Wednesday, July 4th, 2012
If there is one group that is almost never bearish it is sell side analysts – you know the ones, those who almost never issue a sell recommendation. [Dec 5, 2007: The Games Analysts Play - Why Almost No One Says Sell] After all Wall Street sell side analysis is all about
making sure you never upset the company because you might lose business with them in the future advising clients on company prospects in an accurate way.
According to BofA Merrill Lynch, the sell side appears to be the most bearish it has been in 15 years. For the contrarians out there, that might be another near term positive.
The Sell Side Indicator is based on the average recommended equity allocation of Wall Street strategists as of the last business day of each month. We have found that Wall Street’s consensus equity allocation has historically been a reliable contrary indicator. In other words, it has historically been a bullish signal when Wall Street was extremely bearish, and vice versa. See our November report for more details on the Sell Side Indicator.
Tags: Bofa, Bullish Signal, Business Day, Consensus, Contrarians, Equity Allocation, Games Play, Last Business, Merrill Lynch, Prospects, Strategists, Vice Versa, Wall Street
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Tuesday, April 10th, 2012
by Dr. Scott Brown, Ph. D, Chief Economist, Raymond James
April 9 – April 13, 2012
The stock market has risen nicely this year, partly on improving economic data, but are such gains justified by the earnings outlook? The level of the S&P 500 Index does not appear to be out of line with earnings expectations, but there may be some pressure on profits over the longer term. As the election approaches, we may hear more about class warfare.
In the late 1990s, share prices rose more than was justified by the earnings outlook. In hindsight, the market was clearly in a bubble. In the last decade, the market rose roughly in line with earnings. However, the Great Recession sent earnings sharply lower, and the stock market followed. Since the recession has ended, earnings have more than recovered. Bottom-up earnings estimates for more than a year out, compiled from analysts’ forecasts of individual companies, still look a bit giddy, but that’s typical. Top-down estimates, provided by economists and strategists, are more moderate – and consistent with some slowing in corporate earnings relative to the last few years. That’s to be expected. Much of the rebound in earnings has reflected the bounce-back from the recession. Firms have a tendency to cut too many jobs and overly curtail capital expenditures near the end of the downturn and there’s some catch-up as conditions begin to improve.
Part of the strength in corporate profits in the recovery has been due to the restraint in labor costs. Given the large amount of slack in the labor market, wage pressures are relatively subdued. Moreover, since the labor market slack is expected to remain elevated for some time, corporate profits are likely to stay relatively strong. As a percentage of national income, corporate profits are very high and labor compensation is relatively low. The share of national income going to profits and the share going to labor cycles back and forth over time and at some point the pendulum seems likely to swing back in the other direction, but probably not anytime soon.
It’s hard to have an intelligent discussion about the distribution of income. One side sites “corporate greed,” the other sites “class envy.” For the most part, economists have generally shied away from income distribution issues. This is mostly a question of politics. It’s difficult to say what an “appropriate” distribution of income should be and what steps should be taken to achieve it.
However, there’s no doubting that the distribution of income has widened significantly over the last thirty years. Real wages have stagnated. A lot of that is due to the decline of union membership. In the early 1970s, 25% of private-sector jobs were union jobs. Now unions account for less than less than 7% (note that 37% of public-sector jobs are union, but many of these are teachers and the dynamics are a lot different). In the late 1960s and early 1970s, we typically had more than 300 work stoppages per year, involving millions of workers. We had 19 last year, involving 113,000 workers.
It’s unclear what role the distribution of income will take in this year’s election, but investors should pay attention.
Tags: Capital Expenditures, Chief Economist, Class Warfare, Corporate Earnings, Corporate Profits, Downturn, Dr Scott, Earnings Estimates, Economic Data, Hindsight, Individual Companies, Labor Compensation, Last Decade, Raymond James, Recession, Share Prices, Slack, Stock Market, Strategists, Wage Pressures
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Thursday, April 5th, 2012
In his latest piece, Dylan Grice comes very close to explaining some of the more irrational, manic, aspects of modern capital markets. Appropriately coming after the recent mania with the $640 million Mega Millions Jackpot (which as we described is nothing but the government taking advantage of personal gullibility and effectively acting as a tax on the poor), the SocGen strategists effectively succeeded in debunking some of the flawed assumptions embedded in the efficient risk frontier, and points out that just because something has greater risk, does not mean it will generate a higher return. Quite the contrary. After analyzing returns of low (boring) and high beta (big upside opportunity, big risk) stocks, he finds that “higher quality stocks carry the sort of lower risk which is supposed to attract a low return, we’ve consistently found them to be higher return. Quality stocks, in other words, seems to possess that attribute most desirable to the long-term investor: systematic undervaluation.”
Reread the last quote as it has huge implications for all those who, self-professed, scramble after high beta momentum stock, and allegedly make gobs of money. Chances are most of them are lying. But how does one explain this fundamental discrepancy between textbook finance and reality? Simple – think lottery, and the fact that humans are inherently flawed, greedy animals, always seeking shortcuts to wealth, fame and power. In Grice’s words, “Antti Iimanen’s idea that ‘high risk’ securities attract a “lottery ticket” premium is closer to being right than wrong. We also think that the same psychological tendency that overvalues lottery tickets undervalues quality stocks, as their robust business models and solid balance sheets do tend to be quite boring. [Hence the boredom discount]. So our best guess at the moment is that the mispricing of quality is indeed systematic. It reflects something permanent (our psychological hardwiring) rather than something transient (the fads of macroeconomic theory).”
In other words, just like 3 people shared the winning prize from the Mega Millions jackpot and tens of millions ended up empty handed, so chasing after high beta will, over time, lead to ruin. And in this case, one can’t blame the Fed or any other central planners. It also explains the exponential blow off mania phases so evident in every bubble… up until the realization that the latest fad is nothing but another get rich quick scheme with nothing backing it, and driven more by herd mentality than rational thought. To paraphrase Cassius: “”The fault, dear Brutus, is not in our stars, But in ourselves.”
The one SocGen chart that proves Grice’s point with clinical precision:
The implications of this finding also undermine the entire efficient markets hypothesis: in essence, the corollary is that “high risk” in the market is systematically overvalued by all those who assume that just because it is high risk, it will generate greater returns, when empirical evidence shows time and time again that it won’t. The same as playing the lottery at 176 million to one odds. And yet people keep doing it. Until the risky stock blows up in your face. After all: it is risky for a reason! There are those who naturally benefit from this bias, such as all those who are willing to take advantage of the “lottery” mania to issue risky securities to a public which is inherently unable to distinguish inherent bias from objective observation, and overvalue risk, while undervaluing safety.
Grice explains further:
A common finding in experiments is that people prefer, say, a guaranteed $90 to a 95% chance of $100. In other words, a near-certain bet correctly valued $95 will tend to be worth significantly less to most people. We undervalue near-certain outcomes. Yet this is exactly the world in which low beta/high quality stocks live. Cast your eyes down a screen of low beta stocks and you’ll find yourself looking at food retailers, tobacco companies and regulated utilities. Forget the possibility of outsized returns in a few months. Last year was pretty much the same as the one before, and this year will probably be much the same as next … probably …
The next chart shows the difference between the objective probabilities and the decision weights from the previous chart. It shows the over-valuation of possibilities and the undervaluation of near-certainties. And if high beta/low quality stocks live in the world of possible triple-digit returns, attracting lottery ticket overvaluations, low beta/high quality stocks live in the world of near certainty, attracting the boredom discount.
Of course, for this thinking to be correct we, like the guys at GMO, are making the assumption that the lower quality elements of the stock market are effectively more speculative. They are vehicles for trading with, not investing in. If that’s close to the mark, therefore, we’d expect to see more activity in the high beta/lower quality names. The following chart shows exactly such a tendency, with estimated holding period for low beta (fifth quintile) portfolios to be almost three times higher than for high beta (top quintile) ones.
The most common question we get when we recommend quality is whether or not its past outperformance has been simply because it started out cheap, or because there’s something more going on. The possibility effect creates excitement. The near-certainty effect is a slightly anxious boredom. And we’re hardwired to overvalue excitement and undervalue boredom. So I think it’s the latter – because there is something more going on.
So we still have a bias towards quality in the stock market, and we think you should too.
And while we all know that Grice is 100% right, and in the long run risk does not pay off, that animalistic, irrational part of the brain will keep on telling you to buy AAPL call options at $500, $600, $1,000, $10,000 etc, because “it may make you rich.” Sure: so can the Mega Millions. Realistically, will it? Absolutely not.
Tags: Assumptions, Balance Sheets, Best Guess, Boredom, Business Models, Capital Markets, Debunking, Discrepancy, Grice, Gullibility, High Risk, Lottery Ticket, Mega Millions, Momentum Stock, Quality Stocks, Risk Stocks, Robust Business, Strategists, Term Investor, Ticket Premium
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Wednesday, January 11th, 2012
I reported two weeks ago on “Doug Kass’s 15 surprises for 2012”. Hedge fund manager Kass of Seabreeze Partners is a familiar and respected name on this blog, and readers are always keen to learn his views. I therefore thought his 10 reasons for the U.S. stock market to rally might also be of interest. The full article appears on The Street and I urge you to read it in its entirety. A summary is provided below.
Kass said: “I have rarely been accused of being an economic/stock market cheerleader, but I believe the U.S. stock market will surprise to the upside in the near term for the following fundamental, technical and sentiment reasons:”
1. Poorly positioned market participants
Watch not what they say; watch what they do. And the dominant investors (retail and institutional/hedge funds) are underinvested and/or skewed disproportionately in a “flight to safety” into fixed income over equities.
2. Technical breakout
[Breaking out of the recent trading range] will encourage technically based chasers of market momentum.
3. Big rotation
Don’t market historians tell us that a better tone for the financial sector is a necessary condition and reagent for a better stock market? Yet that turnaround of the financial continues to be treated with skepticism by most.
4. Misplaced preoccupation with Europe: The European situation has improved. Timid policy response is moving toward “shock and awe” — yet investors are still scared to wake up every morning to rising sovereign bond yields, and that fear is keeping them sidelined.
5. Recent earnings cuts discounted
Memo to negative strategists: The market has likely already discounted (with a 15% decline in price-to-earnings ratios in 2011) a diminished profits outlook.
6. Likely regime change in the U.S.
Though the odds of a Republican presidency have improved, most investors are ignoring this “market friendly” development that could occur within the next 12 months.
7. Better economic data
The prospects of a self-sustaining U.S. economic recovery have been more solidified in the past six weeks. (I continue to be of the view that ECRI’s Lakshman Achuthan’s recession call is wrong-footed.)
8. Contained geopolitical risks
We should monitor but not let geopolitical issues predominate our investing thinking.
9. Market-friendly rates
Low interest rates around the world in 2012-13 mean that any model based on interest rates results in a very inexpensive market valuation. (I continue to expect a massive reallocation trade out of bonds and into stocks.)
10. Lower volatility
Crazy market swings scared off and alienated investors over the past year. Shouldn’t the recent collapse in volatility help bring back investor confidence?
Source: Doug Kass, The Street, January 10, 2012.
Tags: Bond Yields, Chasers, Doug Kass, Economic Data, European Situation, Financial Sector, Hedge Fund Manager, Hedge Funds, Market Momentum, Market Participants, Necessary Condition, Outlook 6, Policy Response, Reagent, Regime Change, Republican Presidency, Seabreeze Partners, Shock And Awe, Strategists, U S Stock Market
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Thursday, September 29th, 2011
Citi’s Economics team downgraded global growth expectations once again, expecting 3.0% this year (versus 4.0% last year) with more aggressive downgrades next year to only 2.9% (from 3.2% expectations last month and 3.7% two months ago). Growth revisions were downgraded for every major global economy as expectations move with Goldman’s coincidentally-timed discussion of stagnation (also tonight) with advanced economies cut more than developed though Eastern Europe saw the most significant reductions. They note that ‘the recent pace of GDP forecast downgrades is among the greatest of the last ten years’ and extends the recent run of lower forecasts to four months-in-a-row. In a secondary note, Willem Buiter and team also pour cold water on market expectations for the EFSF pointing out, as we have done for a few weeks now at every suggestion, that all the different options have their shortcomings and are unlikely to be implemented quickly.
From Citi’s September 2011 Global Economic Outlook and Strategy:
Global growth prospects continue to deteriorate quickly, both for advanced economies and emerging markets.
This month, we are again cutting our 2011-12 GDP growth forecasts for many countries, including the Euro Area, UK, Japan, US and Canada, with a modest downgrade for China and sharper cuts for Eastern Europe, Singapore, Hong Kong and South Africa.
We expect early sovereign debt restructuring in the Euro Area, and for the Euro Area overall to slip back into recession in coming quarters. The following table outlines progress so far on the initial increase:
Against this backdrop, Citi’s Macro Strategy team are cautious on risk
assets and bullish core fixed income. Citi equity strategists believe
that markets are oversold, but that stock prices are unlikely to move
convincingly higher until there are clearer signs of stability in
economic activity and profits growth. Citi rate strategists expect lower
yields and flatter curves in core EMU markets and the UK. Citi FX
strategists expect the USD and JPY to gain.
Tags: Buiter, Canadian Market, Downgrades, Economics Team, Efsf, Gdp Forecast, GDP Growth, Global Economic Outlook, Global Economy, Global Growth, Gold, Growth Expectations, Growth Forecasts, Growth Prospects, Initial Increase, Market Expectations, Outlook, Singapore Hong Kong, Sovereign Debt Restructuring, Stock Prices, Strategists, Strategy Team, Table Outlines
Posted in Canadian Market, Gold, Markets, Outlook | Comments Off
Thursday, April 14th, 2011
From Nomura’s Bob Janjuah
In Bob’s World USDs are not welcome
My last report (The Sceptical Strategists: Time to fade Jackson Hole) was published nearly two months ago, and after another hectic travel schedule here is an update.
1 – Overall, the issues leading to the 2007-09 crises are still present, and are even worsening in some places. Namely very large global, regional, sectoral and national imbalances (in areas such as incomes, earnings, wealth, trade and financial health); excessive levels of, and excessively narrow concentrations of, debt primarily in Western economies; and significant fat tail risks in the market when it comes to the price of and the levels of assumed volatility. It seems that collectively we learnt nothing from the 2007-09 experience, and the apparent solution to the crisis has been to implement more of the same policies that caused the mess in the first place.
2 – Therefore, as we have said throughout the past four years, we think the key drivers of markets and economies are still the cost of capital (CoC) and balance sheet (BS) strength/financial health. The rising CoC over 2006-09 led to exactly what it always leads to: slower growth, weaker earnings and incomes, and ultimately a default cycle and poor risk asset performance. Since early 2009, primarily through quantitative easing (QE), the CoC fell and has been artificially mispriced in our view since then. This lower CoC also had the usual consequences: more leverage, more debt, and artificially supported, or mispriced, (risky) asset valuations.
3 – As we have discussed previously, the key current global macro themes occupying the market are still:
- In emerging markets (EM) will there be a soft or a hard landing? There is no doubt that a landing is needed in order to address inflation problems, excessive and speculative asset bubbles, approaching cyclical capex peaks, and very real labour squeezes/positive output gaps. But what sort of landing this will be remains to be seen.
- In developed markets (DM) we expect, for the next few years, lower trend growth rates. Already excessive debt levels have worsened, and we continue to expect a weak U-shaped recovery in domestic sectors overlaid by a temporary and highly cyclical super-cycle in manufacturing based largely on demand from the big three EM nations, the BICs (Brazil, India and China).
- In Europe, although we do eventually expect a credible and sustainable solution to Europe?s excessive debt/insufficient equity problem, we expect the crisis to continue for a while yet.
To the above three themes we can now add two more. Firstly, the outlook for Japan after the tragedy, and how it may impact the global economy and any global asset allocation. Second, Arabic unrest/oil price spikes and how such price moves are affecting growth and inflation in both the DM (where growth is the bigger risk), and the EM world (where, in energy and food, inflation is the bigger risk).
Other than the recent shock in Japan, all of the above are clear iterations of the issues discussed in (1) above. Nomura analysts are constantly assessing the shorter-term and medium-term impacts of the triple tragedy in Japan. Of course the nuclear problems are ongoing, but for the Sceptical Strategists the longer-term risk is that Japanese repatriation of its huge net overseas asset position may be hastened by these events. In this context even Japan is an iteration of the problems and issues summarised in (1). Japan has been one of the biggest current account surplus economies for decades, and has as a result been supplying the global economy, especially in the DM, with large amounts of cheap capital. If repatriation becomes a meaningful trend over the next five to ten years as Japan seeks to “service” its domestic deficit and significant (gross – for now the current net position is comfortable) debt burden, then this repatriation will cause the CoC to rise globally. Those predicting the collapse of the Japanese economy should realise that the West is not just addicted to cheap capital from Chinese excess savings/reserves or from the Fed. It has also, over the decades, become very reliant on Japan?s exports of capital!
4 – Our secular asset allocation theme is unchanged – a rising CoC period is, broadly, a risk-off phase, where the strongest BS entities (be they corporate, financial, government or consumer) should relatively (at least) outperform. A falling CoC phase is broadly about risk-on and favours the weakest BS entities. The period from 2007 to early 2009 was a rising CoC, risk-off phase. Early 2009 to the present has been a falling CoC, risk-on phase, albeit punctured by some brutal sell-offs that ultimately forced the Fed into QE2. We strongly believe that the next major secular trend, which will likely begin in 2011 and last through 2012 and maybe even into 2014, will be a rising CoC, risk-off phase where the weakest BS entities will underperform the most.
5 – We discussed at length our tactical asset allocation themes in our previous report two months ago, and we now update them. The first big call we made in late January was that the risk-on trade, expressed via global equity indices, would reach a top of some form in February; we set the S&P 500 target for this February top at 1330/1350. This has worked out well, with the S&P 500 peaking so far this year at 1344 on 18th February. We then expected a (minimum 10%) sell-off in risk assets, with the key risk periods likely to be March and/or April. This call has also worked out well. From the February highs global equity markets sold off close to 10% into the mid-March lows, with some markets well over 10% down but with the US major indices down a little less than 10%. Thereafter we saw two possible paths, either the soft landing path or the hard landing path:
- In the soft landing scenario, where we expect voluntary global policy tightening, driven by EM, we would expect 1350 S&P to act as a ceiling, and this sell-off to end with a 20% fall (from the February) peak to (the end-Q2) trough. Such a sell-off would in our view create a very positive TACTICAL buying opportunity for risk, as it would be the ideal “pause that refreshes” and would take the pressure off global commodity prices, the building global inflation risks, stretched risk asset valuations, and reduce the pressure on rising bond yields in DM.
- Under the hard landing scenario we would expect global policymakers to make even more policy mistakes by failing to tighten, and even more worryingly, by accommodating price shocks, especially in EM. Under this scenario we would expect the 1220 support level to hold for the S&P in Q2 2011, and we would look instead for another melt-up in risk assets over Q2 2011, with the S&P peaking at 1400/1440 by end-Q2. This then would be followed by a very difficult and bearish H2 2011 for risk, as the melt-up in commodities, valuations, expectations, sentiment, inflation, positioning and bond yields would together give the perfect backdrop for a severe hard landing in risk assets. Key here is that QE3 would be delayed until late 2011/early 2012 because of the extremely negative impact that the Fed’s QE2 has had on inflation (globally) and the significant concerns already building about the Fed’s credibility. We think QE3 is still likely, but judge that risk asset markets and the US economy (notably unemployment) will have to worsen considerably before the Fed can make a “credible” case and garner consensus support for QE3. Our view is that over H2 2011, under the hard landing scenario things will get a lot worse. It seems to us that very large amounts of debt and money printing are being used to “buy” a recovery which itself has no real legs (in particular as EM – the BICs – are forced to slow because of their domestic inflation, thus stopping dead the global manufacturing super-cycle which is the only real source of strong growth in the US). And once QE2 stops and other such stimuli are also turned off (fiscal boosts have already had their day, in our view) we think the emperor?s new clothes will be revealed for what they are. Although in this hard landing scenario, in the initial melt-up we think the S&P 500 could reach 1400/1440 by end-Q2, by end-2011 it could be below 1000.
All the evidence of the past few weeks points to the “melt-up then hard landing” path as being the most likely, although for now 1220 and 1350 are still holding, so we still see some hope – albeit diminishing rapidly – for the soft landing outcome. To reiterate, four consecutive S&P 500 closes above 1350 would to us signal the melt-up (1400/1440 S&P 500 by end Q2 2011), to be followed by the hard landing in H2 2011 (1000/sub-1000 S&P 500). Equally, if 1350 provides resistance and the S&P 500 trades below 1220 on four consecutive closes, then in this soft landing path we would expect to see low-1000s on the S&P 500 by end-Q2 2011. The big difference is that under the soft landing path, we would be buyers (tactically, into year-end) of the S&P 500 in the mid-1000s, expecting a bounce back to the 1300s by year-end. Under the hard landing path, a 1000 – even a sub-1000 – S&P 500 would likely not entice us back into high beta DM risk, even tactically, let alone on a secular basis.
6 – Why are we so bearish under the hard landing outcome? The key is that the policy tools needed to respond to a hard landing now are very limited, in our view, perhaps even non-existent in DM (EM/stronger BS nations, e.g. Brazil, Australia, still have plenty of policy flexibility/tools). In the UK and euro zone, we see virtually zero credible policy options from here on in. We think the only “hope” for the West is another policy mistake – in the form of QE3 in the US. But as mentioned above, the “hurdle” over which Mr Bernanke would have to jump to get agreement for QE3 is now much higher because of both domestic and international concerns. So, almost by definition (for us) more QE3 is likely, but only once the situation has become really bad in markets (1000/sub 1000 S&P 500; the UR starts rising again; the hard landing). In our view, the Fed has already put at significant risk its independence and its credibility, which in turn risks leaving both the US dollar and US Treasuries unanchored and as increasingly risky claims on an increasingly risky sovereign balance sheet. We judge that QE3 would significantly increase such concerns.
7 – We think QE3 will be both unavoidable and a grave policy mistake in the hard landing outcome. We think it (QE3) is unavoidable because under this outcome, where we expect a significant slowdown in global growth in H2, driven by an EM slowdown and an end to the global super-cycle in manufacturing, it is the only „stimulative? policy option left, and Bernanke and Obama both seem fixated with stimulus, at any cost it seems. Once this slowdown is apparent it should quickly become obvious that risk asset valuations are way too high, only supported by both overly optimistic growth expectations, and, as a result of QE, by a mispriced CoC; that the Fed has destroyed its credibility; and that there is no, or nowhere near enough “sustainable” growth in the US, in the UK, or in any of the DM. And we think it would be a policy mistake because it would represent all-out debasement and monetisation, which would seriously risk the safe-haven/risk-free/reserve status of the US, of the US dollar and of US Treasuries. And this would only be made worse if the euro zone does indeed solve its problems over the rest of this year, as we expect. We feel that QE3 would risk a very negative outcome whereby US Treasuries start being priced as a risky credit asset (with real yields rising sharply) and where the US dollar would no longer be viewed as any sort of useful store of value. We find it extremely worrying that over the mid-February to mid-March global equity sell-off, where the drivers of the sell-off were not particularly US-centric, the US dollar nonetheless sold off over this period. This is the exact opposite of what has been seen for more than the past two years, and not what the market expected. We worry that it may reflect growing concerns about the US sovereign and US policymakers who may now be turning into the central risk. If this is the case, and, as a result of QE3 the US dollar and US Treasuries become unanchored and are no longer seen as the world?s risk-free assets nor as the ultimate stores of value, then the entire foundations for valuations in financial markets could be at risk.
8 – In summary, the key driver of market returns right now and since early 2009 has been the Fed and its “intentional” mispricing of the true CoC through QE, but we think the Fed is fast approaching the limits of its credibility. We think the Fed is asking investors:
- to lever up at the wrong price;
- to take on risk at the wrong price; and
- to do this at precisely the wrong time in the business cycle.
For this to succeed, the Fed needs to convince investors it can keep the QE-fed Ponzi growing forever, permanently misprice the true CoC without any negative or unintended consequences. The US housing market seems quite clearly to be rejecting this proposition, but the equity market in particular has not. History shows no successful precedent, so under the hard landing path, when the CoC and pricing of risk normalise, as we would fully expect them to, asset prices, especially equities, should be hit very hard. We see this starting in Q3 2011, and likely lasting through 2012/2013 and maybe even into 2014, with QE3 becoming the central risk/problem, rather than the apparent solution. In this significant down move we should expect new lows in weak BS DM and EM equities (not strong BS countries) as in these weak BS nations policymakers, especially the Fed, would likely have little/no credibility and no/extremely limited policy options left (we see QE3 as the Fed?s last big stand). And all it will have achieved in our view, since QE1 and especially QE2 was flagged, is to have encouraged many more investors to wrongly load up on risk, at the wrong price and at the wrong time.
Assuming that the QE3 option is eventually exercised (as we do under the hard landing outcome) and assuming it does what we fear to the credibility and status of the US, the US dollar and US Treasuries, then we think the result, most likely at some point between 2012 and 2014, will be major fx regime changes and significant paradigm shifts in global fx markets. As these changes and shifts occur, gold could perform very well, as could other scarce physical assets (possibly super prime real estate). And the highest quality (by BS strength) nominal corporate assets – top quality equities in other words – may at least on a relative basis (if not absolute) perform fairly well.
Tags: Asset Performance, Asset Valuations, Brazil, China, Coc, Commodities, Emerging Markets, Excessive Levels, Global Macro, Gold, Hectic Travel, India, Investment Outlook, Jackson Hole, No Doubt, Nomura, oil, Output Gaps, Poor Risk, Qe, Risky Asset, Sectoral, Strategists, Travel Schedule, Usds, Western Economies
Posted in Brazil, Commodities, Credit Markets, Energy & Natural Resources, Gold, India, Markets, Oil and Gas, Outlook | Comments Off
Friday, January 21st, 2011
This article is a guest contribution via ZeroHedge.com
John Taylor, traditionally one of the most insightful strategists, has released a controversial note looking at the prospect of surging inflation, which he says is not much of an issue, “because the global economy is suffering from excess manufacturing capacity and a deficit of consumption, history tells us there is little chance that inflation will be a problem.” We wholeheartedly agree with him on this point… to an extent. All the African countries experiencing food riots also have record high unemployment: read massive excess capacity, manufaturing and otherwise. Thus, at least in the developing world, the two are no longer related. Is that the case in the developed world? With enough money thrown at it, the answer is a resounding yes. Should the Chairvillain continue his money printing “third mandate” duty, we are confident we will be proven correct soon. And after all, as many have speculated, the Fed has no other choice to deal with the massive debt load. Additionally, if as the WEF is correct, and world debt stock has to double to over $200 trillion in a decade, the bulk of that debt will have to be acquired by assorted central banks: read – monetization…whose one certain side effect is a surge in excess reserves, and thus, inflationary expectations. Should the ill-defined concept of velocity pick up even a smidge, it is game over for the monetary system, and not just regionally, but globally. Which is why we are in full agreement with Taylor on phase 1 of the reflationary experiment, he is short on the second phase, namely the one in which Bernanke continues to print, print, print, drowning out all incremental deflationary threats from “excess capacity” which always has just one monetary outcome…
Inflation, Not Here, Not Now
January 20, 2011
By John Taylor
Chief Investment Officer, FX Concepts
Commodity prices are flying higher, interest rates are near zero, base money growth is staggeringly high and inflation expectations are going to the moon. It looks like inflation is back, but it isn’t the kind of inflation the Germans worry about or the kind that leads to high interest rates followed by a deep recession. If this is not the inflation of post-WWI or the 1970′s, then what is it? Although the current bout of food shortages and price increases have helped topple the government in Tunisia and led to food riots in Algeria, these commodity price increases and the excess money being spread around should not have any impact in the G-10 countries, unless some central bank makes a big mistake and hikes interest rates. Why is it so different this time around?
Because the global economy is suffering from excess manufacturing capacity and a deficit of consumption, history tells us there is little chance that inflation will be a problem. If we just look at the second half of the 1930′s, the prime example of a consumption shortfall, when interest rates were exceedingly low and base money was growing sharply (because Roosevelt had changed the price of gold), many were worried about inflation but it never arrived. Fed Chairman Bernanke’s QE efforts are only a pale shadow of Roosevelt’s powerful inflationary stroke, but prices stayed subdued back then and they will now. With still climbing excess manufacturing capacity, and so much of it located in low- wage China, there is little or no wage pressure in the developed world. The situation was exactly the opposite in the 1970′s when there was not only a shortage of skilled workers but many contracts were inflation adjusted as well. Now these inflationary adjustments are history except in some public pension plans (which are on their way to insolvency). Labor’s pricing power has been declining since the 1970′s. In the US the number of hours necessary to buy a car bottomed in 1972 and it now takes about twice as long for the average worker to buy the average car. Although monetary growth is a necessary condition for inflation, without tight labor markets it just cannot find the traction necessary. When the price of oil or food goes up, the weakened worker will drive less or eat less, he/she cannot drive wages up. Final demand stays the same but it is just spread around differently.
If commodity prices climb higher and higher, the American and European worker will tend to spend more for food and fuel, cutting down his purchases of manufactured items and locally produced services. Units of food and fuel purchased will drop as well, as each one is more expensive, cutting final demand and lessening the upward pressure on commodity prices. The raw material producers, generally the emerging markets, should prosper in relation to the manufacturing countries, shifting the balance of global power. This change in relative economic dominance matches the concept of the Kondratieff cycle and fits very well with MIT’s capital investment cycle. The current period seems to fit nicely with 1937, and if we use that as a base date, the commodity producers will prosper for another 13 to 15 years as they did back then. Although the western countries will have a growth problem, not an inflation problem, the commodity producers will have plenty of growth and plenty of inflation. Although Australia, a perfect example in the early 1950′s, with high growth and high inflation, controlled its overheating problems fairly well, this time around there will be many countries that have not tasted “capitalist” freedom before. As many of these newly wealthy countries have managed currencies with exploding reserves and money supplies, the next decade or so should see dramatic inflationary booms and busts, plus plenty of political turmoil. With the G-10 consumers facing a difficult 2011, global commodity prices should peak soon and inflation fears will melt away in the US and Europe.
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Tags: Central Banks, Chief Investment Officer, Commodity Prices, Controversial Note, Debt Load, Debt Stock, Emerging Markets, Excess Capacity, Excess Reserves, Food Riots, Global Economy, Gold, Inflationary Expectations, Little Chance, Massive Debt, Monetary System, Monetization, Money Printing, Smidge, Strategists, Wef, World Debt
Posted in Energy & Natural Resources, Gold, Markets, Oil and Gas, Outlook | Comments Off
Friday, December 24th, 2010
At last a contrarian view! The report below comes from Pragmatic Capitalist.
Past is prologue … At least that’s what strategists at CitiGroup are saying. In a recent note they highlighted the three past market environments that most closely resembled the current environment. Unlike just about every investor in the world right now (and every other analyst), they believe January and 2011 could have some surprises in store for us:
- Over the course of this year we have constantly referred to what are the only three overlays that we think fit with the present price action in the equity market.
- Our favourite for some time has been the “spooky chart” of 1929–1939, which we have been watching since 2003.
- A very close 2nd but fast becoming a potential number one choice has been the overlay of 1966–1976.
- A relatively distant 3rd has been the chart of the 1906–1909 period.
- It is these charts that have led us to surmise that 2011 will not be a good year for the equity market, just as all three suggested that 2010 would not be a bad year.
Click here or on the table below for a larger image.
Bottom line: Our favourite overlays suggest for the DJIA.
- The peak may be posted as early as the opening days of January 2011 (possibly even 3rd January as per the other three examples) with a down month in the region of 5%.
- We will see an intra year bear market next year (fall of over 20%).
- We will close the year down double digit percentages (Plus/minus 16% down).
- We could be waiting a further six to eight years to eventually see the DJIA regain the 2007 highs on a yearly close basis.
What will the catalyst be?
- Our bias is likely one of two things.
- The bond market falling sharply as it did in 1977 sending yields higher and fuelling inflation or supply fears or both.
- Europe imploding. While this could stress our view on the dollar fixed income and commodities, this dynamic still supports our bearish equity view.
Source: Pragmatic Capitalist, December 22, 2010.
Tags: Bear Market, Bias, Bond Market, Bottom Line, Catalyst, Citigroup, Commodities, Contrarian View, DJIA, Fixed Income, Good Year, inflation, Investor, Market Environments, One Choice, Percentages, Some Surprises, Stock Market Outlook, Strategists, Supply Fears
Posted in Commodities, Markets, Outlook | Comments Off
Tuesday, April 13th, 2010
Greg Peters, and other strategists from Morgan Stanley are out warning anyone who will listen that what is going on in the economy is a fool’s rush (we would add predicated by momos who know nothing about reading financial statements but everything about following a trend) and that MS’ core advice to clients is to “sell into strength.” Here is how Morgan Stanley differs from the consensus. Also discussed are returns before and after the EPS season, and how to hedge surging implied asset correlations.
- Exit strategy comfort (Fed on perma-hold)
- A disconnect between ever-firming economic data, steep yield curve, higher back-end yields, a strong equity market with a so-called emergency Fed fund rate
- Markets are susceptible to perceptions of a “policy mistake”
Watch inflation expectations very closely
- OPA! We think not
- Markets see this as idiosyncratic white noise – we fret about systemic risk implications
- Core views remain the same
- Sell into strength (admittedly it has been much stronger than we thought)
- Higher rates, steeper curves, weaker EUR, stronger $, buy high quality companies with above average growth, but continue to “buy the junk” in HY
|MS Slidepack.pdf||251.49 KB|
Tags: Attachment Size, Correlations, Curves, Economic Data, Economic Strength, Exit Strategy, Fed Fund Rate, Financial Statements, Gold, Inflation Expectations, Mirage, Momos, Morgan Stanley, Ms Core, Perceptions, Quality Companies, Risk Implications, Strategists, Systemic Risk, White Noise, Yield Curve
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Rosenberg Summarizes The Arguments Of The Great Treasury Bond-Bear Debate, Remains A Staunch Deflationist
Monday, April 12th, 2010
A great overview of the arguments on either side of the great Treasury bull-bear debate, courtesy of David Rosenberg. Rosie juxtaposes the perspectives of two of the most respected yields strategists currently: MS’ Jim Caron, and Goldman’s Jan Hatzius. A dose of Jim Grant is also thrown in for good measure. Must read summary for bond bulls and bears alike.
You really have to have a read of “Yield Views Couldn’t Differ More” on page B1 of the weekend WSJ. It pits Jim Caron, a good pal and former Merrill rates-strategist colleague against Goldman Sach’s Jan Hatzius, a former formidable competitor and I would argue runs one of the best, if not the best, economics houses on Wall Street. Jim is bond bearish, Jan is bond bullish. The world pretty well knows my view. The article talked more about supply than it did about inflation, which is the much more critical ingredient in any simulation of interest rate determination.
Jim Caron makes the claim that the US government has never before been raising so much debt to finance the bloated fiscal deficit and roll over existing obligations. But if truth be told, the US government never before paid down as much debt as it did previously back in that surplus year of 1999 and the Treasury market got hammered. Why? An economic boom absorbed all the slack in the economy and causes a brief episode of inflationary pressure. That was the cause. Just as in 2002 the deficit exploded, bonds rallied massively because deflationary risks moved to the front burner. Yes, Virginia — deficits and deflation can co-exist for extended periods of time. Ask anyone who has lived in Osaka over the past decade. The two Jimmies (Caron and Grant) are entitled to their opinions but not their own facts, and I have run similar correlations as Jan Hatzius has and there is no comparison between fiscal deficits and inflation when it comes to bond yield analysis. If the deficits and bond issuance are occurring at a time when the economy is approaching full employment and private sector balance sheets are expanding, then for sure interest rates will be on a rising trend. But fiscal deficits that are designed to cushion the blow from a credit contraction, especially among households, generate far different results. With credit contracting, rents deflating, the broad money supply measures now declining and unit labour costs dropping at a record rate, it hardly seems plausible that inflation is a risk at any time on the near- or intermediate-term forecasting horizon.
Plus, keep in mind that the price-setter for the entire retail sector, Wal-Mart, just announced price cuts on 10,000 items — you heard that right. That is deflation, not disinflation or inflation or any other ‘flation. And just to show you the enormity of this announcement, the CPI contains 8,018 items!
The “Current Yield” column in Barrons also runs with the bond-bear theme (“Next, a Sharp Jump in T-Yields”). This time, and again, it focuses on the Morgan Stanley forecast of a 5.5% peak in the yield of the 10-year note. We are told in the article to throw away the econometric models of the past and rely solely on the supply backdrop.
Again, this logic defies how bonds rallied through most of the Reagan years despite all the bond supply used to spend the Russians out of submission in terms of military expenditure. We are also told that the consensus is underestimating the recovery — another reason to be bearish on bonds. But to get to 5.5% we had better get one heck of a renewed expansion in bank lending and household balance sheets and a good dose of inflation. It sounds so outlandish. We didn’t even get past 5.25% at the 2007 peak with a late-cycle economic boom, a record-high stock market, dramatic credit expansion, a tight monetary policy stance and sky-high deficits — not to mention an unemployment rate closer to 4% than 10%.
And to top it off, the front page of the Sunday NYT runs with “U.S. Consumers Face End of Era of Cheap Credit”. When the view of higher interest rates comes to dominate the media as much as it has in recent days, you know that something else is bound to happen. That NYT article stated that housing “has only recently begun to rebound” — well, when you look at the chart of new home sales, housing starts and the NAHB index, it’s very difficult to detect any rebound at all…
One reason why interest rates cannot rise is because if they do, there will never be a sustained improvement in the pace of economic activity. Housing is the classic leading indicator, and the most interest-sensitive sector, and until it revives, it seems highly unlikely that bond yields will rise on any sustained basis or that the Fed will embark on a path towards higher policy rates. For a truly sombre assessment on the prospects for a housing recovery, see what Robert Shiller has to say on page 5 of the Sunday NYT biz section. (“Don’t Bet The Farm on the Housing Recovery”).
Full edition of today’s Breakfast with Dave here
Tags: Bond Bulls, Bond Yield, Bull Bear, Critical Ingredient, David Rosenberg, Deflation, Economic Boom, Fiscal Deficit, Fiscal Deficits, Gold, Goldman Sach, Inflationary Pressure, Interest Rate Determination, Jim Caron, Jim Grant, Jimmies, Page B1, Russia, Strategists, Treasury Bond, Treasury Market, Wsj
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