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?