustainability of feeding the corporate profits with taxpayer money, but I will focus on that during next week ...

With this kind of government capitalism I just thought to ask why markets dislike investing in Venezuela?

Obviously, the central belief is that government can control everything, until someone probably recognizes that it cannot (e.g., velocity of money, or on the other side of spectrum - reflation running like the process of unintended panic of currency debasement; just random thoughts)? Or even further out, the current state will be flushed down the closet in the name of corporate profits?

UPDATE: It is worth reading also "A Bounce? Indeed. A Boom? Not Yet" by Robert Shiller at The New York Times. The conclusion at the end is:

WHAT should we conclude? Given the abnormality of the economic environment, the sudden turn in the housing market probably reflects a new home-buyer emphasis on market timing. For years, people have been bulls for the long term. The change has been in their short-term thinking. The latest answers suggest that people think the price slide is over, so there is no longer such a good reason to wait to buy. And so they cause an upward blip in prices.

At the moment, it appears that the extreme ups and downs of the housing market have turned many Americans into housing speculators. Many people are still playing a leverage game, watching various economic indicators as well as the state of federal bailout programs — including the $8,000 first-time home-buyer tax credit that is currently scheduled to expire before Dec. 1 — in an effort to time their home-buying decisions. The sudden turn could signal a new housing boom, but is more likely just a sign of a period of higher short-run price volatility.



Friday, October 09, 2009

SocGen On French Manufacturing, ECRI's Latest Bear Warning

The economists at Societe Generale are wondering about French manufacturing today, click on chart to enlarge, courtesy of Societe Generale.

In the meantime, the ECRI has issued a bear warning:

October 09, 2009 (Reuters) - NEW YORK, - As the U.S. economy rebounds from a long-running recession, a weekly leading index of future growth released on Friday showed the annualized growth rate hitting a record high.

The Economic Cycle Research Institute, a New York-based independent forecasting group, said its Weekly Leading Index rose to 128.3 in the week to Oct. 2 from 127.1 the prior week.

The index's yearly growth rate rose to new all-time high of 26.1 percent in the
latest reading, from a revised 25.0 percent the prior week.

"With WLI (Weekly Leading Index) growth rocketing to a new record high, the economic recovery will prove to be far more resilient in coming months than most believe possible," said Lakshman Achuthan, ECRI's managing director.

"The risk of a double dip (recession) is very low,"Achuthan added.

The index was pushed up by stronger housing activity, he said.

Robert DiClemente, the US economist at Citigroup, added today:
The absence of a strong leading role from consumers does not undermine prospects that recovery will be sustained. Slow and steady improvements in financial markets are closing off risks of a renewed slide.
The supremacy of financial markets and mechanical monetarism will make the trick. Equity bears are punished this week for "gigantic error of pessimism". Just put every bear on government steroids and they will dance!

Thursday, October 08, 2009

Krugman Still Chasing The Shadows

Well, I do not know who is chasing what?
But the chart from BNP Paribas shows quite clearly what is the problem of credit markets! Click on chart to enlarge, courtesy of BNP Paribas.

Reduce debt and/or increase income. Asset reflation is not the same, for most, as income ...

Chinese Credit Festivities

While we celebrate the re-birth of the US consumer, let's look at Chinese winds - what are they blowing? Well, US stock market appears more enthusiastic about materials and energy, less so consumer discretionary titles, at the very moment.

Finally, even the economists at Citigroup Global Markets have noticed the credit boom in China, and are wondering today - How Long Would It Last? First of all, reading the first two paragraphs of summary:

China’s credit growth could decelerate next year, but it’s unlikely to return to “normal” in the near term.

Recently, Chinese officials emphasized the need to maintain a “sustainable level” of credit growth. This could imply around 33% yoy, or Rmb10tn in new loan growth for this year. The unprecedented credit boom lifted the Chinese economy out of its downturn by mainly boosting investment in the state sector.

Interestingly, according to Citi economist, "maintain "sustainable level"" in Chinese means now "unlikely to return to "normal"'.

Further on, the final sentence of summary describes our inevitable destiny:
A continuing credit boom will surely encounter asset price bubbles or CPI inflation, or both in the coming months, in our view.
Obviously, Chinese pig farmers are no fools and know the rules of "asset reflation" even if economic momentum fades. They are hedging the debasement of renminbi by purchase of copper stockpiles? But why are Americans worried about the debasement of US dollar? Well, this is, of course used by smart people (Masters of Mechanical Monetarism) to print the "economic recovery story".

The chart below is supposed to show how stunning growth in credit and money supply in China is hopefully providing the so needed medicine to falling growth of nominal GDP. Click on chart to enlarge, courtesy of Citigroup Global Markets.

As we know, according to Citi' s analysts, the inflation and asset bubbles are our destiny. However, the leading indicator of Shanghai stock exchange is struggling to confirm? Click on chart to enlarge, courtesy of Citigroup Global Markets.

It may be curious, but equity strategists at Nomura were puzzled about the Hong Kong stock exchange yesterday:

In fact, we are puzzled why investors have not questioned more the underperformance of the equity market relative to the build-up in liquidity. Certainly, the underlying strength in the balance of payments has been real and this has forced an easing in domestic monetary conditions. With a rebound in re-exports, ongoing confidence in the Chinese economy and relaxed US monetary policy, in some respects the stock market should have done a lot better. Moreover, it is beginning to underperform the more cyclical economies, such as Korea’s.

Equity’s underwhelming performance relative to changes in the balance of payments is even more stark when compared to previous economic cycles and the recent decline in the greenback. There are a number of reasons. Firstly, real interest rates are still high as deflationary pressures are still passing through the economy. Secondly, the lending cycle remains modest in comparison to previous cycles and household gearing remains low. Thirdly, financial leverage in the equity market is muted in comparison to 2007 as warrant turnover attests. Hence, there has been neither a multiplier from domestic lending or through financial leverage.

Yes, watch that outperforming market of Korea ...
Who knows? Let's party till it lasts ...

Wednesday, October 07, 2009

Deutsche Bank In The Sweet Spot But Upside Remains On The Table

Equity strategists at Deutsche Bank updated their equity baskets yesterday, the description of economic background is "sweet":
DB is optimistic about the economic outlook DB’s economists believe we have now entered the ‘sweet spot’ for the global economy. A slowing rate of inventory reduction, ongoing fiscal stimulus, easing credit conditions and continued loose monetary policy have stimulated a faster than- expected recovery in GDP growth. As a result, over the last six months, both DB and the Street have moved from cutting GDP forecasts to raising them significantly. Despite this swifter growth, however, significant spare capacity means unemployment is still rising (albeit more slowly) and the inflation nemesis remains subdued. Policy action is likely to remain accommodative therefore. DB expects the Federal Reserve to keep rates low until unemployment has clearly turned, so rates should remain unchanged until at least late 2010. In Europe, we expect the ECB to start raising rates in H2 2010.
The current ‘sweet spot’ could persist for six to nine months or longer The sustainability of current conditions remains the unanswered question. It’s likely that by H2 2010, fiscal stimulus and an end to de-stocking will be weaker drivers of yoy growth. By that time, a pick-up in private demand will likely be necessary to drive sustained economic recovery. Visibility remains low on this eventuality. However, if economic data continues to generally surprise on the upside, the likelihood of such a scenario increases. If correct, further upgrades to consensus earnings estimates are likely. We do recognise, however, that there are significant top-down risks. If higher inflation causes central banks to tighten monetary policy sooner than expected or if the recent economic improvement proves to be a false dawn, then a fall in the value of our equity baskets is likely.
Who should care about sustainability, if "the upside remains on table"? Equity buyers prefer "the upside" rather than sustainability concerns?

Well, the strategists at HSBC see the US economic surprise rolling over:
Read the following sentence twice. It is a cardinal error in investing to confuse the cyclical with the secular. Evidence of a cyclical upturn in the developed world shouldn’t be confused with structural health. And there are three signs that the cyclical recovery might be running out of puff.
Click on chart to enlarge, courtesy of HSBC. I would say that J.P.Morgan had a similar call on economy, but remained optimistic on blind bull running ...

Technology freaks should have all eyes open and bet on Windows-7 release, according to equity strategists at Deutsche Bank:
In recent weeks there have been a number of supporting instances of newsflow that further fuels our view that the Windows-7 release will drive a powerful upgrade cycle impacting the software, semis and hardware technology sectors. These data-points have included;
Micron Technology; flagged on 30th September that the “bit content per box” would grow in 2010 riding on the Win-7 release which is particularly encouraging for the memory segment of the semis market. Further, AMD, Broadcom and Marvell flagged order stability which generally reads well for the PC market.
Microsoft flagged in late September that Ford, Continental Airlines, Starwood and Intel have all announced intentions to upgrade to Win-7. Specific details of planned upgrades were not released but this paves the way for the beginning of the corporate upgrade cycle to commence.
Intel in earlier September indicated that corporate PC demand is likely to rise in 2010 driven by an ageing installed base and the release of Windows 7.
Finally, checks by DB US IT hardware analyst Chris Whitmore (“PC cycle to turn” – 22nd September) indicated that Q309 was tracking better than expected. These checks, coupled with the view that macro-recovery in 2010 will help drive PC replacement, encouraged an upgrade to PC expectations for 2010 – from 0% growth to +10% growth year-on-year.
Because Vista is such a disaster? I am also announcing my right to upgrade free of charge, because of mal-investment in Vista!

No wonder that there is an explosion of USD debasement fears, and weaker hands grasping for gold ... to keep the rally alive one needs to expose the "asset reflation", if economic surprise fails? I do not like conspiracy theories!

Tuesday, October 06, 2009

Edwards: Japan Still Leads ...

Albert Edwards, the top ranked strategist at Societe Generale, writes today:
I have long believed that a post-bubble world would play out in a very similar fashion to Japan's lost decade of the 1990s. To be sure there are huge differences, but the similarities are also surprisingly close. Bubbles have a habit of playing out in a certain way.

I remind readers of a few simple key facts that continue to nudge me towards the view
that the Western authorities are set for dismal failure in their attempts to atone for being asleep at the wheel.
and this is key mssage, in my view:
The de-rating of Western equity markets from their New Paradigm highs is still unfinished business. In Japan it took many cycles to fully purge their excess valuation. I have a clear and vivid recollection that at the peak of each mini-cycle, market strategists protested that equities were so very cheap they couldn't possibly de-rate any further; yet they did (see chart below).

However, allow him for:
But let me be humble for just a second. One question I am often asked at the end of a presentation is “how will you know if you are wrong?” Resisting the temptation to totally reject this possibility, I think perhaps I can identify one thing that might indicate this post-bubble world had defied the law of gravity and was reinflating again. Back in the early 1990s minicredit crunch it was not until the middle of 1993 that private sector demand for credit began to grow (supply was not a problem as banks were already healthy). To gauge whether the world economy can surprise and escape this balance sheet recession, keep a very close eye on the bank lending numbers. They may hold the key.
John Hussman also wrote quite interesting commentary yesterday, I would like to point out this one paragraph:
Probably my clearest drawback as an investment manager is that I have too often assumed that investors should recognize what seemed to me to be patently obvious dangers (the predictable collapse of the dot-com bubble, the tech bubble, the housing bubble, the oil and commodities bubble, etc) with a longer lead-time. Unfortunately, we inevitably experience a period of frustration – at least temporarily – for assuming such foresight. Still, none of those has caused trouble for us like they did for the rest of the world. Sustainable long-term returns require the avoidance of major losses, and the best way to avoid major losses is to avoid a) securities where the probable long-term cash flows do not justify the price, and b) markets where the probable returns from accepting risk are unlikely to be durable. There are a lot of investments that can be bought for short-term speculation that fail this test, but advance anyway - until they don't. The most important lesson I keep having to re-learn is how utterly myopic investors can be when there's an uptrend to be played.
There is still an uptrend to be played!

But below 990 for S&P500 one should have a clear picture, why the game ...

Monday, October 05, 2009

Danske Concerned About The Ongoing Dispute Between International Lenders and Latvians

A brief background story of latest political developments in Latvia you will find at MSN News.

The full note from Danske Bank on the current standing is available here, but the key message as follows:
Consequently, we are in a stand-off situation where the lenders seem to have tied themselves to the mast by refusing to change the loan terms, while at the same time the borrowers fail to show the political will to comply with these terms. Something has to give – in this case the ball seems to be in Latvia’s court – in order for the situation to be resolved.

A major Swedish newspaper has during the weekend published an article alleging that the Swedish Finance minister has contacted the management of Swedish banks with large Baltic exposure and warned them of an imminent collapse in the talks in Latvia. Moreover, the same article states that the IMF is pushing hard for a devaluation as the only viable solution. The contents of the article have not been confirmed by any government source, and must therefore be considered as hearsay until further notice.

No later than 23 October the Latvian government must submit its budget proposal for 2010 to the Parliament. The Latvian Parliament thus has another 2.5 weeks to gather support for further austerity measures, or face the consequences of failing to meet with its obligations.
Here are the Swedish links ...