Wrong Focus On Real GDP This Time?

While I would measure a recovery how we are performing compared to the previous peak, and not from the recession trough ... just because the loss is from peak. However, Jim Reid and his team at Deutsche Bank have the following story for us again today:

We think that nominal GDP is far more important in this cycle than real GDP and the Fed is seemingly starting to agree. It's important because with overall US economy debt/GDP at absurdly high levels, the economy is shock prone for as long as you run such a system. A low level of nominal GDP growth only erodes the burden very slowly leaving us exposed even if real GDP is running at broadly normal post recovery levels. In fact we would argue that nominal GDP needs to be running at higher than average levels due to the argument discussed above and the fact that it fell more than it did in all but one of the previous post-WWII recessions. For us this is why we've always felt that QE will be with us for many years. Until the debt/GDP returns back to more sustainable/normal levels we think the pressure will be on the authorities to effective print money to ease the potentially destabilising deleveraging process. We can't help but think that QE2 won't be the last episode of QE.  

Anyway onto the evidence. The first graph shows every post-WWII recovery in nominal terms from the trough in activity (end June 09 in the latest case). We've rebased the trough at 100 and tracked each subsequent quarter's activity. At the end of the last quarter this current recovery was running pretty much neck and neck with the 2001-02 episode as the weakest of the 13 post-war nominal recoveries. If the number comes in as expected today (2% real, 1.8% price deflator) then the graph shows that we'll move away from it being the worst nominal recovery but it will still be one of the weakest and well below average. The second graph shows the prior drop in nominal activity from the start of each recession to the trough. Of the 13 recessions since WWII, 5 have seen a fall in nominal activity and this latest downturn was the second biggest. So not only was this a big fall relative to history but the subsequent recovery has been one of the weakest. In normal times the more things fall the more they recover. This is why this cycle is different in our opinion. We desperately need more nominal GDP growth to grow out of our problems and this is why the Fed will try to inject fresh impetus into the economy next week. Whether it eventually works is a moot point but this for us is the reason it is being attempted.

Click on charts to enlarge, courtesy of Deutsche Bank.

Mike Mayo Expects This Decade The Worst US Banking Revenue Growth Since Great Depression

From the GREED & fear by Christopher Wood today:

Another sign of deflationary pressures is the ongoing decline in US bank revenues as reflected in the recent set of bank results. Thus, aggregate net revenues of the six largest US banks, net of interest expenses, have fallen by 16.3% over the past two quarters (see Figure 5) and are down 4.1% YoY in the first three quarters of this year. CLSA’s US bank analyst Mike Mayo expects that this decade should see the worst US banking industry revenue growth since the Great Depression in the 1930s. The US banking industry’s average annual revenue growth declined from a peak of 12% in the 1970s to 6% last decade while Mayo expects the growth for this decade (2010-2019) to slow to 2%.

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

And then this:

GREED & fear would advise investors to focus on this revenue line when looking at banks, at least as much as the profit line which can be manipulated so extensively via discretionary accounting techniques. This point can be seen in the recent discrepancy in the results announced by Sumitomo Mitsui Financial Group (SMFG) in Tokyo and in New York.

So, you know ... 

Credit Agricole Sees Risks Of QE2

Saving time by showing determination and patience ... with RISKS that depend on complex movements and expectations to be aligned over time.

Reading Halloween Night With Zombies By Jeremy Grantham

Always must read quarterly report by Jeremy Grantham, or alternatively here. This describes the "mood" of script well:

In almost every respect, adhering to a policy of low rates, employing quantitative easing, deliberately stimulating asset prices, ignoring the consequences of bubbles breaking, and displaying a complete refusal to learn from experience has left Fed policy as a large net negative to the production of a healthy, stable economy with strong employment.

Global Trading Battlefields For Greed & Fear

Some statistics from the house of  Nomura today, but look at notes below. Top 47 countries ranked by trading value and Global Top 30 companies by liquidity.

Click on tables to enlarge, courtesy of Nomura.

And here are the most liquid stocks ...

Just Some Facts About Who Is Who In " Beggar-Thy-Neighbour" Game

The economists at Societe Generale has two nice charts just to show who is who in the game of competitive devaluations. Let's start with Current Account imbalances to see who needs adjustment.

Click on charts to enlarge, courtesy of Societe Generale.

And this is what has been done in recent years.

Reading "The Velocity Impediment" By Hoisington

Of course, the entire quarterly report by Hoisington is "a must read", but I focus on chapter of "The Velocity Impediment" today:

For a rise in excess reserves to boost GDP, two conditions must be met. First, the money multiplier must become stable. Second, the velocity of money must not decline. The second condition is not likely in view of the theory and history of velocity. Velocity is primarily determined by the following: 1) financial innovation; 2) leverage, provided that the debt is for worthwhile projects and the borrowing is not of the Ponzi finance variety; and 3) numerous volatile short-term considerations.



Since 1900, M2 velocity has averaged 1.67, and has demonstrated distinct mean reverting tendencies (Chart 3). Velocity has been declining irregularly since Ponzi finance took over in the late 1990s. For leverage to lead to an expansion of velocity the loans must meet the requirement of hedge finance, i.e., where there is a reasonable expectation that the borrower can repay both principal and interest.

Click on chart to enlarge, courtesy of Hoisington Investment Management.

Fundamentally, the secular prospects for velocity have not improved even though velocity recovered by 2.1% in the past four quarters. This marginal uptick in velocity reflected an assist in federal spending along with the unparalleled recovery in inventory investment discussed previously. Without the gain in these two GDP components, velocity was unchanged over the past four quarters ...

More questions?

Wonderful World Of Fallibility And Reflexivity

While the markets digest the Chinese move and latest message from Beige Book, let's look at some issues that are probably worth mentioning from the weeks of my recent absence.

George Soros was addressing "The Sovereign Debt Problem" at Columbia University on October 5. As a starter to the fundamental problems of current affairs, the reminder of his theory is worth re-reading:

... The main points to remember are, first, that rational human beings do not base their decisions on reality but on their understanding of reality and the two are never the same -although the extent of the divergence does vary from person to person and from time to time - and it is the variance that matters. This is the principle of fallibility. Second, the participants' misconceptions, as expressed in market prices, affect the so-called fundamentals which market prices are supposed to reflect. This is the principle of reflexivity. The two of them together assure that both market participants and regulators have to make their decisions in conditions of uncertainty. This is the human uncertainty principle. It implies that outcomes are unlikely to correspond to expectations and markets are unable to assure the optimum allocation of resources. These implications are in direct contradiction to the theory of rational expectations and the efficient market hypothesis.

An excerpt from the lecture is available at Financial Times.

Then, to highlight the ponziness of US economy, and to provide an explanation why corporate investment has been so weak in that country, and why any further investment is very risky, one should consider the words of Brian Sack, the head of the New York Fed' s markets group:
Ponziness...

Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be.

BofA Merrill Lynch Sees Fund Managers "EMbracing Risk"

While the mother BofA fights the legacy, the monthly Global Fund Manager Survey by Merrill Lynch is out of the gates of research factories today. The key take-aways this month:

Liquidity prospects taking risk appetite for a ride
The October FMS sees a resurgence in risk appetite compared to the caution of the last 3 months as the prospect of a further dose of QE in the US is forcing portfolio adjustments. And yet, with only a small uptick in growth expectations consensus is betting on short term relief rather than a long term cure. Equities as an asset class have benefited from this sentiment shift but the focus is a very narrow one on Emerging Markets (and commodities).

Risk appetite: major upgrade

The risk being taken in investor portfolios saw the biggest jump since April ‘09 Our Risk & Liquidity indicator surged to 43 from 37. Cash balances fell to 3.8%, not extreme. Hedge funds raised gearing levels to 1.44, the highest since March ‘08. A net 45% of investors see USD as undervalued, but only net 12% think it will appreciate over the next 12 mths (down from 38% in Sept).

Economic growth: minor upgrade
Investors are reserving judgement on the likely real economic effects of QE. A net 15% now expect higher growth (0% last month) with the threat of a double dip largely dismissed (by net 82%). But only 9% expect above trend growth in the coming 12mths. Inflation expectations moved sharply higher (a net 27%, up from 9%) and with negative $ views commodities benefited. But the narrow focus is highlighted with only a net 11% expect stronger corporate profits (vs. 2% in Sept).

Emerging Markets or emerging market growth
A net 71% of investors see bonds as overvalued, the highest level since Sept ’05. Allocators raised weightings in equities (+27% from 10%) and commodities (+17% from 4%). Bonds fell to a net 24% u/w and cash to 6% o/w (vs. 18%). By region, a net 49% are O/W EM, the highest since Nov ’09; at +3% EU is the only other O/W. Despite valuation concerns, EM is the only region investors want to o/w in the coming 12 mths. Sector moves were EM-related with energy, industrials & materials benefiting over utilities and financials. At +1% consumer discretionary saw its first ever positive reading. Low growth world = tech the favoured sector.

For the contrarian:
long USD, banks, utilities, Japan; short EM, tech, commods
An extreme preference for EM over Japan triggers a contrarian trading rule this month; the last time we got close on this Japan outperformed EM by 9% in the following 3 mths. Other contrarian trades are long USD, banks and utilities; short EM FX, tech and commodities.

Click on chart to enlarge, courtesy of BofA Merrill Lynch.

Latest View From The House Of J.P.Morgan

Over the weekend global asset allocation team of J.P Morgan had the following view:

• Economics –– Forecasts of weaker Q4 global growth are on track

• Asset allocation –– Our overweights in EM, HY and UST duration, and short USD are consensus trades, but aside from USTs are not yet near a bubble
• Fixed Income –– Fed easing combined with ECB inaction should see US Treasuries outperform German Bunds.
• Equities –– Positive momentum and the prospect of more business-friendly policies post US mid-term elections should sustain the rally into November.
• Credit –– Overweight CLO mezzanine and subordinates in both US and Europe, with over 10% expected return over next 6 months.
• FX –– INR and KRW are our preferred longs vs USD in Asia.
• Commodities –– Pace of Chinese crude oil imports is increasing. Stay long oil.

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

Second Upward Phase In The Vision Of Japanese Candlestick Masters

I am back from the Autumn break, and let's start with a quick look at charts. The Japanese candlestick masters at Nomura, in addition to the past, provide also their vision ...

Click on chart to enlarge, courtesy of Nomura.