BRICs

A little under a year ago, with much pomp and circumstance, Goldman’s economic team proclaimed its multi-year long bearish outlook on the economy over, and on December 1 of 2010, issued a report in which it noted that it was turning a new leaf in its “bleak” perception of the economy, based in big part on its expectation that the combination of an ebullient monetary environment (QE2 has just been launched) and a cornucopic (sic) fiscal stimulus (the first, of many, payroll tax cuts had just been passed) would lead the economy to a sustained growth of not less than 4% (and led Zero Hedge to officially proclaim Goldman as having jumped the shark in conjunction with our prediction that a year hence the US economy would be contracting yet again). Zero Hedge was right, and Goldman was 100% wrong. Today, we however witness something different: in what seem to be a major paradigm shift within the firm’s strategic research team (not Jan Hatzius’ group but that of Dominic Wilson), the firm appears to officially give up on “recovery” as a modal outcome for both the US and the developed world, and instead aims a little lower. Far lower. The report is titled “From the 'Great Recession' to the 'Great Stagnation'” and in an extended analysis looking at 150 years of historical data, it concludes that “those historical lessons suggest that the probability of stagnation in the current environment is much higher than usual, at about 40% for developed markets. Trends in Europe and the US are so far still following growth paths that would be typical of stagnations.” Looks like Goldman just proved us at least half right when we said in January that the keyword of 2011 would be “stagflation.” Luckily, the Fed and the world’s central banks still have 3 months in which to prove the second half of our prediction correct as well.

And 9:55 am update in which Mantega responds to Valor (and ZH):

• MANTEGA SAYS BRAZIL ISN'T PREPARING ANY MEASURE

So far the only strategic use of "unnamed government officials" has been to leak rumors, whose sole purpose is to test the market's short covering squeeze potential and to discover just how long the half-life of one after another ever more incredulous rumor is. And since the only thing to come out of Europe in the past month in terms of problem resolution (no really: there has not been one policy that has been enacted since the July 21 Greek bailout), this is a useful strategy. Alas, as Europe is about to find out, this works both ways, because as Brazilian financial site Valor Economic reports, none other than perpetual optimist Brazil, the same country that is supposedly according to one set of rumors preparing to bail out all of Europe, with or without the rest of the BRICs, is now preparing for a Greek default within the week. From Valor: "Something must happen. Greece is a few days [from bankruptcy]" said a high official source.

As alleged details are leaked about an alleged proposal to leverage the EFSF all I can do is cringe. I'm waiting for some actual details, but as far as I can tell, Europe is attempting go all in. It is going to make leveraged bets on itself. If it doesn't work, the senior debt holders will own Europe if the BRICs buy the senior tranche and will end in a fast and furious death spiral if the senior tranche is owned by the ECB or European banks. We may get a lift on the news. We are trying to rally on the back of the news right now. But if this plan goes ahead, even the slightest cold in the future will turn into the plague. There will be no strong countries left as they will have tied themselves to the PIIGS anchor with a Gordion Knot that will never be untied in time.

Despite all the negative news, markets are hanging tough.  Why? I believe financial markets continue to have a "Moral Hazard" premium priced-in.  The idea that governments will step in to save the day remains entrenched in the minds' of investors.  There are signs, however, that this premium may soon be re-priced.  Indeed, this week's rally has left much to be desired.  Copper, nor the credit markets, have confirmed the move higher in equity markets.  Breadth has lagged as well.  These are signs that this latest rally isn't healthy.  Should government authorities fail to come through and Eurozone contagion takes hold, financial markets would begin to compress this premium.  A strong break of 1120 would signal that a re-pricing is ongoing.   Overall, the global economy is at a crossroads.  Until the Eurozone issues are structurally taken care of, I remain very cautious.  Capital preservation remains the name of the game.

• Moody's downgraded long-term debt and deposit ratings for Societe Generale and Credit Agricole by one notch each, whereas extended its review for a downgrade on BNP Paribas ratings. However a French government spokeswoman said that French banks' ratings are still very good despite Moody’s downgrade
• EU's Barroso said that the European Commission will soon present options for the introduction of Eurobonds
• An unexpected decline in the jobless claims data from the UK provided support to GBP

While 30 minutes ago Brazil's Central Bank policy head Mendes spoke in Brasilia saying that the "Euro is less important in Brazil international reserves", and "Brazil seeks reserve currencies with solid fiscal positions", we are now supposed to believe a rumor cited by Reuters that BRICs are setting up for coordinated buying of European peripheral sovereign debt? It appears Rumor Fatigue has taken hold as the market rallied 6pts and then sold it all back within the same minute.

Add this from Reuters to today's rumor trifecta to make the day RDA allowance of crazy pills complete:

• BRICS COUNTRIES IN "VERY PRELIMINARY" TALKS TO COORDINATE PURCHASES OF EURO ZONE SOVEREIGN DEBT - BRAZIL GOV'T SOURCE

And so in one day we have heard rumors of China, Russia and Brazil (in this case"citing a monetary official"... sure beats "unidentified Italian government sources" ahem FT) all bail out Europe, none of which will inevitably happen mind you because these countries aren't governed by idiots, although "idiots" is precisely who trades this market. See the attached chart for the kneejerk reaction to this latest headline.

Like a Swiss watch, Goldman's Jim O'Neill, who refuses to acknowledge that decoupling between the US and the BRICs not only never existed, but was always a flawed premise to begin with, has released his latest dose of Kool-Aid, in which he bets the horse track on, you guessed it, Chinese decoupling.... Sigh. Then again what can one expect: just like Bernanke will keep trying QE until QE succeeds (it won't) or the market breaks; and just like the Krugmanites will keep pushing for an ever bigger fiscal stimulus (because the last one is never big enough, regardless of how big it is), why should one expect the latest addition to Goldman's biggest loss leader (GSAM) be any different. And what makes this particular episode not only tragic but very much comic, is that the former "Red Knight" now sees the Chinese launch of a fully convertible and floating Yuan by 2015 as the panacea to the US stock market, and Goldman bonus doldrums (because when one cuts to the chase, that's really what it's all about). Little does it bother the BRICer that the advent of a new reserve currency would have a devastating impact not only on existing risk markets, but on so-called risk free ones as well. Remember that 0.000% yield on last week's 4 week bond auction? Yeah... that would not come back. Ever. Anyway, with the upcoming week sure to provide significant tears, especially to European readers, here is at least some comic relief (yes, O'Neill does in fact "applauds" the move by the pegging move by the SNB - apparently loading up the asset side of your balance sheet with toxic paper which may or may not exist post the Greek expulsion is considered prudent when one is a Goldman partner) to start it off with.

While the bulk of his weekly parable is primarily about the Swiss Franc (certainly worth the read coming from an old FX trader), the subtext is far more nuanced, and as usual, presents what "next steps" will be in terms of policy response from the G-20 to prevent the end of the Status Quo^TM. For all those who ridiculed us about consistently presenting what Goldman believes is in the economy's "best interest", we have only one thing to say: QE3 is coming. Just as Hatzius demanded it several months ago (as predicted by us back in January). Indeed, the instruction flow never errs: from Goldman to the Fed; from the Fed to the SecTres and teleprompter; from theteleprompter  and out of taxpayers' pockets. So speaking of flow charts, here is what the world should expect, tongue in cheek, in terms of G-20 intervention over the next several months, to prevent a swift plunge into the mother of all depressions.  1.    Clear, credible, targeted action from President Obama and Congress to create US jobs and stimulate domestic investment; 2.    If not more QE from the Fed, an ongoing clarity about their bias; 3.    A quick resurrection of a credible budget in Italy; 4.    A move towards an interest rate cut from the ECB. There is no inflation problem and the Euro Area economy has weakened a lot; 5.    Some indication by German Chancellor Merkel that as part of a more fiscally coherent EMU, Germany would accept the principle of Euro Bonds; 6.    A clear signal from Beijing that once inflation has peaked, monetary tightening is finished. In other words: not just more of the same, but much, much more of the same. In yet more other words: insanity defined.

In a shocking move, one which is sure to reverberate around the Developing and certainly Developed World, the Brazilian Central Bank just announced that it was cutting its Selic (overnight lending) rate from 12.5% to 12.0%, citing "substantial economic deterioration" - something that not one of the 62 analysts covering Brazil had anticipated. It seems that following over a year of small arms fire FX intervention sniping, Brazil has finally reevaluated its growth prospects, and instead of dealing with the inflow of capital on a piecemeal basis by buying dollars daily - a move which has not worked at all, has decided to cut off flows at the stem. This is most likely the first of many rate cuts by Brazil which is obviously anticipating a major growth contraction in China, and as a result we expect the the other BRICs will very soon reevaluate their stance vis-a-vis being the remaining target of global capital flows. Ironically, up until now it was mostly the developed (read bankrupt) world that was devaluing its currencies... Well, make way for the new kids on the block because this is about to get interesting.

Remember when Jim O'Neill was openly taunting the "bears"? Yeah, those days are long gone. In his latest weekend letter the BRICster proceeds to do what so many have already been doing for weeks and months, namely compare the current precarious global economic situation to 2008: "Another ugly week passes, and it is still only August 20th. What a particularly brutal August this is turning out to be so far, even when compared to many challenging ones in recent and distant years. Although there are many substantive reasons why things are very different, many cannot resist the temptation to make comparisons with 2008. So, I thought I would discuss the comparison this weekend." And like a true Keynesian, O'Neill proceeds to do not just that but to provide his solution to all the world's problems: more G7 intervention. Because they keep getting it so right time after time after time...

The week is finally over, and the numbers are in: after narrowly avoiding the "bear market" two weeks ago when we dipped by 19.63%, or about two ticks away from the dreaded 20% correction, the subsequent dead cat bounce fabricated in no small part courtesy of Europe's unprecedented intervention in all markets, both bond and stock, has ended, and we are back to being under 2% away from reentering a Bear Market (and closing at the Lows of the Day). That however will not be the end of the world: as the chart below shows America will actually be the last major market to enter join the Bear party, so little shame there. As the second chart from Rosenberg today shows all the developed countries plus all the BRICs are already there. We expect an ongoing selloff into the last week of August (no need to remind what happens then), at which point the market may get a surprise or two. In the meantime, we depart with Rosie's words: "the US economy is slipping into recession, Europe is as well, and HP served up a reminder that this earnings season has not been the slam-dunk positive reporting period posted in the prior eight quarters. But disciplined investors who took our advice should not be feeling much pain at all." Who laughs last again?

As always, just as the market is about to set off on yet another dead cat bounce courtesy of vapor volume and the lack of concerted selling (after all the Fed is front and center today which means nothing can possibly go wrong... at least until someone actually does some Mark to Market accounting on the left side of Bank of America's balance sheet), here comes David Rosenberg with a cup of very cold water, thrown right in the face of the misguided optimists who carry the deluded idea that this story could possibly have a Hollywood ending...

Gold, silver and the dollar are not the focal point of this email (amazingly). The focal point of this email is what I believe to be the only other major bubble currently in place besides the dollar and that is this absurd view that the “high end” is some sort of great secular investment theme that will carry on forever due to rising incomes in the emerging markets and the bifurcation between haves and have-nots in the West. Like any other bubble, it begins with a real macro trend; a real and powerful story. Then at some point the thing gets stretched beyond its ability to continue and then finally you get to a point where investors confidently extrapolate the trend forever into the future just at the time the trend itself becomes unsustainable. With regard to “high end” I believe we are there now and I think this entire theme will implode on itself in the not too distant future and there are two main reasons why I think this.

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