Daily Comment – 9th February 2010: In Search of a Scapegoat – The Protectionist War on China

Macro

In Search of a Scapegoat – The Protectionist War on China

Grab your pick axe, it’s all out war on China. As if a futile, self-destructive trade friction and tit-for-tat protectionist swipes aren’t enough, The Obama administration now has The PRoC’s communist government firmly in its sights for geopolitical gamesmanship as they up the ante on anti-China rhetoric. It is reported that, in a deliberate move one would think was designed almost to antagonize, President Obama plans to visit exiled Tibetan leader the Dalai Lama. China has been vocal in its disdain for such an action. Taiwan seems to be a favored battle ground with growing anger among the Chinese about US arms deals with Taiwan, yet, only recently, US officials were reportedly stunned at Taiwan’s sudden rejection of US beef imports while China recently announced it was imposing anti-dumping penalties on US Chicken. The Google versus The Republic saga continues along with American resistance Chinese imports of Steel Pipes, Steel Grating, Shoes and Apparel, Tyres even Electric Blankets. Electric blankets, has it really got that petty? Sadly, yes. After all, the last thing you want is an under-priced Chinese blankie keeping Grandma’s little tootsies warm in winter, eh? Protectionism always starts out petty, but the underlying reality could not be more sinister.

While I have nothing against Jim Chanos’ view that the Chinese property market may be overvalued or indeed that the Chinese banking system may have a massive non-performing loans problem (in fact I’ve been banging that drum continuously, now), one cannot help but notice a tone of defiance when talking about China’s lack of strategic might on on CNBC. Short China’s asset prices, yes. Bet against the sustainability of China’s rising global influence? You first, sir…

No doubt, China has an unenvious number of HUGE challenges to overcome, but, I have to admit, I find all the China-bashing a little vulgar. What is particularly disturbing is that it often originates at the highest level – from our political leaders and even central bankers. There are even some economists who lay blame for the collapse of the global economic system and the sub prime crisis  at China’s feet – citing the Chinese “savings glut”. This is almost laughable. True, China had its role to play as a main party in the World’s most prominent bilateral trade partnership, but let’s be clear: Chinese savers did not force Americans or British or even the Greeks to cripple themselves with debt. We were gloriously adept at doing this all by ourselves, encouraged, no less, by the very same voices who now point an accusatory finger Eastwards at scapegoats we collectively (and conveniently) know remarkably little about, from cultural standpoint. This is a time when we need leaders not spin-artists and “political momentum traders”. Rather than jumping on the latest politically-engineered, media-fueled, bandwagon rolling through a, still bemused, electorate, I long for a little introspection among those in positions of responsibility. We will not solve our problems until we all collectively understand their root-causes. The Greenspan Put was not, in fact, a Put Option, it was a taxation-collateralized, piggy-backed liar loan which we were continually allowed to refinance without being made aware of all the consequences. Never-the-less we, the consumer, the electorate, the investor, the tax-payer should have known better, all the same.

Perhaps the most persistent topic is China’s currency policy. It is conveniently ignored that China’s currency policy is not only the trade anchor of a mercantilist operation, it is also a vital monetary policy tool, which I’ve argued before. Indeed it could be argued, that it is no less credible than our own crude system of controlling inflation through a single base rate of interest, “manipulated” by a central body such as our allegedly apolitical (ahem!) Central Banks while espousing a ”strong dollar policy” (ahem!). In fact, Bernanke himself admits to turning to currency manipulation in order to ensure price stability. Yes, it is eventually in China’s own interest to revalue their currency, but this is their business and to suggest that this is the root of all woes in The West and that somehow all our problems will magically disappear the moment China revalues its currency by 40% and stops buying our debt, is stark-raving bonkers rationale that could only have been dreamt up by a politician, nutty-as-fruitcake, who has failed to think beyond the consequences of finding the next battered, submissive voter.

Yet, once it contaminates the blood stream of weak politicians, protectionism is a disease which cannot easily be cured. It attacks the brain of a politician causing confusion, deep paranoia, hypnotic hallucinations of righteousness and delusions of competence. The risks to the health of the global economy in this respect are only rising. I quoted Roach on 6^th January:

A second possible shock would be heightened trade frictions and protectionism, especially a Washington-led outbreak of China bashing. With the U.S. unemployment rate likely to remain higher than 9.5 percent heading into the mid-term congressional election of 2010, the Chinese currency issue has once again become a bi-partisan lightning rod.

If Washington imposes trade sanctions, the Chinese would undoubtedly reduce their appetite for dollar-denominated assets, with severe implications for the dollar and probably real long- term interest rates in the U.S.

The ingenious techniques politicians conjure and conspire to destroy the long term prospects for the standards of living of the people they represent never ceases to amaze me. It just goes to show the power of capitalism – that efficient capital allocations and effective cross-border trade still occurs despite the best efforts of those in positions of power! Worryingly, though, the markets appear to be extrapolating the trajectory of historic globalization trends indefinitely and pricing in seamless global cohesion into current asset prices. But as El-Erian pointed to succinctly in his latest piece, as investors we must be careful to Mind The Gap between the economic potential and the political reality.

Macro Data to Watch

• Japanese Machine Tool Orders
• German CPI

 

Markets

Not a very encouraging end to the day in the US. For a minute it looked as though stocks would close up but they sold off at the last minute to close 1% down on the day. Banks once again were the drivers – in particular BoA and Wells Fargo.

The Sovereign debt issue remains a worry for many investors. My PIIGS CDS chart shows spreads for dodgy European sovereigns reaching new highs.

Source: Bloomberg

The VIX will not settle down, which is a shame – one would like another entry point if one is to actively trade buy volatility. I’m sure we’ll get another chance soon.

Global Stocks to Watch:

• The Banks obviously – especially European Banks with ties to Portugal, Spain, Italy and Greece. I think French banks have the dubious honor of being quite heavily exposed to all of these nations which might explain the sell-off in BNP. UK banks have exposure to Spain but also Ireland.
• SAP CEO suddenly resigned – what was all that about? Keep an eye on the software giants. Oracle appears to be winning the battle for market share here.
• Earnings:
  • Autos/Engineering: Nissan, Kubota
  • Finance: UBS,
  • Consumer: Japan Tobacco, Swatch
  • Media: Baidu
  • Property: British Land

Daily Comment – 8th February 2010: The Capitulation of Complacency

Macro

The Capitulation of Complacency

Good morning! The last week before the whole of Asia takes a siesta for Chinese New Year next week.

Let’s pick up where we left off on Friday. Last week I spent a lot of time talking about inflation and the looming sovereign debt crises facing the globe. The two are, of course, related – given than there is much debt coming due which needs to be refinanced. Run-away inflation would result in significantly higher interest payments, something even economies like the US simply cannot afford. We are on a trajectory where projected interest payments on US Governement liabilities will soon become the single largest expenditure of the Federal Budget. When you repair a road or build a hospital or increase the salaries of teachers this is a “cost”, but on the other side of the ledger there are benefits to this which usually result in long term benefits to the economy. In fact, this type of Federal expenditure should not be considered as costs, they are investments. What do you get when you pay interest to foreign counterparts? Nothing, Zilch, Zip, Didly-squat.

You will recall I also made a throw-away comment on Friday about the “surprise” of downturns and how sell-offs like the one we have just seen rarely come at times we expect.

In my opinion, this is a typical sell-off in the markets. They never happen when you expect them to, do they? That’s because they are sparked by a sudden change in sentiment and sentiment is notoriously hard to predict. But because this is a psychological issue I can deduce two things:

• There is not much substance to this sell-off
• There is a lot of substance to this sell-off

If you see what I mean… or in other words: I have no idea why the markets have chosen the last 3 weeks to stage their sell-off. It seems to be 3 weeks like any other in my opinion. If anything Earnings looked to come in line with expectations and the GDP print was much higher than we thought it would be. It’s a funny old World. 

While I was being a little facetious here, the truth is, there rarely seems to be logic behind the timing of market corrections. This is because, while underlying fundamental conditions could be argued, bears and economic pessimists are best known for how long they are “wrong” before they are “right”.  The “trigger point” for a sell-off is largely psychological, which makes them incredibly difficult to predict and, as we know from the adage; the market can remain irrational much longer than you can remain liquid. This is often where the opinions of market participants diverge from economists (no surprises there). We must be humble enough to realize that there are things we do not always understand even in the market place – it is dangerous to follow economic theory right to the bitter end in a market dominated by a psychology which is continuously moving and evolving.

A physicist, a chemist, and an economist are shipwrecked on a desert island. Starving, they find a case of canned pork and beans on the beach, but they have no can opener. So, they hold a symposium on how to open the cans. The physicist goes first: “I’ve devised a physical solution. We find a pointed rock and propel it at the lid of the can at, say, 25 meters per second –”

The chemist breaks in: “No, I have a chemical solution: we heat the molecules of the contents to over 100 degrees Centigrade until the pressure builds to –”

The economist, condescension dripping from his voice, interrupts: “Gentlemen, gentlemen, I have a much more elegant solution. Assume we have a can opener…”

Macro Data to Watch:

• Swiss Jobs

 

Markets

On the psychology of the markets still; Mauldin quotes Rogoff and Reinhart’s book “This Time It’s Different” where they try to make sense of market psychology – the crucial link between underlying economic fundamentals and market activity. This concept is important as it connects everything I’ve been saying about debt, federal deficits, sovereign creditworthiness, fiscal and monetary policy and how this relates to the psychology of the market place.

A Crisis of Confidence

Let’s lead off with a few quotes from This Time is Different, and then I’ll add some comments. Today I’ll focus on the theme of confidence, which runs throughout the entire book.

“But highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked.”

“If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government’s policies, a financial institution’s ability to make outsized profits, or a country’s standard of living. Most of these booms end badly. Of course, debt instruments are crucial to all economies, ancient and modern, but balancing the risk and opportunities of debt is always a challenge, a challenge policy makers, investors, and ordinary citizens must never forget.”

And this is key. Read it twice (at least!):

“Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence-especially in cases in which large short-term debts need to be rolled over continuously-is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang!-confidence collapses, lenders disappear, and a crisis hits.

“Economic theory tells us that it is precisely the fickle nature of confidence, including its dependence on the public’s expectation of future events, that makes it so difficult to predict the timing of debt crises. High debt levels lead, in many mathematical economics models, to “multiple equilibria” in which the debt level might be sustained – or might not be. Economists do not have a terribly good idea of what kinds of events shift confidence and of how to concretely assess confidence vulnerability. What one does see, again and again, in the history of financial crises is that when an accident is waiting to happen, it eventually does. When countries become too deeply indebted, they are headed for trouble. When debt-fueled asset price explosions seem too good to be true, they probably are. But the exact timing can be very difficult to guess, and a crisis that seems imminent can sometimes take years to ignite.”

Mauldin then goes on to summarize:

The point is that complacency almost always ends suddenly. You just don’t slide gradually into a crisis, over years. It happens! All of a sudden there is a trigger event, and it is August of 2008. And the evidence in the book is that things go along fine until there is that crisis of confidence. There is no way to know when it will happen. There is no magic debt level, no magic drop in currencies, no percentage level of fiscal deficits, no single point where we can say “This is it.” It is different in different crises.

While it is difficult to predict the timing of such macro volatility, this type of environment never-the-less suits those who seek to opportunistically trade upon this market volatility when it occurs, in particular those portfolios which seek to maintain a “long volatility bias” for the next few years. This degree of indebtedness, inflation uncertainty and macro economic fundamentals inevitably leads to market which are hypersensitive to psychological flippancy. This is fodder for active and deliberately-focused long term volatility products.

The Dollar Rally continues as I expected, there is still some juice left in this I think. The Euro and GBP are getting smashed.

As investors sought safety the not only piled into Dollars, they fled from risk assets and ploughed into Euro Bonds. Graph of the day is a 2 year picture of the 5 year swap rate for European Bonds dropped to a 52 week low… actually that’s a 3 year low… errmm, actually 10 year low…sorry… I mean, the lowest level ever recorded. You’ll just get a measly 2.5% return on your investment in Euro Bonds and this is supposed to be an inflationary environment?

Source: Bloomberg

 

Global Stocks to Watch:

• I think as the Dollar continues to rebound it’s worth revisiting those company revenues which will be affected by the Dollar rally. Obviously unhedged US exporters but also those who stand to gain such as unhedged exporters to the US in Europe.
• The biggest movers on Friday were the banks and resource stocks in Europe and Japan. I’d expect a bit of a rebound given the late rally in the US, but I’ve been wrong before!
•  Earnings:
  • Resources: Xstrata, Anglo Platinum
  • Finance: Sumitomo Mitsui Financial Group (SMFG),
  • Consumer/diversified: Asahi Beer, Loews, CVS
  • Tech: Hon Hai Precision

Daily Comment – 5th February 2010: The Globalization of Bond Market Vigilantism: Sovereign Debt Intolerance and the Capitulation of Complacency

Macro

The Globalization of Bond Market Vigilantism: Sovereign Debt Intolerance and the Capitulation of Complacency

I promised that I would expand on the issue of how the US yield curve obligations are heavily weighted at the short end and why this is a looming problem. Rather than paraphrasing, let me simply point you in the direction of David Walker in his Daily Reckoning piece: The Scary Budget Numbers. I quote [emphasis mine]:

The hole is getting deeper because we are doing little to bring our income into line with our spending. And until now I haven’t even talked about the interest payments on our federal debt. Suppose our government fails to increase federal revenues above the current rate. Based on the GAO’s latest long-range alternative budget simulation, within about twelve years, our interest payments will become the largest single expenditure in the federal budget. By 2040, all of our federal tax revenues will add up to enough to cover only our two biggest expenses: interest on our debt and Medicare and Medicaid. Everything else – Social Security, defense, education, road building, you name it – will fail to be funded.

Shocking! Let me get this straight, not only can the US not afford to service its own debt with its own income (savings + taxation revenues) – very soon it will look to foreigners to subsidize the interest payments on its own outstanding debt! As Sen. Judd Gregg says in this CNBC interview (after about 4 min 30 seconds), in response to the challenge Congress has of financing an exploding fiscal deficit and government expansion:

… well, that’s not only true, Jim, but we’ll have to borrow the money to pay the interest. Can you imagine that? We’re borrowing to pay our interest payments. I mean [nervous laughter] … if that’s not the definition of insolvency, I don’t know what is…

What makes this a particularly interesting problem is that this is not limited to the American economy (as you will see below). So there will be an over supply of deteriorating sovereign debt hitting the street. Investors will be trying to catch multiple falling knives in this scenario. This will result in only one thing: a vehemently stringent buyers market and a flight to safety (wherever that is – Antarctica?). Or, in other words: a capitulation of complacency. Or in other words: FEAR.

The age of indiscriminate or “price-insensitive” government debt purchase will soon be over. Investors will have the power, motivation and the determination to demand that returns of all sovereign debt (yields) come at what they collectively regard as adequate compensation for the risks being undertaken – not only at an absolute level but also on a relative value basis (compared to what other sovereign yields out there are offering), or else there is little to prevent them from simply walking away, dumping the sovereign nation in the ditch – as happened with Portugal yesterday (read below). The Globalization of Bond Market Vigilantism – there will be a shake up in risk premia associated with governments and it will be driven by “activist bond market investors”. The natural Darwinist forces of capitalism cannot be avoided – they can only be transferred to another medium. Survival of the fittest is back.

Now, to the overweight of debt coming due at the short end, as Chris Martenson points out.

As for inflation, an obvious connection stems from the fact that unanticipated high inflation can reduce the real cost of servicing the debt. Of course, the efficacy of the inflation channel is quite sensitive to the maturity structure of the debt. Whereas long-term nominal government debt is extremely vulnerable to inflation, short term debt is far less so. Any government that attempts to inflate away the real value of short term debt will soon find itself paying much higher interest rates.

As we argued in that paper, debt thresholds are importantly country-specific and as such the four broad debt groupings presented here merit further sensitivity analysis. A general result of our “debt intolerance” analysis, however, highlights that as debt levels rise towards historical limits, risk premia begin to rise sharply, facing highly indebted governments with difficult tradeoffs. Even countries that are committed to fully repaying their debts are forced to dramatically tighten fiscal policy in order to appear credible to investors and thereby reduce risk premia. The link between indebtedness and the level and volatility of sovereign risk premia is an obvious topic ripe for revisiting in light of the more comprehensive cross-country data on government debt.

Of course, there are other vulnerabilities associated with debt buildups that depend on the composition of the debt itself. As Reinhart and Rogoff (2009b, ch. 4) emphasize and numerous models suggest, countries that choose to rely excessively on short term borrowing to fund growing debt levels are particularly vulnerable to crises in confidence that can provoke very sudden and “unexpected” financial crises. Similar statements could be made about foreign versus domestic debt, as discussed. At the very minimum, this would suggest that traditional debt management issues should be at the forefront of public policy concerns.

 Arguments over deflation versus inflation aside, the point I’m trying to make by bringing Marthenson’s piece up is just concerning the imminent risk coming due. This is not the end of the World, but there is structural change afoot. You cannot simply make bad debts “go away”. You can hide them away in SIV’s or structures off the balance sheets of the banks, then you can then bail out and then subsidize the banking sector with tax-payers money, quantitative easing and a steeper yield curve. Then you can buy all the toxic waste and explode the balance sheet of the central bank while eager think-tanks in Government conspire ingeniously to run massive deficits to stimulate the economy. But the debt is not magically waived, it now just sits on the sovereign balance sheet and it is the sovereign state which now comes under the scrutiny of (foreign) investors and it is the sovereign state which now represents economic credibility of the nation as a whole. As I alluded to in the title of yesterday’s comment: Refinancing Government Debt – the cram-down is nigh. 

Macro Data to Watch:

• Taiwanese CPI
• German Industrial Production
• UK PPI
• Canadian Jobs
• US Jobs

 

Markets

I’m glad we mentioned the stability of the EU yesterday. What good timing! I may be misleading when I say the best place to look for EU disintegration is the Euro – although the European Union’s currency is plummeting. Clearly the most exciting place to look is at the CDS levels of those nations at the “periphery of Eurozone monetary union”. I’m talking the PIGS (Portugal, Italy, Greece, Spain) and Ireland, Eastern Block and, yes, the UK too. Actually, many people lump Ireland in the PIGS and call them the PIIGS, now. These CDS levels are rallying hard which means investors want more return for investing in these sovereign states – which means they don’t trust the state of their government finances as much as they used to.

You know managing the European Union economy must be like fostering 16 adopted children. You have to set rules of the house, and if one kid disobeys and you are lenient, what precedent for the remaining 15 kids? Before you know it order will collapse into chaos and anarchy, as this article by Joseph Trevisani points out. The issue of sovereign debt risk is fast becoming an issue of choice for investors and investors are, quite rightly, becoming more and more stringent. Put loosely, there are so many nations whose fiscal house ain’t in order, which means that, if rely on foreigners to buy your debts so you can run your country, you’d better be prepared to offer them (considerably) higher yield on their investment. Of course then there’s a vicious cycle, the more yield you offer them the more interest obligations you have to service your debt and the more your fiscal credibility deteriorates. Hence yesterday got off to a bad start before the jobs numbers even hit the tape after PIIGS CDS levels exploded after a failed Portuguese Government Bond auction. Expect to hear more of this.

My chart of the day is Portuguese CDS spread – now check this out.

Source: Bloomberg

Of course, when the jobs number came out, that was the nail in the coffin for February gains thus far. We are wiping out the gains of 2009 and at this rate we’ll be done by summer – stocks in the US are trading at the same levels they were in September of 2009. What we need is a surprisingly good non-farm payroll number today in the US to end the week on a high, but I have to say, while yesterday’s number doesn’t inspire one with confidence it was hardly worthy of a 3% drop in the S&P. Something tells me there something else at work here. Let’s hope it is not the onset of deflationary psychological creep.

Biggest mover was Banco Santander, a $100 billion company and the stock is down 9.4%. That it is a bank does not help matters, that it is a bank in one of the PIIGS nations (Spain) makes it all the more worrisome. It seems profitability in Brazil was offset by bad loan bad loans on its book…. Errmmm… so what’s new? You telling me investors expected this massive Spanish bank to be in the clear. Something tells me this was more anxiety and reaction to the sovereign issue more than a pop at the Spanish Banking giant.

Everything got wiped out across the board: Financials, Tech, Resources – all getting puked and in a eerily systematic manner. Stocks open down and then proceeded to trade deliberately down throughout the day – closing at the lows. Brazil got smashed – the index was down 5%.

The VIX spiked again – highest close in 3 months. Opportunities to trade volatility will only become more plentiful over the next 2 or 3 years.

In my opinion, this is a typical sell-off in the markets. They never happen when you expect them to, do they? That’s because they are sparked by a sudden change in sentiment and sentiment is notoriously hard to predict. But because this is a psychological issue I can deduce two things:

• There is not much substance to this sell-off
• There is a lot of substance to this sell-off

If you see what I mean… or in other words: I have no idea why the markets have chosen the last 3 weeks to stage their sell-off. It seems to be 3 weeks like any other in my opinion. If anything Earnings looked to come in line with expectations and the GDP print was much higher than we thought it would be. It’s a funny old World. 

Global Stocks to Watch:

• Keep watching Toyota and Denso
• Watch the Financials as the Sovereign issue plays out over the next few days – HSBC, Santander, Barclays, JPM etc.
• Earnings:
  • Financials: Fubon Financial, DBS, Julius Baer
  • Autos: Suzuki, Volvo
  • Consumer/Electronic: Panasonic
  • Telco: NTT
  • Manufacturing: Toray Industries

Daily Comment – 4th February 2010: Refinancing Government Debt – the cram-down is nigh

Macro

Refinancing Government Debt – the cram-down is nigh

Right, where was I? Oh yes: TIME. We are trying everything humanly possible to fight the ensuing natural economic disaster of credit contraction and deleveraging – which manifests itself after a crisis, in monetary terms, as deflationary pressure. The last crisis was a big one, so it stands to reason that the deflationary pressures are big too. But there is an element of time to consider as well. Each day that goes by where inflation at the Monetary Base fails to follow through to inflation in Money Supply causes an incremental creep in inflation (or should I say deflation) expectations. Even if it means high levels of inflation, we, in The West, need economic expansion and we need it now.

Why is time important? Let’s start with the basic fundamentals. On 9th November I went back to finance 101 and we talked about the yield curve. The yield curve is arguably the most important financial chart - it depicts the yields of “risk free” or government debt plotted over… TIME. Let’s just go back to the Rogoff/Reinhart piece discussed yesterday: Growth in a time of Debt and look at one little paragraph which caught my eye.

Of course, there are other vulnerabilities associated with debt buildups that depend on the composition of the debt itself. As Reinhart and Rogoff (2009b, ch. 4) emphasize and numerous models suggest, countries that choose to rely excessively on short term borrowing to fund growing debt levels are particularly vulnerable to crises in confidence that can provoke very sudden and “unexpected” financial crises. Similar statements could be made about foreign versus domestic debt, as discussed. At the very minimum, this would suggest that traditional debt management issues should be at the forefront of public policy concerns.

It does not take much to connect the dots here. Reinhart and Rogoff are referring to the precariousness of yields in government bonds along spectrum of maturities – in other words they are concerned about how the refinancing of all this ballooning government debt will affect the yield curve. This is natural, of course, all governments are continuously financing their debt but it has more significance today when:

1. Sovereign debt is fast becoming a balance of “choice” for investors given that a number of highly rated economies (UK, US, Japan) are becoming more dependent on the wealth of less highly rated economies (BRICs, Emerging Asia and Oil Producing Nations) to finance their debt. This is no small thing, PIMCO’s Mohammed El Erian predicts that 2010 will become The Year of Sovereign Risk – he alluded to the knock-on effects of sovereign risk in his recent comment, Greece – part of an unfolding sovereign debt story – suggesting that, while the EU may come up with a “solution”, the issue of sovereign risk and (more importantly) the connectivity of such risk across the globe is far from over.
2. The US yield curve (a representation of the largest bond market in the World) is very heavily weighted at the short end. This creates a problem – it means that there is a glut of massive levels of government debt refinancing coming due over the next 24 months.
3. Time is an important variable: how this refinancing bodes for the future is important. Rather than simply rolling into more short term debt (which will just need refinancing again shortly) it is preferable for the US Treasury to look to the 5 to 30 year range to finance its debt. However, as ZeroHedge point out in their piece $700 billion US funding hole desperately seeking very indiscriminate treasury buyer (I think the title says it all):

Today, we focus on the most critical segment of debt issuance for 2010 – those ever critical US Treasuries, without whose weekly uptake by various investors, the multitrillion budget deficit will become unfundable. Using estimates from Morgan Stanley for 2010 Treasury supply and demand, the conclusion is that there will be a demand shortfall of at least half a trillion, and realistically $700 billion, to satisfy the roughly $1.7 trillion in net ($2.4 trillion gross) coupon issuance in the upcoming year.

The implication is that back end prices will decline sharply due to an ever increasing supply overhang, even as nearly $800 billion in Bills are paid down, thereby further accentuating the steepness of the bond curve. And with ever more emphasis put on the coupon supply, the marginal yield on long-dated Treasuries will likely find it needs to be increasingly more attractive to find bidders, which in turn will jar mortgage rates out of hibernation. We are now certain that Q.E. will continue: the weakness in the mortgage backed-market is already becoming a topic of contention, and when it becomes apparent that there is an additional $700 billion demand void in Treasuries, then it is merely a matter of time before Ben (or his successor) realizes the dollar destruction comeback tour has to resume asap.  

ZeroHedge then goes on to suggest that the yield curve will steepen as, while demand for the short end will meet supply, at long end it may be a very different story. A steeper yield curve, of course, is a good thing for the profitability of the banking sector but it has implications for mortgage rates and thus the economy as a whole. Part of the thesis from my piece Inflationary Predator where I suggested that “the powerful” stand to benefit most by these end-game, inflationary workout scenarios, quoting Saxena in Inflation 101:

Apart from diminishing the purchasing power of savings, inflation also creates unfair advantages for the elite. When a new cycle of inflation (expansion of money-supply and credit) commences, usually the governments and banks have first access to this newly created money and they obtain this cash at a time when prices within the economy are still depressed. Therefore, these powerful entities are able to buy inexpensive goods by using this newly created money. Now, by the time this surplus money has permeated through the economy and reached the masses, prices have usually risen significantly by then. Accordingly, the public gets access to the additional money at a time when prices are much higher than the commencement of the inflationary cycle!

This is enough for now, but another time I wish to expand on point #2. Because this is important for understanding both Mohammed El-Erian’s concerns over sovereign debt riskiness and it also plays into the ongoing concern over the credibility of the US Government and the Dollar.

Macro Data to Watch:

• UK BoE
• Eurozone ECB
• US Jobs – whispers of a potentially positive number on Friday (woo hoo!!) spurs more interest on today’s Initial Jobless Claims figure

 

Markets

I have to say, it was a disappointing equity performance yesterday. I think the market was secretly expecting another 3-digit positive move on the Dow (upwards), but it was not to be. The rhetoric coming from reporting companies was not as buoyant as it was on Tuesday and I guess stocks reacted accordingly – despite a great day for News Corp.

Toyota’s woes continue and the stock hit a 10 month low today (see chart below). Toyota’s are no longer safe, Chinese and Hong Kong IPO’s no longer go up … whatever next!?

Source: Bloomberg

As predicted, the Dollar rally is not over – a very big bounce in the Dollar Index yesterday. Looks like the Euro is the currency getting kicked right now.

Global Stocks to Watch:

• Toyota and related autos (see Denso getting smashed today – very uncharacteristic for this AAA rated company)
• Earnings:
  • Finance: Banco Santander, Deutsche Bank, Danske Bank, MasterCard, Zurich Financial
  • Auto: Toyota
  • Real Estate: Oriental Land, Mitsui Fudosan, Mitsubishi Estate
  • Consumer: Unilever, Kellogg, LVMH
  • Tech/Electronics: Sony, Hitachi, Nikon
  • Chemical/Pharmaceutical: GlaxoSmithKline
  • Resources: Royal Dutch Shell
  • Telco: Vodafone

Daily Comment – 3rd February 2010: Let us pray for inflation… but don’t count on it

Macro

Let us pray for inflation… but don’t count on it

Where was I? Oh yes, yesterday I said there are others who side more on the side of disinflation or deflation over inflation. In fact, some have decent credentials and back their theses up with comprehensive studies. But that’s perhaps a comment for tomorrow… well, today is tomorrow.

Personally, I think the threat of a deflationary relapse is underplayed in the media. There is a lot of focus on inflation or hyperinflation or stagflation as people are simply mesmerized by the sheer magnitude of stimulus being thrown at the problem. But I wonder, despite all of this, consumer prices have barely moved an inch, the dollar has weakened considerably – you’d think that for a country which imports so much produce this would spike inflation. The balance sheet of The Fed and the Monetary Base have exploded, stocks have rebounded aggressively, but not so much as a twitch on Main Street. I’m less impressed by the magnitude of inflationary measures taken by us, mere mortals. Rather this, to me, highlights the sheer magnitude of the deflationary forces of nature at work. Firstly, the power of deleveraging by the World’s single largest consumer base – the age of thrift is indeed upon us, and it is a structural change of attitude in The West. Secondly, the sheer magnitude of the disinflationary force due to the momentum of globalization – most notably (still) via the labor arbitrage gap and continued productivity in the developing nations.

Back on 30th November I referred to the notion that I felt there may be a latent, underground deflationary movement building. This is nothing to be complacent about. A deflationary relapse would be catastrophic for an economy still not able to disburden itself from the Debt Corner Greenspan policy promoted. We would have an extension of what is called a Balance Sheet Recession, a phrase which Richard Koo helped to promote. Nomura’s Koo, a student of the Japanese ”Lost Decade”, need only point to Japan’s woes of the last 15 years (and counting) to illustrate how this might pan out. Not only would it be a disastrous work-out for the Anglo American Consumer, all credibility would be lost at The Fed and a chairman who campaigned his appointment as the man who knew how to fight and defeat the deflationary beast – as he pointed to in what is arguably his most famous speech Deflation: Making Sure “It” Doesn’t Happen Here.

What is perhaps a little disturbing are the number of well-seasoned economists who are coming out with some pro-deflationary theses. Take the, much talked about white paper by Reinhart and Rogoff which just came out: Growth in a time of Debt. Now worth bearing in mind that Rogoff  is a Professor of Public Policy at Harvard University – so he’s no fly-by-night charlatan. Reinhart is Professor of Economics at The University of Maryland and ex-Bear Stearns Chief Economist. Of course they have opinions and are biased, but these academics also have a lot of reputation at stake – especially from their peers. A few observations were made in the paper but the one which struck me the most was that an increase of public debt, which normally accompanies massive government stimulus spending, is not necessarily inflationary. In fact there is no relationship between this indebtedness and inflationary growth for all developed countries except the US.

This is a very simple paper to read – do not be put off by the wonkish layout and authors, but, as usual, I have taken a few choice excerpts for you to get the picture.

We find no systematic relationship between high debt levels and inflation for advanced economies as a group (albeit with individual country exceptions including the United States).

We highlight episodes of private sector deleveraging of debts, normal after a systemic financial crisis; not surprisingly, such episodes are associated with very slow growth and deflation.

As for inflation, an obvious connection stems from the fact that unanticipated high inflation can reduce the real cost of servicing the debt. Of course, the efficacy of the inflation channel is quite sensitive to the maturity structure of the debt. Whereas long-term nominal government debt is extremely vulnerable to inflation, short term debt is far less so. Any government that attempts to inflate away the real value of short term debt will soon find itself paying much higher interest rates.

Periods of sharp deleveraging have followed periods of lower growth and coincide with higher unemployment (as shown in the inset to the figure). In varying degrees, the private sector (households and firms) in many other countries (notably both advanced and emerging Europe) are also unwinding the debt built up during the boom years. Thus, private deleveraging may be another legacy of the financial crisis that may dampen growth in the medium term.

As we argued in that paper, debt thresholds are importantly country-specific and as such the four broad debt groupings presented here merit further sensitivity analysis. A general result of our “debt intolerance” analysis, however, highlights that as debt levels rise towards historical limits, risk premia begin to rise sharply, facing highly indebted governments with difficult tradeoffs. Even countries that are committed to fully repaying their debts are forced to dramatically tighten fiscal policy in order to appear credible to investors and thereby reduce risk premia. The link between indebtedness and the level and volatility of sovereign risk premia is an obvious topic ripe for revisiting in light of the more comprehensive cross-country data on government debt.

Of course, there are other vulnerabilities associated with debt buildups that depend on the composition of the debt itself. As Reinhart and Rogoff (2009b, ch. 4) emphasize and numerous models suggest, countries that choose to rely excessively on short term borrowing to fund growing debt levels are particularly vulnerable to crises in confidence that can provoke very sudden and “unexpected” financial crises. Similar statements could be made about foreign versus domestic debt, as discussed. At the very minimum, this would suggest that traditional debt management issues should be at the forefront of public policy concerns.

 

Hmmm… food for thought n’est pas? Mauldin weighs in on the argument too with his reference to the Van Hoisington Fourth Quarter Quarterly Review and Outlook which states:

The real question for financial participants is whether all these influences result in inflation or deflation, and the authors’ research details both outcomes. As is widely feared here in the U.S., they outline that many countries have had the right circumstances and mechanisms to inflate away their debt overhang, and, in fact, have done so by debasing their currency. Those particular circumstances are not currently present in the United States.

According to Reinhart and Rogoff the norm is that major economic contractions lead to deflation. Importantly, they call our present economic circumstances the “second great contraction.”

Source: Van Hoisington

Source: Van Hoisington

Whether the supply curve is in a flat, normal, or upward sloping position depends on the extent of excess resources in the economy. Today it is obvious that the U.S. economy has plentiful excess resources, so any increase in demand will result in little price change. This will be the case until our unemployment rate of over 17% (the U6 measure) drops by a considerable amount and we begin to use our factories well above our current 68% utilization rate.

Thus, our current economic circumstances guarantee there will be no surprise inflation. Employing those who are out of work and fully utilizing our resources will be a slow process. More importantly, it will take time to get the monetary engine reignited. Banks will have to begin lending and people and companies will have to determine that prospects are good enough to take the risk for expansion and investment. It will take years for these processes to get started because of our over-indebtedness and falling asset prices.

Hmmm…. More food for thought, n’est pas?

We must also consider another variable: time. If we are to defeat deflation and “make sure it doesn’t happen here”, limitless time is not a luxury we can afford.

To be continued…

Macro Data to Watch:

• ISM non-manufacturing (ISM manufacturing came out slightly higher than expected)

 

Markets

Another rally and only two days into February and its already looking like the “so goes January, so goes the Year” superstition may be coming to fruition. A nice gentle start to the year, only to be confronted with some serious volatility towards the end. Rally in the US seemed broad-based but once again resource stocks leading the way (despite a disappointment from BP).

Yes the dollar pulled back for another day, but we have to wait for a real trend to be in place before calling the end of the dollar rally.

Another pull back in the VIX – getting close to the 20 level again.

Global Stocks to Watch:

• Toyota still in the headlines – this story just keeps running. I’m just waiting for some pick-up driver in Arkansas to pipe up on national TV wailing: “my windscreen wipers don’t work!”… The hullaballoo will die down when people realize the alternative is a Dodge Ram which needs a Saudi-Oil-Field-sized fuel tank just to back out of the driveway and I think have a security device whereby the automobile is specifically designed to fall to pieces the minute it does more than 3 miles. Most likely, other more efficient car makers will benefit from Toyota’s so-called demise – note, Honda and Mitsubishi Motors earnings today as well as Toyota.
• Earnings:
  • Financials: Mitsubishi UFJ, VISA
  • Pharmaceutical: Pfizer, Roche, Chugai Pharmaceuticals
  • Consumer: Yum! Brands, Polo Ralph Lauren, Espirit
  • Auto: Honda, Mitsubishi Motors, Denso (Toyota affiliate), Toyota
  • Tech: CISCO, Sharp,
  • Media: Time Warner
  • Metals: Sumitomo Metals, Kobe Steel

Daily Comment – 2nd February 2010: Inflation uncertainty, what are YOU going to do about it?

Macro

Inflation uncertainty: what are YOU going to do about it?

Just to clear a few things up; last week I strongly argued the case that inflationary is more than just a minor menace; it is a Predator  - deeply divisive and de-stabilizing, both economically and socially. My point here was that, although inflation is the “better option” for dangerously indebted economies (after all, that’s why we have all this “stimulus” and accommodative monetary policy). Let’s face it: rampant inflation, should it ever occur, is the lesser of two, very evil, evils. So let’s not get complacent about the brutal effects of inflation, one only need look at historic comparisons to understand the effects inflationary pressures can have on previously harmonious societies and buoyant, developed economies.

For Developed Nations, the wealth effect on the cost of one’s living is not completely elastic at the baseline: we all have roughly the same calorific requirement irrespective of our status. A packet of peas costs the same to a pauper as it does to a millionaire, we put the same gasoline into our automobiles, we pay for the same cell-phone bills and flat taxes. Incidentally, remember Gordon Brown the king of “stealth taxation”? Something tells me this will rear its ugly head again if inflation bites. It’s quite possible for one to double one’s income without doubling one’s expenditure – granted not everybody practices this degree of thrift but it is possible never-the-less. A much easier exercise than doing this the other way around, if one had to adjust one’s lifestyle downward (trust me on this, I’ve been there). Those with wealth not only have built-in hedges to safeguard their capital (exposure to rising asset prices/interest rates), they also have the option to make decisions about their investments (cash, property, gold, ETFs, stocks, TIPS, structured products, specialized funds etc). Whether they do or not is less relevant, the consolation of choice becomes an exponentially more important solace during times of stress. Thus it is that one has the choice, the ability to take such action, which is significant here. Given the trajectory of an economy like ours, on a relative basis, inflation favours the rich and powerful over the poor – it is that simple.

There is a misconception that wealth is destroyed during inflation so therefore it is those with large amounts of wealth who are “most at risk”. Yet most wealth is camped in government bond exposure (usually under the guise of savings accounts or investment products) and these markets, by definition, adjust their returns for inflation. This is not just a reaction of the markets, the bond markets are forward-looking: that’s their job. In fact often these markets are ahead of the curve on inflation. So, whether we realize this or not, most savings, in fact, de facto have some protection against inflation. This is of little comfort to savers who quite rightly retort: do you honestly think that the investment products offered to retail will ensure that the savings in my account will rise in perfect in synchrony with inflation? Quite right, of course they will not and this is the true frictional nature of inflation, everything happens at the margin. Inflation is not good for anybody.

But if it is naive to think that interest rates will hedge savings against inflation, it is yet more gullible to assume that, for Western Economies in this predicament, wages too will rise in lock-step with inflation. True, when the times were good and we had real productive, organic economic growth we often found that inflationary pricing pressures were driven by wage inflation. This is a feature of growth, innovation and, most importantly, tight labour markets. The labour markets today are not tight – remember underemployment, which accounts for the number of workers who have simply “given up” looking for work, is closer to 20%! The inflationary pressures from “stimulus” and Extreme Monetary Policy are not organic. Using Trillions of Dollars to bail out a financial system could be argued as necessary action, but productive it is not. In fact it would not be a stretch to say that conditions are exactly the opposite to those which would cause the warm fuzzy inflation we witnessed in bygone eras where a gentle wage pressure enable a steady 1-2% annual increase in consumption prices. Nay, in this environment, with current stimulus and current monetary policy and with this much slack in the employment I defy any rational business person who seeks to raise the wages of his blue collar employees ahead of inflationary expectations. The savings-lite, working class segment of the population is simply not in any way hedged against inflation, nor do they have much choice in the matter – in fact, without the physical cushion of wealth and the psychological cushion of choice, they feel the full force of inflationary pricing pressure with much more sensitivity.

I’ve written about inflation enough, I dedicated the last week of January merely to point out that, as people interested in preserving wealth at the very least, we should consider the real ramifications of the lesser evil we (our central bankers and politicians) have chosen: inflation. If inflation takes 3 cents of the dollar from the rich man’s pocket and 30 cents of the dollar from the poor man’s pocket, then deflation would take 50 cents from both of them. While we can argue whether inflation would be much more divisive to the society, there is no doubt that deflation would be more destructive to the economy. It is with a despondent sense of irony that one could argue that, after generation of Greenspan’s Prostituted Economic HIV  (aka The Greenspan Put) and excessively lax monetary regulation got us into this mess in the first place, we need yet more of the same poison to get us out: Hair of the Dog Monetary Policy.

But, lest we get too distracted, while Bernanke and Co. are doing all they can to stoke inflationary consequences on Main Street, the sheer magnitude of the deflationary back-draft makes their inflationary efforts far from being a foregone conclusion. I am of the camp that, while inflation is a necessary evil and while The Fed has been extraordinarily creative and forceful in ensuring that we do not have a repeat of deflation (a la The Great Depression or Japan’s Lost Decade), the threat of us being unable to reach “escape velocity” from the gravitational pull of deleveraging is being underplayed by most strategists. I say almost, because there appears to be an important group of people who too think that inflation is not a foregone conclusion: that is, The Bond Market. While the yield curve has indeed steepened under the force of extreme monetary policy, the 10 year US treasuries yields well under 4% now and the 5 year bond yields well under 3% – a 40% drop in yield from mid 2008 (see chart). This is hardly the action of a market quaking in fear of imminent, rampant hyperinflation.

Source: Bloomberg

Finally, there are more than a few economists, strategists and investors who also err more on the side of deflation or disinflation. The obvious being Rosenberg – see how he simply tore the GDP Growth number apart, despite it coming out much better than anyone expected. I guess the only thing we could have expected was that Rosenburg would have taken a positive number and turned it into a negative one! But there are others, some have decent credentials and back their theses up with comprehensive studies. But that’s perhaps a comment for tomorrow – this one is already getting a little long.

I will end this comment with a question. The fact is, one cannot and should not simply put all one’s capital into precious metals (especially at these levels). Given the magnitude of forces at play here, the risks of both deflation and hyperinflation have risen to the point where we have to consider the possibility of a tumultuous end-game on either side of the coin – be it inflationary or disinflationary. The question is, as investors, which strategy or investment class would you choose to provide immunity from both scenarios or, better yet, which seek to take advantage of both these potential outcomes?

Macro Data to Watch:

• Eurozone PPI

 

Markets

The markets have a decent rebound yesterday – that’s a good way to start a new month. The Dollar sold off in typical contraction to the equity market but I’m not ready to call this the end of the rally just yet. Banking (RBS up 8%) and Tech rebound eclipsed only by the resource stocks – Rio Tinto, BHP Billiton and Exxon (good numbers) all dragging indices higher.

The VIX is calming down a bit now – dropping back to the 22 handle it had back in December.

The Pound dipped below 1.60 again last night. There’s an 8 month low at 1.57 – look out for a test of this.

Global Stocks to Watch:

• Resource stocks are the main movers today
• Toyota seems to be over the worst of the “gas-pedal calamity” – stock opens up aggressively in Tokyo today.
• Earnings:
  • Tech: Mitsubishi Electric, TDK, NTT
  • Finance: Softbank, Aflac, Metlife, Nomura Holdings
  • Pharmaceutical: Eisai, Astellas
  • Chemical: Dow Chemical
  • Media: News Corp
  • Engineering: Cummins
  • Consumer: Hershey
  • Transport/Logistics: Singapore Airlines, UPS
  • Resources: BP
  • Utilities: Korea Electric Power
  • Trading: Mitsui, Itochu

Daily Comment – 1st February 2010: +5.7% GDP Growth in the World’s Largest Economy is not enough, apparently

Macro

+5.7% GDP Growth in the World’s Largest Economy is not enough, apparently

There is a thin line between protectionism and war. In fact there is no line between them. That is, of course, because protectionism is war. Not military action, but the attack upon another country via trade wars. One country launches an assault on another by banning the sale of their products or by increasing subsidies and/or government leverage to an alien competitor. Even in the World of textiles or beef or rubber tyres, this all gets rather ugly rather quickly. But when it concerns the instruments of war themselves: weapons, arms, defense systems… and when the countries concerned are The US, China and Taiwan… well it gets all the more potent.

Have to make a comment about Friday’s number. Did you see it? +5.7% GDP growth for the US economy! That’s a big number and the component parts were encouraging too. But why on Earth did the stock market close DOWN? Very peculiar; could it be due to the reflexivity of the stock markets – reacting to the possibility that The Fed will exit stimulus early? Could it be due, in part, to Obama’s abrasive spat with Republicans shortly after? Could it be just that the market is overbought and needs a retracement irrespective of the growth numbers? Who knows, but if you’d told people in December that Q4 growth was going to come in at almost 6% annualized I don’t think that this was the performance one would have hoped for from the equity markets…

Macro Data to Watch:

• Hong Kong Retail Sales – we know Hong Kong is all about the shopping!
• Indonesian Inflation
• South Korean Inflation
• Thai Inflation
• US ISM Manufacturing – looks to be rising let’s see if we continue to inch towards 60.

Markets

Poor old Andy Murray, the Brit tried his utmost against the steady Swiss man but there is no substitute for the class and consistency. Much like comparing the British Pound to the Swiss Franc, in fact: one still gets 1.7 Swissies for every Quid you exchange, but only a couple of years ago you used to get 2.5 SFr!

Source: Bloomberg

In his latest comment, Ring of Fire, Gross refers, not to his alimentary escapades after consuming a Brick Lane Vindaloo, but to the prospects of the Pound. I’m afraid this is not pleasant reading for those who look to import produce (the entire British population!?) from other countries or who have assets/earnings/savings in Pounds. Gross concludes with:

Of all of the developed countries, three broad fixed-income observations stand out: 1) given enough liquidity and current yields I would prefer to invest money in Canada. Its conservative banks never did participate in the housing crisis and it moved toward and stayed closer to fiscal balance than any other country, 2) Germany is the safest, most liquid sovereign alternative, although its leadership and the EU’s potential stance toward bailouts of Greece and Ireland must be watched. Think AIG and GMAC and you have a similar comparative predicament, and 3) the U.K. is a must to avoid. Its Gilts are resting on a bed of nitroglycerine. High debt with the potential to devalue its currency present high risks for bond investors. In addition, its interest rates are already artificially influenced by accounting standards that at one point last year produced long-term real interest rates of 1/2 % and lower. 

As far as the Dollar is concerned, the rally continues. The Dollar Index has rallied over 7% since I sounded the alarm back in early December on this. One should always be wary of too many people on one side of a trade, something tells me that this rally is not over yet either.

Source: Bloomberg

Global Stocks to Watch:

• Financials – Goldman Sachs stock hit the lowest level in 6 months and seems to be trending downwards, stock traded in decent volume last week… something to keep an eye on. Meredith Whitney called the banking sell-off in 2008, then she called for the bank rally in early 2009, then she called for the sell off again at the end of 2009 – I rote about it in November, citing:

Meredith Whitney on the state of the banks says that she has never seen this level of credit contraction. For all this talk of inflation, that pretty much puts her in Rosenberg’s deflation camp. The jury is indeed still out. Clearly Meredith thinks that the banking sector is one to watch over the next 6 months – from a volatility perspective, I do too for that matter.

             Hmmm… she’s getting quite good at this, isn’t she?

• The big Techs drove the markets down on Friday: Apple, Microsoft, Intel – watch all the techs and tech-based economies today
• Watch all the oil companies, especially with Exxon Mobil out with earnings today – they also got sold off hard on Friday
• Earnings:
  • Resources: Exxon Mobil
  • Engineering: Larsen & Toubro
  • Tech: Hon Hai Precision
  • Consumer: Ajinomoto
  • Transport: Ryanair

Daily Comment – 29th January 2010: Real Estate Market Rhymes

Macro

Real Estate Market Rhymes

Bernanke re-confirmed as Federal Reserve Chairman in a 70 to 30 vote. Will the “30″ bit undermine his authority at The Fed? I doubt it, but history will tell.

Speaking of History, we are frequently reminded that: history never repeats, but it often rhymes. I love these old market sayings, like: “so goes January, so goes the year”. Of course I never pay any attention to them (ahem). We were hearing that phrase a lot mid January, not so much now… hmmm… weird.

Speaking of rhyming, I just wanted to show this piece from Galland’s interview with Andy Miller on the potential for the commercial property market in the US – this is quite shocking and not for the faint-hearted.

US Commercial Real Estate Train Wreck 

Could it be just coincidental that the government removed caps on Fannie and Freddie on a day when they hoped nobody would notice – Christmas Eve? In fact, on January 7th I wrote:

 In that vein, you will have noticed the little trinket that was snuck in the tax-payers Christmas stocking by US government on Christmas Eve – which effectively gives Fannie and Freddie an open cheque-book on mortgage underwriting. A nice pass-the-buck from Fed-to-Fred continuation of mortgage obligations, if you will – who says that the Fed is politically independent? To quote the Wall Street Journal:

“The timing of this executive order giving Fannie and Freddie a blank check is no coincidence,” said Rep. Spencer Bachus of Alabama, the ranking Republican on the House Financial Services Committee. He said the Christmas Eve announcement was designed “to prevent the general public from taking note.”

Notice, Miller sees the problems in commercial real estate being played out in exactly the same manner as they were with residential property. Well, “history never repeats…”.

Notice, he anticipates things being relatively benign in the Real Estate market until the second half of the 2010 – then things come home to roost in the latter part of the year. A bit like the January we’ve had, smooth and benign for the first part then suddenly (as if out of nowhere) a bout of volatility and the gains were lost. Well, “so goes January…”. 

Incidentally, Miller may be an expert but he’s not the only man to use “commercial real estate” and “train wreck” the same sentence: US Commercial Real Estate Train Wreck – Dimon. 

As its Friday I like to end with something a little less abrasive. Here is a nice visual of the countries which have owned America’s debt since 2002. Given the short time frame it’s quite incredible to see China’s rise to power (yes, owning the largest part of an indebted superpower’s debt is power – that’s the whole point).

Macro Data to Watch:

• Japanese Industrial Production came out worse than expected.
• Japanese Inflation Figures came out in line with expectations at -1.7% (correct, that’s a minus sign in front of the 1.7%)
• BoJ says Deflation will continue – you don’t say?
• Singaporean Jobs Numbers
• South Korean Industrial Production
• Spanish Jobs Numbers – currently at 17.93% unemployment.
• Canadian Industrial Production
• Canadian GDP – expected at +0.3%
• US GDP – expected at +4.7% annualized.

 

Markets

Not so pretty, but at least we saw a degree of orderliness in the market. Tech’s seemed to dominate, Nokia hit the cover off the ball and stock jumped 10%, Qualcomm, on the other hand, didn’t even step up to the plate and stock crashed 14% – see chart. Apple had a chunk bitten out of it too – yeah, I’m not yet a buyer of this “Tablet” thingy either.

Source: Bloomberg

Obama’s speech was fairly well received by the market, I thought – although I felt it was much more divisive than the media made out. There are many things I love Obama for, including the diplomacy and eloquence of his speech-making, but this was not a bi-partisan speech, in fact, claiming it was, only makes it feel more partisan.

On the same topic: Commercial Real Estate Train Wreck. No comment would be complete without talking about China. Chanos thinks the best way to play China is to do everything in your power to short-sell it. But, with respect to commercial real estate, even the hardened China bulls admit, Chanos may have a point, as the Daily Reckoning quote:

The renowned short-seller, Jim Chanos, has been highlighting the credit excesses in China for months…and worrying publicly that these excesses will end badly. Chanos calls the credit-fuelled real estate bubble in China “unprecedented.” And in a recent CNBC interview, he remarked, “One fun fact I’d like to mention: Right now, for commercial real estate, there’s 30 billion square feet under construction. Not all of that will probably get finished…but to put 30 billion square feet in context, that would be a 5 foot-by-5 foot office cubicle for every man, woman and child in China.”

Hmmm… 5-foot-by-5-foot… and that’s just the commercial real estate currently under construction… hmmmm… Hey, but who knows where Chanos gets his figures from – perhaps some of it will be used for indoor bowling alleys, anyway. In any case, you make your mind up.

Chanos is right?

Chanos is wrong?

Global Stocks to Watch:

• Techs are in the headlines
• Consumer cyclicals on this pending GDP number
• Alternative Financials – the listed Hedge Fund Man Group still getting whacked.
• Autos – Toyota news on recalls is still running.
• Earnings:
  • Consumer: Mattel
  • Tech: Samsung, Sumitomo Electric Industries, Ricoh, Toshiba, Fujitsu,
  • Telco: NTT Docomo
  • Finance: Mizuho, Mizuho Trust and Banking, Resona, KBC, Fubon Financial, Daiwa Securities
  • Insurance: Generali
  • Resources: Chevron
  • Metals: JFE, Sumitomo Metal Mining
  • Engineering: NGK Insulators, Honeywell
  • Power: Chubu Electric Power, Tokyo Electric Power, Kyushu Electric Power
  • Transport: All Nippon Airways, Mitsui OSK
  • Trading: Sumitomo Corp, Marubeni, Mitsubishi Corp

Daily Comment – 28th January: Is the Wealth of the Middle Class Expendable?

Macro

Is the Wealth of the Middle Class Expendable?

Obama’s State of Union Address will come at 9pm Eastern Time (10am Hong Kong Time). Obama will be sure to focus on The Middle Class – and so shall we.

No matter your political conviction, its not a stretch to admit that Socialist or Communist beliefs have evolved from sense of “duty” to each individual. They are heavily founded on egalitarianism or, in other words; an equal distribution of wealth among the people. As I’ve been expressing over the past few years, inflation does exactly the opposite of this – it is divisive, it taxes the poor and rellocates their wealth towards the powerful and mighty. 

Here, in ZeroHedge’s piece, Soc Gen’s Albert Edwards expands on how Central Banks Robbed the Middle Class. This sounds sensational, but the reality is, unfortunately, much closer to this than one might think. True, Edwards refers mainly to asset price inflation and not “Main Street Inflation”, as we would observe, say, as measured by CPI, but the theory is much the same. There is a clear relationship between inflation of all types, including asset price inflation, and wealth distribution. Inflation and inflationary policies are not congruous to socialistic or communistic virtues.

Relating this to China’s economy; sure rising equity prices are nice, but make no mistake, this is not the bastardized, paper-wealth dependent economies of The West. In China they keep it simple: enemy #1 is inflation, friend #1 is high growth. The goal is to keep growth sufficiently high to smooth over the cracks of a rapidly changing economy and displaced wealth/resource allocation while keeping inflation low enough to keep social unrest at bay. There is a trade-off between the two, as I’ve mentioned before, but this two-pronged goal is the paramount challenge for Chinese Economic Planners. Believe it or not, as stated in the paragraph above, rampant asset price inflation actually works slightly against fundamental socialistic ideals. So, in a round about way, perhaps the crux of legendary short-seller Jim Chanos’ theory on China is on roughly the right track – albeit, perhaps, slightly from a different angle (cautioning over price inflation in property rather than equities as an asset class). I think his thesis is complicated by the fact that the Chinese property market is a very large part of the economy and thus China’s aspirations towards friend #1 (growth sustainability). However, if, by pursuing sustainable growth and controllable inflation expectations, Chinese policy-makers subsequently jeopardize equity market price inflation … well, I’m sorry but that’s just the dog that gets kicked.

With any luck, China’s pre-emptive assaults on inflation will mean they will not need to take harsher lines in future and a smoother economic trajectory will result.

In The West the middle class is highly geared to asset prices – just look at what happened to economic growth when they collapsed in late 2007/early 2008! The middle class is not only dependent on asset prices – it is hooked on them. There is much evidence to suggest that consumer confidence are more effected by preceding equity market performance than the other way around. But, The West is not The East. Asia’s story is very different. Until China reforms its financial system (pensions, insurance, etc), so that the Chinese underclass actually do have some beneficial attachment to stock market growth, I’m sorry but, to a communist-controlled government, the wealth of today’s middle class stock market punters is relatively expendable.

Macro Data to Watch:

• US FOMC Rate Decision – all about the language – or lack thereof! (“extended period”)
• US Initial Jobless Claims

 

Markets

Two days off and look what happens to stocks! Don’t worry though, I’m back – we’ll be back in the black soon.

The sterling did not get hit as much as I thought it would on such dismal growth performance in the UK. Although what this means for Alastair Darling and Gordon Brown, the “Rafa Benitez” of incumbent G7 political leadership… well… it’s just looking not very good is it. We are to expect an election in early May according to a bluff from a Labour Party cabinet minister, Chris Bryant. Time to start pounding the streets Gordon! And just hope that this is the last of the bad news regarding the UK economy… (ahem)…

VIX spiked over 50% in recent day. It’s an environment to trade volatility. Remember the mantra: uncertainty is here to stay for a while – buy volatility on the dips and you will get spikes to sell into.

Source: Bloomberg

Global Stocks to Watch:

• Financials – Obama’s State of Union Address will mention jobs and middle class. But will it mention The Banks?
• Tullow Oil – remember I mentioned this stock ages ago before it was even a household name? Now it has the ability to move the entire UK stock market index.
• Man Group – largest listed Hedge Fund got smashed again… on decent volume too. Program trading models like AHL (which is Man’s leading strategy) always seem to suffer in these kind of sell-offs.
• Lots of noise over this Apple Tablet – do you know anyone who is rushing out to buy one?
• Earnings:
  • Autos: Ford
  • Consumer: Procter and Gamble, Hennes, Colgate Palmolive, Shiseido
  • Finance: Sumitomo Trust and Banking
  • Media/Internet: Amazon, Time Warner, B Sky B
  • Telco/Tech: Taiwan Semiconductor, SK Telecom, 3M, Motorola, AT&T, Microsoft, Nintendo, Nokia, NEC

Daily Comment – 27th January 2010: Deficits Matter… Yes they do…

Macro

Deficits Matter… Yes they do…

1. Deficits Matter

2. Deficits Matter  

3. Deficits Matter

4. Deficits Matter

UK GDP came out at a comical 0.1% for the fourth quarter of 2009 after SIX consecutive quarters of economic contraction… what a joke. I laughed so loud I almost choked on my coffee when that number came out… until I realized that most of my net savings are in sterling… then I did actually choke on my coffee…