Dark Cloud Cover?

What a beauty! Dark clouds cover the S&P500 Financial sector?

Keep an eye on it!

Edwards On Inventory Recovery & Consumer Fundamentals

Albert Edwards, the top ranked strategist at Societe Generale, has a non-consensus view on inventory liquidation ... he calls it "Some dark deflationary thoughts in the face of market euphoria". I leave the part of market euphoria, but focus on inventory recovery hope.

Albert argues:

We continually hear that the Lehman's debacle produced an excessive liquidation of inventory as companies over-reacted to events and that if production schedules are stepped up to prevent additional declines in stocks, this will make substantial additions to GDP growth (e.g. a 4½% addition if Q3 inventory change comes in at zero).

This is simply wrong. The inventory liquidation, although large in $bn terms, has NOT been excessive given the unprecedented 18% collapse in sales (see right-hand chart below). The rate of inventory decline, at 8% yoy, has barely exceeded that seen at the nadir of the last shallow recession in 2001/2 when sales fell only around 5% yoy. Manufacturing and wholesale inventory/sales ratios are still excessive (see left-hand chart below). This is exactly the explanation the American Trucking Association Chief Economist Bob Costello gave on the release of the 2½% decline in June's tonnage - link. That is why recent inventory data has been surprising on the downside and why H2 growth will be weaker than expected.

The excess inventory situation would not be such an issue if final demand revived. Yet as consumption continues to flat-line, recent data revisions in the latest GDP release show the true extent of shockingly bad consumer fundamentals (see charts below).

US nominal household incomes are now contracting at an unprecedented rate. The largest component of household income is wages and salaries which had been declining some 1% yoy. But after revisions the statisticians now admit to an unprecedented 4.8% decline! Total pre-tax household income is now recorded as falling 3.4% yoy in June.

"But aren't tax cuts holding up household incomes?" I hear you say. Even factoring in massive tax cuts, disposable income is still down 1.3% yoy. Total hours worked in the private sector are down a horrendous 7% yoy. This headlong plunge into negative NOMINAL income and GDP numbers is exactly what happened in Japan and is the stuff of classic Fisher debt deflation ... As debt/income ratios are excessive and need to be de-leveraged, a declining denominator will be the key driver to the coming "Vortex of Debility".

However, John Hempton is extrapolating his view on Brunswick to the whole economy ...

Who is right?

Liquidity Glut Stuck In Trading Rooms?

There is a comment to Singaporean Anecdotes:

JWG said...

People are trying to take advantage of the current situation not realising that yes it is adding fuel to the fire, but you can see it the other way in that it will finally help to drive a more spending taht is needed in the retail sector.

One may assume and hope that asset inflation helps spending in the retail sector.

However, Citigroup in its daily "China Consumer & Retail Daily Bites" wrote yesterday, click to enlarge, courtesy of Citigroup.


Just to zoom in:

China Information News, a daily paper affiliated with the National Statistics Bureau, expressed concern over high residential property prices in China in 1H09. The three worries about high residential property prices, according to the paper, are 1) crowding out effect on urban private consumption, ...

And now think about it once again. Higher asset prices are not always helping the retail sector:
1) as people are more focusing on speculation in the asset markets, and diverting attention from productive investment in the real economy (so probably creating, e.g., additional jobs)
2) created wealth is not necessarily flowing into retail sector, as it may be accumulating among individuals with already high wealth and low additional propensity to spend (a problem of inequality of income) ...

especially, if the liquidity glut and the reflationary trade is stuck in the trading rooms (of, mostly, banks)!

Citi Pours The Kerosene In The Fire

Citigroup Global Markets are out with latest Global Equity Strategist, and valuing recovery:

First 100 Days — Global equity markets have rallied 46% since their March lows in anticipation of an earnings recovery. But we remain in the Twilight Zone. As corporate earnings are still falling, valuations have re-rated sharply.

A Bull De-Rating — Global corporate earnings should start to turn around at the end of this year. We expect earnings to rise faster than prices, which would drive an equity de-rating. This is typical at this stage in the earnings recovery.

Valuations Reasonable — Global equities currently trade on 21x our trough earnings forecast, but should de-rate to 16x as the earnings recovery comes through in the next two years. Equity valuations against bonds look compelling.

Still Upside — Reasonable valuations and a solid earnings recovery suggest further upside for global equities. But the greatest gains have already been made. In such an
environment, stock selection will become increasingly important again.

Earnings Recovery — Sectors with low RoEs have outperformed high RoE sectors
during the early stages of earnings recoveries. This time round such a strategy would leave investors Overweight in Financials and Underweight defensives.

Where were these guys when Citi itself was sinking? I do not know ... but this feels late.

The air smells to me somewhat thin, and I am defensive.

BNP Paribas: We Are Out Of The Woods!

The FX & Interest Rate Strategy team at BNP Paribas declared "We Are Out of the Woods" in its "Asia Trader" publication this morning. The "Call" is based on technical factors:

Equities - S$P500 Closes Above 1,000
• Asia led the way with the BKAS break higher
• S&P closes above 1,000 and Golden Cross Confirmed
• DJIA Golden Cross Just Confirmed and Testing 9422, Break Opens 10,000
• Bank stocks break out from bearish channel with imminent golden cross
• Stock volatility stays depressed, good for risk taking
• Stock volatility declines in Europe and Asia too

Bond Markets: Spread Compression Lingers
• Main Europe spread tightens dramatically
• US investment grade spread tightens further too
• Japanese investment grade spread testing trendline support
• JPM EMBI+ index back to pre-Lehman levels
• USD 10Y swap spread widening reflects mortgage hedging activity
• UST 10Y yield heading back towards 4%

Commodities: Charging Higher
• CRB index breaks trendline resistance with golden cross formed
• Gold joining the party too
• Copper flies off the handle, now targeting 6600
• Baltic Dry Index in bullish channel with golden cross intact

FX: USD Breaks Down
• Led by Asian currencies (ADXY) and remains so
• USD Index cracks 78.35 now looking 3% lower at 76.00
• Even the Fed's TWI threatens to fall off a cliff

Trend is your friend (until it is not)! Respect the market script! Markets appear to be driven by price momentum (especially looking at commodities right now ... industrial metals appear exhausting), the discount of the decline of latest US Non-Manufacturing ISM Index, that shows even sharper contraction in July, was rather short and mild so far today ... Wait, how much services contribute to GDP?

Financials save the party today! Buy on dips is still the rule!

Here are some comments on US Non-Manufacturing ISM today:
Calculated Risk
BNP Paribas

UBS Kills The Debt-Inflation Myth

Inflation bears argue that high debt levels in private sector and the rapid increase in fiscal deficits will force governments to generate rising prices, in order to "inflate" their way out of debt burden.

Economists at UBS decided to line up data, so the myth is killed. FT Alphaville has an extensive feature on the research note. However, I quote here the key take-aways:

The problem with the idea of governments inflating their way out of a debt burden is that it does not work. Absent episodes of hyper-inflation, it is a strategy that has never worked.
...............

The fundamental obstacle to governments eroding their debt through inflation is the duration of the government debt portfolio. If all outstanding debt had ten years before it matured, then governments could inflate their way out of the debt burden. Inflation would ravage bond holders, and governments (with no need to roll over existing debt for a decade) could create inflation with impunity, secure in the knowledge that existing bond holders could do nothing to punish them.
...............

The idea that governments can readily inflate their way out of their debt problems is a misnomer — arising, perhaps, from confusion between the fate of the individual bondholder and the response of the collective market.
..............

The higher debt service cost becomes a problem for a government that is pursuing an inflation strategy because government debt does have to be rolled over. Unless a government is willing to pursue hyper-inflation as a strategy, raising inflation will not reduce the government debt burden. Indeed, history indicates that the reverse result will be achieved.

And some charts with maturity profiles of major governments, click to enlarge, courtesy of UBS Investment Research.



But, of course, there are such short-term governments around that do not see further than till the end of current day ...

Supply Side Economics Will Lead The Recovery?

Supply side economists, and most of sell-side bank analysts appear to be such, are disseminating the idea of supply side recovery. For example, Danske Bank has a following outlook:

We look for further improvement in PMI data in the coming months whereas some of the leading indicators that have risen the most are likely to level off soon from the very high levels. Global GDP growth looks set for a strong H2 recovery.

Click on charts, courtesy of Danske Bank.


Indeed, production will create at least a new inventory that can be sold, that, in turn, improves the GDP statistics as a growth ...

However, the economists at Nomura comment the US consumer spending (they have been responsible for ca. 25% of global consumption):

Nominal personal income declined by 1.3% in June, reversing an equivalent increase in May (Consensus: -1.0%). Last month income growth was boosted by stimulus-related government transfers, and the decline in the current month reflects the absence of those one-time payments. Underlying measures of labor compensation growth remained weak due to soft wage growth, layoffs and furloughs. Nominal wage and salary income fell by 0.4% m-o-m and is now down 4.7% y-o-y. Real disposable (after tax) income fell by 1.8% during the month.

Real personal consumption expenditures (PCE) fell by 0.1% m-o-m and have not increased since February. Despite recent strength in housing and industrial sector activity, consumer spending has shown few signs of a rebound. We continue to expect it to lag as the broader economy emerges from recession. The personal savings rate fell to 4.6% from 6.2% previously.

Who is going to buy the stuff?

Even saltwater economists see one postmodern recovery!

Governments are going forward with stimulus and spending programs, China will push with further consumer stimulus... Total debt to income keeps growing?

Reflationary Trade, Global Liquidity Glut & Inflation Fears

Deutsche Bank published a research piece "Is the next global liquidity glut on its way?". Here are some paragraphs from the summary:

Despite the presence of global excess liquidity short and medium-term risks to CPI inflation appear to be limited because of low capacity utilisation and rising unemployment. However, excess liquidity could still potentially stoke new asset price bubbles. Central banks are aware of this risk and are at the moment preparing post-crisis exit strategies from their current accommodative monetary policy stance.

Given accelerating global excess liquidity creation, it may only be a matter of time until investors become increasingly unwilling to hold liquidity at the current low level of return. Once investors try to reduce their liquidity holdings, asset prices may again receive a temporary boost from global excess liquidity.

Usually less crowded professional markets of inflation-linked bonds and swaps (the trade by retail investors in these markets is rather rare) seem to be rather relaxed about the inflation fear. Charts courtesy of Nordea Markets, my adjustments ... click to enlarge!

Confused? Think about huge debt leverage ... and liquidity is simply needed that the system is not in a permanent condition of credit crunch?

Well, historical seasonality for bonds is good now ...

Iceland Without Comment

SEB (Merchant Banking) in its daily "Emerging Alert" writes today (click to enlarge):

SocGen's S&P500 Technicals & Seasonality + Confidence

Click to enlarge, courtesy of Societe Generale.


Seasonality is entering NOT the most profitable period of the year... (as majority looks for beach-side?).
Click to enlarge, courtesy of Seasonal Charts.


It is quite difficult to measure the sentiment, but it is definitely not about fear in the US, or even more in Asia ...

Is "freshwater" US "inventory recovery" finally discounted?