Europe may be fixed for the next week or two (until someone once again figures out that by manipulating the market, the ECB is merely making it easier for peripheral governments to do nothing to fix their unprecedented intra-Eurozone imbalances, as has been the case all along with the only strategy Europe has deployed to date namely kicking the can), but that doesn't mean all event and newsflow ends. Here is what to expect out of the insolvent continent as it attempts to put a very volatile (and violent) 2012 to bed with just one more month. Of particular note: €123 billion in Euro coupon payments in the month of December, which serves as a timely reminder that in 2013 European banks better be ready to buy up the record gross and net issuance of their sovereigns with gusto, or else Europe may promptly become "unfixed" all over again.
The recent release of the ISM Manufacturing index continues to point to signs of a slowing economy. This (49.5) reading, which is what is reported by the bulk of the mainstream media, is fairly meaningless. Remember, economic change happens at the margins. Since the PMI is more of a "sentiment" index (it is a diffusion index that measures positive versus negative sentiment on various areas from employment to production to inventories) it is a better used as a gauge about what businesses will likely do in the future based on their current assessment of conditions. The importance of the change in sentiment is lost on most economists who have never actually owned a business. However, it is clear that the fiscal cliff, the recent storm, and the continuing Eurozone saga are continuing to erode business sentiment. This erosion in sentiment in turn affects economically sensitive actions such as production, employment and investment.
And so the US debt ceiling of $16.394 trillion is now just $64 billion away.
Today's "trading", in a repeat of what has become a daily routine, can be summarized as follows: flashing red headline about Fiscal Cliff hope/optimism/constructiveness out of a member of Congress who bought SPY calls in advance of statement: market soars; flashing red headlines about the inverse of Fiscal Cliff hope/optimism/constructiveness out a member of Congress who bought SPY puts in advance of statement: market plunges. Everything else is noise, as is said hope/expectations/constructiveness too since it is increasingly likely nothing will happen until the debt ceiling hike deadline in March, but stop hunts must take place in a market which nobody even pretends is driven by fundamental newsflow. Such as the bevy of PMIs released last night, the key of which was the China HSBC PMI as reported previously, which beat expectations by the smallest of possible increments, at 50.5, but rising to expansion territory and the highest in 13 months, which sent the EURUSD spiking and has kept it in the 1.3030 range for the duration of the overnight session. Sadly, those on the ground in China hardly felt the number was a bullish as EURUSD trading algos around the world, sending the Shanghai Composite to a fresh post-2008 low, closing down over 1% at 1,960. But let's just ignore this inconvenient datapoint shall we?
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.
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...
November is now over, and hedge funds can count their lucky stars for the baseless November 16th rally, predicated by the now defunct notion that the GOP and Democrats are close to a Fiscal Cliff compromise (it increasingly looks that the real catalyst on the "cliff" will be the absolute debt ceiling hike deadline in March of 2013, meaning the US will go over the cliff, if only for three months). Had the unprecedented levitation in the middle of the month, the bloodbath would have been epic. As such, with a 13K close in the DJIA, and 1.3000 in the EURUSD, the Nov. 30 P&L it was far more palatable and the surge in redemption calls (and the resulting end of unjustified "2 and 20" fees) has been postponed by one more month. So who are the most prominent winners and losers: leading the table are the fund with European exposure, where the recent bipolar mania has Europe as being better, if only until it fully breaks again. The biggest losers? Macro funds, who still don't realize that the in the New Normal, macro "up is down."
There was some confusion as to why yesterday various Eurozone consumer confidence indices posted a surprising jump and beat expectations virtually across the board: turns out Europeans had an advance warning of today's horrendous economic data among which we learned that Eurozone October unemployment just hit a record 11.7%, up 0.1% from September (we are trying to get data if the Eurozone is gaming its unemployment number the way the US does by collapsing its labor participation rate), with Italy unemployment surging to 11.1% from 10.8%, on expectations of a 10.9% print, French consumer spending in October was down 0.2%, compared to an unchanged reading in September, but far more troubling was that German retail sales imploded at a rate of 2.8%, the biggest monthly collapse in 4 years, and worse than even the most bearish forecast. Do we hear "Sandy's fault."
The good news this morning is that the 2nd estimate of the third quarter (3Q) GDP was revised up from 2.0% initially to 2.7%. This is up sharply from the 2Q print of 1.3%. However, the combination of rising levels of unsold goods (inventory), slowing sales growth and declining incomes all point to weaker GDP growth in Q4 and into the early quarters of 2013. Look for GDP growth in the 4Q to decelerate to 1.5% to 1.7%. While there is currently not an official recession in the U.S. economy, as of yet, the details of the current economic growth are not ones of robust strength. If we are correct in my assumptions the economic underpinnings will continue to negatively impact fundamental valuations as profit margins continue to be compressed. While most of the media, and mainstream analysts, continue to focus on the state of the economy from one quarter to the next - the trend of the data clearly shows the need for concern. Of course, this also why Bernanke is already considering QE4. As we stated previously, while economic growth did pick up this quarter it is the makeup, and more importantly the sustainability, of that growth is what we need to continue to focus on.
Markets sold off earlier today when Boehner commented that "no substantive progress had been made" in the last two weeks, only to recover quite rapidly. The 'rejection' is now in full context as the WSJ has just reported the terms have not changed (or compromised) at all since we first discussed them two weeks ago. A $1.6tn tax increase (upfront), $50 billion economic stimulus, and most importantly (we suspect guided by the miscreant hand of Geithner) the removal of the need for congressional approval to raise the debt ceiling. Overnight futures are down 5-6 points pushing towards Boehner's intraday lows. This should throw a little light on exactly where the negotiations stand (nowhere) and how willing each party is to change and bring hope to the table for compromise (not at all). With DC this far apart still, the game for the next few weeks is not to solve the fiscal cliff but to avoid getting the blame for the cliff-dive.
Regardless if the Fiscal Cliff is resolved tomorrow (impossible), on December 31 (unlikely), or in tandem with the debt ceiling hike some time in March 2013, after all the government fund buffers have been soaked dry as they were back in August 2011 (most likely), one thing is certain: America's wealthiest are about to see their taxes soar - that's more or less a given. The question is what happens then. Will, the wealthiest - those who have access to and can buy banking, incorporation, citizenship and legal services in any global jurisdiction in a world that has never been this decentralized and this , take it all quietly up until that point on the Laffer curve says they will commit mass suicide, or maybe, just maybe, because they don't feel like being force to pay uncle Sam even more than they currently do with the proceeds not used for something constructive like paying down debt, but instead to fund government corruption and inefficiency, they will pick up and leave without saying goodbye or even looking back, and in the process crush future US government tax revenues even more and send the deficit soaring more. "No risk in that", many will say - after all where can they go? Well, apparently many places. Because if the UK, where as the Telegraph reports a stunning two-thirds of domestic millionaires opted to leave the country than pay a "punitive" 50% tax, is any indication it is possible that the imminent tax hike on America's wealthiest is going to be one of the most destructive things that can happen to America's already unsustainable budget deficit.
The schizophrenia in US equity markets (and by correlation all risk markets) is nowhere better highlighted than the last 24 hours of 2% swings in the S&P 500 on nothing more than boiler-plate comments from DC. However, as BofAML's Ethan Harris notes, "the year-end fiscal challenges in the US are more like an 'obstacle course' than a 'cliff' - politicians must navigate about 10 major policy decisions before year-end." We continue to expect a messy multistage deal on the cliff - with some wishy-washy partial deal late December and more complete resolution (as it will be called) late Spring. We agree with BoFAML's view that until then, we suggest that investors fade the likely “press fakes” of an imminent deal, and brace for downside volatility. It seems to us that the negotiations remains stuck at square one.
Harry Reid’s publicly displayed dismay at the lack of progress in the fiscal cliff negotiations finally injected a dose of realism into the process after investors threw caution to the wind and seized on the optimism offered by the Senate Majority Leader and Speaker Boehner on November 16. We view yesterday’s sound bite as more negative than the aforementioned statement on the White House Lawn, for we now sit 11 days closer to the New Year’s deadline. Despite this asymmetry, equities suffered only moderate losses giving up just a modicum of the gains from last week. The relative lack of a response to the comments seem puzzling given the price action from the prior several days; however with month end looming, enough buyers kept stocks from selling off violently. My November 13 “Missive” outlined a game theory exercise that suggests this rancor will continue until very late into December and/or the capital markets dislocate thereby ensuring either a falling over the cliff or a band aid solution to avoid the crisis temporarily. Both parties unfortunately may assume that by agreeing to postpone the tough decisions, they will have prevented a rout in equities; however, the August, 2011 precedent of raising the debt ceiling out of desperation hints otherwise.
It seems like it was only 24 hours ago that Europe bailed out Greece for the third time and everything was "fixed", with a resultant desperate attempt to validate this by pushing the EURUSD above 1.3000. Sadly, as always happens, Europe, and especially Greece, refuses to be fixed, because as we will not tire of saying: you can't fix debt with i) more debt, ii) hockeystick projections or iii) soothing words of platitude and an outright bankruptcy, just like that which Argentina is about to undergo, will be needed. If that means the end of the EUR and the delusion that the Eurozone is a viable monument to the egos of a few technocratic career politicians, so be it. As a result, this time around the halflife of the latest bailout was precisely zero, as was that of the latest Japanese QE episode, as the entire world is now habituated to the lies emanating from Europe, and demands details, which in turn are sorely lacking, especially as relates to the question of just where will Greece get the money desperately needed to fund the Greek bond buyback. But at least Kathimerini was kind enough to advise readers that said buyback must take place by December 7 in time for the euroarea finmins to approve the payment of the next Greek loan tranche at the December 13 meeting, something which will likely not happen, especially if Germany's SPD party delays the vote on the Greek bailout until the end of December as was reported yesterday. We can't wait to learn the details of the buyback package, which will come in the "next few days" per ANA, and especially where the buyback money will come from, especially with the FT reporting that various European countries will already lose money next year on the latest Greek bailout.
By now there is likely not a single individual who is not aware of the impending "fiscal cliff" and the economic impact that it represents. Obama, and the Democratic controlled Senate, have already lined up on raising taxes on the "rich" while the Republican controlled House has firmly asserted that they are amenable to closing tax loopholes in conjunction with spending cuts. The two sides could not currently be farther apart from reaching a deal - yet, as Yoda would say: "Reach a deal we must." The Democrats have given no indication that they will compromise on any front and that tax hikes are all that is available for discussion. Likewise, the stance by the Republicans is just as firm as they stand behind their pledge of no tax increases. However, in the end, it will be the Republican led house that will again define "insanity" by repeating the same mistakes of their past - 'Caving'. In the next few days as the "fiscal cliff" draws nearer that media pressure from the White House will intensify to a fevered pitch with threats of economic recession due to Republican's unwillingness to compromise. This is the same tactic that was used during the debt ceiling debate in 2011 and until the politicians realize that slower economic growth is the "short term pain" required to establish the stable economic foundation from which "long term gains" may be achieved, the Republicans (in this case) will repeat the same 'caving' errors and expect a different outcome.