31 August 2010

Summary US economic indicators

I found the tables below good summaries of US economic indicators.
As well publicized, including in this blog, the weakest point is the employment situation and consumption its corollary; for the rest the situation is not as disastrous as often related in medias, in particular on the investment front. All these graphs and indicators are posted without any further comment.


Federal Reserve Bank of St. Louis: Tracking the Global Economy - United States


U.S. Department of the Treasury: Economic Statistics - Quarterly Data Update


22 August 2010

Greece: no news, good news? Not really...

After the Q2 2010 turmoil in debt markets across the euro-zone following Greek debt problem, everything went quiet from mid-July onwards: the euro dramatically jumped, CDS spreads shrunk and sovereign debt yields followed and media went quiet, like a remake of the Phoney war on the western front at the beginning of WWII.
We had however a few announcements and markets anticipations/reactions:
  • Slovakia did not participate in the first tranche of help to Greece and August 12 the parliament voted overwhelmingly (69-2) to reject taking part in a European Union aid package to Greece – wise men! The angry reaction from the European Commission tells a lot about its disrespect of democracy (this is one of the main roots of the flawed EU construction as we have witnessed it for the past 20-25 years – and don’t talk to me about the European parliament which is nothing more than a puppy House of Representatives). Whilst Slovakia participation in the rescue package (just over 1% of the European participation – EUR 80 billion) is meaningless, its parliament vote is meaningful: countries how small they are ready to stand and say enough is enough; democracy can regain control.
  • Without any surprise (who can think it would have been otherwise?!), on August 19 the European Commission said that Greece meets the conditions to receive the second part of the EUR 110 billion three-year emergency-loan package agreed on May 2: EUR 9 billion (including EUR 2.5 billion from the IMF); so we are at EUR 29 billion and counting (remember it was agreed that Euro-zone would lend EUR 30 billion during year 1 – we already are at 2/3)... This second tranche will be agreed by European Finance Ministers on September 7.
  • On the economic front, Greece’s GDP shrunk for the 7th quarter in a row at -1.5% during Q2 and inflation jumped to an annualized rate of 5.2%; I guess this inflation increase, way away from the rest of the euro-zone, is due to tax increases passed onto consumers. We are better Greece posting a nominal GDP growth in 2010 if such inflation continues on the same path, or one will have to very worried.
Let’s have a look at the 6 month progress report.
The numbers look rather encouraging with a 47.9% reduction in the ordinary budget for H1 yoy.
The revenue side remains however weak at +5.8% during the January-June period (42% of 2010 budgeted revenues), but we will have a clearer view of tax receipts in the next quarterly progress report, and in particular VAT and consumption taxes that represent over 2/3 of Greece’s revenues.
Most of the current reduction in the deficit comes from a decrease in expenditures (+/- 80% of the improvement). However, H1 expenditures already represent 55% of the full year budget.. A closer look at expenditures makes me more than circumspect regarding Greece chance to succeed. 60% of PIB have to be spent during H2 according to the most recently revised budget (and the EUR 9.2 billion has been reviewed downward in the tune of EUR 500 million compared to May) and interest rate payment will increase during H2 since the euro-zone loan bears a 5% rate and Greece has borrowed short term at rate much higher than last year, whilst it shows a decrease compared to 2009. You can see the squeeze: ahead for expenditures and late for revenues (Greece has a wild card: the EUR 3 billion EU help for infrastructure not yet paid that could arrive at the right time...).
Greece can squeeze even more expenditures but the key is on the revenue side and the bottom line is GDP growth. Without any growth, Greece will not be in a position to mend its public finances, and recent economic indicators are not encouraging; in addition, with inflation more than double the Euro-zone average and the GDP still shrinking, the economic divergence with the rest of Europe is increasing not the reverse. And do not forget, Greece is taking more debt every month, mostly financed by other Euro-zone countries and the IMF and its debt-to-GDP ratio follows the same path.
Greece is in a debt trap and I continue to believe that a debt rescheduling (not to call it a default), is the only solution to avoid a straight default or a breakup of the euro-zone. The German economy is doing well thanks to its exports. The economic (and social? political?) rift between Northern Europe and Southern Europe (France included) is widening. This is not sustainable.
What are markets telling us? 
After a relief (and an over-short market) following the publication of stress test for banks across Europe, the euro, sovereign debt yield and CDS spreads are again moving in the direction of anxiety.
Yield on Greek debt are again on the move…
… whilst at the same time yields on the German debt are reaching historic lows, therefore the spread between Greece and Germany is reaching historic highs and …
... the Euro is backing down after a 10% rally.
Finally, I had a look at the BIS quarterly bulletin and I noticed that French banks reduced their exposure to the Greek debt at the end of March, down to EUR 67 billion (-EUR 8 billion) whilst and German banks remained flat at EUR 44 billion compared to the end of 2009. I guess that this exposure has been further reduced since, the ECB becoming the investor of last resort.
In the meantime, the BIS is watering down new regulations to strengthen capital ratios for banks, putting emphasis on core capital; this will drag on, otherwise, the stress test that European banks passed so “successfully” would look meaningless (what it is anyway).
What about investments?
I have not changed for a couple of months: stay clear of Western banks (they are not all that bad, but there is better value elsewhere), invest in high growth economies (directly or via proxy companies), brand name consumer goods, and generally speaking companies with a franchise, a strong balance sheet and high yield on their shares (in this environment, income is key).
Financial Times: Slovakia under fire over Greece
Financial Times: Greece to receive further €9bn of bail-out
Hellenic Ministry of Finance: Budget execution – June 2010
Hellenic Ministry of Finance: The economic adjustment programme for Greece
Bank for International Settlements: Detailed tables on provisional locational and consolidated banking statistics at end-March 2010

10 August 2010

The magnificent 7 and equity markets - Review 8

The S&P 500 has recovered 2/3 of its 15% April/June correction and is just trading above its 200 days moving average, itself in a flattish slope (the 1000 level held well). 
Economic news from the US are pointing towards a slower GDP growth and still high unemployment, but no double dip; Europe has showed recent signs of better growth, mainly due to German exports that are reaching growth rates not seen since 1984.; Fast growing economies in the rest of the world do not see signs of weakening, despite the continued fear of a real estate bubble in China (but authoritarian states are better armed to prevent/cope with it).
The magnificent 7 are telling us that equity market continue to be resilient with no sign of becoming negative. (I recommend readers to go to the GTI web site (www.global-thematic.com) for their monthly newsletter, one of the best available – don’t forget to quote Markets & Beyond to get a special welcome).
S&P 500 Banks index: after falling +/- 25% during the recent equity markets correction, the index is stalling on the 140 level. There is still a lot of noise around additional regulations of the banking sector in the US which to me is largely included in prices. Technically, the sector closely trades around its 200 days MA. Positive.
Global 1200 financial index: The world financial lost +/- 20% during the April-June correction, mainly due to the sovereign default risk in the Eurozone and has since recovered 2/3. The index is trading around its 200 days moving average. The publication in July of stress test results for 91 EU banks has alleviated fears of a meltdown in the short term at least. Positive.
TED spread (LIBOR USD 3 mth - US 3 mth T-bills): After peaking mid-June at nearly 50 basis points (0.5%), the spread went sharply down whilst not yet at its “normal” level. The interbank market shows little stress. Positive
USD bank BBB 10 yr - US 10 yr yield: Whilst still high and above historical average, the spread is back to it April 2008 level; it has been however stalling around the 3% mark since mid-April. Positive.
OEX volatility: OEX volatility is above 20% but 50% below its recent peak in May. We need however this indicator to stay at or below 20%, but the trend is right. Positive.
S&P Case Shiller house price index: The latest data (May) published 27th July continue to show improvement in their annual rates of return. Measured from June/July 2006 through May 2010, the peak-to-date figures for the 10-City Composite and 20-City Composite are -29.6% and -29.1%, respectively.
In May, the adjusted 10-City and 20-City Composites numbers show the 12th m/m and 10 out of 12 months consecutive increase respectively; the unadjusted data are also positive (2009 number in bracket).
Composite-10: May 2010: m/m +1.25%; y/y +5.4% (m/m +0.50%; y/y -16.8%)
Composite-20: May 2010: m/m +1.27%; y/y +4.6% (m/m +0.52%; y/y -16.9%)
As the report comments :
“While May’s report on its own looks somewhat positive, a broader look at home price levels over the past year still do not indicate that the housing market is in any form of sustained recovery … The last seven months have basically been flat.”
“We need to watch where the housing markets will go after these temporary stimuli go away. June’s existing and new home sales and housing starts data do not show much real improvement in those statistics either. It still looks possible that the housing market might bounce along the bottom for the foreseeable future, before showing any real improvement that will filter through to the rest of the economy”
Whilst one should not be distracted by short term noise, recent data are also pointing towards a decrease in prices. Signs are mixed and do not point towards either a rapid recovery or a double-dip. Average.
Oil price: The oil prices continue to be trade in a $70-90/b. Not much happening on the energy front. In the US gas prices trade below $5/btu from despite a positive seasonal factor. Uranium is back where it was in November 2009 at $45: Positive.
Conclusion: All these indicators are positive but for the housing market. The 15% correction seems to have just been a pause in a bull market.
Continue investing in high yielding securities / net cash companies with strong franchise and selected stocks in fast growth economies.
Despite the strong showing of some financial stocks, I prefer to stay clear in Western economies.
I stick to my no tightening by the FED expectation (only the fed funds really matter, not the discount rate) and the ECB any time soon despite the rhetoric. This will be supportive to equity markets and a major tailwind.

02 August 2010

Europe’s banks stress test: not really stressful…

Whilst the ECB was first and foremost to react to the hedge fund collapse of Bear Stearns and BNP Paribas during August 2007, Europe has been running behind events ever since. Within the EU, the recent June decision to screen the main EU banks risk/capital adequacy and publish the findings was taken on the back of a unilateral decision by Spain following the seizure of its banking sector in June.
Being behind events does not mean that the exercise is not useful if properly conducted, whilst its main aim was for policymakers to calm down the markets. I am not going to review at length the criteria used, since the claimed transparency is somewhat tainted with opacity.
Scope of the test
The stress test was conducted on 91 European banks in 27 countries representing 65% of the total assets of the EU banking sector or EUR 28 trillion, which is representative enough.
It covers 2010 and 2011 and mainly focuses on credit and market risks.
Banks pass the test if their Tier one capital over their risk weighted assets reaches a 6% threshold (the regulatory minimum Tier one capital in Europe is 4%).
Adverse macro-economic scenario
The assumptions concerning GDP growth are no so adverse: a 2% drop in GDP over 18 months doe not cry foul, particularly if countries outside Europe see their growth decrease significantly (a real possibility in the US a possibility in Asia). However, I can live with this. As I do with the assumption concerning a 175 basis points hike for 3 months rates and 75 basis points for 10 years by the end of 2011, even if in case of crisis these would most likely head north and fast.
Sovereign debt
The haircut applied to sovereign debt is not appropriate: it is not a question of taking off, 10% here, 2% there and 4% elsewhere. It is a binary game: a country defaults or not; in case of default the haircut will be much larger than the ones assumed in the CEBS analysis. Again, I can live with this.
Where things are becoming questionable is the treatment of sovereign debt in banks books. A cut is applied to the trading book whilst none is for the “investment” book; I must admit that the difference is quite specious: either a country can default or not and any investment would be affected. European policy makers said that there no way that any European country will be allowed to default; well, they also said that the euro would enhance economic growth and protect European citizens (the famous fortress Europe - like the Maginot line of defense)... In addition, if only 7 banks have to quickly raise EUR 3.5 billion of equity, 17 banks have a ratio comprised between 6 and 7% (including Deutsche Bank, the largest German bank which may explain why Germany refused to publicize details of the sovereign debt books of German Banks).
As stated by the CEBS report:
In total, aggregate impairment and trading losses under the adverse scenario and additional sovereign shock would amount to 566bn € over the years 2010-2011.
The aggregate Tier 1 ratio, used as a common measure of banks’ resilience to shocks, under the adverse scenario would decrease from 10.3% in 2009 to 9.2% by the end of 2011 (compared to the regulatory minimum of 4% and to the threshold of 6% set up for this exercise). The aggregate results depend partly on the continued reliance on government support for currently 38 institutions in the exercise.
The aggregate Tier 1 ratio incorporates approximately 197bn € of government capital support provided until 1 July 2010, which represents 1.2 percentage point of the aggregate Tier 1 ratio.
So the picture looks rather rosy with plenty of cushion…
However, beyond affirming that no European country will allowed to default (saying otherwise would trigger a new rout on banks and the euro) does not mean that it could not occur (please note that I do not believe that a EU country – at least any eurozone country – will default straightforwardly, but I do believe that a rescheduling of debt is on the cards GDP growth failing to deliver enough to service it which according to my simulations is at least true for Greece). To conclude, trading books were tested and cleared from a double-dip recession – not the complete balance sheet impact of a sovereign debt default was analyzed.
There are at least two additional questions: 
  • Did the study take into account rating downgrades that would require banks to match their assets with more capital?
  • There is no test taking into account core capital only; banks have used financial engineering to boost their Tier one capital ratios instead of core equity to enhance their return on equity. In my opinion core equity is the real parameter to take into account to test bank’s stress conditions.
After a mild reaction on Monday 26th July, banks shares showed strong gains, particularly in the eurozone and this continues today (August 2nd). This has however probably more to do with the Basel Committee on Banking Supervision that moderated several of its planned rules that would have required more capital and increased costs for banks on the very same Monday. In the meantime, CDS 5 yr spreads across Europe went down between 20 et 50% since June peak. Accounting rules also remain accommodating.
To conclude, the stress tests fulfilled their objective short term to calm markets; longer term, the fundamentals of Greece and several other European countries with structural budget deficits and subdued growth are not properly addressed. This will come back to the forefront of market concerns in the coming 12 months. Meanwhile, I will closely follow the progress of the Greek stabilization plan and GDP growth.
Committee of European Banking Supervisors (CEBS): Aggregate outcome of the 2010 EU wide stress test exercise coordinated by CEBS in cooperation with the ECB
FT: Triple bonus boosts Europe bank shares