FMX | Connect – www.fmxconnect.com - (Reported 5/06/2010)
WHILE YOU WERE SLEEPING
Some stability is returning to the European equity market so far today and bonds are losing some of their safe-haven allure but likely only temporarily. The Asian equity markets continue to falter (MSCI Asia Pac index down to a three-month low). The Nikkei played some catch-up with a 361 point, or 3.3% decline, to 10,695, and there were losses through much of the region, including a 4.1% slide in the Shanghai composite — now down 21% from the recent peak to its lowest level in eight months (!), which hardly bodes well over the near-term for the commodity complex given the strong correlation. Indeed, the likes of nickel (down to a 10-week low) and rubber, which had been flying high, are now rolling over big time.
The one currency that seems to be in favour is the New Zealand dollar as the central bank chief (Bollard) hinted strongly at coming rate hikes even as Australia looks set to pause (hence the NZ$-A$ cross rate is soaring at the moment). This was reinforced by the news that the NZ unemployment rate tumbled to 6.0% in Q1 from 7.1% in the fourth quarter of 2009. Sterling is weakening further ahead of the U.K. elections as signs grow that we will see a “hung” parliament — Canada has much more experience in dealing with minority governments, and as Britain is going to need decisive political leadership as it confronts its own set of intense fiscal challenges. The Canadian dollar is moving further away from “par” and closer to fair-value (around 93 cents — a few pennies still to go).
It was light on the economic data docket — German manufacturing orders surprised to the high side, surging 5% in March (that was month-over-month — then again, March seems like a lifetime ago given recent turbulent events across the pond). We will reiterate that the greatest pain trade out there right now is not the downdraft in equities but it is the rally in Treasuries — the net speculative short position on the U.S. 10-year Treasury note of nearly 200,000 contracts is feeling the pain. The short squeeze is very likely going to lead to even lower bond yield activity ahead too. For all the resistance to this view, look at where Germany and Sweden (2.9%), Denmark (3.0%), Finland (3.1%), France (3.2%), Austria and Norway (3.3%), Switzerland (1.7%) and of course, Japan (1.26% — fresh four-month low) all trade. Canadian and U.S. yields north of 3.5% look like a bargain next to these markets.
ALL PART OF THE GLOBAL DELEVERAGING STORY
The turmoil of the past few sessions begs the question as to how it is that Greece can manage to secure a combined EU and IMF financing of US$145 billion (€110bln), which should cover funding needs for at least the next two years, and yet the yield on 2-year Greek bonds could surge as much as it has of late. It boggles the mind.
Well, the bottom line is that, in the past, external rescue packages, which always have stipulations attached to get your finances in order, are typically accepted by the citizens of the problem country. But this is hardly the case in Greece. The population seems to think that the world owes them something — the strikes, riots and deaths have left the global marketplace with a view that Greece will never have any intention of accepting the caveats attached to the rescue package, especially since the fiscal restructuring is so intense that we are talking about 3-4% GDP contractions annually for at least the next three years. That indeed is draconian, but necessary nonetheless.
Debt restructuring (default) seems inevitable, as does an exit from the Eurozone, which is probably going to be in everyone’s best interest notwithstanding the turmoil that would likely ensue over the near-term. Greece could do what it has done in the past — not to mention a whole slate of other countries (remember Argentina’s currency board?) which is to go back to the Drachma and devalue its currency dramatically and thereby reflate its way out its morass. And, as history teaches us, memories in this business are pretty short.
The question then is where the next debt bubble is going to pop? This is all part and parcel of the global deleveraging cycle. Entities or countries that massively overextended themselves during the boom years are going to be paying the piper, as we are now, on the opposite side of the credit cycle — the secular contraction phase. It may have started with U.S. banks and American real estate three years ago, but now it is about European banks and welfare states within the Eurozone.
The canary in the coalmine was actually the Dubai debacle late last year, but there was a big brother called Abu Dhabi that came in to fund the bailout. And, the reason why the initial turmoil out of Greece early in 2010 was brief — and ended up emboldening the ‘buy-the-dip’ crowd — was because investors believed that Germany in particular would have to play big brother too. You see, ever since the Obama team bailed out Citigroup and BoA, not to mention GM and GMAC, the markets has become increasingly complacent that for every problem there is a government bailout plan.
However, when the majority of governments are now running fiscal deficits of 10% or more relative to GDP and debt ratios at or about to rise above the 100% threshold, the ability to continue along the bailout path becomes increasingly constrained. So, this post-bubble credit collapse carries with it many dimensions, and it is an entire book with many chapters, and now the problems have morphed into sovereign default risks with attendant geopolitical fallouts and the risk of massive currency depreciations, huge haircuts for banks that own the problem government bonds and very likely a move towards trade protectionism. All of this, by the way, is good news for high-quality bonds where you can find them for entities and governments with reasonably long maturity schedules and little in the way of refunding needs over the next few years, and of course, precious metals.
As we mentioned above, Dubai was the real canary in the coal mine on the sovereign credit front, and now Greece is very likely going to be the touch-off point for other high-debt/high-deficit countries with weak economic structures such as Portugal, Spain (already rumoured to be in talks with the IMF) and even Italy. Next will be the U.K. whose balance sheet is not far off from what Greece looks like and looming political uncertainty to boot. So it pays to not be complacent at this time, and to try to identify what the next chapters of the deleveraging book are going to be — especially since the McKinsey report tells us that the aftermath of a global credit collapse typically last 6-7 years. It doesn’t mean that we won’t go through whippy bear market rallies like we did in the past year, but these rallies, despite their intensity, are rallies you rent in a secular bear phase. Do not overstay your welcome.
Once we are through with Euroland and the U.K., perhaps the next problem spot will be China where the government is tightening to combat what well could be a significant property bubble. Then it may come right back to the U.S.A. where we have massively indebted State and local governments. And then … well, take a look at the mania in Toronto and Vancouver real estate as an example. Bubbles will be popping.
The lesson of the past 12 years, since the first bailout (LTCM) ushered in by the Fed and Treasury, is to wade into the equity pool when the S&P 500 is down 50% from the interim peaks and to take chips off the table once the market is up 70% or more from the lows. And since we know that the primary trendline is deflation, income is king and capital preservation strategies will be back in vogue as well.
The operative theme going forward is quite simple: the best way to make money is not to lose it.
THE FIX ON THE VIX
Including yesterday’s further up-move (+4.5% to 25), the VIX index is now up 50% on a 20-day basis. Ouch!
This is symptomatic of the onset of a bear market phase, or at the least, the very late stage of a bull run. But the key takeaway is that spasms like we just saw are not symbolic of the early- or mid-stages of a bull market. The post-bailout/stimulus effects of the last 13 months were fun while they lasted, but the bull now looks to be rolling over, in my humble opinion.
In the current run, this is the first time we saw such a big increase in the VIX index (on a 20-day basis). There was only one other time, back on February 8, 2010 when the VIX index rose 51% on a 20-day basis. Of course, that was seen as a ‘buy-the-dip’ scenario; however, what it represented was an initial market peak à la July 2007, and today likely represents the subsequent blowoff peak we saw in October 2007. If there are any differences, the market is not quite at the same extreme overvalued level and technical divergences are not as acute. But investor sentiment is almost equally as complacent and denial over double-dip outcomes is as evident as recession expectations were back then when the consensus was for a soft-landing (the economic downturn was only two months away — staring us in the face, and yet so many naysayers).
Back in the bull market of 2003-2007 when the S&P 500 doubled, the VIX index never surged to such an extent as it just has — at least not until the rally was all but over (mid-March when the ABX indices were melting) and then in August and November (when the mortgage strains morphed into an outright credit crisis).
By way of comparison, in the 2000-2003 bear market, the VIX index was up this much over a 20-day span during the depths of the recession (September 2001) and during the growth relapse and just ahead of the retest and break of the prior market lows in 2002 (the VIX broke out like this in late July and early August of 2002). Some food for thought.
INTELLIGENCE?
The Investors Intelligence poll for the past week just came out and showed the ‘buy-the-dip’ mentality is as entrenched as ever. The bull share climbed to 56.0% from 54.0%; the bear camp, at 18.7% versus 18.0% the prior week; and those seeing a correction slipped to 25.3% from 28.0%.
The last time that bullish investor sentiment was as high as it is today was back in December 2007. The fact that the bull/bear spread has widened further is disturbing from a “contrary” standpoint — a lot of good news is priced in currently.
U.S. SERVICE SECTOR STALLS IN APRIL
The U.S. ISM non-manufacturing index stalled in April, staying at 55.4, which was slightly below the consensus estimate of a rise to 56.0. Pulling the index lower was the 4.1 point decline in the new orders index (largest monthly decline since November 2008), to 58.2 in April, and the three-tenths of a point drop in the employment index, to 49.5.
According to the press release, 14 reported growth in April, which the same as in the March report, with very positive comments from the management of companies and support services (“Business conditions are improving”) and wholesale trade (“Best production/service levels in 24 months”). However, what was different in April was that there were four industries reporting a contraction versus only two in March. Looking at the comments by the respondents, it seems that the service sector remains very cautious about the economy. Consider the following comments:
Educational Services: “The market and other financial indicators point to an improving economy; however, that is being overshadowed by skepticism and lack of confidence. Capital spending is being constrained by concern over the economic view in a post-stimulus era, with double-digit interest rates and mounting debt.”
Information: April report: “Market shows slight signs of tightening.” Compare this comment to the March report, which was much more optimistic: “Business conditions have returned to normal (pre-recession). Our business is up significantly since 2009. We are very positive about the upcoming year”.
ADP EMPLOYMENT REPORT POINTS TO MODEST PRIVATE-SECTOR JOB GAINS
The ADP report was nearly spot-on consensus estimates, rising by 32,000 in April versus the 30,000 estimate. Nonfarm payrolls (NFP) and ADP have been diverging as of late but back revisions to the ADP report helped bring the two reports closer together (February was revised up from -24k to +3K and March was revised up from -23k to +19k). Few analysts changed their NFP estimates after yesterday’s ADP and Challenger (which reported that the number of layoffs fell in April, although hiring intentions remained anemic) reports, with the consensus sitting around 190K (note that most analysts expect census hiring to come in at around 100-125k).
Within the details, the service sector saw another month of job increases — up 50k (the third monthly increase) — while the goods producing sector was down 18k. Small (under 50 employees) and medium (50-500 employees) businesses in the goods sector continued to shed jobs while large firms posted increases. We see similar trends out of the National Federation of Independent Business survey (which covers small- to medium-firms) — percent of firms with one or more job openings remains at record lows.
CANADIAN HOME PRICES BUBBLY
Take a look at the two charts below, which benchmark resale home prices to income and rents in Canada. Both show home prices in overvalued territory (while resale home prices have slipped from record highs, they are still running at 17% YoY).
Relative to labour income, home prices are about 1.5 standard deviations above norm (data going back to 1980). The situation is even more dire when we look at resale home prices versus rental prices — this metric is over 2.5 standard deviations above the average, which is very reminiscent of what we saw in the U.S. in 2004-2006. Our statistical work implies that given current income and rent, we could see a price correction of around 15-35% if these ratios were to mean revert, which would certainly be a U.S.-style correction.
David A. Rosenberg May 4, 2010
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919
Source: Market Musings & Data Deciphering
http://www.fmxconnect.com/
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