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.

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.

Conclusion

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...

Sources:

Financial Times
European property groups face debt time-bomb
http://www.ft.com/cms/s/0/a29bce72-a60e-11de-8c92-00144feabdc0.html

Federal reserve Statistical Release
Consumer Credit
http://www.federalreserve.gov/releases/g19/Current/

John Mauldin
Thoughts from the Frontline Weekly Newsletter
The Hole in FDIC
http://www.frontlinethoughts.com/gateway.asp

Institutional Risk Analytics
Q2 2009 Bank Stress Index Ratings
http://us1.institutionalriskanalytics.com/pub/IRANews.asp

Northern Trust
Loan Delinquency and Charge-Off Rates at Troughs of Business Cycles
http://web-xp2a-pws.ntrs.com/content//media/attachment/data/econ_research/0909/document/dd091809.pdf

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.

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.

Sources:

Bloomberg
U.S. Consumer Credit Falls by a Record $21.6 Billion (Update2)
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aAYZpSNGocVM
Record Plunge in U.S. Consumer Credit Signals Weakened Spending
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=avvF5aNtrCfc

The Conference Board
Economic indicators
http://www.conference-board.org/economics/indicators.cfm

Goldman Sachs
Where to invest now? Sustainability of rally depends on final demand
http://www.fullermoney.com/content/2009-09-08/WheretoinvestSep09.pdf

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.


Sources:

Bureau of Labor Statistics
http://www.bls.gov/news.release/empsit.nr0.htm

U.S. Department of Commerce
http://www.bea.gov/national/nipaweb/Nipa-Frb.asp?Freq=Qtr

Prof. Michael Hudson
Debt Deflation Arrives:What the Jump in the U.S. Savings Rate Means
http://www.michael-hudson.com/articles/financial/090630ODebtDeflation_SavingsRate.html#_ftn2

The New York Times
http://economix.blogs.nytimes.com/2009/05/08/comparing-this-recession-to-previous-ones-job-losses/

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.

Natural gas prices: something wrong?

Natural gas prices in the US have followed a downward spiral for a couple of month, and are now 4.5 times lower than in July 2008 at less than $3 / mmBtu (Henry Hub spot). This downward spiral accelerated since August 6, 1 month future prices losing 30%.

According to the EIA:

Factors on both sides of the market place have contributed to the price declines over the past several months. Recent reductions in natural gas price levels may be related to continued strength in domestic production capacity, specifically in unconventional gas fields [...]. Reduced demand as a result of the decline in economic activity is evident in the industrial sector, which accounts for more than 30 percent of yearly natural gas deliveries. The combined impact of these influences on the recent natural gas supply and demand balances has resulted in an inordinately high amount of natural gas in storage for this time of year.

Working gas in underground storage as of last Friday is estimated to have been 3,204 billion cubic feet (Bcf), which is 19.1 percent above the 5-year (2004-2008) average. During the week ending Friday, August 14, implied net injections of natural gas into underground storage totaled 52 Bcf.

In addition, the hurricane season did not bring any production/distribution disruption in the Gulf of Mexico so far which likely contributed to lower prices. However, peak storm season has only just begun, and a potential disruption to supplies cannot be discounted in the coming weeks.

Finally, August 24 the U.S. Natural Gas Fund, an exchange-traded fund held about 10% of the contracts in the October 2009 futures market traded on NYMEX. Combine that position with its over-the-counter swap holdings, and UNG held the equivalent of more than 50% of the October contract's open interest. In following its plan to buy and hold natural gas, UNG keeps rolling its position into the next futures month. In a bear natural gas market, UNG's massive monthly gas sell-off accelerates the fund's losses and brings down the price of natural gas with it.

UNG's equivalent position in the October futures contract amounts to over a trillion cu. ft. of gas. Given that the U.S. consumes an average of about 2 trillion cu. ft. of gas per month, UNG's position in the front month — at over half of that month's consumption — seems too large for a purely speculative fund.

This results in creating a great pricing inefficiency because this natural gas speculator is following a predefined plan — and the plan is publicly known.

Whilst the number of rig count was halved during the year, it did not offset the weak economy, good weather conditions, snappy production at both conventional and unconventional sources such as shale.

In the meantime, oil prices have continued to recover. Since the trough of the stock market on March 9, oil prices (WTI) have increased by over 50% whilst gas prices (Henry Hub) decreased by almost 30%. This has resulted in a oil/gas ratio reaching historical high. Technically the acceleration is impressive and cannot last. This ratio stand at 28, more than twice the historical average.

Gas prices are very volatile and there is no world market: it is a difficult instrument to trade where local circumstances can have large impact on prices. Whilst I cannot dismissed a total collapse of gas prices (particularly if there is not enough storage capacity and UNG's foolish strategy in futures market continues), my sense is that current prices are overshooting on the downside with the charts showing an acceleration that usually is an ending characteristic; but no key day reversal yet. Any recovery will bring substantial rewards. If you find storage capacity: buy spot and sell forward, there is a $2.2 spread between spot and December contracts.

Source:

Energy Information Administration
Natural Gas Weekly Update
http://tonto.eia.doe.gov/oog/info/ngw/ngupdate.asp

Time
As Oil Explodes, Why Natural Gas Prices Stay Low
http://www.time.com/time/business/article/0,8599,1918674,00.html

Chart of the Day

The US stock market continues it resilience, which surprises me since I do not see any additional steam coming through: all good news are priced and bad news ignored; this cannot last for ever, whilst I am not denying that markets can diverge from reality for a long time. Risks of a larger correction are only increasing.

Today's chart illustrates how the recent plunge in earnings has impacted the current valuation of the stock market as measured by the price to earnings ratio (PE ratio). From 1936 into the late 1980s, the PE ratio tended to peak in the low 20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s) and the dot-com bust (early 2000s). As a result of the recent plunge in earnings and recent stock market rally, the PE ratio spiked and just peaked at 144 – a record high (Japanese style before the stock market crashed - I do not predict this, different time, different situation).

Currently, with 97% of US corporations having reported for Q2 2009, the PE ratio now stands at a lofty 129. At constant market prices, earnings have to be multiplied sixfold to go back to the historical average. Yes markets anticipate, but I doubt that 1) we will see earning recover by the magnitude withing 12-18 months and 2) that markets anticipate earning further away. Draw your own conclusions.

"capitalisme étatique" / socialist capitalism

France Seeking Ban on Guaranteed Bonuses for Bankers

Sarkozy's Minister of Finance, Mrs Lagarde, strikes again! the question of guaranteed bonuses for banks' top performers should be discussed at the next G20 meeting in September, as if the G20 did not discredit enough itself during the last meeting with its list of so called tax havens (remember the grey list where neither the Delaware, nor the Channel Islands nor China dominated Hong Kong and Macao were included, etc.). One farce is not enough, let's go for a second one.

Beyond what could be anecdotal (our politicians must not be busy to spend so much time on bonuses, whilst they should, at least, explain that performance must be rewarded - true, it would not bode well for themselves, just look at public deficits for the past 30-40 years...), it is very worrying that politicians are seizing the financial crisis (where they bear a huge responsibility - see previous post) to interfere more and more with the private sector. At least if they were managing economic affairs as well as the Chinese (don't misread me: I would not like to live under a Chinese inspired regime) one could discuss.

I am in broad agreement with Martin Spring's Newsletter:

If you think my recent comments have been over the top about how politicians and bankers have used the credit crisis to hijack the mega-billions of taxpayers’ money to promote their own interests, you should read what the Bank for International Settlements, the “central bankers’ club,” has to say in its latest annual report.

To recap, the essence of my criticisms of the way governments have been handling the crisis has been:

► Nearly all the effort, with its enormous expense, has been directed to containing the symptoms rather than addressing the cause -- bad debt. That’s like trying to cure cancer with doses of morphine instead of radical surgery.

► The money flood is largely being used to protect jobs and investments in a bloated banking system – it’s not flowing through to where it’s needed most, in the soundest companies in manufacturing and the other service industries.

► Even worse, the money is going to the least deserving – such as the big banks with the right political connections, with major responsibility for causing the crisis in the first place – putting at a competitive disadvantage their rivals, who were and are being managed responsibly.

► Banks, other financial intermediaries, and long-term investors such as pension funds, are all refusing to acknowledge the scale of their bad debt, write down so-called “assets” to their true value, and recapitalize and restructure accordingly.

► Stimulus packages are largely designed to favour political vested interests and ideological obsessions, rather than provide immediate and effective support for business survival and job creation. They are a huge waste of money – borrowed money that will have to be repaid by future generations.

► Political management of the crisis is so obviously corrupt, self-serving and incompetent, that it is producing a voter backlash that will gather momentum and make it very difficult to implement future unpopular measures, no matter how necessary they may be. The politicians, their bankster friends and the bureaucrats have poisoned the well.

N.B. emphasis mine

Sources:

Bloomberg: France Seeking Ban on Guaranteed Bonuses for Bankers
http://www.bloomberg.com/apps/news?pid=20601087&sid=ah2OmuI9QqEA

BIS: An assessment of financial sector rescue programmes
http://www.bis.org/publ/bppdf/bispap48.pdf

BIS: Annual Report
http://www.bis.org/publ/arpdf/ar2009e.htm

Marin Spring: On Target Newsletter - Sept 2009 Issue

Weakness in U.S. Retail Sales

U.S. Retail Sales Shows No Signs of an Uptick in Final Demand

Nominal retail sales fell 0.1% m/m (-8.3% y/y) to US$342.2 billion in July 2009 after rising 0.8% m/m in June. While motor vehicle and parts sales rose 2.4% m/m with a boost from the "cash for clunkers" program, ex-auto sales fell 0.6% m/m (-8.5% y/y). Gasoline station sales fell 2.5% m/m (-32.5% y/y) and core retail sales fell 0.2% m/m (-3.4% y/y). (U.S. Census Bureau)

Like in Europe, clothes and auto were mostly leading the positive numbers thanks to rebates at retailing outlets and help from the government for the auto sector. This is not sustainable beyond the short term if genuine final demand is not back in September and Q4. We can have all the inventory building in the world but it can't last in the absence of a consumer pickup.

US equity markets ended the day up, beyond my understanding.