Macro And Market Thoughts From David Rosenberg
David Rosenberg summarizes his latest views on Europe, the EURUSD, risk, volatility, bond curves, gold, geopolitics, oil, a subsidized shopping season courtesy of no mortgage payments, and two years of home inventories.
MACRO AND MARKET THOUGHTS
All these “rescue” packages in euroland really do is provide bridge financing — they do not resolve the underlying structural problems in these countries or the deflating asset values in bank balance sheets. Greece has already breached its deficit target and a Greek default is likely only a matter of “when”, not “if” at this stage. To suggest that its economy is too small or that its debt obligations are tiny ignores the uncertainty that would prevail as credit default swaps have this nasty way of redistributing those liabilities around the world. This is what the Lehman shock taught everyone. Plus we have to consider that all these funds being earmarked for bailing out sovereigns and shoring up undercapitalized banks.
The massive selloff in government bond markets, even in countries like Belgium and Italy (let alone Portugal and Spain), is a clear sign that the bond vigilantes are now targeting the supposedly stronger governments in the eurozone. These bond vigilantes are also speculating that the national purse will be needed to keep their banks afloat and the relentless widening in CDS spreads is an added suggestion from the markets that these governments may not have the resources to fully repay their creditors once they have moved to support their banking systems.
What is notable that does not get a lot of press is that both the M3 money supply and private sector credit has contracted in the euro area in each of the past two months. The austerity packages needed to bring intractable deficits down will fuel the deflationary pressures, which will only further destabilize the financial system and add damage to the economy. While Germany is viewed as a darling in the region, its trade and banking exposures to the euroland periphery is huge. Judging by the market action, the contagion through to Belgium, Italy (never mind Portugal and Spain) is increasingly apparent. This is very much like how the problems in Thailand ultimately spread to Singapore and South Korea back in the 1998 Asian crisis. The question ultimately will be how the banking systems in the rest of the world will be affected.
Tack on the tensions from North and South Korea and how that will play into U.S.-Chinese relation. Plus the intensifying inflation pressures in emerging markets, which in turn raises the specter of capital controls.
In the U.S, as the lame duck Congress reconvenes, with the influence of Reid and Pelosi still around, gridlock may not be good in terms of getting any of the tax/benefit goodies extended into next year. Gridlock isn’t always good. And the new Congress intends on politicizing the Federal Reserve, which is another source of uncertainty. And all this at a time when the latest batch of U.S. economic data — at least outside of the housing market — has started to improve. Consider the following:
- The VIX index (a measure of volatility), at 22x, looks inexpensive. From late April to late May, it jumped from that level to 45x on the back of the round of Greek-related concerns at the time.
- Larry Fink is dead on — dollar-euro is very likely going to go back and re-test 1.20.
- Recall that the risk-on trade that worked so well in September-October was highly correlated to a weak U.S. dollar. These now go into reverse.
- The long bond, at 4.2%, relative to core inflation and the funds rate looks cheap, in my view.
- The 5-year government of Canada bond is very attractive at today’s level if the Bank of Canada goes on hold.
- Gold has emerged as a reserve currency, which is why it rallies even on days that the U.S. dollar is bid. It continues to hug the uptrend in the 50-day moving average very nicely. Although we remain long-term bullish on gold, we are near-term cautious given the technical picture and the high net speculative long positions.
- The tensions between the Koreas should be a negative for the Asian FX complex and bullish for the U.S. dollar. Weakness in the yen is a positive for Japan’s large-cap exporters.
- Oil should be viewed as a strategy here and should be bought on the dips. Same for base metals and food. Government procurement policies and inventory hoarding are likely to support raw materials.
- A great holiday shopping season is priced into U.S. retailing stocks. Utilities, health care and staples have been laggards but could make up some ground if growth expectations recede.
- With a total of 6.3 million in inventory of U.S. homes, or about two years’ supply, another leg down in housing prices is underway. Apartment space looks much better from an investment standpoint.
What is remarkable is that since the Greek bailout was unveiled back in May, instead of alleviating fiscal concerns in the Eurozone periphery, contagion risks have actually intensified. Even with German 10-year bond yields declining 25bps, they have risen nearly 70bps in Italy, 150bps in Spain, 225bps in Portugal, 420bps in Greece and 460bps in Ireland. Once the stabilization fund ends in 2013, there is no way these countries can fund themselves at current debt-service cost levels.
Ireland may have secured funding, but at a 5.8% interest with nominal GDP declining, the situation is untenable in terms of sustaining any balance sheet improvement. Debt restructuring is inevitable. Looking at current CDS spreads, we are up to around 80% on default risks in Greece, 60% in Ireland, over 50% in Portugal, nearly 40% in Spain (this is big), nearly 30% in Italy and 20% in Belgium. No wonder the VIX is breaking out.
The risk is one of financial contagion to be sure, but there is the added macro risk as U.S. exports to the EU account for over 20% of the total volume of shipments sent abroad — about double the relative importance of the B.R.I.C.s in relation to U.S. producers. Plus, there is the added deflationary thrust from the strengthening U.S. dollar, which will come home to roost in that large share of corporate earnings derived from foreign sources.
From Gluskin Sheff