FMX | Connect – www.fmxconnect.com - (Reported 6/02/2010)
Excerpts from MARKET MUSINGS & DATA DECIPHERING
WHILE YOU WERE SLEEPING
Another rough day on global equity markets, although U.S. equity futures are pointing to a better open on this side of the two oceans. At last look, Europe was down over 1% and there was a sea of red ink across Asia, yet again, with the Nikkei down 1.1% to 9,603. The Kospi was also off 0.7% and the Hang Seng lost a tad (-0.1%) — there were gains in China and India but the good news stopped there. Bond markets are, for the most part, flat — though yields continue to back up in the fiscally challenged Club Med part of the Eurozone.
The U.S. dollar has lost a bit of ground this morning and the weakness on overseas bourses has not translated into any further advance in the gold price (oil and copper are down too). Although as we said yesterday, the chart and the fundamentals look very good for the precious metals complex — concerns over global financial market stability now that the credit crisis is hitting sovereign balance sheets are not likely to reverse course any time soon, and gold, as well as silver, are effective ways to protect the portfolio against this recurring instability. Simply put, we are still early in the deleveraging cycle, notwithstanding the great efforts made by U.S. banks to write down bad debts and recapitalize themselves (with government support) — much of the delinquent part of the massive $200 trillion in global debt has not really been extinguished but was merely transferred to taxpayer-supported public sector balance sheets.
Once government balance sheets start to come under scrutiny, and this is a global affair stretching from the problem Eurozone areas, to Japan, to the U.K. and now to U.S. state and local governments (and not likely to stop there), the deleveraging cycle typically intensifies. Governments become tapped out in terms of what they can do stimulus-wise and so the burden is placed back on central banks. However, the problem is that when policy rates are at or near 0%, the emphasis shifts towards money printing and massive balance sheet expansion on the part of the monetary authorities to cushion the blow on the economy and investor confidence. We may come out of this with massive inflation — though the Japanese experience cautions us on this particular point — but it will take a long time coming. Deflation is still the primary trend, coupled with massive reflation efforts and the laws of unintended consequences that come along with those efforts — the New Deal in the 1930s was not entirely successful in quashing deflationary pressure (and yet the Sterling price of gold managed to double — go figure).
The name of the game is to focus attention on strategies that:
•Delivers income (including dividend growth, hybrid funds and corporate bonds since company balance sheets are in fine shape);
•Minimize volatility and emphasize on capital preservation in a secular bear market (true long-short “hedge fund” portfolios), and;
•Commodities (precious metals as a “buffer” in a financially unstable world; and industrial commodities to take advantage of (i) the secular growth dynamics in Asia, and (ii) repeated rounds of currency depreciation inevitably lead to trade protectionism and “security of supply” constraints, which tend to benefit basic materials.
This by no means suggests that now is the time to load up on resources seeing as they are cyclical in nature and prone to sharp short-term swings — but commodities are in a secular bull market so these periodic spasms offer nice long-term buying opportunities. Defense stocks — hardly politically correct but I don’t claim to be a saint — should also be considered seeing as global military conflicts tend to follow suit, if history repeats itself, in the context of these global financial crises (Turkey is all of a sudden a big power broker, and not necessarily in a very stable fashion). Investors should focus their attention on the currencies and government bonds of countries whose public balance sheets are truly AAA rated — low debt ratios, low primary or structural deficits and with stable banking systems: these would include Canada, Australia, New Zealand, Norway, Sweden and Switzerland.
The U.S., of course, is wealthy and has shown an uncanny ability to withstand storms, but the losses at Fannie, Freddie and the FHA are staggering and will exacerbate the national balance sheet. In addition, local governments are likely to be forced to declare Chapter 9 as finances at the lower levels of the public domain are in deep stress. The regional banks are also in very rough shape; unfunded liabilities are a really big problem as are underfunded pension liabilities. Finally the U.S. household balance sheet must be downsized. There is simply too much debt and debt service relative to income-generating capacity to believe that economic growth in America will be vibrant or sustainable.
Meanwhile, the consensus is discounting record corporate earnings for next year in a period of minuscule nominal GDP growth and no more springboard from profit margin expansion since margins are now at their third highest level ever. As far as we are concerned, it is plain to see what the big surprise is likely going to be — earnings disappointment. And, that has yet to hit the market — so far it has been multiple compression as credit spreads re-widen and risk premia expands amidst the European debt crisis and associated contagion concerns.
The lesson is that even if one has a “bearish” view on the macro and market outlook, it does not mean one is devoid of an investment strategy that transcends cash (and firearms, tents, lanterns, baked beans, canned tuna, bottled water and the like) and can help grow capital over time in a prudent manner that allows the investor to sleep at night. Although, I can understand that some folks do like to swing for the fences, and if you hear them tell the tale, they are always in at the lows and out at the peaks. As if.
As an aside, having a “perma bearish” view of the U.S. equity market over the past 10 years (keeping in mind that secular phases tend to last 16-18 years) has not altogether been a bad strategy. Moreover, in the next recession, which is likely to occur in the next two years seeing as the cycles now are being increasingly shortened, we are likely to see new lows emerge just as they did in the last two recessions. The vagaries of a secular bear market — equity markets go to new lows in the economic downturn, which is far different than in a secular bull market where the pullback is more akin to a short-term correction (as was the case in 1990).
ISM: END OF INVENTORY CYCLE?
U.S. manufacturing activity slowed slightly in May, with the ISM coming in at 59.7, slightly better than the 59.0 expected by analysts. By most accounts, ISM looks to have peaked with the May reading slightly below April’s 6-year high. Sixteen of the 18 industries reported growth, down from 17 in both April and March.
The majority of the sub-components were lower; the most notable being the inventory index, which slipped another 3.8 points, on top of April’s 5.9 point drop, to 45.6, the lowest level since the end of last year. Note that inventory accumulation has contributed to over 50% of GDP growth in the past two quarters, but this report is suggesting inventories will add a lot less to GDP growth for this quarter and beyond, if anything. Current production was slightly lower, slipping to 66.6 from 66.9 and the new orders index was unchanged at 65.7 (both slightly below six-year highs). New exports ticked up, but given the turmoil overseas, we would expect this to recede sharply in the coming months.
While most components were down, the closely watched employment component ticked up 1.3 pts to 59.8. Wall Street analysts continue to expect a large census-worker driven jump in nonfarm payrolls this Friday (current estimate at around 500K with 175k of that coming from the private sector).
David A. Rosenberg
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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