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Monday, April 13, 2009

Spring Time ?

By Claus Vistesen: Copenhagen

First of all, I hope that our readers have passed a nice couple of days with their families and friends and that they are ready to pick up the baton again here after Easter. One who sadly will not be joining us as we move forward is Greg Newton author of the blog Naked Shorts who passed away recently from a heart attack. I shall immediately confess that I only, on rare occasions, stopped by NS to get a dose of the often very sharp pen wielded by Greg. However, with endorsements and fine obits from the likes of Felix, Cass, and Hempton I am more than convinced that the econsphere has lost a great presence. My thoughts go out to his friends and family.

Meanwhile and here in Denmark things are definitely getting better. After a March of cold and lots of rain April the Easter days have, in particular, blessed us with a fabulous couple of days of sun and (relative) warmth. I doubt that the Spring is more beautiful anywhere else in the world than in the North mostly because the change in scenery is so striking. Judging by a number of recent analyses, comments and data points it is hard to escape the feeling that perhaps, just perhaps, markets are also feeling a bit of spring sensation too even if the signs are most tentative.

Europe, Still not Ready to Take Off

Starting off in Europe, Morgan Stanley's Elga Bartsch recently engaged in bottom fishing where she essentially voiced the sentiment that although the h01 outlook is grim the data is paving the way for a recovery in h02. To support her argument ms. Bartsch fields data on forward looking indicators such as output plans, the so-called Surprise Gap Index, and the (in)famous second derivative which has set in with respect to demand for orders. Generally though, there is plenty of juice for those who carries a more pessimistic approach. A couple of days ago, the Bank of Italy opted to lift the curtains a little bit on what is certain to be an abysmal Q1 GDP reading; as if it was not enough that Italy suffered that dreadful quake over the Easter. Over at Kaiserstrasse, the messages are getting more "interesting" by the day too. Consequently, Nowotny who heads the Austrian central bank noted that although he did personally think the interest rate should go below 1% it was, of course, open to discussion. Bloomberg interprets it as a sign that the council is split which may of course be the case, but on the other hand I also think the ECB is slowly but surely preparing markets for moves which will take the bank into an area where most believed it would not go. For example, Nowotny explicitly noted the option for the ECB to enter the corporate debt market.

“If you’re aiming at intensifying credit supply, measures which focus directly on credit supply are of interest,” Nowotny said. “For example the purchase of commercial paper, corporate bonds and similar things.”

Such moves would mean that the ECB moved in behind the Fed and the BOJ who have both been supporting credit markets through the purchase of commercial paper (A1 grading in the case of the BOJ) for some time.

Also the Dutch representative in Frankfurt Noel Wellink voiced a similar sentiment when he noted that the Eurozone would be likely to experience negative price movements in 2009. Mr. Wellink pointed out that there is room to lower interest rates beyond its current level and that other measures could be deemed necessary too. One can only speculate what such measures would be, but something along the lines suggested by Nowotny is probably not far off.

More generally, the situation in Europe is not only tainted by the obvious crisis in EU-15 and the Eurozone, but also very much so by the lingering mess in Eastern Europe. In real economic terms we need to remember that there is indeed a strong link between the Eurozone and the CEE not least in the context of Germany's obvious dependence of exports to the Eastern European economies. Moving to financial markets we also know that many banks in EU-15 are heavily exposed to the whims of the CEE. Obviously, the new mandate for the IMF in the form of capital injection it was handed at the G20 summit will help in the strides to present a workable solution many of the most exposed countries' trouble.

The US, Tiptoeing Analysts

With regards to the US the second derivative discourse is being advanced much more timidly especially in light of the fact that payrolls once again posted an abysmal showing in March which suggests that the real economic slowdown is intensifying.

Still, some are convinced that the near term at least may indeed bring a bit of spring sensation. Consequently Swiss investment icon Marc Faber was quoted by Bloomberg of saying that the SP500 might rise as much as to reach the 1000 mark within the next three months. If this prediction turns out to be a truism it would mark the biggest so-called sucker rally so far in this crisis and surely one worth pursuing by investors. Faber only, it has to be said, makes a short term forecast based on the fact that since the government (through the new PPIP) essentially is giving away free money and since the Fed seems to committed to reflating the economy companies may have a sound short term earnings horizon. For the equity strategists among you, this is Faber's contention;

“The market very near term has become somewhat overbought and the correction should essentially follow, but I doubt it will go and make new lows in the intermediate future,” Faber said. “The lows in early March at 666 in the S&P will hold and we’ll have another push up into July

With respect to a long term view I attach considerable significance to the report out yesterday that fundraising by US venture capitalists fell by a whopping 39% last quarter as investors understandably chose to shun these investments. The story is pretty straightforward in the sense that startups are literally not finding the same finance opportunities as before and this essentially mean many of them don't make it. Such is of course the darwinian nature of finance, but one wonders whether in fact there wasn't some genuine sound positive NPV projects sacrificed on the altar of the PPIP et al. Whether this is true or not one thing is certain, this kind of investment used to be the hallmark of the US economy and although one can't hardly make any kind of inferences based on this figure alone, seed capital for venture capitalists is probably a part of the macroeconomic investment activity which yields the strongest positive externality with respect to productivity growth (empirical studies anyone?).

As for the overall sweep in terms of a macroeconomic snapshot we can do a lot worse than visit Morgan Stanley's Ted Weiseman and Richard Berner and their respective analyses. If anything Monsieurs Weiseman and Berner seem set to debunk any talk of the second derivate, something which Weiseman addresses specifically when he says;

The key round of early economic figures for March released over the past week was uniformly terrible in absolute terms, though somewhat mixed directionally. A particularly bad employment report stood out, however, against directionally mixed ISM surveys, though with both remaining well below the 50-breakeven level, and some improvement, though to a still-dreadful level, in motor vehicle sales. Weakness in other data, notably in the construction spending and factory orders reports, also pointed to a weaker trajectory for 1Q growth, and we cut our 1Q GDP estimate to -6.0% from -5.1%.

So; Morgan Stanley, for what is worth, is cutting their growth forecasts for the US economy and if you have the stomach for a thorough parsing of the recent US data, Weiseman is the place to go. If Weisman implicitly tried to shy away from the second derivative punt, Berner is very explicit. His main point is consequently that while markets (equities in particular) are embracing the idea of a positive second derivative the recession does not look to be any less sharp and long than it did when we entered 2009. In this respect, I think that the talk of a recovery in early 2010 is largely irrelevant since we need to calibrate first what exactly we mean when we talk about a recovery. If positive or neutral growth is the criteria so be it, but I hardly think that we will be back to normal in any sense of the word.

Asia, a Chinese Conundrum and Japanese Debt Woes

If I am fairly certain that we are not standing before an impending recovery in Europe or the US recent data from China seriously prompts me to consider whether in fact the great tiger is ready to pounce and perhaps save the global economy in the progress. What has caused a lot of commotion was consequently that the Chinese PMI for march actually rose above 50 which indicates expansion. Or did it? As Edward details here there has been considerable confusion over which reading to use, but that did not deter Bloomberg to narrate China (and its recent stimulus package) as the economy to pull its global peers out of the current mire. Add to this that industrial production clocked in a healthy 8.3% increase in March and you get plenty of ammunition on which to build a recovery and even rebalancing story. Of course, this is all a bit of a lame, ermm, Peking duck I think [1] since as Brad Setser eloquently points out with great force, recent trade data indicates that imports are declining more rapidly than exports which makes the fact that exports are not declining more slowly rather innocuous. This is also a point Edward uses to neatly summarize the overall message;

(...) with a growing surplus (at this point, and on a year on year basis) China's economy isn't going to pull the rest of the world anywhere, since essentially it is still draining-off demand from elsewhere.

For more on the recent, mystifying, data from China Pettis' latest tour de force is a fine piece of work and of course Bloomy itself proxied by Kevin Hamlin takes some of the sting off of the bullish China story with today's piece about cooling Chinese growth.

Meanwhile, in Japan things continue to look murky. In particular it seems that investors have realized the growing debt burden of the Japanese society at the worst of times since now would really be a nice time for investors to allow Japan to seriously turn on the fiscal stimulus machine. Of course this is not possible and as we learned recently that while observers certainly realize that the proposed stimulus package by PM Aso totalling some $153 billion will mitigate the situation in the short term, it will also serve to make the future debt burden even more unsustainable. Also do note, that the discourse of Japan's ageing population is popping up all over the place in relation to the immediate short term outlook which suggests to me that we may be close to an inflection point. Basically, yields are beginning to climb for the MOF as it attempts to issue paper to pay for the politicians' plan and it appears that yields, at least in part, are driven by the obvious problem Japan will have in servicing the liabilities as we move forward. This means that the BOJ will have to seriously contemplate how to inflate their way out of this one since this is really the only solution, barring of course that everybody else realizes that this is what Japan has to do in order to avoid deflation. It is of course this last part which is the niggle and which will cause much debate as we move forward. My guess is that we will soon see a BOJ not only buying up short term paper, but indeed trying to manage the whole yield curve.

All this is not without consequences for the JPY, and it is difficult not to concur with Macro Man's Easter poetry styling that it may very soon be raining yen. Meanwhile, the spring sensation in markets is not passing by the JPY either as Bloomberg serves up one of those familiar headlines that the JPY is weakening while the AUD, NZD et al. are strengthening on the back of a heightened appetite for risk.

“There’s some optimism in the markets, which supported yen selling,” said Hidetoshi Yanagihara, senior currency trader at Mizuho Corporate Bank in New York.

This sell JPY on optimism punt is something I have dealt with extensively here at Alpha.Sources not least in the context of this working paper. I recently had a look at the paper and realized that it needs a thorough re-write. So this is, in part, what I am working on at the moment. Of particular interest is the fact that I am trying to model the currency pairs (not the stock indices) as a function of the VIX which has so far given me some quite interesting, if of course entirely intuitive, results. In short, stay tuned on this one.

Spring Time?

While there is still plenty of bad news to focus on, it certainly seems as if markets just as well as Denmark may now be entering a more mild season. Spring in Denmark, however, is known to be extremely volatile. If the Easter served up a nice sunny abode the next week may be rainy and even snowy. One has to think that the same reasoning can be applied to the newfound spring sensation in markets. Far be it from me to take away the punch of the bulls out there, but I would simply note that the fundamentals have not changed one bit since the crisis began. Deleveraging is only begun, unemployment is bound to rise further, and all parts of the real sector are stretched to the limit with respect to spending capacity. Add to this that everyone wants someone else to do the spending for them and you end up with a recipe for a long hard walk upwards. Perhaps it is the second derivative punt that is being misunderstood. Evidently, we were always going to see this effect given the almost cataclysmic way in which all economic data points and indices suddenly cratered. However, the point is not so much whether we are still on our way down (which I think we still are), but more so how long we will stay down and how far we will move back up from the mire and indeed who will be able to lift their economies within a reasonable time frame. It is here that I am still fundamentally pessimistic. Consequently, I too am enjoying Spring time, but as a Dane I am well taught not to get my hopes up.


[1] - Sorry