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The cost of default insurance on eurozone bonds has surged to an all-time high on reports that Greece is preparing the way for a sovereign debt restructuring after 2013, with tacit support from the EU authorities.
The disputed claim came as Fitch Ratings downgraded both Portugal and Hungary and placed five Greek banks on negative review. Fitch cut Portugal's rating one notch to A+, warning that the economy is caught in a low-growth trap. Plans to cut the structural budget deficit by 4pc of GDP next year "will be extremely challenging especially if, as Fitch expects, the economy falls into recession next year".
The Greek newspaper Ta Nea said Athens was examining plans to impose a cut in interest rates on its debt and to extend maturities once the €110bn (£94bn) rescue deal from the EU and the International Monetary Fund expires in mid 2013. The proposals stop short of "haircuts" on the principle of the debt and would be done in a co-operative fashion with bondholders. While this would qualify as an orderly restructuring of debt, it is tantamount to default.
Ta Nea said Brussels had given a "green light" to the idea, provided that Greece complies with the terms of its fiscal austerity package and carries out deep structural reforms. The European Commission denied that it had given its blessing for "any restructuring of government bonds by Greece or anywhere else".
"This is going to worry the markets a lot: if it is true, it changes the whole politics of the eurozone debt crisis,"
Elizabeth Afseth, a bond expert at Evolution Securities.
The claims caused a wild spike in credit default swaps for Greek debt, with ripple effects across the EMU periphery. Markit's iTraxx SovX Western Europe index measuring risk on sovereign debt in the region surged to a record 208 basis points in intra-day trading, though the moves may have been distorted by a lack of liquidity in the run-up to Christmas.
1. “Spain is not Greece.” (Elena Salgado, Spanish finance minister, Feb. 2010)
2. “Portugal is not Greece.” (The Economist, 22 April 2010)
3. “Ireland is not in ‘Greek Territory.” (Irish Finance Minister Brian Lenihan)
4. “Greece is not Ireland.” (George Papaconstantinou, Greek Finance minister, 8 November 2010)
5. “Spain is neither Ireland nor Portugal.” (Elena Salgado, Spanish Finance minister, 16 November 2010)
6. “Neither Spain nor Portugal is Ireland.” (Angel Gurria, Secretary-general OECD, 18 November 2010)
"There are no quick fixes for Europe's debt crisis and China must be on its guard in case the problem escalates, especially in January and February. Europe's debt problems cannot be solved by selling more government bonds and setting up a near-$1-trillion (648 billion pounds) rescue fund as the money has to be repaid at steep interest rates. These measures just turn an acute disease into a chronic one, and it's really hard to say whether these countries that are in deep trouble over the debt crisis can recover in the coming three or five years"
China's Commerce Minister Chen Deming said on Friday in the Shanghai Securities News
He did not elaborate on the measures that he thought European officials should take.
Chen's comments were the harshest yet from a Chinese minister, a sign that patience may be wearing thin among some senior officials in China, which has invested an undisclosed portion of its $2.65 trillion reserves in the euro.
Earlier this week at annual EU-China trade talks, Chen urged European authorities to take "real action" to contain the debt crisis and prevent it from engulfing bigger European economies. In part to protect its investment in the euro, China has repeatedly pledged support for the single currency, a stance reiterated by China's ambassador to the European Union on Friday.
"The euro will definitely tide over the current crisis," Song Zhe said in a statement on the China Foreign Ministry's website. www.mfa.gov.cn "The euro plays an important role in stabilising the international monetary system and promoting the diversification of the international currencies."
Worried about China's reliance on the U.S. dollar -- China is the world's biggest foreign holder of U.S. Treasuries, with nearly $907 billion in October -- senior Chinese officials have advocated alternatives to the U.S. dollar for a reserve currency. The euro is seen by many as the most viable alternative right now. But its future has been put in doubt by investor concerns Europe officials cannot afford to rescue the bigger economies of Spain and Italy should the crisis spread.
With Portugal due to repay more than 12 billion euros between April and June 2011, investor confidence in the euro zone will be tested in the first quarter of next year. Market pressure on Portugal's fiscal health has intensified in recent weeks as investors worry it could be next in line for a euro zone bailout after Ireland and Greece. A Portuguese newspaper said earlier this week that China was ready to buy 4-5 billion euros of Portuguese government debt to shield it from funding pressures. China's central bank declined to comment on the report.
Whitney’s big scare:
* 50-100 American cities will go bust next year, triggering the next leg down in the financial crisis.
* Estimated debt load of cities & states: $2.8T.
* New Jersey is in a three-way tie for No. 2 on her worst states list.
REACTION - Towns and cities are furious. Muni bond holders want blood.
" the whole country is now aware that hundreds of towns, cities, and states face massive budget shortfalls that have to be addressed. Dozens of analysts are now frantically gathering data to figure out whether Meredith Whitney is right or wrong. And we've all gotten a lot better informed about our slow-motion municipal trainwreck"
Richard Larkin, credit analyst with HJ Simms & Co., went on FBN on Wednesday to call her predictions "ludicrous," "irresponsible" and "damaging" to people's portfolios.
Bloomberg columnist Joe Mysak called the forecast "the boldest, most overreaching" of Whitney's career.
Matt McCall, president of Penn Financial Group, told Fox Business Network viewers that Whitney unnecessarily "spooked" the muni bond market
Ben Thompson, who manages tax-exempt investments for Samson Capital, told CNBC that Whitney's "numbers just don't add up."
North Korea's Minister of the People's Armed Forces Kim Yong-chun on Thursday hinted darkly at a nuclear attack on South Korea, saying,
"Our revolutionary armed forces are fully ready to start a sacred war based on the nuclear deterrent at a time we deem necessary."
Kim was speaking during a meeting at the April 25 Cultural Hall in Pyongyang to mark the anniversary of leader Kim Jong-il becoming supreme commander 19 years ago.
"If the U.S. imperialists and their followers should ignite an all-out war, our revolutionary armed forces will annihilate the aggressors and their strongholds, to remove the root of war and achieve the historic cause of the fatherland's reunification,"
Official Korean Central Broadcasting Station quoted him as saying.
Kim claimed South Korea
"launched a military provocation by firing artillery shells consecutively during an exercise for an aggressive war in the West Sea. This shows that the enemy's aggressive plan aimed at igniting a second Korean War has now entered a practical stage. the North will not hesitate to strike if the enemy invades even 0.001mm of its sky, land and sea"
1. GROUP THINK: In Barron’s look-ahead piece, not one strategist sees the prospect for a market decline. This is called group-think. Moreover, the percentage of brokerage house analysts and economists to raise their 2011 GDP forecasts has risen substantially. Out of 49 economists surveyed, 35 say the U.S. economy will outperform the already upwardly revised GDP forecasts, only 14 say we will underperform. This is capitulation of historical proportions. The last time S&P yields were around this level was in the summer of 2000, and we know what happened shortly after that.
2. BOND WITHDRAWALS: The weekly fund flow data from the ICI showed not only massive outflows, but in aggregate, retail investors withdrew a RECORD net $8.6 billion from bond funds during the week ended December 15 (on top of the $1.7 billion of outflows in the prior week). Maybe now all the bond bears will shut their traps over this “bond-bubble” nonsense.
3. BULLISH SENTIMENT: Investors Intelligence now shows the bull share heading up to 58.8% from 55.8% a week ago, and the bear share is up to 20.6% from 20.5%. So bullish sentiment has now reached a new high for the year and is now the highest since 2007 ― just ahead of the market slide.
4. EU SOVEREIGN CRISIS: It may pay to have a look at Dow 1929-1949 analog lined up with January 2000. We are getting very close to the May 1940 sell-off when Germany invaded France. As a loyal reader and trusted friend notified us yesterday, “fighting” war may be similar to the sovereign debt war raging in Europe today. (Have a look at the jarring article on page 20 of today’s FT — Germany is not immune to the contagion gripping Europe.)
5. STOCK DIVIDEND YIELDS: What about the S&P 500 dividend yield, and this comes courtesy of an old pal from Merrill Lynch who is currently an investment advisor. Over the course of 2010, numerous analysts were saying that people must own stocks because the dividend yields will be more than that of the 10-year Treasury. But alas, here we are today with the S&P 500 dividend yield at 2% and the 10-year T-note yield at 3.3%.
From a historical standpoint, the yield on the S&P 500 is very low ― too low, in fact. This smacks of a market top and underscores the point that the market is too optimistic in the sense that investors are willing to forgo yield because they assume that they will get the return via the capital gain. In essence, dividend yields are supposed to be higher than the risk free yield in a fairly valued market because the higher yield is “supposed to” compensate the investor for taking on extra risk. The last time S&P yields were around this level was in the summer of 2000, and we know what happened shortly after that. When the S&P yield gets to its long-term average of 4.35%, maybe even a little higher, then stocks will likely be a long-term buy.
6. DOW/GOLD OZ: The equity market in gold terms has been plummeting for about a decade and will continue to do so. When measured in Federal Reserve Notes, the Dow has done great. But there has been no market recovery when benchmarked against the most reliable currency in the world. Back in 2000, it took over 40oz of gold to buy the Dow; now it takes a little more than 8oz. This is typical of secular bear markets and this ends when the Dow can be bought with less than 2oz of gold. Even then, an undershoot could very well take the ratio to 1:1.
7. BREADTH & MOMENTUM: As Bob Farrell is clearly indicating in his work, momentum and market breadth have been lacking. The number of stocks in the S&P 500 that are making 52-week highs is declining even though the index continues to make new 52-week highs.
8. PE RATIOS: Stocks are overvalued at the present levels. For December, the Shiller P/E ratio says stocks are now trading at a whopping 22.7 times earnings! In normal economic periods, the Shiller P/E is between 14 and 16 times earnings. Coming out of the bursting of a credit bubble, the P/E ratio historically is 12. Coming out of a credit bubble of the magnitude we just had, the P/E should be at single digits.
9. REAL ESTATE- HOUSING: The potential for a significant down-leg in home prices is being underestimated. The unsold existing inventory is still 80% above the historical norm, at 3.7 million. And that does not include the ‘shadow’ foreclosed inventory. According to some superb research conducted by the Dallas Fed, completing the mean-reversion process would entail a further 23% decline in real home prices from here. In a near zero percent inflation environment, that is one massive decline in nominal terms. Prices may not hit their ultimate bottom until some point in 2015.
10. STATE & LOCAL GOVERNMENT: Arguably the most understated, yet significant, issue facing both U.S. economy and U.S. markets is the escalating fiscal strains at the state and local government levels, particularly those jurisdictions with uncomfortably high pension liabilities. Have a look at Alabama town shows the cost of neglecting a pension fund on the front page of the NYT as well as Chapter 9 weighed in pension woes on page C1 on WSJ.
Consumer spending was taken down 0.4 of a percentage point to 2.4%, which of course you never would have guessed from those “ripping” retail sales numbers.
In the absence of Chapter 9 declarations or dramatic federal aid, fixing the fiscal problems at lower levels of government is very likely going to require some radical restraint, perhaps even breaking up existing contracts for current retirees and tapping tax payers for additional revenues. The story has some how become lost in all the excitement over the New Tax Deal cobbled together between the White House and the lame duck Congress just a few weeks ago.
The following set of conditions is one way to capture the basic "overvalued, overbought, overbullish, rising-yields" syndrome:
1) S&P 500 more than 8% above its 52 week (exponential) average
2) S&P 500 more than 50% above its 4-year low
3) Shiller P/E greater than 18
4) 10-year Treasury yield higher than 6 months earlier
5) Advisory bullishness > 47%, with bearishness < 27% (Investor's Intelligence)
[These are observationally equivalent to criteria I noted in the July 16, 2007 comment, A Who's Who of Awful Times to Invest. The Shiller P/E is used in place of the price/peak earnings ratio (as the latter can be corrupted when prior peak earnings reflect unusually elevated profit margins). Also, it's sufficient for the market to have advanced substantially from its 4-year low, regardless of whether that advance represents a 4-year high. I've added elevated bullish sentiment with a 20 point spread to capture the "overbullish" part of the syndrome, which doesn't change the set of warnings, but narrows the number of weeks at each peak to the most extreme observations].
The historical instances corresponding to these conditions are as follows:
December 1972 - January 1973 (followed by a 48% collapse over the next 21 months)
August - September 1987 (followed by a 34% plunge over the following 3 months)
July 1998 (followed abruptly by an 18% loss over the following 3 months)
July 1999 (followed by a 12% market loss over the next 3 months)
January 2000 (followed by a spike 10% loss over the next 6 weeks)
March 2000 (followed by a spike loss of 12% over 3 weeks, and a 49% loss into 2002)
July 2007 (followed by a 57% market plunge over the following 21 months)
January 2010 (followed by a 7% "air pocket" loss over the next 4 weeks)
April 2010 (followed by a 17% market loss over the following 3 months)
This week’s surveys of bullish sentiment from Investors Intelligence (II) and the American Association of Individual Investors (AAII) showed the ninth highest combined reading since 1987, and it was the sixth period ever where the combined reading was above 120%. One place where the holiday spirit is not in short supply is the equity market.
The National Association of Active Investment Managers (NAAIM) shows that on average they are 81.83% invested.
This is in the high end of the range and shows that these managers are quite bullish.