Global Market Commentary From Russ Certo

From Gleacher's Russ Certo

Good morning.  The investment thesis for this comment advocates a barbell.  Long quality flight "insurance" Treasury bonds (despite 3 leg 2yr, 5yr, and 7yr auctions in shortened Holiday week), short complacency, and long energy/geopolitical plays.  The upshot is that markets will be dominated by geopolitical risk which I don’t feel is valued properly at the moment.  This is a departure from an extended period of catalysts to investment performance dominated by a chronology of sovereign and Club Med imbalances, QE light and QE2 ruminations, midterm election/budget austerity leanings, and earnings recovery/growth prospects contributions to valuations.

Until ever so late the marketplace hasn’t had the liberty of focusing on simple mundane economic fundamentals, and I suggest that fundamentals may be put aside again in light of tidal wave of hearts and minds of peoples versus regimes.  Petty domestic partisan budgetary and ideological spats will play second fiddle to a global stage littered with toxins that possess the potential to re-arrange global allocation of physical and human resources.  The stakes are high and any investment theses must aspire to handicap risk premium of potentially explosive re-arranging of deck chairs of all things political GLOBALLY. 

Hey, but the S&P 500 index is up an eye popping 100% from its low of 2009.  But energy was the undisputed leader given Mid-East wranglings posting returns north of 3% on the week.  The marriage of flows related to exogenous events can be seen by investors pouring some $4.5 billion into domestic exchange traded funds in the latest week, nearly ten times the amount allocated to foreign stock ETFs. 

Hot monies searching to preserve alpha and a return of capital versus returns on capital have fled emerging frontiers and these and asset allocations have underpinned a $9 billion outflow from emerging market ETFs, the new quick and efficient proxy for investment expressions, in merely the last four weeks.  Just last week over $3 billion left emerging ETF funds not to mention the sister managed fund variety. 

By contrast the U.S equity funds have taken in an average of $5 billion a week in last six weeks.  The S&P has closed higher in 12 consecutive sessions.  Moreover, since November the S&P 500 has shimmied up 10% returns while broad emerging {EEM equity <go>} is down 5% and China {FXO equity<go>} is down 10%. 

There is a linkage of international and domestic experience and flows at the moment.  Despite the above flows, on Friday China hiked reserve requirements for the eighth time since 2010.  And Shanghai and Guangzhou joined China’s capital, Beijing, in announcing restrictions on home purchases over the weekend, aimed at preventing housing bubble.  Further, China may force banks to set up crises-handling procedures, kind of like the corporate finance evolution of CoCos which aspire to convert capital for banks in times of duress.  And this may begin to resonate with risk asset complex. 

Across the pond ECB executive board member Lorenzo Bini Smaghi, I just enjoy saying his name and used it as an alias a few times this weekend in Vermont and you should have seen the reactions, suggested the bank must monitor  rising price pressures more vigilantly.  The Euro actually rallied despite the decidedly risk off Middle Eastern developments and afore-mentioned USD beneficial capital flight.  This ascent of the Euro was also impressive despite the ECB saying on Friday that bank borrowing from the ECB’s emergency lending facility rose to its highest level in 19 months on Friday by $22 billion and at a prohibitive 1.75% rate.  Other measures, like the Euro Overnight Index Average, don’t really confirm the confusion but money talks and doesn’t sleep, so, one should take interest in these iterations.

Some suggest the ECB engineered the move as a sign and indication of tighter policy.  Some of our contacts suggest that the borrowing may be necessitated due to the auction sale of Anglo Irish and Irish Nationwide’s deposits.  We all should take a look at interbank funding and some extremely interesting activity this week.  Not only have Libor/Ois ticked up recently but most short term rate tenors have been on the move HIGHER in rate lately.  In addition, talking about a block trade, someone apparently (sent earlier) aggressively sold 100,000 contracts of the March Eurodollar future.  Again, for us to decide what is the intuition behind such maneuvers. 

There is clearly a pro-growth camp that is extrapolating food and energy inflation run-ups and moving the needle forward in terms of the chronology of rate tightening or otherwise and may be behind these creeping short term rates.  Again, the Euro was stronger despite Middle Eastern volatility, possibly on perceptions of tighter policy.  A concept which may be worth considering at the moment is that central bankers may begin to conveniently and coincidently exude a hawkish lean in light of Agra-food and commodity price pressures. 

Just like the Fed is supposed to take away the punch bowl as the party is getting started, a bevy of central banks may consider the unintended adverse consequences of their easy policies, namingly higher prices for countries feeding their populations and the consequent associated uprisings and unrest.  Simply, the illusion or reality of tighter policy in the form of saber-rattling the froth out of an across the board inflated complex may be the new self serving implicit policy prescription at the moment, rather than the real teeth threat of ACTUAL action.  Not to mention player’s expectations of other removals of liquidity starting to creep into the price structure of forward rate curve in recent weeks.  The irony is that the byproduct of the unrest could be market driven asset allocation flows which benefit the rate space despite the veneer of central banks communicating otherwise. 

And this may be the frustration in trading in markets or making asset allocation or investment decisions based on traditional metrics like economic fundamentals like DEFICITS.  As death tolls mount in the Gulf, talks of cutting microcosmic domestic deficits stumble or are being hotly debated.  The bantering of prospective caps on discretionary spending or the canary in the coal mine ENTITLEMENT spending, which we all know is the only relevant part of this union’s fiscal footprint going forward.

It seems so pedestrian how Wisconsin Democrats skip town and the debate of how private industry workers benefits compare to state and local government workers.  See the comparisons and weigh in for yourself.

This epic debate of entitlement and country budget ledgers arguably pales in comparison to Egyptian, Bahrain, Iranian, Libyan, Jordanian, Algerian, Israeli ….but a $137 million Wisconsin deficit and asking 5,500 state workers to keep their jobs by contributing 5.8% of their income towards their pensions and 12.6% towards health insurance, the national average contribution polarizes the country and is the order of the day.   But what is at stake for all stakeholders?  Like the Suez stake for all global stakeholders? 

Illinois pension is an academic lesson in accounting for All to learn.  The smoothing of market value of assets masks underfunding.  And the discount liability calculations which underrepresented the liability.  Please read.

The order of the day as Barron’s chimes in on spending cuts and tax increases versus paying interest on national debt.  Even by the highly optimistic calculations of the Office of Management and Budget, interest on the national debt in 2015 will be more expensive than all of the domestic non-security programs Congress was debating last week.  Lawmakers fussed over all things non-discretionary 15% while a 100% cut in these programs would be needed for the next seven years to offset increased national debt interest expenses.  For the first time since 1983 Social Security payouts exceeded Social Security taxes last year.

Meanwhile, retiring boomers with 401k accounts have less than one quarter of what is needed to maintain its standard of living in retirement according to the Federal Reserve.  Estimates suggest Social Security will provide as much as 40% of pre-retirement income or $35,000 a year, leaving the 39,000 from other sources like 401ks.  The median 401k plan has $150,000 and would generate just 9,000 a year for a couple.  Just 8% of households approaching retirement have $650,000 or more in their 401Ks.  Since housing and financial markets began to collapse, about 39% of all Americans have been foreclosed upon, unemployed, or are underwater on a mortgage or behind more than two months on a mortgage according to weekend.  Quite factual and is a harbinger of public and private allocations of resources, budgets, entitlements and fiscal and monetary policies.

Many see the economy improving, but not for them as most Americans think unemployment will decline and than business conditions have improved but they do not see their own finances getting better compared with a year ago.  And see what they think about their income prospects and ability to keep up with inflation over the coming year, from the NYT.  The evolution of these developments both domestic and abroad will impact investment philosophies.  


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