Archive - Apr 30, 2012 - Story

On this slow news and market action day it is worth noting that Equities and Treasuries have dramatically dislocated in the last few days with Treasury yields near multi-month lows and stocks at one-month highs. Whether this is the ($700 billion expected) QE3-trade or a reflection of the increasingly bifurcated world in which we live is unclear but for certain this is the largest disconnect (with equities rich) of the year so far.

A month ago we chronicled what we consider one of the biggest problems for America's long-term viability in "No Country For Thin Men: 75% Of Americans To Be Obese By 2020" which goes straight to the heart of the biggest shortfall in America's balance sheet: the net present value of future spending associated with Medicare and various other healthcare related programs, which will sadly only rise as more and more Americans become morbidly obese, and demand more expensive health service out of the piggy bank that even now has tens of trillions in unfunded liabilities. And while the future is certainly not bright, the past and present are just as bleak. A Reuters report focuses on just how it is that America got to where it is today (most likely sitting in front a computer, eating potato chips and drinking sugar-laden soda): "The percentage of Americans who are obese (with a BMI of 30 or higher) has tripled since 1960, to 34 percent, while the incidence of extreme or "morbid" obesity (BMI above 40) has risen sixfold, to 6 percent. The percentage of overweight Americans (BMI of 25 to 29.9) has held steady: It was 34 percent in 2008 and 32 percent in 1961. What seems to have happened is that for every healthy-weight person who "graduated" into overweight, an overweight person graduated into obesity." Which is not surprising: with pink and white slime food substitutes (as an example) allowing more and more low income individuals to drown their sorrows in fat (aka high calorie dollar meals) it was only a matter of time. Sadly, there is nothing in the equation that indicates this is set to change any time soon, even as the all too real costs, to both the individual and to society, mount in an exponential manner.

Given the TBTF's dominant oligopoly of the credit derivatives market (due mainly to the large exchange's unwillingness to act appropriately when they know the blow-back from their sell-side clients would be considerable), it is perhaps surprising that ISDA (the body that 'regulates' watches over and determines credit events in the CDS market) is coming under increasing pressure to honor the spirit of CDS contract after the FUBAR debacle surrounding the Greek restructuring. As Katy Burne notes in today's WSJ, ISDA is set to decide on a revamp of the CDS rules within weeks as pressure from the buy-side (the other side of the trade obviously) to alter the legal wording governing what is (and is not) a credit event trigger. "Whether it is a series of small fixes or a root-and-branch rewrite is still to be decided" but we note that the market - as we discussed in depth with regard to Portugal over the weekend - is becoming more comfortable once again with the CDS contract as a hedge against 'problems' in the $2.9 trillion sovereign credit derivatives market. This is without doubt a positive step - as opposed to the typical silent arrogance of the ISDA or more broad dismissal of CDS (ban them - they are to blame) arguments that political leaders will tend to bias to. The simple fact of the matter is that CDS have been a much less manipulated market indicator of real-money stress than bonds for much of the last four months and with Portugal's basis normalizing (presumptively on the back of lower concerns at CDS event risk dislocation), perhaps real-money will slow its bond selling (choosing to hedge instead) and/or Italian/Spanish banks will be forced to buy back protection en masse to cover the huge leap in exposure they have taken on - especially with the surcharge chatter of Basel III re-appearing.

By definition, we cannot shrink our way back to the sort of growth required to service the West's accumulated debts. Something has to give. That something will ultimately be social and political disorder on a continent-wide basis, particularly as the taxpayer becomes increasingly frustrated in his obligations to fund the rapidly growing and untenable costs of Big Government. Such disorder is almost universally feared-- by politicians, by markets, by institutions. As the London-based marcoeconomic research consultancy Capital Economics recently commented: "The last thing that the markets need right now is increased political uncertainty at the heart of Europe at a time when the economic outlook is already bleak..." The only reasonable response to this is: tough. If social and political disorder is what it takes to shift an unsustainable status quo in which vampire banks and clueless bureaucrats suck the life out of the productive economy, bring it on.

“…we have not had to put any taxpayers’ money into our financial system in Canada, nor do I anticipate that we’ll be obliged to do so.”

—Jim Flaherty, Minister of Finance

“Without wanting to appear arrogant or vain, which would be quite un-Canadian... while our system is not perfect, it has worked during this difficult time, I don’t want the government to be in the banking business in Canada.”

—Jim Flaherty, Minister of Finance

“It is true, we have the only banks in the western world that are not looking at bailouts or anything like that...and we haven’t got any TARP money.”

—Stephen Harper, Prime Minister

While in 'normal' times the commonly held view is that P/E ratios tend to fall as real interest rates rise, as we recently pointed out here, the relationship is highly non-linear and nowhere is this regime-dependence more evident than in the following chart from Morgan Stanley. Empirically, the current interest-rate regime (the 2-3% 10Y) is as good as it gets and whether rates rise or fall from here, equity valuations are likely to drop. The market rarely trades at the average multiple, though the current market trades at near average levels currently (not cheap as many would like us to believe). Of course, as Morgan Stanley notes, there are a number of other drivers but on a long-term basis and top-down, equity valuations have a hard hill to climb to prove its different this time.

While the Dallas Fed Manufacturing Index tends to be a little less of a headline-maker  than many of its macro-data peers, today's dismal report is worth paying attention to. The index turned negative for the first time this year, dropped to its lowest level in 7 months and missed expectations by the largest amount in 10 months. The drop from +10.8 to -3.4 is also the largest sequential drop in 11 months. Only the inventories sub-index rose (hardly a bright spot) as Production, Number of Employees, New Orders, and Capacity Utilization all plunged and the average workweek fell for the first time in months. The US decoupling myth continues to come apart at the seams and the likelihood of more easing (extreme or not) seems to be rising by the day - because that has worked so well in the past.

Over the weekend, just because apparently someone really needed content at any cost (in this case zero), we got a new intellectual stillborn from none other than the man who more than anyone is responsible for the global economic collapse the world has been in for the past 4 years, and from which it is nowhere even close in escaping. The man of course is Larry Summers, who first crushed global finance, then Harvard, and finally Obama's economic platform, whom the FT saw fit to give the chance to pontificate on such concepts at growth and austerity, because apparently, growth through austerity, whereby banking sector debt is written down in parallel is not growth, but there is some subsegment of "growth", heretofore unknown, that Europe has not tried before, and will instead focus on that going forward. To paraphrase Lewis Black: don't think about that sentence too hard, or blood will shoot out of your nose.

... the only question is whether the number,which printed at 56.2, down from 62.2, and missing expectations of 60.0, is horrible enough to send stocks soaring. Based on some of the core numbers it may be: the headline nuimber was the worst since November 2009, the miss was the biggest since September 2009, Production of 57.1 was the lowest since September 2009, New Orders slide to 57.4 from 63.3, Supplier deliveries lowest since September 2011, and so on. The only good print was employment which mysteriously rose from 56.3 to 58.7, just in time for the NFP print to come really, really ugly. On, and Joe LaVorgna was at 61.0: way to earn that bonus Joe. ISM downward revisions to come. But not from Joe- look for upward revisions there. Finally, comment #6 from the PMI respondents says it all: "Despite all of the rhetoric to the contrary, it looks like the air got let out of the balloon."

While the most commonly held perspective on the aging demographic in the US is a retiring Boomer generation that is increasingly risk-averse (rotating to fixed income) and in desperate need of a growing segment of the healthcare pie, it appears that this may not be the entire picture. The data shows, via UBS Larry Hatheway, that in fact asset preferences do not change much by age cohort and therefore is not the driving reason behind a secular rotation out of stocks per se (as opposed to more simple reasons such as mistrust) and more notably the perception of an increased longevity could actually incentivize older investors to extend investment horizons (whether in stocks or fixed income). There does, however, remain a clear correlation (intuitive rather than causal if one is splitting hairs) between equity valuations (P/E ratios) and the older cohort (implying expectations of dropping equity valuations). Critically though, it appears from the data that older investors are not more risk averse. There is one further issue that is quietly emerging and that is US fertility data which points to an 'eventual' rejuvenation of US society - which could eventually shift the demographic influence back in the opposite direction. The simple take-away is that while old people continue to desperately cling to wealth preservation in their longer-than-expected lives, with their notably higher-than-average net worths, there will be an increasing pressure to stealthily tax part the aged of their wealth to cover the costs of a growing and even more state-dependent youth demographic that is emerging. Forget the 99% versus the 1%, it appears the new and more clearly-defined class warfare could well be the old versus the young.

May had arrived in Spain. It was not, however, the May of years’ past but a Spring that was somehow devoid of warmth and of joy. The flowers had begun to blossom but they were gnarled, deformed, as if the land was reflecting the mood of the people. It seemed as if the Devil had arrived in Spain and, having conducted his Inquisition, was loosening various punishments upon the country based upon the confessions that he had witnessed.  The Cathedrals appeared to have been defaced, the bones of the Saints were pocked with mildew and the once dazzling Crosses in the churches were inlaid with some type of worm that had not been seen before. Sadness, like a thick band of fog, had descended upon the coastline and it moved inward untouched by any wind or plea to God for Salvation. The malfeasance of what Spain had brought upon herself was about to be bourne and the hope of any other conclusion was now but a faint prayer remembered in our winter memories. The Piper has arrived from Hamelin; and Spain, like so many before her, will be forced to pay.

While expectations for today's March Personal Income and Spending were for a rise of 0.3% and 0.4%, which if confirmed would have pushed the 3.7% savings rate to the lowest since 2007. Instead we got a reversion, with Income rising 0.4%, higher than expected, while Spending printed at 0.3%, the lowest since December 2011, just below expectations, and tumbling from February's 0.9% print, the biggest slide since August 2011. In real terms, spending was up 0.1% and income up 0.2%. The data also confirms that at every moment somewhere in the world, people are laughing at Joe LaVorgna, whose forecast of a 0.6% rise in personal spending was just 50% off. Most importantly, the surprising inversion between spending and income, pushed the savings rate from 3.7% to 3.8%, just shy of 4 year lows, and the first increase in 2012, although well below the 4.9% savings rate in March 2011, which means that increasingly the consumer is tapped out. When one takes away the impact of the record warm winter (of which March data was still part of), it becomes quite clear that unless Joe Sixpack is charging everything, then Q2 GDP will be a very big disappointment.

As noted earlier, and in the aftermath of both the UK and Spain officially double dipping, very soon a majority of Europe will be submerged under the latest recessionary tide which has already engulfed Spain, UK, Greece, Italy,  Portugal, Ireland, Belgium, Denmark,  Holland, Czech Republic, and  Slovenia. The primary wildcard remains Germany, although there is a more than 50% chance that following some very weak PMI data, the country will follow up its already negative Q4 GDP print with another decline, officially pushing the European growth dynamo into recession as well (as for France which reps and warrants that everything is great, it is not as if anyone actually believes those numbers, especially after Hollande becomes president in one week). For everyone who wants to track the European double dip tsunami in real time, the following interactive chart from Reuters is just for you.

The following are from a report published last week by the European Union’s Institute for Security Studies (ISS). They’re projections that assume today’s trends will continue in one direction only — which may not be the case.

All major European bourses are trading lower with the exception of the DAX, which holds just above the open by a modest margin. Adidas ranks among the top performers in the German index, following the report of a strong set of sales figures, contributing to the positive trade. Spanish concerns continue to build up as Standard & Poor’s took ratings action on 16 of the country’s banks, downgrading the notable names of Banco Santander and BBVA. Although the move was not a surprise as this is the usual procedure following a sovereign downgrade, both Santander and BBVA, along with the IBEX are in negative territory.  The Bund is seen higher amid a generally risk-off theme to markets this morning. Volumes have been relatively light, however a slight pick-up has been observed in recent trade, grinding the security upwards in the last hour or so.  EUR/USD continues to experience weakness and now trades close to a touted option expiry of 1.3200, as traders seek the safety of the USD across a number of currency crosses.