Thursday, July 19th, 2012
by Peter Tchir, TF Market Advisors
July 2007 to January 2008
These are the stock prices, “normalized” to 100 in July 2007. In the August swoon, JPM and C did the worst. Barclay’s eventually caught up in later August, while BAC did well. We briefly rallied on a Fed Rate cut in October, but then the swoon returned with C underperforming by far. It was down over 40% in that period. Barclay’s was in the middle, and JPM was actually the best performer, down only 11% by year end.
These are “normalized” CDS spreads. You can see that at first they moved in line, then Barclay’s underperformed, but returned to the fold by the time of the Fed rate cut, and then ultimately we saw a separation as JPM did the best (just like in stocks) and Citi did the worst (just like in stocks). But this overstates the divergence a bit. Looking at the outright spreads shows that Barclay’s actually started the period trading tight, and JPM was the widest, but by the end CDS markets viewed JPM, Barclays, and BAC as similar, but Citi was noticeably wider.
These are “normalized” LIBOR. All banks were submitting very similar rates. Then the stock market decline started and bank LIBOR increased. This was a function of credit spreads. Then as Fed programs kicked in (discount window) and then rate cuts were implemented, LIBOR moved down.
The outlier to me, is Citibank. Citi was the worst on CDS, the worst on stock, but actually did the best on LIBOR? Really? Was Citi really able to borrow from other banks at rates equal to or lower than BAC and JPM? Shouldn’t it have been closer to Barclays? There is the fact that Barclay’s was reliant on BoE rather than the Fed. That is one reason for Citi to more closely track JPM and BAC, but that close? CDS was relatively tame, so maybe the differential in 5 year CDS overstates the issue, but just doesn’t seem right.
August 2008 to January 2009
All the banks moved more or less in line at first. Then Citi, Barclays, and BAC underperformed. For one brief moment, Citi actually bounced and got back to JPM levels, then a long slow decline started. Barclays was for awhile the worst performer, but Citi took over, being down 80% at one stage and finishing down 65%. Those are big numbers. Citi, BAC, and Barclays all saw their stock price decline by 55% to 65%. JP was “only” down 23%.
On a “normalized” basis, it’s surprising to see Barclay’s CDS do better than anyone else’s at any time during the period. What is clear, is that on a “normalized” basis, Citi consistently was the worst name. One spike up with JPM, one with Barclay’s, and one big spike all by itself. But maybe like in 2007, the levels were low enough that the differences might be immaterial?
No, these moves in LIBOR are real. Citi started the crisis as the highest spread name, and maintained that “distinction” throughout the entire period. Barclay’s never traded as wide in CDS as Citi. JPM was probably the best, but BAC wasn’t too far behind (though it widened as noise about hidden ML losses came out). Barclay’s was surprisingly not as bad as I would have guessed. Citi though is just clearly the worst.
This is “normalized” and Barclay’s is a clear underperformer. You can tell when they were allegedly “told to catch up”, but throughout, they remained the high submitter. They underperformed through the entire crisis. Not quite consistent with stocks or CDS and may explain why they complained that others weren’t submitting “true” rates. Citi was somehow consistently able to submit LIBOR that was lower than BAC but was even lower than JPM on some days. By the end of the year, once Barclay’s was presumably fully in liar mode, they were similar to BAC and C. Maybe it’s the normalization process screwing up the data?
I’ve added the 3 month yield so you can get a sense of the Ted Spread, but it is clear that Citi felt they funded in line with BAC and at times with JPM. It is only at the end when we see Citi, BAC, and Barclay’s submit similar rates.
If Barclay’s said others were lying, who could it be? There were days the separation between the U.S. banks and Barclay’s was as high as 100 bps. 50 bps difference wasn’t uncommon. I can justify JPM trading that much better. The stock market performance and CDS of JPM would all be good explanations of why JPM was better than Barclay’s at funding. That much lower, is a guess, but it actually doesn’t seem unreasonable.
Citi in particular looks bad. Especially since BAC’s spikes in LIBOR coincide at least somewhat to times when their stock and CDS underperformed.
This is only one point in one curve. I have focused so far on 3 month USD Libor. That is the most important one in my opinion in terms of number of contracts that reference it. The 1 month has such short duration that I didn’t focus on it yet. The 6 month is interesting because it would have more credit risk and should reflect more differentiation. The same analysis would have to be done for every bank, every currency, and every spot on the curve to get a true estimation of how much LIBOR LYING was done. Determining, or guessing how much each bank lied would be critical to any lawsuit. Lawsuits will ultimately have to be tied to how much a bank lied, and how much of that lie impacted the LIBOR setting. The complex mechanism by which LIBOR is calculated means that not all (or possibly any) of a lie would impact LIBOR’s setting. In spite of Barclay’s rush to catch up, they were still being excluded from the LIBOR calculation on most days for being too high.
From this data, there is no way to prove anyone lied, or to prove by how much if they did.
I have spent more time focused on Barclay’s and their US issues. So far, it looks to me like they were submitting LIBOR more accurately than other and their claims that others were too low seem right. I have more work to do, but am getting to the point where the damage to Barclay’s stock price is worse than the risk.
Concerns over JPM’s exposure seem overdone as well. Yes, they were at the low end of submissions, but I think it would be hard to prove that is a lie without some real evidence. They had low submissions, but their CDS and stock performed the best. I do not think that they can be sued just because they have a large book of business if they didn’t have material amounts of “lying”. Again, I’m not concluding anything yet, but fears related to them seem overdone from all the work I’ve done.
For some reason I want to say something bad about BAC, and my gut tells me I’m right, but as of now, they seem reasonable. Their LIBOR moved with their stock and CDS. Maybe they were slow occasionally, but if anything they come out better so far than I would have guessed.
Citi. It is impossible to say they did anything wrong from the data I’ve looked at, but their submissions don’t pass an initial smell test. If Barclay’s is saying banks were submitting LIBOR that was too low, they strike me as a candidate for much deeper scrutiny. Their stock and CDS did the worst, yet consistently during those peak times, they submitted LIBOR closer to the better performers. Again, it could be a function that it is so short dated, and a function that Barclay’s was so high they were being excluded, but I would want to take a closer look at Citi’s submissions and would be nervous that their stock does not fully reflect the risk.
We are not lawyers, and have no access to actual interbank trades from the time, and this is not a recommendation to buy or to sell, but if the market is going to throw around lawsuit numbers in the $20 billion to $50 billion range and move prices based on that, figuring out how real those numbers are and who would bear the brunt of the burden is key. From all of our work so far, any “manipulation” prior to August 2007 would have had minimal impact as all the submitters were so close together and there really wasn’t a “credit” problem so the fluctuations of LIBOR seem reasonable, at least within a bp or two.
More banks to look at, more points on the curve, and more historical bond prices to dig up.
Tags: Barclay, Barclays, Boe, Citibank, Differential, Divergence, Fed Programs, Fed Rate, Jpm, Liar, Libor, Nbsp, Outlier, Pants On Fire, Stock Market Decline, Stock Prices, Stocks, Swoon, Tf, Year End
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Monday, February 27th, 2012
Nice list from Jeremy Grantham, via Marketwatch:
1. Believe in history
“All bubbles break; all investment frenzies pass. The market is gloriously inefficient and wanders far from fair price, but eventually, after breaking your heart and your patience … it will go back to fair value. Your task is to survive until that happens.”
2. ‘Neither a lender nor a borrower be’
“Leverage reduces the investor’s critical asset: patience. It encourages financial aggressiveness, recklessness and greed.”
3. Don’t put all of your treasure in one boat
“The more investments you have and the more different they are, the more likely you are to survive those critical periods when your big bets move against you.”
4. Be patient and focus on the long term
“Wait for the good cards this will be your margin of safety.”
5. Recognize your advantages over the professionals
“The individual is far better positioned to wait patiently for the right pitch while paying no regard to what others are doing.”
6. Try to contain natural optimism
“Optimism is a lousy investment strategy”
7. On rare occasions, try hard to be brave
“If the numbers tell you it’s a real outlier of a mispriced market, grit your teeth and go for it.”
8. Resist the crowd; cherish numbers only
“Ignore especially the short-term news. The ebb and flow of economic and political news is irrelevant. Do your own simple measurements of value or find a reliable source.”
9. In the end it’s quite simple. really
“[GMO] estimates are not about nuances or Ph.D.s. They are about ignoring the crowd, working out simple ratios and being patient.”
10. ‘This above all: To thine own self be true’
“It is utterly imperative that you know your limitations as well as your strengths and weaknesses. You must know your pain and patience thresholds accurately and not play over your head. If you cannot resist temptation, you absolutely must not manage your own money.”
(H/t: Barry Ritholtz, The Big Picture)
Tags: Aggressiveness, Barry Ritholtz, Critical Periods, Ebb And Flow, Grit, Investment Lessons, Investment Strategy, Jeremy Grantham, Lousy Investment, Margin Of Safety, Marketwatch, Nuances, Optimism, Outlier, Political News, Rare Occasions, Recklessness, Strengths And Weaknesses, Term News, Thresholds
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Thursday, February 9th, 2012
Bill Curry of the Globe and Mail reports, Ottawa looks abroad for OAS pension solutions:
The Conservative government is looking abroad to find the best way to phase in a higher qualifying age for Old Age Security.
Human Resources Minister Diane Finley argued Sunday that Canada is one of the only countries in the 34-member Organization for Economic Co-operation and Development that isn’t already raising their retirement age.
Ms. Finley was asked directly on CTV’s Question Period whether the government’s plans would see Canadians having to wait until age 67 – rather than the current 65 – in order to qualify for Old Age Security.
“That’s one option. But let’s look at it. It used to be people were expected to have a life expectancy [of] between 68 and 71. Now it’s 81, and they’re still expecting to retire at the same age,” Ms. Finley said. “Almost all of the other countries in the OECD have already moved in this direction. The U.S. started doing this a little close to 20 years ago.”
Ms. Finley, 54, continued the government’s practice of offering hints at the government’s pension reform plans without specifically spelling out when the change would take effect or what it will involve.
“What I’m saying is that in terms of implementing it, we’re not going to tell people that they have to adapt within two years to a dramatically different model. … We’re going to make sure that people my age and younger have time to adjust their retirement plans,” she said.
Alice Wong, the Minister of State for Seniors, told the House of Commons last week that more information on the changes will be in the 2012 budget. The date of the budget has not been announced.
One heavyweight that stepped into this debate is the Bank of Canada’s former governor, David Dodge, who hopes Harper steps up on pension reform:
When it comes to pension reform, David Dodge has seen this movie before – twice – but he hopes it ends differently this time.
Prime Minister Stephen Harper has refused to answer repeated questions in the House as to whether he is planning to raise the eligibility age for Old Age Security to 67 from 65, leading opposition parties to howl that he is refusing to come clean.
However, Mr. Dodge – the former governor of the Bank of Canada who was deputy minister at the Finance Department during the deficit-slashing mid-1990s – hopes the government does just that. Moreover, in an interview Friday, Mr. Dodge suggested Mr. Harper should take advantage of his majority government and even raise the age for the Canada Pension Plan, something other governments have shied away from, and which the current Conservatives say is not on the table and not necessary.
“At least since the mid-1980s we’ve known we were going to have to do something,” he said. “We knew that back in ‘97 when we did the revisions of the CPP. At the time the decision was we were doing so much to fix that adding one more layer – i.e. the gradual increasing of the age – was probably too much to bear. So, we didn’t do it, although we certainly talked about it, and the finance minister and officials at the time talked about it and realized we really should do it. But we didn’t because we were doing so much else.”
“So, quite frankly,” he continued, “we’re at least 15 years late in getting started in raising that age of entitlement for CPP, OAS and the normal expectation as to how long people would work in the private sector with private-sector pension plans. That’s absolutely clear, and because labour participation rates will start to fall later this decade, we’re up against the wall. It would have been a lot better if we’d done things in 97, it would have been even better if we had done things in 85 when we first looked at this under the Mulroney government, because you need a long phase-in.”
David Dodge is right, time to get on with pension reform. But it’s more pressing than just raising the retirement age. We need a ‘radical rethink’ of our pension system which I already alluded to when I went over Prime Minister Harper’s speech at Davos:
- Increase the retirement age to 67 (people are living longer; some economists think we need to raise the retirement age to 70)
- Review cost-of-living adjustments (COLAs) and cut when necessary
- Scrap all private companies’ defined-benefit plans and consolidate them into a few large public defined-benefit (DB) pension funds. Companies should focus on producing goods and services, not managing pensions.
- Consolidate all municipal and city pension plans into large public DB plans
- Consolidate all Crown corporations DB plans into one large DB plan
- Expand CPP to all Canadians and get the funding right
- Cap CPPIB and all large public DB plans at a certain size and create new ones as needs arise
- Make pensions portable so no matter where people work, their pensions are safe, secure, well managed and will follow them
- Last but not least, get the governance right and improve it continuously.
Canadians whining over an increase in retirement age are wrong but so are others who think that this is the only adjustment needed to bolster pensions.
Let me be more blunt: we need to get our collective heads out of our a*&es, stop fear mongering, stop peddling to interests groups, and start getting on with some serious pension reform which introduces common sense measures and builds on the success of our large defined benefit plans.
I’m tired of watching interests groups from all sides of the political spectrum cry, scream, bitch and whine about pension reform. Wake up already, look what’s going on in Europe, especially in Greece where partisan politics has destroyed the country. Having escaped the carnage that has rocked other nations, we’ve been lucky in Canada, but our good fortune could change at any time and we better be prepared.
Finally, don’t be scared of working past 65. Work is good for you, it’s healthy. It keeps your mind young and sharp. I see my 80 year old father working 10 hour days as a psychiatrist and he never complains. Admittedly, he’s lucky, he’s healthy, loves his job, his colleagues, and feels good helping mentally ill patients. Wish more Canadians had his attitude when it comes to work. Below, Canadian politicians doing what they do best, screaming at each other. Absolutely pathetic.
Tags: Alice Wong, Bank Of Canada, Bill Curry, Canadians, Conservative Government, Countri, David Dodge, Diane Finley, Eligibility Age, Globe And Mail, House Of Commons, Life Expectancy, Mail Reports, Member Organization, Minister Of State, Oas Pension, Oecd, Old Age Security, Outlier, Pension Reform, Pension Solutions, Question Period, Retirement Age, Retirement Programs
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Saturday, January 14th, 2012
The Economy and Bond Market Radar (January 16, 2012)
Long-term Treasuries rallied this week, sending yields lower as the schizophrenic market continues to gyrate up one week and down the next. This is what we’ve experienced since mid-November.
Most of the gain in Treasuries came on Friday as Standard & Poor’s (S&P) downgraded several European countries including France, Italy and Austria. The U.S. dollar and Treasuries rallied on this news, while stocks sold off.
Economic data was mixed but one outlier was the consumer credit report from the Federal Reserve, which grew by more than $20 billion in December. The 9.9 percent annualized increase is the fastest growth since November 2001. Consumer confidence and retail sales have improved over the course of the quarter but it appears a sharp reversal in consumer credit may dampen the outlook going forward.
- The University of Michigan Confidence Index and the IBD/TIPP Economic Optimism Index both registered strong increases in January.
- The three month rate in China’s M2 money supply index has accelerated very sharply and is an indication that the government is addressing the concerns of an economic hard landing. China’s bank loans rose 14 percent in December and reinforce the idea that policymakers are taking action.
- Italian 10-year bond yields fell sharply this week as bond auctions in Europe were met with strong investor demand.
- Overnight deposits with the European Central Bank (ECB) hit another record high at $591 billion as banks are still unwilling to lend to each other in the overnight interbank market. This indicates significant lack of confidence in the European banking sector.
- Weekly jobless claims rose back near the 400,000 level and are at the highest level in six weeks.
- Consumer credit surged $20 billion this week as consumers levered back up in November.
- Inflation data will be released next week and should confirm the declining trend in inflation. We also have housing starts and building permits which will hopefully confirm some of the recent positive data points in housing.
- The situation in Europe remains extremely fluid and negative news is almost expected at this point. Unfortunately, decisions are politically driven and it is difficult to predict outcomes and ramifications.
Tags: Bank Loans, Banking Sector, Bond Auctions, Bond Yields, Confidence Index, Consumer Confidence, Consumer Credit Report, European Banking, Ibd, Inflation Data, Interbank Market, Investor Demand, Lack Of Confidence, Market Radar, Money Supply, Outlier, Schizophrenic Market, Supply Index, University Of Michigan Confidence, Weekly Jobless Claims
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Friday, December 2nd, 2011
Following yesterday’s shove-liquidity-down-your-throat-of-last-resort action by the Fed et al. 3M USD Libor fell, admittedly marginally, for the first time since July 25th. The 0.1bps compression was practically insignificant as only 4 of the 18 member banks actually reduced their bids – Citi, Rabobank, RBC, and UBS but we are sure headlines will crow of the impact the coordinated central bank action has had already. What is most concerning when we look at the individual Libors of each member is one bank stands out over the last few weeks. Given that we know the dollar funding market is highly stressed (USD-cross currency basis swaps), this appears to be the only efficient way to understand which bank might be under the most stress. Given Credit Agricole’s notably weak Tangible Common Equity Ratio and the fact that its Libor was such an outlier recently, it is hard not to suspect the global stick-save was instigated because this $1.59tn asset-heavy bank was on the verge of failure.
Credit Agricole’s borrowing rate has been an outlier for the last few weeks suggesting, given the dollar funding stresses we know exist, a far greater desire to borrow USD than the rest of the motley Libor crew.
And given Credit Agricole’s 2nd worst position on Bloomberg’s Tangible Common Equity Ratio screen (behind Landesbank Berlin no less), it is hardly surprising that the giant French bank is suffering. At 66x leverage, it is perhaps no wonder the massive French bank was willing to pay up to 13bps more for 3M USD than the average Libor in early November, and still 7bps more (around a 15% premium). As an aside, the whining out of Deutsche Bank this morning (to be discussed shortly) that “using the swap lines is not stigmata” is perhaps understandable considering their position in the “weakest TCE Ratio” screen is third worst, just behind CA.
Tags: Basis Swaps, Bloomberg, CréDit Agricole, Currency Basis, Deutsche Bank, Early November, Equity Ratio, French Bank, Landesbank Berlin, Last Resort, Libor Market, Libors, liquidity, Member Banks, Outlier, Rabobank, Rbc, Stigmata, Tce, Usd Libor
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Wednesday, September 14th, 2011
While skyrocketing long-term interest rates in many of the troubled European countries have been widely covered, the charts below highlight the yield on ten-year government debt from major countries/regions around the world that aren’t in the midst of their own debt crises (…at least according to the conventional wisdom). As shown in the table to the right, ten-year yields in the US are currently just under 2%. The only other markets where ten-year debt is trading below a 2% yield are ECB and Japanese debt. Currently, ten-year debt in Canada is yielding 2.19%, while UK long-term debt is yielding 2.4%.
The big outlier of the group is Australia, where 10-year debt is trading at a yield of 4.13%. Relative to most other regions of the world, Australia’s economy is booming given that its economy is heavily leveraged to commodities.
Tags: Canadian Market, Commodities, Conventional Wisdom, Crises, Economy, European Countries, Government Debt, Highlight, interest rates, International Government, Midst, Outlier, Regions Of The World, Regions Of The World Australia, Ten Year Yields, Term Debt, Term Interest
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Friday, May 20th, 2011
by Trader Mark, Fund My Mutual Fund
About this time last year – or perhaps 14 months ago as QE1 ended – the talk was about the Fed tightening that was to come by the end of 2010. With the tsunami of spending out of the federal government still going full blast, one could assume the economy could handle a few less steroids from the central bank. Instead economic activity drooped, and the stock market (after flash crashing), had an awful summer. By late August, QE2 was hinted at strongly and it’s been all (mostly) “good times” since. (I say that with sarcasm)
As I look around we are in Groundhog Day. I hear the Fed and the financial infotainment industry believing that tightening will happen by the end of this year or early next. Now “tightening” is all relative – even if the Fed began selling inventory off their balance sheet, the Fed funds rate is at its lowest in history and the Fed still holds trillions of product. So we’re simply talking from going from”ultra ultra ultra ultra easy” to “ultra ultra ultra easy”.
Call me an outlier. I don’t think it will happen. My belief is the structural economy is so dependent on easy money from the federal government spigot, plus super easy monetary policy [Nov 18, 2009: Our Economy is on Steroids] any true reversal of policies will lead to the same type of weakness (economic) we saw last summer, and the Fed will immediately panic. QE3 will be here. Indeed I expect it by next winter. Just about the time everyone believes The Bernank will “tighten”.
We’re running at a 10% annual federal deficit simply to push out paltry 2-2.5% GDP growth. It’s pathetic. If the government goes back to 3% type deficits (which I don’t foresee but even a drop to 5-6% will be a blow to the economy) the US goes back into recession immediately. No one wants to take the ‘medicine’, so QE infinity it is. Some say it is politically impossible – I say, I disagree. More dollar weakness and commodity speculation? Yes. Is the Fed trapped in a box? Yes. But to appear to be useful the Fed has to do ‘something’. They can’t sit on their hands. And the only ‘something’ they have left is the same thing.
Yes, the Fed policies will blow up the US again down the road – I expect Bernanke to be viewed like Greenspan now is in due time – I wrote that 2+ years ago. If the stock market corrects 12-15% I expect an immediate QE hint in a speech. We’ll see, perhaps I am wrong. But according to this story on CNNMoney, some of the sharp minds at Goldman Sachs agree with my outlier view on no ‘tightening’ anytime soon. Indeed they don’t believe the Fed will tighten until near the end of the decade. With a cyclical recession surely to hit sometime mid decade, I don’t necessarily disagree with them on that count either. Where Goldman disagrees with me, is they believe no more QE….
From the story:
- A report issued by economists at Goldman Sachs argues that a coming wave of government belt tightening, hailed by hawks everywhere, will actually keep central bank doves in control for a long stretch — perhaps well into the second half of this decade.
- The yawning U.S. deficit and the fear that tighter policy could derail a weak recovery could keep the fed funds rate near zero for perhaps six years, the Goldman research suggests. “The best the Fed can do is keep monetary policy on hold to cushion the growth drag from the fiscal consolidation,” writes Goldman economist Sven Jari Stehn. “As a result, the looming fiscal adjustment should reasonably be expected to see policy rates — and probably longer-term rates too — at lower than normal levels for an extended period.”
- With all the frothing about inflation, how on earth will Bernanke & Co. be able to justify staying on the sidelines? The answer lies in the unhappy math of a profligate nation out of control for so long that its excesses can’t be trimmed all at once, no matter what the Paul Ryans of the world might claim.
- Even if our political leaders quickly agree on a package of spending cuts and tax increases – an outcome that doesn’t look terribly likely right now, on debt ceiling day – it will take years to bring that massive deficit under control. Goldman cites an IMF survey of fiscal consolidations in rich countries that puts the average length of the successful government belt-tightenings at six years.
- That is a daunting enough statistic. But most of these successes – ranging from Ireland in the mid-1980s toFinland, Italy and Sweden in the mid-1990s – shared one notable characteristic: A cut in short-term interest rates that averaged 5 and a half percentage points. Pulling that lever isn’t an option for the Fed, which cut its fed funds rate to its current level just above zero in December 2008.
- “With the funds rate close to the zero lower bound,” Stehn writes, “a spending based adjustment could not be accompanied by monetary easing unless the Fed decided to adopt another asset purchase program (which we think is highly unlikely).“
- That means that even a successful U.S. consolidation could feature a Fed on hold for, all things considered, a decade. (just remember, we are not Japan) If you start back in 2008 and figure it will take our solons in Washington the rest of the year to put together a plan for meaningful reforms, a six-year timeline means we could still be consolidating in 2018. And that assumes something gets done before next year’s presidential election.
- It will also mean more trials for the dollar, which has fallen 10% against major currencies since Bernanke said in August that the Fed would do anything to boost domestic demand.
Copyright © Trader Mark, Fund My Mutual Fund
Tags: Easy Money, Economic Activity, Fed Funds Rate, Federal Deficit, Full Blast, GDP Growth, Goldman Sachs, Groundhog Day, Late August, Monetary Policy, Mutual Fund, Outlier, Qe, Qe2, Recession, Sarcasm, Spigot, Steroids, Stock Market, Trillions
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Monday, April 11th, 2011
The Return of the Carry Trade?!
by Jeffrey Saut, Chief Investment Strategist, Raymond James
April 11, 2011
“The mid-March G7 currency intervention on the Yen has given carte-blanche to Japanese investors to once again deploy capital abroad and seek yields wherever they may be found. And on cue, all the higher-yielding bonds and currencies (Indonesia, Hungary, Turkey, Australia, New Zealand …) have soared. This influx of liquidity (and the balance sheet of the Bank of Japan has just grown by approximately US$275bn) has also helped push risk assets higher across the spectrum. The question of course is how sustainable this increased appetite for risk will prove to be in the face of rising oil and commodity prices, and of diverging monetary policies. Putting it all together, it seems obvious to us that we are approaching some kind of a tipping point. The concomitant rise in commodity prices and risk assets does not seem to be compatible. Neither does the rise in commodity prices, equity prices, and inflation expectations (whether from TIPS, consumer surveys, ISM surveys …) and overly easy central banks. Finally, the recent surge in certain currencies (AUD, CHF …) to two standard deviations above their purchasing parities should also have economic consequences. So the current situation does not seem stable from a bottom-up perspective. And from a top down perspective, it seems obvious that the recent period of exceptionally easy fiscal and monetary policies is an outlier and should come to an end. This is already occurring in Europe and in China. The next step is for the US to follow suit.”
We have long admired the prescient folks at the GaveKal organization for their ability rotate the “investment prism” 180°, giving them the ability to view things from a different perspective. Said “different perspective” often reveals net-worth changing ideas unforeseen by many conventionally focused strategists on Wall Street. GaveKal’s views can be gleaned tomorrow (4/12/11) at 4:00 p.m. in a conference call with portfolio manager Steve Vannelli by dialing (877) 216-1555 (Code: 722117). That said, in our opinion the G-7 intervention was meant to prevent a stronger yen from hurting Japan’s exports, braking capital flows into Japan, not necessarily encouraging outflows. There may be an increase in the carry trade in both dollars and yen, but I don’t think this is the main factor behind the rise in commodity prices and increased demand for risk assets. In the short-term, central bank policies matter a lot for currencies. However, the U.S. is not going to raise rates anytime soon, implying a somewhat softer dollar. You’re hearing inflation concerns among some of the district bank presidents, but that is very much a minority view. The Fed sees higher oil prices as a negative for growth, not a catalyst for a higher trend in underlying inflation; but officials will be watching inflation expectations, the trend in core inflation, and wages. The Fed, in fact, wants higher inflation (2%, not sub-1%). To be sure, the Fed will not tighten because everybody else is.
Nevertheless, we think interest rates have seen their cycle “lows.” While that does not mean they will rise in the short-term, over the longer-term it is tough to envision why they won’t. Indeed, recently there have been large “capital calls” in regions that have typically been our natural lenders. As stated, Europe needs more of its capital at home to bail out the PIIGs. The Middle East needs its capital to pay off dissidents. Japan clearly has a capital call and the Federal Reserve is preparing to exit QE2. Accordingly, it is difficult to see how our cost of capital (interest rates) can’t keep from rising. However, that does not mean it has to happen in the next quarter or two. It also doesn’t mean that GaveKal’s observation regarding “the return of the carry trade” can’t play in the short to intermediate-term as well.
Yet, that wasn’t the case last week as stocks stalled their way through the week, leaving the D-J Industrial Average (DJIA/12380.05) better by a mere 0.03%. The week, however, was not without its milestone, for the DJIA notched a new reaction high, thus confirming the D-J Transportation Average’s (DJTA/5228.30) new reaction high of a few weeks ago. Accordingly, another Dow Theory “buy signal” was recorded. It was the third such signal of the past 10 months, suggesting the path of least resistance remains “up.” Still, the stock market “feels” as if it needs to consolidate its gains, and rebuild its internal energy, before moving higher. That implies more of the churning action we experienced last week. In fact, as is often the case, the indices tend to expend so much energy in achieving a Dow Theory “buy signal” they need to rest a bit before reenergizing. On a very short-term basis, the downside should be contained in the 1320 – 1325 zone [basis the S&P 500 (SPX/1328.17)]. Failing that support brings 1305 into play, which would be a 38.2% retracement of the recent rally. Whatever the near-term outcome, we believe it would take some major “news shock” to break the SPX below the massive support now visible at 1275 – 1300.
Of course such a “shock” could come from the Middle East, causing crude oil to vault even higher. To us, this is the biggest risk to the economy. If oil prices were to stabilize, even at these elevated levels, we think the economy will be just fine. However, Brent crude oil traveled above $126 per barrel last week, with a concurrent rise in WTI to $112.79 per barrel; that brought retail gasoline prices to $3.75 per gallon. Due to such energy machinations many economists reduced their GDP estimates last week; while lower growth may be in the cards, even slower growth should still allow earnings to exceed current expectations. Indeed, last week saw a solid retail sales report, initial employment claims fell, German factory orders were strong, and the ECB and PBOC raised interest rates. Moreover, last Friday’s BLS report confirmed that employment is starting to recover at a faster pace. All of this data doesn’t sound all that weak to us.
Speaking to energy, we have been writing about the La Nina weather pattern, combined with more volcanic ash in the atmosphere than anyone can remember, since last August. Our conclusion was that the 2010 – 2011 winter was going to be wet and colder than most expected. Our investment strategy was to WAY overweight the energy complex. Recently, however, we have recommended selling partial positions (not all) to rebalance those overweight positions back to their intended allocations. Our worry is that some of the climate factors causing the wicked winter will be fading this summer. While we expect a stormy spring, and droughts in the South, things should be better by mid-summer. That does not mean we won’t have a worse than normal hurricane season . Still, readers are advised to rebalance our overweighting energy recommendation as the summer season approaches.
Of course, that includes our recommendations on the Canadian Oil Sands, despite our enduring belief that over the longer-term the Oil Sands are likely the best energy investment around. Last week, however, the Alberta government announced a draft for the Lower Athabasca Regional Plan. In this new framework, the government outlines new conservation and recreation areas, which in some cases cut into previously existing oil sands leases. As our Canadian Oil Sands analyst (Justin Bouchard) writes:
“Impact to current oil sands leases is minimal – for the most part, there are very few leases which are impacted by the new regional plan, and in almost all of the cases where existing leases are impacted, it is minimal.”
“No impact to existing producing projects – existing projects are untouched as are areas with any near or medium term development plans.”
For further information, please see our Canadian analysts’ comments.
The call for this week: Over the weekend things have indeed heated up in the Middle East with Gaza-based Hamas launching anti-tank missiles and hitting an Israeli school bus, a responding Israeli air strike, Egyptian talk of war if Israel attacks Palestinians in the Gaza, Egypt ready to resume diplomatic relations with Iran, more demonstrations in Egypt’s Tahrir Square, and talk that Israel might combine with Libya. Yet, crude oil is actually down, increasing our sense that rude crude is at/near an upside inflection point. If true, after another few consolidation sessions, it would surprise the most if the SPX rallied above its reaction high of 1344 for another leg up. We are positioning accounts accordingly. And don’t look now, but our fundamental energy analysts had some VERY positive comments on 5.4%-yielding EV Energy Partners (EVEP/$56.24/Outperform).
P.S. I’m in New York City all week; subsequently this will be the only investment strategy commentary for the week.
Copyright © Raymond James
Tags: Bank Of Japan, Canadian, Carry Trade, Central Banks, Chief Investment Strategist, China, Commodity Prices, Concomitant Rise, Consumer Surveys, Crude Oil, Currency Intervention, Different Perspective, Economic Consequences, Fiscal And Monetary Policies, Increased Appetite, Inflation Expectations, Japanese Investors, jeffrey saut, Mid March, oil, Outlier, Parities, Raymond James, Standard Deviations
Posted in Canadian Market, Energy & Natural Resources, Markets, Oil and Gas | Comments Off
Saturday, December 4th, 2010
This week’s chart plots the residential prices of major cities around the world against the purchasing power of the people living there. In terms of affordability, the upper left quadrant is where you don’t want to be. That means that the cost for housing is high while the average income per household is low.
What about the lower right quadrant? Abu Dhabi is the outlier there because it has the third-highest GDP per capita in the world behind Luxembourg and Norway but residential prices remain low. This can be both a good and bad quality. On the one hand, Abu Dhabi has a very wealthy population which reflects the city’s economic vitality. On the other hand, residential prices are still showing the effects of the 2008 crash when prices for higher-end apartments and homes fell 35 percent in just three months.
The ideal place to be is right in the center, striking a balance between residential prices and incomes.
Two cities that are moving toward the center, though at different speeds, are Moscow and Istanbul. Residential real estate in both Russia and Turkey stands to benefit from historically low interest rates, recovering unemployment and improving consumer confidence, according to Merrill Lynch.
In Turkey, the strength of the recovery has resulted in record auto sales, growth in mortgage loans and restored consumer confidence, Merrill Lynch says. Recently, this strength has raised inflation concerns but there are several pillars to support the residential market.
Demand from the young and growing middle class is jumping as developers have begun offering smaller units, banks are offering longer loan durations and interest rates are at an all-time low. As a result, mortgage loans have grown 32 percent so far this year and are estimated to grow an additional 30 percent in 2011.
If you need more evidence, just look at what happened yesterday when property developer Emlak’s initial public offering jumped 12 percent in its first day of trading and another 11 percent in early trading today. We were fortunate to participate in this offering in U.S. Global’s Eastern European Fund (EUROX); adding Emlak to the fund’s existing weighting in Turkey. Emlak isn’t the first Turkish company looking to tap into Turkey’s potential growth. Six Turkish real estate investment trusts have already sold shares to the public this year, according to Bloomberg.
Though the Russian economy has recovered, it is not nearly as far along as Turkey. Affordability is an issue in Russia. Official statistics show only 20 percent of the population can afford their mortgage payments at the moment, but the expectation is that this will extend an additional 20 percent in the next five years.
Banks are using government subsidies as a crutch and have been reluctant to hand out mortgages not backed by the government, but the market could heat up quickly once more mortgages are released into the system. Russia is currently under-levered in terms of debt compared to its Central Emerging European peers, which means there is ample catch-up potential when consumer confidence returns.
Long term, the trend for both residential markets looks positive. Low mortgage penetration in both markets means there is room to grow if inflation can remain under control.
Please consider carefully a fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.
Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk.
By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio.
The Eastern European Fund invests more than 25% of its investments in companies principally engaged in the oil & gas or banking industries. The risk of concentrating investments in this group of industries will make the fund more susceptible to risk in these industries than funds which do not concentrate their investments in an industry and may make the fund’s performance more volatile.
Holdings in the Eastern European Fund as a percentage of net assets as of September 30, 2010: Emlak 0.00%.
Tags: Average Income, Bad Quality, Cities Around The World, Consumer Confidence, Currency, Economic Vitality, Gdp Per Capita, Gdp Per Capita In The World, Inflation Concerns, Initial Public Offering, Low Interest Rates, Merrill Lynch, Mortgage Loans, Outlier, Property Developer, Purchasing Power, Residential Market, Residential Prices, Residential Real Estate, Russia, Upper Left Quadrant, Wealthy Population, World Cities
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Rosenberg says “ISM Flunks Sniff Test “; Cashin calls ISM “an Outlier”; ADP, Other Data Does Not Confirm
Sunday, September 5th, 2010
When futures ramped into the close on Tuesday, with heavier volume, I had an inkling the ISM number would be hot Wednesday morning. Indeed, that was the case.
However, a hot manufacturing ISM makes little sense (not that any economic numbers have to make sense except perhaps in the long haul).
One thing that struck me right off the bat was how the monthly ADP jobs report does not confirm the ISM number. Nor do the regional Fed reports that I have been following, especially the Philly Fed report as noted in 58 out of 58 Economists Overoptimistic on Philly Fed Manufacturing Estimate; Median Forecast +7 Actual Result -7.7, a “Veritable Disaster”.
August ADP Employment Reports Shows Contraction in Manufacturing Jobs
Inquiring minds are reading the ADP August 2010 National Employment Report for clues on strength of hiring trends.
Private-sector employment decreased by 10,000 from July to August on a seasonally adjusted basis, according to the latest ADP National Employment Report® released today. The estimated change of employment from June to July was revised down slightly, from the previously reported increase of 42,000 to an increase of 37,000.
The decline in private employment in August confirms a pause in the recovery, already evident in other economic data. The deceleration in employment was evident in the major sectors and by size of business. This month’s decline in employment followed six monthly increases from February through July. Over those six months, the average monthly gain in employment was 37,000 with no evidence of acceleration.
August’s ADP Report estimates nonfarm private employment in the service-providing sector rose by 30,000, the seventh consecutive monthly gain. This increase was not enough to offset an employment decline in the goods-producing sector of 40,000. Employment in the manufacturing sector decreased 6,000, the second consecutive monthly decline.
Large businesses, defined as those with 500 or more workers, saw employment remain essentially flat while employment among medium-size businesses, defined as those with between 50 and 499 workers, decreased by 5,000. Employment among small-size businesses, defined as those with fewer than 50 workers, decreased by 6,000. In August, construction employment dropped 33,000. Construction employment has declined for over three years and the total decline in construction jobs since the peak in January 2007 is 2,275,000. Employment in the financial services sector dropped 5,000. Financial Services employment has declined for over 3 years.
ISM Smell Test
Rosenberg blasted the ISM report in Breakfast with Dave.
STRANGE ISM NUMBER … DOESN’T PASS “SNIFF TEST”
1.Most of the regional reports were very poor in August. Either they are collectively all wrong or the ISM is.
2. The share of respondents saying they experienced “growth” was 61%, the exact same as a year ago when ISM was sitting at 52.8.
3. The ISM gain was led by employment (58.6 to 60.4 — best since December 1983) in the same month that ADP manufacturing fell 6,000 (second decline in a row — it was -11k in July when ISM employment was 58.6, so clearly the latter is proving to be, at least for now, an unreliable labour market barometer). Production also ticked up to 59.9 from 57.0 and inventories rose to 51.4 from 50.2. These are all coincident indicators, as an aside (but an important aside).
Strange ISM number, it doesn’t pass the sniff test and here is one reason: most of the regional reports were very poor in August… either they’re wrong or the ISM is
4. According to the ISM, 76% of the manufacturers surveyed said that in August, their customer inventory levels were either “too high” or “about right”. At the turn of the year, just ahead of the big inventory swing that bolstered the GDP data, this metric was sitting at 60%. As a result, it would be folly to assume that the inventory and production categories will contribute to further ISM increases in the near- and intermediate-term. Norbert Ore, who presides over the ISM survey, had this to say about inventories: “If the inventory build isn’t voluntary then we have a huge issue on our hands.”
5. Meanwhile, the more forward-looking components dropped, though were hardly a disaster. But orders slipped for the third month in a row, to 53.1 from 53.5 in July, 58.5 in June and 65.7 in both April and May. That is still a sharp squeeze in the growth rate of capital goods-related order books. At 53.1, ISM orders index is down to levels last seen in June 2009 (but when they were rising in “green shooty” fashion).
6. Backlogs were down as well, to 51.5 from 54.5 in July, 57.0 in June and 59.5 in May (and peaked in February at 61.0). At 51.5, order backlogs stand at their low-water mark of the year.
7. Supplier deliveries (measure of production bottlenecks) eased for the fifth month in a row — to 56.6 from 58.3 in July and well off the March peak of 64.9.
8. Looking at five decades worth of data, the share of the time in which we see orders, backlogs and vendor deliveries all decline in tandem, and the headline ISM index rise, is the grand total of 1%. No wonder equities rallies so much — we just witnessed a 1-in-100 event! Bring your camera.
9. Export orders dipped to 55.5 from 56.5 — the lowest they have been since last December. If the overseas economy is rocking and rolling, then why on earth would this component be declining? Not only that, but it looks as though, yet again, a good part of the inventory boost we still seem to be getting is being filled by imports — that sub-index jumped four points in August and does not bode well for the trade deficit, which subtracted 3.4 percentage points from headline GDP growth in Q2.
MORE ON THE DATA
It would be something if the ISM was being fuelled by broad based increases and occurring alongside a decent path in domestic spending. But the ISM gains were narrowly based and the inventories are continuing to be built up even as domestic demand is slowing down. And it is spending that drives production, not the other way around. The fact that fewer respondents are saying inventories are at low or desirable levels is going to set us up for some pretty hefty production and ISM reversals through the fall.
Art Cashin says “ISM is an Outlier”
For more from Art Cashin, please see 26 of Last 88 Trading Days have been 90% Days (Either Up or Down); 7 More Lean Years in Stock Market?
Let’s assume for a moment the ISM number is correct. If so, manufacturers are ramping up production just as the economy is dramatically slowing by nearly every other measure.
I smell huge inventory problems coming up in the 4th quarter. In the meantime, let’s party over a ramp in production with no buyers.
Tags: Adjusted Basis, Cashin, Contraction, Deceleration, Economic Data, Economic Numbers, Employment Report, Employment Reports, Inkling, Inquiring Minds, Ism, Long Haul, Manufacturing Jobs, Manufacturing Sector, National Employment, Outlier, Private Employment, Private Sector Employment, Rosenberg, Wednesday Morning
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