Friday, February 26, 2010

Edwardian Clash Over The Future Of Latvia

Well, it is not about the King Edward VII, but kind of Edwardian style, hopefully ...

Edward Lucas of The Economist proudly posted the article on his blog today. However, Edward Hugh responded to the article in The Economist quite hard:

Basically there is no doubt that Latvia's great economic fall may be coming to an end, but as I explained in this post here, that is not the same thing at all as resuming growth. To get back to growth Latvia's internal devaluation needs to be driven hard enough and deep enough to generate a sufficient export surplus to drive headline economic growth at a sufficient speed to start creating jobs again. This is not about a fiscal adjustment, it never was, and it is little consolation for Latvia to be compared with Greece and told that they are doing just that little bit better. Cry Victory we are told, and unlease the jobs of war. Would that things were as easy done as said!
Not to wait for long and Paul Krugman joined the ring too.

I wrote about the inflated Latvian wealth expectations very recently ...

Latvian banking narcissists were talking hyperventilated about the"turning point" in domestic consumer demand, as local statistics reported today:
Compared to December total retail trade turnover in January 2009 has increased by 4%, according to seasonally adjusted data (calculating at constant prices). Retail trade turnover in enterprises selling mainly food products grew by 1.7%. But in enterprises selling mainly non-food products retail trade turnover growth in January reached 5.3%.

Non-adjusted data marked the lowest level since "depression" started, and the seasonal adjustment from the "December of hunger", as food sales grew by 1.7%, may play a certain role in the "turning point" ...


Thursday, February 25, 2010

Nomura Sees The Ascent Of Asia

Let's start with the driving horse of the Asian miracle. Nomura's strategists and banking analysts wrote over the night:
We have quantified the reduction in liquidity by China to reduce speculation in real estate. BPOC bond issuance and increased RRR have reduced liquidity in the past 25 trading days by US$203bn — almost all of the build-up of excess liquidity in all of 2009. This aggressive slamming on of the brakes took us by surprise. Banks’ stock prices have followed changes in liquidity for several years. (It’s all about liquidity). We think much of the liquidity has been hoovered up. Property prices in major cities are down 5% and volumes are down by half.
Deutsche Bank Research has a nice note on the China's Provinces, and write in regard to the Western hope:
Pinning hopes on China to take the place of the US consumer is asking too much. While private consumption offers some catch-up potential especially in China‟s non-coastal provinces this will not be enough to offset the loss in demand from the US. Moreover, much of the additional demand for consumer goods will be served by local companies.
FT Alphaville sums-up the great Chinese tightening, but also respected economists, like Ken Rogoff and Simon Johnson, have expressed a dose of scepticism and criticism recently.

However, Nomura's global economics team has produced gigantic report "The Ascent of Asia". Here is the summary:

- Asia’s medium-term economic prospects look bright. The region has major, largely untapped, resources, suggesting that it has the supply-side capacity to maintain the strong growth of previous decades.
- The global crisis hit Asia hard, but its good macroeconomic fundamentals enabled it to take strong policy action that proved effective in boosting domestic demand,
- Asia thereby recovered quickly from the global crisis, and this accelerated the shift in economic and political power from the West to the East that has been taking place over the past 30 years.
- Asia’s economic resurgence has thus not come at the overall expense of the economies of the West, although some individual industries in the West are being challenged hard by competition from Asia.
- Realising Asia’s supply-side potential over the medium term will require that the recent strong growth of aggregate demand be maintained. For this, the structure of that demand has to be sustainable.
- Asia’s policymakers would be unwise to assume that, once the world economy recovers, they will be able to count on strong export-driven growth. Western opposition to penetration of its markets by Asia is growing.
- Asia should instead plan on taking part in a global rebalancing of demand: faster Asian domestic demand growth, and slower growth of exports to outside the region – with the converse in the West.
- Continental-sized economies have the requisite potential for growth to be driven by domestic demand. The US until the early 1960s, and India since independence in 1947, are two important historical examples.
- China has had strong export growth over the past 30 years, but domestic demand growth has been strong, too. History suggests that China’s future growth could be led, sustainably, by domestic demand.

- India’s growth has been led fundamentally by the growth of domestic demand, and this should continue for the foreseeable future.
- Smaller economies, by contrast, depend importantly on export growth: their home markets are individually too small to offer economies of scale, and the spill-over of domestic expenditure into imports too substantial.
- Collectively, however, Asia’s smaller economies add up to around 6% of world GDP. By linking themselves through trade they can emulate a medium-sized economy and so depend less on exports to the West.
- Japan continues to rely heavily on exports. However, with its real wages now high, it, too, is less able to depend on export growth. Spurring domestic demand through supply-side reforms has become urgent.
- China, and possibly India, will also need to achieve a rebalancing of the main components of domestic demand: away from investment towards consumption.
- Investment, a potentially volatile component of demand, accounts for a high proportion of total demand in these economies. Over time, it will probably need to come down to reduce the risk of economic instability.
- Asia’s economies, like their OECD partners before them, will experience a growing need to embark on a range of structural reforms, including labour, competition, financial market, social, and trade policies.
- A prerequisite to success with structural policies and trade policies, however, is resolution of the issue that has long been at the forefront of policy concern -exchange rate policy, particularly as regards the renminbi.
- Continual government intervention to prevent currency appreciation is not only causing trade frictions with the West; it is also creating internal problems, including a loss of control over monetary policy.
- To minimise instabilities caused by currency appreciation, China will have to proceed cautiously, in stages. As it does so, it will become easier for other Asian economies to accept appreciation of their currencies.
- Asia’s rapid growth has brought with it pollution problems that are becoming important nationally and, in the case of greenhouse gas emissions, globally.
- Addressing these environmental problems will inevitably impose a cost. But given that all economies globally will be facing similar costs, these should not reduce the competitiveness of Asia’s producers.
- Furthermore, world-wide, policy-induced increases in the (relative) price of carbon, and increasing pollution standards worldwide, offer huge potential opportunities to producers of green technologies.
- Asia’s policymakers face considerable challenges in implementing the policies that will ensure that their economic growth remains sustainable. But the potential rewards are huge: Asia has everything to play for.

Asia's share of world GDP should grow, according to the economists at Nomura. Click on charts to enlarge, courtesy of Nomura.



Macroeconomic growth does not equal to returns to capital.

Wednesday, February 24, 2010

From The House Of Sweet German Confectionery

According to guys at Bespoke (Think B.I.G.), Binky Chadha at Deutsche Bank is the most bullish strategist on the Street. In a note yesterday Binky reiterates $80.8 EPS and 1325 S&P500 target:
Strong earnings momentum and a turn in provisioning argue for revising up estimates, but faster than expected dollar appreciation argues against. An imminent increase in enterprise spending, positive guidance, and a turn in provisioning argue for overweighting the Financials, Industrials, Consumer Discretionary and Tech, which is how we are positioned. Negative guidance and a strengthening dollar argue for underweighting Energy and Materials, with underweights for Utilities and Telecom supported by negative guidance and poor earnings momentum, respectively. We see high cash and low macro growth expectations spurring M&A and reiterate our Acquisition Targets basket which has outperformed the S&P 500 by 6.7% so far year-to-date...
Click on charts to enlarge, courtesy of Deutsche Bank.

Interestingly, the "mini-crisis" of early 1990-ties required longer duration of "charge-off rate" to hover at the same level as "QoQ Chg in Unemployment Rate"?

And who has tested the "loan loss provisions" in the case of prolonged unemployment around the current level?


Just climbing the wall of worry?

Chart Of The Day: ex-Bubble Midcycle P/E

Cannot get off the bubble? A wonderful chart at The Big Picture, read and see more here ...


Cannot Afford Low Prices And Low Interest Rates?

Markets tanked yesterday, and one of the reasons was the gauge of US consumer mood by Conference Board, that failed to inspire.

Bulls were sceptical - should we take the reading seriously? For example, Nomura commented:

The Conference Board's index of consumer confidence fell over 10 points in February after reaching a 15-month high in January. Though the consensus expected a small retreat , the magnitude of this drop was stunning and, at face value, would seem to signal an important set back for the nascent recovery. The decline, which cut the headline index to a 14-month low, reflected mainly a marked downgrading by consumers of their assessment of current conditions. That index fell to 19.4, an all-time low. Against a back-drop of rather impressive recent economic data, including a surprising dip in the jobless rate and low core inflation, this seems especially puzzling. The overall drop in confidence reflected deterioration in attitudes across all income groups, 7 of 9 regions and 2 of 3 age groups. As uniformly unsettling as the details of this report look, the contradiction of this evidence with other measures of consumer attitudes (e.g. the Michigan survey and recent Gallup poll readings) warrant skepticism. So too does the rather suspicious regularity of February weakness in this index. Since 2000, the index has declined in all but one (2007) February . Such a regularity across a varying backdrop of cyclical conditions business cycle time is unusual and raises questions (for which we have no ready answer) about the reliability of this particular seasonally adjusted measure.
On the other hand, BNP Paribas had the lust to dig for explanations. Click on chart to enlarge, courtesy of BNP Paribas.

BNP Paribas focused on home buying conditions and plans to buy:

The University of Michigan index of buying conditions for homes, which is calculated as a percentage of people who believe that it is a good time to buy less a percentage of people who think it is a bad time to buy, bounced up in 2009 and remains above its long-term average (see above chart). However this measure has diverged sharply from plans to buy a home in the next six months in the Conference Board Survey, although ... the improvement in the Michigan survey has better captured the movements in home sales. The University of Michigan survey also asks the respondents why they think it is a good or a bad reason to buy a house. Low house prices have been the main driver of the improvement in housing demand, while the percentage of people citing prosperity or good investment as a reason for a purchase is virtually zero.
Click on chart to enlarge, courtesy of BNP Paribas.

Low prices and low interest rates are not enough to afford a house? Where are we going?

I do not wonder that people cannot afford a house at these "low prices" and "low interest rates", especially, if one keeps in mind "Labour Underutilization Rate By Household Income".


Tuesday, February 23, 2010

F-Armaggedon's "Hard Rocks And Hard Shocks"

I had the chance to read the latest strategy journal by Don Coxe last night. Here are some interesting quotes:
Wall Street’s words of repentance and its acceptance of meaningful reform are as impressive and reliable as the investment quality of the average sub-prime CDO...

Despite that the technicals of US regional banks are improving on relative basis vs S&P500. Click on chart to enlarge, courtesy of Coxe Advisors, BMO Capital Markets.

This is addressed to Greeks:
Athenian democracy disappeared 23 centuries ago, and only returned when Truman intervened after World War II to prevent the USSR from taking over. Greece’s democratic performance since then suggests that the genes of Pericles and Solon are extinct.

Intimated with gold bugs, that are also gamed by the psychology of scarcity :
Aaron Regent, Barrick’s market-savvy new CEO, comes from a base metals background at Falconbridge. He helped fuel the flames of desire (after he had shrewdly convinced Barrick to pull in its huge hedges) by touching and stroking a hitherto-undiscovered erogenous zone in gold bugs: peak gold— which could be the latest Big Thing since peak oil.
This on responsible mining:
Therefore, responsible mining means mining some lower-grade ore during periods of high metal prices to expand mine lives. This not only serves the community, it protects the value of the company’s biggest asset—the mine. This was illustrated a while back when Freeport McMoRan announced a slight reduction in its copper and gold output, which meant earnings came in modestly below the estimates of some Street analysts. Some of these responded with criticisms of management’s “failure to execute,” and argued that shareholders should reconsider their approach to the stock.
Equity vs Stuff:
...investors should overweight the gold mines and underweight the bullion if they are bullish on the metal, and reverse the strategy if they turn bearish on the metal.
More of trading type conclusions available at The Pragmatic Capitalist, but so far I have not seen the full report available freely on web ...

Rajiv Sethi Offers "Some Readings On Liquidity, Leverage And Crisis"

A nice compilation of sources and a comment by Rajiv Sethi you will find here. For the straight entrance look below:

Financial Intermediation, Loanable Funds and the Real Sector by Holmstrom and Tirole
The Limits of Arbitrage by Shleifer and Vishny
Understanding Financial Crises by Allen and Gale
Credit-Worthiness Tests and Interbank Competition by Broeker
Credit Cycles by Kiyotaki and Moore
The Leverage Cycle by Geanakoplos
Collective Moral Hazard, Maturity Mismatch and Systemic Bailouts by Farhi and Tirole
Liquidity and Leverage by Adrian and Shin
Market Liquidity and Funding Liquidity by Brunnermeir and Pedersen
Outside and Inside Liquidity by Bolton, Santos and Scheinkman

Monday, February 22, 2010

Sacred Cows And Toxic Narcissists

I read at Dean Baker's "Beat The Press" today:
Actually, he has a pretty good case. With Goldman Sachs and the rest of the financial sector siphoning off an ever larger share of the country's output, we may not be able to afford much of anything in the future. If the financial sector's share grows at the same rate it has been growing over the last three decades, the rest of us will have to learn to get by on less.

This reminds me how Barry Ritholtz summed-up the Dean Baker's conclusions on "Big Bank Subsidy":
-The spread between big banks’ (1.15%) and smaller banks’ (1.93%) cost of funds is 0.78%:
-The annual boost to profits of 18 biggest banks from that funds -cost advantage: $33 billion;
-Pre-2008 spread in big and small banks’ funds -cost: 0.49%:
-Part of big banks’ profits from rate “subsidy” (1H09): 48%:

and then also this by Barry:
Here is something to think about: Even after the TARP has been fully paid back, the US Government is STILL bailing out TBTF banks more than we are giving bailouts to US families with hungry kids, and more than all of our overseas aid . . .
Of course, all those bank profits still have the "Mark to Make Believe" stigma ... and now when there is a doubt growing about the Eurozone recovery, the banks, especially in the Europe, may get into a difficult situation again. Bank analysts at Citigroup Global Markets estimated last Friday:

Funding Concerns — The volatility in bond markets has once again elevated the issue of funding for the banks. Sovereign and interest rate risks could add additional pressure to earnings. Recent 4Q results have already revealed NII pressures due to rising funding costs.

10% Earnings Hit — We estimate 10% cumulative impact to normalised earnings from four factors: higher credit risk spreads, higher interest rates, maturity extension, and net stable funding ratio requirements. This impact equates to c. 21 bps cumulative repricing of loan books. A sizeable chunk of the impact could be passed on to customers if changes in underlying rates & spreads are not abrupt.

€240 Billion Annual Issuance — We estimate that twenty-four European banks accounting for 65% of system assets may need to issue c. €240bn annually for the next three years. This issuance should be enough to fund the banks’ existing business and new business, as well as satisfy the new Basel stable funding requirements. At 76% of historical issuance for 2007-09, needs are not onerous.

Risk Appetite Flourished...and Wilted? — These twenty-four banks were able to issue €56bn of long/medium-term funding in January 2010. This is double the rate of January 2008 and 50% higher than in January 2009. However investors’ macro
concerns are restricting their appetite for new issuance in February and this could eventually drive up funding costs meaningfully. Fears of crowding out by sovereign and corporate issuers, however, look overblown.

Click on chart to enlarge, courtesy of Citigroup Global Markets.

Equity strategists at Danske Bank have an even less rosy look at European banks today:

The harsh future conditions for the Financials sector and specifically the banking industry are not discounted by the stock market.

This is a key problem for the stock market in 2010/11 as regulation, policy exit strategies and debt crisis make investments in banking stocks risky.

The high valuation of the industry makes it especially risky. Today investors pay a premium on European Banking stocks of 10% vs. a historical discount of 20%, and the market is discounting long-term EPS growth of 5% vs. historical 4%.

As Financials is still one of the two most market trendsetting sectors in the European stock market universe, the market, in our view, will remain vulnerable to the erosion of earnings conditions for the banking industry.

However, European banks are outperforming the market as I write ...


ECB Harmonized Competitiveness Indicator

In case one wants to know who has inflated oneself through the roof, economists at Societe Generale have drawn a nice chart, click to enlarge, courtesy of Societe Generale.
George Soros writes at FT today:
So makeshift assistance should be enough for Greece, but that leaves Spain, Italy, Portugal and Ireland. Together they constitute too large a portion of euroland to be helped in this way. The survival of Greece would still leave the future of the euro in question. Even if it handles the current crisis, what about the next one? It is clear what is needed: more intrusive monitoring and institutional arrangements for conditional assistance. A well-organised eurobond market would be desirable. The question is whether the political will for these steps can be generated.

Latvians inflated their wealth expectations into the sky, but the economists at CEPR still now write:
But even after two years of recession, with unemployment hitting 22 percent, the real effective exchange rate has only dropped 5.8 percent from its peak.
Interestingly, what it takes for Southern Europe to deflate?

Friday, February 19, 2010

Foreseeable Future Of Narcissists Ended Yester-night

Federal Reserve raised the discount rate yesterday night. Note that discount rate is charged to banks for direct loans by the Fed, and it is not the policy "Fed Funds" rate. WSJ Real Time Economics has a list of opinions on the move.

Interestingly, Bruce Kasman at JPMorgan opines:
This move is part of the removal of unconventional measures and should not be seen as a signal of a change in the Fed’s monetary policy stance.
That rather sounds like talking the "sweet spot" and "reflation trade"... However, Macro Man has it right, IMHO:
So while the Fed and much of the sell side are claiming that the discount rate hike "don't mean a thing", given current market pricing Macro Man ain't biting.
There is quite obvious risk of inflation scare in the markets (that would be wrong, IMHO), mainly due to base effects. Societe Generale, among the members of the hawkish wing commented:

The Fed is moving faster than anticipated and the pace suggests that we should anticipate outright rate hikes in the second half of 2010 rather than early 2011 as we previously expected.

The next likely step will be dropping the “extended” language from the FOMC statement. It is now a very likely outcome at the next Fed meeting on March 16. Whereas we thought that such an outcome was conditional on employment increases, the hurdle on that now looks much lower. Unless the employment situation deteriorates, the Fed is set to move forward with its accelerated exit plan.

Singaporean DBS got it even more hawkish:

Markets currently have one 25bps hike priced in Q3 and another Q4. DBS has been modestly more aggressive in its view than markets for some time. We continue to look for two hikes in Q3 and another two in Q4, putting Fed funds at between 1% and 1.25% by end-10. (The fed funds target midpoint is currently 0.125%). We view yesterday’s discount rate hike as confirmation that we are on the right track.
Global equity strategy team at BofA Merrill Lynch have it really sweet in their backyard:
Rising rates are a bull market phenomenon. Confirmation of this view requires a positive reaction from bank stocks and the yield curve staying steep.

MSCI ACWI target remains 350. Three quiet positives which boost our bullish cyclical view for global equities: US consumer data improving; there has been no deflationary shock for equities from Greece (inflation expectations are surprisingly elevated); bank performance yet to respond to steep yield curve ...

The next secular bull market in equities will coincide with a secular bear market in government bonds ...
As to me, the foreseeable future of narcissists ended yester-night, with global liquidity getting tighter and uncertainty increasing ...

Thursday, February 18, 2010

Market Impact Of Adjusting Inflation Targeting

IMF staff came out with a note last week "Rethinking Macroeconomic Policy" that has sparked the "inflating out of debt" talk again. The Keynesian school a la Krugman is trying to support the idea with a reasoning by "academic economics", that often ignores the basics of markets. On the other side of reaction spectrum the "Austrian Mish" strikes back hard, but hyperventilated Zero Hedge digs deeper.

I am listing here couple of posts more or less related to the issue above and that I was quick to find, in random order:

Why hasn't the Fed been targeting two or three percent inflation?
Conducting Monetary Policy when Interest Rates Are Near Zero: Will it Work?
Googling "Inflation targeting" and "fiscal stimulus"
“Why Bernanke’s Defense of Super Low Interest Rates Does Not Hold Up”
Chris Sims on Policy at the Zero Lower Bound

The FX strategists at BNP Paribas had a note yesterday, with their views on the market impact:

It seems that long-term trends are in the process of terminating. When in the early 80s New-Zealand adopted inflation targeting policy the economy increased its inflation neutral growth potential which allowed for a higher valuation of assets. New-Zealand became the role model for other economies and when Norway experienced its NOK crisis in 1998 it was the last G-10 economy de facto converting towards an inflation targeting policy (the ECB targets inflation and money supply and the FED targets inflation and the labour market). Inflation targeting policy has been successful with inflation not only declining in absolute levels as well as in volatility. Reduced inflation rates encourage economic agents to forecast falling interest rate volatility given that its main component would have a smaller size. As a result, investors were able to reduce cash provisions and increase leverage. Monetary velocity moved up. This process was additionally supported by Western demographics where baby boomers invested trying to create assets to draw on when retiring. This environment allowed inflation to decline, leverage and monetary velocity accelerate as risk taking could increase and securitisation grew, further pumping up capital market valuation. This was the past, but the future will look very different.

Baby boomers are set to retire and thus will reduce the pace of capital accumulation which will not bode too well for risky assets. However, the biggest challenge for capital and implicitly for currency markets will come from the inflation front. The IMF’s chief economist Olivier Blanchard claims that the 2% inflation target adopted by most G-10 central banks should be revised to a higher level with 4% probably optimal. An inflation target of 4% will allow nominal rates to rise to 6-7% providing monetary authorities sufficient ammunition for easing policies when ever required. Higher inflation rates have as well the advantage channelling wealth from asset to liability holders, from the old to the young generation and within Europe from the rich south towards the poorer south. Additional effects suggest that agents will have to assume a higher volatility of rates and yields forcing them to reduce leverage and to hold higher levels of equity relative to assets. In the long-term a conversation toward a higher inflation target will reduce monetary velocity.

But what will be the market implications. First, central banks will have to remain accommodative in order for inflation to reach a higher inflation level. This additional liquidity will seek an asset class leaving the question, which one? Since higher inflation will be the outcome of this policy we suggest that equity markets will not benefit from central bank liquidity. When inflation rises, expected earnings will be discounted with a higher (inflation) rate suggesting equity markets would not benefit. PE ratios will generally decline. Higher inflation would be hostile for any sort of fixed income related products unless it is High Yield. The flow of funds will move there were revenues can be adjusted according to inflation. Soft commodities fall into this category. We have been arguing for some time that rising income in population rich areas such like Asia and Latam will promote soft commodity prices. G-10 potentially converting to a higher inflation target will additionally promote soft commodities as an asset class. Currencies of Australia, Canada, New-Zealand and the US will benefit from this potential long-term trend.


Click on chart to enlarge, courtesy of BNP Paribas.


Well, there seem to be a lot of questions for me. First, was not the high asset prices and high debt levels compared to incomes that caused the crisis? Simply reflating to get higher asset prices do not solve the problem of incomes. US is loosing jobs because there are cheaper employees elsewhere. Secondly, food and energy inflation will squeeze out the discretionary spending in the lower income deciles anyway, so reducing the real quality of life, without making a change in the structure of incomes and consumption the effect will be short-lived? Increasing volatility will force to reduce leverage anyway. Among others also, why anyone believes that there are agents who can control that process? Rather, sovereign credit will be crucified in the name of corporate profits without any consequences?
Trying to fight secular forces?

Behavioral Economics By Thaler, Mullainathan, Kahneman

This comes via Farnam Street, H/T FT Alphaville:

...There's new technology emerging from behavioral economics and we are just starting to make use of that. I thought the input of psychology into economics was finished but clearly it's not! (Kahneman)


Class 1 LIBERTARIAN PATERNALISM: WHY IT IS IMPOSSIBLE NOT TO NUDGE (Thaler)
Class 2 IMPROVING CHOICES WITH MACHINE READABLE DISCLOSURE (Thaler & Mullainathan)
Class 3 THE PSYCHOLOGY OF SCARCITY (Mullainathan)
Class 4 TWO BIG THINGS HAPPENING IN PSYCHOLOGY TODAY (Kahneman)
Class 5 THE IRONY OF POVERTY (Mullainathan)

Wednesday, February 17, 2010

Reading James Montier ... Just A Bad Dream?

As always, worth spending some time reading the latest by James Montier - "Was It All Just A Bad Dream? Or, Ten Lessons Not Learnt", available at Zero Hedge and The Pragmatic Capitalist ...

European Bankruptcies To Come?

The economists at Societe Generale are looking at the yesterday's ECB survey of SME's (small and medium enterprises) access to bank financing. It appears that it is still tough to be small:

In terms of lending needs, while half of SMEs reported an unchanged need for bank loans in H2, a quarter of them reported an increased need. At the same time, about a third of SMEs complained that the level of interest rates on loans had increased despite the fact that policy rates have been constant. Underscoring the continued weakness of demand in the euro area, the most pressing problem faced by SMEs was still finding customers (28% compared to 27% in H1). However 19% of firms reported that access to finance was their most pressing problem, up from 17% in H1. SMEs reported that external financing was required to fund both fixed investment and inventories and working capital.

Banks, of course, see things differently. They claim lending is contracting in the euro area not just because they are pricing risk more appropriately but also because demand from companies, reluctant to invest, has fallen; this latest survey would appear to refute the banks’ claims. It is not hard to envisage a whole raft of SMEs that were viable businesses in the past but who are now screaming out for bridging loans to help see them through the recession. A number of SMEs are fearful of what will happen in the coming months as end of year results are presented to existing creditors. Having survived so far on existing covenants, there is a real risk that loans will not be rolled over, forcing increasing numbers of smaller and medium sized companies into bankruptcy. Clearly, there is a risk that this could yet provoke a second leg to the current downturn.


Click on charts to enlarge, courtesy of Societe Generale.

I will not wonder if at the end of the day some will conclude that the recovery so far has been overestimated. Just because statistics overestimate the performance in the SMEs, especially in the services?

Tuesday, February 16, 2010

Merrill's Global Fund Manager Survey

The heads were quite hot last month, but now we have got a bit of fresh shower. Though, Greek bail-out complacency prevails:

China & Greece chill January's excess optimism

The February FMS reverses the excess optimism on January. All growth and risk indicators moved lower: global growth diffusion index (DI) dropped from +72% to +51% and investors raised cash balances from 3.4% to 4.0%. February sentiment is cautious enough to steady markets but is not yet pessimistic enough for an unambiguous contrarian buy signal. Note two-thirds of our panel believe Greek default is unlikely, with 58% seeing a last minute bail out as most likely.

Three sentiment extremes to watch

First, the "double-dip" plunge in Chinese growth expectations (growth expectations cratered from +51% to +7%, lowest since March '09). Second, the collapse in European bank overweight from -16% to -53%. Third, investor optimism on the US dollar (a net 57%) is at a 10-year high. Reversals in Chinese equities, European banks and/or the dollar would signal ‘correction over’.

Consensus more bullish on rates

In reaction to the perceived growth shock, 42% of panellists now expect the Fed to be on hold until 2011 (vs. just 17% last November), and 45% expect the ECB to do nothing until 2011 (up from 17% in December).

Asset allocators cut equities, raise cash and bonds

In February, a net 33% of asset allocators were overweight equities, down sharply from +52% last month. Cash was raised with allocators now 12% overweight cash vs. 8% underweight last month. The proportion underweight bonds fell to -39%, from -48%, back to December levels. With a nod to changing China sentiment commodity overweights halved to +10% from +23% in January. Gold is viewed as overvalued (net 15%) but oil is now seen as undervalued (18% vs. 1% in Jan.).

The pain trades

Contrarian investors should be positioned for the following: US dollar depreciation, yen or Euro appreciation, global bank outperformance, tech sector underperformance, UK equity outperformance, lower bond yields. Elsewhere sentiment on EM looks more balanced, exposure to US equities is notably lagging US dollar optimism, telecoms and utilities are the better laggard defensives.


Growth expectations already peaked? Click on chart to enlarge, courtesy of Bank of America Merrill Lynch.

Watch the China equities, European banks and the dollar!

Monday, February 15, 2010

Taiwanese Bull Rodeo?

I was curious about the "bull" in Taiwanese equities. However, a look at 30 year history of Taiwan Weighted equity index does not make that bull visible?

Click on chart to enlarge, courtesy of Nordea Analytics.


The run-up into 1990 and the subsequent collapse has left the bull without direction, but a wide range trading for the last 20 years...

Reading "The Invincible Market Hypothesis"

Rajiv Sethi, the professor at Columbia University & Santa Fe Institute, had a post yesterday that is worth reading in full. Here are some highlights for the lazy soul:

This passage illustrates very clearly the limited value of informational efficiency when allocative efficiency fails to hold. Prices may indeed contain "all relevant information" but this includes not just beliefs about earnings and discount rates, but also beliefs about "sentiment and emotion." These latter beliefs can change capriciously, and are notoriously difficult to track and predict. Prices therefore send messages that can be terribly garbled, and resource allocation decisions based on these prices can give rise to enormous (and avoidable) waste. Provided that major departures of prices from intrinsic values can be reliably identified, a case could be made for government intervention in affecting either the prices themselves, or at least the responses to the signals that they are sending.

Under these conditions it makes little sense to say that markets are efficient, even if they are essentially unpredictable in the short run. Lorenzo at Thinking Out Aloud suggests a different name:

...like other things in economics, such as rational expectations, EMH needs a better name. It is really something like the "all-information-is-incorporated hypothesis" just as rational expectations is really consistent expectations. If they had more descriptive names, people would not misconstrue them so easily and there would be less argument about them.

But a name that emphasizes informational efficiency is also misleading, because it does not adequately capture the range of non-fundamental information on market psychology that prices reflect. My own preference (following Jason Zweig) would be to simply call it the invincible markets hypothesis.

Well, for the lovers of complexity theory and computer science here comes the cake!

Global Asset Class Competition

With the focus on 4 main asset classes. This chart is almost one week old, but still valid. Click on chart to enlarge, courtesy of Jan Bylov of Nordea Markets.

Although the uptrend in commodities appear to be broken, Societe Generale is trying to push the maximum overweight trade in commodities today, and prefers precious metals/energy vs base metals/softs ...

Friday, February 12, 2010

Sentiment Vs Reality?

Disappointment of the week in the house of BNP Paribas. Click to enlarge, courtesy of BNP Paribas.

While the "mean reversion" fans in the US may be playing with the fire, cyclical hyper-ventilators are whispering:
"While the U.S. economic expansion is well set to strengthen in the near term, the current easing in WLI growth to a 25-week low suggests that growth will begin to throttle back by mid-year," said ECRI Managing Director Lakshman Achuthan.

Thursday, February 11, 2010

Reading On Latvia's Recession And Cost Of Adjustment With An "Internal Devaluation"

Mark Weisbrot and Rebecca Ray from CEPR with their view "Latvia’s Recession: The Cost of Adjustment With An “Internal Devaluation”".

Overconfidence In The Future Self-Control Leads To Large Bond Market "Event"?

I am not a fan of research from GaveKal, but I happen to discuss their ideas with my friends. However, the guys had a statement yesterday, I tend to agree:
The end of Lehman marked the death of securitization as we knew it, and the markets took a good six months to adjust to this new reality. But today, the Greek events mark the death of another pillar of the bull market: the idea that country risk can be safely discarded, at least in developed markets. And this could prove to be just as momentous an event.

Dylan Grice, the strategist at Societe Generale, goes further today with a basic math to explain the possibility of "to be just as momentous an event":

... maintaining a stable debt to GDP ratio requires governments to run a primary balance proportionate to the difference between interest rates and GDP growth.

Before seeing how our governments compare, two qualifications are necessary. Firstly, the European estimates are distorted by the recent "convergence" within the eurozone which allowed periphery economies temporarily higher GDP growth rates and lower interest rates. This makes on-balance sheet debt loads appear more stable for those economies than they actually are. Secondly, the calculations
show only those surpluses required to stabilise the debt loads which are on-balance sheet. And it's important to be clear about this. According to Gokhale [“Measuring the unfunded obligations of European Countries” by Jagadeesh Gokhale; National Center for Policy Analysis Policy Report 319; Jan 2009], most government indebtedness is in the form of unfunded pension and health liabilities, which are unrecorded and effectively off-balance sheet ...


Click on chart to enlarge, courtesy of Societe Generale.

Those on the left have been running budget balances consistent with falling on-balance sheet debt to GDP ratios, while those on the right haven’t. The US, the UK, Greece, Portugal and Norway (?) all fall into this latter category.

Eyeballing this chart, one might think governments ‘only’ need a 3% underlying contraction of fiscal policy in order to right the ship. Wouldn’t doing that over a number of years be plausible? Perhaps, but I can’t find any examples of it having happened before. And while that doesn’t make it impossible it does illustrate both the political difficulty of following such a path, and the behavioural biases present in politicians’ confidence that they will - if it is difficult to summon the political courage today, why will it be easier tomorrow?


But consider this: all countries, and especially those to the right in the chart, are enjoying exceptionally favourable financing positions, with government bond yields near unprecedented lows. Should anything push bond yields higher, even by just a percentage point, the on-balance sheet debt situation will become explosive. This is the situation in Japan where the 8% contraction required to rein in its already explosive debt ratio is politically impossible. And again, remember that the estimated 8% required contraction assumes the Japanese government can continue to fund itself at a 1.4% JGB yield, which is clearly unrealistic.

If the on-balance sheet position today looks dicey for the rest of us, the off-balance
sheet numbers are far more worrying. The following chart shows Gokhale’s estimates of the perpetuity surpluses governments would have to run to meet the current outstanding obligations which are both on- and off-balance sheet. The chart speaks for itself. Such fiscal deflation is clearly a political impossibility.


Click on chart to enlarge, courtesy of Societe Generale.
And he finalizes with an elegant warning to Keynesians:
Apparently heroine addicts can become so drug dependent their bodies cannot withstand the shock of withdrawal, and failure to continue taking the drug triggers multiple organ failures. I just wonder how apt that analogy is to our governments’ debt dependency today. As long as governments think that taking these difficult decisions to end the addiction will be easier in the future than it is today, they will never take the decision ‘today.’ At the very least, there will have to be a sufficiently large bond market ‘event’ to force the issue.

Keynesians have much more issues to re-consider, including the ones related to structural shifts in the incomes and taxes ...

Wednesday, February 10, 2010

Neuroeconomics Reading ...

HT Mebane Faber, the "Neuroeconomics: How neuroscience can inform economics" by Colin Camerer, George Loewenstein, Drazen Prelec.

French Bears Look At Japanese Government Bonds

Analysts at BNP Paribas have mastered nice charts today. One interesting thing in the context of "The Great Recession of 2008/2009" is that the yields for Japanese government bonds were not pushed down to record low levels ... like in, for example, US.

Click on charts to enlarge, courtesy of BNP Paribas.


While Japanese are brewing THE TRADE, as Japan fades into the future with a walking stick... Latvians may miss the chance of that luxury.

Tuesday, February 09, 2010

Why Getting Slowly Lite Also With Defensives In Risky Assets?

Well, some "defensives" may be not so defensive in these days. First of all, think about the companies that are "easier to tax". Secondly, there are some market issues of which the analysts at Barclays Capital had a nice summary in relation to European affairs last week:

Signs of stress across asset classes: Concern over budget deficits could affect not only European bond yields, but also the euro (trade-weighted euro -5% since late October 2009) and equities (Euro STOXX 50 -6% since 11 January 2010).

Reduce Banks, Telecoms, Utilities: We see the greatest spillover effect from higher potential funding costs into these three sectors given: 1) their historically high correlation between the sector credit spread and underlying sovereign credit spreads; and 2) their high absolute debt levels and thus need for regular bond refinancing.

Move to ‘safe haven’ sectors/indices: We believe the low-debt defensive sectors to switch into include Healthcare, Food & Beverages and Food Retail. On a regional basis, we would expect the national equity indices of Portugal, Italy, Ireland, Greece and Spain to underperform other European bourses owing in large part to their heavy banks weightings.

Pick your risks very careful!

Myth Of Greek Problems

Following up on the Doug Kass, I mentioned yesterday, the excellent economists at Societe Generale have got a nice reference for Greece versus California.

Click on picture to enlarge, courtesy of Societe Generale.


I am looking forward to sunny Spain, and UK, US ... Some facts and myths of Euro zone debt crisis nicely packaged here.

Monday, February 08, 2010

Recovering Tariffs?

While we wait for a kind of bounce in risk markets, and here the wisdom of admired Jeff Saut of Raymond James may be spot on with the call for this week:
Economist, historian, and savvy seer Eliot Janeway stated decades ago, “When the White House is in trouble, the markets are in trouble!” Plainly, we agree and would add that the January Barometer has registered a cautionary signal, as has Lucien Hooper’s December Low indicator. That said, Friday’s turnaround, accompanied by pretty oversold readings, should lead to some sort of one- to three-session rally attempt. To that point, the NASDAQ 100 (NDX/1746.12) was “up” last week (+0.29%), as was Info Tech (+0.72%), Materials (+0.83%), and Natural Gas (+6.7%); so they may lead the “bounce.” Luckily, we have investments in all of these complexes. However, at session 14, in the envisioned 17- to 25-session “selling stampede, we remain cautious.

... I went to see what Google Trends are telling about the "TARIFFS". Another sign of healthy global economy?

Well, I looked also at the latest run through the blog roll, and chickens especially get grilled recently:
Protectionism: China and chickens versus Canada and Buy American
China Announces 105% Tariffs on Chickens in Retaliation for US Steel and Tire Tariffs
MARKET WRAP – VOLATILE DAY ENDS WHERE IT STARTED
China Vs. US Chickens
China Complains to WTO About EU Tariffs

and then these too:
Should we cancel Haiti’s debts?
China GDP Growth Trumps Arms Dispute
Wonderful books added to literature

that' s only for February to start with!

Well, some "bulls with faith" are burning fingers, some believe greed might get good again, some still see no panic at all ...

I do not fear to sell in strength ... but do not rush, as we, indeed may be still higher in a week or two.

Friday, February 05, 2010

CDS Spreads Lead Bond Spreads?

This comes from the astute Euro zone government bond guys at Nordea Markets today:

Greece’s CDS levels traded above Greek-German bond spreads before the spreads soared, suggesting that some market participants simply had to buy protection, almost at any price. We saw the same phenomenon in Portuguese CDS-bond basis.

It is also worth noting that the Greek and Portuguese CDS levels fell below bond spreads before the spreads narrowed in H1 last year, i.e. credit default swaps were leading the bond market performance. We would also note that the Portugal CDS spread is still wider than the bond spread, suggesting that the sell-off in Portuguese bonds will continue.


Click on charts to enlarge, courtesy of Nordea Markets.


Enjoy, while the Spain is a serious country ... Be careful!

Read more about the sovereign credit in "Q&A: Carmen Reinhart on Greece, U.S. Debt and Other ‘Scary Scenarios’" at WSJ Real Time Economics!

US Employment & Tax Receipts

While the market waits for US non-farm payrolls fantasy today, economists at Societe Generale have some nice charts today, linking employment and tax receipts:
In the US, personal taxes are the biggest source of government revenue. They make up 70% of current tax receipts vs. 21% from corporate taxes. Since the start of recession and job losses in early 2008, personal tax receipts have dropped by 32%, or by 3% of GDP. In other words, the drop in employment is responsible for nearly half of the widening in fiscal deficit over the past 2 years.

Click on charts to enlarge, courtesy of Societe Generale.

Would bond vigilantes appreciate improvements in employment?

But watch for quality of that employment improvement! Government hiring may be misleading ...

Thursday, February 04, 2010

Fear Of Bond Market Collapse?

According to Bloomberg today:

Feb. 4 (Bloomberg) -- Nassim Nicholas Taleb, author of “The Black Swan,” said “every single human being” should bet U.S. Treasury bonds will decline, citing the policies of Federal Reserve Chairman Ben S. Bernanke and the Obama administration.

It’s “a no brainer” to sell short Treasuries, Taleb, a principal at Universa Investments LP in Santa Monica, California, said at a conference in Moscow today. “Every single human being should have that trade.”


Ufff! Scared? Well, Felix Salmon has an interpretation of Taleb's words:
Taleb isn’t actually giving investment advice here, although it might sound as though he is. He’s just making a rhetorical point that Bernanke and Summers are bound to make some kind of a mistake in trying to steer the US economy — and that such mistakes are likely to result in higher long-term rates. The problem is that, as we saw during the most recent crisis, every so often an economic disaster results in lower long-term rates. So overall I’d say that following Nassim’s investment advice from his book is definitely preferable to following off-the-cuff comments he’s making in Moscow.

Not convinced by Salmon's interpretation? Interestingly, but I look at 10-year US Treasuries in my screens right now, and we are trading close to the lowest intra-day yield of ca. 3.60%, but we were at 3.71% in the European morning today. Gold was also thrown down from (spot) 1110 USD in the European morning to 1062 as I write. Of course, the markets have been flooded with bond market bubble fear now. Also Australian equity strategists at Citigroup Global Markets had a refreshing reminder of bond market collapse of 1994 last week. The key messages were as follows:

Unlikely, but Beware — The massive sell off in bonds yields through 1994 caught the market by surprise. Even with the benefit of hindsight, it was not “obvious” in the way we now view equity market corrections of late 1987, 2000 and 2008.

Similarities to Now — Leading into 1994, economies were in upgrade mode with equity markets performing strongly. The Fed funds rate had been kept at a (then) record low for an extended period of time so as to nurse US commercial banks and the property market off the critically ill list.

Warning Signs — Look for upward movements in US Fed fund futures, an increase in long term inflation rate expectations, underperformance by US treasuries and hawkish central bank commentary as signals of a potential repeat.


Click on chart to enlarge, courtesy of Citigroup.

Well, from historical perspective the jump in yields in 1994 does not look that big at all. Further, we have discussed the bond market collapse of 1994 behind the scenes in the meantime. The key finding so far are:
... contrary to 1994 when no one believed it should come/crash it appears that most believe that bonds can only collapse this time around!
... they appear very eager to buy interest rate caps i.e. this is an expression of fear of an upcoming bond bear market. Again, this attitude is very different to the end-1993/early 1994 sentiment where "everyone" believed that the 1993 bull market should carry on (forever).

So far it looks different to 1994. And it is not only about the Greece or PIIGS in the Eurozone, but also other fiscal jokes.

Behind the sovereign debt background, there are some issues in the credit markets worth mentioning. According to BNP Paribas credit strategists:
Within corporate credit, financials have been the main underperformers, particularly in CDS, with the spread between iTraxx Senior Financials and Main hitting 12bp – a higher differential than after Lehman's demise.

Click on chart to enlarge, courtesy of BNP Paribas.



Credit jokes?

Wednesday, February 03, 2010

Refreshing On Current Chinese Affairs

Some links on Chinese hope:

First of all, let's start with a great sum up by Felix Salmon with Shorting reserves.
It may get tough in the real life, and not only with language ...

Nice chart-book by BBVA, and comment by BNP Paribas on latest PMI reading.

James Chanos with little love about 1 hour long...

Tuesday, February 02, 2010

Deutsche Prescribes The Focus On Fiscal Performance For Baltics

Busy economists at Deutsche Bank finally had the chance to make a quick look at the economic affairs in Baltics last week. In their weekly "Focus Europe" their take was rather straight forward:

The Baltic economies are showing some tentative signs of stabilization. Base money has stabilized as currency pressure has eased while demand for FX deposits appears to have peaked, at least for now. The data flow on economic activity is no
longer uniformly negative and at least in Estonia and Latvia 2010 should produce some modestly positive QoQ GDP growth rates.

Click on chart to enlarge, courtesy of Deutsche Bank.


All three governments have taken extensive measures to contain their budget deficits. But only in Estonia has fiscal management been sufficient to maintain the deficit within 3% of GDP. This may be sufficient to win the country EMU entry next January.

In Latvia and Lithuania sizeable fiscal hurdle sremain ahead. Deficits in both countries remain well in excess of the criterion in Maastricht while Latvia’s October general election could weaken political support for further reform. In the near term better than expected fiscal performance in Latvia has boosted the sovereign’s liquidity position while access to Eurobond markets is crucial for Lithuania if it is to avoid an IMF programme.

Click on table to enlarge, courtesy of Deutsche Bank.

Interestingly, has Deutsche noticed some demand for "Italian-style" lipstick cosmetics in Estonia?
Encouragingly Estonia may receive an upbeat recommendation from the European Commission in May on its bid to adopt the Euro in January of next year. But even though we should learn in April that it met the fiscal target last year and that inflation should remain below the required threshold, risks remain. For example could the Riksbank’s provision of a swap line to the Estonian central bank represent a violation of the ERM II criterion? The ECB also recently warned against some elements of a piece of proposed government legislation on national statistics. ‘Several provisions of the draft law indicate that the Ministry of Finance has extensive powers to interfere in the production of national statistics.’