Friday, January 29, 2010

Japanese Adapting To Chinese Religion

The economists at BNP Paribas run an interesting story about the Japanese machinery orders in the weekly "Market Movers".

Click on charts to enlarge, courtesy of BNP Paribas.

The message is straight forward:

China leads recovery in overseas demand

A closer look at the country breakdown of machine tool orders confirms that the drivers of overseas demand are the emerging economies of Asia. In fact, orders from Asia ex-Japan have been so brisk that December’s level was in line with the previous peak. Naturally, the most conspicuous strength is shown by China (whose economy in Q4 2009 surged 10.7% q/q, returning to double-digit growth for the first time in six quarters). Chinese orders began reviving at the start of 2009, with the tempo accelerating sharply from the autumn. By December, the level was well above its past peak. Orders from South Korea and Taiwan are also solid, though the magnitude is less than China’s. As is widely known, domestic demand in China and the other Asian EMKs is expanding briskly thanks to (1) very aggressive domestic stimulus programmes, coupled with the lack of balance sheet problems, and (2) very accommodative monetary conditions from the influx of capital via escalating dollar carry trades.

US and European demand remain weak

Meanwhile, orders from the US and Europe are as lacklustre as Japan’s. Orders for the EU are especially weak, with the recovery (if it can be called that) so anaemic that the level in December is still just 20% of its former peak. Orders coming from the US stood in December at 28% of their former peak, and the pace of recovery there also remains slow.

However, the headline growth is not equal to returns on invested capital.

Deutsche Looks At Growth And Returns To Capital

The economists at Deutsche Bank decided to look beyond the "sexy growth story":
What is important for returns to capital is not growth per se, but rather growth relative to the amount of investment required to achieve that growth.
Click on chart to enlarge, courtesy of Deutsche Bank.

Of course, it depends on God and pure luck, however:

Bearing all the caveats we listed in mind, we can still draw a few tentative investment conclusions from the analysis. First, the emerging market universe as a whole is not necessarily more attractive for equity investors than the industrial country universe. Second, within EM Latin American markets appear more attractive than other regions, while China appears least attractive. Third, within the industrial country universe the US market seems more attractive than other (notably European) markets. Fourth, the best way to benefit from high emerging market GDP growth is to invest in companies that combine a lean capital structure with a strong exposure to emerging market economies’ demand.
Run, run ... I just do not know how much of Latin American dream is driven by China hunger for resources?

Thursday, January 28, 2010

Eurozone Sovereign Risk With The Eyes Of Credit Agricole, And The US Debt Delusion

A short summary of challenges the Eurozone governments are facing available here, but for the lazy reader here is the conclusion:

1. In the short, and most importantly, the long term, Greece is by far the riskiest country: it combines high public debt with a severely degraded initial budgetary position and major demographic concerns.
2. Ireland and Spain are also risky countries in the short and long term. The deterioration in their public finances is rapid but it is taking place in an environment where initial public debt levels are lower.
3. Portugal appears to hold large-scale risks in the short term. In the longer term, age-related risks are lower. However, the structural weaknesses surrounding the Portuguese economy (low
productivity and competitiveness) will continue to adversely affect its public finances over the longer term.
4. Italy is the country with the lowest public-finance related risk, due to its fiscal efforts made in recent years and structural pension reforms.

I was reading Paul Kasriel's, the chief economist at Northern Trust, "Debt Issues" at the beginning of the week, and was disappointed. Of course, Japan is probably the macro trade of this decade, but why Paul is focusing on US press? The problem with US debt is of another sort, not that only Europeans are a joke, but also Americans and the other Paul with full faith in debt delusion?

Christopher Wood, the strategist at CLSA Asia-Pacific Markets, was nailing down the "off-budget tools" of US government last week:

The term “off budget” is obviously used facetiously. The implicit federal government guarantee has become over the past two years ever more explicit which means that Fannie and Freddie obligations should really be counted as part of Federal Government debt with the only difference being that Fannie and Freddie debt is higher yielding. Thus, Fannie and Freddie 30-year bond yields are now yielding 4.9% or 35bps above US Treasuries ... , while the Fannie Mae MBS yield spread over Treasuries is now 71bps. And investors should also note that, if the elephantine monstrosities’ combined outstanding debt of US$1.6tn is included, total US gross public debt rises from 87% of GDP to an estimated 98%. Furthermore, if the US$3.9tn of MBS sold and guaranteed by Fannie and Freddie are included, public debt rises to about 125% of GDP.
European joke?

Shiller's Check-List To Diagnose A Form Of Psychological Malfunction

According to NYT's DealBook, Robert J. Shiller, a well-known Yale economist, suggested on Wednesday:

After all, a bubble is a form of psychological malfunction. And like mental illness there’s a tricky gray area between being really sick and just having a few problems...

The solution: a checklist like psychologists use to determine if someone is suffering from, say, depression. So here is Mr. Shiller’s checklist.

- Sharp increases in the price of an asset like real estate or dot-com shares
- Great public excitement about said increases
- An accompanying media frenzy
- Stories of people earning a lot of money, causing envy among people who aren’t
- Growing interest in the asset class among the general public
- “New era” theories to justify unprecedented price increases
- A decline in lending standards

So, watch after your mental health ... and get lite with shit in books on strength?

Wednesday, January 27, 2010

On The Watchlist At BNP Paribas

This chart comes from the Number Cruncher of last week, click on chart to enlarge, courtesy of BNP Paribas.

Unprecedented ...

Tuesday, January 26, 2010

Spending Bulls?

Economists at Societe Generale have a reminder for spending bulls today:

At the end of 2009, food prices in developing economies were rising about 10% faster than nonfood prices. This reflects the fact food price increases at the production level tend to be rapidly passed through to final food prices.

The current upswing in food commodity prices has only ever been rivalled on two occasions in the last century. One was the price boom of the 1930s – which reflected the recovery from sharp declines in the Great Depression – and the other was the commodity price rise of the 1970s – driven by strong world demand and supply shortages of food items.

Click on chart to enlarge, courtesy of Societe Generale.

Emerging Asia is going to pull the global spending? Just think of these sentences written by economists:

Asia has a particularly high disposition to inflation. Food and energy have particularly high weightings in the CPI basket and it is here where inflation is displaying its budding strength.

• In terms of Oil, Asia in general uses twice as much energy per unit of GDP as developed economies. Japan is the exception, using only half the oil per unit of GDP the US does and one quarter the oil Asia on average uses to produce a unit of GDP.

• In terms of food, the actual cost of food accounts for a bigger fraction of the retail costs of food items in emerging economies. In the developed world, the bulk of the retail cost of food items reflects retail, advertising and other service costs.

Click on charts to enlarge, courtesy of Societe Generale.

There are so many disseminating the view that asset reflation is going to help. Let's hope that monetary policy tightening in Asia is not derailing the hope of global recovery?

Reading Grantham's "Stop the Presses!"

Always worth spending the time by reading the latest thoughts by Jeremy Grantham. Couple of quotes here:
The real trap here, and a very old one at that, is to be seduced into buying equities because cash is so painful. Equity markets almost always peak when rates are low, so moving in desperation away from low rates into substantially overpriced equities always ends badly.

And, if the market surprises me and goes into an early setback in 2010, then quality stocks should outperform by a lot. What could cause an early setback would be some random bunching up of unpleasant seven-lean-years data: two or three bad news items in a week or two might do the trick.

Let’s start with the Investment Industry component. It is so obvious in this business that it’s a zero sum game. We collectively add nothing but costs. We produce no widgets; we merely shuffle the existing value of all stocks and all bonds in a cosmic poker game. At the end of each year, the investment community is behind the markets in total by about 1% costs and individuals by 2%.

This is true with the whole financial system. Let us say that by 1965 – the middle of one of the best decades in U.S. history – we had perfectly adequate financial services. Of course, adequate tools are vital. That is not the issue here. We’re debating the razzmatazz of the last 10 to 15 years. Finance was 3% of GDP in 1965; now it is 7.5%. This is an extra 4.5% load that the real economy carries. The financial system is overfeeding on and slowing down the real economy. It is like running with a large, heavy, and growing bloodsucker on your back. It slows you down.

And here is the glutton's link to the debate on financial innovation!

Monday, January 25, 2010

J.P.Morgan Refocusing On Risk

It is still cool in the house of J.P.Morgan, as the latest view on markets suggests:

Asset allocation: Near-term correction on rising policy uncertainty. We stay with medium-term positive view. Investors planning to add risk do not have to hurry.

Economics: Forecasts on hold, but data confirm widening growth gaps between US/EM and EU/JA.

Fixed income: Stay short duration. Await better news to reenter EMU convergence trades.

Equities: Uncertainty has risen, but not enough to change strategy. Stay long, focusing on EM, cyclicals, and small caps. Within financials, favor credit banks over investment banks.

Credit: Spread volatility likely to rise as policy risk increases uncertainty.


Alternatives: Stay short crude oil. Be long cocoa, sugar, and coffee, but short grains.

Click on chart to enlarge, courtesy of J.P.Morgan.

The guys assert they almost knew what is coming:
We have argued before that the main risks to markets emanate from policy errors and residual delevering. Our argument had been that, while each needs to be monitored, they are likely less acute than generally feared while markets offer us sufficient risk premia against them. That is why we are long risky assets. The risk of policy errors comes from any premature monetary and fiscal tightening and regulatory overkill. The reaction of markets to Chinese tightening and Obama’s new bank plan fit this category.

Sufficient risk premia? I cannot see the margin of safety ... but we are pretty oversold in short term.

Friday, January 22, 2010

Raging Bull Breaking The Neck?

And again today, there are much more things worth to focus on today, but a la cynical Le Fly' s "Trading Crazy":
This current slide is a bit different than the ‘09 variety. I am seeing aggressive selling, spearheaded by retarded government policy mishaps. The end result: bulls are having their faces punched in by burlap boxing gloves.

In closing, I sold a little bit more today, upping my cash position to about 16%. I am taking hits and not enjoying the carnage. Nevertheless, it is my belief we shall bounce soon and hard. instead of adding to names here, then having to worry about it over the weekend, I elected to “slow my roll” and reserve my buy orders for Monday, which may coincide with The PPT’s legendary oversold reading (below 2.30).

I have no clue at all, but ECRI' s US WLI media appearance wears a horror label, but for the second derivative only. On a "one way Wall Street" is has no meaning at all, but I still feel OK with Merton and Dividends ...

Wednesday, January 20, 2010

Bond And Models

It is not about James Bond. It is about the "New York January Asset Allocation" presentation by Tim Bond, the head of asset allocation at Barclays Capital, where he mentions, among all other bullish things, the demographic shift in an unfavorable direction for financial asset valuations.

Click on charts to enlarge, courtesy of Barclays Capital.

Despite the models forecasting the drop in CAPE (cyclically adjusted price-to-earnings) at least 2 times, modelled profit recovery of circa 30% (already priced in?) and current "credit regime" should be bullish for equities?

Tuesday, January 19, 2010

Social Cancer?

This is just a reference in my quest for the "inequality" effects on economy.

Lane Kenworthy looks at a new book, The Spirit Level: Why Greater Equality Makes Societies Stronger, by Richard Wilkinson and Kate Pickett. While being skeptic about the findings of the book, he concludes at the end:

I wish it were that simple. I share Wilkinson and Pickett’s conviction that it would be good for America and some other affluent nations to reduce income inequality, but this book hasn’t convinced me that doing so would help us to make much headway in improving health, safety, education, and, trust. To achieve those gains, my sense is that our best course of action is greater commitment to specialized programs and services, coupled with poverty reduction.

Then again, I’m not certain that Wilkinson and Pickett are wrong. I’ve focused here mostly on the effect of inequality on life expectancy, because that is the social outcome for which the hypothesized causal link (stress) seems most plausible and because it has received the most attention in prior research. I’m skeptical that income inequality has much of an impact on average life expectancy. But perhaps life expectancy will turn out to be the exception to the rule.

Booooo ... I wish I knew!

Nordea's Litmus Test Of A Solid Foundation For Latvia's Long Term Growth

Nordea is out with its "Economic Outlook" today. While the title of the Latvian comment is a bit of "muddle through" thing, but the key message for the hope of growth on page 29 seems to be right, though it may be not enough for the whole economy to print real growth this year:

Signs of a recovery are still scarce, but the worst plunge in the economy seems to be over. Domestic demand and investment are still exerting the main pressure on the economy, and hopes are focused on the export sector, which turned into an upswing last year. However, almost a third of Latvia’s exports goes to the other Baltic countries, which limits the short-term recovery potential of export demand. We thus expect the economy to show export-driven growth over the next year.

Click on chart to enlarge, courtesy of Nordea.

The latest review of Latvia's macroeconomics by SEB can be found here, but Swedbank's Economic Outlook here.

Monday, January 18, 2010

Deflationist Reading The "Hard Road Ahead"

The wise economists at Hoisington have placed their latest "Quarterly Review and Outlook" at your disposal ...

Leverage Cycle And Wealth Distribution

I read "John Geanakoplos on the Leverage Cycle" by Rajiv Sethi, the professor of economics at Columbia university, today (my emphasis):
The latest paper in the sequence is The Leverage Cycle, to be published later this year in the NBER Macroeconomics Annual. Among the many insights contained there is the following: the price of an asset at any point in time is determined not simply by the stream of revenues it is expected to yield, but also by the manner in which wealth is distributed across individuals with varying beliefs, and the extent to which these individuals have access to leverage. As a result, a relatively modest decline in expectations about future revenues can result in a crash in asset prices because of two amplifying mechanisms: changes in the degree of equilibrium leverage, and the bankruptcy of those who hold the most optimistic beliefs.

Link it to this story and the compilation of links by Steve Randy Waldman at Interfluidity ...

Friday, January 15, 2010

Expected Surprises In The House Of Mother Morgan

Economists at Morgan Stanley have got an expected surprise today:
Many investors believe that the developed-economy recovery could be aggressive; certainly, much stronger than the current economic consensus. The evidence for this is the stellar performance of a number of tried-and-true leading indicators, some of which now flag a rebound of multi-decade vigor. We don’t buy it. But the more important point is this: Risk assets have already performed consistently with those upbeat leading indicators. The ‘surprise’ is, in our view, increasingly in the price of risk assets, particularly equities.

Click on charts to enlarge, courtesy of Morgan Stanley.

ECRI's US WLI climbs higher, but at a slower pace ...
On the downside cash earns more than negative returns in risk assets!

An interview with Seth Klarman (look at top left corner of this web page!) available here...

Thursday, January 14, 2010

Only A Bit Of Volatility In Monthly US Retail Sales?

Heh, who ever said that economists are not optimistic? Look at compilation of views on latest US retail sales data by Wall Street Journal. Societe Generale has even more bulls:

Retail sales posted major upward revisions to prior months to offset the December dip. Moreover, late month spending in December could be the basis for further upward revisions.
Yea, and that inventory bounce too?

One should be also scratching the balls while looking at same-store sales over the year, where, e.g., ICSC-Goldman Sachs weekly index shows 2.5% advance from a year ago, and MBA reports that "retail vacancies rose from 12.9 percent to 18.6 percent." Geee, put increase of vacancies of some 5% over the year and 2.5% increase in same-store sales on one line ... Smells like increase in retail sales, even if one takes into account the new openings? Well, the markets will sort that out!

It does not stop risk markets from climbing higher ...

For real "realized volatility" watchers Goldman Sachs had a list of key themes yesterday:

1. 2010 should be a year of “normal” volatility, moderate correlation.
2. M&A activity is likely to pick up given cash-rich balance sheets, more attractive capital markets, and attractive valuations.
3. Financials volatility should moderate further with regulatory clarity and supply from TARP warrants.
4. We expect Defense spending events in 1Q2010 to create volatility and downside risks for the sector.
5. Key product launches in Technology such as Nexus One and AAPL’s Tablet will heighten competition and add to volatility in exposed stocks.
6. A corporate PC refresh cycle, more powerful than investors expect, should be a key driver of Technology stocks in the next two years.
7. Large-cap Pharma could see an inflection point in its new product cycle in 2010 with key data releases on major drugs ahead.
8. Australia LNG projects should be a major catalyst for E&C and select energy stocks as Australia looks to double its LNG capacity by 2018.
9. Cable/Satellite companies likely to return cash to shareholders in a more significant way in 2010, with buybacks and dividend increases.
10. Advertising spending looks poised to recover in 2010, driven by corporate profitability; national markets and online are top categories.
So watch the right things! Who wonders keeping in mind point 6 from Goldman's list and good activity in Intel options before earnings results tonight?

Wednesday, January 13, 2010

Exceptional Divergence Between Retail Sales And Credit In The US?

The economists at BNP Paribas addressed the topic of latest data on US consumer credit yesterday:

Consumer credit has fallen in each of the past 7 months and 11 of the past 13 months. As a result, consumer credit has declined by $117 billion, or 4.5%. The declines in consumer credit have begun to reduce the ratio of household debt to disposable income from its historic peak of 24.4% at the end of 2004 down to an estimated 22.1% in November 2009. Because disposable income has also begun to increase in H2 2009, this ratio has now fallen slightly below its long term trend, but it remains at a level that exceeds any past business cycle high.
Click on charts to enlarge, courtesy of BNP Paribas.

However, there is one issue that hints to heavy dis-savings by US households in recent months:

The importance of consumer credit to the economy cannot be stressed enough. Of course too much of a good thing can be fatal but not enough can severely slow down the pace of consumer spending over time. As the last chart reveals the rise and fall of retail sales has been mirrored by the similar changes in consumer credit for nearly the entire period. The major exception has been in the past 6 months when credit has declined and sales have increased. The history of this relationship suggests that sales cannot continue to rise if credit continues to shrink.
Click on chart to enlarge, courtesy of BNP Paribas.

Who can dis-save now? One issue is increase in incomes ... On the other hand, there is an issue with income inequality, that I have been trying to address some time ago.

Steve Randy Waldman at Interfluidity has an excellent compilation of links today, that try to address the role of inequality in macroeconomic stability. It is worth looking at ...

Tuesday, January 12, 2010

China Shakes The Boat

I already made a pre-warning before Christmas, but that was then. Lena Komileva, the Head of G7 Market Economics at Tullett Prebon, sums up the recent actions by PBOC today:

* China's central bank announced today that it was raising reserve requirements by 0.5% to 16% for large banks and 14% for smaller ones, effective January 18, in the clearest sign yet that it has begun to tighten financing conditions.
* China sold 1yr bills at a yield of 1.8434%, up 8.29bps from last week. The move was accompanied by a record CNY200bn ($29 billion) drain from the money market through 28-day repos.
* China’s benchmark 1yr lending and deposit rates remain unchanged. A comment from a PBOC policy official to the press signalled that today’s action does not constitute a policy shift but the market has taken the view that it brings forward the
chances of expected rate hikes in 2010.
So far the market reaction has, probably, some meaning to the bears. As The Fly noted today:
Today’s bloody tape is good for the bears’ confidence. Let them get all huffy again, so that I may burn them at the stake later. It’s equal to letting a small child win a footrace. Run little bear, run.
Tullett Prebon explained their view as follows:
...the only way that the 2009 equities and credit rally can mature into a genuine recovery and avoid resulting in another bubble is if central banks acted to tighten policy ahead of the financial leverage cycle and behind the real economy recovery. It is perhaps too early to judge, but it is not too clear from the commodities and stock market selloff in response to China’s policy normalisation, despite a booming economy, that international policy has been successful in this respect.
So far it is still a minor "baby set-back" ...

Monday, January 11, 2010

Are Asian Equities Expensive?

As Christopher Wood, the strategist at CLSA Asia-Pacific Markets, wrote last week:

Valuations of Asian equities may be above historic averages. But they are not yet dangerously so. The MSCI AC Asia ex-Japan Index is trading on 2.1x trailing price-to-book, compared with a 15-year average of 1.8x

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

So far only bears are disappointed, and may have a fear ...

Friday, January 08, 2010

Remaining Focused On The Trend

US non-farm payrolls disappointed only economists, and some are keen to get new additional stimulus, and, very likely, for right reasons. But stock market (at least initially) follows the script of "headline watching" Societe Generale today:

Remaining focused on the trend is the key and recognizing changes in trend is most important for anticipating policy changes.

But the headline trend remains for new bid in cyclical stock prices (at least initially), and wholesale inventories provided megatons of hope, as did ECRI' s US WLI, by climbing to 1.5 year high, as the sight through the fog is key.

Interestingly, but US Dollar gave up versus Euro, despite the fact, that Euro zone unemployment rate moved above 10% for the first time since the formation of union.

Rounding up on the global view, the look at December 2009 survey of JPMorgan' s Global All-Industry PMI reveal more insights. JPMorgan concluded in the summary on Wednesday:

Both J.P. Morgan’s global services and manufacturing PMIs advanced in December, but their combined gain fell short of the level consistent with our global GDP growth forecast. As reported Monday, our global manufacturing PMI output index rose 1.4 pts to 58.2, a very elevated level that points to continued boom conditions in the manufacturing sector.

Today’s new information concerns activity in the global service sector. Our services PMI output index posted an even larger gain of 1.8 pts, but from a much lower base, so that it ended 2009 at a level of just 52.1. The shortfall in the service sector was widespread. Services PMIs in the US, the Euro area, Japan, China, India and Russia all lie below their 2006-07 averages. The gaps are especially large in the US and Japan, whereas they are more modest in the EM. The US gap is especially significant, since the US accounts for about 40% of the global services PMI and about 1/3 of the global all-industry PMI.

Taken alone, this unbalanced picture of booming manufacturing and sluggish services poses downside risk to our global GDP growth estimates of 3.7% in 4Q09 and 3.4% in 1Q10. ...

Click on charts to enlarge, courtesy of JPMorgan.

In the meantime commodities in major currencies are breaking out to the upside. Asset reflators win big! Of course, those who believe that economy is led by corporate sector will conclude that this is a bullish sign. Click on chart to enlarge, courtesy of Nordea Markets.

I remain focused and cool, as it is quite cold outside ...

Thursday, January 07, 2010

Is Great Wall Of China Liquidity Closing The Gates?

There is a fascinating action in the US bank equities also today, as we broke the downward trend on the first day of trading this year. Click on chart to enlarge, courtesy of

One of the largest concerns for bank shareholders has been unemployment. The direction of the movement appears to be right so far, and that is enough to drive the bulls now. Let' s see what we sing tomorrow!

However, the gigantic gates of the Great Wall of Chinese liquidity seem to be closing, but very very slowly for now. Asian equity markets were bleeding today, and Europe joined the red sea until European mid-day.

Societe Generale remains cool on Chinese move today, by explaining:

... China has the harsh lesson of 1992-93 when bank lending was abruptly curtailed and non-performing loans started to rise sharply.

Why? Simply because as in 1992-93, China's banks are currently lending for multi-year projects, such as expansion of the railways. If China were to cut bank lending aggressively now, the result would be a half-built railway track, or an incomplete irrigation project. These projects would immediately be non-viable and Banks would be saddled with a large non-performing loan problem.
Click on charts to enlarge, courtesy of Societe Generale.

Simply put all those conspiracy theorists with Total NSA Unemployment Claims Hit Another Record and Treasury Flooded Consumers With Money In December, Just In Time To Unleash Holiday Shopping "Animal Spirits" aside, kill all prominent bears and join the herd of best bulls?

Wednesday, January 06, 2010

I Found A Rarity ...

Japanese candlestick masters, this time from the house of Nomura, still maintain their bearish (a rarity these days) view on US equities in today's bi-weekly report. Click on chart to enlarge, courtesy of Nomura.

In the meantime, the European credit markets remain in bullish mood today, according to the highlights by credit strategists at Societe Generale:

Once the non-financial corporate new issue market opens for business, the clamour for paper will likely help all issues to push tighter. And this trend could well continue for several weeks, if not the whole of Q1. So far, so good. We'll also get a better idea on the level of sidelined cash, amount of new inflows and the type of investor still showing interest. However, we think that after two testing years, the cash investment grade, non-financial corporate bond market is approaching 'normalisation' status. That is, new issue premiums will be close to zero; not every deal will tighten vs reoffer and the retail support (measured through primary allocations) may wane if underlying yields eventually start to head higher. For now though, current lower coupons offer little protection against inflation and rising yields unless they are hedged out immediately or investors flip bonds quickly after locking in some small upside. The market has grown to over €1.2tn in size and become a core asset class, but investors will need to be more selective as to the type of paper they take down this year. As the year progresses, the traditional investor may become the only player in town, again.
Go, go ... On the other side of the pond, the bond king Bill Gross steps on my feet and is trying to get fiscal:

If 2008 was the year of financial crisis and 2009 the year of healing via monetary and fiscal stimulus packages, then 2010 appears likely to be the year of “exit strategies,” during which investors should consider economic fundamentals and asset markets that will soon be priced in a world less dominated by the government sector. If, in 2009, PIMCO recommended shaking hands with the government, we now ponder “which” government, and caution that the days of carefree check writing leading to debt issuance without limit or interest rate consequences may be numbered for all countries.

Tuesday, January 05, 2010

Danske: Even A 100% Debt-To-GDP Ratio In 10 Years Time Could Prove Difficult For Several Countries

Sovereign debt problem has come to the forefront of mainstream media, even to new heights of default discussions. While some saw this coming as early as last summer, there is unstoppable belief that countries will sacrifice their credit in the name of corporate earnings growth?

Well, it looks like the credit markets have been caught by the virus too, as Suki Mann, the credit strategist at Societe Generale, notes today:

It's been an incredibly upbeat start to the year supported by better-than-expected economic data streams, with everybody's favourite risk measure – equities – now hopeful of a V-shape recovery. We think that’s unlikely and the stock rally is not sustainable at the current pace - there will be many bad days/periods where the data will leave much to be desired. We're wary of (but welcome) the good news currently and we’ll need to be pragmatic also when the tide goes out. For credit specifically, cash activity is limited (market better bid though), and so the focus is on the indices. They are ratcheting lower and at such a pace that it is already likely that we will need to revisit the targets we set for 2010. The X-Over index for example (target 340bp), traded with a 3-handle today having been in the 500bp area for much of Q4 (610bp in October). X-Over is also outperforming Main with the ratio at 5.7x now vs 5.9x at the end of 2009. The ratio was as low as 3.9x(624bp/159bp in March 2008) and as high as 10.5x (242bp/23bp in November 2006). Elsewhere, for now, the ills of sovereign indebtedness are forgotten as their CDS levels also head a little lower as hopes rise of a sustainable (“stimuless”) economic recovery. Even Greece is benefiting with its 5-year CDS at 257/262bp (-23bp today), compared with a recent high of 291bp.
However, those, who still can see further than 3 months ahead, may be interested in the latest note by Danske Bank on the sovereign debt that has taken "a dangerous path". Here are some key findings:

Euro area debt levels are rising faster than at any peacetime rate in the aftermath of the ongoing crisis. Further, as a result of the crisis government bond yield spreads between different euro area member states have exploded.

We take a closer look at debt sustainability for various euro area member states. The approach chosen is to make mechanical projections until 2020 for each country and analyse the projected path for future debt levels.

We conclude that debt levels will rise to unsustainable levels for some countries if member states do not tighten their primary balances significantly.

It is not too late to avoid default. If plans put forward by Greece and Ireland are strictly adhered to, it will stop the debt-to-GDP ratio from skyrocketing. Significant spread tightening in addition to fiscal tightening could stabilize the debt ratio.

The Maastricht Treaty’s debt-to-GDP criterion of 60% seems unrealistic within the next 10 years for many EMU countries. Even a 100% debt-to-GDP ratio in 10 years time could prove difficult for several countries.

Well, while some bulls simply cannot change their New Year's costume yet, there are some early cyclical bulls turning cautious? Jeff Saut, the admired strategist at Raymond James, issued a following weekly call yesterday:
Last Monday we wrote, “As we enter the New Year, we are once again turning cautious because the Treasury market is breaking down (higher rates) and the U.S. dollar is rallying. . . . Therefore, we think it prudent to ‘bank’ some trading profits and hedge some investment positions as we approach the new year.” Moreover, one of the lessons we have learned is that the beginning of a new year is often punctuated with head fakes, both on the upside as well as the downside. One of the greatest upside head fakes was in January 1973 when in the first two weeks of that year the DJIA rallied to a new all-time high of 1051.70 before sliding ~20%. While we are clearly not predicting that, what we have indeed experienced since the March “lows” is the second greatest percentage rally (69%), adjusted for time (nine months), since the 1933 rally. Following that 1933 explosion of 116% in just five months came a pretty decent downside correction. Since we tend to be “odds players,” prudence suggests some caution is again warranted.
Prudence? For some time already, as clowns were hiding in the homes for too long...

Monday, January 04, 2010

Just Another Average Recovery?

There is a nice chart from Citigroup Global Markets this morning, click to enlarge, courtesy of Citigroup.

Tobias Levkovich, the Citigroup' s US equity strategist, issued an updated 2010 Outlook for the US markets on the last American trading day of last year:

Gains likely to be more tempered in 2010. After a tumultuous 2009 and a roughly 25% gain in equities, the probabilities of sustained double-digit appreciation in 2010 seem rather low when looking back at history. In the past, during the year after the one in which recessions ended, the S&P 500 has gained less than 1%, on average, despite earnings growth that averaged better than 10%. Since we expect teen-like EPS gains in 2010, equities can move higher but one should not anticipate substantial gains for the full year. Nonetheless we have tweaked our S&P 500 target up to 1,175 from 1,150.

Earnings strength should bolster the market early in the year. Rising industrial activity, tight cost controls, and inherent operating leverage should provide a significant boost to 4Q09 and 1Q10 reported earnings, ahead of current Street estimates, in our opinion, though some of the late 2009 strength could be subject to early 2010 profit-taking. Nonetheless, the S&P 500 may climb as high as 1,250, leaning heavily towards 1Q10, and things may wane towards mid-year.

Reduced liquidity and higher expectations could lead to market challenges by 2Q10. The Fed is indicating that it will remove some of its monetary accommodation as early as March 2010 and Citi’s economists expect the fed funds rate to climb to 1.0% by year-end from essentially zero now. As yields begin to climb, we would expect P/E multiple compression to ensue, restraining much of the EPS growth benefit. In addition, we suspect that analysts will increase their forecasts sharply if companies top their estimates by significant margins, thereby establishing higher hurdles to overcome in the future, which may lead to some disappointments as the year progresses.

Portfolio positioning may need to shift to more defensive names during the year. While a risk-oriented trading posture still seems appropriate early in 2010, a shift to defensive segments of the market may be required sometime in 2Q10. Thus, investors will find it necessary to adjust their portfolios more frequently in order to post strong relative returns. As such, our overweight stances on Capital Goods, Energy and Consumer Services may need to shift to Household Products and Telecom Services later in 2010, for instance, during the year. In addition, the so-called high quality trade may generate better returns than the alleged junk beta trade over the course of 2010.

Equity investors could be very focused on the mid-term elections. Given weakness in poll numbers for Democrats of late, especially from independents, the mid-term elections may loom over markets as many investors have preferred divided government in the recent past. Thus, one could witness markets easing off as spring slips into summer and the electoral season swings into full bloom, with the Street waiting to see how the political winds blow. With the Bush tax cuts expiring, substantial government involvement in various industries and yawning budget deficits, some clarity on the country’s political direction may become more important to capital markets.

Indeed, it is quite difficult to find a bear these days! Or, pick yourself?

There is an excellent compilation of predictions and outlooks for 2010 at The Pragmatic Capitalist.

Yea, and watch these non-existing bears!