3 reasons Eurozone’s investors love Danish bonds

Sunday, July 15th, 2012

by Sober Look

Would you pay Denmark’s government 0.6% to hold your money for two years? Sounds strange, but that’s exactly what investors are now doing. Denmark’s government paper yields just hit new lows. And it’s not only the short-term bills with the negative yield (short term bills sometimes go negative when investors seek immediate liquidity). The 2 and 3-year notes are now also comfortably in the negative territory as Eurozone’s investors simply can’t get enough.

Denmark’s 2 and 3-year government yields

Why do the Eurozone investors love Demark’s bonds so much that they are willing to lock in negative yields for 2-3 years? Here are 3 key reasons:

1. Eurozone based investors are not taking much FX risk because Denmark keeps EUR-DKK exchange rate tightly pegged.

DKK per 1 euro

2. Investors love Denmark’s economic fundamentals, particularly the relatively low government debt and deficit.

Source: Bloomberg/BW

3. Keeping funds outside the Eurozone may provide a hedge against potential problems associated with the monetary union’s stability.

Bloomberg/BW: – If the euro crisis worsens, foreign capital may keep pouring in, negative rates or no. Says Ian Stannard, chief European currency strategist at Morgan Stanley in London: “For an international investor with euro zone exposure, buying Danish assets can be a hedge against the extreme scenario of the euro breaking up.”

SoberLook.com

Tags: Bloomberg, Bw 3, Currency Strategist, Demark, Dkk Exchange Rate, Economic Fundamentals, Euro Zone, Extreme Scenario, Government Debt, Government Paper, International Investor, Key Reasons, liquidity, Lows, Monetary Union, Morgan Stanley, Negative Territory, Stannard, Term Bills, Zone Exposure
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Eric Sprott: The Real Banking Crisis, Part II

Friday, June 1st, 2012

by Eric Sprott and David Baker, Sprott Asset Management

Here we go again. Back in July 2011 we wrote an article entitled “The Real Banking Crisis” where we discussed the increasing instability of the Eurozone banks suffering from depositor bank runs. Since that time (and two LTRO infusions and numerous bailouts later), Eurozone banks, as represented by the Euro Stoxx Banks Index, have fallen more than 50% from their July 2011 levels and are now in the midst of yet another breakdown led by the abysmal situation currently unfolding in Greece and Spain.

EURO STOXX BANKS INDEX

Source: Bloomberg

On Wednesday, May 16th, it was reported that Greek depositors withdrew as much as €1.2 billion from their local Greek banks on the preceding Monday and Tuesday alone, representing 0.75% of total deposits.¹ Reports suggest that as much as €700 million was withdrawn the week before. Greek depositors have now withdrawn €3 billion from their banking system since the country’s elections on May 6th, seemingly emptying what was left of the liquidity remaining within the Greek banking system.² According to Reuters, the Greek banks had already collectively borrowed €73.4 billion from the ECB and €54 billion from the Bank of Greece as of the end of January 2012 – which is equivalent to approximately 77% of the Greek banking system’s €165 billion in household and business deposits held at the end of March.³ The recent escalation in withdrawals has forced the Greek banks to draw on an €18 billion emergency fund (released on May 28th), which if depleted, will leave the country with a cushion of a mere €3 billion.⁴ It’s now down to the wire. Greece is essentially €21 billion away from a complete banking collapse, or alternatively, another large-scale bailout from the European Central Bank (ECB).

The way this is unfolding probably doesn’t surprise anyone, but the time it has taken for the remaining Greek depositors to withdraw their money is certainly perplexing to us. Official records suggest that the Greek banks only lost a third of their deposits between January 2010 and March 2012, which begs the question of why the Greek banks have had to borrow so much capital from the ECB in the meantime.⁵ Nonetheless, we are finally past the tipping point where Greek depositors have had enough, and the past two weeks have perfectly illustrated how quickly a determined bank run can propel a country back into crisis mode. The numbers above suggest there really isn’t much of a banking system left in Greece at all, and at this point no sane person or corporation would willingly continue to hold deposits within a Greek bank unless they had no other choice.

The fact remains that here we are, in May 2012, and Greece is right back in the exact same predicament it was in before its March 2012 bailout. Before the bailout, Greece had approximately €368 billion of debt outstanding, and its government bond yields were trading above 35%.⁶ On March 9th, the authorities arranged for private investors to forgive more than €100 billion of that debt, and launched a €130 billion rescue package that prompted Nicolas Sarkozy to exclaim that the Greek debt crisis had finally been solved.⁷ Today, a mere two months later, Greece is back up to almost €400 billion in total debt outstanding (more than it had pre-bailout), and its sovereign bond yields are back above 29%. It’s as if the March bailout never happened… and if you remember, that lauded Greek bailout back in March represented the largest sovereign restructuring in history. It is now safe to assume that that record will be surpassed in short order. It’s either that, or Greece is out of the Eurozone and back on the drachma – hence the renewed bank run among Greek depositors.

Meanwhile, in Spain, bank depositors have been pulling money out of the recently nationalized Bankia bank, which is the fourth largest bank in the country. Depositors reportedly withdrew €1 billion during the week of May 7th alone, prompting shares of Bankia to fall 29% in one day.⁸ The Bankia run coincided with Moody’s issuance of a sweeping downgrade of 16 Spanish banks, a move that was prompted over concerns related to the Spanish banks’ €300+ billion exposure to domestic real estate loans, half of which are believed to be delinquent.⁹ The Spanish authorities were quick to deny the Bankia run, with Fernando Jiménez Latorre, secretary of state for the economy stating, “It is not true that there has been an exit of deposits at this time from Bankia… there is no concern about a possible flight of deposits, as there is no reason for it.”¹⁰ Funny then that the Spanish government had to promptly launch a €9 billion bailout for Bankia the following Wednesday, May 24th, an amount which has since increased to a total of €19 billion to fund the ailing bank.¹¹ Deny, deny some more… panic, inject capital – this is the typical government approach to bank runs, but the bailouts are happening faster now, and the numbers are getting larger.

The recent bank runs in Greece and Spain are part of a broader trend that has been building for months now. Foreign depositors in the peripheral EU countries are understandably nervous and have been steadily lowering their exposure to Eurozone sovereign debt. According to JPMorgan analysts, approximately €200 billion of Italian government bonds and €80 billion of Spanish bonds have been sold by foreign investors over the past nine months, representing more than 10% of each market.¹² The same can be said for foreign deposits in those countries. Citi’s credit strategist Matt King recently reported that, “in Greece, Ireland, and Portugal, foreign deposits have fallen by an average of 52%, and foreign government bond holdings by an average of 33%, from their peaks.”¹³ Spain and Italy are not immune either, with Spain having suffered €100 billion in outflows since the middle of last year (certainly more now), and Italy having lost €230 billion, representing roughly 15% of its GDP.¹⁴

Tags: Bailout, Bank Of Greece, Banking Crisis, Banking System, Bloomberg, Business Deposits, Collapse, David Baker, Depositors, ECB, Emergency Fund, Eric Sprott, Escalation, Euro Stoxx, Greek Banks, Infusions, liquidity, Reuters, S 165, Sprott, Withdrawals
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Trade Idea of the Week: Gold Rush … To The Exit

Tuesday, May 22nd, 2012

Gold Rush … to the Exit

by Wade Guenther, Horizons ETFs
Gold bullion was the poster child for lofty returns in 2011, boasting a 10.06% increase over the tumultuous period, December 31, 2010 to December 30, 2011. Surprisingly, the gold producer returns lagged gold bullion returns in 2011 with the NYSE Arca Exchange Gold BUGS Index and the S&P/TSX Global Gold™ Index achieving -13.01% and -14.32% returns respectively over the same period.

How can we profit from understanding the gold bullion and the gold producer relationship?

Gold Spot, NYSE Arca Exchange Gold BUGS and S&P/TSX Global Gold™ Index Returns: 2007 – 2012 (Click to enlarge)

Source: Bloomberg, between May 7, 2007 and May 8, 2012.

Gold bullion experienced daily increases 54.16% of the time over the measurement period, May 7, 2007 to May 8, 2012. The NYSE Arca Exchange Gold BUGS Index and the S&P/TSX Global Gold™ Index had daily increases 49.23% and 46.89% of the time, respectively over the same period.

The difference between gold bullion and gold producer returns became exacerbated when gold bullion returns were negative. Gold bullion experienced daily decreases of -1.00%, or less, 16.90% of the time between May 7, 2007 and May 8, 2012. However, the NYSE Arca Exchange Gold BUGS Index and the S&P/TSX Global Gold™ Index had daily decreases of -1.00%, or less, 32.90% and 31.53% of the time respectively, over the same period. The frequency of daily losing periods for gold producers was almost 2 times greater than the frequency of losing periods for gold bullion.

Over the shorter reference period, of August 22, 2011 to May 8, 2012, gold bullion reached a high $1897.60 $USD/oz. on August 22, 2011 and had a -13.32% return and an annualized standard deviation of 18.97%.

Gold Spot, NYSE Arca Exchange Gold BUGS and S&P/TSX Global Gold™ Index Returns: August 22, 2011 to May 8, 2012 (Click to enlarge)

Source: Bloomberg, between August 22, 2011 and May 8, 2012.

There is a noticeable divergence between gold bullion and the gold producer returns over this shorter gold bullion downtrend. The NYSE Arca Exchange Gold BUGS Index and the S&P/TSX Global Gold™ Index experienced -30.77% and -27.82% returns respectively between August 22, 2011 and May 8, 2012. The volatility of the indices were significantly higher than gold bullion with a 30.36% and 29.82% annualized standard deviation for the NYSE Arca Exchange Gold BUGS Index and the S&P/TSX Global Gold™ Index respectively, over the same measurement period.

There is a positive outlook, from analyst’s consensus, for the gold producers with higher expected earnings per share in the second and third quarters of fiscal 2012.

NYSE Arca Exchange Gold BUGS and S&P/TSX Global Gold™ Index Fiscal 2012 Actual and Estimated Quarterly Earnings and Dividends

Source: Bloomberg, as of May 8, 2012.

Actual = Trailing 3 month actual weighted average earnings for the index members
Q Est = Index weighted average of the member estimates for the current quarter
Q+1 Est = Index weighted average of the member estimates for the next quarter
Q+2 Est = Index weighted average of the member estimates for the two quarters forward

Generally, analysts are forecasting dividends to decrease which could be considered a growth indicator because companies may use the retained dividends to invest in higher yielding investment opportunities versus distributing cash to the public.

The ratio between the gold producers and gold bullion also becomes an interesting metric.

Gold Producer-to-Gold Bullion Ratio: 2007 – 2012 (Click to enlarge)

Source: Bloomberg, between May 7, 2007 and May 8, 2012.

The gold producer-to-gold bullion ratio was 0.178, as of May 8, 2012. The last significant low gold producer-to-gold bullion ratio was a value of 0.215 on October 27, 2008. Following the October 2008 low gold producer-to-gold bullion ratio, the S&P/TSX Global Gold™ Index increased 120.36% between October 27, 2008 and February 18, 2009 whereas gold bullion increased by only 34.77% over the same period.

If you believe that gold bullion returns will be positive and gold producer returns will be negative:
- HUG (1x): 100% exposure to gold bullion
- HBU (2x): 200% leveraged exposure to gold bullion
- HIG (1x): 100% inverse exposure to the S&P/TSX Global Gold™ Index
- HGD (2x): 200% leveraged inverse exposure to the S&P/TSX Global Gold™ Index

If you believe that gold bullion returns will be negative and gold producer returns will be positive:
- HBD (2x): 200% leveraged inverse exposure to gold bullion
- HGU (2x): 200% leveraged exposure to the S&P/TSX Global Gold™ Index

If you believe that gold producers will experience higher volatility than gold bullion:
- HEP (1x): Exposure to a portfolio of gold producer securities with a buy-write covered call strategy

If you believe that the price of gold bullion will experience higher volatility than gold producers:
- HGY (1x): Exposure to gold bullion with a buy-write covered call strategy

The views expressed herein are of a general nature and this Trade Idea is not and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.

ETF Performance as of April 30, 2012

Wade Guenther, CFA
ETF Research Analyst
Horizons Exchange Traded Funds

HUG Investment Objective
The Horizons COMEX® Gold ETF (“HUG”) seeks investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs, that endeavour to correspond to the performance of the COMEX® gold futures contract for a subsequent delivery month. Any U.S. dollar gains or losses as a result of the HUG’s investment will be hedged back to the Canadian dollar to the best of the HUG’s ability. If HUG is successful in meeting its investment objective, its net asset value should gain approximately as much, on a percentage basis, as any increase in the COMEX® gold futures contract for a subsequent delivery month when the COMEX® gold futures contract for that delivery month rises on a given day. Conversely, HUG’s net asset value should lose approximately as much, on a percentage basis, as the COMEX® gold futures contract for a subsequent delivery month when the COMEX® gold futures contract for that delivery month declines on a given day.

HEP Investment Objective
The investment objective of the Horizons Enhanced Income Gold Producers ETF (“HEP”) is to provide unitholders with: (a) exposure to the performance of an equal weighted portfolio of North American based gold mining and exploration companies; and (b) monthly distributions of dividend and call option income. Any foreign currency gains or losses as a result of HEP’s investment in non-Canadian issuers will be hedged back to the Canadian dollar to the best of its ability.

HEP invests primarily in a portfolio of equity and equity related securities of North American companies that are primarily exposed to gold mining and exploration and that, as at each semi-annual rebalance date, are amongst the largest and most liquid issuers on the TSX in that sector. HEP will rebalance, on an equal weight basis, the portfolio of constituent securities on each semi-annual rebalance date.

To mitigate downside risk and generate income, HEP will generally write covered call options on 100% of its portfolio securities. Covered call options provide a partial hedge against declines in the price of the securities on which they are written to the extent of the premiums received.

HGY Investment Objective
The investment objective for Horizons Gold Yield ETF (“HGY”) is to provide Unitholders with: (i) exposure to the price of gold bullion hedged to the Canadian dollar, less the ETF’s fees and expenses; and (ii) tax-efficient monthly distributions, and (iii) in order to mitigate downside risk and generate income, exposure to a covered call option strategy on 33% of the securities of the Gold Portfolio. The level of covered call option writing to which HGY is exposed may vary based on market volatility and other factors.

HIG Investment Objective
The Horizons BetaPro S&P/TSX Global Gold Inverse ETF (“HIG”) seeks daily investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs, that endeavour to correspond to one times (100%) the inverse (opposite) of the daily performance of the S&P/TSX Global Gold™ Index.

HBU and HBD Investment Objectives
The Horizons BetaPro COMEX® Gold Bullion Bull Plus ETF (“HBU”) and the Horizons BetaPro COMEX® Gold Bullion Bear Plus ETF (“HBD”) seek daily investment results equal to 200% the daily performance, or inverse daily performance, of COMEX® Gold Bullion, before fees and expenses. HBU and HBD are denominated in Canadian dollars, as the U.S. dollar exposure of the underlying index is hedged daily.

HGU and HGD Investment Objectives
The Horizons BetaPro S&P/TSX Global Gold Bull+ ETF (“HGU”) and the Horizons BetaPro S&P/TSX Global Gold Bear+ ETF (“HGD”) seek daily investment results equal to 200% the daily performance, or inverse daily performance, of the S&P/TSX Global Gold™ Index, before fees and expenses. The Index consists of securities of global gold sector issuers listed on the TSX, NYSE, NASDAQ and AMEX.

The views expressed herein may not necessarily be the views of AlphaPro Management Inc., Horizons ETFs Management (Canada) Inc. or Horizons Exchange Traded Funds Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.

Tags: Annualized Standard Deviation, Bloomberg, Decreases, ETFs, Global Gold, Gold Bugs, Gold Bullion, Gold Index, Gold Producer, Gold Producers, Gold Rush, Gold Spot, Horizons, Index Returns, Measurement Period, Nyse Arca, Nyse Index, Poster Child, Tsx, Tumultuous Period
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Global Shipping: Any Port in a Storm? (PIMCO)

Monday, May 21st, 2012

by Sai S. Devabhaktuni, and Gregory Kennedy, PIMCO

May 2012

• With the exception of LNG tankers, all three major shipping categories have been suffering from a supply glut. This, combined with higher fuel costs, has led many shipping companies into financial distress.
• Although banks have worked with ship owners through this down cycle, they have also pulled back from financing the industry.
• Given the current low point in the cycle, we believe downside risks are likely minimized in the shipping industry for new lenders and investors. Vessel values are depressed by rates that are sometimes below owners’ operating costs and by an oversupplied market that suppresses secondary market values.​

In spite of the current woes in the shipping industry, including a significant erosion of value and a glut of new vessels, we see the potential for a brighter future on the distant horizon – especially as the order book of new vessels begins to shrink and emerging market growth provides a much-needed driver of demand.

As a result, select opportunities to buy the debt of operators or to buy portfolios of vessels at prices below their intrinsic value are now available to informed investors – and could offer attractive long-term returns. Capitalizing on this anticipated rebound, however, requires patience, dedicated long-term capital and a strong understanding of industry fundamentals and maritime restructuring dynamics. These waters demand careful navigation.

A brief history of the voyage to today’s market
The global shipping industry is in the midst of its worst cycle since the 1980s. A recent Bloomberg article highlighted that “the combined market value of the world’s 80 biggest publicly traded shipping companies plunged by $101.7 billion in the four years to March 23, 2012.” What caused so much value destruction? The combination of an excess supply of new vessels that were financed at the peak of the market and a global recession from which there has been an uneven recovery has led to persistently low charter rates and plummeting ship values. In its wake is nearly $500 billion of debt, the overwhelming majority of which is held by European banks.

Over 90% of world trade activity depends on the shipping industry’s global fleet of 58,000 ships, according to Clarksons and J.P. Morgan. The fleet includes tankers, dry bulk ships, container ships, chemical tankers, liquefied natural gas (LNG) tankers and other cargo ships across what is a highly fragmented industry. As the global economy expanded and international trade increased after the end of the Cold War, world seaborne trade increased by nearly 50% from 1990 to 2000, from about four billion tonnes to six billion tonnes annually, which helped the shipping industry recover from the vessel oversupply it faced in the 1980s (see Figure 1).

The global shipping industry has long cycles and was historically driven by demand and GDP growth in developed economies. But by 2003, demand from emerging economies like China began accelerating, which pushed global seaborne trade to over eight billion tonnes by 2008. China’s demand for coal and iron increased nearly 20% per year from 2004 to 2011, and the country is now a net importer rather than exporter of coal. This insatiable emerging market demand, combined with increased prosperity due in part to the credit bubble in developed markets, led to a vessel shortage, driving shipping rates to new highs (see Figure 2).

The shipping industry responded to these historically high shipping rates by ordering what turned out to be an excessive number of vessels. From 2003 to 2008, over $800 billion of new ships were ordered, with half of the orders placed in 2007–2008, when vessel prices were at their peak, according to Clarksons. During these boom years, bank lending was widely available for new ships, as banks offered financing of up to 80% loan-to-value (LTV) for new vessels (versus 50% to 60% today), leaving little margin for error in vessel values. Most of those vessels were scheduled for delivery in the years immediately following the financial crisis of 2008–2009, compounding the oversupply issue.

Rough seas follow the expansion
As a result of the order book overhang resulting from overly optimistic expectations of demand (i.e., volume) growth, shipping rates have faced persistent headwinds from net new vessel deliveries at about twice the rate of shipping demand growth during the recovery of the past few years (see Figure 3). With the exception of the under-fleeted LNG tanker market, all three major shipping categories (bulkers, tankers, containers) have been suffering from a supply glut. This, combined with higher fuel costs, has led many shipping companies into financial distress.

Because of new vessel deliveries over the past three to four years, the global fleet is fairly young, which means there are not as many older ships available that would typically make economic sense to scrap. And while delivery slippage of the order book and cancellations help to slow the supply of new vessels entering the market, there is an incentive for shipyards to maintain their order backlog.

Tags: Bloomberg, Distant Horizon, Downside Risks, Emerging Market, Excess Supply, Financial Distress, Fuel Costs, Global Recession, Global Shipping Industry, Gregory Kennedy, Intrinsic Value, Lng Tankers, Long Term Capital, Peak Of The Market, PIMCO, Port In A Storm, S Market, Secondary Market Values, Ship Owners, Shipping Companies, Supply Glut
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NYSE Short Interest Rises to 2012 Highs

Thursday, May 10th, 2012

On the surface, the fact that NYSE short interest was just reported today to have risen to 13.1 billion shares as of April 30 could be troubling for the bears, as this just happens to be the highest short interest number of 2012. Indeed, an increase in short interest into a centrally-planned market is always disturbing, as it opens up stocks to the kinds of baseless short covering melt ups that simply have some HFT algo going on a stop hunt as their source, that we have seen in the past several weeks. Naturally, it would be far easier to be short a market in which Ben Bernanke managed to eradicate all other bears, especially when considering that a year ago the Short Interest as of April 30 was virtually identical.

However, courtesy of some recent discoveries by Bloomberg, we now know that his very pedestrian way of looking at short exposure is simply naive, as it ignores all the synthetic means that hedge funds truly express their position these days, mostly in attempts to avoid observation, and to magnify their balance sheets in any way possible. In other words: epic abuse of leverage, but not simply on the books, but through repos, Total Return Swaps, and various other shadow “shadow” P&L enhancement techniques. To wit from Bloomberg:

Citadel Advisors LLC and Millennium Management LLC said their assets soared ninefold when tallied under a new rule that requires hedge funds to disclose investments financed through borrowings.

 

Citadel, run by Ken Griffin out of Chicago, reported $115.2 billion of regulatory assets in a March 30 filing with the U.S. Securities and Exchange Commission, compared with $12.6 billion of net assets. Millennium, founded by Israel Englander, disclosed comparable figures of $119 billion and $13.5 billion as of year-end.

…

 

In short sales, investors borrow assets to sell them in anticipation that they can be repurchased at a lower price later and they can pocket the difference. Hedging includes the purchase of offsetting positions to limit risk in a trade.

 

While some fund managers only gave information on their gross assets, 31 of the 50 largest also disclosed their net assets in a separate section known as the client brochure. For these advisers, gross assets of $949 billion were more than double their net assets of $422 billion.

 

That indicates hedge funds may be using as much leverage as they did prior to the 2008 financial crisis. On average, hedge funds held total assets that were double their net capital as recently as 2007, said Daniel Celeghin, a partner at Casey Quirk & Associates LLC, a Darien, Connecticut, adviser to asset managers.

 

Not all of the difference between net and gross assets may be explained by leverage, because the SEC’s gross number also includes proprietary stakes that money managers hold in their own funds as well as assets that don’t get charged a management fee. The SEC’s calculating method can lead to double counting of assets at funds, such as Citadel, that include multiple entities.

 

“If you are heavily levered, obviously that will result in you having a larger gross asset number,” said Gary Kaminsky, a principal in the business advisory services group at Rothstein Kass, a Roseland, New Jersey, accounting firm that audits hedge funds. That’s because, under the SEC approach, “all that matters is what’s on the asset side of the balance sheet,” Kaminsky said.

 

Hedge funds are relying less on margin loans from prime brokers, the securities firms that provide credit and facilitate trading, and more on repurchase agreements, leveraged exchange- traded funds, and derivatives such as total return swaps, according to Josh Galper, the managing principal at Finadium LLC, a Concord, Massachusetts, investment research and consulting firm.

 

“Leverage is down across the board from the perspective of borrowing from a prime broker,” Galper said in a telephone interview. “It’s tough to measure how much embedded leverage funds are using.”

In other words, while the chart above is useful generically, the reality is that a true picture of outright bullish or bearish appearance is now impossible to be gleaned courtesy of precisely the same synthetic instruments that nearly destroyed the financial system in the fall of 2008. Funds will do anything in their power to systematically boost their leverage at the gross level, while leaving their net leverage appear innocuous, and then spin how gross is not net, even as their Prime Brokers onboard all the risk: after all who bails them out if things go wrong? Why, you do.

And who benefits if they are right? Here’s who, together with an AUM breakdown based on the old and new methodology:

Tags: Anticipation, Balance Sheets, Bloomberg, Borrowings, Citadel Run, Comparable Figures, Enhancement Techniques, Hedge Funds, Hft, Israel Englander, Ken Griffin, Millennium Management, Net Assets, Nyse Short Interest, Recent Discoveries, Regulatory Assets, Return Swaps, Securities And Exchange Commission, Ups, Year End
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PIMCO’s Bill Gross – No QE3 Right Away, but a Few Weak Employment Reports Brings It

Monday, April 30th, 2012

PIMCO’s Bill Gross has a wide ranging interview on Bloomberg discussing all sorts of topics from more QE, the Fed following the Bank of England’s plan to ignore any inflation as ‘temporary’ so they can continue ultra easy policies, the dysfunction in Europe, the potential for recession, among other topics.

9 minute video – email readers will need to come to site to view

Tags: All Sorts, Bank Of England, Bill Gross, Bloomberg, Employment Reports, Europe, inflation, PIMCO, Qe, Qe3, Recession, Video Email
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News Digest: April 24, 2012

Tuesday, April 24th, 2012

* China’s Biggest Banks Are Squeezed for Capital (NYT)
* Greeks detect hypocrisy as Dutch coalition stumbles (Reuters)
* Hollande Blames Europe’s Austerity Plan for Le Pen’s Rise (Bloomberg)
* In a Change, Mexico Reins In Its Oil Monopoly (NYT)
* China Tire Demand Slows as Economy Decelerates, Bridgestone Says (Bloomberg)
* Social Security’s financial forecast gets darker; Medicare’s outlook unchanged (WaPo)
* Fed’s 17 Rate Forecasts May Confuse More Than Clarify (Bloomberg)
* Senate to vote on array of Postal Service overhaul proposals (WaPo)
* Weidmann Says Bundesbank Is Preserving Euro Stability (Bloomberg)
* Hungary Pledges Cuts Aimed at EU Demands (WSJ)
* Immigration from Mexico to US at standstill (FT)
* Orbán stands firm in central bank dispute (FT)

Overnight Media Digest via Reuters

WSJ

* In what is likely to be the last snapshot of its financial condition before an expected May IPO, Facebook disclosed that its first-quarter profit and revenue declined from the final quarter of 2011.

* Government trustees are projecting Social Security will exhaust its trust fund three years sooner than previously thought.

* New York law firm Dewey & LeBoeuf is more deeply in debt than previously thought. It owes about $75 million to a syndicate of bank lenders.

* Unilever is negotiating to build a $100 million palm-oil processing plant in Indonesia, an attempt to accelerate its commitment to sourcing the oil in ways that don’t destroy the environment.

* Planetary Resources will outline a plan to send an unmanned spacecraft to an asteroid and mine it for valuable metals and water that could be used in further space exploration or returned to earth.

* The union representing American Airlines’ mechanics agreed to send the airline’s latest contract proposal to members for a vote.

* A U.S. trade panel Monday voted against imposing retaliatory duties on galvanized steel wire from China and Mexico, determining that U.S. producers aren’t being hurt by the rise in imports.

* Spain’s economy contracted 0.4 percent in the first quarter from the fourth, the country’s central bank said Monday, the latest evidence that Spain’s efforts to rein in government spending could be feeding a downward economic spiral.

FT

MEXICO BRIBERY CLAIMS HIT WALMART SHARES

Walmart shares tumbled nearly 5 percent and shares in its Mexican business dropped even further as allegations of bribery and a cover-up shook the U.S. retailer.

FACEBOOK GROWTH SLOWS AHEAD OF IPO

Facebook’s revenue and profit growth are slowing, marking a turning point for the high-growth social networking company just weeks before its initial public offering.

CABLE AND WIRELESS NAME TO DISAPPEAR IN UK

The Cable & Wireless name is set to disappear from the UK telecoms market after almost 80 years following Vodafone’s agreement of a 1 billion pound ($1.61 billion) cash acquisition of the group.

INVESTORS LAUNCH DEUTSCHE BANK PROTEST

Deutsche Bank’s non-executive board is facing a protest from an influential activist investor over its pay policies and turbulent succession planning in another sign of how global investors are challenging bank directors.

COBHAM HIRES AMERICAN CHIEF

Cobham, the UK defence and aerospace group, has completed its five-month-long search for a chief executive by hiring Robert Murphy from the U.S. subsidiary of BAE Systems .

EX-CALPERS CHIEF ACCUSED OF FRAUD

The former head of the California Public Employees’ Retirement System, the largest U.S. pension fund, has been slapped with civil charges accusing him of defrauding Apollo Global, the private equity group.

VENTURE CAPITAL FIRM DEFENDS INSTAGRAM HOLDING

Andreessen Horowitz has been forced to defend its early stake in Instagram, the photo-sharing app acquired by Facebook this month for about $1 billion, despite the venture capital firm receiving a more than 300-fold return in two years.

VOLVO TO EXPAND OFFERING IN CHINA

Volvo Cars will launch 10 models in China over the next five years as it seeks to make up for lost time in the world’s largest car market, its chief executive said.

NYT

* A commission of energy specialists formed by Mexico’s Congress has begun to question where and how Pemex, Mexico’s state-owned oil monopoly, drills for oil.

* Wal-Mart’s stock slipped as investors reacted to a bribery scandal at the retailer’s Mexican subsidiary and a report that an internal investigation was quashed at corporate headquarters.

* MetLife on Monday became the third big life insurer to settle regulatory accusations of failing to keep track of policyholder deaths, trapping money that should have gone promptly to the beneficiaries.

* A euro zone strategy to cut deficits has come under increasing strain from slowing economies, gyrating financial markets and electoral setbacks.

* Mainland Chinese banks are turning to markets to raise funds, even as they report strong profits and say their balance sheets are solid.

Canada

THE GLOBE AND MAIL

* Less than a year after he asked Canadian voters to make him prime minister, ex-Liberal leader and academic Michael Ignatieff warned that the country is drifting towards a breakup.

r.reuters.com/jav77s

* One of Canada’s leading polling firms says it has found strong evidence of a targeted program of voter suppression aimed at non-Conservative voters during last May’s federal-election campaign.

r.reuters.com/nav77s

Reports in the business section:

* Swapping out engines is costly, but natural gas has grown so much cheaper than diesel that, according to a new analysis conducted by the Conference Board of Canada, a long-distance trucker could save nearly $160,000 over a decade by making the change.

r.reuters.com/tav77s

* Shoppers Drug Mart Corp has been hit with yet another round of Ontario cuts in generic prescription drug prices while still grappling with earlier profit-pinching drug reforms.

r.reuters.com/cev77s

NATIONAL POST

* Defying the odds of pollsters and naysayers, Alberta’s long-ruling Progressive Conservatives won their 12th straight majority government Monday night.

r.reuters.com/dev77s

Reports in the business section:

* Ontario’s minority Liberal government is set to survive a budget vote after Premier Dalton McGuinty said he will introduce a 2 percent tax on people with incomes greater than $500,000, meeting a key demand from the New Democrat Party.

r.reuters.com/kev77s

* Three weeks after Baja Mining Corp narrowly won a proxy fight with its largest shareholder, the company revealed on Monday that three directors have resigned and that it is facing a big funding shortfall at its flagship copper project.

r.reuters.com/hev77s

European economic highlights:

* Finland PPI for March 0.40% m/m 1.4% y/y – lower than expected. Consensus 0.80% m/m 1.80% y/y. Previous 1.20% m/m 2.20% y/y.
* Finland Unemployment Rate for March 8.50% * higher than expected. Consensus 8.20%. Previous 7.70%.
* Switzerland Trade Balance for March 1.69B – lower than expected. Consensus 3.00B. Previous 2.68B. Revised 2.61B.
* Switzerland Exports real s.a. for March -2.50% m/m – lower than expected. Consensus 1.00%. Previous 9.20%. Revised 12.00%.
* Switzerland Imports real s.a. for March 4.60% m/m. Previous -12.30% m/m. Revised -12.20% m/m.
* Switzerland UBS Consumption Indicator for March 1.22. Previous 0.87. Revised 0.9.
* Sweden Unemployment Rate for March 7.70% * lower than expected. Consensus 8.00%. Previous 7.80%.
* France Consumer Confidence Indicator for April 88 – higher than expected. Consensus 87. Previous 87.
* France Business Survey Overall Demand for April 3 – higher than expected. Previous -12. Revised -8.
* Spain Mortgages-capital loaned for February -49.60% y/y. Previous -34.00% y/y.
* Spain Mortgages on Houses for February -47.10% y/y. Previous -41.30% y/y.
* Italy Hourly Wages for March 1.20% y/y. Previous 1.40% y/y.
* UK Public Finances (PSNCR) for March 16.5B – higher than expected. Consensus 13.0B. Previous -7.8B. Revised -8.2B.
* UK PSNB ex Interventions for March 18.2B – higher than expected. Consensus 16.0B. Previous 15.2B. Revised 12.2B.
* UK Public Sector Net Borrowing for March 15.9B – higher than expected. Consensus 14.2B. Previous 12.9B. Revised 9.9B

Tags: American Airlines, Austerity, Bank Lenders, Biggest Banks, Bloomberg, Bundesbank, Contract Proposal, Financial Forecast, Galvanized Steel, Galvanized Steel Wire, Leboeuf, Nyt, Oil Monopoly, Palm Oil, Planetary Resources, Quarter Profit, Reuters, Unmanned Spacecraft, Weidmann, Wsj
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The Curious Case of the Deviant Dividends

Sunday, April 22nd, 2012

Pull up any ETF ticker on your favorite finance page and a wealth of information awaits you. Ever wonder about how accurate all of it is? If the answer is No, then today’s column is for you.

Most of the information is beyond dispute. The price is the price. But some values such as price-to-earnings and especially dividend yields really need to be scrutinized to avoid nasty surprises.

The other day on Bloomberg (the paid version), I came across several ETFs with incredibly rich dividends, with one – Guggenheim’s Solar ETF (TAN/NYSE) – outshining the others.

TAN holds about 30 solar energy companies. Its dividend yield is 9.2% according to Bloomberg and others. Indeed, its dividend of $2.11 (adjusted for a 1:10 reverse split) divided by its price of $23.02 works out to 9.2%. But is that likely for what should be a high growth sector?

In fact, looking deeper, only seven of the companies in the ETF, representing about 28% of the total allocation, have ever paid a dividend. Of those, two have postponed dividends for 2012 and another has cut its dividend by more than half. The weighted average yield on the seven is under 1%.

Since holdings can change every quarter I also checked holdings as of February 2011. The picture was the same: seven dividend-payers with an average yield of below 1%.

Where then did most of TAN’s dividend come from? The answer, according to the fund’s prospectus, is securities lending. Nearly 90% of TAN’s investment income for the 12 months ending last August came from lending about half its shares to short sellers.

You may recall that short sellers, expecting a stock to fall, sell shares that they have borrowed from other investors who are “long” (ie. They are invested in the shares). If the share price falls, short sellers buy it back at the lower price, return it to the lender and pocket a profit.

TAN, being an index ETF, is always long its shares. By lending, it earns interest from the short sellers and protects itself by demanding collateral, usually worth more than the value of shares loaned.

Generally, the ETFs with higher levels of lending income tend to be sector specific or they hold securities that are thinly traded or harder to borrow for other reasons.

Now you may say, a dollar is a dollar. However, a dollar from securities lending is not nearly as safe as a dollar from dividends. Few ETFs can earn so much from securities lending. It helps that TAN targets a very specific sector of the market. That likely means its holdings are harder and more expensive to borrow.

It could also be that the manager is lending to less credit-worthy short sellers or that the manager is accepting lower quality collateral. Either way, it does open the fund up to more risk than if it prohibited or restricted securities lending to a minimal amount. If a short seller is not able to return the borrowed stock, the fund manager will have only the collateral. In the normal course, that’s OK. But in a crisis, especially if the manager is holding poorer quality assets, the fund will suffer.

The other concern, especially for those seeking a steady stream of income, is that the income from lending will be much more volatile. TAN has fallen by 70% over the last two years and valuations on its holdings are beginning to look really cheap. At some point, that should see short sellers close their positions. Without that lending income, TAN’s yield will likely be closer to 1% than to 9.2%.

One last thought: There is no argument that securities lending is a completely legitimate activity within modern capital markets. But consider the optics: a fund manager enabling short sellers to pummel the very stocks held in the fund. For investors, the extra lending income helps fill the belly but taste like cardboard.

Besides dividends, there are other factors – price-to-earnings, use of derivatives and integrity to mandate being three – that must be examined carefully when selecting an ETF. It takes time and effort but as the example of dividends shows, this added scrutiny is a must for the serious investor.

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Tags: Bloomberg, Curious Case, Dividend Payers, Dividend Yield, Dividend Yields, Earnings, ETFs, Growth Sector, Guggenheim, Investment Income, Investors, Nasty Surprises, Nyse, Prospectus, Reverse Split, Rich Dividends, Share Price, Short Sellers, Solar Energy Companies
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Bracing for Bondageddon

Friday, April 20th, 2012

April 18, 2012

“Bondageddon” now?

Dire warnings about the coming collapse of the US bond market have grown in frequency and volume over the past two years. Some of these warnings have come from very prominent voices: Warren Buffett was quoted saying that bonds are “dangerous” and “should come with a warning label,” while Professor Burton Malkiel of Princeton suggested in aWall Street Journal editorial that bonds are no longer appropriate for “prudent” investors.

We believe warnings like these are dangerous and imprudent because they may lead investors to abandon diversified portfolios and unwittingly take more risk. Let’s put the situation into perspective: Bond yields have been falling for more than 30 years. The 1.8% low in 10-year US Treasury yields reached at the end of January may be the lowest level we see for a while. However, the “spike” in rates from those lows has been pretty modest.

Ten-Year US Treasury Yields Trend Steadily Downward

Source: Bloomberg, as of March 29, 2012.

In our view, current economic conditions don’t point to a risk of a significant increase in rates in the near term. Although the US economy has shown signs of stronger growth, Europe has tipped into recession and leading indicators for some major emerging-market economies such as China and Brazil are slowing. As a result, central banks around the globe have been lowering interest rates. Inflation pressures have actually eased since late last year despite the recent rise in energy prices. Finally, we see longer-term demographics pointing to rising demand for fixed income as the population ages.

OECD Composite Leading Indicators for US, Europe, Brazil and China

Source: The Organisation for Economic Co-operation and Development, an organization that monitors events in its member countries, as well as others, and makes regular projections of short- and medium-term economic developments. Y-axis represents OECD composite leading indicator.

Nonetheless, there’s clearly less upside than downside potential in bond prices overall. We think that some of the forces driving bond yields lower in the past few years, such as fears of deflation and the risks in the global banking sector, have begun to abate. With the US economy seemingly on the mend and yields low relative to inflation, bond valuations look stretched. Once the economic expansion is established, the Federal Reserve will likely begin to raise interest rates, probably in 2013 or 2014. However, longer-term bond yields have historically moved higher six to nine months before the Fed raises short-term rates for the first time in a cycle.

Don’t panic—strategize

Despite headline-grabbing warnings, we believe the risk of rising rates is no reason to panic or abandon the bond market. Bonds can serve an important function in your portfolio: They help generate income and provide diversification from stocks. These attributes have been important factors in helping stabilize portfolios over the past decade, while stock prices have been volatile.

In addition, the bond market is large and varied. There’s no single bond in the bond market, any more than there’s one single stock in the stock market. The types of bonds or bond mutual funds you hold can make a big difference in the way your portfolio performs when interest rates rise. Moreover, you’ll only realize a loss on an individual bond if you sell it or if the issuer defaults. Even in bond funds, the net asset value of the fund will likely decline if rates rise, but the fund manager may be reinvesting in higher-yielding bonds, so the income received may rise even though the net asset value is declining.

First, do the math

A first step is to assess the impact a rise in rates may have on your bond portfolio. “Duration” is a term used to measure a bond’s sensitivity to changes in interest rates. The concept is similar to maturity, in that longer-term bonds usually have longer durations and tend to be more volatile than shorter-maturity bonds. In general, the longer the duration of a bond, the more its market value is going to fluctuate with the interest-rate cycle.

Although duration is a complicated concept, the most important part to remember is fairly straightforward—it represents the percentage change in a bond’s price give a 1% rise or fall in interest rates. For example, if you own a 10-year bond with a five-year duration and interest rates decline 1%, you should expect it to gain 5% of its value. The opposite is also true: A 1% increase in interest rates will mean an expected 5% decline in the value of a bond with five-year duration.

What if Rates Rise?

Source: Barclays US Aggregate Bond Index, as of March 9, 2012. Illustration assumes the Barclays US Aggregate Bond Index modified adjusted duration of 4.97 years, semiannual compounding, reinvestment of coupons at prevailing interest rates and a rate shift immediately after purchase. Numbers may not add up due to rounding. For illustrative purposes only.

In our hypothetical example, we assume interest rates suddenly jump from 2.5% to 4.0%. If you were unlucky enough to buy a five-year-duration bond yielding 2.5% just before rates rose to 4.0%, it would immediately decline in value. However, if you continue to hold it and reinvest the interest, then the total return (income plus price) would be in positive territory after two years. The example is purely hypothetical and simplified, and assumes that rates stay flat for four years after the rise in the first year—but it illustrates one potential path of a bondholder’s return in the event of a jump in interest rates.

Most bond funds will provide an estimate of the fund’s average duration in their reports to investors. For individual bonds or portfolios of individual bonds, you can estimate duration by adding up the yearly income payments, giving greater weight to the payments made sooner rather than later, and then dividing the payment total by the bond price. Your Schwab representative can also help find a bond’s duration.

Second, consider various strategies

1. Reduce the duration of your bond portfolio. If you’re holding long-term bonds that have appreciated in value, it might be time to realize some gains on those holdings. Although you’ll no longer receive the income from those bonds, it’s reasonable to reduce duration to a level where you’re comfortable with the potential impact on your portfolio.

We’re fans of bond ladders because they’re designed to provide income and flexibility. Ladders spread out maturities of bonds over time. Shorter-term bonds on the lower rungs of the ladder should generally be less volatile and provide cash for near-term needs or for reinvestment. Income generated from the longer-term bonds on the higher rungs of the ladder can be reinvested and compounded or consumed, depending on your needs. Bond ladders can comprise any type of bond—municipal, corporate or Treasury—or a mix of various types.

2. Consider higher-coupon bonds. All else being equal, bonds that pay higher coupons (current income) are less volatile than bonds with lower coupons. Higher-coupon bonds generate more current cash flow that can be reinvested in a rising-rate environment. Money received today is worth more than money received later. Consequently, bonds that generate more cash flow up front tend to have higher prices and be less volatile than those for which the cash flow is paid out at a lower rate over time. Not surprisingly, bonds with higher current coupons may trade at a premium to their par value when rates are low and decline less than lower-coupon bonds when rates rise.

Higher-Coupon Bonds Less Sensitive Than Lower-Coupon Bonds

Source: Bloomberg, Schwab Center for Financial Research. The illustration above is for two 10-year Treasuries: a “seasoned” older Treasury issued when rates were higher with a 5% coupon; and one issued with a 2% coupon closer to the market rate today. The bond with a 5% coupon is selling at a premium compared to the bond with the 2% coupon that is pricing at par. The chart assumes a 1% and 2% increase in the 10-year interest rate. Illustration assumes semiannual interest payment and an immediate change in interest rates after purchase. For illustrative purposes only.

3. Decide on the amount of credit risk you’re willing to take. Credit risk refers to the risk of default—the chance that you won’t get your money back. One way to try to earn more income without taking more duration risk is to take more credit risk. Investment-grade corporate bonds (those rated BBB or above) usually yield more than Treasuries. However, credit quality varies depending on the sector and the issuer. Moreover, if interest rates rise, the value of these bonds will most likely decline as well.

Sub-investment-grade (or “high yield”) bonds have tended to outperform other sectors of the bond market when rates rise, because interest rates tend to rise when the economy is getting stronger and economic growth is generally positive for companies that issue high-yield bonds. With stronger economic growth, conditions for improving their earnings and cash flow are better, which in turn may mean they have an easier time paying interest on their bonds. In addition, high-yield bonds tend to have shorter maturities than other types of bonds and higher coupon rates. The offsetting factor is that high-yield issuers are less creditworthy, so the risk of default is higher than with other types of corporate bonds.

4. Diversify globally. International bonds can also help provide diversification in a fixed income portfolio, because economic cycles aren’t always in sync around the world. International bond funds may or may not hedge the currency risk in owning foreign bonds. Either way, allocating some portion of a portfolio to non-US bonds has historically demonstrated diversification benefits.

5. Other types of bonds. Alternative bond structures such as floating-rate bonds or convertible bonds may make sense in a rising-rate environment. Coupon rates for floating-rate bonds are usually set to move up and down with an index, such as the London Interbank Offer Rate (LIBOR). Individual investors usually get access to floating-rate bonds through mutual funds. However, floating-rate bonds may come with greater credit risk than traditional corporate bonds, so it’s wise to be cautious. In addition, many mutual funds use leverage in an attempt to boost returns, and if short-term rates rise, the leverage can reduce the fund’s returns.

Convertible bonds are hybrids that combine characteristics of fixed income and stocks: They pay regular interest but can be converted to equity shares at certain price levels. Convertible bonds have historically tended to outperform traditional fixed-rate bonds in a growing economy with rising interest rates, but they can be volatile and less liquid than other sectors of the bond market.

Preferred securities are also frequently considered hybrids of debt and equity because they have characteristics of both. There are many types of preferred securities: Some are very close to bonds because they pay interest rather than dividends and have set maturity dates, while others are more like stock in that they pay dividends and are “perpetual,” with no set maturity date. While yields tend to be higher for preferreds than traditional bonds, the risks are higher as well. If the issuing company needs capital, the dividend can be cut or eliminated. Due to their long duration and credit risk, these securities generally tend to be more volatile than bonds.

Avoid Bondageddon

You can’t control interest rates, but you can control what’s in your portfolio. We believe it’s prudent to make sure your portfolio isn’t over-allocated to bonds—especially long-term bonds. However, we believe it would be ill-advised to ignore the potential benefits of diversification and income generation that bonds can provide in an overall portfolio. The types of bonds or bond funds you hold should be based on your own needs and circumstances, rather than trying to time the interest-rate cycle. A fixed income portfolio should be constructed with the goal of matching your income stream with your needs over time, keeping in mind how much risk you’re willing to tolerate.

Important Disclosures

Tags: asset class, Bloomberg, Bond Holdings, Bond Portfolios, Bond Yields, Burton Malkiel, Coupon Bonds, Diversified Portfolios, Emerging Market Economies, Fixed Income, Interest Rate Risk, Leading Indicators, Lows, Professor Burton, Prudent Investors, Us Bond Market, Us Treasury Yields, Wall Street Journal, Wall Street Journal Editorial, Warren Buffett
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Gary Shilling Still Looking for a Recession in 2012 Part I

Wednesday, April 11th, 2012

Gary Shilling has been more dour than most on the underlying economy the past 3-4 years, and that could be argued was a relatively good call.  Despite never before seen levels of federal government and central bank intervention, the economy continues to limp along at what I call a “meh” pace.  Normal recoveries sans massive intervention should have had some sustained periods of 4-5%+ type GDP growth; we’re happy with 2-3% nowadays.  Gary’s long U.S. Treasuries call has been against the grain, and mostly right the past few years, and he’s had quite a few other prescient calls as well.  Shilling posted 2 articles on Bloomberg, stating the case for a recession in 2012 – which is now again an outlier view.  We’ll look at part 1 today, and look at part 2 which focuses on the labor market tomorrow.

Here are some of his views as he looks at the main pillars of the economy:

• For several months, I’ve been forecasting a recession in the U.S. this year, arguing that weakened consumer spending – the key to the economic outlook — would tip the economy back into a downturn.  But what about recent positive data and markets? Do they affect my forecast?
• Consumers Are the Linchpin: The U.S. economy is being fueled these days by strong consumer spending, which increased in February by 0.8 percent, its best showing in seven months, after rising 0.4 percent in January. Retail sales rose 1.1 percent in February — the fastest pace in five months — while same-store sales advanced 4.7 percent. These numbers correlate with recent gains in consumer confidence and sentiment.
• I don’t see this pace continuing. Personal-income growth continues to be weak — up just 0.2 percent in February — meaning this recent exuberant consumer spending is being fueled largely by increased debt and tapping of savings.
• At the same time, pay per employee is rising slowly and continues to fall in real terms. So increased job growth remains the key to any increases in real household after-tax income, which declined in February for a second straight month and gained a mere 0.3 percent, compared with February 2011.
• Spending, Saving and Debt: The support that consumer spending has received from less saving and more debt appears temporary. Household debt – including mortgages,student loans, and auto and credit-card loans — has fallen relative to disposable personal income, though. In my analysis, this is largely because of write-offs of troubled mortgages. Nevertheless, revolving consumer credit, mostly on credit cards, is no longer being liquidated.
• Non-revolving consumer credit continues to rise in response to growing sales of vehicles — most of which are financed — and in student loans, as the poor job market keeps students in school or sends them back. Tuition increases encourage more borrowing, while interest costs on past-due loans mount.  [Mar 8, 2012: What Drove Yesterday's Surge in Consumer Credit? Massive Upswing in Federal Student Loans]
• It would seem, then, that contrary to my steadfast belief that consumers are being forced to save more and reduce debt to rebuild net worth, they have been doing the opposite lately.
• Consumer Retrenchment: The data so far aren’t conclusive, but evidence of U.S. consumer retrenchment is emerging. Consumer confidence has moved up recently but remains far below the levels of early 2007 before the collapse in subprime mortgages set off the Great Recession. Real personal consumption expenditures growth has been volatile in recent months and falling on a year-on-year basis. Voluntary departures from jobs, another measure of confidence, may be decreasing. And consumer spending will no doubt have a big slide if my forecast of another 20 percent drop in house prices pans out. (Mark’s note: that seems aggressive!)
• Housing activity remains depressed, with the only signs of life coming from the multifamily component, which is being driven by the appetite for rental apartments as homeownership declines.
• What Oil Threat?: Recently, there has been great concern about $4 per gallon gasoline and whether, as in 2008, those high prices will act as a tax on consumer incomes and force drastic cutbacks in other purchases.  These concerns are overblown. American consumers have reacted to rising gasoline prices as you would expect in tough times: by consuming less. Demand (DOEDMGAS) in the mid-February to mid- March four-week period was down 7.8 percent from a year earlier, mainly due to more efficient vehicles.
• As a result, the recent surge in gasoline prices has had a relatively small impact on consumer purchasing power. The $14.8 billion increase from October 2011 to March 2012, compared with the year-earlier period, amounts to about 0.3 percent of consumer spending.

Conclusion:

• Consumer spending is the only major source of strength in the U.S. economy this year. State and local-government spending remains depressed because of deficit woes and underfunded pension plans. Housing suffers from excess inventories and may face a further 20 percent drop in prices. Excess capacity restrains capital spending. Recent inventory building appears involuntary. So consumer retrenchment will tip the balance toward a moderate and overdue recession.

Tags: Bloomberg, Central Bank Intervention, Consumer Confidence, Downturn, Economic Outlook, Federal Government, Five Months, Gary Shilling, GDP, GDP Growth, Market Tomorrow, Massive Intervention, Personal Income Growth, Pillars, Recession, Retail Sales, Sentiment, Seven Months, Tapping, Treasuries
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