30 December 2009

The magnificent 7 and equity markets - Review 5 (end of the year)

We are now 10 month up after the trough reached on 9th March 2009. Following extremely oversold conditions in March, the marked forged ahead with a vengeance the MSCI World Free index having surged 76% (less in the Western world and more in the developing world). The magnificent 7 are telling us that there is no reason for the markets to pause beyond short term overstretched valuations (I recommend the reader to go to the GTI web site for their monthly newsletter, one of the best available).

S&P 500 Banks index: For 5 month the index has traded in a narrow 120-140 band. The index and the 200 days moving average are converging after the latter turned up in July and is now positive. The index is still 70% below the nadir reached in February 2007. The 120 support is holding very well. Positive.

Global 1200 financial index
: The world financial sector broke multiplied its value 2.5 times since it trough in March this year, to trade between 930-1040 since July. As for the S&P Banks index the 200 days moving average turned positive and is converging with the index. Positive.

TED spread (LIBOR USD 3 mth - US 3 mth T-bills): The spread is back to normal - no stress showing at +/- 20 basis points (0.20%). The interbank market shows no stress. Positive.

USD bank BBB 10 yr - US 10 yr yield
: Whilst still high and above historical average, the spread has steadily decreased since July and is nearly 3% below the highest point reached in March standing at 4.5%. Positive.

OEX volatility: OEX volatility has continued it downward trend and is now hovering around 20% well below the stress times of Q4 2008 and Q1 2009, and at the level I wanted to see during my lats review in October. We need this indicator to stay at or below 20%. Positive.

S&P Case Shiller house price index: The latest data (October) published 29th December (see my comment yesterday) showed a picture at best flat, stopping a series of solid gains. There is a clear dichotomy appearing between existing homes where the market improves and new homes that is still very weak.

Composite-10: October 2009: +0.01%, y/y: -6,4%
Composite-20: October 2009: -0.05%, y/y: -7,3%

Signs are becoming more positive but still ambivalent. Slightly positive.

Oil price
: The oil prices seems to be capped at +/- $80/b. Higher oil prices can be absorbed by economies it if the pace of increase is not sharp. For example, the doubing of prices since the low reached in March has not impaired the "recovery". If the economy gains impetus things may however look different however: beware of a sudden and sharp rally. Positive for the time being.

Conclusion: All these indicators are positive. I have been dead wrong to get out of equity markets in July but jeopardizing 20-25% gain between early April and late June for a possible 15% additional profit did not appeal to me. I still believe that there are strong headwinds ahead: unemployment not going down as fast as wished (and its psychological effect on consumers), the private sector unable to take the relay from the public sector leading to a second package in the US (and as a slump in the USD as collateral damage), additional delinquencies on residential, commercial and credit cards damaging the recovering (but still weak) bank's balance sheets, etc.

I am not (yet) in the camp of the commentators that see the current rally being a bear market rally. Liquidity is still huge and on the sideline: this should continue to spur equity markets. I however expect a 20-25% correction in equity markets by 2010 H1 but a real and fundamental improvement in company results.

29 December 2009

US housing market: still mixed signals

According to data released by the US Census Bureau on 23rd December, New home sales dropped by 11.3 per cent in November to an adjusted annual rate of 355,000. That was the lowest level in seven months. The good number for existing home sales last month seem to have cannibalized new home sales, as well as the tax break extension into next year announced by the Obama Administration.

The Case-Shiller 20 index published by Standard & Poor's today shows that home prices were flat and failed to keep pace with gains so far in 2009. The figures are not seasonally adjusted (+0.4% seasonally adjusted – the fifth straight improvement). In the past year, prices are down 7.3% in the 20 cities.

These numbers are not showing the beginning of a double dip in the housing market as yet. I will, however watch them very carefully in the coming month.


U.S. Census Bureau: New Residential Sales in November 2009

Financial Times: Sales of new US homes plunge unexpectedly

Standard & Poor’s: S&P/Case-Shiller Home Price Indices - October 2009


The New York Times: Slight Rise in Home Prices Masks Signs of Weakness

28 December 2009

How much money did the US Government commit during the financial crisis to date?

Here is a diagram that summarizes the current state of the US commitment to avail the current financial crisis: $7.8 trillion and counting...


The Washington Post

27 December 2009

Governement debt: a huge Ponzi scheme?

Since Central Banks wide-open an endless flow of money, I have warned about the next bubble to implode, “The Mother of all Bubbles”: Government debt.

Eric Sprott & David Franklin, of Sprott Asset Management from Canada, recently wrote a paper on where the huge amount of new debt issued by the US Treasury went: “Is it all just a Ponzi scheme?

I found their findings particularly interesting (emphasis mine):
In the latest Treasury Bulletin published in December 2009, ownership data reveals that the United States increased the public debt by $1.885 trillion dollars in fiscal 2009. So who bought all the new Treasury securities to finance the massive increase in expenditures?

So to summarize, the majority buyers of Treasury securities in 2009 were:

1. Foreign and International buyers who purchased $697.5 billion. (+23% from FY 2008)
2. The Federal Reserve who bought $286 billion. (+60% from FY 2008)
3. The Household Sector who bought $528 billion to Q3 – which puts them on track to
purchase $704 billion for fiscal 2009.- (+35x (!!) from FY 2008)

In fact the third group is labeled as “others”, but, after careful analysis, Sprott discovered that most of this group represented the “Household Sector” (and this is outside of Money Market Funds, Mutual Funds, ETF’s, Life Insurance Companies, Pension and Retirement funds and Closed-End Funds, which are all separate reporting categories).
Who could believe that Households could have increased their 35 times in a year after the crisis we went through? So, our Sprott friends went a bit further and their discovery is somewhat scary:
So to answer the question - who is the Household Sector? They are a PHANTOM. They don’t exist. They merely serve to balance the ledger in the Federal Reserve’s Flow of Funds Report.
Already PIMCO’s co-chief investment - Bill Gross, the world most powerful bond investor – is advising to front run Government debt and and boosted cash to the highest level since 2008.

Zhu Min, deputy governor of the People’s Bank of China, alongside other foreign holders, also expressed concern over new Treasury purchases. He went on to say, “The United States cannot force foreign governments to increase their holdings of Treasuries… Double the holdings? It is definitely impossible.”
If the foreign support wanes in 2010, the US will require significant domestic support to fund future debt issuance, which is far from assured if we refer to Mr. Gross’s recent comment.
Sprott concludes:
The fact that the Federal Reserve and US Treasury cannot identify the second largest buyer of treasury securities this year proves that the traditional buyers are not keeping pace with the US government’s deficit spending. It makes us wonder if it’s all just a Ponzi scheme.
Me too... Don't be long Government debt.


Sprott Asset Manangement: "Is is all just a Ponzi Scheme?"-Markets at a glance December 2009

Business Week: Pimco's Gross Boosts Cash to Most Since Lehman Failed

Shanghai Daily: Harder to buy US Treasuries

Federal Reserve: Flow of Funds Accounts of the United States - Q3 2009


25 December 2009

Christmas, Insurers and Obama's health bill

BRICs Dominating World Economy: O'Neill

An insigth from Goldman's O'Neil on BRICs for 2010. This goes along my long term investment themes

17 December 2009

A virtual interview with the WSJ and the FT - Part 5 (end)

FT: Regarding asset allocation, it seems that you disregard all studies that advocate a balanced portfolio and diversification: could you elaborate?

M&B: One should not make a confusion between balanced and diversification. A balanced portfolio has no signification per se; what matters is to build a portfolio with respect to each investor's objective and risk tolerance -and often they contradict each other- hence, beyond well understanding the objectives and risks, the need to educate clients.

To me, a balanced portfolio is a mix bag and a way to dilute responsibility: it is more marketing than anything else and make sure you are within the industry average. I do not consider I am paid to be balanced but to have opinions (strong ones more often than not!) that are the result of a longstanding experience and deep analysis. If I am not balanced, I however diversify investments, not only because of the themes my Partners and I at P&C Global Wealth Managers are absolutely convinced are secular trends but because it is common sense: no fund manager can be good on all instruments on all markets. Many empirical studies show that portfolio performance results from a very large part from asset allocation (some studies concluded 90% of the performance), stock picking representing the balance: I focus on asset allocation and timing (to some extent - one never can be exactly and always right on timing) and leave the stock picking to specialists, particularly for mid and small cap companies (Remember, we may be 100% cash is warranted - and it served my clients very well in July 2008!. Here a slide that we include in some of our presentation and perfectly illustrate this:

We put the team together, but we leave each specialist competing to be first in his category.

My investments are centered around 8 themes:
  • Energy and alternatives
  • Supply inelasticity
  • Aging population
  • Emerging middle-class in developing economies
  • Global outsourcing
  • Emerging China
  • Water shortages & ecology
  • Japan restructuring
You will take notice that beyond Japan (located nearby the world fastest growing zone economically and still an innovation powerhouse, despite it long term problem that is its aging and diminishing population - this can be reversed however- and record debt/GDP ratio), no Western country is included. However, Supply inelasticity and Energy are also plays on Canada and Australia for example.

WSJ: Many of your themes are redundant however

M&B: Yes, and why not? True the emerging middle-class implies more energy and commodities consumption but also excellent opportunities in retailing for example. And whilst there is no Western country/zone that is included in my themes, many companies based in these countries are investment vehicle (water treatment or energy for example); but it does not make any sense to invest in France, Europe or the US as a theme (I have already discussed this on this blog at length).

I wrote several time that the shift of power towards Asia is in motion and quick motion, despite all the imperfections in these countries that need to be addressed and changes that are required for a generational growth and success.

Going back to the first question I would link my answer to the current financial, political and economic crises (and soon social one): There is a huge difference between developing a business where you have a share ownership and being an employee judged on the annual (quarterly?) performance: in one case your interest is to develop a long term viable business, in the other your next bonus; this is human nature and can work in the short term. It is worth revisiting the agency theory; it would explain a lot about the evolution of capitalism during the last 20 years.

WSJ: This concludes our first round of interviews; thank you for your insight

: This was somewhat refreshing and quite different from the mainstream: thank you.

M&B: Thank you to both of you, to have allowed me to express some of my thoughts. One last word: we are living in Historical times and the forthcoming few years will shape the world for at least a century. If I have one wish, it is that the quality of Western policy makers dramatically improve for the sake of our children, grand-children and great grand-children since, as Chruchill said once, democracy is the worst system after all the other ones.

07 December 2009

Chart of the Day -US Unemployment

Last week, the Labor Department reported that non-farm payrolls (jobs) decreased by 11,000 in November - the smallest decline since the recession began at the close of 2007. Temp-agency employment surged 52.4 k in November, the largest surge for 5 years; this metric is a quite reliable forward-looking indicator. These number are definitely positive but let's wait their confirmation in December and if they are not just part-time employees hired for the season's shopping.

Today's chart puts that decline into perspective by comparing job losses during the current economic recession (solid red line) to that of the last recession (dashed gold line) and the average recession from 1950-2006 (dashed blue line). As today's chart illustrates, the current job market has suffered losses that are more than triple as much as what occurs at the lows of the average recession/job loss cycle.


Chart of the Day

Bureau of Labor Statistics


28 November 2009

A virtual interview with the WSJ and the FT - Part 4

WSJ: Earlier during this interview, you mentioned that the roots of the problem have not been properly addressed or even no at all?

M&B: Let me start by saying that I have sympathy for the Austrian school of economics but also believe that governments and central banks had to act after having closed a blind eye (or even encouraged directly or indirectly) on an irresponsible behavior (besides their even more irresponsible behavior); they however stopped short (and by a long margin) from making sure the magnitude of this crisis will not happen again (we will get other crises, but please let’s lay the ground to avoid what is avoidable) since policy makers are quick pointing the finger at scapegoats but not at themselves, and they bear their part of responsibility which is not small.

To me, the root of the problem is over-indebtedness, quasi-exclusively in the West (and mainly in the US) and Dubaï (in 2006 I was asked by a friend about investing in a real estate fund focusing 100% on Dubaï: I just told him to stay away; too many square meters built for too few buyers at the end and prices going up too far too fast), from consumers, governments (national and local) and banks; corporations were not so badly indebted.

WSJ: How did this become possible?

M&B: It became possible because of the lack of accountability and short sighting (you were better making a succession of one off deals instead of building a business). Banks magnified the problem but did not cause it: they use a favorable environment to substantially increase their Return On Equity (ROE) via leverage and proprietary trading. It is easy to
directly or indirectly encourage consumers to over-consume and forget saving: true, people have been encouraged by the irresponsible behavior from banks and, overall, governments (not least in Europe). Accountability is what will ensure we learn from past mistakes:

1) Accountability from Boards of Directors: you probably noticed that just a few chairmen/CEOs were fired (and not many) whilst boards remained more or less the same. They are the one that vested chairmen/CEOs packages/bonuses, strategy, etc.

2) Accountability from regulators: after all it is the SEC that did not act on naked shorts for so long (the SEC was not worried when banks were shorting naked small and mid cap companies, resulting in outstanding shares representing over 100% of the issued capital!!).

Capital ratios were not set up by banks, but by Governments via Basle accords.

Accounting rules were no set up by banks either, but by regulators. Yes, banks lobbied: so what? Do regulators/policy makers need to follow what lobbyists say?

3) Accountability from Central Banks: 2 months after taking the helm at the FED, in 1987, Greenspan wide opened the flow of money. There was no will to seriously tighten the belt. LTCM was too big to fail? This was opening the door to the next "too big to fail".

4) Accountability from politicians: they have always been (voluntarily) dead wrong in projecting the economy and have not laid the foundation of a sustainable growth: look at (pre financial crisis) the state of public debt, budget deficits, pension disarray and health system decay/cost in the Western world.

5) Accountability from consumers: how can a consumer with some sanity borrow at 15%, 16% or 17% to buy a plasma screen or whatever consumer good, or use a credit card for the same purpose when official CPI is in the 2-3% range? How can someone borrow 100% for a house, or worse draw equity out of it. The western world, and the US in particular, have lived on steroids called over indebtedness.

6) Accountability from media: most of them are just relying information (and the more sensational, the better, whether true or not, important or not, what matters is the scoop) without investigating. Soros says something? It must be true. Greenspan says something? It must also be true. Don't question please, or mildly. The way the media reported the "success" of the G20 summit in London or Pittsburgh is shameful: as if the tax haven scapegoat (oops! depending if you are a large country or not, you are on the grey list or on the white list - Delaware, Macao, etc.) or the bankers' bonus were at the root of the crisis and solving these “identified” problems were key to lay down the foundation of a long term sustainable growth. They were just communication aimed at the man in the street (should I say the voters) and did not bring any viable and sustainable solution.

The important point is that, what we are witnessing is the brutal adjustment to this over indebtedness. The economic growth of the past 20 years was largely built on money creation by central banks and speed of velocity by commercial banks.

Did banks (and the financial sector as whole) create this background? No! They took advantage of an existing framework (in some instances they convinced regulators and policy makers to shape it in their favor) to maximize profits.

We DO NOT need more regulation but better regulation.

The previous "new paradigm" in many ways hid the relative demise of the Western world towards Emerging markets, and among them the largest: China. The economic and financial fragility of the West came to light with this crisis.

This will sooner or later result in a confrontation with the West since both sides are going to be increasingly at odd on many subjects, starting with a competition for the same limited resources to spur their growth and at least maintain (the West) / foster (emerging markets – haven’t they already emerged?) in real terms the standard of living of their populations (I unfortunately have doubts for the Western world to rebound looking 15 years forward with all the challenges we are facing - public debt and budget deficits, pensions and the health service, to name a few). This is already the case in some parts of the world ( starting with Africa - Soudan for example) spilling over into confrontation at a geopolitical level.

This crisis has revealed at least one thing for the ones who were not aware of it: this shift of power is unstoppable in the current environment. People of the West need to point the finger at the right responsibilities to make sure that, we, in the West, will be able to reshape the economic, financial and geopolitical environment to our advantage: don't be mistaken, we are not in a nice people world, but a world of domination (as it has been for a couple of thousand years and longer). there, too, there is not, and there will no be, a new paradigm: either you are on the side of the dominant or on the side of the dominated.

P.S. Wait for the next bubble to deflate, the Mother of all Bubbles: Government debt


The Economist

19 November 2009

The 27 heads of European states meet: joke of the day!

The Lisbon Treaty (as its failed twin predecessor, the European constitution), was meant to provide the EU with more transparency in its decision making process as well as provide a stable and strong leadership by creating the jobs of President and Foreign Minister, and was "marketed" as such by politicians to voters. Bullshit! Once again, people in Europe are left naked.

Tonight decision to appoint Herman Van Rompuy, the Belgian prime minister, for the presidential job, and Catherine Ashton of Britain, the European Union’s trade commissioner, as foreign minister, the two low-profile candidates with no international clout and little or no international experience just exemplify that large European countries have no intention to give away their prerogatives. I could laugh about it if it were a funny joke with no consequence. But I cannot: does anybody believe that these two will have any credibility on the international stage with the Chinese, Indians, Russians, Americans, Brazilians, OPEC, etc? And this at a time of worldwide power shifting? No way: this is just a shameful failure.

The decision process itself was totally opaque and the choice of the two appointees was the result of a mix bag of vetoes, bargaining, bullying being close doors. Next appointee? Michel Barnier for the internal-markets post, which writes financial-services rules and Christine Lagarde to head up the Eurogroup. The big loosers? Jean-Claude Junker, the Luxembourg Prime Minister, and the UK (not surprising with "Moron" Brown who was at the helm of the sale of the BoE gold when Chanceler of the Exchequer and gold at the lowest over the past 20 years). The winners: Nicolas Sarkozy and to a lesser extent Angela Merkel (the German will get the Presidency of the BCE when Jean-Claude Trichet steps down).

[emphasis mine]
As reported by the NYT, Jean Quatremer predicted in the French newspaper Libération that “The E.U. will not wake up Friday morning to the George Washington called for by Valéry Giscard d’Estaing, but with a René Coty, the last president of the Fourth Republic. Or even worse. All strong personalities will be eliminated by a crossfire of vetoes. And the secrecy of the deal gives the worst image possible, that of petty arrangements between friends that will produce a mediocre compromise.”

Unfortunately, Europe (its institutions and politicians) is indeed mediocre at best and getting worse as time passes by.

10 November 2009

A virtual interview with the WSJ and the FT - Part 3

FT: There is a debate about whether we are in a deflationary or inflationary environment: what are your views on this?

:My answer is yes to both. It looks contradictory but it is not. It depends of the time frame you choose. Let me explain. Short term we are in a deflationary environment for three main reasons:
  1. Banks are deflating their balance sheets and rebuilding their equity leading to less credit available that is definitely deflationary. It is more profitable and less risky to invest in Treasuries instead of lending to businesses and consumers with a financing cost near zero.
  2. Unemployment is above 10% in the US (add 10% more for underemployed and unemployed so discouraged they are not even looking for jobs), and rising. Therefore there is no pressure on wages (to the contrary) and there is no example of a sustained inflation period without wage inflation.
  3. There have been a massive wealth destruction (housing, bear markets) that not only left many in an extremely difficult financial situation but also resulted in a real psychological shock for many more, the pensioner or soon to be retired not being the least. They have to rebuild their savings and regain confidence; it will take time. This will be detrimental to consumption.
If short term I do not see any inflation threat, longer term I do.

  1. The FED and the likes will do everything they can to avoid a deflationary spiral. Money will continue flowing. It is however not flowing to the real economy (at least in the Western world) but to risky (equities) and non-risky assets (Treasuries/fixed income). There is an apparent contradiction here, since the surge in equity markets imply a V shape recovery whilst bonds imply a U shape recovery. I will come back on this later.
  2. The long term rise of developing economies will again spur demand for commodities and energy. The pause we have witnessed with the current crisis is only temporary. In the meantime many exploration projects have been postponed or canceled due to diminishing demand and a move away from riskiest assets; due to the time frame to develop mines and wells to bring them to production (a couple of years), we will see a new rise in commodities that will dwarf the 2006-2008 one.
    This may even go beyond: China has taken advantage of the crisis to use its financial might to secure reserves all around the world and are better placed than the West (and Europe in particular): the access to commodities may add to price surge.
  3. The wage deflation (stricto sensu or via high unemployment) cannot carry for too long without having long term destructive effects on the economy: consumers need purchase power to consume.
  4. Inflation is the politically less painful way to pay down ballooning public debt.
Medium to long term money creation coupled to growth in the developing world will lead to inflation (I do not expect hyperinflation however). This will lead mainstream investors to add fund to hard assets. Before this comes watch the mother of all bubbles to deflate: fixed income instruments.

Going back to the apparent contradiction between equity and bond markets, I refer to an interesting paper written by PIMCO, the world largest fixed income manager. Two extracts summarize it:
Thus, while rich risk asset prices can certainly be viewed as a consensus expectation for a strong recovery, such lofty valuations can also be viewed as a consensus expectation about the Fed's commitment to erring on the side of being too late, rather than too early, in starting a Fed funds tightening cycle. Indeed, one could actually be agnostic, even antagonistic, about a big-V recovery and still be favorably disposed to risk assets, in the short run. Historically, what pounds risk asset prices is either a recession or unexpected Fed tightening; or worse, both. Right now, it is hard to get wrapped around the axle about recession, since we've just had one, which might not even be over.
In turn, a bull flattening bias of the Treasury curve, with longer-dated rates falling toward the near-zero Fed policy rate, can be viewed as a consensus view that the level of the output/unemployment gap plumbed during the recession is so great that disinflationary forces in goods and services prices, and perhaps even more important, wages, will be in train, even if growth surprises on the upside. Accordingly, Treasury players, like their equity brethren, need not fear the Fed, as there is no economic rationale for an early turn to a tightening process.
I totally subscribe t0 their conclusion (emphasis mine):
Simply put, big-V'ers should be wary of what they wish for. U'ers, meanwhile, must be mindful of just how bubbly risk asset valuations can get, as long as non-big-V data unfold, keeping the Fed friendly. But that's no reason, in our view, to chase risk assets from currently lofty valuations. To the contrary, the time has come to begin paring exposure to risk assets, and if their prices continue to rise, paring at an accelerated pace.


Federal Reserve Bank of St Louis

The Uncomfortable Dance Between V’ers and U’ers

03 November 2009

Gold, gold and gold!

This afternoon, gold futures reached an all-time high at 1,085.30/oz (COMEX Dec contract), following the purchase of 200 tonnes of gold by India from the IMF for about $6.7 billion. Well done India!

The last gold hangover is now withdrawn: gold sales by the IMF will easily be absorbed by emerging economies. I also doubt China will stay on the sidelines watching India catching all this gold against worthless paper without getting their piece of the cake. Whatch gold and take any fallback as a buy opportunity. Gold is on its way to it record high, at 2009 prices US CPI deflated, of $1,600/oz.

For the US and Europe, they have no money left and over all would not like to send a signal of lack of confidence in fiat currencies (and the USD in particular) and expose to the public the wrong policy followed by many European central banks: selling the jeweleries for hot air. Don't forget that Mr. Brown, the current UK Prime Minister and then Chancellor of the Exchequer, initiated this irresponsible policy in the UK during the second half of the nineties when gold prices were at the lowest (in the $250-300/oz range) at the same time Tony Blair was dramatically increasing the number of civil servants and digging deep in the fantastic work undertaken under the tenure of Margaret Thatcher and to a lesser extent John Major...

What best than the shift in gold possession is exemplifying the shift of power from the West to the developing world?! It also says a lot on the lack of understanding of challenges faced and short sighting by policy makers in the West. Worrying.


US gold hits record high $1,081.70/oz on IMF sale

Gold Climbs to Record as India’s Central Bank Buys From IMF

A virtual interview with the WSJ and the FT - Part 2

FT: From early April to early July you saw the glass half full, and have seen it half empty since against improving economic indicators. Could you explain us why?

M&B: My view was that the sentiment was so negative and central banks providing so much money at near no cost that markets could only improved. Since the bottom of equity markets in March (China and Brazil excluded: they bottomed end October 2008, the MSCI emerging markets index in November) to 27Th October, the DJ is 50% up, S&P +57%, NASDAQ +70%, FTSE +48%, DAX +53%, NIKKEI +43%, SENSEX + 95%, SHANGHAI +75%, BOVESPA +70% and the MSCI emerging markets +102%. In the meantime, the economy has not really improved, whilst no longer in a nosedive. The improvement noticed during Q2 and Q3, was mainly due to Government money (car industry and the financial sector in the US and Europe, tax credit for first-time owners for residential real estate in the US, etc.) and inventory rebuilding after having been crushed late 2008 and early 2009. However, if unemployment does not improve in the coming months (which I doubt), I believe that retail sales will be flat or nearly flat towards the end of the year (I do not see how sales could improved when consumers are fearing for their jobs and need to rebuild their balance sheets). In my opinion, this could lead to a second wave of adjustments by companies or at least delay investments and hiring. Interesting enough, last week, Goldman Sachs cut its US GDP prevision from 3% to 2.7%.

I have also been worried about the commercial real estate situation where prices dropped 40% between August 2009 (latest data available) and October 2007 (peak of the cycle) – I remember well what happened in the early 1990’s. The outstanding face value of US commercial real estate loans amounts to USD 2-3.5 trillion depending on sources, including USD 270-275 billion due next year and over USD 1 trillion by 2015. Banks own 45% of commercial real estate loans, compared to only 21% of single-family loans and U.S. Office Vacancies Reach Five-Year High of 16.5%. In September, the FED noticed that banks were slow to take losses on their commercial real-estate loans.

Undoubtedly, banks will have additional large losses coming from this sector and the rest of the economy will be impacted, whilst probably not to the same extent as the residential real estate that had a huge psychological effect in additional to the financial one: this may stall any recovery in 2010-2011. Banks will need either to further reduce their balance sheet to be in adequacy with prudential ratios and/or raise new capital. Just look at all the cash call that banks in Europe and the US have done over the past few months or are attempting to do, besides selling assets.

I will not come back to changes that occurred on rule FSA 115 regarding fair value accounting (and my opposition to it since it increased opacity): whilst giving some breathing space for banks, it did not solve the problem and may compound it in the future.

To summarize: too far too fast. Markets have been sustained by liquidity that has not been channeled to the real economy (i.e. most of it!). I am not however in the camp of the gloom and doom for the world economy, whilst I am rather negative on the Western world economy.


U.S. Office Vacancies Reach Five-Year High of 16.5%

Wall Street Journal
Local Banks Face Big Losses

Foresight Analytics
Commercial Mortgage Outlook: Growing Pains in Mortgage Maturities

Congressional Oversight Panel
August oversight report: The continuing risk of troubled assets

MIT Center for Real Estate

28 October 2009

A virtual interview with the WSJ and the FT - Part 1

WSJ: We read with interest your views on the origin of the financial crisis we went through: In a recent article you were indicating that you would prefer to be short instead of long in the banking sector: why?

M&B: The crisis that started in August 2007 is the abrupt adjustment to 20 years of over-indebtedness: over indebtedness by governments, individuals and corporations (to a lesser extent), thanks to central banks having provided plenty of liquidity, particularly in the US. Each time we had a crisis, the liquidity ticked up, and we had such crises more often over the past two decades and they became more acute and important in size. No decision was made to go to the root of these crises: over-liquidity leading to the misallocation of resources. Besides a loose monetary policy, these crises were also spurred by bad political decisions.

Is there anything new? No. The G20 in London focused on tax havens and in Pittsburgh on traders’ bonuses. Wrong, these are meaningless vis-à-vis the current crisis and its causes even if they do the front page of media and are talked up by politicians. These are pure scapegoats to deflect the attention of the public from the real roots of the problems and solutions that will be painful.

Regarding the banking industry, I do not believe that problems are healed. True, a collapse has been avoided and this is fine; we gained time, very important in troubled times. Many banks received public money, and many have repaid it. However so called toxic and non-performing assets are still in their balance sheets (or off balance sheets) and their value has not improved (home values not really increasing, credit card delinquencies on the rise, commercial real estate starting to hit, to name a few). Bank’s lending continues to go down, so the real economy is not getting the financing it needs, particularly small and medium businesses (loosing 50k jobs 10.000 small business is politically and journalistically irrelevant, loosing the 10k jobs via GM is important, this is the power of communication and making “events”).

Many banks have returned to profits, but a lot has to do being financed at close to 0% whilst investing the proceeds in Treasuries yielding +/-3 % - a no brainer to make money by the way. The core business of banks (or what it should be) is not improving at all.

Look at Q3 results at JP Morgan Chase in details – one of the best managed banks. Net profit $ 3.6 billion: 7X Q3 2008 and +32 % / Q2 2009. Great! But hold on, look at the details. Over 50% are coming from investment banking (and over 2/3 of Investment banking revenues coming from trading profits). Retail financial services are hardly making any money ($ 7 million profits) and the situation is deteriorating compared to previous quarters with provision increasing (nearly $4 billion representing nearly 50% of net revenue). Card services losses are mounting: $ 700 million (close to $5 billion provisions) vs. a Q2 $ 672 million loss and a Q3 2008 $ 292 million profit (if I however do not dismiss the ability of the management to "overcharge" provisions to reduce the effective tax rate and create a cushion for the future and smooth results, in this case I believe the assessment is real). The rest of business lines is more or less flat.

And what about Goldman Sachs – the best fully-fledge investment bank – where 70% of its net revenues are derived from trading at $ 8.8 billion during Q3? Net common equity stand at more or less the value of level 3 assets (the illiquid difficult to value assets). From what I read, Goldman Sachs is also back to the happy days of leveraging (15X from my rough calculation of common equity/total assets - it is beyond the purpose of this interview, but I would be quite interested to know the ratio with off balance sheet items...). We are back to a Return on Equity (ROE) above 20%: I thought we were in a new world... Never mind, the tax payer bails out, and management retains their position with no financial sanction (the only one that really matters, besides jail).

A final word on commercial banks and subprime mortgages. A recent study published by the US FED showed subprime borrowers represented 20% of all new mortgages in 2006 to zoom down to zero in Q1 2008 to reach... 20% currently in an environment where net lending is negative for the first time since 1970.

All this led me not to be optimistic about the banking sector, bearing in mind that deleveraging will translate into lower ROE and lower valuations (just look at the collapse in private banking valuations that went from 6-8% of AUM some years ago to 1-3% now).


Goldman Sachs

JP Morgan Chase

Federal Reserve Bank of St Louis

Federal Reserve Bank of San Francisco
Economic Letter: Recent Developments in Mortgage Finance

26 October 2009

Chart of the Day

For some long-term perspective, today's chart illustrates the Dow adjusted for inflation since 1925.

When adjusted for inflation, the bear market that concluded in the early 1980s was almost as severe as the one that concluded in the early 1930s.

The inflation-adjusted Dow is now a little more than double where it was at its 1929 peak and trades a mere 51% above its 1966 peak – not that spectacular of a performance considering the time frames involved.

It is also interesting to note that the Dow is up 54% from its March 9, 2009 low which is actually slightly more than what the inflation-adjusted Dow gained from its 1966 peak to today.

18 October 2009

Chart of the Day

Despite a host of concerns (weak economy, high unemployment, mounting foreclosures, geopolitical issues, etc.), the Dow made another post-crash high today. While the recent string of new rally highs is significant, it should be noted that the Dow is currently testing resistance (see red line).

Liquidity is still abundant and flowing to investing asset classes more than to the real economy. The dichotomy between the real economy and equity markets is widening.

09 October 2009

The magnificent 7 and equity markets - Review 4

For the past 3 months, equity markets have continued to forge ahead unabated. The magnificent 7 are telling us that there is no reason for the markets to pause beyond short term overstretched valuations (I recommend the reader to go to the GTI web site for their monthly newsletter, one of the best available).

S&P 500 Banks index: the index has now been consolidating for 2 months around the 130 level. The index continues trading over the 200 days moving average which in turn is near its inflection point and on the brink of becoming positive. Results fro banks should be positive for Q3 and any disappointment should be limited around the 200 days moving average. The new support at 128-130 is holding very well. Positive.

Global 1200 financial index: The world financial sector broke through the 800 cap mid-July to gain +/- 25% since. The new cap/consolidating zone is around 1000. The index looks more over-extended than the S&P 500 Bank index (but also with better fundamentals due to emerging markets not plagued by the sub-prime and the-likes debacle), standing well above its 200 days moving average; the latter is however firmly on a positive slope, technically favorable. Positive.

TED spread (LIBOR USD 3 mth - US 3 mth T-bills): The spread is back to normal - no stress showing at +/- 20 basis points (0.20%). Positive.

USD bank BBB 10 yr - US 10 yr yield: Whilst still high and above historical average, the spread has decreased by 1.5% since our last review in August, and now stands at 5.4%. Positive.

OEX volatility: OEX volatility is now hovering around 25% well below the stress times of Q4 2008 and Q1 2009. Ideally, I would like to see it at 20% or below. Positive.

S&P Case Shiller house price index (source: S&P): The latest data (July) published in September show the 6th consecutive month of yoy decrease in the rate of decline. More importantly, the index continued to increased:

Composite-10: July 2009: +1,7%, y/y: -12,8%
Composite-20: July 2009: +1,6%, y/y: -13,3%

Signs are becoming more positive. Slightly positive.

Oil price: For nearly 3 months, oil prices have been trading in a narrow $65-75/b band , the latter seeming to be the resistance. This range will last as long as the economy in the US is not decisively improving (watch retail sales numbers). When it breaks upwards, it will rally very sharply. Positive for the time being.

Conclusion: All these indicators are now positive for the first time since 2006. I am not (yet) in the camp of the commentators that see a bear market rally. I however expect a 20-25% correction in equity markets by 2010 Q1.

In my last review (11th August), I advised to relax and wait for the next move, expecting a consolidation that did not occur beyond a few percentages in July. Liquidity and strong anticipations are very forceful factors that have driven markets higher. I still believe that they went ahead of themselves and will very carefully watch retail numbers as well as the employment situation (whilst a lagging indicator, in the current crisis, I think it is important to follow it due to its strong psychological effect on consumers).

I however do not forget that banks' balance sheets are still fragile (look at all the capital increase announcements in Europe for example) and may be hit by commercial real estate write-downs. In that case I would change my view and become bearish. I will watch the bank index regularly for any clue about a possible repeat (whilst not as large) of last year collapse.

03 October 2009

Chart of the Day

Friday, the US Labor Department reported that nonfarm payrolls decreased by 263,000 in September. Note how the number of jobs has steadily increased (top chart) over the long-term. During the last economic recovery, however, job growth was unable to get back up to trend (first time since 1960). More recently, nonfarm payrolls have pulled away from its 50-year trend by a record percentage (bottom chart). The number of US jobs is currently at level first seen in early 2000.

25 September 2009

Chart of the Day

Where do we stand with the US residential real estate?

Whilst the Case-Shiller index has improved over the past few releases, yesterday's single-family home price dropped 2.3% in August.The stock market sold off on the news.

today's chart illustrates the US median price of a single-family home over the past 39 years. Not only did housing prices increase at a rapid rate from 1991 to 2005, the rate at which housing prices increased – increased. That brings us to today's chart which illustrates how housing prices are currently 30% off their 2005 peak. In fact, a home buyer who bought the median priced single-family home at the 1979 peak has seen that home appreciate by a mere 4%. Not an impressive performance considering that three decades have passed. Over the past two months, single-family home prices have resumed their decline and remain (until proven otherwise) in an accelerated downtrend.

21 September 2009

Time to short the banking sector?

After being hit hard (and for a reason), the banking sector posted fantastic gains:

High Low Close H to L C to L C to H

S&P 500 Banks 414.75 46.72 131.45 -89% 181% -68%

Feb-07 Mar-09 18-Sep-09

FTSE 350 banks 11696.3 1877.1 5308.74 -84% 183% -55%

Feb-07 Mar-09 18-Sep-09

DJ Euro Banks 491.78 84.61 231.75 -83% 174% -53%

May-07 Mar-09 18-Sep-09

DJ Stoxx Asia Pacific banks 96.93 32.97 56.96 -66% 73% -41%

May-06 Mar-09 18-Sep-09

Topix Bank Index 508.18 125.65 150.72 -75% 20% -70%

Apr-06 Mar-09 18-Sep-09

Hang Seng Financial 4932.55 1718.91 3573.2 -65% 108% -28%

Nov-07 Mar-09 18-Sep-09

Are these sustainable (at least in the developed world)?
  • Banks profitability is driven by the endless open check book provided by central banks around the world at 0% or near 0% financing cost whilst investing in US treasuries or equivalent and getting around +/- 3% for 5-10 years maturities. Despite the rhetoric, central banks are more interested in banks increasing their shareholders funds than increasing lending to consumers and companies. The decrease in lending accelerated in July to an annual rate 10.4% (7.4% the previous month) according to data from the FED.

  • Whilst having improved, balance sheets are still weak despite deleveraging, capital increases seen for the past 12 months and write-downs. According to today's FT:
    There is mounting concern among industry professionals about how to restructure or refinance the $2,100bn of European commercial property loans, in particular the $200bn in CMBS. [Commercial Mortgage Backed-Securities]

    A report from the UK industry group that met with the Bank highlighted that the UK commercial property sector could be in negative equity until 2017 and undercapitalised by up to £120bn ($195bn) based on current conservative banking refinancing terms.

    Close to £43bn of loans to the commercial property sector are due for repayment this year alone, according to De Montfort University research.

    Half of the outstanding European CMBS market needs to be repaid in 2011 and 2012, and CMBS in default have already proved difficult to restructure.

  • In the US, the situation is not much rosier. Since the beginning of the crisis, the FDIC (Federal Deposit Insurance Company - the body that insure deposits) has spent approximately $50 billions and is now underfunded (see graph below). Write-off on US commercial real estate loans could amount up to $400 billion. Add increased delinquency for credit cards and you get the picture.

  • Banks are again mulling calls to their shareholders to raise new equity, Royal Bank of Scotland being the last one to queue. With banks showing profits again during H1 2009, investors would have thought that they should not need to come to the markets again so soon. This lead me to be suspicious about the solidity of banks' balance sheets, and I am not convinced by the argument where new equity is needed to get freer from Governments: they need to raise capital because their loan losses are high and rising. The latest release from Institutional Risk Analytics shows that bank stress in Q2 2009 was at the highest level ever.


Between being short or being long, I would choose the former since too many uncertainties are lingering at this juncture of the crisis in the banking industry which benefited from the central bank largess. And I do not expect anything great from the G20 meeting in the US if I refer to the previous meeting in London where tax havens were wrongly targeted and now traders' bonuses seems to be the next scapegoat. I however still scratch my head with leading indicators having improved for 5 months in a row...


Financial Times
European property groups face debt time-bomb

Federal reserve Statistical Release
Consumer Credit

John Mauldin
Thoughts from the Frontline Weekly Newsletter
The Hole in FDIC

Institutional Risk Analytics
Q2 2009 Bank Stress Index Ratings

Northern Trust
Loan Delinquency and Charge-Off Rates at Troughs of Business Cycles

16 September 2009

W shape recovery?

Economic numbers have been rosier for a couple of months. Underneath, some fundamentals problems have yet to be solved:
  • Rising unemployment (slowing, yes, but still)
  • Households continue to deleverage /rebuild their balance sheet and savings
  • Whilst conditions in the interbank market is back to normal according to OIS and TED spreads, banks' lending to consumers and companies is muted
  • Governments are going to compete with the private sector to finance their needs
  • Excess liquidity is finding again it way into financial assets, commodities in particular that are well above what the medium term economy warrants
  • Taxes are on the rise in some countries to finance the fiscal gap: US and UK in particular. At a time of high unemployment and low wage growth, there is a risk of withdrawing additional money from households potential spending
I do not believe (as yet) that we will witnessed a double dip recession. However all the noise made by the media and politicians about a better economic outlook, makes me nervous, and the risk of policy mistake is on the rise, fear having disappeared.

09 September 2009

Are US consumers going to get the economy rolling at the speed the markets are pricing in?

In a post yesterday, I indicated that unemployment, and therefore consumers, will be key to the recovery: recent numbers are not particularly encouraging with a continued deleveraging in consumer credit that ties up with an increase in the savings rate. These numbers seem to contradict positive noise on consumer sentiment (rebound in the Conference Board Consumer Confidence index in August compared to the bad July number); personally, I prefer hard facts.
Record Plunge in U.S. Consumer Credit Signals Weakened Spending

Sept. 9 (Bloomberg) -- A record $21.6 billion drop in borrowing by Americans added to evidence that consumer spending will be slow to recover as banks and credit-card companies tighten lending standards and households pay down debt.

Consumer credit fell by 10 percent at an annual rate in July to $2.5 trillion, according to a Federal Reserve report released yesterday in Washington. The drop was more than five times larger than economists forecast. Credit fell for a sixth month, the longest series of declines since 1991.

Do not misunderstand me: I do not say that Amaguedon is for tomorrow, but that equity markets went ahead of themselves and will need to adapt to the reality of the economy.


U.S. Consumer Credit Falls by a Record $21.6 Billion (Update2)

Record Plunge in U.S. Consumer Credit Signals Weakened Spending

The Conference Board
Economic indicators

Goldman Sachs
Where to invest now? Sustainability of rally depends on final demand

07 September 2009

Can green shoots be sustainable?

For a couple of months, media ahs been full of greenshoots: the economy is back on track, we are going to see a V shape recovery, GDP upgrades are multiplying, corporate earnings are much better etc.

However without the consumer going back to shops to buy, these greenshots with end up like leaves on trees during the Autumn: brown.

Whilst a lagging indicator, unemployment will be key in this current recession due to its psychological effect on consumers combined with the depth of this recession. Let's review 3 graphs.

Graph 1 shows that the unemployment in the US will be the deepest since WWII. True the pace of employment destruction eased to 216,000 in August vs. 276,000 in July (revised up) and 463,000 in June (revised up). This is however not surprising being nearly 2 years in recession: the pace of 400,000/500,000+ new unemployed a month was not sustainable for very much longer with the stimulus package and money injected. Unemployment rate increased to 9.7%; however including part-time workers who would like to work fulltime and other unemployed that are discouraged to seeking a job, the rate is above 16%!

This recession is however by far the deepest since the early 70s, and will affect the way the baby boomers will consume and reflect on their pensions having lived on debt steroids for 20 years: fear is new; fear of losing their job, fear of losing their home, fear of losing their savings, fear about the social and health coverage, fear about their pension, concern about their children higher education and job, etc.

This results in reconstituting their savings (up to 6.9%) after having been sub zero 3 years ago. However, this steep increase is mainly in the form of debt repayment (and not in liquid savings accounts) and is helped by deflationary pressures. it does not bold well for consumption in the coming months.

The third chart illustrates that the current job market has suffered losses that are more than six times as much as average (20 months after the beginning of a recession). In fact, if this were an average recession/job loss cycle, the number of jobs would have begun to increase five months ago...

Whilst at odd with many commentators, I am still convinced that we are due for not so nice surprises on the economic front by year-end, Q1 2010 at the latest, hence my view of an equity market correction.


Bureau of Labor Statistics

U.S. Department of Commerce

Prof. Michael Hudson
Debt Deflation Arrives:What the Jump in the U.S. Savings Rate Means

The New York Times

31 August 2009

Are equity markets due for a correction soon?

For 4 weeks, the Chinese Shanghai Composite Index has been down (-23.2% as of this morning). It was leading on the way up post September 2008 financial crisis, and one may wonder whether it is not showing the way down for other equity markets. All stock markets are well above their 200 days moving average, but the Chinese market that is less than 5% away. This dichotomy cannot carry on for long.

Let's see 2 graphs.

1) Shanghai composite/S&P 500: Whilst both markets peaked at the same time in October 2007, the S&P started to diverge during the first quarter of 2008, the Shanghai Composite having almost no pause in its downward spiral. It then bottomed early October 2008 to peak early July. The Shanghai index has clearly been leading the S&P for +/- 2 years.

2) Shanghai Composite / S&P 500 ratio: This an other way to look at the previous graph, but the ratio makes the comparison more striking. Since early July, the Shanghai composite is under-performing the S&P 500, under-perfomance that accelerated early August.

In the absence of really new good news, this leads me to expect the US market ( an other major markets) to be under pressure in the coming weeks. This pause would be most welcome in a secular bull market that I feel is intact since March 2009.