Danske: Disease That Takes Time To Cure

I am back, but I cannot promise the posting will be regular going forward.

My "focus list" consisting of Spanish and Italian bonds, and JPY worked well, however all of those instruments have experienced interventions by central banks and cannot be considered as leading indicators anymore.

The liquidity crisis usually resolves with a victim, and while none of fundamental macro problems have been solved, the liquidity will just postpone the resolution.

However, for the greedy people we all are, I would be still cautious beyond the obvious speculative action. Danske Bank had a good reminder yesterday, see the picture below, but you decide whether the witch-hunt has ended.

Click on picture to enlarge, courtesy of Danske Bank Markets.

Moody's Does Not Like Portugal

As the European government debt crisis just seemed to turn the corner, Moody's junked the Portugal today...

Credit Agricole: Sisyphus Cannot Simply Kick The Can Down The Road

Posting will be very light, or even absent in July. For the longer reading the latest macro prospects by Credit Agricole are at your disposal here.

Second Anniversary Of Impossible Equation

With the second round of "Greek bail-outs" already passed the "feel good" kicking of the can down the road goes on. However, I return to history that has second anniversary today, when I singled out the report by Societe Generale and posted on this blog SocGen: Public Finances - The Impossible Equation two years ago. The first anniversary I remembered with Anniversary Of Impossible Equation. But how far have we got today?

As Keynes noted: 

"In the long run we are all dead."


Anyway?

Liquidity Glut And Low Interest Rates

I have been writing about liquidity glut and low interest rates, and their impact on real economy some time ago. Gerard Minack, the strategist at Morgan Stanley, brings up this issue today and makes it very clear, again:

Exhibit 1 shows the contribution to the 12 month return on US equities from the change in the prospective PE ratio (the PE based on consensus earning forecasts). The amplitude is significant: the swing in the PE often contributed plus or minus 20-30 percentage points to the annual equity return. Importantly, the biggest influence on the PE ratio was interest rates. Falling rates led to a rising PE, and vice versa. (The line in the chart is the 12 month change in the 10 year Treasury yield – but it is inverted: so the line goes up as yields go down.)

Click on chart to enlarge, courtesy of Morgan Stanley.

Well, the times may be changing, as Gerard Minack continues:
This was the basis for the ‘don’t fight the Fed’ mantra. In a credit super cycle – when investors are willing to increase borrowing as rates fall – lower rates are good for risk assets.


A post-bubble environment is different. As I’ve discussed before, macro cycles tend to be weaker and more fragile. As importantly, investors do not respond to lower rates in the same way as they did through the credit super-cycle.

On a days like today it feels like bubble never ended? Some evidence of global stabilisation?

Spanish Government Bonds In Focus

As the interest rate strategists at Commerzbank write today, despite hope for better sentiment in the weeks ahead:

At the same time, the risks of a re-widening in spreads from lower levels later this year have increased. Should politicians fail to come up with a coherent plan to ring-fence Greece in the case of default, highly adverse consequences like a bank run in Greece or Spanish yields moving to unsustainable levels cannot be ruled out.

Click on chart to enlarge, courtesy of Commerzbank.

Interestingly, but 10-year Spanish government bonds appear to be testing unchartered waters with a potential upside breakout from technical perspective, while still below the point of no return at 6%, as per Commerzbank. At the same time 5-year Spanish bonds still appear somewhat friendly...

However, this is one area to keep an eye on.

Nomura: How Much Of A US Slowdown Is In The Price?

Interesting observations by strategists at Nomura today:

While June ISM risks are skewed to the downside, growth-related assets seem to be underestimating the possibility of a disappointing outcome. Figure 1 compares the ISM index with the year-on-year changes in our common measure of US market-implied growth, which we define as the first component of a PCA on a group of US growth-related assets. It is apparent that after months of relative pessimism the market is now trying to look through the recent data and view it as a transitory slowdown. As such, growth assets appear vulnerable to further disappointing data in June. Currently, on this simplistic measure the market implies an ISM of roughly 57.0 vs our economists forecast of 51.8 and the Philly Fed's dismal ISM-equivalent reading of 45.5.

While buying Treasuries and selling stocks would be the natural trade to position for a deeper-than-expected ISM dip, optimising this trade could be key given current valuations. Figure 2 looks at the relative mispricing of each asset with respect to the common US growth component. Clearly, while Treasuries would benefit from a disappointing growth outcome, yields already appear too low compared with the rest of the assets in our universe and arguably offer only a limited reward. Conversely, S&P Consumer services, oil and copper still appear too optimistic with respect to growth, despite their recent retrenchment, and thus offer an interesting trade for investors positioning for a longer and deeper "soft patch" than currently expected.

Click on charts to enlarge, courtesy of Nomura.

Well, markets seem to be focused on "technically oversold" conditions and Greek "victory" today...

Jump In Correlations In European Credit Markets

The message from credit strategists at BNP Paribas today:

A confluence of events has increased volatility which could turn systemic in nature. With correlations bunching up once again and trending towards 1.0, the message from the markets is loud and clear that systemic risk is rising and liquidity is poor, which is being reflected in higher volatility and risk premia.

Click on chart to enlarge, courtesy of BNP Paribas.

If this is not enough, one should consider - what has made US markets "so weak" recently?

Click on chart to enlarge, courtesy of BNP Paribas.

Well, ECRI tells us not to blame Japan for slowdown ...

DBS Sees "Summer Lull A Window Of Opportunities" For Asia Equities

DBS came out with latest Asset Allocation report today, as for Asian equities the view is more than clear:

• The short-term ebbs and flows we are currently experiencing are nothing but a proverbial 'tempest in a tea cup'. Financial instability in Europe and an economic soft patch in the US heighten risks, but not enough to derail the ongoing global recovery


• Volatility and mixed data signals are the norm at this stage of the cycle. We find comfort in attractive valuations, supported by realistic earnings growth expectations. Asian equities as an asset class are cheap relative to cash and inflation


• Asian markets probably bottomed at the end of March and should end the year comfortably higher than current levels. The passing of QE2 is unlikely to be a big event. The associated risks are rising bond yields and capital outflow in the early part of 3Q. We believe the stage is set for a 2H rally after the removal of this overhang.


• We are maintaining our Overweight recommendation in Taiwan, Malaysia and Indonesia whilst Thailand is downgraded to Underweight. China, Hong Kong and India are still Underweight. Korea is upgraded to Neutral.

So, the window of opportunity may close soon, or be the wall to hit soon in full speed.

Stunning difference, that is very obvious in the picture below, creates views like this:

Asian demand is the main determinant of its own fate

Click on chart to enlarge, courtesy of DBS.

Well, there are views that the "main determinant of its own fate" may face serious problems of rebalancing ...

No Capitulation For Merrill's Fund Managers

They were about Fading Or Risking last month, this month key messages from BofA Merrill Lynch Global Fund Manager Survey are as follows:


No capitulation... no QE3

In the June FMS investors raised cash, reduced risk asset exposure and rotated to defensive sectors. But investor panic is not yet visible. The recent drop in global growth expectations stabilized and despite sharply lower inflation readings, two-thirds of investors predict no QE3.


Growth expectation stabilise
Growth and profit expectations stabilised after recent sharp falls. Inflation expectations fell to 38% from 69% two months ago. But the macro backdrop is not seen as weak enough to warrant more stimulus: three out of four panellists think a recession unlikely and only 13% expect a new round of QE in H2.


Risk is off
The percentage of investors OW cash rose to 21%, the highest since July-09. Actual cash balances rose from 3.9% to 4.2% but this did not trigger a buy signal from our trading rule. Hedge funds cut gearing levels sharply to 1.27x from 1.53x while 43% of investors believe EU sovereign debt funding is the biggest "tail risk". Overall our risk & liquidity index fell to 38, below its long term average of 40.


Gold overvaluation highest since 2009
Equity allocations fell, benefiting bonds and cash, but positioning overall stands in the middle of historic ranges. Note that the gold price is seen as more overvalued than at anytime since Dec-09 while commodity allocations again fell.

Japan remains most unloved market

Despite China growth expectations dropping to the lowest reading since Jan-09, EM remains the most preferred region for equities, pipping the US. Regional allocations show a big drop in exposure to Eurozone and UK equities but Japan remains the most unloved equity region.


Bank underweight most negative since March 2009
Contrarians note that the weighting in global banks fell to its lowest since March 2009. Consumer discretionary saw the largest monthly drop in exposure with the only positive sector moves coming from defensives. Tech remains the most popular sector followed by pharma and energy.


Contrarian trades...
Despite no contrarian "buy" signal for risk being triggered, the contrarian trades within the June FMS are: long banks, short gold; long Japanese banks, short US tech; long Eurozone, short EM; long US dollar, short Japanese yen.

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

I have no intention to be contrarian this month ...

Chinese Holes

While the markets digest the bearish PMIs/ISM reports, with the weakness attributed to Japanese earthquake, I am looking elsewhere today. Actually, my mind is in China, again.

Today I list some of the "Holes in the bull argument" written by property analysts at Credit Suisse on Monday:

■ Credit Suisse proprietary surveys on banks, construction companies and unlisted developers showed no light at the end of the tunnel. Banks’ lending has become much more pragmatic, and the well-accepted perception of favouritism on SOEs may not be correct; many developers are delaying payments to construction companies, and taking private loans with interests beyond 20%—sector cash flow may get much worse soon.


■ ‘Rising salary’ may not solve China's housing affordability issue. Income growth targets and the proposed new income tax reform focus on low income class—the target customers for private housing may actually be worse off as a result.


■ The industry consolidation argument has neglected the impact to book value. Major listed developers only represent a fraction of China’s property market. The potential exodus of small developers could be overwhelming, and lowered land prices may force listed developers to adjust book value.

Click on chart to enlarge, courtesy of Credit Suisse.

By the way, China takes on its massive muni mess with a $463bn bailout, to start with ...

Chinese Imports Already Show Signs Of A Slowdown

I am entertaining myself with the chart below that comes from economists at Barclays Capital. We have had musings about the importance of Chinese growth story, also as a leading indicator for the global manufacturing cycle. Obviously, Chinese imports play here some role.

Click on chart to enlarge, courtesy of Barclays Capital.

The economists at Barclays Capital wrote on Friday:

... there are already signs of a slowdown in Chinese imports from the US and Europe.

BNP Paribas: US Bank Credit Has Underperformed Europe's

Indeed, interesting, brought to you by credit strategists at BNP Paribas today, my emphasis in bold and underlined:

It is interesting to note that while European bank paper (Senior and LT2) has widened on the back of sovereign concerns, US bank paper (Senior and LT2) has widened more over the last month due to housing double-dip, legal issues and relatively weaker economic environment. This US bank underperformance stresses two key points, namely that the GIP sovereign crisis is increasingly being seen as idiosyncratic and manageable while the US economic slowdown if sustained is likely to become a bigger issue in June.

Click on charts to enlarge, courtesy of BNP Paribas.

Well, let's see!

Profit Margins Again

It just happens, as a follow-up on the post from yesterday, also the economists at BCA Research made their conclusions on the corporate profit margins yesterday. So, here some excerpts to consider:

Ultimately, the health of the corporate sector depends on the financial health of its customers. Thus, the divergence between rising profits and weak growth in real consumer incomes will have to change. Historically, the growth in real profits has been correlated closely with that of real consumer spending, and the wide gap in the current cycle represents a major aberration.

I have discussed the real consumer spending and especially the incomes that should drive that spending here earlier. So, here are the mains points about margins, according to BCA Research:

To conclude, the corporate sector has been enjoying a very favorable set of circumstances that will not persist. This does not mean that profit margins are about to plunge. Companies will remain intensely focused on cost control and boosting efficiency, and the weak dollar will continue to provide support to overseas earnings. However, it is hard to see margins moving higher from current levels in the coming year.


Margins and thus profits will face a severe challenge during the next recession. The ability to repeat this cycle’s aggressive cost cutting will be minimal, and pricing power will be under pressure. If we are going to have a mean reversion of margins, then that is when it will occur. A severe margin squeeze does not seem likely while the economy is still expanding.

All in all, not bad? Just imagine how much money has been thrown at non-existing problems. Save that challenge for next recession, while at least couple of bears were growling also today ...

Still Some Adjustments In Labor Legacy Costs To Expect

Charts below are self-explanatory, while housing is non-productive and legacy cost of domestic labor. I marked some countries that I believe deserve attention.

Click on charts to enlarge, courtesy of Goldman Sachs, my annotations in red and yellow.

More than couple of those "marked" countries are enjoying record high housing prices in nominal, real and relative terms now.

European Debt Sinners

While Europeans are not the only sinners, the majority of brains with money are focused on EU sovereign debt issues. Economists at Erste Bank delivered excellent reminders today - who is who in this game?

Click on charts to enlarge, courtesy of Erste Bank.

Merrill's Fund Managers Are Fading Or Risking

We saw Reluctant Equity Bulls last month, this month key messages from BofA Merrill Lynch Global Fund Manager Survey are as follows:

The potential summer surprises

The May FMS sees investors questioning global growth (in a re-run of summer 2010) but enjoying ample liquidity that keeps risk appetite high. A stand-off has ensued with little change in allocation across asset classes but some switching within asset classes, typified by defensive rotation within equities. The summer surprises are either growth to the upside or liquidity disappointing as QE2 ends.


Growth expectations are falling
Only a net 10% of investors expect stronger global economic growth in the next 12m, down from 58% in Feb. This is easing inflation concerns, albeit marginally, with a net 61% seeing higher inflation down from 75% in March.
Risk appetite resilient
Three-quarters of the panel expect no Fed rate rise before 2012 and so risk appetite remains firm. Hedge funds are risk-on with 1.53x gearing the highest since Nov-07. Cash balances rose to 3.9% up from 3.7%, but remain low. Our risk appetite indicator eased to 43 but is well above the average of 40.


EU debt the tail risk but watch China
Growth fears see EU debt issues again ranking as the main investment risk. A slightly lower EU growth outlook (49 vs. 52) is being offset by US resilience and a rebound in Japan sentiment (74 vs. 42). A bigger concern is the deeper decline in China optimism with a net 28% seeing weaker growth compared to 15% in March.


Asset allocation: very modest change
Asset allocation saw modest rotation into bonds (48% UW from 58%) funded by lower commodities (12% OW vs. 24%) and equities (41% OW vs. 50%). GEM regains its position of most preferred region (29% OW vs. 22%) replacing US (26% OW). Consensus is UW Europe (-1%) and Japan (-17%). USD sentiment (48% undervalued) is one of the highest readings since 2002.


Sector rotation: defensive rotation
Sharp falls in energy (to 19% OW from 40%) and materials (2% UW from 17% OW) accompanied a sharp defensive rotation into staples (8% OW from 6% UW), pharma and telecoms. Banks are once again the most unpopular sector (26% UW down from 15%) with technology by far the most popular (35% OW).


How to trade the risk scenarios
If the summer sees stronger-than-expected growth: long banks, short pharma; long commodities, short bonds. If the summer sees weaker liquidity: long bonds, short equities; long US$, short EM.


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

 
While there is still room for "feel good" short-term rally, it is more likely to see weaker liquidity over summer ...

So Much About Inflation

Tiny bit about inflation from monthly Macro Strategy Views by Standard Chartered today:

Yet there is no room for complacency, given that the current round of inflation is driven by massive monetary easing and by extraordinarily high commodity prices due to a mix of supply and demand factors. No single monetary, fiscal or exchange policy tool is sufficient to arrest the situation. Given initial signs that inflation is peaking, it is critical that EM policy makers are not seen as wavering in their determination to fight inflation, and are viewed as having sufficient flexibility to reduce the risk of a hard landing. While we expect most EM central banks to continue tightening in the coming months, some – such as Brazil and China – could be close to the end of their current hiking cycles.

Click on charts to enlarge, courtesy of Standard Chartered.

Do you hear the sweet and enchanting music of "...sufficient flexibility to reduce the risk of a hard landing" and "could be close to the end of their current hiking cycles"?

There are those seductresses, Greek bird-women ... well, but not because of inflation.

Grantham Gets Serious, While We Look At Bubbles In Terms Of Bubbles?

The legendary Jeremy Grantham moves on today and says it is Time To Be Serious ...

However, as I have been serious for a while, I decided to look at industrial metals in terms of gold, that was brought to me by good folks Citigroup Global markets today.

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

Bubbles in terms of bubbles? Or, all we saw so far was just an adjustment in USD value? Well, we are indeed constrained by resources and capital in the real world, that are not reserves of fractional reserve banking.

Spanish Insolvencies

You thought that situation in Spain is stabilising? Well, the analysts at German Commerzbank write today:

According to provisional data of the national statistical office, the number of insolvencies in Spain reached a new high in the first quarter. The recovery of autumn 2010 was therefore short-lived. The property sector’s share of bankruptcies remains strikingly high: Property developers or construction companies accounted for nearly a third of all business failures. This persistent concentration shows that the consolidation of the Spanish real estate market is still not over. At the same time, house prices continued their downward trend: At the end of March the house price index had fallen by a further 4.6% yoy. Pressure on asset quality in the credit portfolios of Spanish financial institutions therefore appears likely to continue for the time being.

Click on charts to enlarge, courtesy of Commerzbank.

Right, all is contained and under control, as always ....