Archive for September 25th, 2012
Tuesday, September 25th, 2012
An article from three months ago on the SentimentCharts website noted the slowing YOY change in Private Fixed Investment (FPI) had signaled all seven U.S. recession over the last 45 years. The data used in the SentimentCharts’ article was through the first quarter of the year and an increase in the growth of FPI was seen. One quarter later though, through the second quarter, the YOY growth in FPI is slowing.
Private Fixed Investment is an element that goes into the calculation of GDP. In the BEA’s second release of second quarter GDP, they noted weakness in fixed investment as a cause for the deceleration of Q2 GDP.
“The deceleration in real GDP in the second quarter primarily reflected decelerations in PCE, in nonresidential fixed investment, and in residential fixed investment that were partly offset by a smaller decrease in federal government spending, an acceleration in exports, and a smaller decrease in private inventory investment.”
The slowing growth in fixed investment along with a significant increase in the number of companies lowering Q3 earnings guidance are just a couple of actors that should be a cause for concern for investors.
Posted in Markets | Comments Off
Tuesday, September 25th, 2012
With just one week of trading before the start of October, many portfolio managers are beginning the quarterly ritual of window dressing where they sell the quarter’s losers and buy the winners in an effort to make their portfolios look more attractive. While the impact of window dressing varies from quarter to quarter, there is evidence that it tends to have at least some impact.
With that in mind, the table below highlights the best and worst performing S&P 500 stocks so far this quarter. If window dressing were to actually have an impact this quarter, you would see the best performing stocks continue to outperform, while the losers lag.
Perhaps the most notable aspect of this quarter’s list of best performing S&P 500 stocks is that three of them are from the Telecom Services sector (PCS, S, and FTR). That may not sound like much, but when you consider the fact that the sector only has seven stocks, it is pretty impressive. Refinery stocks also had a good third quarter as three stocks in this group (TSO, PSX, and VLO) made the top eleven on our list of top 25 performing stocks. Finally, Google (GOOG) is the highest priced stock on the list. Even with a share price above $500, GOOG managed to rally 28% so far this quarter.
In terms of the quarter’s worst performing stocks, some individual Consumer Discretionary stocks were hit particularly hard. Of the 25 names shown below, nine are from the Consumer Discretionary sector, including some former leaders like TripAdvisor (TRIP) and Chipotle (CMG). Some individual Technology names also have had a rough go of it so far this quarter, and they all reflect what many believe to be a secular decline in the PC Industry. Names like AMD, DELL, INTC, and HPQ were all some of the biggest winners of the PC era. Now that the world has gone mobile, though, these companies are being relegated to the trash heap.
Subscribe to Bespoke Premium to receive more in-depth research from Bespoke.
Posted in Markets | Comments Off
Tuesday, September 25th, 2012
by Douglas Peebles, AllianceBernstein
Treasury-inflation protected securities, or TIPS, have been a popular choice for investors concerned about future inflation. And TIPS’ returns have been impressive in recent years. But the main contributor to TIPS’ performance isn’t inflation. It’s an ingredient that could become as hurtful down the road as it’s been helpful in the past.
While TIPS were the best-performing sector among high-quality assets in two of the past six years—2007 and 2011—and are leading so far in 2012, it’s interest-rate sensitivity we can thank. And interest-rate sensitivity is a sizable risk that could be very painful when rates rise again.
Indeed, inflation hasn’t been a major presence in recent years. The inflation rate has been relatively benign throughout the latest performance streak by TIPS. Inflation, as measured by the Consumer Price Index, has averaged between 2.0% and 2.5%.
The truth is that what’s been driving performance is falling interest rates. Over the last several years, US rates have plunged, with the 10-year Treasury yield falling from 4.7% at year-end 2006 to 1.6% on August 31, 2012. This has created a strong tailwind for bonds—and for TIPS in particular. A steady decline in rates has benefited TIPS more than Treasuries and more than the broad US bond market.
Why have TIPS benefited more? Because their higher interest-rate sensitivity—that is, their longer duration—magnified TIPS’ returns. The Barclays Capital US TIPS Index is almost 50% more sensitive to interest-rate changes than the standard Treasury bond index. This greater responsiveness put TIPS in position to receive the bigger price boost as rates tumbled. But with rates at all-time lows, having a longer duration now poses a big risk to TIPS.
So what happens when rates begin to rise again? In a rising-rate environment, longer-duration securities such as TIPS will underperform.
What about the inflation-protection component? What if inflation picks up? Importantly, it’s quite likely that if and when inflation does rise, TIPS’ yields will also be rising—and values will be declining—as the Federal Reserve tightens monetary policy. In that situation, the result of having a longer duration could more than offset the inflation protection.
So we’ve established that standard TIPS portfolios possess a lot more interest-rate risk than investors realized—or intended. Many investors looking for inflation protection have a taken on a lot more interest-rate risk too.
What do we think is the right strategy? Investors should harvest their recent gains now, but should continue to guard against the potential of rising inflation by moving into an inflation-protection strategy with a shorter-duration benchmark.
Inflation affects the longer-duration US TIPS benchmark and the shorter-duration US 1–10 Year TIPS benchmark in exactly the same way; thus, each offers an identical measure of inflation protection. The difference in return comes from how each responds to changes in interest rates, as shown in the display below.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Douglas J. Peebles is Chief Investment Officer and Head of Fixed Income at AllianceBernstein.
Copyright © AllianceBernstein
Tuesday, September 25th, 2012
by Neuberger Berman Investment Strategy Group
The “BRIC” countries have been a focal point of investor interest since the early 2000s. Brazil, Russia, India and China account for about half of the world’s population, boast vast natural resources and are among the fastest-growing economies in the world. That said, progress at times has been uneven. Since 2010, the MSCI BRIC Index has largely underperformed the S&P 500 as economic growth flagged. In this edition of Strategic Spotlight, we discuss current conditions and the outlook for these markets.
Following the global financial crisis of 2008–2009, the BRIC countries enjoyed a strong economic rebound as forceful policy measures reignited growth. However, a surge in capital inflows stoked inflation and led to tightening measures in 2010 and 2011. Currently, the BRICs are experiencing varying stages of easing as growth and inflation decline. Unlike the synchronous rebound we saw in 2009, progress in the BRIC countries is diverging due in part to idiosyncratic policy initiatives aimed at managing structural changes within their specific economies.
BRIC GROWTH RATES HAVE SLOWED
Brazil’s real GDP growth declined from 9.3% in the first quarter of 2010 to 0.5% in the second quarter of 2012—a number that disappointed investors looking for 3.5% GDP growth for all of 2012. The slowdown is partly a function of so-called macro-prudential measures—meant to fight inflation and control the appreciation of the real currency due to capital inflows—as well as a slowdown in exports. The tightening measures have had the desired impact of reducing inflation from 7.2% from last September to 4.1% in August 2012, but have also caused investment spending to plummet as the outlook for commodities (a key sector for Brazil) deteriorated. Domestic consumption, which accounts for about 60% of Brazilian GDP, has held up surprisingly well, supported by the country’s still-low unemployment rate.
Since the end of 2011, the Brazilian central bank has reduced interest rates, complementing the government’s recent accommodative fiscal measures such as payroll tax cuts. The OECD expects growth to pick up gradually in the third quarter as these measures work through the system.
Russia: The Limitations of Oil
The Russian economy has held up reasonably well in the past few years despite turmoil in Europe. Since the end of June 2012, real GDP has grown at around 4% annually, which is close to the post-crisis peak of around 5% in 2010. This good fortune is mainly due to relatively high oil prices and, most recently, fiscal spending ahead of the presidential elections in March 2012. Unlike Brazil, Russia is grappling with rising inflation as record-low unemployment has supported wage growth. In September, the country’s central bank surprised investors by hiking interest rates as inflation had come in above the bank’s target range of 5%–6%.
For the most part, Russia’s domestic consumption has been strong but the impact of declining oil demands from key trading partners such as Europe and China could have spillover effects—weakening the outlook for budget and current account balances. Concerns about an overheating economy have led to predictions that further tightening measures could be introduced, marginally reducing growth in 2013.
PERFORMANCE AND VALUATIONS
Source: FactSet as of Sept 17, 2012.
Despite a year-to-date equity market return of about 20% (see display), India’s real GDP growth continuously slowed to about 4% in the second quarter—a level last seen during the crisis of 2008–2009. Declining global growth, reductions in foreign investments and monetary tightening measures have contributed to a slowdown in manufacturing and services. In June, government agencies reported that foreign direct investments had decreased by as much as 67% from a year ago, as economic reforms stalled and business conditions were increasingly viewed as being biased against foreigners.
In addition, India is dealing with rising consumer price inflation, as recent cuts in government fuel subsidies and the effects of the monsoon season feed through the system. Consumer price inflation ramped up to 10% in August, reducing the scope for further rate cuts by the Reserve Bank of India. Moreover, warnings of a downgrade have been issued by rating agencies, given that India’s government finances are weaker than other BRIC countries. Investors are closely watching reform measures designed to promote competition and improve market efficiency following the decision last week to expand foreign companies’ access to the retail and airline industries.
China: Political Transitions
Recent data indicate that China continues to slow from tightening measures enacted in 2010–2011 and a decline in exports. Investors have been somewhat surprised by the government’s passivity toward this slowdown. Following small cuts in interest rates and reserve requirement ratios earlier in the year, the People’s Bank of China (PBoC) has not done more despite inflation dipping below its 3%–4% target. And while most analysts did not expect a repeat of the 2008–2009 RMB 4.0T fiscal stimulus, the government has acted less forcefully than expected.
The failure to act could be a result of widely reported complications in the current once-in-a-decade change to the country’s political leadership. Moreover, the PBoC could be concerned about magnifying the inflationary impact of loose monetary policy in developed countries. The political transition is expected to conclude by March 2013, potentially paving the way for better policy engagement. Regardless, the IMF expects China’s growth to reaccelerate next year.
A More Nuanced Progression
In the past decade, the BRIC countries have experienced rapid growth, but are now showing signs of slowing down as cheap labor and abundant resources are beginning to yield a diminishing impact on their economies. As such, investors should consider looking towards the rising middle class to lead the charge in driving growth.
Before we reach that point, however, we believe some structural reforms will need to be made. Investors should remain vigilant of the various policy prescriptions during this period to avoid potential speed bumps. Not every policy change will be successful, but if imbalances are adequately addressed, the BRIC countries should continue to offer investment opportunity.
This material is presented solely for informational purposes and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. The views expressed herein are generally those of Neuberger Berman’s Investment Strategy Group (ISG), which analyzes market and economic indicators to develop asset allocation strategies. ISG consists of five investment professionals who consult regularly with portfolio managers and investment officers across the firm. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events may differ significantly from those presented. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
Tuesday, September 25th, 2012
by Jeffrey Saut, Raymond James
September 24, 2012
At 10:00 A.M. that day in London, Alexander telephoned … he wanted to know why the dollar was plunging. When the dollar moved, it was usually because some other central banker or politician somewhere had made a statement … but there was no such news. I told Alexander that several Arabs had sold massive holdings of gold, for which they had received dollars. They were selling those dollars for marks and thereby driving the dollar lower … I spent much of my working life inventing logical lies like this. Most of the time when markets move, no one has any idea why. A man who can tell a good story can make a good living as a broker. It was the job of the people like me to make up reasons, to spin a yarn. And it’s amazing what people will believe. Heavy selling out of the Middle East was an old standby. Since no one ever had any clue what the Arabs were doing with their money or why, no story involving Arabs could ever be refuted. So if you didn’t know why the dollar was failing, you shouted out something about the Arabs. Alexander, of course, had a keen sense of the value of my commentary. He just laughed.
… Michael Lewis, “Liar’s Poker”
So wrote Michael Lewis in his bestselling book Liar’s Poker that was first published in 1989. Recall that fresh out of Princeton, and the London School of Economics, Michael Lewis landed a job at the esteemed institutional brokerage firm of Salomon Brothers. Over the ensuing three years he rose from a trainee to an institutional salesman making millions of dollars. Subsequently, he left Salomon and penned the aforementioned book, which is an insider’s expose of an unprecedented era of greed and gluttony. While that era died, along with the secular bull market, I still find many of his humorous insights to be right on the mark. I remembered said quip last week when someone asked, “Who is buying stocks and preventing the stock market from correcting?!” Without even thinking I responded, “The buying is coming out of the Middle East because the rising turmoil is causing a flight to safety; and the safest place in the world is the U.S.A.” My caller then asked, “Really, why is that?” My response went like this:
In additions to being a country of laws, as well as the world’s reserve currency, you are not going to wake up one morning and find out you no longer are using euros but drachmas [the previous Greek currency] that have been devalued by 50%. Indeed, the U.S. is in the best position seen in years. To wit, there are four basic inputs that are needed to drive economic activity: 1) labor, 2) energy, 3) raw materials, and 4) financial capital. Plainly, with the current high unemployment rate we have a huge reservoir of labor. Second, the collapse in natural gas prices, and new technology in drilling, has caused our energy analysts to opine that the U.S. is moving toward energy independence. Third, worries about a Chinese economic slowdown has pressured most raw material prices down to levels far below where they were a few years ago (exception, precious metals). As for financial capital, in this country we have record low interest rates and if rates are inflation-adjusted the effective cost of capital is zero.
“You’re just a cockeyed optimist,” was my caller’s response. That’s patently untrue, I wrote about the Dow Theory “sell signal” in September 1999, as well as the Dow Theory “buy signal” in June 2003. Then there was the Dow Theory “sell signal” in November 2007; and, I was very bullish in March of 2009. As my father used to tell me, “If you think the market is going up be bullish and if you think it’s going down be bearish.” Manifestly, I have been pretty bullish for more than three years with intermittent “cries” for caution along the way. As often stated, all you had to get right for the past three years has been to raise some cash in the spring and put it back to work sometime during the summer. That reoccurring strategy has worked because economic numbers began to soften every spring for the last three years. That brings on worries of another recession, which causes analysts to cut their earnings estimates followed by a decline in stock prices. When no recession shows up, they start raising their estimates and the stock market rallies. And, believe it or not, that’s what is happening currently, as can be seen in the attendant Net Earnings Revisions chart from our friends at the Bespoke Organization (please see page 3). However, despite this improving earnings backdrop investors continue to shun stocks, worried about Euroquake, our dysfunctional congress, Middles East unrest, China’s slowing economy, etc. Meanwhile, many pundits have heightened those worries by talking about the weakness of the D-J Transportation Average ($TRAN/4910.79), as well as a Dow Theory “sell signal.” The last time this same crowd trumpeted a Dow Theory “sell signal” was back in May when the Industrials fell below their mid-April lows confirmed by a similar move from the Trannies. At the time I was adamant that according to my work there had been NO Dow Theory “sell signal,” which is the same stance I am taking now. In my opinion, the Trannies were affected last week by a downgrade of the railroad stocks from a major brokerage firm, a depression in the coal industry (less rail traffic), and the weather (hurricane Isaac). Regrettably, it will be a few months before we see if that is the correct “call.”
Certainly many of the sectors, as well as indices, think that is the correct “call” because the Biotechnology, Consumer Discretionary, Consumer Staples, and Healthcare sectors have traded to new all-time highs. Ditto, the S&P Equal Weighted Index, the S&P 400 Mid Cap Index, the S&P 600 Small Cap Index, and the Value Line Arithmetic Index have traded to new all-time highs. If past is prelude it should not be too long before the S&P 500 (SPX/1460.15) does the same thing. Of course this differs with the election year chart I have been using this year, which telegraphed a peak for the SPX at the beginning of September follow by a pullback into mid/late-October and then a rally to higher highs. And, it looked like we were going to get a continuation of that election year trading pattern until the Federal Reserve announced QEternity. On that announcement the 98% correlation with the typical election year trading pattern completely fell apart as the INDU vaulted 206 points. The Dow Delight, however, left ALL of the macro sectors I monitor severely overbought; as well, the NYSE McClellan Oscillator was about as overbought as it ever gets.
Accordingly, in last Monday’s missive I wrote:
An overbought condition can be resolved in one of two ways. First, the SPX can pause and move sideways while the overbought condition is remedied. Second, the SPX can pull back to what had previously been an overhead resistance level, but now becomes a support zone. In the current case that would entail a pullback to 1400 – 1422 for the SPX. Importantly, when the stock market generates an overbought condition of last week’s magnitude it suggests there is more strength coming in the future after the overbought condition is rectified. Indeed, uptrends typically do not end on really high overbought readings from the NYSE McClellan Oscillator. So, while two weeks ago I thought we were reaching for a short-term “trading top,” I believe that following some kind of pullback, or sideways movement, the major market indices will go higher.
In Tuesday’s verbal strategy comments I modified the strategy by noting that given Monday’s trading pattern we were probably going to get a sideways correction; and that’s exactly what we got last week, which brings us to this week.
The call for this week: Speaking to the divergence of the Industrials and the Transports, Bespoke had this to say:
Over the last six months, the Dow (DJIA) is up 3.47%, while the Transports are down 7.90%. While wide, the 6-month spread in performance between the two is not out of the ordinary, as shown in the chart (see page 3). At the same time, peaks and troughs in the performance spread have not really been bullish or bearish for the future direction of the overall market either. While the spread could widen more, it’s likely that we’ll see a reversal in the relative underperformance of the Transports in the near future, but that doesn’t mean the Dow is doomed (see chart).
Obviously I agree, yet it still does not feel like the stock market is ready to leap higher until we spend a few more sessions working off the overbought condition …
Copyright © Raymond James
Tuesday, September 25th, 2012
Via Bill Blain of Matrix Group Ltd
“I propose we stop worrying about Europe and go for a “good” lunch instead…”
German business confidence y’day. France today? Pants is the only way to describe growth prospects across Europe! Which means the debt crisis goes on and on and on. So the Euro is lower, and it kind of confirms the benignsummer market that saw the Euro rally, sovereign debt tensions lessen and bank stocks recover is likely to dissolve in the autumnal rains – which we saw in bucketfuls here in London.
At the risk of sounding a broken record…, a broken record…, a broken record… Hic.. I’m reckoning the final quarter of 2012 is going to prove increasingly challenging. All the issues the EU Elites were able to bury, smooth and bluster through the summer are coming back to the fore. The immediate challenges are Spain, contagion, and banks, and who knows how many sucker punches wait in the wings?
European banks. Don’t ya just love ‘em. The papers are full of news about how they might (or might not be regulated) and how much new capital the Spanish banks might need following the Wyman audit. The question is whether the recent rally across bank stocks and bonds can be maintained. Some bank analysts believe the problems are contained – unique to Spain, a special situation and non-contagious. Don’t believe it.
Thru September we’ve seen an absolute deluge of bank primary senior and some subordinated bank debt debt. So no surprise more than one major Investment Bank has gone market positive on bank paper – after all its much easier to provide liquidity in paper you’re positive will sell. I’m always fascinated and more than a little suspicious when banks go “Market Overweight” on subordinated bank debt. I suspect the recent rally across financials looks to be a product of the benign news-less summer markets rather than a fundamental improvement in conditions for banks.
Let’s start with mean reversion – a phrase analysts love. It might be time to short the Financial Sub iTRAXX CDS index on the basis it peaked at 600 in November – it’s now tightened to around 310.
What drove that tightening? LTROs at the close of last year and then the Draghi promise to do whatever is required. But, but, and but again – nothing fundamental has been fixed regarding European banking. We’re still waiting for definitive rules on many issues and the regulatory burden on banks is growing. The highlight of the early summer was the US regulatory pop at Standard Chartered as a Rogue Bank.. Wowser.. is there nothing a politician looking to make a name will not stoop to?
But “Front Page of the FT” risks still loom large for banks. Many leading names are still implicated in the unravelling Libor farce, while news that Singapore’s Temasek is going to exit its Standard Bank stake is noteworthy. We’ve still got banks across Europe sitting on asset portfolios and commercial property valuations that are “imaginative” at best.
The banks talking up capital say the risks have lessened: Better outlook for Europe and“Burden-sharing” (ie, converting sub debt holders into stock during a crisis) is less a risk for Spain’s bad banks and therefore isn’t something holders across the rest of Europe’s rickety banks should worry about. They say burden-sharing “bail-ins” will be an absolute last resort that will only be imposed after voluntary Liability Management deals. That sounds a bit of triumph of hope over reality.
We still don’t know how bad Spanish banks are. (We’ll have a better handle on Friday.. and if anyone is expecting a pleasant upside surprise from the Wyman audit I’ve got some Bankia bonds I’d like to sell you!) If anyone is keen to invest in the new Spain bad bank – do let us know. It reeks of political compromise. To my jaundiced mind its more likely Spain’s difficulties will translate into political pressure for increased – not less – burden sharing by bank holders. And in the very worst cases I don’t expect it to stop at sub debt – look out senior holders.
And the stock rally in Banks? Well compare and contrast Europe with the US. The Fed aggressively forced banks to raise capital and address their weaknesses. In Europe we’ve seen a smorgasbord of regulatory bluster and little agreement. CRD and Basel III capital standards are somewhere down the line… 2019? Well at least there will likely be less banks to regulate. And the left hand has no idea what the right is doing – hence capital strapped banks waste time on branch sales and enforced poison liquidity rules.
In poor markets, it’s no wonder banks are de-leveraging by cutting lending (and accelaterating recession) instead of raising new capital. Well at least the Euro Elites understand it.. This morning we have Bank of Italy chief Visco saying “Italian Banks lowering Leverage Reduces Risk…” Pass me a doughnut..
Posted in Markets | Comments Off
Tuesday, September 25th, 2012
Upcoming US Events for Today:
- Case-Shiller 20-city Index for July will be released at 9:00am. The market expects a year-over-year increase of 1.2% versus an increase of 0.5% previous.
- Consumer Confidence for September will be released at 10:00am. The market expects 63.0 versus 60.6 previous.
- The FHFA Housing Price Index for July will be released at 10:00am. The market expects 0.8% versus 0.7% previous.
- The Richmond Fed Manufacturing Index for September will be released at 10:00am. The market expects –4 versus –9 previous.
Upcoming International Events for Today:
- German Consumer Confidence for October will be released at 2:00am EST. The market expects 5.9, consistent with the previous report.
- Canadian Retail Sales for July will be released at 8:30am EST. The market expects a month-over-month increase of 0.2% versus a decline of 0.4% previous.
Markets ended lower to start the week as commodities succumbed to selling pressures. Oil, Copper, and Silver each sold off by more than 1%, while Palladium topped them all, producing a decline of 3.34%. Commodity markets began to destabilize last week leading into the quarterly futures expiration date on Friday. A number of commodities produced bearish momentum crossovers with respect to MACD, RSI, and Stochastics. The price action of Crude Oil is even showing a bear flag formation, resisting off of a now broken 50-day moving average, hinting of further declines to come. The period of seasonal strength for oil concludes around this time of year as favourable influences pertaining to the summer driving season come to an end. Other commodities also realize declines into the month of October as the US Dollar typically stabilizes into the start of the new quarter. Momentum sell signals provided today combined with negative seasonal influences give reason to believe that a correction within commodity markets has begun. Many commodities, including Gold and Silver, resume seasonal uptrends into the months of November and December.
It is well known by now that volatility, as measured by the VIX, remains depressed. The jury is still out as to what this represents: complacency indicative of peaks or bullishness indicative of further gains to come. Over the past three years when the VIX has fallen to current levels of apparent support, a correction in equity markets has typically followed. Another gauge of volatility is also showing a similar stat. The 20-day Average True Range for the S&P 500 has fallen to the lowest levels since February 2011. Over the past three years as the 20-day Average True Range hit levels equivalent to what is presently being realized, an intermediate top in equity markets is typically confirmed within the days to follow. Yesterday we reported that the S&P saw the tightest 5-day closing range last week since 1989, suggesting debate amongst investors as to whether further buying is justified given present equity valuation and uncertainty surrounding the upcoming earnings season. Volatility is more indicative of bear market conditions, so the fact that volatility itself is subdued doesn’t necessarily mean a significant peak is confirmed, but investors may be reluctant to chase at present levels given the late stages of the equity market rally.
Sentiment on Monday, according to the put-call ratio, ended bullish at 0.79.
Chart Courtesy of StockCharts.com
Chart Courtesy of StockCharts.com
- Closing Market Value: $12.62 (down 0.55%)
- Closing NAV/Unit: $12.65 (down 0.38%)
|2012 Year-to-Date||Since Inception (Nov 19, 2009)|
* performance calculated on Closing NAV/Unit as provided by custodian
Click Here to learn more about the proprietary, seasonal rotation investment strategy developed by research analysts Don Vialoux, Brooke Thackray, and Jon Vialoux.
Tuesday, September 25th, 2012
Summer 2012 in Europe
I have clearly had another change in sentiment on the outlook for assets in Europe. At the height of the crisis I was an unabashed bull. The timing of this Bloomberg TV interview couldn’t have been better, but in general the bull case was based on 3 things
- Not doing anything was risking catastrophe and a Eurozone wide banking run, followed by a freeze in economic activity
- That the Spanish bank bailout deal would progress and had been designed to get banks up and running in a timely manner
- Prices already reflected much of the risk and little of the upside
From the moment of the “whatever it takes” speech, where Draghi clearly answered my How Dumb is Draghi question, European markets rallied.
The Spanish bank bailout seemed to be running slower than I would have liked, nothing was getting done in Greece, but at least Draghi seemed determined to follow up on his promise (or threat if you were short). His first ECB after the big pronouncement was a bit of a dud, but he said enough to keep the markets happy.
Too many people focused on the German “Nein Nein Nein” when in reality, Nein didn’t mean No. So the markets remained underwhelmed by the prospects, but Draghi surprised many by launching OMT.
My initial reaction to the program and the press conference was that while it didn’t go far enough, it had demonstrated a big change in attitude. The plan was comprehensive, well thought out, and most importantly, ACTIONABLE. Everything about the plan showed that it was designed to be implemented within the existing scope and framework of the ECB and the EFSF and would only benefit from ESM approval. It went to great lengths to address investor concerns (allegedly pari passu for example) while pushing the envelope so that Germany couldn’t stop it, as it was “within the ECB’s mandate”.
I had three reasons to be long, each of those has been dialed back significantly, if not outright removed.
Prices Now Reflect Balanced Risk Reward
In Spain, the IBEX went from 6,000 to 8,150, 5 year bond yields went from 7.5% to 4.2% and CDS went from 650 to 350.
In Italy, the MIB went from 12,500 to 17,000, 5 year bond yields went from 6.3% to 3.8%, and CDS went from 580 to 310.
So my view that prices already reflected much of the risk no longer makes sense. The markets performed incredibly well. We saw “re-coupling” of epic proportions. Greek, Portuguese and Irish debt went along for the ride. Greek PSI bonds have almost doubled off their lows. The returns have been great, but now represent a much more balanced risk/reward than before. Even in OMT goes into effect
Bank Bailouts Delayed and Economies Suffer
There is a clear link between banking health and economic activity. Whether it is as simple as loan availability impacting car sales (from Nick Colas at Convergex) to bigger projects, economies cannot function well, while their banks are struggling. The U.S. learned that during the crisis. The Greeks should have, yet NBG and other Greek banks continue to live on in some cruel zombie purgatory. Yet, Spain and the EU still don’t seem to get it.
Bankia should have received capital already. Other banks should have been in the midst of the restructuring. Instead, we have a pretty MOU, and more committees. Europe continues to act as though the “promise” of money acts the same as “actual” money. While the stock market may react well to promises, the real economy tends not to. Yes, the nature of all these diffusion indices means we will likely see some bounces in the data (it really is almost physically impossible for each month to be worse, or “worser” than the month before) but the real economy has limited hope of improvement when the banks are a total mess.
I was willing to play along that the delays made sense, but at this stage I cannot see any justification for the delays, which indicates something deeper is going on behind the scenes.
The focus on a pan-European bank regulator or something seems like a pure smokescreen. Nothing like that would have prevented the crisis and nothing like that will help their current balance sheets. Would it possibly ease the way, down the road for some sort of kind of maybe possible deposit insurance? Sure, I’ll give that, but there is no immediate tangible benefit, this is once again Europe trying to create an aura of co-operation and support, without any real support.
I think there is a growing risk that longer dated bond holders get punished with some form of PSI. It’s just a feeling, a perception, but it feels like some European leaders are going to demand “their pound of flesh” in the form of PSI for longer dated bondholders. They have sympathy for “shorter dated bond holders” since they themselves encouraged purchases of those bonds, and even enabled it with ECB money. Any PSI is unlikely to be rational or fair, since the intent is to punish and show a strong hand to the public. Unlike sovereign PSI, I would expect many more legal challenges. Again, this is out there, and new to my thinking, but isn’t inconsistent with various comments and interpretations of comments.
So Europe doesn’t have the willingness to truly support banks, and now that it is obvious, it is hard to see a dramatic improvement in the economies, which is needed to support valuations here.
The Window on OMT is Closing
OMT was a stretch. Draghi looked for loopholes and seemed to have found them. Merkel could pretend to be surprised and the Bundesbank could complain, but in the end they could shrug their shoulders and say that the ECB was acting “independently” as it should.
I have argued repeatedly, that Draghi is desperate to get pregnant. He wants to start OMT NOW!!!! He knows he stretched the mandate. He knew some countries (Finland) and some National Central Banks (Bundesbank) would be opposed from the start. He knows that in each and every country within Europe there is growing disagreement over the direction that the EU and ECB have been going. He knows that while the ESM was only be challenged in the German courts, there is risk of other challenges.
He wanted to launch a program, buy bonds, “get pregnant” so that he could continue to grow the balance sheet to the point that the dissenters would get more scared of losses from existing positions than of growing the positions. That has been a key element of all European policies. They have been “slippery slope” policies, where once they started on small or even temporary policies, the fear of being exposed as having been wrong, has lead them to expand their policies.
Draghi needs that on OMT. Every day that goes by, increases the risk that the deal is challenged.
I also strongly believe that the IMF could have made the terms of OMT relatively favorable for Spain and Italy. They could have gone along the lines of the “Fiscal Compact” which both countries have already agreed to. That would have caused some screams in German and even Greece, but they probably could have pushed it through in the confusion.
But now opposition has had time to organize. If the ECB’s plan is really within its mandate (and growing risk of investigations into that), then the other way to stop it, is to make terms harsh, with regular check-ups.
The ability to sneak through an agreement with few obligations on the part of Spain or Italy, and relatively few ongoing checks and balances is diminishing. There will now be strong opposition to this, and that opposition has recovered from the initial shock when they could possibly have been railroaded.
Finally, Mme Lagarde’s latest attempt to become involved in the money throwing party is unlikely to give anyone, including the U.S., a sense that she is performing her duties in an unbiased way. She is rapidly losing trust, as more people see her going out of her way to support her beloved Europe without representing her constituents (U.S., China, Japan, etc.). She seems left out as not being in the top 5 most important people in the world (along with fellow unelected bankers Ben and Mario).
So there is growing distrust of the IMF, at least outside of Europe, and even within Europe, reports that some countries are unhappy with their policies and monitoring in existing recipient countries.
On the other side, you have Rajoy. Enough said. If you are a bear, he is your best friend.
So something may get cobbled together, but I think the opportunity for a less onerous plan is long gone. We will now see something with conditions that the market doesn’t believe will be met, coupled with regular check-ups that would terminate the plan when those conditions aren’t met. More muddling along, which neither the market, nor the economy will react positively to.