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.

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?

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 ...

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.

Listening To Valuable Voice Of Jean-Marie Eveillard

Look for the MP3 link via King World News.

Victory Of Monetarism At Citi

Tobias Levkovich, the US equity strategist at Citigroup, posted the "chart of the month" yesterday, and the monetarism obviously leads the investment idea there:

Credit conditions remain critical for business investment and economic activity. The latest senior loan officers survey released by the Federal Reserve Board shows further easing in loan standards during 2Q11 (including those for small business and consumers) which has been a powerful nine-month lead indicator for investments in human, physical and working capital. As credit conditions improve, it is highly likely that business trends and GDP should remain constructive for the balance of 2011, reducing the probability of economic weakness developing. However, actual commercial & industrial loan activity lags the survey by 18 months and investors need to understand the differences in timing.

And the market concerns should be misguided:

Concerns about QE2 ending, higher energy prices and some moderation in ISM new orders miss the durability point. While the investment community may get distracted by the end of the Fed’s $600 billion in bond purchases this June, not to mention plausible softening in ISM new order figures from current elevated levels, the costs of corporate capital is far more crucial for determining capital spending programs as the return of investment capital is weighted against its cost. Indeed, worries with respect to higher gasoline prices undermining consumption should be offset by more jobs as a result of the eased lending standards. Thus, as the credit environment progresses more favorably, so should the decision making to generate returns.

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

Bears should be disappointed? Well, if not Loan Demand, Not Credit, Is The Problem ... and some price issues ...

Nomura: US Factory Orders Rose Because Of Higher Gasoline Prices

While media focuses on headlines of factory orders, the real picture may be a bit different to Keynesian dream that either neglects or intentionally sees compression of corporate margins.

However, the economists at Nomura explain today:

US factory orders rose 3.0% m-o-m in March exceeding market expectations of a 2.0% increase. Although the solid growth in orders partly reflected healthy growth in the manufacturing sector, price effects of higher input costs to some extent drove up the US dollar value of orders for US manufactured goods. Orders for nondurable goods jumped 3.1% in the month, part of which was led by a 7.8% m-o-m increase in orders for petroleum and coal products. The solid gain in overall orders should be viewed with caution because of price effects, as orders for goods excluding petroleum and coal products rose by only 1.7% m-o-m compared with the 3.0% increase in orders for overall products.

Well, probably Fed will discover someday the difference between nominal and real growth, which one is to drive the employment ...

US Nominal Vs Real Spending

I am not going to make long speech or writing about the sustainability of US spending, but it is the driving force of "growth" again. Just one question to Mr. Bernanke who is about to embrace new real-time tests of Philips Curve. Is nominal or real growth more likely to lead to employment gains?

Click on chart to enlarge, courtesy of BNP Paribas.

Surprised By Bullish Action In Bonds?

This "Chart of the week" from macro team at Nomura explains the bullish action (lower yields for longer term bonds) in US.

Click on charts to enlarge, courtesy of Nomura.

If that is not a sufficient evidence, one may look at the latest updates on global cooling by Simon Ward.

Well, Citigroup Economic Surprise Index provides an alternative view too.

"Fight Of The Century: Keynes Vs. Hayek Round Two"

Excellent continuation ...

Reading Wake-Up Call By Jeremy Grantham

The fact is that no compound growth is sustainable. If we maintain our desperate focus on growth, we will run out of everything and crash. We must substitute qualitative growth for quantitative growth.

Finding statements alike interesting? Go and read the entire message here.

Merrill's Fund Managers Are "Reluctant Equity Bulls"

While the last month was "Wait & see", this month key messages from BofA Merrill Lynch Global Fund Manager Survey are as follows:


Equities: a reluctant default position

In the April FMS, global growth expectations fell for the second consecutive month while inflation expectations remain high. But with no imminent change in Fed policy anticipated and bonds looking more risky, investors feel compelled to stay in stocks. Equity allocations rose in April despite another sharp drop in profit expectations: a net 19% see higher profits in the next 12m, down from 32% last month and 51% in Feb.


Monetary policy: gone wild
A net 51% of investors regard monetary policy as too stimulative, the highest level since July 2004, and commodity price inflation is now regarded as the largest tail risk for financial markets. Just 6% of the panel think long-term interest rates will be lower in 12 months’ time. Liquidity expectations remain high, nonetheless, with Q1-2012 seen as the most likely date for the first Fed rate hike.


Equity risk-reward: poor
Cash balances fell to 3.7% from 4.1%. No sell-signal is triggered for equities but upside looks constrained. Risk-taking has increased: our Risk Appetite index is at 45 vs. a long-term avg of 40; levels of hedge fund gearing rose to 1.49 from 1.38.

Asset allocation: equities over bonds and cash
The equity risk premium for investors continues to fall (3.79% vs. 3.86%) and supports an increase in equity allocation (net 50% O/W from 45%). The big U/W in bonds (58%) continues and cash O/W was cut to 10% from 14%. A long position in commodities was extended, rising to 24% from 21% in March.


Regions: out of Japan, back into Emerging Markets
In a growth-constrained world, investors want profit visibility and this month sees a big rotation out of Japan (to an 18% U/W from an 8% O/W) back into Emerging Markets (to a net 22% O/W from neutral in March). The US remains the most favoured region at 30% O/W while the consensus is neutral on Europe.


Sectors: Energy now #1 sector; but defensive shift
Energy is now the most popular sector at a net 40% O/W displacing the under performing tech sector. But the sector mood is more defensive with rotation into utilities, pharma, staples & telecom, out of discretionary, industrials and materials. Financials remain stubbornly unpopular; the net global position falling to 15% UW.


Contrarian trades
Long bonds, short equities/commodities; long Japan equities, short EM; long Europe equities, short US; long consumer discretionary, short energy; long utilities, short tech/ industrials.

Let's ride the biggest "tail risk"? Click on chart to enlarge, courtesy of BofAML.

I prefer to be contrarian ...

Folks Simply Cannot Agree On International Political Economy?

Lots of diverging paths at Bretton Woods Conference ... agreement seems to be still distant!

George Soros's talk.