Monday, November 30, 2009

Secret Predictions By Swiss Watchmakers

Following the old traditions, the obligatory predictions for the next year are piling up. Now it is the turn of well known Swiss house of UBS. The economists and strategists have the following asset allocation outlook for 2010:
Squaring the portfolio paradox: Risk re-allocation
Equity and credit valuations are ‘fair’, global growth remains uneven, and in 2010 market volatility may increase. Yet we opt to increase allocations to equity, credit, commodities, and real estate for 2010. Why? A gradually improving global economy and the prospect of higher policy rates undermine the case for government bonds, nominal and inflation-linked. Cash returns remain unattractive. Stocks and corporate bonds are likely to out-perform, along with commodities and selected REITs. But in a world of lower returns and higher volatility, increased allocations to ‘risk’ assets only makes sense if accompanied by a lower cyclical profile in terms of sector and style. Squaring the portfolio paradox (lower risk-adjusted returns but higher allocation to risk assets) requires a redistribution of risk within the portfolio.

What to avoid: Bond markets

By early 2010 investors will anticipate the end of the Fed’s ‘zero-rate’ policy and will expect rate hikes elsewhere, as well. Rising short rate expectations will push up bond yields, as well as bond market volatility. The appropriate asset allocation is to reduce bond holdings and shorten duration in fixed income portfolios.

Milestones and catalysts

Important investment signposts include a peaking of US unemployment (by Q1 2010), validation from the Fed and other central banks that growth is sustainable (by Q2 2010), and healthy corporate profits growth (Q4 earnings season). Upside risks to our view include the advent of asset price bubbles (above all in Asia). The chief downside risk remains a faltering US recovery.

Revised asset allocation

Our revised allocations are as follows. We increase overweight allocations to global equities and high-yield corporate bonds, and move REITs and ‘soft’ commodities from market-weight to overweight positions. We reduce our government nominal and inflation-linked bond weightings to underweight. Finally, we retain our maximum underweight position in cash.
Click for graphical depiction of asset allocation, courtesy of UBS.

Sounds very much like consensus bank reflation case...

Global Intermarket Perspectives And Questions About Value Of Implicit Policy Guarantees

Let's start with Jan Bylov, chief analyst at Nordea Markets, who 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 Dubai aftershock

Year-end is fast approaching and liquidity is drying out alongside; hence, intraday price moves can increase as we witnessed with the Dubai aftershock. And most likely, the Dubai incident is an aftershock tightly related to the well-known and well-analysed global credit and real-estate crisis, and we find that the market impact from an incident which finds its root in a now well-known problem keeps decelerating on every new aftershock! Further, in spite of the many prominent market pundits calling for a recovery peak global stock markets are holding up well, and just maybe people are underestimating that surviving companies have never been so lean and mean and capable of making profits as illustrated during the latest earnings season. Also, the shadow of the old “Goldilocks” remains evident as: bond yields are low and ranging, the US dollar remains weak suggesting still amble global liquidity, commodity prices not soaring, leading stock indices confined within consistent post March uptrends and major central banks erring on the side of dovishness. Consequently, we remain structurally bullish, and an unusual large setback remains necessary to cause a real worry.

Bonds – Fight between “inflation” and “deflation” believers

The wider consequences of the public intervention to halt the credit and real estate crisis are debated intensely, and judged by internet activity the fight between “inflation” and “deflation” believers is gathering momentum (see page 2). Now, when looking at US mutual funds flows hoarding of bonds are taking place at an unprecedented magnitude, while abandoning stocks! Is this disillusioned baby-boomers or true investor fear of deflation as so many people don’t believe in the global 2009 recovery? And are we witnessing the build-up to the mother-of-all and 1994-like long bond market squeeze? Clearly, “deflation” believers dominate with 2y yields trading at the lowest levels since January 2009 and 10y yields edging lower, and we continue to believe that this group of market participants are receiving a tailwind from the primarily dovish statements from Fed, Bank of England, ECB and the IMF… centred on the timing of “exits” should err on the side of further supporting demand and financial repair. Overall, we maintain that the yield direction will continue to oscillate between the popularity of two transient investment themes: 1) “supply fear and political discipline” and 2) “hesitating central bankers”. Market action continues to back theme #2.

Commodities – Overall recovery remains on track

Intraday volatility aside, the overall commodity recovery remains on track and apparently also lifted by Money Managers (speculators) building long commodity exposure. This raises the risk of a long squeeze – not least in oil and gold – but with investors still embracing “Goldilocks” and the price uptrends intact then we continue to favour sideways to higher prices.

Currencies – US dollar downtrend intact

Characteristics of Peak Performers advise us to spend more time on market observation and less on prediction! Pursuing this doctrine we believe we can observe: 1) the post March 2009 consistent USD downtrend remains intact and 2) shorting of USD is a crowded trade and 3) global central bank divergence is against USD and 4) the “Goldilocks” theme works against USD. Therefore, we believe that it is premature to cancel the prospect for USD still heading for the 2008 lows! Consequently, we hold on to our May -09 carry basket strategy of long BRL, TRY, RUB funded by CHF and CAD… with a protective stop (profit) now close to spot.

As usually, the look at four main asset classes provides an insight into longer term "performance pressure". Click on chart to enlarge, courtesy of Nordea Markets.

So far, so good! Now, close your eyes and read the comment by Lena Komileva, the Head of G7 Market Economics at Tullett Prebon, today:
The market is trying to draw the line between widespread risk-asset contagion and selective credit default. The difference between the present environment and 2008 is that there is a broad-based policy liquidity hedge in place and financial institutions are able to refinance risk even in shakier markets as central bank balance sheets have become the antifreeze for capital markets dysfunction. This leaves deteriorating institutional perceptions of credit risk to compete with favourable broad market liquidity conditions glued together by a global implicit policy guarantee. This has already prompted investors to look for value following last week’s risk shake-out even as they exit richer asset valuations. Yet, in the long run, the market's ability to withstand losses depends on the depth of the implicit government bailout for financial credit risk. The main lesson from Dubai and Greece is to question the value of the implicit public sector guarantee assumed across highly-leveraged assets, even if these are assets of systemic importance. Increased market risk sensitivity will remain a theme into 2010.
Isolated questions? Recovery in Spain, for example, for some time in the future ...

Friday, November 27, 2009

Broken Arrows And Contrarians

In fact, it does not matter whether Dubai goes broken or not, if the world sees it as a singular event ... Abu Dhabi, the sandy oil brothers, already own Dubai's iconic Burj Al Arab hotel. So, nothing new in that regard. The only thing that matters in the global picture is whether this has an impact on the view of global recovering.

Markets have shown technical non-confirmations for some time now ... and Citi's US Economic Surprise index has turned down too.

Click on chart to enlarge, courtesy of Citigroup Global Markets.
Contrarians, whatever sort of them, have their own game, also today.

For example, Citigroup Global Markets were musing in their latest European Portfolio Strategist:
Contrarian strategies work well at turning points. We have seen a major turning point in 2009. Investor sentiment swung wildly from depression fears to recovery hopes. The Survivors Party brought with it the return of the “baggers”.

But, contrarians are insatiable. Looking ahead to 2010, they will be looking for another major turning point for the global economy and for financial markets. But, by definition, such turning points do not occur that often. That is why contrarians can struggle for years before enjoying the fruits of their strategy.

While at the end of last year we saw the building case for a contrarian investor,
it is more difficult to see clear leadership from our contrarian and momentum baskets into 2010. We believe contrarian investors will not enjoy the same level of outperformance. We suspect that 2010 will be a more even battle.

The longer-term contrarian position is perhaps more interesting. The patient
(10-year) contrarian would be buying equities, big-caps and growth but selling emerging market equities. That is a big contrarian call. Time will tell. But, for now we disagree and think that emerging markets continue to offer investors the best route to growth in a lower growth world.
Unlike with TMT at the end of the 1990s, emerging market equities do not look expensive currently. Valuation is often one of the key ingredients to a successful contrarian strategy. Selling TMT at the end of 1999 and buying the 2009 risk trade (eg ultra-cheap Banks) were both helped by extreme valuations. At 2x price/book, emerging market equities do not look cheap or expensive enough for contrarians to make a big call on.
Do you know what kind of contrarian are you?

Thursday, November 26, 2009

Giving Thanks To Dubai's Moment

Stocks Slump, Bonds Rise as Dubai Roils Markets today, according to Bloomberg ... and affected species are trying to get out.

Otherwise, I read wise words of Michael Pettis and think of consumption crisis and bank bail-outs in the West:

The low deposit rates mean that Chinese savers are effectively being taxed to replenish bank capital. Although this may be necessary in order directly to maintain the health of the banking system, it indirectly undermines the banking system in another way. By forcing Chinese households not only to subsidize China’s very low cost of capital for producers and SOEs, but also to protect the banks from the effect of economically non-viable policy loans, Chinese households are bearing a pretty hefty share of the cost of China’s investment-led boom, and it is these same households whose surging consumption will be necessary to absorb the increased production resulting from the investment boom.

Given the increased financial burden being placed on them, I doubt that they will be able to do so. After all, it is because of lesser versions of these same policies in the past that the enormous gap between production and investment exists in the first place. And if they cannot raise their consumption sharply to absorb all this additional excess production, the banks will be stuck financing rising inventory and unprofitable companies. It’s a vicious circle.

Here are couple of links for China lovers:
European Union Chamber of Commerce in China, Overcapacity in China: Causes, Impacts and Recommendations;
Yu Yongding at Australian Government, Productivity Commission, China's Policy Responses to the Global Financial Crisis;
Citi's Nightmare on Commodity Street

High stakes at make or break ...

Wednesday, November 25, 2009

Gaming The Goldilocks?

Let's start with "gaming", i.e., the game theory, according to Jeff Saut of Raymond James on Monday:
Nevertheless, we think the upside should continue to be driven by “game theory,” which suggests that the under-invested institutional portfolio managers have to buy stocks into year-end driven by their under-performance, their subsequent “bonus risk,” and ultimately their “job risk.” Verily, many of the portfolio managers we know remain under extreme pressure to commit their outsized cash positions in an attempt to “catch up” to their benchmarks between now and year-end ...
State Street Global Markets, the investment research and trading arm of State Street Corporation, yesterday released the results of the State Street Investor Confidence Index® for November 2009. Among others it reported:

Global Investor Confidence fell by 7.6 points to 100.8 from October’s level of 108.4. The most pronounced decline was evident among Asian investors, where confidence fell 4.1 points from 95.3 to 91.2. In other regions, confidence was somewhat more upbeat. The risk appetite of North American investors was largely unchanged, ticking up 1.1 points from 101.1 to 102.2. European investors struck a somewhat more optimistic note, and their confidence rose 3.7 points from 101.8 to 105.5. A reading of 100 in the Index represents a neutral level where institutions are neither allocating towards nor away from risky assets.

Developed through State Street Global Markets’ research partnership, State Street Associates, by Harvard University professor Ken Froot and State Street Associates Director Paul O’Connell, the State Street Investor Confidence Index measures investor confidence on a quantitative basis by analyzing the actual buying and selling patterns of institutional investors. It is not a survey, but rather fact-based. The index is based on a financial theory that assigns precise meaning to changes in investor risk appetite. The more of their portfolio that institutional investors are willing to devote to equities, the greater their risk appetite or confidence.

“Across all regions, institutional investors are largely treading water; neither increasing nor reducing their aggregate holdings of risky assets,” commented Froot. “However, the aggregate figures mask some country- and region-specific views...

Click on chart to enlarge, courtesy of State Street.

Fed's FOMC Minutes yesterday almost promised the continuation of the sweet Goldilocks fairy tale.

The real institutional money so far seems rather neutral for games. Send the clowns in to play the game? Why those Goldilocks and charts by Japanese candlestick watchers remind me too of 2007?

Reading Basics Of Financial Psychiatry

Heavy article on mental disorders in financial world at MarketWatch ...

Naked Monetary Vigilantes

While gold price is making another record high in USD terms today, this reminds me of Far Eastern monetary vigilantes in China and Hong Kong. Interestingly, those same monetary vigilantes somehow cannot drop the peg to that insane American currency.

Curious, but China installed credit printers have little backing by real stuff, as we can see in the picture below?

Click on picture to enlarge, courtesy of CLSA Asia-Pacific Markets.

Tuesday, November 24, 2009

Reading Robert Shiller At The New York Times

Somehow missed it, Robert Shiller had a script "What if a Recovery Is All in Your Head?" at The New York Times over weekend ...

BofA Merrill Lynch On FX In 2010 & S&P500 Targets

Year's end is approaching and everyone is preparing obligatory 2010 predictions. No exceptions for FX team at BofA Merrill Lynch(ed) as they write in a summary today:
Overview: USD rallies but the JPY may steal the show
The macro economic backdrop is, in our view, set to become less USD negative in 2010. Middle-way conditions should gradually give way to a right of middle environment that is more challenging for high beta currencies and risky assets. Our forecasts embody several important correlation breaks. The USD is likely to become less negatively correlated with risk appetite as reserve manager flows weaken. The JPY is expected to strengthen broadly even as global equities gain. Cross rates are set to become more volatile.

Theme 1: Time to share the burden
Reserve accumulation by EM central banks has, in our view, created a significant distortion in the relative valuation of EM and G10 currencies. The current system of exchange rate management is, however, now encountering limits. As China embarks upon reform, other EM countries will also likely reduce their FX intervention. This will eventually reduce reserve manager demand for EUR allowing the valuation distortion to start to unwind.

Theme 2: Asia’s granddad stirs

We have changed our view and become contrarian JPY bulls. The change is motivated by our expectation that the US Federal Reserve will remain on hold through 2010 as well as a flow of funds based assessment that demand for JPY from longer-term investors and trade flows is likely to strengthen in the quarters ahead.

Theme 3: Differentiation at last
We believe 2010 will bring a more discerning approach among both underlying asset market and currency investors. A receding liquidity tide may expose currencies that have rallied on excess liquidity rather than fundamental strength.

Theme 4: Know your limits

Recent USD weakness is not, in our view, a precursor to an accelerated secular decline. We believe the risks from the policy response to the financial and economic crisis are both manageable and non-unique. USD downside risk is also curbed, in our view, by a likely aggressive policy response to further weakness that is concentrated against G10.

Volatility viewpoint
We expect G10 implied volatility to continue its trend downwards throughout much of 2010 based on declining risk aversion and realized volatility. Nevertheless as markets transition from middle-way to the right of middle-way, we expect vols. to settle into a higher regime compared to the pre-crisis environment.
Click on picture to enlarge, courtesy of BofA Merrill Lynch.

BTW, the US equity bulls at BofA Merrill Lynch, led by David Bianco, raised S&P500 targets yesterday:
We raise our 2009, 2010 and 2011 S&P 500 EPS estimates to $63, $73, and $83 from $61.50, $70 and $80, respectively. We also raise our “2010 normalized EPS” estimate to $79 from $76. Hence, we raise our 12-month S&P 500 target to 1275 from 1200 on higher “2010 normalized EPS” and moving forward in time.
And they cannot see a correction in the near-term:
We expect the S&P 500 to finish 2009 at a little over 1100. We do not expect a yearend correction because the earnings and interest rate support is very strong.

Final 3Q09 S&P 500 EPS came in at $16.80, above our $16.00 estimate set in late September. This 3Q09 quarterly EPS represents 6 - 7% sequential growth achieved against a real US GDP backdrop that is likely to be revised down to ~2.5%. We now expect 4Q09 EPS to be $17.32 or about $70 annualized against ~3.5% BofAML 4Q09E US GDP. If the S&P 500 is capable of generating ~$70 in annualized EPS just 1-2 quarters into the recovery than we feel very comfortable that EPS can be $73 and $83 in 2010 and 2011 with several more quarters of slow economic growth. EPS will be highly levered to growth in 2010 and 2011.

At about 1100 the S&P 500 is trading at 15.5x annualized 4Q09E EPS of ~$70. At 15-16x current quarter annualized EPS, the market should climb as quarterly EPS climbs because 15-16x immediate EPS is undemanding when the 10yr Treasury bond yields less than 5% and especially with it under 3.5%. As confidence rises in this being the start of a multiyear expansionary cycle, investors will think more about 2011 and even 2012 S&P 500 EPS and this will provide the market ample headroom to appreciate in 2010.
So, everyone is invited now ...

Monday, November 23, 2009

Brutish Socialism In Latvia?

Claus Vistesen at Alpha.Sources has done a terrific data work making preliminary assessment of brutish rebalancing in the Baltics:

Compared with the average quarterly value of GDP in 2007-08, the first two quarters of 2009 are down in nominal terms to the tune of 15.9%, 15.4% and 10.5% in Lithuania, Estonia, and Latvia respectively.

The average quarterly current account deficit of the Baltics from Q3 2008 to Q2 2009 was mill 500 Euros. This amount to just 18% of the average quarterly current account deficit two years prior to the crisis. Consequently, the Baltics have delevered to the tune of 80% over the course of less than 1 year.

In the two first quarters of 2009 (relative to Q1-2006 to Q4-2008), imports have contracted 16%, 33% and 11.5% more than exports in Lithuania, Latvia and Estonia respectively.

In Euro terms, the Baltics have lost external financing to the tune of bn 1.87 Euros in the first half of 2009 compared to the peak of the boom which amounts to 12.6% of the entire region's GDP in the same period.

However, the internal deflation will still make its impact anyway:
So far, a preliminary assessment suggests that while the Baltics are indeed rebalancing, they are only doing so because internal demand has caved in. We are yet to see whether the dose of internal devaluation/deflation will bring back competitiveness in due time to turn a vicious cycle into a virtuous one.
Further on, Danske Bank in its EMEA Daily note writes today:
Unemployment in Latvia rose to 18.4% in Q3, up from 16.7% in Q2, as the sharp economic downturn has taken its toll on the labour market.
This (the unemployment in Latvia), of course, reminds me of a chart I saw at Calculated Risk in relation to US last week... The Swedish new economy banks?

Click on chart to enlarge, courtesy of Calculated Risk.

Not that different in Latvia? I have a doubt of linearity of the function ...

Friday, November 20, 2009

Citi Speaks Technically Asia ...

Yutaka Yoshino, technical analyst at Citigroup Global Markets Japan Inc., poses the question today - "How will inter-market distortions be resolved?". In the summary of opinions he writes:
Major market timbre — We believe the tide that has prevailed since March— low interest rates leading to dollar weakness and euro strength, resulting in rebounds for equities and commodities—is beginning to turn. The euro/dollar rate looks to have peaked, and equities could be entering a correction phase globally. Gold, on the other hand, looks likely to keep rising. Our focus is on what happens to long-term yields in the US.

Japanese equities — TOPIX broke below 867 (10/5), confirming to our eyes
that it has embarked on a near-term second leg corrective wave. If the Nikkei breaks below 9,400, it could ease back to 8,980 or 8,450 before the year is out. Jasdaq and other small-cap markets are also in a corrective phase but nearterm bottoms may be close at hand.
Click on chart to enlarge, courtesy of Citigroup Global Markets.
Overseas equities — Shanghai peaked in August, South Korea in September, and Australia and the SOX in October. We sense the DJIA and Hang Seng may also peak in November and join the global correction.

Forex — We are set to move from dollar weakness to yen strength. The
euro/dollar rate hit a near-term peak at $1.5064 (10/26) and could fall back to $1.42. We see the dollar falling through ¥87.01 (1/21) sooner or later and sliding down to ¥82.30 or ¥80 by next spring. We caution on intensifying corrections for other yen pairs, such as the euro/yen.

Commodities — Gains for gold continue. We think it could rise to $1,190 or
$1,300 before the end of the year. WTI crude could peak at $85 and LME copper at $6,800, and they could then be subjected to big shakedowns.
There is something brewing in Japan. Probably the macro trade of the decade?

However, this all was no problem for Citi strategists over the pond in the US, as they were "succumbing to the surge" on Wednesday.

Thursday, November 19, 2009

Steve Keen: How Do We Pay For All This?

It is worth spending ca. 30 minutes to get a sense, originated by au ...

New Economy Banks & Old Habits

Couple of remarkable quotes I read today.

Let's start with bank equity analysts at Danske Bank:
The Swedish banks told the market in September that losses had peaked. It was confirmed by the Q3 reports. But do we believe that we have seen the worst? Do we believe that Swedish banks are able to come through as deep a recession as this with loan losses only reaching some 20bp on their Nordic books? If that is the case, Sweden has rewritten the text books and if there something the market loves it is the so-called new economy, where base rules are removed from the textbooks.

Despite remaining sceptical about the ‘Swedish miracle’, we don’t see any reason why a continued positive share price performance should not be supported by strong earning figures as long as the central banks stay on hold. And even the first couple of interest rate hikes would probably be interpreted positively as revenue-boosting by the market.
Smoking something? Or chewing?

Dominic Bryant, the economist at BNP Paribas, wrote on Spain, Germany and Eurozone today:
A continuation of old habits – wage indexation and a two tier labour market in Spain and export reliance in Germany is a sure fire way to undermine growth in the eurozone for years to come. The fact that in recent months we have seen something of a return to old patterns, highlighted by a widening in the Spanish trade deficit and German trade surplus, suggests there is a lot of work to do in this area. Simply relying on fiscal and monetary stimulus does not cut it.
And Anna Piretti, the economist at BNP Paribas, wrote on US CPI released yesterday:
Over the past year, consumer prices have generally surprised markets on the upside, as a series of special factors (the cash-for-clunkers program, a surge in tobacco taxes) and the recent rebound in commodity prices pushed consumer prices higher in spite of mounting spare capacity in the economy. The latest CPI reading extended this trend, with total and core CPI increasing by 0.3% m/m and by 0.2% respectively in October, one-tenth of a percent above market’s expectations. For both indexes, the upward surprise was largely the result of a surge in vehicle prices, which rose by 1.7% from their September levels, marking the largest monthly gain in almost 30 years. In addition, gasoline prices increased by 1.6%, providing further support to the headline CPI reading.
Click on chart to enlarge, courtesy of BNP Paribas.

EconomPic has been digging deeper the US CPI surface.

Think what you want!

Wednesday, November 18, 2009

Cost Of Recovering

Economists at BNP Paribas are focusing on "Fiscal Jitters" today, while the problem was very clear some months ago ... Well, we have nice capital gains in the risky asset markets now, so a basis for taxes is created?

Well, let' s move to the folks at BNP Paribas, who have following considerations:

1. The deterioration of public finances over the past two years has been unprecedented. According to the IMF, public deficits globally widened from an estimated 0.5% of GDP in 2007 to 6.7% of GDP in 2009 (Chart 1). The deterioration was even greater for advanced economies, given the bigger role of automatic stabilisers. The public deficit in advanced economies is estimated in excess of 8.5% of GDP this year, from 1.2% of GDP in 2007.
Click on chart to enlarge, courtesy of BNP Paribas.

2. This deterioration has not been merely cyclical. Indeed, about half of the deficit widening over the past two years was due to discretionary measures and/or more structural trends in expenditures and revenues.
3. Public debt is estimated to rise sharply over the next few years across all advanced economies, with the exception of Australia and Canada. The worst affected economies are those in which growth has been most reliant on consumer and domestic demand. Our estimates, for example, suggest that in the absence of corrective action, the UK and the US could end up with net debt at a level comparable with, or even above, that of Italy by 2015.
4. These trends do not take into account unfunded public pension liabilities and unfunded future health-care liabilities. In a number of countries these are significant due to unfavourable demographic trends, implying the risk of an even worse outlook for public-sector finances. The EU Commission, for example estimates that age-related public expenditure in the eurozone will increase on average by 4.8 percentage points of GDP by 2060.

5. Large corrections of fiscal balances are therefore needed in order to reverse the unfavourable trends in public debt. According to IMF’s estimates, the average adjustment of the primary surplus required to stabilise the debt-to-GDP ratios of advanced economies to their post-crisis levels is between 3.5% and 5.2% of GDP. But, if the aim is to reduce the average debt to 60% of GDP, the adjustment required could be as high as 9.1% of GDP.
6. These estimates are consistent with the effort required in past significant fiscal adjustments (which are described in Table 1).

Click on table to enlarge, courtesy of BNP Paribas.
BNP Paribas draws conclusions:
- The needed fiscal adjustment is a significant risk for the sustainability of the undergoing economic recovery in the medium term.
- We are not likely to see any significant fiscal adjustment until at least the end of 2010, with the UK probably the only notable exception. This could be an increasing source of concern for the markets.
- Last but not least, in line with the principles set up by the IMF, fiscal consolidation ‘should be a top policy priority’ while ‘monetary policy can adjust more flexibly when normalisation is needed’. This is one of the reasons – combined with unspectacular growth in the medium term and persistently low and slowing core inflation – why
we believe that the market went ahead of itself in pricing in rate hikes in advanced
In fact, the situation with government finances may be much worse, if one assumes also the off-balance sheet liabilities.

Click on chart to enlarge, courtesy of Societe Generale.
Governments are risking the confidence ...

Kindleberger - Minsky Anatomy Of Bubble

Dylan Grice, the global strategist at Societe Generale, has an excellent note about "A Minskian road map to the next gold mania" today. If one focuses on the gold, then Grice wrote about it:
The price at which the USD would be fully backed by gold (as it was during the peak of the 70s mania) is $6,300. So there is a case for gold being “cheap.” Moreover, the 70s bull market was facilitated by tight energy markets, overly accommodative central banks and nervousness that policymakers had lost their way. Sound familiar?
The fans of Warren Buffet may be thinking along the lines:
It [gold] has no utility.
Dylan Grice argues:
The more verbose answer is that this “uselessness” is exactly what gives gold its value because it makes it the perfect currency. If you own silver, a recession will cause the price (and therefore its purchasing power) to fall because industrial demand has fallen. The same is true for platinum or palladium. But the price of gold will be unaffected by any decline in industrial demand because there is no industrial
Well, the outline of "anatomy of bubble" is very interesting, as I am expecting the phase of adoration in the equity markets, but I may be wrong:

Stage 1 sees “displacement”. Frequently, this comes about through the introduction of a new disruptive technology (e.g. canals, railways, or the internet) although Kindleberger says it doesn’t necessarily have to come from such an innovation. It can arise on the back of greater market liquidity through, for example, financial deregulation.

Stage 2 is the “boom.” A convincing narrative gains traction (e.g. Asian economies are “miracle” Tiger economies; the Internet will change the world; sub-prime mortgages help financial institutions diversify risk). Price movements which seem to confirm the narrative are stoked by credit creation.

Stage 3 is “euphoria.” In the words of Kindleberger, “there is nothing so disturbing to one’s well-being and judgement as to see a friend get rich.” This greed sucks people who wouldn’t normally involve themselves in such practice into the mania. More and more people seek to become rich without understanding the process involved. Rationality becomes stretched and increasingly fanciful notions excuse what would ordinarily be considered irrational behaviour.

Stage 4 sees the “crisis.” The insiders originally involved start to sell. Prices level off and begin to fall. Those who bought at the top find themselves pushed out first and their selling eventually cascades down through the remaining believers. Speculators realise prices can no longer rise and the rush to exit is on. To the extent that leverage was used to finance any purchases at irrationally overvalued prices, savage price declines put banks in trouble too.

Stage 5 sees “revulsion” where prices likely overshoot fundamental values on the downside. Scams and frauds are uncovered. Scapegoats are found for the financial distress caused. The object so richly desired as the bubble inflated becomes an object of ridicule and disgust, along with anyone or anything associated with it.

Click on picture to enlarge, courtesy of Societe Generale.


Tuesday, November 17, 2009

Non-Confirmations Are Developing ...

The title of this post are the words of Jeff Saut in a post at Minyanville today, worth reading ...

While the Big Boys are entertaining themselves in the shadow of worse than expected hard (industrial production and deflated PPIs) economic data in the US, some creative people have a reminder for all of us (ht Barry Ritholtz):

Nordea's Baltic Rim Outlook

Nordea sees uneven recovery ...

Monday, November 16, 2009

Big Boys In Action

It is all good for risk assets today. Good news are good, and bad news support low interest rates for longer, so the positive feedback loop of sweet spot is maintained?

Putting aside the already high flying Asian markets, where Hong Kong and Malaysia closed at new cyclical highs, US equity futures were also highly demanded. A bit of mystery we saw as NY Fed Manufacturing Index came in below consensus expectations of polled economists. It was a bit trickier with US retail sales, as last months headline was reported stronger than estimated by consensus economist, but assuming the revisions of previous month they were in fact below estimates. After initial zig-zag US stock futures markets retreated a bit, however, cash market opening at the NYSE brought a stunning bid. Obviously, those who cannot afford (also due to legal constraints?) even an e-mini S&P500 futures contract on CME were the "Big Boys In Action" this morning ...

There is no doubt, except bears, for China rising. Everyone should learn from Goldman's O'Neill how the unpleasant question about Chinese gasoline consumption should be answered. Really smart and convincing, and everyone should fear missing the "Story of Our Generation". However, Stephen Green at Standard Chartered was trying really hard. Impressed? Markets speak for themselves.

What is important? US Large Caps are powering ahead ... and releasing dopamine. Champions of Latin America still lag behind, but very close to follow US Large Caps.

Jeff Saut, the strategist at Raymond James, one of the best leading through the jungle of last recession, has a simple message today:
We think the normal economic cycle will play once again. If so, economic reports, fundamentals, and earnings should continue to improve, putting even more pressure on underinvested participants (according to the latest surveys, hedge funds are only ~52% net long). And, that pressure should buoy stocks into the first part of 2010. It is the back half of 2010 that begins to worry us due to harder earnings comparisons, loss of the “sugar high” stimulus funds, higher taxes, an election year, increased government regulation, etc. In fact, it is the probability of further government regulation of corporate America that worries us the most, and we are not alone...

And the call for the week:
In bull markets, be they secular or not, it is rare to get anything more than a 7% - 10% correction; while we have been looking for such a correction for more than a month, time is running out. The trick then becomes to commit some capital to areas that have good risk/reward metrics. By our pencil, the sectors displaying the best relative strength are Energy, Consumer Non-Cyclicals, Basic Materials, and REITs (real estate investment trusts).

So, don't climb the wall of worry? Respect the market.

Sunday, November 15, 2009

Reading "F-armageddon" 's "Power Of Zero"

Grave diggers at Zero Hedge have the full report that is always worth reading.

I list some ideas of Don Coxe here that are relevant, IMHO, in the context of bullish action in the risk asset markets right now, my emphasis added:

The US and British economies are performing at roughly the level they were during the late stages of the 1981-82 recession—when corporations’ and consumers borrowing costs’ were infinitely higher. That inflation could be in the zero range would also astonish them, even though the biggest factor in their first election victories was the runaway inflation of the Carter and Callaghan era—when “malaise” was the Presidential euphemism for the spreading despair.

So why shouldn’t the economic recovery be at least as strong as Reagan’s—if not even more robust?

It’s because those Zero rates tell us that the financial system’s problems that triggered the economic collapse aren’t going away quickly—and could even be getting worse.

Why this is relevant in the context of bullish market action? Well, if you look at camp of "Generic Bulls" of equities, e.g., step in warm shoes of Birinyi, this points to cardinal difference. Not only that, of course, as S&P500 trades now at almost 19x Shiller PE, and it took well into 1985 to get Shiller PE above 10.02x ... Well, we touched the issue of stable and low inflation recently?

This is quite striking in the context of recent history:

Last week, the Bank of America summed up the disappointments of our era for institutional investors. It noted that there were 42 trading days left this year, and the S&P would have to rise 42% to deliver a Zero rate of return for the past decade.

By some calculations, on a compounded basis, long Treasurys have outperformed the S&P since the beginning of the Reagan bull market. The problem with those data is that they assume sustained reinvestment of interest at the long end of the curve, but most bond managers would have been below benchmark duration for extended periods, which meant their cash income would have been reduced.

Apart from that nitpick, what that number shows is that capitalism has failed its most basic test—delivering higher returns to investors than was paid on risk-free government bonds. And this was the best of all times in the best of all capitalist worlds: classic economic liberalism was becoming the fashion everywhere outside North Korea, most of the Arab world, and Cuba. There were more playing fields for multinationals than ever, corporate tax rates were generally declining, there were no major wars, the supply of highlye ducated engineers, MBAs and CFAs was at record levels, and business was more respected than it had been since the onset of the Depression.

Hmmm ...

Well, Don Coxe does not end up with only this. There is much more ...

Friday, November 13, 2009

Quant Vs Discretionary

I thought I prefer discretionary approach in managing investments.

There are, however, two different opinions in my mailbox this morning, and I am leaning towards the one of quants. Interesting?

Let's start with the opinion of Jan Bylov, the chief analyst at Nordea Markets, that I have been regarding discretionary in judgement so far. He writes today:
All kinds of wild opinions, forecasts and reasoning are circulating making it hard to stay convinced of anything beyond the next up or down tick. This week, however, an interesting quote surfaced from fund manager Ed Yardeni: "I am running into more equity portfolio managers who are fully invested bears." (9 November 2009)!

Now, aside from the paradox of being bearish and fully invested his observation may hold a very revealing truth: a lot of investors remain very skeptical about the "validity" of the post March 2009 asset gains!

Of course, bears and bulls both have powerful arguments behind their opinions, but whatever argument it should never blind us to the fact that we just don't know how the future will unfold. So why are so many still bearish of the future… in spite of huge asset gains everywhere?

Well, according to behavioural studies investors (and other human beings) always oscillate between a mental state of euphoria and despair and while this probably makes life more exciting it certainly doesn’t make it easier to invest ones money.

Fortunately, as our mental state constantly oscillates between euphoria and despair we can actually use Ed Yardeni's observation of the"…fully invested bears" to claim that such underlying "skepticism" strongly suggest that the overall post
March 2009 global recovery hasn't run its course as "skepticism" is distant from the mental state of "euphoria".

Further, should bears be fully invested it also suggests that this group of market operators are very sensitive to short-term price swings; even a brief setback may cause them to exit as they clearly remain unconvinced about the prudence of being invested in all the cyclical markets like stocks, credits, commodities, emerging markets and the cyclical sensitive currencies.

Being Friday 13th some investors may even be more sensitive than at other times and below you will find some charts revealing price levels where "fully invested bears" may place classic exit orders, and as you will observe the levels centre on
setbacks from early October and early November.

Finally, be aware that convinced bulls typically take advantage of the same levels as the unconvinced investors… to load up!

This in itself sounds pretty bullish, and is a manifest of simple trend following. Should be fair enough till it works. Note, he is quoting Ed Yardeni ...

However, the quants at Societe Generale have a message today, that may be a mirror of my concerns expressed yesterday, or a confirmation of my expectations (they should be rather expiring now?) for euphoric adoration:
Our equity surprise index highlights movements which are specific to one market and cannot be related to more global movements. Over the past week, the equity surprise index has risen sharply after the stock market’s performance.

The last time equity surprise rose this way was in March 2009, when stocks had led global markets early into the rally. This could therefore be another early sign of an acceleration of the rally, or an overshooting by equities
Note, that the surprise index for equities was also so high at the January 2009 highs in the equity markets. Click on chart to enlarge, courtesy of Societe Generale.

In order to spice up the confusion, let's look at the message by Tim Bond, the head of asset allocation at Barclays Capital, as he wrote on Tuesday! One of my friends described it being "seductive rhetoric", but Tim starts with winning the attention of the cautious reader on around page 3:
In digression, we doubt that the business sector will continue to exhibit a pronounced tendency to increase leverage during economic expansions on the same scale that was seen in the 1980s, 1990s and earlier in the current decade. Business cycles are likely to display overtly Hobbesian characteristics (nasty, brutish and short) over the next few years. Under such circumstances, wise CEOs will avoid high leverage.
However, as any banker these days, when assertion of banker's supremacy is needed, concludes at around page 7:
Pragmatically, we should expect that the prevailing phase of very low real interest rates will produce a boom in asset markets that is followed – or even accompanied – by a similar boom in economic activity and unexpectedly fast GDP growth. We highlight that both trends are mutually reinforcing.
So, guys, unintended (?), but "seductive rhetoric" invites you to join the reflation trend, that unfortunately is "likely to display overtly Hobbesian characteristics (nasty, brutish and short) over the next few years".

As the strategists at JPMorgan put it in style of "mechanical monetarism" last week (my emphasis added):
Equities and credit have recovered much faster than the economy, and though hard to prove, they have run way ahead of so-called fundamentals. Even if this is the case, we would argue that this is not a negative, but exactly the purpose of monetary easing. Economists call it the monetary transmission mechanism, because it is through lower funding coats and improved asset prices that monetary policy will affect the economy. Given the greater importance of asset prices in the modern economy, we increasingly find that asset price movements create their own fundamentals, rather than the other way around.
Well, if the reflationists are right, why central banks are not targeting asset prices and "their own fundamentals" as they happen to get excessive and destructive like Internet bubble, housing bubble ...? This also implies that central banks are always successful on the upside, but systematically fail on the downside? You know whom you trust?

Coming back to practical stuff on earth, Christopher Wood, the strategist at CLSA Asia-Pacific Markets, wrote yesterday:
...oil is for now a proxy for risk.
But get it adjusted for USD debasement blurb and keep in mind that George Soros wrote:
... positive feedback process is self-reinforcing. It cannot go on forever because eventually the participants’ views would become so far removed from objective reality that the participants would have to recognize them as unrealistic. Nor can the iterative process occur without any change in the actual state of affairs, because it is in the nature of positive feedback that it reinforces whatever tendency prevails in the real world. Instead of equilibrium, we are faced with a dynamic disequilibrium or what may be described as far-from-equilibrium conditions. Usually in far-from-equilibrium situations the divergence between perceptions and reality leads to a climax which sets in motion a positive feedback process in the opposite direction. Such initially self-reinforcing but eventually self-defeating boom-bust processes or bubbles are characteristic of financial markets, but they can also be found in other spheres. There, I call them fertile fallacies—interpretations of reality that are distorted, yet produce results which reinforce the distortion.
Be careful! Missed the difference between current quant and discretionary? Respect the trend, but be ready for both directions ...

Thursday, November 12, 2009

Scaling Back Risk

Prudent people are scaling back, as technical weakness shows its multiple heads:

1. Trader's Narrative with little room ...
2. TraderFeed with divergences...
3. StockCharts with lagging Nasdaq AD line...
4. Bespoke with breadth.

BTW, that's not all! Potential of double top for S&P500, double bottom for dollar index, broken downtrend for VIX and others ... worth all watching!

MBA purchase applications remind us today about "demand brought forward" on macro scale, and think of global credit festivities in the last years ...

Doug Kass sums up the market ignorance.

Nothing major yet, but not a time to play the hero!

Randoms By Dylan Grice

Dylan Grice, the global strategist at Societe Generale, had some interesting thoughts along the lines of value, volatility and inflation today. Here are some that I wanted to point out:
...if equity volatility is a proxy for market visibility, then current equity volatility at its historical average suggests we are in such a delusional equilibrium right now. And thanks to Taleb's insights, which teach us that this delusional equilibrium is merely a neurological sleight of hand and not based on anything fundamentally true, the current confidence exhibited by the "average" level of equity volatility today isn't based on anything fundamentally true either. It's based on the tricks of our collective minds.
While focusing on higher inflation expectations in the markets right now, especially in the ones where experts of Quantitative Easing are active and promoting the reflation propaganda, the conclusion is quite straight forward:
During the 20th century, the ultra-low valuations have occurred when inflation wasn't under control. Low/stable inflation regimes, which I've loosely defined as occurring during the 1920s, the 1950s to the early/mid 1960s and the 1980s to the present, have seen considerably higher Shiller multiples than inflationary regimes. The average multiple during inflationary regimes has been 12.2x. During price stability it has been 19x.

Low PE was also observed during deflation period (unstable, not under control) of early 1930ties. The latest reading of Shiller's PE stands at almost 19x, the latest data to check available here, so equity markets appear to be fine with inflation outlook right now?

Surreal China's Growth: Empty City And Gasoline Consumption

The mystery story of China's growth against the official wisdom at

Al Jazeera report on empty city built with government money.