The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

As no one is immune to the travails of debt troubled sovereign nations in Europe, the slowdown in Asia and Latin America and mediocre growth in the US, Germany’s economic stats today showed chinks in its armor. The May German IFO business confidence # fell 3 pts to a 6 month low and was 2.5 pts less than expected. Also, German mfr’g PMI fell to 45, the lowest since June ’09 and this led to the euro zone mfr’g and services composite index to drop also to the weakest since June ’09. French mfr’g PMI fell to 44.4 from 46.9 and business confidence dropped 2 pts to a 3 month low. The UK economy was confirmed to be in an official recession as Q1 GDP was not revised up to a positive reading but was instead revised lower to an even weaker one. On the heels of a non event EU summit and just weeks before another Greek election, every comment from an ECB member will be parsed. ECB member Nowotny this morning said a Greek exit will be a mess but also said “a good central bank is ready for everything” and the “ECB hasn’t used its full arsenal.” In Asia, China’s HSBC flash mfr’g PMI for May fell .6 pts to 48.7, the 7th month in a row below 50.

Real Time Economics (WSJ Blog) – Structural Unemployment Would Affect Both Sides of Fed Mandate
Over the past few months, Federal Reserve Chairman Ben Bernanke and other Fed officials have wondered how many of the millions who lost their jobs during the Great Recession are morphing into structural unemployed. The discussion has policy implications — and potential headaches. Structural unemployment is the result of permanent dislocations within labor markets, such as a mismatch between the skills a growing company needs and the experience job seekers have. Cyclical unemployment, on the other hand, results from not enough demand in the economy. The prospect of high structural unemployment will challenge the Fed to fulfill its dual mandates of supporting full employment and price stability. Monetary policy is designed to boost aggregate demand, but can do little to change structural forces. The threat to the Fed’s duty to promote full employment is obvious. “A pessimistic view is that a large share of the unemployment we are seeing, particularly the longer-term unemployment, is structural in nature,” Bernanke said in a speech in March. “If this view is correct, then high levels of long-term unemployment could persist for quite a while, even after the economy has more fully recovered.” Structural unemployment’s impact on inflation is more indirect, but also a concern. If many job seekers lack the skills required in current job openings, then businesses have a much smaller pool of workers to choose from. (Indeed, business surveys show companies cite the lack of skilled labor as an increasing problem.) Companies might have to raise starting salaries to attract appropriate workers and then recoup the extra cost by raising selling prices.

Real Time Economics (WSJ Blog) – Most States Still Years Away From Getting Back Lost Jobs
Most states are still more than two years away from returning to prerecession employment levels, according to a new analysis. Only four states — Alaska, North Dakota, Texas, and Louisiana — have created enough jobs since the recovery to get back to where they were prior to the recession, according to economist Steven Frable of IHS Global Insight. All four of those states have benefited from an energy boom, and Louisiana was starting at a low level of employment after taking a major hit from Hurricane Katrina. Two more states, New York and West Virginia, are expected to return to their prerecession peak later this year, and 10 more should reach the mark next year. But the majority of states still won’t get there until after 2014. Meanwhile, returning to peak employment levels doesn’t necessarily mean jobs markets are healed. In fact, getting back to where a state started doesn’t account for the jobs needed by new entrants to the labor force over the past four years.

Source: Bianco Research

Reuters – U.S. lets China bypass Wall Street for Treasury orders
China can now bypass Wall Street when buying U.S. government debt and go straight to the U.S. Treasury, in what is the Treasury’s first-ever direct relationship with a foreign government, according to documents viewed by Reuters. The relationship means the People’s Bank of China buys U.S. debt using a different method than any other central bank in the world. The other central banks, including the Bank of Japan, which has a large appetite for Treasuries, place orders for U.S. debt with major Wall Street banks designated by the government as primary dealers. Those dealers then bid on their behalf at Treasury auctions. China, which holds $1.17 trillion in U.S. Treasuries, still buys some Treasuries through primary dealers, but since June 2011, that route hasn’t been necessary. The documents viewed by Reuters show the U.S. Treasury Department has given the People’s Bank of China a direct computer link to its auction system, which the Chinese first used to buy two-year notes in late June 2011. China can now participate in auctions without placing bids through primary dealers. If it wants to sell, however, it still has to go through the market.

Comment

Greece and Banks
David R. Kotok
May 23, 2012

“Europe’s banks, sitting on $1.19 trillion of debt to Spain, Portugal, Italy and Ireland, are facing a wave of losses if Greece abandons the euro. While lenders have increased capital buffers, written down Greek bonds and used central-bank loans to help refinance units in southern Europe, they remain vulnerable to the contagion that might follow a withdrawal, investors say. Even with more than two years of preparation, banks still are at risk of deposit flight and rising defaults in other indebted euro nations.” Bloomberg, May 23, 2012

Susan B. asked: “Do you not think most banks are already prepared for more Greek downside?”

Oh, Susan the question is a good one but to answer we need to ask another question for clarification. Which banks are you talking about?

1. Small and mid-sized Community banks in the United States?

Answer: no exposure to Greece. If they have any, their board members need to fire the president and send him to a psychiatrist.

2. Larger regional banks in the United States?

Answer: some may have a little exposure to Greece because of portfolio diversification that includes the Eurozone or because of trade financing with certain customers who are Greek-connected. US regional bank exposure directly to Greece is quite small. Indirect exposure may be bigger if contagion occurs. We own the regional banks and do not anticipate any negative issues in that subsector. We use the ETF whose symbol is KRE.

3. The very large US banks (the big 6)?

Answer: there is definite exposure to Greece but it is manageable. The large US banks have had several years to structure themselves to address this developing risk. The amount of hedging and the defensiveness needed are now in question because of the Jamie Dimon revelations. Markets have marked down the value of the large US banks as if there is going to be another systemic shock. We think this is over done. We are scaling into the large US banks. We will not name the ETF selections until the trading is complete. There are many ways to structure a rebalancing into ETFS and the financial sector. The ETF space is filled with options. The combination of them makes the portfolio selection challenging and opportunistic. See our new book “From Bear to Bull with ETFS” for how financial ETFs work in bull and bear markets. Links to all book vendors (e-book or paperback) are found in the flyer on the Cumberland website, www.cumber.com .

4. Larger banks in non-periphery countries in Europe and particularly in the euro zone?

This is murky which is why the market has re-priced these bank shares to the downside. They definitely have direct exposure although they have been adjusting it lower at every opportunity. French, German, Dutch and Finnish banks can manage this risk. A Greek exit from the Eurozone or a Greek default beyond what has already occurred will definitely cause them to take more losses and to mark down the present value of assets. We do not own them except where they are a part of a broader ETF. We are underweight Europe and only deployed in northern European countries. It is too soon to buy in this sector.

5. Banks in troubled periphery countries like Spain, Ireland, Portugal and Italy?

These banks are bleeding deposits and under stress. The best indicator of this stress is the credit spreads on sovereign debt of each country compared to the benchmark German “bund.” We post these spreads weekly on our website, www.cumber.com . The worse the country condition, the more the runs on the country’s banks accelerates. These banks are not sufficiently prepared. They cannot recapitalize themselves. They have lost the needed market access at a reasonable cost. They must have official intervention or the condition will worsen.

6. Banks in Greece?

Answer: private Greek bank ownership is dead. The banking sector is preserved ONLY because of the ELA. This is the Emergency Liquidity Assistance program that is administered by the central bank of Greece, not the European Central Bank. The ECB has passed this baton to the Bank of Greece for complex reasons having to do with the structure of central banking in Europe and with the strength of ECB claims in the event of a Greek government default or repudiation. Were it not for the ELA, banks in Greece would be failing like a sequence of falling dominoes. Without ELA, they would run out of cash. Anyone who can is moving his or her money out of Greece. Tens of billions of euro deposits have shifted to other places in Europe.

Susan, we are watching a contagion and banking crisis unfold in slower motion (the last few years). The speed is now accelerating. The longer it takes to resolution, the worse it will be for Greece, for the periphery and for Europe. We expect the ECB to move in very large size and inject another round of liquidity in order to try to maintain the weakening fence around Greece. Will they be able to insulate Italy or Spain? That is not clear and longer they wait, the harder it will be. Is Portugal the next Greece? We do not know but the markets have widened spreads so it seems that the market vigilantes are saying Portugal is next.

7. What is an investor to do?

If you think the contagion will spread around the world, sit in cash. Make that cash the US dollar, if you are American-based.

If you believe as I do, that there will be no global contagion, buy the US financials. We are overweight and scaling up using ETFs. Susan, for ten bucks, you can buy my e-book at the Kindle Store on Amazon.com. Read the appendix list of ETFs and the chapter on financials. Any profits from the book will go to the Global Interdependence Center, an organization holding a central banking, Europe-focused discussion in Poland this week.

Thank you, Susan, for asking the question. Stay safe and good luck.

~~~

David R. Kotok, Chairman and Chief Investment Officer

Here is my presentation from this morning:

Visual Culture: New Opportunities for Consumers, Publishers & Brands [Sponsor Spotlight], Speaker — Bob Lisbonne (Luminate)

@ l u m i n a t e T h e “ I m a g e s p h e r e ” : P i c t u r e s E m e r g e a s t h e N e w N e w T h i n g

by Conversational Marketing Summit 2012 on May 14, 2012

While a Greek exit from the euro zone is a distinct possibility and the extent of the mess it will create is highly worrisome, the comments yesterday from the ex Greek PM was just stating the obvious to anyone paying attention over the past month since the election. He doesn’t want Greece leave but it could happen and it would be ugly if it did. Duh. This said, the markets are on edge and sensitive to every possible out of control scenario coming out of Europe. A German newspaper is reporting that the ECB has formed a group to prepare for the possibility of Greece leaving the euro and said the ECB would take new steps if the financial markets freeze up. While Germany will be pushed for euro bonds at the EU summit, the German Deputy Fin Min said no way Jose stating bluntly “euro bonds mean nothing other than that Germany would be liable for 100% of the debt in the euro area, not just Germany but also France.” Germany sold two yr notes at a whopping yield of .07%. Italian consumer confidence fell to a new low at 86.5, 3 pts below estimates. In Asia, the BoJ stayed on hold and the yen is getting back all it lost yesterday vs the US$. In the US, mortgage rates hit a new low and it helped to boost refi apps by 5.6% to a 14 week high but purchases were not lifted as they fell 3% to a 4 week low.

II: Bulls 38.3 v 39.4 Bears 26.6 v 22.3

Click to enlarge:



The Financial Times – Dollar in a rut as recovery disappoints

Back in January, foreign exchange strategists predicted 2012 would be the year of the dollar. The US currency was expected to enjoy strong gains as a positive recovery story unfolded in America. Instead, the dollar is stuck in a rut. Rather than soar, it has traded in a tight range against other big currencies as that economic recovery has looked less certain. The dollar index, which weighs the US currency against a basket of other global currencies, is almost flat for the year-to-date, having risen just 0.3 per cent. And, inexplicably for many traders given the divergence between the health of the US and eurozone economies, the dollar is also barely changed against the euro this year. In fact, for all the revived fears about the euro area’s debt crisis, the single currency has risen 0.5 per cent, trading on Tuesday at about $1.30. For currency traders, the big question is whether the US Federal Reserve will embark on another round of “quantitative easing” – dubbed QE3 – this year. That would prove negative for the dollar. The message here has been mixed, in line with recent economic data. While the US central bank raised growth forecasts for this year at its quarterly meeting last month, Ben Bernanke, Fed chairman, was keen to stress that its monetary easing tools “remain very much on the table”. That has led to markets forensically combing over each set of economic data – what foreign exchange analysts call a “data dependent approach” – to assess whether it adds or takes away from the case for QE3.

Source: Bianco Research

Poor sovereign government finances are not just the province of Europe. Fitch this morning downgraded the credit rating of Japan to A+, one notch below both S&P and Moody’s. Fitch stated the obvious extraordinary amount of debt they have relative to GDP but said “the country’s fiscal consolidation plan looks leisurely relative even to other fiscally challenged high income countries.” As in some European countries, there will never be enough growth in Japan to sustain their debt so policy makers have only two choices, debt restructuring/writedown or print money and unfortunately printing money will be the politically easier decision. The BoJ may announce its 3rd QE in 3 mo’s tomorrow. Also of note and ahead of our own debt ceiling battle again upcoming, 5 yr US CDS is rising to the highest in 4 mo’s.

Existing Home Sales totaled 4.62mm annualized in April, a touch above estimates and up from 4.47mm in March which was revised slightly lower. For contracts likely signed in Feb and March, closings rose for both single family and condos/co-ops. Because though the amount of homes for sale rose, months supply rose to 6.6 from 6.2 to the most since Nov. The median sales price rose 10.1% y/o/y to $177,400, the highest since July ’10, likely helped by what the NAR said was “a diminishing share of foreclosed property sales.” Distressed home sales made up 28% of the total, down from 29% in March and 37% in April 2011. Bottom line, it will be a few months before we know whether the spring selling season started in Jan/Feb because of the mild winter and it remains to be seen the full extent of the shadow inventory that is out there. The foreclosure process should start to pick up as the banks have made their settlement with the states. This said, there is a better tone to the housing market (relatively speaking) but with what’s been seen, it wasn’t going to take much other than time.