Bylov: Weekly Inter-Markets Trading View

Jan Bylov, chief analyst at Nordea Markets, is a "rare specie" among analysts, as he is looking himself at all asset classes and uses inter-market approach in analyzing the markets. He writes in the summary today:

Stocks – Profit taking mode spreading

Bellwether western stock markets have recovered to the January highs and thereby removing 1/3 of the overall bear market losses! Now, it appears that market pundits are split into two groups of perception: 1) “this is just a suckers’ rally within a structural bear market” or 2) “having faced unlimited downside risk in March the significant recovery illustrates that markets still respond to traditional economic stimulus”. Therefore, with indices having recovered to conventional “overbought” technical levels and consensus sentiment well into buy readings profit taking is spreading to most regions and sectors. Looking further ahead we remain optimistic based on the concept that as we already have faced “unlimited downside risk” it will take a new black swan accident to cause global equity markets to extend the bear market lows of 2009! Consequently, we are currently facing a congesting of the first move from “unlimited downside risk” towards below potential growth expectations… to be followed by higher stock market levels ultimately.

Bonds – Asset allocators gaining importance

With central banks already implementing unconventional market operations (quantitative easing) in a continued effort to improve credit access (also beyond the normal credit creation through the banking system) and interest rates flirting with “nothing” what shall it take to invigorate enough investor interest to force long government bond yields back to the historic low levels of recent months? More printing of new money? Statement of low interest rate policies for the next many quarters/years? Intensified central bank buying? Or will it increasingly be related to the oscillating decisions by global asset allocators whom primarily will decide based on their perceptions of either a global economic recovery or global economic recession. With evidence that the financial business cycle has bottomed we believe that decisions by asset allocators are becoming increasingly important, but also that long bonds hold unattractive risk/reward relations beyond trading opportunities. Whatever one may believe, two dominating investment themes continue to exist: 1) global recession and dovish central banks i.e. bullish bonds and 2) the fear from enormous bond issuances i.e. bearish bonds.

Commodities – Recovery stabilising

In sympathy with other asset classes the recovery process which actually began back in February appears to be losing buy momentum – gold aside. Interestingly, the recovery has NOT been driven by speculative interest as data reveals that Large Traders in futures generally have stayed neutral or short – aside from a still hefty long position in gold. We find this evidence encouraging on a wider scale with financial markets already having looked into the abyss of “unlimited downside risk” in March and other evidence that the financial business cycle has seen its bottom.

Currencies – Is USD weakness a global signal of better times?

Futures traders are significantly concentrating their bets against USD and the recent change away from diversified reflation bets raises the question whether this move is a global constructive signal? Historically, a stable/weak USD works as a tailwind to the global financial and economic system and combining this experience with the fact that the we have already faced abyss of “unlimited downside risk” in early March we believe that the reported ongoing allocation away from USD is yet another piece of evidence of markets returning slowly towards better times. Further, this development increases the odds that the extreme currency valuations seen in Feb./March marks important reversal points!

Consider as a probability!

SocGen Quants On Stability In US 10 Year Inflation Break-Evens

Quantitative Strategy team of Societe Generale had interesting observations yesterday:

Stability in US 10Y inflation break-evens signals overshoot in equities and curves
- Our model fair value for inflation break-evens is related to the global market factor and to the inflation factor, which includes a strong exposure to yield curves.
- The combination of the past few months’ bull market and of the recent steepening of yield curves has therefore led to a rise in our short-term fair values for inflation break-evens. Meanwhile, market values remained unchanged or even decreased.
- Fair values would correct towards zero inflation if the recent bullish trend inverted, bringing stocks back to the nadir of the recent V-shape. The correction could also come from a flattening of yield curves.

Click on chart to enlarge, courtesy of Societe Generale.

Yeaa, look at equities via 10 year inflation linkers ...

BNP Paribas On US Inventory Dreaming ...

I was looking at the chart prepared by the economists of BNP Paribas today...
Stunning feeling just thinking about the "green shoot screamers" of "extraordinary inventory adjustment" so far ...

Just to add the economic context, here is what the economists at BNP Paribas write:

The need to reduce inventories much further is very apparent from the lofty level of the present business inventory sales ratio. This ratio, which spans manufacturers, wholesalers and retailers, presently stands at 1.44% marginally down from a cycle peak of 1.46%. In the last cycle the I/S ratio plunged to 1.35% in the subsequent 2 years.

Business inventories are expected to plunge in the last two months of this quarter when major automobile manufacturers and all of their suppliers suspend new vehicle production for two months. While this period will include the normal 2 week retooling shutdown in July the present decision lasting for 9 weeks will affect all suppliers such as chip makers, tire, glass, leather, plastic, aluminium, steel, axel and wheel makers, paint suppliers and all those other industries too numerous to account for. Auto inventories account for 14% of the stock pile of unsold business inventories and approximately 70% of these inventories are held at the retail level.

Credit Suisse: Becoming More Defensive

The Global Equity Strategy team of Credit Suisse suggests today:

We reduce the size of our overweight in our favoured three cyclical sectors—autos, steel and technology—and raise food producers to overweight from benchmark. We reduce weightings in cyclicals because:

• Valuation
• Magnitude of performance
• W not V recovery
• Bond yields close to peak
• Positioning & Technicals: European fund managers have close-to-record overweight and cyclicals are 2 standard deviations overbought

We raise food producers to overweight

Click on chart to enlarge, courtesy of Credit Suisse.

Hmmm, and their S&P500 year-end target remains 920 ... not really much to gain.

Hugh: Non-performing Loans In Latvia

Indeed, who cares about the devaluation?

Edward Hugh has a good reminder today!

How much worse would it be? A friend of mine told today:

Who cares - is it 18%, or 15%?

SocGen: Decline In EPS Momentum ...

The quant equity strategy team at Societe Generale is out with a note today, and warns:

If history holds (and we see no reason for it not to) it will be interesting to see how equities cope with the expected down leg in EPS momentum. This is especially the case given that on a six-month view equities are now in positive territory and the sharp improvement seen in the US upgrades/downgrades ratio seen during the last couple of months. The strong outperformance of some lower quality cyclical stocks could also be called in question.

At the same time James Montier, the prominent strategist at Societe General, has listed seven habits of highly defective managers in a separate note:

1. They see themselves and their companies as dominating their environments, not simply responding to developments in those environments.
2. They identify so completely with the company that there is no clear boundary between their personal interests and corporate interests.
3. They seem to have all the answers, often dazzling people with the speed and decisiveness with which they can deal with challenging issues.
4. They make sure that everyone is 100 percent behind them, ruthlessly eliminating anyone who might undermine their efforts.
5. They are consummate company spokespeople, often devoting the largest portion of their efforts to managing and developing the company's image.
6. They treat intimidating and difficult obstacles as temporary impediments to be removed or overcome.
7. They never hesitate to return to the strategies and tactics that made them and their companies successful in the first place.

So watch out where the weakness resides!

Saut: The Ambergris Factor

Jeff Saut, the respectful strategist at Raymond James has posted his weekly missive, see the latest version here. Last time on this blog Jeff suggested this.
His call for this week (but read the full story) in very short:

Well it’s a record, at least according to our notes of more than 40 years, as the current “buying stampede” has eclipsed the previous record stampede of 41 sessions. Indeed, today is session 45 in the upside skein without so much as anything more than a one- to three-session pause/correction since the stampede began on March 9th; and, we were bullish at that time. The straight up rally has lifted the senior index (DJIA/8574.65) some 33%, and to within 4.5% of its 200-day moving average (DMA) at 8575, which should act as overhead resistance. Clearly, the markets are currently overbought with 91% of the S&P 500 components above their respective 50-DMAs, while 44% are above their 200-DMAs for the highest 200-DMA overbought reading since August 2008 (we were cautious). Moreover, as the astute Dines Letter observes, “April has been a month with a pivotal reversal of the March trend 67% of the time since 1963; and, at least a semi-important TOP has been reached in virtually every April or May since then.” Consequently, while we don’t think the old stock market “saw” of “sell in May and go away” is going to play in 2009, we do believe the trick from here is to harvest trading profits and hedge some of your investment positions for a downside correction. That said, we are buyers of select thematic investment positions, preferably ones with a dividend yield, on weakness.

Consider as a probability!

Hempton: The (Latvian) Hooker No Longer Cost Too Much ...

As Claus of Alpha.Sources noted today:

one of those "must reads" ...

John Hempton has a "makes sense" post on Latvia and Baltics today:

The hookers no longer cost too much: geopolitics and the price of prostitutes in the Baltic States

go and read it!

Danske: The Worst Case Scenario Is The Reality ... As GDP Collapses 18% y/y

Ooouch! This sounds painful!

The Danske Bank noted today:

This afternoon we saw really shocking GDP numbers for Latvia for Q1. GDP dropped by 18% y/y – much more than consensus forecast and our expectation of a drop of 16.8% y/y – and a very significant deterioration from Q4 08, in which GDP dropped by 10% y/y.
The details for GDP have not been published yet, but it is almost clear that the drop in GDP is broad based – with both domestic and external demand.
We already expected that the Latvian economy might decline by 15% y/y in 2009, but today’s GDP numbers mean that we would have to adjust our GDP forecast in a significantly more negative direction and it is now likely that GDP will drop by more than 20% as an average for 2009.
The very weak GDP numbers are also a clear indication that the Latvian government budget situation will have further deteriorated. It looks like the IMF agreed fiscal deficit target of around 7% of GDP will be very difficult to achieve. We believe that uncertainties with regard to the budget situation have increased significantly.

Nordea bank commented:

Latvian Q1 GDP contracted by 18% compared to a year ago (Consensus -16.2%, Nordea -13.5%). The clearly steeper than expected fall confirmed the view that the economy has gone on an even steeper downhill from Q4, when the economy already shrank by -10.4%.
The weakness in the Latvian economy is broad-based. The decline in both the manufacturing and the service sectors continued in Q1. The export sector is slow, due to dampened world demand, the situation of companies is strained, as demand is weak and the financing situation is tough. Furthermore, the situation of the consumers in Latvia is difficult, as unemployment has shot up and wage growth has slowed.
The year 2009 is likely to be difficult in Latvia, and the government faces the challenge of keeping the budget deficit within a limit accepted by the IMF in order to receive the rest of the emergency loan. At the moment the government is working towards a deficit of 7% of GDP, more than the 5% initially agreed upon with the IMF. According to the Prime Minister the discussions whether the IMF will allow a larger deficit are still going on. Keeping the deficit within 5% of GDP is turning out to be increasingly difficult as the economy has contracted further.
We foresee the economy contracting by 12% in 2009, with the recession easing towards the end of the year. In 2010 we expect a decline of 3%, as the world economy starts to recover.

But the "green shoots" were observable also in Latvia, as exports climbed more than 10% in March on month, but still more than 20% down on year ...

US Bank Stress Tests

Conservative market observers say the test was not so stressful.
Dean Baker seems to be one of them, see his post "Background on the Stress Tests: Anyone Got an Extra $120 Billion?", and offers insight into his thinking:

Most news outlets seem anxious to join the Treasury's PR campaign in pronouncing the banks essentially healthy based on the stress test results. There is of course enormous uncertainty around the course of the economy over the next few years, and the results of these stress tests may well prove to be an accurate assessment of the banks' health, but there are some reasons for believing that the stress tests are likely to prove too lenient.
1) Fraud in mortgage issuance -- we know that many of the loans issued in this period involved fraud, more often on the lenders' side than the borrowers. In these cases, for example where the mortgage application grossly overstates the buyers income or the appraisal hugely overstates the market price of the house, default rates will be far higher than would be expected even in bad economic times. Also, recovery rates will be far lower if the original appraisal price was inflated.
2) Unemployment -- in their negative scenario, the stress tests assumed a year-round average unemployment rate of 8.9 percent for the 2009 and 10.3 percent for 2010. The economy is on track to have a much higher unemployment rate, as it is likely to hit 9.0 percent in April. My best guess for a year-round average would be 9.4 percent for 2009 and probably around 10.5 percent for 2010. (These numbers assume no second stimulus, but of course Congress will not sit back and just let the unemployment rate go through the roof.)
3) House prices -- the negative scenario assumes that house prices, as measured by the Case-Shiller 10-City index fall 22.0 percent in 2009. Prices in this index have been falling at a 24 percent annual rate in recent months. Given the massive inventory of unsold homes, It is reasonable to expect that this rate of price decline could continue at least through 2009.
What difference would harsher assumptions make? The projected loss rate on first mortgages increases by 45 percent between the baseline scenario and the negative scenarios in the stress tests. The baseline scenario assumes an 8.4 percent unemployment rate for 2009 and 8.8 percent for 2010 (some serious stimulus here), compared to the 8.9 and 10.3 rates in the negative scenario. The rate of house price decline in the baseline scenario was 14 percent in 2009 and 4 percent in 2010, compared to 22 percent and 7 percent in the negative scenario.
So, if my somewhat more negative numbers prove accurate let's assume that it increases losses by about 20 percent. That comes to an additional $120 billion in losses. That would mean that instead of having to raise $75 billion, these banks would have to raise $195 billion. That's a qualitatively different picture.
So, are the stress tests worthless? They did provide a much clearer picture of the position of individual banks than we had previously. It is worth noting that this is a 180 degree shift from the original course pursued by Treasury Secretary Henry Paulson last fall. Paulson tried to conceal the situation of individual banks, putting a cloud over all of them. Treasury also should be credited for disclosing many of the specifics of the stress tests so it is possible to do a quick (or more in depth) analysis of its assumptions and explore the implications of alternative assumptions.
Still, it is hard not to conclude that these stress tests and certainly the PR campaign around them, were intended to paint as positive a picture as possible of the banks' financial condition. If this picture proves to be wrong, then it means that we will have unnecessarily delayed the clean-up of the financial system. It will also be bad political news for the administration (Geithner and Summers will presumably be joining the ranks of the unemployed).
Of course, the big second stimulus package that Congress will pass this summer, will save both the banks and the administration.

Calculated Risk and BNP Paribas credit strategists have similar views ...

Some time ago I wrote that bank equity is an option (like here re Citigroup), and the credit strategists at BNP Paribas have an interesting comment in their "Credit Driver" today:

The fading risk of a forced nationalisation (or indeed receivership or wind-down) in the foreseeable future is definitely good news for both banks’ shareholders and bondholders. While some equity dilution looks inevitable, and more may be needed going forward, that seems to be a better prospect for shareholders compared to being wiped out. If one looks at equity as a call option on the assets of the banks, even an out-of-the-money one becomes more valuable if its expiry date is pushed back. Therefore, a rally in bank equities was indeed warranted; the question is whether it has gone too far.

BTW, back in March I noted for reference the Barbie's Ken promising to repay TARP money, now he is obliged to raise the most common equity, according to stress test ...

John Hempton at Bronte Capital argues: Why American banks will not wind up looking like Japanese banks - Part 1, obviously with more arguments to follow. In the meanwhile Doug Kaas writes that financials are done, and priced for perfection ...

BTW, I expressed some critics in relation to Buffett PR and WFC (Wells Fargo) on Monday, WFC was first to announce capital increase last night ... Indeed, style-drifting.