Archive - Dec 2012

Whether you trust the squid and their thought process or believe in 'better the devil you know', Goldman's top thinkers - from Garzarelli to Himmelberg and from Stolper to Hatzius and Wilson - lay out the top ten global macro themes from their economic outlook that will dominate markets in 2013. Agree or disagree, one thing is for sure - these ten 'themes' will impact us all one way or another and for each theme, Goldman discusses the wider implications for markets, and the potential issues and options for investing around them. Aside from the ten key themes, they provide succinct macro outlooks for rates (steeper curves and seniorty shifts), FX (moderate USD weakness amid broad stability), equities (accelerating growth and risk reduction underpin a solid 2013), and credit ('search for yield' has less to find).

Remember when after the Fukushima explosion, in order to avoid panic Japan doubled the maximum dose of "safe" daily radiation allowed, and then raised it some more? This is kinda like that, but instead of Gamma rays you have Twinkies.

The world no longer makes sense to most people over forty years of age. Much of what we thought was true is now denied. What to us is obviously false (or at least always was) is now accepted as being true. Truth cannot be changed by repeating falsehoods. Nor can it be altered by more people believing untruths. But, when these fantasizers overwhelm society with their false beliefs, society will no longer function. As Ayn Rand stated:

You can avoid reality, but you cannot avoid the consequences of avoiding reality.

The avoidance of reality has overtaken our society. The consequences of doing so have been building for decades and will soon overwhelm us. On our current path, much of what we knew and cared about will be destroyed.

Thus far, the US has been the mainstay of Western recovery - the basis upon which investors' cautious optimism is espoused. As Diapason Commodities Sean Corrigan notes, a large slug of non-recourse debt default in the residential mortgage area has helped people escape the yoke while not serving to imperil the state-supported banks. A drastic, 20%-plus fall in house prices has seen the market clear, forming a base from which many feel a new advance in construction activity is slowly being built. The shale energy bonanza – if not yet filtering through to the price of the consumer’s routine fill-up – has begun to alter the landscape as far as producer competitiveness is concerned. And yet a host of interrelated indicators are flashing red; especially when one notes that these are closely correlated with either non?financial corporate profits and/or the stock market level itself - and form the basis of an informed realist's skeptical pessimism at equity market exuberance (or blind enthusiasm) - none more so than the two-sigma plunge in Durable Goods Shipments and its implications for a greater-than-15% crash in stocks.

On November 27th, 2012, the Eurogroup (comprising the Eurozone’s finance ministers) reached a decision on Greece. Its essence is a guarantee that Greece will remain in the Eurozone (and therefore off the Northern European agenda) for another ten to twelve months; at the very least until the German federal political cycle has seen through the election of a new Bundestag. The repercussions of this short-sighted agreement are grave not only for Greece but for the Eurozone, and indeed the European Union, more broadly. The fact that the markets’ expectation of some OMT assistance for Italy and Spain are keeping their bonds’ yields low, for the time being, does not alter the fact that the vicious contagion dynamic is gathering strength. Beyond this ‘small’ matter, Rome, Madrid and, indeed, Paris must now reckon with a Eurogroup decision that demonstrates how bogus all talk of a Growth Pact really has been. The fact that the Eurozone’s finance ministers declared, without the slightest hesitation, that substantial growth will come to depression-hit Greece without an iota of a smidgeon of a hint of fresh public investment reveals that Europe is truly blind to what it will take to deal with the recession it faces in aggregate and with the various depressions in its Periphery. So, what will come of Greece, given the latest Eurogroup ‘decision’? It is my fear, and belief, that the country is becoming a version of Kosovo – a protectorate in which the euro remains the currency, sovereignty is minimal, the population is ruled over by a glorified kleptocracy with strong links with Berlin and, last but not least, a permanent migratory flow is established that sees the young and the skilled move to northern Europe and beyond.

The personal income and spending report Friday morning left a lot to be desired for those expecting a stronger economic environment soon.  However, the report fell well in line with what we have been expecting over the past several months as the drag on real wages and incomes have weighed on the consumer; and with personal consumption making up more the 70% of the economy, changes to employment, incomes or credit has an immediate and significant impact to growth. When it comes to the economy, and particularly the ongoing recession watch that has nearly become a sporting event, it is real (inflation adjusted) incomes that matter.  In the most recent report we see that real personal incomes declined for the month from $11,546 to $11,532 billion for the month reflecting a -.12 change. Economic expansion since the last recession has been hovering around a flat line for the past seven months. The next couple of months will be very telling about the strength of the underlying economy.  The manufacturing data continues to point to further economic weakness, hiring plans have deteriorated and the main drivers of economic growth have all stagnated. While we can hope to get lucky that things will work out for the best - "hope" rarely works out as an investment strategy.

The natural reaction from policy makers, so far, has not surprised us. Rather than addressing the source of the problem, they have and continue to attack the symptoms. The problem, simply, is that governments have coerced financial institutions and pension plans to hold sovereign debt at a zero risk-weight, assuming it is risk-free... and just like since the beginning of the 17th century almost every serious intellectual advance had to begin with an attack on some Aristotelian doctrine, I fear that in the 21st century, we too will have to begin attacking anything supporting the belief that the issuer of the world’s reserve currency cannot default, if we are ever to free ourselves from this sad state of affairs. This problem truly brings western civilization back to the time of Plato, when there was nothing “…worthy to be called knowledge that could be derived from the senses…” and when “…the only real knowledge had to do with concepts…”. Policy makers then believe in recapitalization and coercive smooth unwinds. With regards to recapitalization, I will just say that we are not facing a “stock”, but a “flow” problem. With regards to smooth unwinds, I think it is obvious by now that the unwind of a levered position cannot be anything but violent, like any other lie that is exposed by truth. Establishing restrictions to delay the unmasking would only make the unwinds even more violent and self-fulfilling. But these considerations, again, are foreign the metaphysics of policy making in the 21st century.

After this year's presidential campaign, private equity and certainly Bain Capital, will likely be the last entity that those pandering to populist agendas will go to advice over the future of the business cycle in broad terms, and the future of US labor, most certainly including outsourcing, in narrow terms. And Goldman - that staunch defender of the superiority of capital over labor - will hardly be confused as ever taking the role of workers in any discussion. Which is why we read the following interview by Goldman's Hugo Scott-Gall with Bain Capital partners Michael Garstka and Alan Bird on such topics as corporate restructurings and the future of outsourcing with great interest, as it is very much unlikely that any of the conventional media sources would carry it. And while one may have ideological biases in whatever direction, the truth as presented previously, is that US private equity is a massive "behind the scenes" juggernaut, whose portfolio holding companies account for a whopping 8% of US GDP, and is directly and indirectly responsible for tens of millions of currently employed US workers! At the end of the day, it may well be that what private equity firms such as Bain think about the future of US labor prospects is the most important thing that matters for the future of the so very critical US unemployment rate. Which is why we present, for your reading pleasure, the somewhat unorthodox interview below...

One of the best bond traders on Wall Street said this recently:  “Get ready for The Great Bond Shortage in North America.  If it has a cusip and it is rated, it is going higher/tighter.” The compression in bond spreads since the Fed started all of their “made-up/newly printed money for free” antics is the root of all of this and we do not expect a change anytime soon. There are various estimations for the 2013 net new issue supply in all sectors of Fixed Income but I peg it around $400 billion.  Around $800 billion will be paid to bond holders during the year in coupon payments and, if reinvested, will cause a supply deficit of about $400 billion for the year.  Exacerbating all of this is the Fed, who will buy around $500 billion in MBS this year and perhaps the same amount in Treasuries which could take $1 trillion out of the market all by itself. Consequently we face a lack of bonds denominated somewhere between $900 billion and $1.4 trillion, depending upon the Fed, which will increase the rolling train of compression, lower interest rates further in all likelihood and cause great angst for investors who will find very little of value left in the Fixed Income markets. Safety; yes but yield; no. Inflation and Deflation, it should be noted, only work in operative systems; but it is not Inflation or Deflation that are going to matter in the short run, though it will later; it will be the lack of bonds of any sort to purchase and a stock market that may be dangerously out of sync with the fundamentals opening the possibility of a crash. If so much money is printed and so little regard is placed upon fundamental economic principles then the Real Estate crash of several years ago will look like child’s play by comparison. “Systemic Breakdown” would be the functioning words.

After all, it's about the money. Right?

There was a time when flings (insert personal contextual experience) used to be simple, impromptu, largely trivial things seeking instant gratification. That was until Shell's Floating Liquid Natural Gas facility, or FLiNG, came along: currently being built in the South Korean shipyards (largely unoccupied in the past several years after a surge in dry bulk container ship construction left the industry with a massive inventory glut and little demand for its precision engineering), this behemoth of a ship, measuring nearly half a kilometer in length, and displacing 600,000 tonnes of water, will be the world's largest offshore floating facility when deployed 200 km off the north-west coast of Australia in 2017 to process the recently discovered Prelude and Concerto gas fields. It will also likely revolutionize the field of Liquified Natural Gas extraction.

Some policymakers (and commentators) are attempting to make a molehill out of a mountain; seemingly less worried about the outcome of negotiations in the short-term, as they believe the cliff is not a cliff, but more of a slope, since economic damage will initially be limited while any equity market sell-off will only spur a resolution. We tend to side with Barclays and BofAML that the full set of expiring measures constitutes a cliff, not a slope. In brief, here is why - automatic withholdings and in Geithner's words "no authority to delay the process." The extent to which households can buffer this higher withholding is significantly weak as recent 'savings' rates have plunged - implying a need to draw on liquid assets to smooth any consumption shortfall. Citing Winston Churchill, BofAML sums up the siutation well - "You can always count on Americans to do the right thing - after they have tried everything else," and we remain stoic that stock market weakness and severe outside criticism will be important in forcing any agreement, as the politicians appear to face six signficant hurdles ahead. Meet the Three 'F's of Fiscal Policy In America...

Right now the world produces more Oil than it consumes each day, and it has for the past 16 months, this trend will only get worse in 2013.

Anyone watching the close of the market last night will likely still be shaking off the hangover as we noted 'the most ridiculous' market movements occurred in the space of a few milliseconds. As ever, trusty investigator of all things ridiculous in equity markets, Nanex highlights a rather disturbing trend, now completed its third year, where volume compression simply breaks the market. On 11/30/11, quotes from Nasdaq suddenly stopped for about 20 seconds after another explosive close where multiple seconds worth of trading were jammed into the last second. However, trading at Nasdaq wasn't affected. This is yet another example of where direct feeds illegally give data to one group of subscribers ahead of the consolidated feed. Clearly, the NBBO was ignored. For the last 3 years (2009, 2010, and 2011), there has been unusually high trading activity in the final minutes of trading activity on the last trading day in November. We show one example stock in detail below (SPY). Human discounting of a known rebalancing event? No. Completely 'broken markets' that are driven by self-reinforcing and chaos-reverting algos? Yes.