Citi's Robert Buckland explains: If policymakers really do want to encourage stronger economic growth (and especially higher employment) then we would suggest that they take a closer look at the equity market's part in driving corporate behaviour. Despite high profitability, strong balance sheets and ultra-low interest rates, any stock market observer can see daily evidence of why the listed sector is unlikely to kick-start a meaningful acceleration in the global economy. A recent Reuters headline says it all: "P&G Plans to Cut More Jobs, Repurchasing More Shares". If anything, low interest rates are increasingly part of the problem rather than the solution. Perversely, they may be turning the world's largest companies into capital distributors rather than investors.
Senator Reid’s frustration that progress had stalled as he blamed the Republicans for not bargaining fairly in trying to iron out a compromise signaled to Speaker Boehner that the Democrats will play hardball as well. However, yesterday’s Wall Street Journal article, via quotes from Erskine Bowles, claimed the White House will be flexible when proposing a raise to the top marginal tax rate. This perceived increase in the probability of a near term accord appropriately rallied stocks aggressively. We question why Mr. Obama would leak his best alternative to a negotiated agreement (BATNA) so early in the process, for classic bargaining strategy suggests keeping that information close to the vest as long as possible. Complicating matters, Mr. Obama declared a preference to strike a deal by Christmas which approximates the Friday, December 21 “zero barrier”. Ironically, if the Republicans acquiesce to yesterday’s posturing by Mr. Bowles, then the likelihood of a Moody’s and/or Fitch downgrade rises, for the ratings agencies would almost assuredly be disappointed by a lower than anticipated level of incremental revenues.
The S&P 500 achieved its anticipated 4-5% bounce off the recent 7-10% pullback, most of it accomplished in a very light holiday trading week. Much of the gains were attributed to overly effusive optimism over the prospects of resolving the fiscal cliff. Ironically, with Washington abandoned the past ten days for Thanksgiving, we have not heard anything substantive on the negotiations since Senator Reid and Speaker Boehner spoke jointly on the White House Lawn on November 16. The returns in equities that resulted from this perceived positive outlook has likely run its course as the blue chip index has regained the levels from the morning after the Election. Certainly, the mundane increases in open interest for the futures and the outperformance by the blue chips versus smaller capitalization names on a beta adjusted basis hint at such vacuous motivation for the upward move.
Several weeks ago, when sharing his latest outlook at the Economist's Buttonwood gathering, Hugh Hendry had this to say about gold miners: "I am long gold and I am short gold mining equities. There is no rationale for owning gold mining equities. It is as close as you get to insanity. The risk premium goes up when the gold price goes up. Societies are more envious of your gold at $3000 than at $300. And there is no valuation argument that protects you against the risk of confiscation.” For those confused, what he means is quite simple: the higher the price of gold goes, the greater the temptation of those extracting it (usually mined in various locales where worker satisfaction with labor conditions is less than stellar - see recent events in South Africa) to strike and demand higher wages (i.e., lower EPS), or of host government to nationalize it. The end outcome is a collapse in the extracting miner's cash flows and profitability, if not outright liquidation. The paradox is that the fewer actual global miners in operation, the better for the price of the actual hard commodity, as less supply means lower price, means greater probability of more miners suffering the same fate, means even higher gold price and so on. But back to the topic of gold miners. Below, for those still confused, is a simple story courtesy of the BBC in 10 pictures, summarizing the bitter dispute over Kyrgyzstan's gold production.
I was a super bull of long-term bonds. I stated my case over 3 years ago with a yield target on 30-year maturities of 2.5%. Back then, the timing and structure looked right for another run to new highs. Discussions about hyperinflation were premature.
One of the most commonly cited 'bullish' memes for stocks is the so-called Fed Model (or Equity Risk Premium) or more simply - the fact that earnings yields are not catching up to Treasury yields (i.e. why put your money in government bonds at such low rates when there is a smorgasbord of yummy equities with 'attractive' dividend yields). There are three key problems with this perspective: 1) No concept of 'risk' is imbibed in this return-based differential (as we have discussed before here and here); 2) Longer-term historical context is critical (as we discussed here - must read); and most importantly 3) Financial Repression breaks the 'Fed Model'. As Barclays shows in the following three charts (and we pointed out recently) normalization of the equity risk premium will not occur until Financial Repression ends. Brings a whole new meaning to 'Don't Fight The Fed' eh?
We expect a return to a skittish environment in markets. We are confident in my prediction for the course of the economy by leveraging simple game theory in handling the upcoming crisis as Congress returns for its lame duck session. “Compromise” reflects a decision from either side that each find unpalatable. Both President Obama and Speaker Boehner would rather shove two sticks in their eyes than move from their hardened stance despite some of the recent rhetoric in favor of bargaining in good faith. As long as the loss of utility from both sides’ digging in their heels is more favorable than conceding to the preferences from those across the aisle, then the game arrives at a Prisoner’s Dilemma. the above matrix concludes that the fiscal cliff virtually guarantees an aggressive selloff for equities until the stop loss for the Democrats and Republicans has been triggered. For example, if the clock hits midnight on New Year’s Eve with the blue chip index at or near its September peak, each faction would feel comfortable standing up to the other well into January.
On October 21st, 2012, Ambrose Evans-Pritchard wrote a note titled “IMF’s epic plan to conjure away debt and dethrone bankers”, on UK’s The Telegraph. The article presented the International Monetary Fund’s working paper 12/202, also titled “The Chicago Plan revisited“. I will begin the discussion on this working paper with two disclosures: a) my personal portfolio would profit immensely if the Chicago Plan, as presented by the IMF’s working paper 12/202, was effectively carried out in the US. The reason I write today, however, is that to me, it is more important to ensure that my children live and grow in a free and prosperous world, and b) I have not read the so called Chicago Plan, as originally proposed by H. Simmons and supported by I. Fisher. My comments are on what the IMF working paper tells us that the Chicago Plan proposed, without making any claim on the original plan.
The Fed sees the need to reduce interest rates as it takes over the US Treasury and MBS markets; but the ECB's actions are more aimed at reducing divergences between peripheral nations and the core. As SocGen notes, it remains unclear how and when the Fed would exit this situation and in Europe, bond market volatility remains notably elevated relative to the US and Japan as policy action absent a political, fiscal, and banking union remains considerably less potent.
Hugh Hendry: "I Have No Idea Where The Stock Market Is Going To Be"... But "I Am Long Gold And Short The S&P"Submitted by Tyler Durden on 10/25/2012 14:51 -0400
Hugh Hendry: "I have resigned from the professional undertaking of coin flipping. I am not here to tell you where gold’s going to be. I have no idea. That’s my existentialism. I am a student of uncertainty, I have no idea where the stock market is going to be. So when I am creating trades in my portfolio for my clients, I am agnostic. I just want to enhance the probability that I make money come what may."
Greg Smith's 15 minutes of fame has come and gone, but the muppet crushing at Goldman is only starting to ramp up, courtesy of the man who singlehandedly has made sure Goldman's FX prop trading team should be the most profitable one in the entire universe by simply doing the opposite of what Goldman's clients do. As a reminder, sent out at 5 pm yesterday, as we alerted our Twitter followers: "Go long EUR/CAD on further risk premium compression in the EUR and a more dovish BoC... We recommend going long EUR/CAD at a current level of 1.296 with an initial target of 1.37 and a stop on a London close below 1.26." Big Oops (see chart). Then again, after Stolper epic failure to Impala the muppets on his last EURUSD trade reco, it is great to see him back to 0.000 batting form.
IBM weighed on the Dow - much to the chagrin of the mainstream media - but if they'd replaced IBM with AAPL things would have been just as ugly (if not worse). The tech-darling dumped after trying to ramp in the last hour and once again failing at VWAP on heavy volume as the big boys exited. S&P futures auctioned up to QEtc. spike levels and were unable to get through but still had a solid day. Interestingly, while today was an 'uncorrelated' day across risk assets, the rise in Treasury yields, rise in stocks, drop in Gold, and drop in USD has brought them all back together in sync post-QEtc. - from here who knows? Credit markets tracked equities generally - but HYG and LQD saw major volume spikes early on this morning (looked like HYG sells and LQD buys). VIX limped sideways most of the day - falling 0.14vols to 15.08% (though for the year remains on average at a high premium to realized). The USD is down 0.85% for the week with EUR back above 1.31 and only JPY weaker vs USD among the majors.
Economists, market analysts, journalists and investors alike are all talking about it quite openly, generally in a calm and reserved tone that suggests that - to borrow a phrase from Bill Gross – it represents the 'new normal'. Something that simply needs to be acknowledged and analyzed in the same way we e.g. analyze the supply/demand balance of the copper market. It is the new buzzword du jour: 'Financial Repression'. The term certainly sounds ominous, but it is always mentioned in an off-hand manner that seems to say: 'yes, it is bad, but what can you do? We've got to live with it.' But what does it actually mean? The simplest, most encompassing explanation is this: it describes various insidious and underhanded methods by which the State intends to rob its citizens of their wealth and income over the coming years (and perhaps even decades) above and beyond the already onerous burden of taxation and regulatory costs that is crushing them at present. One cannot possibly "print one's way to prosperity". The exact opposite is in fact true: the policy diminishes the economy's ability to generate true wealth. If anything, “we” are printing ourselves into the poorhouse.
The biggest headlines (and refutations) have been saved for the struggling nations of Europe's periphery. Top-down, this makes sense as PPP-weighted PMIs show Europe notably decoupling (badly) from the rest of the world - with periphery and eurozone-ex-periphery having resynced at these lower levels. This convergence (down) of the core with the periphery is not good news but what is more concerning is that while many investors have assumed the 'pricing' of risk assets in the periphery relative to the core is due mostly to 'contagion', there is in fact a massive fundamental divide between the core and periphery's corporate debt credit quality. With ECB's OMT apparently removing much of the systemic risk premium (though we are clear on our views of this short-term LTRO-esque reaction), the idiosyncratic risk differential between Core and Periphery credit quality is large and getting larger. It seems the need for simultaneous private and public deleveraging in the periphery - especially in Spain - is as critical as ever.
Goldman's equity strategist David Kostin has been very quiet for the past year, having not budged on his 2012 year end S&P target of 1250 since late 2011. Today, he finally released a revised forecast, one that curious still leaves the year end forecast unchanged at a level over 200 points lower in the S&P cash, and thus assuming a ~15% decline. The reason: the same fiscal cliff (which would otherwise deduct 5% in GDP growth) and debt ceiling debate we have warned will get the same market treatment as it did in August of 2011 when the only catalyst was a 15% S&P plunge and a downgrade of the US credit rating. However, one the fiscal situation is fixed, Kostin sees only upside, with a 6 month target of 1450 ("We raise our medium-term fair value estimates for the S&P 500 in response to openended quantitative easing (QE) announced by the Fed."), and a year end S&P target of 1575, calculated by applying a 13.9 multiple to the firm's EPS forecast of 114. Of course, this being bizarro Goldman Sachs it means expect a continued surge into year end, then prolonged fizzle into the new year. Why? Because there is not a snowball's chance in hell the consolidated S&P earnings can grow at this rate, especially not if the Fiscal Cliff compromise is one that does take away more than 1% of GDP thus offsetting all the "benefit" from QE. Simply said, companies who have already eliminated all the fat, and most of the muscle, and are desperate for revenue growth to generate incremental EPS increase, have not invested in CapEx at nearly the rate needed to maintain revenue growth, having dumped all the cash instead in such short-sighted initiatives as dividends and buybacks. Also, recalling that revenues are now outright declining on a year over year basis, and one can see why anyone assuming a 14% increase in earnings in one year, is merely doing all they can to make the work of their flow desk easier.