Anniversary Of Impossible Equation

Exactly one year ago I posted SocGen: Public Finances - The Impossible Equation. Dylan Grice, the global strategist at Societe Generale, writes today:

Stabilising government finances has nothing to do with economics and everything to do with politics, and politics is merely the art of the possible. A breakthrough akin to time-travel is needed if the required fiscal retrenchment is to be achieved painlessly.

However, this is the time for the next impossible equation, that I already touched upon on Monday, but Steve Waldman brings us to the options available. Corporate sector seems the right one to solve the issues of sectoral balances?

Corporate Income Taxes By Country

This comes from the good folks at Societe Generale today. Well, we learned that effective rates may be different, though ...

Click on chart to enlarge, courtesy of Societe Generale.

Asian Domestic Excess Liquidity And Stock Valuations

I made cautious about global liquidity before last Christmas, but analysts at Citigroup Global Markets still see the contraction lasting till August/September. Shanghai Composite managed to break into new bear market lows today with a stunning move of more than 4% on day. This may be, though, just coincidence ...

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

Well, but it does not appear that Asia X Japan equities are cheap either ... Click on chart to enlarge, courtesy of Citigroup Global Markets.

Fearing ECB Liquidity Miracle

As the analysts at Barclays Capital put it yesterday:

A litmus test for European bank funding – On 1 July, European banks need to repay the ECB €442bn that they borrowed a year ago. To smooth the process, banks can refinance with the ECB at 10am (BST) the day before – but on less attractive terms. How reliant will the sector be on ECB “life support” now that the effective cost is going up?

Click on chart, courtesy of Barclays Capital.

Nordea Markets clarifies the time-table today:

The liquidity situation in the Euro-zone banking system is likely to see notable changes this week, as the ECB’s first 1-year refinancing operation with an outstanding amount of EUR 442bn will mature on Thursday. The big question of course is, how much of this will be rolled over and what effects it will have on the markets. The ECB offers banks the chance to roll the maturing operation into a 3-month or a 6-day operation. The results of the 3-month tender will be announced tomorrow, and they will reveal a lot of the upcoming changes in liquidity. However, the demand at the 6-day operation will not be known until Thursday.

Click on charts to enlarge, courtesy of Nordea Markets.

While Spanish Banks Rage at End of ECB Offer, some are playing fairly relaxed games of LTROops. Economists at Societe Generale conclude today:

Although excess liquidity in the system is likely to decline, we believe it will do so only very little. Hence, money market liquidity will in our view remain very ample, implying only the mildest of increases in money markets.

Plenty of offers to replace the €442bn refinancing.

Click on charts to enlarge, courtesy of Societe Generale.

Watch out!

Perfect Austro-Keynesian Austeria Cocktail For Equity Fans

I am quite sure that open minds will put together decent big macro picture by reading Parenteau: Marching to Austeria* and Other Neolib Fibs and Krugman: Inequality and crisis ..., as well as Guest post: El-Erian on a disappointing G20 compromise, and conclude on outlook for equities ...

Somebody has to save (except for printing machines), if Asian household savings rates are set to decline?

Click on charts to enlarge, Chart 1 is for Japan, courtesy of BNP Paribas.

Midsummer Break ...

May return early, if Gods decide to interrupt the liquidity festive!
Otherwise enjoying the Midusmmer ...

In Anticipation Of Liquidity

As I was expecting, once again, that liquidity is going to fool us, and the Gods of financial markets promised to deliver it, resulting in a nice relief rally in risk assets in the last weeks.

The credit strategists at BNP Paribas were kind to sum up on these developments yesterday:

While sovereign concerns are still very much prevalent, the positives of agreement on euro stabilisation fund details,followed by the ECB meeting extending 3-month refinancing operations acted as the initial catalysts (Chart1) and developments of European bank stress tests and the better-than expected Spanish auction over the past week has helped the momentum to continue. Credit has decoupled away from the SovX somewhat, as the 1-month correlation between iTraxx Main and SovX has fallen to 56% (lowest since April), while correlation between senior financials and SovX has fallen to 82% which is still high historically. In general, compression has been the theme as senior financials (34bp tighter since the ECB meeting) has outperformed SovX (4bp tighter over the same period) and Main (-20bp). An additional supporting factor has been rising equities on rather thin volume that have shrugged off the recent mixed to slightly disappointing macro economic data.

Click on chart to enlarge, courtesy of BNP Paribas.

July 1 could be the day liquidity dies? Not so sure yet ...

Most Important Factors ...

This should be "The Quote Of The Day", delivered by equity strategists at Societe Generale today, while looking at DJ Stoxx 600 companies:

... the most important factor is not the extent of the currency revaluation, but rather that it will automatically lead to an increase in the purchasing power of both China’s corporations and households, thus boosting domestic demand.

So, alles klar?

Click on table to enlarge, courtesy of Societe Generale.

Donkey's Carrots?

What creates the greed and willingness to allocate money in equities? Earnings forecasts? Excellent chart by US equity strategists at Goldman Sachs, click on chart to enlarge.


Are corporate managers performing well in increasing the shareholder returns? It depends on how you look at that. Also lobbying in the Hill may be beneficiary to shareholders...

Expectations do a lot ...

Streets Do Matter If Heading For China

Asian markets celebrated the Chinese de-peg move today (S&P Asia 50 +3.29%, Nikkei 225 + 2.43%, Hang Seng +3.08%, Kospi 200 +1.75%), and Europe was trying to join the festive, but US is somehow escaping the sweet feel of nirvana so far ...

FT Alphaville made a quite comprehensive compilation of views and data today:
Renminbi reservations
Renminbi variations
Renminbi reverberations

However, Lombard Street Research delivered the most bearish take, of what my eyes were able to process so far, on Chinese festive today:

WE SUGGEST: Yuan no more than 3-5% up vis-à-vis the dollar if that
SUMMARY: Beijing’s attempt to throw sand in the eyes of the world with its announcement of increased yuan flexibility is set to backfire. It is not 2005 all over again as this time around the world is demand deficient. Minimal yuan appreciation is unlikely to be acceptable when the US recovery peters out later this year, while Europe heads for a recession. It will also mean a sharper domestic correction in overheating China.

and more:

Unless there is a fundamental change in China’s mode of development, it will be difficult to seethe world not slipping into increased protectionism and every country/region having to fend for itself. Even the Great Recession and China’s decisive domestic demand recovery were not able to do more than cut China’s current account surplus to 5.8% of GDP in 2009 from a peak of10.6% of GDP in 2007. Worse still, the latest trade data shows that China’s trade surplus is yet again on the rise as export growth forges ahead. The immediate problem for Beijing is cyclical.The economy is overheating at a rapid pace and needs to cool down. A higher yuan would have helped to curb inflationary pressures, with no need to hammer domestic demand. Instead not only is the yuan unlikely to be revaluated substantially, but policymakers have been slow off the mark in tightening monetary policy in general. Hence, China’s needed domestic demand correction will be that much larger and that much more destabilising as inflation has been allowed to gain more traction.

Click on chart to enlarge, courtesy of Lombard Street Research.

Nasdaq family and Spooos500 are swimming in red sea, as I write ...

Message From Japanese Candlestick Masters

Click on chart to enlarge, courtesy of Nomura.

By the way, smells to me quite a consensus at the very moment ... errr, except for the sell-side strategists.

Does Liquidity Reduce Risk Premia?

I was recently looking at liquidity versus solvency, and Jim Reid at Deutsche Bank was still wondering about the credit matters in the European periphery on Wednesday. The credit strategists at BNP Paribas had an interesting take on divergences in credit and equity markets today, my emphasis:

The inconsistency between credit and equity markets can only be explained by the discrepancy in confidence levels being expressed by the markets with regards to the various liquidity measures announced by the ECB, EU Commission and IMF in assisting the PIIGS. We believe the ECB will be forced to expand their quantitative easing measures or the sovereigns may have to go directly to either the EFSF facility or the IMF to overcome medium term refinancing risk, a factor that is spooking credit markets but being ignored by equities. For once, we believe, equities may be telegraphing the right message, as in more liquidity from the authorities to reduce risk premia and hence painting a glass half full picture.

Click on charts to enlarge, courtesy of BNP Paribas.

Inspired by Battle Royale Between Fundamentals & Technicals at Trader's Narrative, I would rather say that the "Battle" is won, as stupid as it may be, by ECB' s "Unlimited Liquidity", that is Resolving The Emergency Of Investors, err, Banks ...

If need for additional liquidity and low interest rates are signs of tight money, does liquidity then reduce the risk premia?

More Details About "Cream Lickers"

US equity strategy team at Goldman Sachs provides us with more details about "cream lickers" at efficient frontiers. Click on chart to enlarge, courtesy of Goldman Sachs (I have a small problem with the date on the chart).

But note, US equity mutual funds have still difficult times ...

Who Loves The Government Debt?

Nice chart from global fixed income strategists at Nomura. Click on chart to enlarge, courtesy of Nomura.

However, in many cases, and ever more often, the private sector brings the governments down, via banking system... and sometimes governments bring down the banks? Or everyone has inflated expectations about the future?

Japanese Savers Remain Cool

From the latest Fixed Income Outlook by Societe Generale:

USD JGB CDS indeed widened, but largely as a result of re-pricing of sovereign CDS globally in reaction to the crisis in Europe. Other measures of creditworthiness such as USD JGB ASW have been largely stable and only increased slightly since May 2010 as USD/JPY CCS basis widened amid concerns of USD shortages globally.

Click on chart to enlarge, courtesy of Societe Generale.

And continued:

Risks to consolidation are very substantial, nonetheless. In case fiscal tightening efforts by the current administration are non-credible to Japanese savers, a crisis of confidence is possible.

... we are only likely to see a Japan sovereign crisis if Japanese savers lose confidence in the safety of their ¥ assets. This would manifest itself in capital flight from Japanese banks, higher JGB yields and a wider USD/JPY CCS basis. As such, in a real sovereign credit crisis we would expect convergence between JGB USD CDS and JGB USD ASW.

Watch China?

Test Your Habits Of Highly Ineffective People

Interesting reading by Dan Ariely, The 7 Habits of Highly Ineffective People ...

Citi From Russia With Love

Equity strategists at Citi Global Markets came with a new hit "From Russia with Love" yesterday:

The PE ratio probably exaggerates Russia’s valuation discount. One reason Russia’s multiple is so low is the market’s heavy weight in energy stocks, which look cheap everywhere. Understated depreciation, low payout ratios and high capex needs also play a role in this discount.

Nevertheless, Russian stocks do look cheap to us. A review of PE, PB, EV/EBITDA, free cash flow yield and EYR metrics all suggest that Russia is at the bottom of the emerging market valuation spectrum, even if we adjust to account for Russia’s sector weights. One exception: dividend yield.

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

As to earnings yield ratio vs. bond yields:

The earnings yield ratio is another metric worth watching... This ratio, by which the earnings yield or inverse of the PE is compared with the bond yield, is particularly flattering to Russia given the current level of external debt yields and the relatively narrow Russian Eurobond spread. Russia’s earnings yield of 17% is triple the eurobond yield of 6%, a ratio that is very unusual in a global context (Figure 15).

You never know for sure why the discounts ...

Spain Entering Next Danger Zone And Equities Still Very Much At Risk?

Still a lot of caution on the lips of technical chartists in the house of Swedish SEB today. Click on charts to enlarge, courtesy of SEB.

Average Chinese Investment Math?

Click on chart to enlarge, courtesy of JPMorgan.

It is not clear to me, why the real 3-year deposit rates are used, but, probably, due to best visual fit. However, the economists at JPMorgan note:

At the root of the Chinese property market’s boom-bust tendency is the lack of investment alternatives for the average Chinese citizen. As Figure 15 shows, investors are more inclined to channel their funds into real estate when deposit rates are at low or negative levels. While the government’s administrative measures may help stabilize the sector in the short-term, capital market reforms and the broadening of both onshore and offshore investment options are necessary preconditions for stability in the long-term.

Eehhh, imagine what happens, if capital account goes free?

Ready For World Cup Volatility?

The ueber-bull Binky Chadha & Co. from Deutsche Bank looked at volatility so far this year on Wednesday. Here are some charts, click on charts to enlarge, courtesy of Deutsche Bank.

Guys at Bespoke Investment Group also have a kind of compilation on recent volatility:

Up and Down and Round and Round
S&P 500 50-Day Average Daily Change Back Above 1%
The All or Nothing Market

Strategists at Nomura have a reminder today:

- Those hoping that this afternoon’s first World Cup game will herald a quiet month for markets may be disappointed.
- The past four World Cup tournaments have produced lower trading volumes, with the exception of Korea/Japan in 2002 when the majority of games took place outside the trading hours of most of the world’s football fanatics who are largely based in Europe and the US.
- With this year’s World Cup taking place in South Africa which is in the GMT+2 hour time zone, we think a similar decline in volumes could be expected over the coming month.
- However, this decline in volumes has not always translated into a decline in realised volatility. During the last World Cup, Germany 2006, realised volatility rose markedly vs the month before and after and the average of the year despite volumes falling.
- All those planning to put their feet up for the next month can expect a lot of company, but keep half an eye on the trading screens as portfolio P/L may not be as lethargic.

Click on charts to enlarge, courtesy of Nomura.

Deluded By Liquidity Glut?

I read latest by Rick Bookstaber today - Common Sense Crisis Risk Management, but this sentence does not leave my sick mind:

With so much money flooding into the market (and so much money means so much leverage), people start to scan the landscape for the less known – and less liquid – markets to find value.

This should be amazing, and I have noted that long time ago, there seems to be some mis-understanding? Even Milton Friedman, the high priest of mechanical monetarism, according to TheMoneyIllusion, I thought so too Dr. Friedman, has noted:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.
. . .
After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.

So, liquidity is needed to keep the system alive, but "cream lickers" at efficient frontiers...

... start to scan the landscape for the less known – and less liquid – markets to find value.

Deluded by liquidity glut and...

... fallacy of identifying tight money with high interest rates and easy money with low interest rates ...

Apparently, old fallacies never die.

Mixing Up Liquidity Versus Solvency

I was reading Doug Kass: Mixing It Up on "Fast Money", and should conclude that indeed the technical picture in equities is stretched and oversold ... but the fundamentals are getting worse (e.g., one of leading indicators - ECRI's US WLI is dropping very fast and y-o-y growth now is barely above zero), and the "cream lickers at efficient frontiers" that 99% have devoted to the equities, may miss the difference between liquidity and solvency. Credit markets are stressed about long-term solvency, and targeting the very heart of credit markets - governments and banks (don't be fooled by short-term instruments (e.g., LIBOR) that are distorted by liquidity glut).

Jim Reid, the strategist at Deutsche Bank, notes this morning:

What is also incredible is that we now have a situation where the iTraxx Fin Snr index is only 9bp off its wides (+211bp) in March 2009. In comparison, the Xover is 531bp below its all time wides (1,163bp in March 09) and the S&P 500 and the Stoxx600 are still 57% and 52% above their March 2009 lows. We detail these differentials and those of other CDS indices in the table below.

Click on table to enlarge, courtesy of Deutsche Bank.

And Jim Reid continues:

With the dislocations seen in the table, one could argue that either Financial Senior spreads are a strong buy or the rest of the risk complex is way too sanguine about the state of the financial system. Both surely cannot be correct?. This disparity is also captured in the chart below where we have plotted the S&P 500 against the iTraxx Fin Snr (inverted) since the beginning of 2008. The two indices have generally been quite well correlated over the past 2.5 years but the recent deterioration in Fin Snr credit spreads seems to have outpaced the decline in equities. Clearly we are looking at the extreme end of things here and the relationship seems to be a CDS story for now as the iBoxx EUR Bank Sen index is about 157bp tighter than March 2009 wide of 302bp. Nevertheless the two markets are still probably at odds with each other.

Click on chart to enlarge, courtesy of Deutsche Bank.

FX strategists at BNP Paribas believe this morning:

The current share price valuation suggests that a slight stabilisation of money market spreads should lead to a good equity rebound. Hence, all eyes will be on the ECB tomorrow. A prolongation of the 3-month tender is a given and the launch of a six month tender a likely to be considered. The ECB loosing monetary conditions should allow risk appetite to rebound globally. Our trading strategy will be adjusted accordingly.

Click on chart to enlarge, courtesy of BNP Paribas.

So, this is what happens when liquidity is mixed up with solvency, but those are traders... Investors would be wise, indeed, to take note!

SocGen Sees Needs For Rebalancing

The economists at Societe Generale are out with their flagship "Global Themes" report "Tri-policy - Getting the mix right" today, and see the need for rebalancing (just as a reminder), though that may be not that easy as to write down the "wish-list":

The US needs to de-leverage in the household and financial sectors. Cheap credit may be needed immediately due to economic threats, but ultimately credit must be fairly priced. Higher rates are needed for credit rationing and to encourage savings. We look for higher term premiums on US Treasuries as China purchases fewer securities. At the same time, banks need to reduce risk and hold safer products with appropriate returns.

European governments need to reduce their spending and revamp their safety nets. Social spending plans throughout Europe are too expensive. Policymakers resisted the free-market ways and avoided some of the pitfalls that befell the US (UK, Iceland and Ireland), but a new balance now needs to be struck to secure future economic growth. Most importantly, European policymakers need to put the E in EMU. The current system of a single currency and single monetary policy without an efficient fiscal policy framework is clearly not sustainable.

In Asia, the use of under-valued currencies and export growth cannot be a lasting source of economic growth. China and many other Asian countries hold large intrinsic wealth that is not captured in their currencies and capital market systems. The economies are too large to continue growing their surpluses. These countries need to appreciate their currencies and foster domestic consumption. The world has tremendous productive capacity. There is a scarcity of viable consumption. To avoid inflation, particularly of consumer food products, a currency appreciation would provide households with significant purchasing power to boost demand for cheap agricultural products.

Current Account Dificit Exacerbates The US Picture

Foreign exchange analysts at Deutsche Bank are on defending the Euro today, actually - again. If one puts all the Euro-area countries in one basket, then it looks better than US and UK.

Click on charts to enlarge, courtesy of Deutsche Bank.

Analysts at Deutsche Bank are sharp to highlight the "US consumer addiction" and uncompetitiveness of US manufacturing that gets visible via current account deficit:

What helps the euro more fundamentally is that the US’s fiscal balance is not much better than Spain’s and clearly worse than the Euro-areas’ (see first chart). Moreover, the longer term trajectory of the US sovereign is worse than the Euro-area’s. Our economists expect US debt-GDP to reach 260% by 2040 compared to 160% (see second chart). So just as markets have moved from Greece to Spain and now to Italy, they would likely move on to re-price the US fiscal risk premia. What exacerbates the US picture is the US current deficit.

Obviously, the US will "take the maximum pain" out of the privilege to remain the last resort of consumer borrowing ...

Nordea's Baltic Rim Economies

There is a joke about Mr. Zatlers, the President of Latvia, having huge discount for a call home from the Hell, compared to Obama and Putin ... because it was the local area call.

Well, Nordea is out with its latest "Baltic Rim Outlook" today, and is cautiously optimistic about the epicentre of Baltic depression economics:

The Latvian economy is stabilising, and we see a gradual recovery over the coming quarters. The main support is expected to come from the export sector. Increasing the uncertainty in the economy is the political instability, which is likely to intensify ahead of the parliamentary elections in October. The fiscal consolidation measures for the 2011 budget are likely to be postponed to after the elections.

While not as explicit as one may expect, Nordea notes that for Latvia the "main hope of a recovery from the export sector", but "forgets" to go deeper in details that are somehow overlooked. However, the Swedish counterpart SEB was a tiny bit more transparent on this last week, as, actually, the net exports and also current account, stripping out the pervert statistical aberrations, is deteriorating again since at least October 2009 ...

Danske Bank sees significant risks to recovery, and not only in Baltics, but in CEE.

Little Historical Support For Capex-Driven US Recovery?

Similar to guys at Goldman Sachs, the economists at BCA Research are also sceptical (excerpt from their BCA Premium Service in May 2010):

Various pundits have argued that capital spending could drive the economic recovery. While a Capex revival is underway, there is little historical support for a capex-driven recovery. With private consumer spending more than 70% of GDP, the pace of recovery hinges crucially on consumers.

Click on chart to enlarge, courtesy of BCA Research.

But the US consumer has its own challenges, with global rebalancing and structural change so difficult ...

US Aggregate Annual Household Expenditures By Quintiles Of Income Before Taxes In 2008

Pretty nice chart by CLSA Asia-Pacific Markets, highest quintile spends 4 TIMES more than lowest quintile. Click on chart to enlarge.

As bond vigilantes are also about moral hazard and clear evidence that without punishment mentality, there is low probability of structural change. There is Upside of Irrationality and Revenge! Squeeze the top quintile for the benefit of ZIRPed bond investors?

Debt Market Tensions Becoming More Entrenched?

Interest rate strategists at Commerzbank wrote yesterday:

... the market damage looks set to become more structural in nature. Spreads among EMU sovereigns remain at very elevated levels even in the face of the unparalleled EU stabilisation fund and ECB bond purchases. True, spreads of the “high yielders” (Greece, Ireland, Portugal) have come in by more than 100bp after the announcement, Greece is even more than 400bp tighter (see left-hand chart below). More worrisome, however, is the fact that spreads of the peripheral heavyweights Spain and Italy are trading back near their widest levels (see right-hand chart below).

Click on charts to enlarge, courtesy of Commerzbank.

Therefore, some may believe, like the analysts at BNP Paribas wrote yesterday:

At the end of the day, the continuation of this quantitative easing competition amongst industrialised nations will prolong currency appreciation in emerging economies and keep their markets flooded with surplus funds. Indeed, the major emerging equity markets rebounded towards the end of last week.

Click on chart to enlarge, courtesy of BNP Paribas.

However, the economists at Tullett Prebon remained cautious today:

A depressionary “liquidity trap” – a scenario of unrealised growth potential from the starting point of current depressed credit channels and growth levels – is, in our view, the real risk. And since weaker growth would ultimately increase public leverage, the longer the financial system remains unstable, the greater the chance of a more inherently unstable global economy through rising public sector liabilities across major economies. In any case, there is ample uncertainty about systemic and cyclical risks related to the major economies that keep markets volatile.

So, ready to jump?

Cross-Border Lending

European sovereign issues have some impact on European banks, that are heavily involved in cross-border lending. Click on chart to enlarge, courtesy of Deutsche Bank.

Continued rise in Spanish government spreads does not support bullish dreams?

Who Is Afraid Of Sustained Decline In Public Expenditure?

Are economists at Societe Generale suggesting that there is no reason to be afraid of a sustained decline in public expenditure? Nice charts from latest Global Economic Outlook, click on charts to enlarge, courtesy of Societe Generale.

Though, the economists at Societe Generale concluded today at the same time:

The euro area debt crisis has raised a dilemma for policymakers in many of the advanced economies. If all tighten fiscal policy simultaneously, the multiplier effects are such that a return to global recession is guaranteed. If those economies with relatively stronger - but still weak in absolute terms – public finances wait, the risk is that markets will lose patience with them too. In the euro area, this dilemma is particularly acute. All the more so as market attention is now turning away from the short-term issue of funding to the medium-term issue of solvency. This latter issue is set to keep intra-euro area spreads at high levels and act as a structural drag on the euro.

Highly Consensus...

Fred Goodwin, the macro strategist at Nomura writes today (my emphasis):

Financial markets are priced for ISM in the low 50's. There is much bad news in the price about Europe, financial regulation, and fears about a China bust. "Buy the dip" is seductive and may prove right. Risk aversion episodes are typically short lived. A quiet first couple of months of summer are certainly possible. The problem with this view is it that it looks highly consensus.

Tobias Levkovich, the US equity strategist at Citigroup Global Markets, wrote last Friday:

Recent events generate incremental risks. The escalation of tension in the Korean Peninsula, further bank and credit problems in Europe, as well as the apparent weakening of US lead indicator momentum are contributing to a growing sense of despair within the investment community. At the same time, many market observers are seemingly trying almost desperately to call a bottom. In this context, the bad news is beginning to get priced in but there’s no specific catalyst for a turn in stock prices beyond short-term relief rallies from oversold conditions even as the Panic/Euphoria Model plunges into “panic” territory.

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

Bad news is BEGINNING to get priced in?