30 June 2009

From green shoot to brown shoot?

Tuesday's numbers in the US were nothing to rejoice:

The biggest downward surprise was the slide in the Conference Board consumer confidence measure to 49.3 in June from 54.9 in May and well short of the 55.3 consensus. The decline was spread out between both "expectations" (to 65.5 from 71.5), which does a decent job in predicting the near-term trend in consumer spending, and the "present situation" (to 24.8 from 29.7). Confidence is still well above the historic 25.3 low posted in February but is still very much consistent with an economy knee-deep in recession. For example, when the economy was moving out of recession in November 2001, the index was 84.9; at the end of the 1991 recession it was 81.1; when the 1982 recession came to a halt, the confidence survey was sitting at 57.4. Never before has a recession ended with confidence as low as it is today.

Inflation expectations jumped 3 tenths in the month to 5.9 percent fed by a roughly 5 percent rise in pump prices during the month. There's no indication that concern over monetary inflation is at play in inflation expectations.

The gap between this survey and the University of Michigan sentiment index, which ticked up to 70.8 from 68.7, is that the former has more of an "employment" orientation to it — and the labour market still looks very soft. The "jobs hard to get" series went from 43.9 to 44.8; and the "jobs are plentiful" component slumped to 4.5 from 5.8. The labour market gap (the spread between these two series) rose to 40.3 from 38.1 in May, which portends yet another month of rising unemployment when Thursday's data roll out.

In terms of spending intentions, housing is still getting very little traction as home buying plans edged down to 2.7% from 2.8%; plans to buy a major appliance slipped to 26.5% from 29.2%; and even with all the excitement over 'cash for clunkers', auto purchase intentions rolled over big-time to 4.6% from 5.7% in May in what was the second lowest print of the year (and suggests that the expected 10 million unit auto sales for June is a blip in an otherwise fundamental downtrend in consumer discretionary spending).

Case-Shiller's 20-index fell 0.6 percent in April, down from a long run of minus 2 percent readings, while the year-on-year rate improved to minus 18.1 percent, thus moving in the right direction. Whilst the second derivative is improving, don't forget that there is still at least 10 months supply of unsold inventory in both the new and existing residential market. Let's see what data the 2-3 forthcoming months will produce.

Next data on the housing front will be Wednesday's MBA report. Also the important ISM manufacturing report will also be released Wednesday to see whether it confirms Tuesday's data.


Bloomberg: June 30, 2009

Gluskin Sheff: June 30, 2009
Market and data musings - David A. Rosenberg

24 June 2009

New regulation in the financial sector: US and Europe

I reproduce in extenso RGE Monitor's Newsletter regarding new proposed financial sector's regulation in the US and Europe:

"As decided at the latest G20 meeting, authorities around the world are devising micro- and macro-prudential reforms in order to strengthen the resilience not only of single financial institutions but of the entire financial system by extending oversight to all important financial institutions, products, and activities.

The United States

In the U.S., the Obama administration introduced its widely anticipated regulatory reform proposal on June 17. Its five main components include:

1. The establishment of the Fed as systemic risk regulator and supervisor of “too-big-to-fail” institutions in return for Treasury permission requirement for extraordinary liquidity programs. The plan proposes creation of a “Council of Regulators” (formerly the President’s Working Group) chaired by Treasury but with advisory powers only;
2. The creation for the first time of a regulatory regime for all financial derivatives, as well as a requirement that the originator, sponsor or broker of a securitized vehicle retain “skin in the game” – i.e., a financial interest of at least 5% in its performance;
3. The creation of a new Consumer Financial Protection Agency with rules against predatory lending and transparency standards at the retail level;
4. A new resolution mechanism that allows for the orderly divestiture of any non-bank financial holding company whose failure might threaten the stability of the financial system, including investment banks, large hedge funds and major insurers such as AIG;
5. Adopting a leadership role in the effort to improve and coordinate global regulation and supervision.

The main points of contention in Congress are likely to include the scope of the new regulatory powers conveyed to the Federal Reserve in view of the arguably minimal use it made of its already existing regulatory powers in the run-up to the crisis. Equally controversial are the need and the powers of the new Consumer Financial Protection Agency. Furthermore, some policymakers and market participants are equally worried about the potentially stifling effect of too much regulation on financial innovation.

The European Union and Switzerland

Two days after the Obama plan’s introduction, on June 19, EU leaders reached agreement on a new framework for coordinated (rather than unified at EU-level) macro- and micro-prudential supervision along the lines proposed by Jacques de Larosiere and endorsed by the European Commission on June 9. Regarding the macro-prudential authority, the new European Systematic Risk Council (ESRC) will comprise EU central bank governors and will most likely be chaired by the ECB president. The Council will issue financial stability risk warnings and macro-prudential recommendations for action to supervisors and monitor their implementation. In contrast to the U.S. Federal Reserve, however, EU central bankers will not oversee and regulate systemic cross-border institutions directly. ECB vice president Lorenzo Bini Smaghi, in a June 19 speech, deplored this discrepancy.

The EU agreement also establishes a new micro-prudential authority at EU-level. In particular, the European System of Financial Supervisors, comprising three new European Supervisory Authorities, will help ensure consistency of national supervision and strengthen oversight of cross border entities. This will be accomplished by setting up supervisory colleges and establishing “a European single rule book applicable to all financial institutions in the Single Market.”

Importantly, the new EU-level supervisory authority will have binding decision powers in the case of disagreement between the home and host state supervisors, including within colleges of supervisors. EurActiv cites the following example: “If Italian and Polish supervisory authorities disagree regarding recapitalization of an Italian bank operating in Poland, for example, it would be the new EU-level authority that would settle the issue with binding decisions.” However, EU leaders are clear in their agreement that “decisions taken by the European Supervisory Authorities should not impinge in any way on the fiscal responsibilities of Member States.” This precludes any ex ante burden-sharing provision, a very controversial issue. As EurActiv explains: “Should a major financial institution fail, there will be no European competence to establish which countries will have to foot the bill and by what means. National interests are likely to prevail again on this issue.”

Up until now, then, an EU-wide resolution regime for cross-border banks remains unaddressed. While this is welcome news for Britain, which worked hard to confine any EU interference to a minimum, smaller EU countries as well as non-EU countries with large banking sectors have a problem.

Not by coincidence, Philipp Hildebrand, vice president of the Swiss National Bank, noted on a June 18 speech: "The lack of any clearly defined and internationally coordinated wind-down procedure contributes to a de facto obligation on the part of the state to provide assistance to these institutions." Small countries, in particular, will need to develop wind-down rules for crisis situations. One possible consideration, according to Hildebrand is to "split off those units of a bank that are important for the functioning of the economy and wind down the rest."

‘The rest,’ of course, might include foreign EU operations in need of domestic backing. In terms of pro-active regulatory interventions, the Swiss have been at the forefront with an overall leverage cap for their large institutions, an innovative ring-fencing framework for bad assets at UBS, and a risk-adjusted remuneration scheme at Credit Suisse (i.e., to pay top bankers based on the performance of the toxic waste they originated or acquired on behalf of the bank).

The UK established new resolution powers for national institutions in the Banking Act 2009 in the aftermath of Northern Rock. Large and complex financial institutions, however, still await a comprehensive solution, a fact noted in Mervyn King’s June 17 speech. He noted that “one important practical step would be to require any regulated bank itself to produce a plan for an orderly wind down of its activities,” i.e. akin to making a will. That kind of information would also be a valuable input for the new EU cross-border regulators.

Alternative Investment and Derivatives Regulation

In the U.S., the President’s plan requires all advisers to hedge funds and other private pools of capital, including private equity funds and venture capital funds whose assets under management exceed some modest threshold, to register with the SEC under the Investment Advisers Act and provide sufficient information for effective systemic risk supervision. Similarly, under the EU Commission draft regulation, managers of hedge funds and similar ‘alternative investment funds’ that handle at least €500m (€100m for those using borrowed money) would have to be registered in trade repositories and provide information about leverage. For now, the draft law applies only to managers, rather than funds, because many funds are based offshore. After three years, the rules will get tougher for funds based outside the EU. Although the EU plan was under heavy attack by the industry, the latest U.S. backing should put any hope of a reversal to self-regulation to rest.

New rules in major financial centers also require all financial derivatives to be brought under the regulatory umbrella. As part of the U.S. plan, standardized credit default swaps (CDS) and other over-the-counter (OTC) derivatives will be required to clear through a central counterparty and trade on exchanges and other transparent trading venues. More customized products will be required to register with a central registry that makes aggregate data available to the public and detailed positions for regulators. In the European framework, the UK secured that the new EU supervision will not cover clearing houses for derivatives – an important objective for the City of London who is global leader in terms of trading volumes of derivatives."

I will have only one comment (besides the fact that I do believe that State regulation will sow the seeds of further and even more damaging crises - just look at the increasing indebtedness of States in the West for the past 40 years): the emerging markets' banking system is in much better shape and does not need to increase regulation. Interesting...


RGE Monitor's Newsletter: June 24, 2009

19 June 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. Also, the inflation-adjusted Dow is now less than double where it was at its 1929 peak and trades a mere 30% 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 30.7% from its March 9, 2009 low which is actually slightly more than what the inflation-adjusted Dow gained from its 1966 peak to today.

Despite globally better news on the economic and financial front (well... let's see that will happen to commercial real estate), I believe that we have entered a period of market correction after a superb performance: look beyond the Western world tropism, emerging (leading?) markets (MSCI index) have increased by +/- 80% from through (28 October) to recent peak (2 June)! Since, they decreased by 8%.

12 June 2009

A new challenge to US domination?

The financial crisis has heralded the start of US decline as WWI did for Europe. The shift of power is becoming more vocal and organised: over the pas few months China and Russia voiced their concern about US budget deficit and mounting debt; they now are joined by Brazil and India, BRIC countries demanding more clout, commensurate with their 15 percent share of the world economy and 42 percent of global currency reserves.

Brazil and Russia joined China this week in saying they would shift some $70 billion of reserves into multicurrency bonds issued by the IMF: this is a clear signal to the US to get their house in order.

According to Goldman Sachs, the BRICs may overtake the combined $30.2 trillion gross domestic product of the Group of Seven nations by 2027, 10 years earlier than previously forecasted.

It will be interesting to see what comes out of their meeting in Russia on 16th June; one sure thing: a multipolar world is being fostered.

Emerging markets is one of my other favorite investment themes.


El-Erian Says Summit Shows `Rebalancing' as BRICS Buy IMF Bonds
Bloomberg, June 12 2009

10 June 2009

US budget deficit and debt: unthinkable solutions?

VAT to plug the deficit?

Facing unprecedented budget deficits and mountains of debt plus a health care reform, the US administration has already tested the water about introducing a VAT (Value Added Tax) that is common in most countries across the world.

are ranging from a 10% to a 25% rate depending of the scope, the latter permitting a balanced budget, financing of Medicare and Medicaid, exempting most of the population from income tax and slashing the top rate down to 25%. Paul Volker seems to have endorsed Yale law professor Michael J. Graetz of a VAT of 10% to 14% to finance the health reform and exempt 90% of the population from income tax.

The Obama administration is also testing the water to tax greenhouse-gas emissions could raise trillions of dollars. Alternatives are discussing new taxes on sugary soda, alcohol and employer-provided health insurance. The last proposal could raise a lot of money - nearly $1 trillion over the next five years, according to White House budget documents.

Since Detroit and the American way of life have been dented with the fall of the US auto industry and green discussions about carbon emissions are becoming more entrenched, let's have a look at an increase of taxation on gasoline which today is way below European levels: at the actual $2.6 per gallon, the price of gasoline in the US is +/- 50% the level of Europe and the American motorists consume 142.4 billion gallons a year… if the US administration takes an additional 25 c / gallon (i.e. a 10% increase on current prices), it would raise $35.6 billion a year, and be still way below European prices.

I am sure of only one thing: taxation will increase in the US (as well as in Europe) to pay the bill and arrears.

I despite government intervention as much as over-taxation (i.e. in my opinion paying to the State more than 20-25% of what you earn, including health care), but some situations require war style answers. And this is less bad than over-inflation (even if any new tax will increase prices when introduced). Let’s clean the house and start on new foundations, leaving entrepreneurship strive and keeping governments and large corporations (that often act inefficiently like administrations when not managed by entrepreneurs – it is time to study again the agency theory…) out of the way: only the former is really creating wealth (intellectually, financially and socially) and makes humanity move on..

Doom, gloom or boom? (Part 2)

2. Is the US moribund?

Despite the long term demise of the US (in relative terms – not to talk about Europe that is in a worse situation), the leash effect of the country on the word economy and markets is still present.

We are told by Nouriel Roubini , the IMF (note: with its 2,500+ economists it went from “it will be ok” in 2007 to “oh! My God!” 2 months ago – a useless organization that found a new “raison d’être” after the G20 summit in London) and some other that, depending on sources, the finance industry has USD1.3 – 2.5 trillion of forthcoming losses to absorb in addition to the $1 trillion that already hit their balance sheets, due to a near zero GDP growth, a continuing deteriorating real estate market (residential and commercial, the latter having more bad surprises to come with many shopping mall in bad shape for example and too many office space available – have a look at Manhattan -, as well as an increased delinquency for credit cards). That may be true or probable (making the banking sector insolvent at least in the US), I do not know; what I know is that helicopter Bernanke and pilot Tim will throw whatever money is necessary to avoid a collapse, even at the price of high inflation in the years to come, despite all the rhetoric of denial. Next year you get Senate and US House of Representatives elections, so do not expect any tightening (beyond a token one) for a good 12 months.

Debt and deficits are however a real problem. I posted a must see video on the sheer size of the problem the US is facing. Obama, Geithner, Bernanke and the lot are well aware of this and talk about it, but no real measures are taken to tackle it. The Chinese are becoming impatient but have no real alternative (but buying real assets, like natural resources; the West will, with reason, resist it however – see Rio Tinto as the most recent example – beyond Africa, the Chinese eye Australian and Canadian resources); it will be interesting to follow the results of Obama's forthcoming trip to China.

The latest revised deficit projection (May) brings the expected US budget deficit to $1.84 trillion (4 times the previous year), from a February projection of $1.75 trillion. For the 2010 fiscal year, the new estimate is $1.26 trillion, up from $1.17 trillion. Since optimism usually reigns in the blind kingdom of politics, just round the numbers to $2 trillion and $1.5 to get closer to the truth. On the official numbers, this represents a shortfall of 12.9% of GDP for 2009 and 8.5% for 2010.

We are back to the end of World War II! In February, in his 10-year budget outline, Obama projected the US would fall back just below the 3% level in the last months of his term, in the 2013 fiscal year: by “chance”? Who can believe a politician making such an assumption at time of his re-election time?

Annual deficits would never dip below $500 billion and would total $7.1 trillion over 2010-2019. And those dismal figures rely on economic projections that are significantly more optimistic (1.2% decline in GDP in 2009 and a 3.2% growth rate for 2010) than those forecast by private sector economists and the Congressional Budget Office.
And do not forget the +/- 41 trillions more in Social Security, Medicare and Medicaid obligations as baby boomers retire (If significant reforms are not undertaken, benefits under entitlement programs will exceed government income by over $40 trillion over the next 75 years according to the Governement Accountability Office).This would cause debt ratios relative to GDP to double by 2040 and double again by 2060, reaching 600 percent by 2080). Some argue that the total US Government current and future liabilities amount today to an astonishing $65.5 trillion and counting. Whatever the number, it is huge, enormous, unthinkable.

This leads to a ballooning debt standing at $11.4 trillion early June due to increase to $20 trillion in 2015.

Consequences are threefold:
  • Issuance of Government debt will be huge during 2008-2009 fiscal year [link to part 1]
  • The yield curve is steepening very quickly over the past few weeks (the difference between 2 and 10 year Treasury notes has reached 2.75% surpassing the previous record of 2.74 % set on Aug. 13, 2003).
  • Either(1) markets anticipate a recovery, or (2) anticipate a quick deterioration of the US fiscal outlook or (3) Chinese are refocusing their portfolio on short dated maturities or (4) investors anticipate the huge increase in supply. It is probably a combination of the four factors, but I would put a 90% probability on the latest three that are linked anyway. The consequence would be for the FED to buy more US Treasuries to keep long rate down in order to limit/stop any hike in mortgage rates.
  • Increase taxes, increase inflation or a combination of the two, leading to lower standard of living of American citizens and a continued debasing of the USD.
Whether the US will be moribund and in a secular decline will depend on policies adopted to fix the debt/deficit problem. On sure thing, the American people will have to pay for having lived on steroid for too long; using the $ dollar devaluation tool to have other countries paying for the US financial and economic sins will not longer work with foreign savings needed more than ever to pay for the US historical deficits and debt burden.

The leash effect of the US economy will diminish over time. During the current crisis, it is the Chinese market that led the rally: for investments, look at East and South not West.

For the US, gloom, not yet doom.

In part 3 , I will review one of my favorite investment theme: commodities.

03 June 2009

Doom, gloom or boom? (Part 1)

1. Where are we?

GM is dead after several years of agony and Chrysler is Italian. Ford is the only surviving automaker (pending what the new GM will become).

Citicorp and GM are no longer constituents of the Dow Jones.

This must look like a revolution for our American friends.

Since its low on March 9, equity markets have sharply rallied, with the financial sector leading the charge. The MSCI world index is up 47% and emerging markets display an even better performance: +64% for the MSCI emerging markets index (interestingly, the low was posted in October and in March the low was a couple of days earlier than in developed countries)

In the meantime, the USD index has rapidly fallen at -14%. The safe haven status of the USD (which I have difficulties to see) has disappeared as fast as the perceived meltdown has receded.

The commodity and energy complex has also bottomed out, posting steep increases:

Interest rates are on the increase and artificially low yielding government debt is the last bubble (the mother of all bubbles?) to explode.

10 yr US Treasuries yield increased over 80% (or 101 basis points) from 2.05% at the end of 2008 to 3.06% on June 2. And this move applies to all government debt around the world, to a lesser magnitude however (30%-35% in the UK, Japan, Canada and somewhat less in the eurozone – from 7% for Italy to 28% for Germany).

This sharp increase is due to (1) to the receding market fear that benefited the US Treasuries and (2) investors demanding more remuneration to compensate for their perceived risk of holding US Treasuries.

At the end of April 2009 the total marketable US Treasuries was $5.8 trillion (ex TIPS). In 2008, the flight to safety helped US debt to rally 14%. We are now at juncture where the US:
  • is perceived to have its economy bottoming out
  • has huge fiscal deficits to finance ($1.85 trillion in 2009 and $1.38 in 2010 projected according to the Congressional Budget Office)
  • needs to raise $3.25 trillion in 2009 (less than $1 trillion in 2008) according to Goldman Sachs
  • faces the largest foreign buyer, China ($ 768 billion invested), getting nervous about its ability to control the situation and reign in fiscal deficits
  • sow the seeds of inflation with its 12. 8 trillions of government and Fed spending and commitment to unfreeze the credit market

This year, the Treasuries have lost 5.1% in value i.e. $295 billion and we are jut at the beginning of a long, very long downward trail; the bull market for treasuries lasted 28 years (thank you Mr. Volker). The bear market is just starting. Assuming a loss equivalent to 18 % 2008 gains spread over 2 years (quite a conservative assumption) losses will reach more than $1 trillion; bond investors have a good reason to be nervous...

Still gloom.

The next article will review whether the US is moribund.