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Greece – Europe – Credit Spreads Worldwide – Stocks
February 11, 2012

So far, the Cassandras’ predictions of global collapse and failure have been proven false. Some of the most notorious bears are now turning bullish and revising their forecasts to the positive. Other “gloom and doom” holdouts are feeling the heat. We think that heat will intensify.

The key to watch is in the credit markets. Credit spreads tell a story of overwhelming liquidity being applied to the financial-system open wounds like a steroidal salve. Such treatment can alleviate interim pain. It is treatment for the symptom; it works for a while. It does not provide a permanent cure.

One can easily track the credit spreads of sovereigns around the world. We have listed both the “good guys” and the “bad guys” on our website, http://www.cumber.com/. We are following a concept first presented to us by Erwan Mahé, who is doing seminal work from his Paris location. We have expanded on his work to include sovereign spreads in Asia and South America as well as those in Europe, both in and out of the eurozone. We update these charts on a weekly basis, due to the continuous demand from clients and readers to view the data: http://www.cumber.com/content/misc/EU_Contagion.pdf.

Why have all the Cassandras been wrong? Because they ignored the power of central banks to cause credit spreads to narrow. The outcome is reflected in market movements and in certain sectors.

Banks are a good example. If you made bets on banks, you won. If you were a detractor of banks, you lost. This holds true in Europe, in the United States, and in many other places in the world. The European Central Bank’s ingenious concept of a three-year, 1% loan via LTRO (long-term refinancing operation) worked. It was successful because it allowed the banks to buy their own debt at a higher yield than 1%, book the difference in yield as income, and mark up the value of their own bonds to par. That process functioned as a mechanical way for there to be an addition to the bank’s capital. The ECB used a creative way to solve a portion of its eurozone and the Europe-wide banking crisis.

We believe that the Fed must take notice of the LTRO. It can give them another arrow in their quiver. It takes the Fed beyond 28 or 84 days into contemplative periods of transitional policy, from the present massive stimulus that is all focused on the short run. The ECB has given the Fed a monetary laboratory in which to watch a longer-term, transitional-workout framework.

We expect the ECB to do another LTRO within the next month. The size is unknown; the impact will be positive. The markets now expect it and are already pricing it in.

Credit spreads are reflecting transition from worldwide recession and double-dip forecasts to gradual and improving economic outlooks around the globe. Data supports this shift in the United States, as well as in other places in the world. It will happen in portions of Europe, but not in Greece. In other European countries we expect to see some gradual improvement.

The world has had enough gloom and doom. Investors have been terrified since the beginning of the crisis in mid-2007, when Bear Stearns said “We have a small problem with a couple billion dollars in a hedge fund; don’t worry, it means nothing.”

We have replaced meltdown of the type we saw after Lehman/AIG with “melt-up” of the type we have been seeing since March 2009. We have shifted from collapsing leverage and failure at the institutional level to central bank intervention of unprecedented size.

The G4 central banks (http://www.cumber.com/content/misc/G4_Charts.pdf) have taken the size of their collective balance sheet from $3.5 trillion to $9 trillion. That number is likely to rise. The G4 have extended duration so that the focus of their policy is not just in the overnight lending rate or in the very short term. Massive liquidity has blunted liquidity squeezes everywhere in the world.

However, the issue of solvency remains. Greece remains insolvent. It must work out its payment schemes or it will default. It will require austerity and hardship. Despite the protests of unionized workers in public squares, there is not enough money to pay on the promises that were made.

Workouts are not easy, whether they are in Greece or Harrisburg, PA. Workouts involve recognition of loss and economic pain. Deferring the workout only makes it worse. Greece and Harrisburg will learn this lesson the hard way. Default is even worse. Ask Argentines who are still recovering from their government’s policies. Ask the citizens of Vallejo, CA, who squandered $10 million in legal fees on a municipal bankruptcy and have lots of unfixed potholes to show for it.

Workouts, however, do not cause total collapse; in fact, they bring out strength. Ask the Scandinavian countries that avoided this financial crisis, having learned from their previous one. Ask Singapore, which has imposed governance standards. If we had Singapore law applied in the US, many in Congress and on Wall Street would be in jail for many years to come.

The biggest threat to financial-market pricing comes from periods of uncertainty, the sequence of ambiguous and conflicting views that alter investor perceptions. Uncertainty is the enemy of market pricing. Once you achieve clarity, markets adjust quickly to the new reality and move on. This will hold true in every city, county, and country. And it will apply to every banking system in the world.

At the present time, our US stock market ETF portfolios remain fully invested. We are concerned about a market correction, which appears underway. It is necessary, since we have moved dramatically higher from the October selling-climax low. The upward move has been at a sustained pace. We expect this to be a correction, not a market peak. We believe the financial sector is still attractive. As it repairs, it will become even more attractive.

We are going through huge transitional times. Never before have we seen coordinated, global central bank activity of this order or magnitude. By the end of this year, the G4 central banks will have expanded their balance sheets approximately threefold during the financial crisis. The negative and inflationary results of this activity may appear in the future. That remains to be seen. For the present, this is a very bullish construction for asset prices and equities in particular.

David R. Kotok, Chairman and Chief Investment Officer

As expected, markets closed lower on Friday, but by not as much as expected and, indeed, off their lows.

My very clued up friends advise me that there is a wall of money from investors who have missed the recent rally and who are ready to buy on any dip. I have no doubt that they are right and, indeed, even if markets don’t correct shortly, I suspect that these guys will be forced in, especially as we near the end of the 1st Q. However, the market has rallied to a point where, in my humble opinion, risks are beginning to outweigh prospective returns. After all, how much more will markets rally. By 5%, possibly 10%, seems to be the consensus – I’m afraid that’s not enough to interest me, in particular, given the macro/geo political risks. In addition, personally, I hate consensus views, though, I suspect, I’m also beginning to get a bit less confident as to the sustainability of the current rally.

We all know that Greece will default and, quite frankly, I’m going to reduce my coverage of that country significantly – its far too boring and has played out for far too long. In addition, a Greek default, apart from the initial knee jerk sell off (good opportunity to buy the market, I suspect) is, I believe, almost fully priced in and, most likely, good news for the rest of the Euro Zone.

Portugal, well the Euro zone will need to provide additional funding. Furthermore, a conversation between the German Finance Minister and his Portuguese counterpart, caught on an open mike, confirmed that Germany ie the Euro Zone, will provide additional support – it will certainly be necessary and, in my opinion, deserved. The Euro Zone has to be prepared to offer a “carrot”, in addition to the stick (austerity measures). In any event Portugal has to be saved, or the rest of the Euro Zone is kaput.

The Germans, whilst playing hard ball with the Greeks, are sympathetic towards the Portuguese, who are introducing radical structural changes to improve their (previously non existent) competitiveness/lack of growth – unlike the Greeks. In my humble view, contagion threats remain limited following a Greek exit, especially as a result of the ECB’s 3 year LTRO. Indeed, Portuguese bonds continue to rise – the 10 year yield declined further to around 12.85% on Friday (yields were even lower during the day and nearly 600bps off recent highs) – even after the nonsense with the Greeks. I really should have followed my own advice and bought the bonds – Oh well, that’s the problem of being a 1 man shop.

Whilst yields on Portuguese debt are declining, yields on Italian and, in particular, Spanish bonds, rose. Indeed, Spanish bond yields are converging towards Italian yields. No surprise – I remain firmly of the view that Spain is in far worse shape than Italy and, I suspect that the market is (finally) beginning to get it.

Over the next month or so, the market will begin to focus on the upcoming French Presidential elections. The opposition (Socialist) candidate, Monsieur Hollande is in the lead in recent polls. However, don’t write of Sarkozy, my French friends tell me. France is struggling – there is no doubt of that, but a President Hollande is something we don’t need at present, irrespective of your views of Monsieur (“bling bling”) Sarkozy – actually he’s being less “bling bling” these days. However, whilst Hollande’s continues with his rhetoric ie that he will renegotiate the austerity pact etc, etc, we all know that, if elected, he wont be able to. Mrs Merkel is rooting for Sarkozy, which is amusing as the two of them do not get along – its “better the devil you know….. ” principle, as far as Mrs M is concerned.

One of my best friends lambastes me on my views on China. Well, if I’m wrong on my China derivative plays (short the miners, luxury sector, A$ and quite, likely EM’s) I will lose money – my own money, may I add.

As far as I’m concerned, all recent available data (OK, a bit too early to establish an totally informed view), suggests that the Chinese economy will slow by more than expected. Friday’s loan data came in below expectations. Sure the Chinese authorities have the firepower to introduce stimulus measures (likely) and ease, though with oil at around US$118 and food prices not declining by much, indeed if at all, combined with the policy of raising wages, inflation could well rear its ugly head again.

January’s inflation data was impacted by the Chinese New Year and should decline in coming months, but, I for one, am not quite as certain as other analysts that inflation will continue to drop sharply in the 2nd half of the year, especially if oil remains at current levels and food prices remain elevated. Remember that China imposed, in effect, price controls to curb “reported” inflation last year. These measures have resulted in suppliers reducing production – something that cannot be sustained. Indeed, China recently allowed prices of petrol and diesel to rise to deal with shortages created by their price control policy – the 1st time in 10 months. If they allow others to increase prices…….

Basically, my problem with China remains the same. I believe, quite firmly, that any action taken by the Central authorities to correct (much needed) previous imbalances (of which there are many), will have a significant negative impact on the economy, with resultant social consequences. In addition, in my experience, I do not believe that a command economy can grow by the rates that China has, uninterrupted, for an extended period of time.

I remain (ever increasingly) bearish on Japan. A friend of mine reminds me of the dreadful demographics of the country, in addition to the other issues I have raised – he’s totally right – its going to be a massive problem for the Japanese.

My well established/positioned Indian friends, whilst generally sanguine are, however, certainly becoming far more cautious than they have been. I always listen to these guys – they are way, way better than any analyst, I assure you.

The US economy is improving – recent data confirms that. I trust it will continue. I was surprised by the weaker University of Michigan confidence data though, given better employment data and job openings (JOLTS survey).

I’ve found in the past that I (generally) make money on my high conviction calls, though then proceed to fritter some/all of it away due to over trading. That’s something I’ve changed significantly for some time now. I suppose the real issue is that I have no real high conviction play at present – the negative China derivative play comes close, but I accept is not quite there as yet. Having said that, I believe that there will be numerous opportunities in coming months and, as a result, patience is called for.

Having said that, there’s the Roubini/Rosenthal contrarian index !!!!

I’ve had a great YTD, particularly on my over long European financials play – a truly fabulous start for the year. As a result, I suspect, I can afford to be a bit cautious and wait to see how things pan out. In the current economic climate, there will be lots of opportunities and I just do not feel like chasing a rally, which seems pretty long in the tooth to me.

Probably loving being a beach bum here in Goa as well.

Have a great weekend.

Richmond Fed Economic Brief, “Where Are Households in the Deleveraging Cycle?,” by R. Andrew Bauer and Betty Joyce Nash. PDF

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Where Are Households in the Deleveraging Cycle?

While the Rest of the World Is Abandoning Unsafe Nuclear Designs, America Will Build New Unsafe Reactors

The geniuses at the Nuclear Regulatory Commission have given the green light for new nuclear power plants in the U.S. … which don’t include safety upgrades which were demonstrated vital by the Fukushima meltdown.

The Atlanta Journal Constitution notes:

The Nuclear Regulatory Commission on Thursday approved Southern Co.’s plan to build two reactors at Plant Vogtle, south of Augusta — though the decision was not without dissent.

Gregory Jaczko, chairman of the five-member NRC, cast a lone vote against issuing a license for the project. He said he wanted but had not gotten a binding commitment from Southern that it would incorporate changes stemming from last year’s nuclear disaster in Japan.

“Significant safety enhancements have already been recommended as a result of learning the lessons from Fukushima,” Jaczko said, referring to the plant on Japan’s coast that was devastated by an earthquake and tidal wave, “and there is still more work ahead of us. Knowing this, I cannot support issuing these licenses as if Fukushima never happened.”

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The NRC’s 4-1 vote directs the agency staff to prepare the construction and operating license needed to start major work on the two reactors, which are expected to start producing electricity in 2016 and 2017.

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The last new reactors were approved in 1978, the year before a partial meltdown at Three Mile Island in Pennsylvania. After that, increased regulatory scrutiny and skyrocketing costs halted expansion. Plant Vogtle’s two existing nuclear reactors, Units 1 and 2, ran over budget by $8 billion and took 16 years to build.

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The U.S. remains without a long-term plan to store nuclear waste.

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“The U.S. is approving new reactors before the full suite of lessons from Japan has been learned and before new safety regulations that were recommended by a task force established after the meltdown crisis at Fukushima have been implemented,” said Allison Fisher, Outreach Director of Public Citizen’s Energy Program.

How Could This Happen?

As I noted last December:

New US plant designs are very near being licensed by the Nuclear Regulatory Commission without any Fukushima modifications.

Now we know why.

Congressman Markey wrote yesterday:

As part of his ongoing investigation into U.S. nuclear safety since the Fukushima meltdowns, today Rep. Edward J. Markey (D-Mass.) … released a blockbuster new report that details how four Commissioners at the Nuclear Regulatory Commission (NRC) colluded to prevent and then delay the work of the NRC Near-Term Task Force on Fukushima, the entity tasked with making recommendations for improvement to NRC regulations and processes after the Fukushima meltdowns ….

Rep. Markey’s office reviewed thousands of pages of documents, including emails, correspondence, meeting minutes and voting records, and found a concerted effort by Commissioners William Magwood, Kristine Svinicki, William Ostendorff and George Apostolakis to undermine the efforts of the Fukushima Task Force with request for endless additional study in an effort to delay the release and implementation of the task force’s final recommendations. Documents also show open hostility on the part of the four Commissioners toward efforts of NRC Chairman Greg Jaczko to fully and quickly implement the recommendations of the Task Force, despite efforts on the part of the Chairman to keep the other four NRC Commissioners fully informed regarding the Japanese emergency.

“The actions of these four Commissioners since the Fukushima nuclear disaster has caused a regulatory meltdown that has left America’s nuclear fleet and the general public at risk,” said Rep. Markey. “Instead of doing what they have been sworn to do, these four Commissioners have attempted a coup on the Chairman and have abdicated their responsibility to the American public to assure the safety of America’s nuclear industry. I call on these four Commissioners to stop the obstruction, do their jobs and quickly move to fully implement the lessons learned from the Fukushima disaster.”

A copy of the report “Regulatory Meltdown: How Four Nuclear Regulatory Commissioners Conspired to Delay and Weaken Nuclear Reactor Safety in the Wake of Fukushima” can be found HERE.

Major findings in the new report include:

• Four NRC Commissioners attempted to delay and otherwise impede the creation of the NRC Near-Term Task Force on Fukushima;
• Four NRC Commissioners conspired, with each other and with senior NRC staff, to delay the release of and alter the NRC Near-Term Task Force report on Fukushima;
• The other NRC Commissioners attempted to slow down or otherwise impede the adoption of the safety recommendations made by the NRC Near-Term Task Force on Fukushima ….
• The consideration of the Fukushima safety upgrades is not the only safety-related issue that the other NRC Commissioners have opposed.

The Hill’s energy and environment blog reported yesterday:

[The chairman of the Nuclear Regulatory Commission, Gregory Jaczko] believes the commission “has taken an approach that is not as protective of public health and safety as I believe is necessary.”

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The commission has disagreed in recent months over how to deal with the recommendations of a task force assigned to reevaluate the country’s nuclear safety regulations in light of the disaster at the Fukushima Daiichi plant in Japan.

The report called on the commission to make sweeping improvements to NRC’s “existing patchwork of regulatory requirements and other safety initiatives.”

Jaczko called on the commission to quickly evaluate the report and implement the necessary recommendations. But the commissioners initially resisted Jaczko’s call for swift action.

It turns out the leader of the group of commissioners which Jaczco is fighting was a consultant for Tepco – the company which operates Fukushima.

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Because Obama’s top adviser and top funders are connected with the nuclear power industry, the White House has also aggressively pushed four new nuclear power plants in the U.S., even though virtually all of the current nuclear reactors in the U.S. are of the same archaic design as those at Fukushima, and this design was not chosen for safety reasons, but because it worked in Navy submarines, and produced plutonium for use in nuclear weapons. And even though the same folks who built and run Fukushima will build and operate the new U.S. facilities.

Note: Nuclear power could be safe, if designed and operated correctly. But neither the nuclear industry or government regulators care about safety.

This week officials from the Obama administration, the banking regulators, and state Attorney Generals announced a settlement of claims stemming from the financial crisis. The nominal amount put forward as the cost of the settlement is $26 billion, and in return the banks will be released from civil claims on origination of mortgages and the falsification of documents in the foreclosure process, or “robosigning”. This caps off a month of political noise on the housing situation which started at the State of the Union, when the president announced a task force on financial fraud headed by officials from his administration as well as New York Attorney General Eric Schneiderman.

An investigation, and a multi-billion dollar settlement. That sounds like a lot, until you put it into perspective. Here are the numbers. Roughly half of homeowners with mortgages are underwater, which means they owe more than they own, to the tune of $1 trillion or so. And housing values are still declining so far in this “recovery”, throwing more homes underwater. In terms of an investigation, the Savings and Loan crisis used roughly 1000 FBI investigators to uncover fraud — this task force taking on a crisis forty times more severe will employ 10 FBI agents.

There’s a reason this is so inadequate to the problem at hand. For the last three years, the policy has been to impose a political solution to a math problem. It hasn’t worked. America simply has too much mortgage debt to pay back. Serious economic thinkers across the spectrum, from Democrat Alan Blinder to Republican Martin Feldstein to New York Fed President William Dudley, believe that there is only one solution — writing down the enormous creaking mound of debt. This solution is currently off the table, because writing down these unsustainable debts could cost our fragile banks enormous sums of money and possibly lead to a restructuring of one or more of our major banks. Avoiding this clear policy choice has resulted in our economy falling into a Japan-style “zombie bank” torpor, with debts carried on the books at full value which everyone knows will not be paid back at par.

This crisis of American political economy in the form of excess mortgage debt is preventing a more powerful economic recovery. Three years after Ben Bernanke used the term “green shoots” to describe a recovering economy, job growth hasn’t really revived in any meaningful way. In fact, this is by far the worst recovery we’ve had since the end of World War II. The best way to measure this is not through traditional unemployment indices (which can be gamed), but by asking the question of how many Americans are working as a percentage of the population. In 2007, this was 63 out of 100. Today, it’s a full five percentage points lower. The ratio hasn’t been this bad since the early 1980s recession, and remember, we’re in a recovery. And the labor force participation rate is dropping, which is a long-term bigger crisis.

The housing market’s vicious deflationary cycle demands serious policy action to match the scale of the challenge. Dropping housing values lead to foreclosures, which damage housing values, and so on and so forth. According to Zillow, roughly half of homeowners with a mortgage are effectively underwater, which means they owe more on their mortgage than their house is worth. So far, the alphabet soup laden set of programs (HAMP, HARP, Hope for Homeowners) put forward by the Bush and then Obama administration have been failures. And this is because, as the Congressional Oversight Panel noted as far back as March of 2009, the single best predictor of default risk is how much equity homeowners have in a home. Many Americans, though considered homeowners, are essentially “renters with debt” (as housing analyst Josh Rosner put it). And Amherst Securities Laurie Goodman noted that with our current housing trajectory, we can expect up to 10 million more defaulted mortgages over the next decade. These foreclosures impacts housing values, reduce consumer purchases, and costs municipalities money.

The proposals on the table to solve this problem aren’t inspiring. The meager mortgage settlement deal cut via furious and dramatic negotiations is unlikely to be meaningful. This settlement is essentially a continuation of previous alphabet soup housing programs, because it would not force banks to fundamentally restructure the trillion dollar underwater mortgage problem. It will generate headlines, but it will fail to address the extent of the problem. State attorneys generals have accepted the settlement for a variety of reasons, one of the most frustrating being that they are substantially under-resourced and this deal moves cash their war. This is not how to make good policy. And the housing market will continue to suffer if our political leaders cannot acknowledge the depth of the problem.

Instead, we need some serious discussion from both the Republican candidates and the Obama administration about how to write down mortgage debt. Some proposals would reduce principal, while giving the banks an equity appreciation stake in the home. Others would deal with the problematic accounting standards which allow banks to overvalue second mortgages, and imply that one or more large banks needs to be restructured by the government. These are worth considering. We think it’s important, regardless of how policy-makers reduce the debt, to force the banking system to appropriately value mortgage debt.

Anything less would simply continue the deflation and uncertainty in the housing market.

Ultimately, we need to look at our banking and housing system and engage in a ruthless yet compassionate evaluation of whether it is working to solve our national needs. Serious thinkers in both parties recognize that it isn’t, and that we should find a way to write down this mortgage debt. Only then will we head down a pathway to a healthier banking system, and begin generating the roughly thirty million jobs that will bring America back to full employment. It’s time that the major presidential candidates, and President Obama himself, be honest with the American public, and openly recognize this as well.

Yet Another Bailout for the Giant Banks … Homeowners Get Hosed Again

The 50-state settlement with the banks (Oklahoma didn’t sign, but supports letting the banks go scot-free) over mortgage fraud is a stealth bank bailout, according to many top observers. See this, this, this, this, this, this, this and this.

This is par for the course … All of Obama’s previous “mortgage relief” programs have really been stealth bank bailouts which screwed the homeowner. And see this.

For example:

Most independent experts say that the government’s housing programs have been a failure. That’s too bad, given that the housing slump is now … worse than during the Great Depression.

Indeed, PhD economists John Hussman and Dean Baker, fund manager and financial writer Barry Ritholtz and New York Times’ writer Gretchen Morgenson say that the only reason the government keeps giving billions to Fannie and Freddie is that it is really a huge, ongoing, back-door bailout of the big banks.

Many also accuse Obama’s foreclosure relief programs as being backdoor bailouts for the banks. (See this, this, this and this).

Settling prosecutions for pennies on the dollar is a form of stealth bailout. It is also arguably one of the main causes of the double dip in housing.

“The Greek offer is not sufficient and they have to go away to come up with a revised plan,” said a spokesman for the German Finance Ministry. The Greeks must first have a plan that satisfies the Germans which this comment states they clearly don’t yet and then the Greek Parliament will vote on it this weekend. This said, whatever package gets voted on in Greece is basically an up or down vote on euro membership so we are entering another uncertain weekend for global markets. A failed vote will likely lead to a hard default which may be what the Greeks want at this point where a clean slate can be established. As we await, CDS is wider for a 2nd day for all US banks and the European iTraxx financial CDS index is wider by about 14 bps to 217 bps up from 192 on Tuesday. The other news of note is in Asia as Chinese loan growth data in Jan was well below expectations at 738.1b yuan vs the est of 1T yuan. Also, M2 rose 12.4%, below forecasts of up 13.7%. Because of the lunar holiday though, this figures were likely distorted. Their trade data was also likely impacted as imports fell 15.3%, much more than the expected decline of 3.6% while export fell a touch as expected. The loan and M2 data came out after the Shanghai index closed up slightly.

Manal Mehta is a Banking & Finance analyst with Branch Hill Capital; contact him at manal@branchhillcapital.com.

Why I Wouldn’t Invest in Banks: The Return of Exposure to Off balance Sheet Securitizations

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Why I Wouldn’t Invest in Banks by Manal Mehta

Chinese auto sales declined by the most in 7 years, in January . They were down -23.8% YoY (-15.2% MoM) in January, much weaker than the forecast of -18%. Yes, an early Chinese New year, but its more than a little concerning that virtually all data points are turning lower.

Chinese exports declined by -0.5% in January, admittedly much less than the forecast -1.4% decline, though imports fell by -15.3%, as compared with a forecast decline of just -3.6%. These were the 1st declines in 2 years. The trade surplus was US$27.3bn. The 1st 2 months of the year are normally affected by Chinese New Year. However, the Chinese Commerce Minister Chen Deming stated that Chinese exports in January “cannot make us optimistic”.

SAFE, the Chinese authority responsible for its forex reserves, stated that they expected China to maintain a current account surplus for the year, in spite of the global slowdown;

The Spanish finance ministry expects 1st Q 2012 GDP to contract by more than the 4th Q 2011. Spanish bond yields are widening against bunds and also by more than Italian – indeed, Spanish yields are converging towards Italian. As you know, I believe that Spain is in far worse shape than Italy;

The Greeks advised the EU and the ECB (Mr Draghi reported it at his press conference yesterday) that they had agreed to the austerity measures demanded by the Troika, in return for the 2nd bail out package. However,surprise, surprise, the Euro Zone finance ministers have rejected their proposals. Apparently, a further E325mn of cuts must be delivered, without which, there is no 2nd bail out etc. The Euro Zone also warned of the need (and to verify) that taxes would be collected etc – ie no dodgy stuff. Does this mean that Greece is terminated. I B well hope so and I suspect many of you would agree. Unfortunately, that the Greeks will be around, for a while longer;

Greek economic data continues to show clear signs of an economic collapse in the country. Unemployment rose to 20.9% in November, from 18.2% in October. December’s industrial output was down -11.3% YoY, much lower than the -7.8% in November. Inflation in January was +2.3% YoY, slightly less than Decembers +2.4%;

UK manufacturing seems to be picking up – the December Global goods trade deficit declined to Sterling 7.11bn (lowest since Feb 2010) and much lower than the Sterling 8.6bn forecast. The November trade deficit was Sterling 8.91bn. Overall, the trade deficit (including services) declined to Sterling -1.1bn in December, from -2.8bn in November. Some of the improvement was due to lower oil imports as a result of a warmer winter though.

UK manufacturing output was also much better – it was up by +1.0% MoM in December, against expectations of just +0.2% and +0.8% for the year (once again much better than the +0.3% expected). Industrial production rose by +0.5% MoM (even better than the actual number suggests, as the energy component declined sharply, given the warmer winter), though down -3.3% YoY. Manufacturing surveys for January together with CBI data suggests that the better performance has extended into January.

Recent UK services data (much more important for the UK economy) was also much better than expected. The data may result in positive 1st Q 2012 GDP (last Q 2011 was -0.2%) and just avoid the UK being in a technical recession

As expected the BoE raised its QE programme by Sterling 50bn. Interest rates were kept at 0.5%, also as expected. The accompanying statement reported that the UK’s near term growth outlook remained weak, though they did expect output to strengthen through the year. The BoE reiterated that inflation should continue to decline sharply, due to base effects, particularly in respect of the VAT hike in January 2011. Interestingly Sterling improved on the news;

The ECB also kept interest rates on hold at 1.0%.

In the Press Conference, Draghi reported that inflation would be above 2.0% “for several months to come”, though would decline below thereafter – sounds like in the 2nd half of this year. He reiterated that credit had tightened in the last 2 Q’s of 2011 and that that the ECB remained concerned. The LTRO would increase risk (mitigated by over collateralizing apparently) and the ECB would manage the potential risk – yeah right. The ECB would review collateral rules established by national Central banks, in accordance with ECB guidelines. He would not discuss the holdings of Greek bonds owned by the ECB. The 2nd half of last year was particularly difficult, but he expected the Euro Zone economy to stabilise – though uncertainty remained high. Finally, he stated that selling the Greek bonds at a loss (to the EFSF) would be tantamount to monetary financing (clever old Draghi), which the ECB was prohibited from doing – sounds like the ECB will sell its bonds to the EFSF, in exchange for EFSF bonds at its book cost;

The lowering of credit standards, as a result of the ECB new policy of accepting lower quality collateral, was opposed by the Bundesbank. The ECB’s decision was not unanimous – the Germans certainly voted against.

US jobless claims unexpectedly declined in the week ending 4th February to 358k, as opposed to the forecast of 370k. The less volatile 4 week moving average declined to 466k, the lowest since April 2008. Today’s data just confirms the recent improvement in employment in the US;

The recent rally looks as if its a bit long in the tooth. “Risk off” me thinks.

Even I have had enough – I think its time to crash out on the beach over here in Goa.

Former Morgan Stanley Analyst Andy Xie explains why the outlook for the global economy is gloomy and leaders lacking vision are to blame. Eventually, this will come back to haunt all of us:

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Recently, stock markets around the world have performed remarkably well. This may even continue for a few months. The U.S. Federal Reserve’s promise to hold interest rates near zero until 2014 and signal of a third round of quantitative soon, combined with an improving U.S. labor market, have emboldened risk-takers. Financial markets are seeing more risk-on trade.

However, the fundamentals for the global economy remain dire. The West is mired in debt troubles, declining competitiveness and unsustainable social overheads. The East is struggling to build up robust consumer demand to balance its manufacturing prowess. So far, world leaders have used liquidity and fiscal measures to prop up demand without addressing structural problems. In essence, they are continuing to treat the global economy as a car with a dead battery rather than a bad engine.

So, 2012 will be an extremely difficult year. The global economy is likely to slip into recession, as Europe and Japan are mired in deep recession and emerging economies stall. Black swan events, such as a sovereign default in Europe, an emerging market crash, a surge in oil prices due to conflict in the Middle East, and a selloff in Japan or the U.S.’s sovereign debt market, will haunt the fragile global economy.

At the annual World Economic Forum in Davos we again saw familiar faces from the West, but some different characters from emerging economies. Some of the last year’s bunch went to jail amidst the revolutions engulfing the Middle East. They were discussing how to fix capitalism. Apparently, the same people who blew up the world and got their governments to bail them out are now again making millions and talking about how to fix things. Not many people see the irony in this. The tragedy of the global financial crisis is that it didn’t sweep away the old order.

During an economic boom people who are good at ingratiating themselves with the establishment tend to rise to the top. After a boom of two decades, leaders are already two to three generations into such a process. These people pretty much make a living by just looking the part. This is why the global crisis will last for years to come, until a new generation of leaders rises through a competitive process.

America’s problem

The Fed’s announcement sparked a 10 percent rally in stock markets around the world. By promising to keep money cheap and holding down bond yields through asset purchases, despite the inflationary impact of cheap money, it is pushing investors into risk assets. I believe that it is targeting the stock market.

Playing with expectations works temporarily. The risk-on trade is in a mini bubble, as today’s buyers want to be ahead of the slower ones. The buying trend is sustainable only if the global economy strengthens, which is unlikely. The stocks aren’t cheap. Desirable consumer stocks are selling for twenty times earnings. Banks are cheap for a reason. Internet stocks suggest another bubble in the making. The Fed is trying to inflate an expensive asset. The rally, hence, is quite fragile. As soon as a shock like Greece defaulting or bad economic news unfolds, the market will quickly head south.
There is a saying that one shouldn’t fight the Fed. Because the Federal Reserve keeps money cheap, other assets become more attractive. This logic works as long as the Fed knows what it is doing. But, can it predict three years out? Newly released information tells us that it was laughing at the troubles in the housing market in 2006, right before the crash. This shows that the Federal Reserve couldn’t see events a few months ahead, let alone years.

I believe it will have to raise interest rates way before 2014, as inflation becomes a problem. The Fed and most analysts believe that a weak economy wouldn’t suffer an inflation problem. However, I think that labor markets in the emerging economy and energy shortages will turn monetary excess into inflation around the world. One can shield from these forces by running a strong currency like Japan. But, this kills the economy through weakening exports and the balance of payment. The US dollar isn’t strong like the yen.

Recent statistics give hope that the labor market in the United States is recovering. In the past six months, the U.S. economy has added 2.2 million jobs. However, the improvement may not be sustainable or sufficient. The country’s under and unemployed is still close to 20 percent of the labor force. The improvement hasn’t come quick enough to overcome the crisis in the labor market. Further, the improvement may not be sustainable because the recent improvement is due to a declining savings rate and the debt overhang remains unaddressed.

First of all, the U.S.’s debt overhang largely remains. It is well known that the U.S. government has run up a lot of debt, doubling that not held by the social security trust in four years. The 2008 financial crisis with its origin in overleveraged U.S. households hasn’t made them cut debt. Household savings surged to nearly US$ 1 trillion per year after the crisis, but has declined by more than half since to $429 billion. The savings rate is too low to bring down debt to sustainable level, probably half of the current level, any time soon.

Also, the financial sector has a current debt level of US$ 13.7 trillion, about the same as four years ago. I suspect that financial institutions couldn’t get rid of their dubious assets and are waiting for a rising tide to bail them out. Hence, the financial sector cannot help the economy, but is instead waiting for help from the economy.

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