Archive - Jan 2012

If there is one lesson to be learned from the Japanese experience with deleveraging over the past few decades it’s that deleveraging cycles have there own special rhythm of reflationary and deflationary interludes.  Pretty simple thinking as balance sheet deleveraging by definition cannot be a short term process given the prior decades required to build up the leverage accumulated in any economic/financial system.  If deleveraging were a short term process, it would play out as a massive short term depression.  And clearly any central bank would act to disallow such an outcome, exactly has been the case not only in Japan over the last few decades, but now also in the US and the Eurozone.  We just need to remember that this is a dance.  There is an ebb and flow to the greater (generational) deleveraging cycle.  Just as leveraging up was not a linear process, neither will the process of deleveraging be linear.  Why bring this larger picture cycle rhythm up right now?  The recent price volatility we’ve seen in assets that can be characterized as offering purchasing power protection within the context of a global central banking community debasing currencies as their preferred method of reflation for now, specifically recent the price volatility of gold.

While the market continues to simply fret over when and where to start buying up risk in advance of inevitable printing by the US and European central banks, those of a slightly more contemplative constitution continue to wonder just what it is that has allowed the US to detach from the rest of the world for as long as it has - because decoupling, contrary to all hopes to the contrary, does not exist. And yet the lag has now endured for many more months than most thought possible. And making things even more complicated, the market which doesn't follow either the US nor European economy has decoupled from everything, breaking any traditional linkages when analyzing data, not to mention cause and effect. How does reconcile this ungodly mess? To help with the answer we turn to David Rosenberg who always seems to have the question on such topics. His answer - declining gas prices (kiss that goodbye with WTI at $103), and collapsing savings. What happens next: "in the absence of these dual effects — lower gas prices AND lower savings rates — we would have seen real PCE contract $125 billion or at a 3% annual rate since mid-2011 (looking at the monthly GDP estimates, there would have also been zero growth in the overall economy). Instead, real PCE managed to eke out a 2.7% annualized gain — but aided and abated by non-recurring items. Yes, employment growth has held up, but from an income standpoint, the advances in low paying retail and accommodation jobs have not compensated the losses in high paying financial sector and government employment." Indeed, one little noted tidbit in the monthly NFP data is that those who "find" jobs offset far better paying jobs in other sectors - as a simple example the carnage on Wall Street this year will be the worst since 2008. So quantity over quality, but when dealing with the government who cares. Finally, will the market continue to decouple from the HEADLINE driven economy, which in turn will decouple from everyone else? Not unless it can dodge many more bullets: "As was the case last year, the first quarter promises to be an interesting one from a macro standpoint. The U.S. economy has indeed been dodging bullets for a good year and a half now. It might not be October 26, 1881, but something tells me we have a gunfight at the O.K. Corral on our hands this quarter between Mr. Market and Mr. Data." Read on.

Is December 2012 a great contrarian buying opporunity?

Have we set the MSM on FIRE! Let's see if a trend was created. 18 hours after warning on the insurance sector, record losses were announced!!!

Politically speaking, austerity is a challenge. While we would expect that governments imposing spending cuts on their voting public may face electability issues, in fact, a recent paper from the Center for Economic Policy Research finds that there is no empirical evidence to confirm this - i.e. a budget-cutting government is no less likely to be re-relected than a spend-heavy government. However, what the CEPR paper does find as a factor in delaying austerity is much more worrisome - a fear of instability and unrest. The authors found a very clear relationship between CHAOS (their variable name for demonstrations, riots, strikes and worse) and expenditure cuts. As JPMorgan notes, austerity sounds straightforward as a policy, until the consequences bite. It remains unclear that the road Europe is taking is less costly in the long run, in economic, political and social terms. The history of Europe over the last 100 years shows that austerity can have severe consequences and outcomes and perhaps most notably, the independent variable that did result in more unrest was higher levels of government debt in the first place. Judging from France's Noyer's recent jab at Britain's credit rating, at a time of increasing budgetary pressures and declining growth, there may also be limits to European solidarity.

Those waiting on edge for HSBC hedge fund report #53, aka the year end edition, can now relax: here is the full list of winner and losers. Keep in mind, the Paulson HF update is as of November 30, which explains why Advantage Plus (or is that Minus) still shows it down only 48% when in reality it closed the year more than half down according to preliminary reports. Also, momo superstar JAT Capital is nowhere to be found. That said, the carnage of the year is more than evident. And to think everyone could have just bought gold and gone on a long vacation...

Former Greek PM, and career politician, George Papandreou, is effectively retiring. Per Reuters: "Greece's former prime minister George Papandreou told his PASOK socialist party on Wednesday that he will step down as party leader and not seek re-election, a socialist deputy told Reuters. "He told us that he will resign as PASOK leader and that he will not run for prime minister again," said the deputy who attended a party meeting on the leadership succession. Papandreou stepped down as prime minister in November last year to make way for a coalition government to help Greece exit its biggest financial crisis in decades." Nothing like scurrying away in the last lifeboat just as your country is caught in the 21st century equivalent of the 22nd Catch, where your tax collectors, so critical for procuring the much needed tax revenue (sorry Greece, only America can "print" its revenues) are on what seems to be perpetual strike.

With Unicredit's stock down 14% and sovereign spreads continuing their decompression trend, European corporate and financial credit markets are tanking - dramatically underperforming European equity markets. Perhaps the credit market is much more acutely aware of the 'bumpy road' ahead in terms of supply and the heavy calendar of both sovereign and corporate issuance at a time when demand (away from Ponzi bonds) seems weak. Nowhere is that pressure more obvious than in French government debt spreads which have popped over 40% in the last week, ahead of tomorrow's huge issuance and redemptions.

How many of those millions of dollars in cars does the "Foreclosure King" still have? How is he able to stay so warm and cozy in his castle on the intercoastal in Ft.Lauderdale staring out at his 100 foot yachts and where is the Florida Bar in all this?

Since the start of December, the tight correlation between EURUSD and risk assets has deteriorated. Most notably from the middle of December, as LTRO pronouncements began, the positive correlation has flipped to negative and EURUSD became considerably less relevant while AUD (and other carry currencies) dominated as correlated drivers. Citi's Steven Englander notes this divergence and sees two reasons for it: the LTRO has contributed by theoretically underpinning eurozone (EZ) bank funding, reducing one source of EZ risk, but leaving in place broader concerns on sovereign debt (risk transfer from private to public balance sheets once again); and the growing confidence in the US that growth will be mediocre but not disastrous. However, even though growth expectations have bounced back to some degree, taking the S&P with it, expectations of future Fed policy have not adjusted upwards at all. Our fear, in agreement with Englander, is that asset markets may be much more sensitive to economic outcomes than is commonly expected and with growth expectations having angled up, the risk rally may be very sensitive to disappointment. The deterioration of European sovereign and corporate credit along with the EUR, combined with US credits underperforming equities in the last few days suggests cracks in the risk divergence are quickly starting to appear.

Wondering why gold has moved by over $20 in the last few minues? Wonder no more - according to a note just released by Citi analyst Tom Fitzpatrick, the gold correction "has run its course and a rally is now back on the cards." Granted it is not all smooth sailing - "Gold may drop to $1,550 before turning", but when the turn comes, Fitzpatrick sees it as going all the way up to $2,400. He has the following technical observations: "Only a weekly close below $1,535/oz means corrections may be deeper." The result can be seen on the chart below. Incidentally this is a 1:24 scale replica of what will happen once the Fed and ECB proceed with the only logical step which is doing what they do best. Unless, of course, the plan is to have a modest war in the middle east to distract everyone from the economy. Because we have never seen that movie before.

As if the situation in the Gulf was not enough on edge, here comes Europe with news, via Reuters, that EU governments have reached a deal to ban Iranian oil imports. The only thing pending is the determination of the starting date and other details. The result, as expected, is another leg up in crude. Sooner or later, this relentless rise higher will spill through to the pump, which according to the Michigan Bizarro confidence indicator will sent consumer optimism to historic levels. And now, the escalation hot grenade is back in Iran's court. Expect more missiles to be fired into the water and more rhetoric about Straits of Hormuz closure in 5...4...3...

If there is one piece of data that should make you scrap all optimistic forecasts for 2012 year end S&P price targets and EPS forecasts, it is the following chart from Morgan Stanley which shows the relative contribution of financial stocks to the change in full S&P earnings (combined they account for 26.3% of the change from the actual $883.5 billion to $970.6 billion). Specifically we are looking at Bank of America, which with a forecast surge in Earnings from ($2.5) billion to $10 billion accounts for 14.1% of the entire change in S&P earnings forecasts. And since the S&P is simply the Earnings number multiplied by some multiple, all consensus views that have 1400 as their 2012 year end forecast rely on bank of America to account for nearly 20 S&P points! The US market has now devolved to such a sad state when the most insolvent of all US banks has to carry nearly the bulk of earnings growth in 2012. At least with Apple they produce something - unfortunately in BAC's case it is only legal fees for the avalanche of endless litigation against them.

As Spanish 10Y bond spreads break back above 350bps over Bunds for the first time in three weeks (having jumped over 10% so far this year alone), it is clear that its not all sangria and siestas in the land of the bull...and matador. With unemployment at record levels (youth unemployment at over 40%), industrial production back at record lows - along with retail sales, and a still collapsing housing and construction space, we agree with JPMorgan, in their 2012 Outlook, that there is no doubt that there are large budget deficit and current account deficit adjustments still to come. The pain in Spain is plain for all to see in the following six charts and as Michael Cembalest notes: "If there are socioeconomic limits to how much austerity a country can take in order to remain in a currency union, we are likely to find out in Spain."

There is still hope that the cash markets will see strong demand, but yesterday didn’t exhibit any rush to put capital to work. With HYG and JNK and both trading at a significant premium (2% is a big premium in a 7% yield environment when the market isn’t bid without).  We are at best case neutral on these, and if anything would be selling under the assumption they will underperform in a rally, and catch up quickly in a sell-off. We remain decently positive on LQD on a hedged basis. Munis actually still seem to offer decent value, with BABS looking more attractive than MUB.