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.