Second Derivative Thinking

This is the "news in brief" by an investment bank this New York morning:

Germany: Retail sales picked up to -0.3% m-o-m in December following a 1.9% drop in November (consensus: 2.0%).

Did you pick up?

Random Walk In News Headlines

Let' s ignore the air pockets of Amazon, Ford, SanDisk and others, and who cares about the warnings of fat tails for developed soil ... just took one headline from DowJonesNews.com:

28 Jan 2011 *DJ DAVOS: Sweden's Borg: Domestic Bank Lending Unsustainable

What's that? Go on, and figure out!

Alison Snow Jones About The Fat Tail Risk Of Capitalism

I was not sure I should say anything about Maxine Udall (girl economist), however Steve Randy Waldman and his commenters inspired me (while some guys have all means right). I have been bashing bankers lately, but Alison was simply brilliant to point out the fat tail risk of bank bailouts and capitalism (my emphasis):

So this is a message to bankers and anyone else who at least putatively cares about capitalism and commercial exchange. I am probably among the most sympathetic to both and to the institutions that support them. I am losing sympathy. Nay, I have lost it. This is the stuff from which revolutions are born and you will have brought it on yourselves. The problem is that capitalism when done right yields real value, real benefits to us all. So when it dies, when you have killed it, as with all of your other financial chicanery, we will all pay the price.

In memoriam ...

Bankers Are Managing Their Careers, Not Their Clients' Risk

Another MUST READ by Jeremy Grantham of GMO yesterday. There is a lot more, but assuming my obsession with bankers, also very recently, I would highlight the following:

You can be wrong in company; that’s okay. For example, every single CEO of, say, the 30 largest financial companies failed to see the housing bust coming and the inevitable crisis that would follow it. Naturally enough, “Nobody saw it coming!” was their cry, although we knew 30 or so strategists, economists, letter writers, and so on who all saw it coming. But in general, those who danced off the cliff had enough company that, if they didn’t commit other large errors, they were safe; missing the pending crisis was far from a sufficient reason for getting fired, apparently. Keynes had it right: “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.” So, what you have to do is look around and see what the other guy is doing and, if you want to be successful, just beat him to the draw. Be quicker and slicker. And if everyone is looking at everybody else to see what’s going on to minimize their career risk, then we are going to have herding. We are all going to surge in one direction, and then we are all going to surge in the other direction. We are going to generate substantial momentum, which is measurable in every financial asset class, and has been so forever. Sometimes the periodicity of the momentum shifts, but it’s always there. It’s the single largest inefficiency in the market. There are plenty of inefficiencies, probably hundreds. But the overwhelmingly biggest one is momentum (created through a perfectly rational reason, Paul Woolley would say): acting to keep your job is rational. But it doesn’t create an efficient market. In fact, in many ways this herding can be inefficient, even dysfunctional.

Go, read ...

About Closing The Equity Market Gap

While we know that long lasting bastard child of Europe named EuroStoxx 50 has made the break-out to the upside, some people have gotten sentiment-al on the other side of the pond. Also quants at Societe Generale are asking the question how the gap between Eurozone and US equities will be closed.

Click on chart to enlarge, courtesy of Societe Generale.

The Fine Art And The Deep Value Of Banking

While the smart guys of moral hazard are riding the waves of it for some time, the academia indeed seems to be waking up. Axel Leijonhufvud has a nice post Shell game: Zero-interest policies as hidden subsidies to bank. Here are some paragraphs worth pointing out:

The two pioneers of modern monetary economics – Irving Fisher and Knut Wicksell – were passionately concerned to find monetary arrangements that would insure against arbitrary redistributions of income and wealth. They saw such distributive effects as offenses against social justice and consequently as a threat to social and political stability.

Are these sentences worth keeping in mind when arguing about the sustainability? Well, the case is rather clear and applicable to whatever country, including Spain:

* The Fed is supplying the banks with reserves at a near-zero rate. Not much results in bank lending to business, but banks can buy Treasuries that pay 3% to 4%.

* This hefty subsidy to the banking system is ultimately borne by taxpayers. Neither the subsidy, nor the tax liability has been voted for by Congress.

However, it is all about "arbitrary redistributions of income and wealth":

* The bailouts of the banks during the crisis were clear for all to see and caused widespread outrage; now the public is being told that they are being repaid at no cost to the taxpayer.

* What the public is not told is that the repayments come to a substantial extent out of revenues paid by taxpayers for the banks to hold Treasuries.
* Both parties supported the bailouts so neither party seems ready to protest the claim that they are being repaid at no cost to taxpayers.

I am wondering is there a way to return to normal interest rates at all? I do not see how this ends well either, but cream lickers at efficient frontiers will sing the song of victory!

Sentiment-al

Quite a few strategists are cautious these days, and Tobias Levkovich from Citi too. However, while the sentiment arguments may be valid, I have some questions about cyclical expectations, as he writes:

Indeed, sentiment data is beginning to send out some worrisome signals. For instance, the proprietary Panic/Euphoria Model, which captures investor activity rather than just feelings, via various metrics including margin debt, short interest and the ratio of price premiums in puts versus calls, to name a few, is beginning to edge up closer to euphoria territory (see Figure 3). Moreover, our shorter-term lead measure, the Cyclical Expectations model actually is even more ominous. Specifically, the CEM captures data from the bond market (such as the shape of the yield curve and credit spreads), the commodity market (the price of copper and oil) as well as the real economy (via weekly retail sales and freight transport) to collate the weekly changes in confidence about cyclical conditions. Importantly, the CEM leads weekly stock price trends by one-to-three weeks (see Figure 4) and its recent dip from elevated levels suggests that equity markets may be facing a more challenging environment next month.

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

Still, thinking about the cyclical expectations ..., but the other side of Pacific may less promising?

Size Does Matter ...

Nice chart from Deutsche Bank, click on chart to enlarge.

In current greenbacks ...

Side-Effects Of Chinese Quantitative Easing

Once in a while let's look at latest Chinese economic performance. BNP Paribas sums up today:

Stronger Q4 GDP 9.8% y/y or 11.2% SAAR on exports and property. Strong Inflation pressure spills over to decade-high core CPI as result of excess liquidity, robust food prices and strong inflation expectation. Loose monetary condition calling for more tightening, peaking PMI suggests domestic demand soft landing, cushioned by exports.  

Danske Markets writes about China: Growth accelerates, but December data weak.

So,  is a "decade-high core CPI as a result of excess liquidity" and a minor side-effect of Chinese own quantitative easing? Nice chart, once again, by economists at Societe Generale, click on chart to enlarge.

Budget Deficits & Expected Record US Corporate Profits

A look at US corporate profits should scare off any equity bear, unless you do not bother about the huge economic cost (imagine direct transfer from budget deficits to corporate profits), which also Americans will be carrying ...

Click on charts to enlarge, courtesy of Societe Generale.

Amazing, but to many economic health is expressed in form of corporate profits only. Budget deficits are run to maintain corporate capacity that was created on false perception of sustainable aggregate demand driven by growing debt. Now, let's live in that delusion ... by making private debt and credit markets even more dysfunctional with quantitative easing and other aberrations ...