Just because it is always amusing to watch the cognitive dissonance in the head of a permabull, here is Jim 'Soon to be head of the BOE... allegedly' O'Neill's latest missive to (what?) GSAM clients. Yes, the same O'Neill who week after week, letter after letter kept on saying that 2012 is nothing like 2011, finally being forced to admit that 2012 is, as we have been saying since January 1, nothing but 2011, as the central planners' script writers prove painfully worthless at coming up with anything original. That, of course, and that the lifelong ManU fan had to suffer the indignity of interCity rivals picking up the trophy this year after a miraculous come back win against QPR. Oh, the horror...
Is it One of Those May’s Again?
Not another one, surely? It is almost too simple to be true. I have been saying to people all year that we would have a great rally into May. Then, it might be quite a challenge for the Summer and, like clockwork, we could come back in the Autumn to take the markets to fresh highs. I had expected that the S&P would get to the 1470-1480 area before the correction would set in. In this sense, it has happened quicker, because of the fact that “May” started in April, just as it did last year? While I have read a few articles recently trying to dismiss the “May” factor, the evidence is annoyingly persuasive that if the May to October months could just be 6 month holiday periods, and we picked up our investments as though nothing had
changed, the long term annualized return would be notably higher. Of course, it is difficult to find a coherent reason why this occurs so often. And, as some doubters correctly point out, it often doesn’t occur.
Anyhow, as can be seen in the attached chart, the momentum in the S&P has clearly turned lower, but interestingly, we sit just above trend line support (and well above the 200-day moving average). So, this is probably just a correction.
For some of us spoilt Manchester United fans, for the best part of the past 20 years at least, we have been able to take solace with the May issue, because around about this time, we are usually picking up the Premier League Trophy, and often there is a European Champions League Final to be thrown in as well as an FA Cup Final. Alas, this year, the cupboard might be empty and, of course, City could be picking up the League for the first time in 44 years.
Europe. Could it get any Messier?
I went to visit a rather weird play with my wife early last week, and I found myself thinking at one point “This is nearly as screwed up as the Euro Area.” I did warn last weekend that the French, and especially the Greek election, might have some impact this past week. It is quite ironic, as a couple of people pointed out to me given that I am always dismissing Greece’s economic relevance, that I suggested it might be more important in the short term than the French election. I shall discuss the French election issue more below, but given we all knew this was coming for months, and that Hollande won with the majority reasonably similar to the polls, I am not sure what was really new last week on this score (except for the German reaction).
Greek voters appear to now face another election in a few weeks with some simple choices. Do you want to remain in the EMU and stick with the commitments and support that your international allies have generously given you? Or, do you want to recreate the Drachma and run the risk of a massive banking collapse and lots of other unpredictable consequences? Polls appear to suggest the far left is likely to do well, so these questions are pretty real ones. As for the Euro, as I argued last week, it is not entirely clear to me that, once the dust settles, Greece leaving would be material either way. But we shall see.
French Election and Germany.
As I said above, there was not really a lot of new information about Hollande’s plans last week. Therefore, in some ways, it was all discounted. Quite a few contacts of mine suggested that, despite the rhetoric, France under Hollande will not do anything dramatic against the spirit of the Fiscal Compact, although they will push the issue of a supplementary plan for a Growth Pact. And as I reminded many of my colleagues, they are probably more fundamentally “pro Euro” than Sarkozy, which many people seem to have forgotten. Importantly, in this regard, this Administration is another one now in power in Europe that supports a true
Euro bond at the core of a more integrated Europe.
As I found myself thinking as the week wore on, this means that the German elections in the Autumn of 2013 are going to be really important. Anyone who wants to be in a coalition with either the SPD or Greens (or both) is going to have to support the idea also. I suspect Chancellor Merkel will be more than happy to support it. A number of meetings that I coincidentally had this week added to my confidence on this score.
Against this “big picture” background, the most interesting aspect of the French election is how German policymakers responded. Suddenly there is a fresh tone of what I would regard as welcome realism and open mindedness. First of all, Finance Minister Schauble talked about the need for higher German wages, which would help rebalancing within the EM. And a few days later, some Bundesbank officials acknowledged that Germany would probably have to accept inflation above 2 pct for some time. As one of the people I was referring to above put it to me, it would be through “gritted teeth,” but the reality is that they really have no alternative if the EMU is to persist following the shifting ground demanded by European voters. All of this should be good, and it will probably mean that the ECB will be less hawkish as a result.
To top off this rather encouraging week from Germany, their latest data took a turn for the better with orders and IP positively surprising, keeping the great debate alive about which of their leading indicators, the PMI or (stronger recently) the IFO is more accurate. 1-0 for the IFO last week I’d say.
Unfortunately, much of this new “MerHollande” mood was not only overshadowed by Greece, but also the mess that is known currently as Spain. I feel for their policymakers as you can see their dilemma. Their basic problem is similar to that of Ireland, a burst housing bubble. But given what happened when Ireland committed to support all its banks, Spain is obviously reluctant to do so. The problem is that without some other solution, such as early financial support from the EFSF or the IMF, how can markets be optimistic all the problems have been priced in? Hopes were raised early on in the week that a “big bang” solution would come Friday, but it didn’t seem that way. At least the issues are all now out on the table, and there is much less denial.
I read an interesting piece in the FT about a joint RBS/EEF survey about UK exports to so-called emerging markets in the next decade. Chancellor Osborne has a goal of doubling exports by 2020 according to the piece, and the survey analysts claim the responses suggest this goal will be “extremely challenging” to meet. Survey participants expect exports to China to rise by 46 pct in the next 5 years, India 39 pct, and Russia by just under 25 pct, according to the FT piece. I think the Chancellor’s goal is the right one, and it is probably the most critical thing for the UK this decade. I suspect it is more likely to be achieved than this survey suggests, but as they do point out, the 4 BRIC countries at 8 pct of the UK total will need to see especially strong increases.
A Better Week for US Data.
Last week was definitely a good week for the US economy bulls. A better-than-expected weekly job claims again, supplemented by various lead indicators of both the job and housing market reporting good signs. And the monthly small business survey, the NFIB survey, improved again. All of this would suggest that those looking for a lengthy period of 1-2 pct growth might be too cautious, and that coming quarters might match or exceed the 2.2 pct initially reported for Q1.
Financial Markets, Trading and Regulation.
Thursday’s late news of a notable trading loss at a major US institution was obviously very unwelcome news for two reasons. First of all, it reminds some investors that aspects of major financial institutions earnings are rather volatile, and therefore some discount may be applied to the sector’s P/E ratio. Second, in the current climate of intense debate about the appropriate regulation, this news has not surprisingly been seized upon by all that believe in “more” and are less interested in “better”. This is quite unfortunate, as it seems quite obvious that the financial sector needs better, not necessarily just more.
I find myself this weekend thinking back to the immediate post-crisis days of late 2008 and early 2009 when all the apparent policy push was for a relatively simple and sensible move to introduce counter cyclical and variable capital ratios on the global financial industry. What happened to those days? Now, many politicians clamour for just more, without really thinking about the negative consequences.
China. A Bit of a Surprise.
If this late Thursday news wasn’t enough of a mid-May shocker, we had quite a surprise with the mass release of China’s monthly economic data Friday, especially with the much weaker-than-expected IP data. Coming on top of the news of a bigger-than-expected April trade surplus primarily because of weak imports, and then followed by softer-than-expected credit and monetary data, the China “ hard-ish” landing crowd were out in force Friday.
For most of the year, the lead indicators I have followed for years were clearly suggesting weaker cyclical Chinese GDP than consensus expectations. Each of, the GS coincident GDP indicator, the GSCA, the lead indicator of this, and especially the GS China Financial Conditions Index were suggesting the same. This is why, at GSAM, we have had a weaker-than-consensus forecast for 2012. Ironically, in our May Monthly released Thursday, we suggested we were thinking of revising our forecast upward, because both the FCI and the lead indicator are improving as monetary policy has been relaxed. We may have to think again.
That said, I am not overly worried about this “disappointing” data for two reasons. First, financial conditions have been tightened a lot in the past two years. And, unlike so many Western countries, they can be relaxed significantly. This Saturday, the reserve ratio has already been cut and, so long as inflation stays low, more easing is coming.
Second, the weakest of the “disappointing” numbers was IP, and China needs to produce less. It is more consumption that China needs. While the retail sales report disappointed also at “just” 14.1 pct, this is not too shabby. Retail sales rising strongly relative to industrial production is what China needs and what the world needs of China.
And so to Sunday.
It has been 44 years since Manchester City won the top league of English football. Ironically, last time, United could have won it on the last day, but we lost at home to Sunderland, who we play this weekend. I remember it well. I was there. Of course, City couldn’t even crow too much that year, as we just happened to win the European Cup soon after, the first English Club to do so. What can we do to keep them out of the news this year? I wonder…Anyhow, it is now City’s to lose. Come on QPR!
I will not be writing a Viewpoint next weekend. I am off to the States next week, hoping to hear some positive anecdotes as I travel around. Pending quite how bad Sunday is, I might have to spend a few weeks on Jupiter too…
Chairman, Goldman Sachs Asset Management.