COMING UNGLUED: Market Fragility and Credit Market risk indicators are now at post-Lehman levels.
Global Economic Risks have taken a noticeable and abrupt turn downward over the last 30 days. Deterioration in Credit Default Swaps, Money Supply and many of our Macro Analytics metrics suggest the global economic condition is at a Tipping Point. Urgent and significant actions must be taken by global leaders and central banks to reduce growing credit stresses.
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MORAL METASTASIS : Malfeasance, Manipulation & Malpractice - Metastasis is the spread of a disease from one organ or part to another non-adjacent organ or part. Cancer occurs after a single cell in a tissue is progressively genetically damaged to produce a cancer stem cell possessing a malignant phenotype. These cancer stem cells are able to undergo uncontrolled abnormal mitosis, which serves to increase the total number of cancer cells at that location. The moral fiber of our society is going through this same process as it breaks down, spreads and metastasis. We are presently in the process of Moral Metastasis that will prove fatal if not immediately operated on and surgically removed. Sadly, however it has gone undetected too long and the damage it has caused is now irreparable. MORE>>
The market action since March 2009 is a bear market counter rally that has completed a classic ending diagonal pattern. The Bear Market which started in 2000 will resume in full force when the current "ROUNDED TOP" is completed. We presently are in the midst of of a "ROLLING TOP" across all Global Markets. We are seeing broad based weakening analytics and cascading warning signals. This behavior is typically seen during major tops. This is all part of a final topping formation and a long term right shoulder technical construction pattern. - The "Peek Inside" shows the detailed coverage available this month.
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Just to recap, there are now five countries that have sought bail-outs. They are Ireland, Greece, Portugal, Spain, and Cyprus. To this must be added Italy and Slovenia, both of which are in difficulty. The problem is made more acute because they have all committed themselves to guaranteeing the funding of the EFSF (the ESM does not yet exist but is expected to do so eventually on a similar basis), meaning that they have to contribute to their own bailouts or request a suspension of their commitments from the other guarantors. Ireland, for instance, decided to raid state pension funds to meet her contribution in her own bail-out.
The EFSF guarantees are shown in the following table.
The countries that have been given bailouts are Ireland, Portugal, and Greece, for totals of €17.7bn, €26bn and €179.6bn respectively, including pending disbursements. Think of the effect on other countries in trouble having to raise funds in the bond markets: Spain has had to contribute or commit €26.5bn, which it currently has to fund at 7% and lend to these three countries at about 3.5%. This is over one quarter of the bail-out Spain is seeking for her own banks.
This is obviously crazy.
If we look at the guarantees of all those who are receiving bail-outs, requesting one, or are likely to need one, they total 41% of the fund. This eventually has to be covered by the other guarantors, principally Germany, France, and the Netherlands. While it would be a mistake to underestimate the political tensions this causes in these states, these countries are at least committed to the European cause, and we can assume their politicians will continue to fight to support the Eurozone’s objectives and institutions for as long as possible. A rebellion is more likely to come from elsewhere.
There is less drive behind paying for the status quo in the smaller nations, such as Slovakia, who are relatively new to the European Ideal. While Slovakia is unlikely to make too much fuss, the same cannot be said of Finland, who offers the greatest danger of an exit altogether. She has been sufficiently worried about previous bail-outs to independently seek preferential terms from the recipients. In her alliances, Finland regards herself as Scandinavian first and European second. The other Scandinavians are not in the currency union, and the richest state, Norway, is not even in the EU. Denmark manages its currency to maintain an approximate rate against the euro, so why cannot Finland do the same, without all the liabilities?
Increasingly, public opinion in Finland is that membership of the Eurozone is becoming an unjustifiable burden. The country lacks the historical imperative to pursue European integration and is far more likely to be the first to leave the Eurozone than other candidates frequently mentioned, particularly Germany.
The questions arises:How can the Eurozone stay together, and if not, how quickly is it likely to start disintegrating? And where does the exchange rate for the euro fit in all this?
1- EU Banking Crisis
SPANISH & ITALIAN CAPITAL FLIGHT: How Long Will Germany Allow Itself to Accept Contingent Liabilities through Target2 Transfers?
Since no money system could tolerate such a sustained attack for long, the outflows are compensated for by "target 2" inflows from the European Central Bank, which in turn borrows the money from the eurozone's creditor central banks, in particular the Bundesbank. The process thereby becomes something of a money go round. The foreign investor withdraws his money from the Spanish or Italian bank and deposits it with an apparently "safer" German bank, which in turn lends the money to the Bundesbank, from where it finds its way back through the ECB via the target 2 system to the original Spanish or Italian bank.
From Reuters: "Italian Prime Minister Mario Monti said on Tuesday he expected the governor of Sicily to resign following a growing financial crisis that has pushed the autonomous region close to default." Because the resignation of Sicily Governor Lombardo will somehow allow all those who care about the fundamentals of Italy to stick their heads in the sand... at least until Sicily is followed by Calabria, Campania, Lazio, Abruzzo, Tuscany, Lombardy, Umbria, Liguria, Veneto and so on. At least the governors of those respective provinces now have an advance warning what the endgame is.
Monti said in a statement there were "grave concerns" that the island could default and he said he had written to the governor Raffaele Lombardo seeking confirmation that he would resign by the end of the month.
"The solutions which could be considered that involve action on the part of the government cannot fail to take account of the situation of the administration at regional level but rather have to be matched to this so as to deploy the most efficient and appropriate instruments," the statement said.
As to how Italy will actually fund the bailout its insolvent regions, fear not: ze Germans will be delighted to step in and make it rain cash courtesy of the ESM, which may or may not be active one day.
Italian premier Mario Monti is mulling emergency action to take direct control of Sicily’s regional government before the island spirals into a full-blown financial crisis, fearing contagion to the rest of Italy. We thought it was coming; we heard the rumors; but now the 'temporary liquidity problem' that faced Sicily has been resolved by... yes, you guessed it - the transfer of EUR400 million from the Italian government. Do not worry though. As one official noted "there's no default risk for Sicily, whose budget was in surplus in 2010 and 2011". Unbelievable.
As Bloomberg notes:
"The developments in Sicily are very serious," said Prof Giuseppe Ragusa from Luiss University in Rome. "It is just the sort of negative shock we don’t want right now. Everything has to go perfectly for Italy to pull through."
"We mustn't let the disaster in Sicily infect Italy"
"We are victims of disinformation, lie, and falsehoods. What are we supposed to do? Cut even further? Detonate a social explosion in Sicily? Turn Sicily into a land of desperation where everything is destroyed," Sicily's governor Lombardi said.
"Sicily is not at risk of default," said Mr Lombardo, blaming the crisis on cuts by Rome itself under its EU-imposed austerity regime. "We face a liquidity crisis linked to the recession in the rest of the country. It is hard for lots of regions, and not just Sicily."
2- Sovereign Debt Crisis
SPAIN: Bonds Fall (Yields Over 7%), Housing Falls at Record Pace, Bad Loans Surge
Despite the world and their lemur believing that, with a self-referential EUR100 billion bailout (loan) for its banks and a ponzi guarantee scheme for its insolvent regions, all will be well and more debt fixes too much debt, Spanish 10Y yields are back near 7% and spreads over 575bps. The reason - simple - the backbone of their credit-fueled economic growth has crumbled and is now crumbling faster. As the FT reports today, Spain's housing and banking sectors continue to deteriorate, grim new government data showed Wednesday, providing the latest indication that the country's economy remains caught in a protracted recession. House prices declined at the fastest pace since the start of the crisis in the second quarter, the public ministry said, and bad loans increased for a 14th month in a row, the Bank of Spain reported. What is more worrisome is that in spite of a bank rescue plan (that is obviously tyet tto be implemented), bank deposits saw a record decline shrinking 5.75% from a year earlier. The vicious cycle of rising borrowing costs and continued economic recession prompted the International Monetary Fund earlier this week to predict that the downturn will last into next year. "This government can't decide between a good and a bad choice," Mr. Rajoy said. "This government has to choose between the bad and the even worse."
Since the EU Summit, and basically month-to-date, Spanish 10Y spreads are 100bps wider back near record wides... (Red = Spain, Blue= Portugal, Black = Italy)
Spain and Japan are seen to have debt ratios that are not stabilizing...
The IMF believes that advanced economy deficits will decline by about 0.75 percentage points of GDP this year which 'strikes a compromise between restoring fiscal sustainability and supporting growth". However, continued focus on nominal deficit targets runs the risk of compelling excessive fiscal tightening if growth weakens. In addition, there is a risk in the United States of political gridlock that puts fiscal policy on autopilot and results in a sharp and sudden decline in deficits—the “fiscal cliff.” What is more troubling is the significant upward revision to all of the peripheral European nations (with Greece now at 171% Debt/GDP in 2013 versus 160.9% forecast only 3 months ago). While the average debt-to-GDP ratio among advanced economies is projected to continue to rise over the next two years, surpassing 110 percent of GDP on average in 2013, debt ratios will by then have peaked in several advanced economies - though rather explosively they do not see debt ratios for Spain and Japan stabilizing.
Negative yields on European government securities, paced by a record of minus 0.074 percent on German two-year notes, aren’t deterring investors seeking the safety of debt with the best perceived creditworthiness.
“It’s not return on capital, it’s return of capital,” said Peter Allwright, the head of absolute rates and currency at RWC Partners Ltd. in London.
“We are in a horrible deflationary and deleveraging world. In euros, we only want to hold Germany as it’s the best and the most liquid.”
Yields on two-year German, Austrian, Finnish and Dutch debt dropped below zero this month after the European Central Bank said July 5 it would stop paying interest on deposits.
Investors also are paying France, Switzerland, Denmark and the European Financial Stability Facility for the right to lend to them by buying their securities.
A dearth of top-rated assets around the world means investors are chasing a dwindling pool of supply, according to Carl Norrey, head of European rates securities at JPMorgan Chase & Co. in London.
Data compiled by Bank of America Merrill Lynch index show the number of securities in its AAA index has dropped to 3,581 from 3,611 in March and 5,331 in 2007.
EUOPEAN BOND BUYING FALLING
The interest of foreign investors in euroarea bonds continues to decline on a trend basis.
That is likely to remain a weight on the region’s currency.
The 12-month average of foreign purchases of euro-area bonds hit a new record low in May, according to Bloomberg Brief calculations based on data released by the European Central Bank yesterday.
It fell to 1.6 billion euros from 5.3 billion euros in the previous month.
Those figures compare with a recent high of 26.9 billioneuros in June 2011 and a record of 49.5 billion euros in August 2007.
The weakness over the last year was driven by a large reduction in exposure to euro-area bonds prior to the completion of the ECB’s two three-year longerterm refinancing operations.
Foreign purchases of debt registered minus 24.9 billion euros in January, minus 3.7 billion euros in December, minus 15.9 billion euros in November and minus 52.4 billion euros in October
The euphoria created by those liquidity injections faded after one month, though the monetary authorities appear to have slowed the stampede of international investors toward the exit.
Foreign purchases of debt registered 37 billion euros in May, minus 0.1 billion euro in April and 8 billion euros in March after having jumped to 47.8 billion euros in February. The latest figure was less than half the 81.4 billion euros of debt purchased by foreign investors in May 2011.
International demand for those fixed-income instruments is likely to remain muted as the crisis in Europe intensifies.
The spread between the five-year government bond yields of Spain and Germany widened today to 631 basis points, its highest level since the creation of the monetary union. Inflows into the bond market have been the largest source of portfolio investment in the euro area.
Foreign investors have purchased 21.6 billion euros of debt on average per month since the birth of the monetary union.
The equivalent figure for stocks is 9.5 billion euros.
The reduced interest of foreign investors in the region’s debt has weighed heavily on the overall level of net foreign portfolio investment.
The 12-month average declined to 6 billion euros in May from a recent high of 29.6 billion euros in November 2011 and a record of 32.5 billion euros in July 2009.
Portfolio investment has created the largest source of external demand for the euro since its inception. It has averaged 9.6 billion euros per month.
The purchases have largely offset the persistent deficit of foreign-direct investment.
Those capital flows have averaged minus 8.6 billion euros a month since January 1999.
The current account has been close to balanced, averaging minus 1.3 billion euros per month.
Those developments have led to a deterioration in the broad basic balance – the sum of the current account, foreign direct investment and portfolio flows – of the euro area.
The 12-month average has fallen to 2.4 billion euros from a record 22.5 billion euros in September 2011.
The euro is likely to remain under pressure as long as foreign interest in the region continues to wane.
That depreciation is likely to be especially pronounced versus the U.S. dollar, given its safe-haven status, as the storm continues to rage through Europe.
Grice said he thinks treasuries are very risky at these yield levels because governments are manipulating their numbers:
"I guess the idea I’m getting at is that buying Treasuries is dancing with the devil. Aside from locking into a real negative return, you’re doing so from a position of weakness. You have no idea how negative the return is likely to be because you have no idea what inflation over the period (let’s say ten years) is likely to be.
What you do know is that the worse the fiscal position, the more likely the Fed are to print the money required, and so the more negative your real returns are going to be.
So what this chart illustrates is really what we all know (or all should know), which is that the official fiscal position of the US government understates the true position (and I don’t mean to pick on the U.S since they’re not the only one misrepresenting their fiscal position, the Europeans and Japanese are doing the same thing). One line shows an estimate which includes accruals in the deficit calculation, the other (official one) doesn’t."
Grice has previously warned that safe haven assets like government bonds are not actually that safe. For a more accurate picture he thinks measures of the federal deficit should include accruals since they indicate future liabilities.
6- Bond Bubble
CHRONIC UNEMPLOYMENT: Disabilitiy Rolls Growing Fasters Than Jobs
Retail sales in June were much softer than expected, including auto sales, which contradicted manufacturers numbers for the month. This is an important point. We have discussed that automobile dealers are again stuffing inventory channels with near record levels of autos even though they are not moving off of the dealer lots. Furthermore, with auto manufacturers skewing seasonal employment data recently by not shutting plants for retooling during the summer, as is historically the case, this leads to further concerns about future economic data. (Click here for lawsuit against GM for channel stuffing)
Retail sales in June fell 0.5 percent, following decreases in both May and April as well. This is the first time since 2008 that retails sales have declined 3-months in a row, and historically, this has never occurred without the economy either in or about to be in a recession. With both sales of automobiles and gasoline (lower prices leads to lower dollar sales) stripped out retail sales still declined by 0.2%. Most importantly this core sales data showed widespread weakness in June with declines in building materials & garden equipment, sporting goods & hobby, furniture & home furnishings, electronics & appliance stores, health & personal care, general merchandise, and food services & drinking places.
As shown in the chart retail sales declines tend to lead consumer confidence reports. Therefore, with retail sales on the decline we should expect to see further weakness in the coming months where consumer confidence is concerned. For the markets, however, this "bad news" has been good news as market participants continue to build the case for further stimulative programs from the Fed. This is why the markets have held up so well in face of a continued string of weak economic reports.
With personal consumption expenditures driving more than 70% of the economy any substantial change to that dynamic could negatively impact the economy. Since the beginning of this year consumers have seen an increase in disposable incomes due to declines in commodity costs even though wages have remained fairly stagnant. This rise in disposable income, however, has not made its way into significantly more consumption but instead into higher personal savings rates. While higher personal savings rates are important to longer term economic prosperity - in the near term it decreases potential current consumption and aggregate end demand which keeps economic growth under pressure.
One important note is the significant rise in consumer credit in recent months without a relative adjustment to consumption. Historically there has been a fairly consistent correlation between changes in consumer credit and consumption. However, as of late we have seen continued increases in credit without coincident increases in consumption. In our article on "Consumer Credit And The American Conundrum" we go into this phenomenon in much more detail stating: "Most of the deleveraging process that has been occurring up to this point has NOT been voluntary. Banks have been cutting off excess credit lines, consumers have been defaulting on debt, mortgage foreclosures, and personal bankruptcies.
Consumers, on the other hand, are struggling just to make ends meet and are in reality doing very little in terms of voluntary debt reduction. As incomes have decreased over the past two years - the inflationary pressures in food, energy, medical and utilities have consumed more of that declining wage base. This is why today we have 1 out of 2 Americans on some form of governmental assistance, more than 47 million people on food stamps and transfer receipts making up more than 35% of personal incomes. It is hard to make the claim that the economy is on a fast track to recovery with statistics like that. That is why the recent increases in consumer debt are disturbing. The rise in NOT about increasing consumption by buying more 'stuff' it is about just about being able to purchase the same amount of 'stuff' to maintain the current standard of living.
While bad news may be good news for the market hoping that it will spur more stimulative measures from the Fed to boost asset prices - for Main Street America bad news is just bad news. More importantly, the decline in consumer confidence continues to perpetuate the virtual economic spiral. As the consumer retrenches the decline in aggregate end demand puts businesses on the defensive who in turn reduces employment. The reduction in employment, and further stagnation of wages, puts the consumer further onto the defensive leading to more declines in demand. It is a difficult cycle to break
Food is likely to be a more persistent problem than oil supply
Food is the most inelastic part of consumption
global food production has been hitting constraints as rising populations and changing diets hit against flattening productivity, water and fertility constraints, and the likely early effects of climate change.
in the recent all-encompassing theory of global-collapse, there is general agreement that one of the contributing factors to the rolling revolutions beginning at the end of 2010 was increasing food prices eating into already strained incomes.
Food is likely to be a more persistent problem than oil supply. This is because we require almost continual replenishment of food to stay alive and avoid severe social and behavioral stress - food is the most inelastic part of consumption.
There is general agreement that one of the contributing factors to the rolling revolutions beginning at the end of 2010 was increasing food prices eating into already strained incomes.
Food is, and always has been a mainstay of welfare and social peace. Figure:9 shows the recent correlation between the FAO index and outbreaks of political and social unrest.
One outcome was the revolution in Libya, a result of which was the loss of nearly two million barrels of high quality oil a day to the global economy. Thus oil prices remained high, averaging well over $100 even as fears for the global economy increased and growth in many major economies began to stall. From this perspective, QE temporally displaced risk to banks that returned as higher oil and food prices, via the real economy and a distant revolution.
More broadly, food is likely to be a more persistent problem than oil supply. Firstly, this is because we require almost continual replenishment of food to stay alive and avoid severe social and behavioral stress. Secondly, the loss of food in society had a far deeper impact than oil. Finally, the implications of evolving systemic risk means food production, access and affordability would be undermined.
BDI signals a steep decline in true demand around the world for raw materials used in the manufacture of consumer goods, and that similar declines in the BDI’s past have almost always prophesized a crisis event in financial markets.
The mainstream media attempted to write off the implosion of the BDI as a fluke, tied to the “overproductions of cargo ships”, instead of a warning sign of deteriorating demand. Of course, the past 6 months have proven that assertion to be entirely false.
Crashes in the index are usually made visible on mainstreet around 8 months to a year after the event. That is to say, the economies of multiple nations move into a widely felt crisis event around 8 to 12 months after the BDI crashes.
There is a strange delayed reaction between the initial exposure of weakness in the financial system and the public’s realization of the truth, sort of like Wile E. Coyote dashing off a cliff in the cartoons only to continue running in mid-air above the abyss below. It is a testament to the fact that beyond the math, there is an undeniable power of psychology in our economy. The investment world naively believes it can fly, even with the weight of endless debt around its ankles, and for a very short time, that pure delirious oblivious belief sustains the markets.
Eventually, though, gravity always triumphs over fantasy…
'Risks are all to the downside for Asia' is the view of UBS' global macro team. It appears the markets are pinning their optimism on growth and earnings over the next year on three hopes: that the US will not fall off its 'fiscal cliff'; that Europe will 'muddle through'; and that China will pull Asia out of the current morass. Duncan Wooldridge takes on each of these 'hopes' noting that he expects Asian exporters to be far more likely to pull back on investment and take a wait and see attitude than simply ride into the breach.
Hope number one is that the US will not fall off a “fiscal cliff” in early 2013.
The fiscal cliff refers to automatic spending cuts and tax hikes that are scheduled for 1 January 2013 that equal 5% of US GDP according to the Congressional Budget Office (CBO). The CBO believes this could cause the US economy to contract 1.3% in 1H13 and would result in the US growing just 0.5% next year. The only way the US can grow close to 2.5% next year is if US politicians renege on their prior policy commitments and that is the view UBS is taking. But it is important to understand that the uncertainty around this debate, as it heats up later in the year, will likely have a dampening impact on private investment in places like Asia because of the uncertainty the debate itself will generate for Asia’s export outlook. Asian exporters are far more likely to pull back on investment and take a wait and see attitude than simply ride into the breach.
Hope number two is that Europe can continue to muddle through.
Is the risk that Europe surprises on the upside or the downside? This depends critically on policy and what we arguably know is that European policy is reactionary; i.e., policymakers seem to only respond after the economy deteriorates. So for those who believe that in the end everything will work out for the best, one has to admit that further deterioration is probably a precondition for the sort of sea change in policy that markets want to see. Piecemeal policy measures in response to a gradually worsening scenario in Europe should not be cause for hope and optimism, at least from where we sit in Asia. If anything the risks in Europe are to the downside on the horizon. Again, not terribly helpful forgetting Asia out of her current funk.
Hope number three is China. Can China pull Asia out of the current morass?
In reality China has limited room to play global or regional saver this time around. In part, that’s because domestic debt is now driving toward 190% of GDP and it is especially high in the corporate sector. And as we pointed out several weeks a go pushing Chinese leverage higher from current levels will not have the same salubrious effect as in 2009. Credit expansions overtime tend to suffer from diminishing marginal returns. Debt can go higher, but it won’t feel as fun. The other issue is this. China’s domestic investment cycle is mainly driven by construction. China’s policy response to the global financial crisis was very successful precisely because credit poured into housing and infrastructure construction. But look at chart 2.
Chinese construction is now sitting at what can only be considered a cyclical peak as a share of GDP, around 7% on a value added basis or close to 14% if you prefer to think of this on an expenditure basis. Yes, China can do a little something, something with infrastructure spending per UBS China economist Tao Wang’s assertions, but that’s not going to compensate for everything else going on in the world. You really need to see another massive surge in Chinese construction activity to get bulled up on growth – and that would be very hopeful indeed.
INDIA: Watch Out For RE-emergence of Food Price Inflation
As everyone knows the product the PBOC pays more attention to than anything else is food: pork, soy, corn, etc., and particularly food prices. Because if there is one thing that can cause social upheavals in the world's most populous country, it is a rerun of the spring of 2011 when as a result of global easing, we saw not only the Arab Spring, but violent flare ups throughout China. Which brings us to today's topic: black swans. Deep fried black swans.
As UBS explains the record drought that has gripped America may well have far-reaching implications beyond just the price of corn in the US. If, indeed, adverse US climatic conditions spread, and it appears they already have as "the monsoon season, which is critical for that country’s agricultural production, is 22% below normal conditions for the year" it means that Asian food prices will broadly be the next commodity sector to go sky high, and with that kill any hope of either an RRR cut, or an outright reduction in the PBOC's Interest Rate.
Asian food prices have generally trended down since late last year, but that could change. US agricultural prices are on course to increase a whopping 25%m/m in July due to a severe drought. That translates into about a 6%y/y gain. If US agricultural prices stop rising sequentially they should finish the year up 20%y/y. By itself that doesn’t justify panicking over Asian food inflation based on the traditional relationship with US agriculture (not yet anyway). Chart 1 shows the relationship is positive, but far from one-to-one. There have been times over the last decade when US agricultural prices and Asian food inflation have even decoupled. That could happen for example if weather conditions in Asia are favourable (particularly in India and China) or in other parts of the world that compensate for US agricultural output. However, our fear is that poor weather on one side of the world tends to be followed by poor conditions on the other side.
If you’ve been following Philip Wyatt’s work on India then you know that the monsoon season, which is critical for that country’s agricultural production, is 22% below normal conditions for the year. That’s not a catastrophe, but it’s also not helpful given what’s happening in the US. The good news is that Chinese weather conditions have remained favourable for agriculture so far and that’s a positive. So this is where we stand. Recent US agricultural price increases are a negative for Asian food inflation, but not necessarily disastrous as long as local agricultural production can be sustained and that in turn depends mainly on the weather – something nobody seems very good at predicting.
Then again, praying for rain is oddly more appropriate and realistic than hoping that the central bankers will ease more with the US stock market at its 2012 highs.
According to most experts, the U.S. is still growing. However, some experts like Lakshman Achuthan and Albert Edwards argue that the U.S. is in a recession.
"Frequently, in the early stages of recessions or during growth soft-patches, there is not a clear consensus among forecasters as to whether or not a recession is actually occurring," writes Deutsche Bank economist Carl Riccadonna.
The issue is that economists opposite sides of the argument weight different metrics differently. But Riccadonna and the economics team at Deutsche Bank have an incredibly reliable indicator of recessions. They call it the "rule of 10%" and it's an interpretation of the U.S. weekly initial jobless claims. Riccadonna explains:
Our rule of thumb is as follows: In the past, when jobless claims backed up by 10% or more from the prior quarter’s average, in all but one instance (Q1 1967), the economy was on the brink of recession. Thus, the rule has proven to be fairly reliable over the past several decades.
Here's his chart showing the record of this indicator:
So based on the recent quarter's average jobless claims and the current trend of jobless claims, Riccadonna notes that that "rule of 10%" would suggest we are not heading into recession. In fact, the bar for jobless claims is actually quite high:
Therefore, given that Q1 initial jobless claims averaged 369k, the subsequent backup to 382k in Q2 was troubling—and likely reflective of slowing growth in sequential terms—but it was not the magnitude of move necessary to signal an imminent recession. To meet the aforementioned criterion, we would have needed to see claims exceed 400k. The threshold for the current quarter is higher still—roughly 420k, so we take comfort in the fact that jobless claims appear to be drifting back toward May levels (roughly 375k).
Then again, recent jobs data in general have been quite disappointing. In June, U.S. companies only added 80k jobs.And Riccadonna recognizes the U.S. economy isn't exactly in the clear.
"Of course, this also supports the notion that July payrolls should not deteriorate significantly from the pattern of the past few months, which is why we are preliminarily forecasting +75k," writes Riccadonna.
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
Federal Reserve Chairman Ben Bernanke delivered a bleak new assessment of the U.S. economy to lawmakers on Tuesday but remained guarded about what the Fed would do about the disappointing outlook.
In testimony before Congress on the economy and central bank policies, Mr. Bernanke repeated a statement the Fed made in June, saying central bank officials were prepared to take additional action.
He refrained from being specific about what he had in mind, but in his answers to questions he appeared at times to be leaning toward action. "We haven't really come to a specific choice at this point," Mr. Bernanke said in answer to a question later. "We are looking for ways to address the weakness in the economy should more action be needed."
His restrained tone about additional action by the central bank initially disappointed stock investors.
Recent data suggest that real gross domestic product increased at a 2% pace in the first quarter of this year and will grow at an even slower rate in the second quarter, he said. Mr. Bernanke noted that Fed officials at last month's policy meeting based their decisions on their expectation that real GDP would grow between 1.9% and 2.4% this year.
Among his latest concerns was the outlook for business investment. In June, the Fed said investment was continuing to advance. But in his testimony, Mr. Bernanke marked down his assessment. Mr. Bernanke said investment had decelerated in the first part of the year and added that he foresaw "further weakness ahead."
He also sounded sharp concerns over the labor market, which Fed officials have made clear is central to whether they decide to enact more programs to spur growth. The Fed chief predicted that progress in reducing the country's 8.2% unemployment rate "seems likely to be frustratingly slow."
Mr. Bernanke discussed several steps the Fed could take if it chooses to take additional action.
It could put off to beyond 2014 its plan to avoid short-term interest-rate increases.
It could add to its holdings of mortgage-backed securities or Treasury securities as part of an effort to drive down long-term interest rates and drive up stocks and other bonds—a step known to many as quantitative easing, or QE.
The Fed could also cut the 0.25% interest rate it pays to banks on the approximately $1.6 trillion in excess reserves they keep parked at the U.S. central bank, Mr. Bernanke said. The European Central Bank took a similar step recently. The Fed has explored this option in the past but refrained from taking it, in part because of worries that it would disrupt short-term money markets.
The Fed chairman hinted at another option—the possibility of getting credit to banks through the Fed's discount window, which normally is used only for emergencies. "We would look at a range of possible tools," he said.
The Fed chief highlighted two main risks to the U.S. economy:
Intensifying tensions in Europe's debt crisis and
Unsustainable path of U.S. budget policy.
MONETARY MALPREACTICE: According to THE Central Bank
The central banks’ central bank, the Bank of International Settlements or “BIS” – which is the world’s most prestigious mainstream financial body – has slammed the policy of America’s economic leaders.
Paul Krugman has urged the Federal Reserve to simply lend banks an amount equal to their bad loans and negative equity (debts in excess of the market price of assets). He urges a “Keynesian” program of spending to re-inflate the economy back to bubble levels. This is the liberal answer: to throw money at the problem, without seeking structural reform.
[BIS] disagreed last week in its annual report. It said – and I believe that it is right – that monetary policy alone cannot solve an insolvency problem. And that is what Europe has now: not merely illiquidity for government bonds and corporate debt, but insolvency when it comes to the ability to pay.
In such circumstances, the BIS explains, it is necessary to write down the debt to the amount that can be paid – and to undertake structural reforms to prevent the Bubble Economy from recurring.
The report [by BIS] was particularly scathing in its assessment of governments’ attempts to clean up their banks. “The reluctance of officials to quickly clean up the banks, many of which are now owned in large part by governments, may well delay recovery,” it said, adding that government interventions had ingrained the belief that some banks were too big or too interconnected to fail.
This was dangerous because it reinforced the risks of moral hazard which might lead to an even bigger financial crisis in future.
BIS has also repeatedly criticized the Fed and other central banks for setting interest rates too low.
BIS’ chief economist William White warned against overly lax monetary policy as early as 2003. As der Spiegel reported:
White and his team of experts observed the real estate bubble developing in the United States. They criticized the increasingly impenetrable securitization business, vehemently pointed out the perils of risky loans and provided evidence of the lack of credibility of the rating agencies. In their view, the reason for the lack of restraint in the financial markets was that there was simply too much cheap money available on the market. [Low interest rates equal cheap money.] To give all this money somewhere to go, investment bankers invented new financial products that were increasingly sophisticated, imaginative — and hazardous….
“The fundamental cause of today’s emerging problems was excessive and imprudent credit growth over a long period. Policy interest rates in the advanced industrial countries have been unusually low,” [White] said.
The Fed and fellow central banks instinctively cut rates lower with each cycle to avoid facing the pain. The effect has been to put off the day of reckoning.
“Policymakers interpreted the quiescence in inflation to mean that there was no good reason to raise rates when growth accelerated, and no impediment to lowering them when growth faltered,” said the report.
In 2009, BIS released a paper amplifying on this point:
Easy monetary conditions are a classic ingredient of financial crises: low interest rates may contribute to an excessive expansion of credit, and hence to boom-bust type business fluctuations. In addition, some recent papers find a significant link between low interest rates and banks’ risk-taking ….
Indeed, BIS documents that interest rates which are too low are a grave risk financial to stability. See this, this and this.
The Fed Allowed Destructive Bubbles to be Blown … and then Used “Gimmicks” and “Palliatives” to Try to Paper Over the Mess
BIS also slammed the Fed and other central banks for blowing the bubble, failing to regulate the shadow banking system, and then using gimmicks which will only make things worse.
Nor does it exonerate the watchdogs. “How could such a huge shadow banking system emerge without provoking clear statements of official concern?”
“Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand. If asset prices are unrealistically high, they must fall. If savings rates are unrealistically low, they must rise. If debts cannot be serviced, they must be written off.
“To deny this through the use of gimmicks and palliatives will only make things worse in the end,” he said.
In other words, BIS slammed the easy credit policy of the Fed and other central banks, and the failure to regulate the shadow banking system.
BIS also slammed “the use of gimmicks and palliatives”, and said that anything other than (1) letting asset prices fall to their true market value, (2) increasing savings rates, and (3) forcing companies to write off bad debts “will only make things worse”.
But Bernanke and the other central bankers (as well as Treasury and the Council of Economic Advisors, the heads of congressional and senate banking committees, and the others in control of American, British, French, Japanese, German and virtually every other country’s economic policy) ignored BIS’ advice in 2007 and 2008, and they are still ignoring it today.
Instead, they are doing everything they can to
(1) prop up asset prices by trying to blow a new bubble by giving banks trillions,
(2) re-write accounting and reporting rules to let the big banks and other giants keep bad debts on their books (or in sivs or other “second sets of books”) and to hide the fact that they are bad debts, and
(3) encourage consumers to spend spend spend!
“The world’s most prestigious financial body”, “the ultimate bank of central bankers” has condemned Bernanke and all of the other G-8 central banks, and stripped bare their false claims that the crash wasn’t their fault or that they are now doing the right thing to turn the economy around.
QE III: What We Are Watching
Sadly, not even the extension of Twist can do anything about the biggest concern that banks are currently facing, namely the accelerated decline in reserves, as a result of the prepayment of Maiden Lane obligations and the gradual drop in FX swaps (at least until the next time Europe needs a Fed-based bail out that is). As can be seen in the chart below, Adjusted Reserves have tumbled to level not seen since December, and then May of 2011, both times when the market was about to turn over if not for global coordinated central bank intervention.
A 50-200 moving average crossover, based on months, not days (or even weeks).
The S&P 500 only dates back to March 1957. Since that time the 50-month MA has never crossed below the 200 month MA. The closest it came was the June 1978 monthly close, which gave us a 2.09 point spread between the 50-month (92.09) and the 200-month (90.00). During the 55-plus years that the S&P 500 has existed, there has never been an "Ultimate" Death Cross. At the end of last month, the spread was a little over 11 points.
How disastrous would a trip to the "Death Zone" be? Let's look further back in time. The chart below uses the S&P Composite data set popularized by Yale professor Robert Shiller. It consists of the monthly averages of daily closes since 1871 -- over 140 years of US market history.
"Consensus now expects year/year EPS growth to accelerate from 0% in 2Q, to 3% in 3Q to 17% in 4Q." Sorry, but this is not going to happen, and as more and more companies preannounce on the back of the global slowdown which many has seeing US GDP down to 1.3% in Q2, and sliding further in Q3 absent some massive QE program out of the Fed, it is virtually guaranteed that the unchanged Earnings precedent that Q2 will set (and there is a very high probability that Q2 2012 will mark the first YoY drop in earnings since the unwind Great Financial Crisis) will continue into Q3 and likely Q4. Because, sadly there simply is no catalyst that will drive revenues higher, even as margin contraction was already set in.
The only possible driver of S&P growth in Q3 (of which we are already 2 weeks deep into) and Q4 will be multiple expansion. This, however too, will be a disappointment. Again from Kostin:
We believe P/E multiple expansion is unlikely in 2H. Headwinds include the fast-approaching Presidential election, associated policy uncertainty, and the looming “fiscal cliff” that everyone outside the beltway decries but no one in Washington, DC seems willing to seriously address.
Not to mention the debt ceiling which is still on track from making US landfall sometime in the next 3 months.
So while short covering rallies are fast and furious, corporations -that traditional deus ex to justify US "decoupling" - now have only one fate before them: disappointment.
Our 2012 investment thesis for the US equity market has three pillars: a stagnating economy, static P/E multiple, and minimal earnings growth.
First, weak macro data and three proprietary Goldman Sachs indictors support our view of a lackluster economy. The Goldman Sachs Current Activity Indicator (CAI) shows the US economy growing at an annualized pace of just 1.3%. The three-month moving average of our Earnings Revision Leading Indicator (ERLI) diffusion index, a measure of 29 separate micro-driven industry data points, remains below trend at 41, consistent with a softening of our Global Leading Indicator (GLI). On the macro front, the June ISM report slipped to 49.7, the first sub-50 print in three years.
Second, we believe P/E multiple expansion is unlikely in 2H. Headwinds include the fast-approaching Presidential election, associated policy uncertainty, and the looming “fiscal cliff” that everyone outside the beltway decries but no one in Washington, DC seems willing to seriously address.
The third leg of our three part framework will come into clarity during the next several weeks as firms report 2Q results and offer guidance on business activity for the second-half of 2012. 80% of S&P 500 market cap will report between July 16th and August 3rd. Firms to watch next week include: BAC, C, GE, IBM, JNJ, KO, MSFT, PM, SLB, and VZ.
We expect a modest quarterly earnings miss. A shortfall in sales rather than margins will be the primary culprit. Firms will struggle to meet revenue forecasts given weak global demand and a strong US Dollar. Consensus margin expectations are already flat or negative in most sectors.
Bottom-up consensus currently forecasts flat year/year EPS growth, driven by a 4% increase in sales and a 40 bp fall in margins to 8.9%.
Five sectors are expected to post negative earnings growth in 2Q 2012 compared with 2Q 2011: Energy, Materials, Utilities, Consumer Discretionary and Consumer Staples. Analysts forecast Materials and Energy will both post year/year EPS declines of 12% reflecting the sharp fall in commodity prices during 2Q, with Brent plunging by 16% and copper dropping by 10%. In contrast, Industrials and Information Technology will report EPS growth of 7% and 11%, respectively. Apple (AAPL) will again be a standout performer with year/year sales and EPS growth of 32% and stable margins of 25.6%. Including AAPL, the Tech sector is forecast to deliver sales and EPS growth of 9% and 11%, respectively. Without AAPL, the sector will post revenue and EPS growth of 6% and 7%, respectively.
2Q results will affect the market’s outlook for earnings in 2012 and 2013. Consensus now expects year/year EPS growth to accelerate from 0% in 2Q, to 3% in 3Q to 17% in 4Q. Consensus forecasts full-year EPS growth will double from 7% in 2012 to 14% in 2013. In contrast, we do not forecast a steep 4Q 2012 inflection and anticipate EPS growth climbing from 3% in 2012 to 7% in 2013.
Our full-year 2012 and 2013 S&P 500 EPS forecasts remain $100 and $106. Current bottom-up consensus equals $103 and $117. Consensus 2012 estimate has dropped from $107 in January and from $114 in August 2011.
Earnings season focus points: (1) domestic demand; (2) international weakness; (3) margins; and (4) losses from JP Morgan’s CIO unit.
Our ERLI Diffusion Index suggests US micro data improved in June but the three-month moving average remains below trend at 41. In May, our diffusion index of micro driven, industry-level data points fell to 29, the lowest reading since April 2009 (a reading of 50 implies “trend” growth). However, data rebounded in June producing a slightly above trend reading of 53, with 23 of 29 industry variables increasing at a trend or better pace. Examples include hotel occupancy, rail car loadings, and NY/NJ port activity. If this trend persists, it implies that the micro data points which inform equity analysts’ earnings projections may not be as poor on a near-term basis as an otherwise gloomy macro picture suggests. In contrast, our macro driven Global Leading Indicator of industrial production has been contracting at an accelerating rate for the last three months, which our research has shown augurs poorly for S&P 500 returns.
Margins will once again be source of scrutiny. Margins have stabilized at 8.9% for more than a year after having surged by 300 bp from a cyclical low of 5.9% in 2009. Differing margin forecasts explain 80% of the gap between our top-down EPS estimate and bottom-up consensus for 2012. Consensus expects margins to remain flat during the first three quarters of 2012 before rising sharply starting in 4Q and expanding to 10% by year end 2013. In contrast, we forecast margins will hover around 8.9% for the next two years.
EARNINGS ROUNDUP: Problems heaviest In Europe and Asia but broadbased.
Companies Feel China's Slower Growth 07-16-12 WSJ China's slowing economy is beginning to hit the corporate bottom line at a number of foreign and domestic companies, as warnings of lower profitability set the stage for discouraging results in coming weeks. Since late Friday, major Chinese companies including electronic equipment maker ZTE Corp., China Eastern Airlines Corp., retailer Suning Appliance Co. and electronics maker TCL Communication Technology Holdings Ltd warned that results would be lower than expected. The reports helped send Shanghai's benchmark stock index down 1.7% on Monday despite a generally positive day in Asian markets. The reports followed similar ones in recent days from sportswear maker Li Ning Co. and Dongfeng Automobile Co. A number of foreign companies, including engine maker Cummins Inc and shoemaker Nike Inc of the U.S. as well as Burberry Group PLC of the U.K., have also indicated softening growth in demand in China.
Industrial profits, a measure that includes industrial companies with annual income above 20 million yuan ($3.1 million), have fallen 2.4% in the first five months of this year compared with a year earlier, according to the National Bureau of Statistics.
Business / Markets Majority of listed firms report earnings slump 07-13-12 China Daily More than half of the mainland's public companies reported lower earnings or losses in the first half, underscoring the challenges facing the economy. But analysts say the earnings outlook will improve in the second half, as pro-growth monetary and fiscal policies take effect. A total of 1,070 companies had released first-half results by Monday. Only 448 of them expected earnings to increase, according to data compiled by Financial China Information & Technology Co Ltd. As many as 130 companies said they lost money in the first six months of the year. The chemicals, automobile and machinery industries were the hardest hit.
Advertising Slips at Gannett - Gannett, publisher of USA Today, said second-quarter earnings fell 21% amid an ongoing slide in print ad revenue and lower circulation. Revenue edged down 2.1%.
Levi's Profit Falls 38% - Levi Strauss's fiscal second-quarter profit slid 38% as the jeans maker's revenue declined in Asia and Europe and as cotton costs continued to increase.
The sad 'this-is-how-politics-works' punchline of this brief animated clip is "those who can afford political influence get the benefits; and those who cannot afford it suffer the consequences" as Professor Matt Zwolinski attempts to balance the question the common claim that 'capitalism exploits the masses for the benefit of the few' - implicitly advocating increased government power - by suggesting (shock, horror) that government power may be more exploitative than free-market capitalism. In just over two minutes, Zwolinski argues that bigger government (thanks to cronyism among other things) makes citizens more vulnerable to exploitation given its power to coerce - intriguing given the recent comments by Obama.
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Tipping Points Life Cycle - Explained Click on image to enlarge
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