New Lows and a Dud IPO
Sentinel Investments
By Christian W. Thwaites
May 22, 2012
We're testing all sorts of lows: 1) record low for GT10 auction last week 2) GT30 yield, same level as Dec 2008 3) European banks are at same price level as 1987...so 25 years of gains wiped out 4) euro stocks same level as March 2009, so all the gains gone 5) US safest and best place to be 6) China stocks at same level as 2006, since then the Chinese economy has doubled and 7) to cap it all we had an IPO that should never have happened. We're back in risk territory and markets don't want to extend or commit. Reasons follow...
Greece: Wishful thinking that we would not have to go over the same issues here. Markets worry about it, rightly, because there is simply no precedent for what is being played out in real time. We've had defaults before. We've had countries and unions break up. We've had countries ditch one currency for another. We've had full blown capital flight. But we've never had a country where all funding could be cut off and where the attractions of repudiating debt seem to grow daily. What we do know is:
1. We have at least one more month of uncertainty.
2. Greek banks are seeing more capital and deposits up and leave, and they owe around €100 bn to other European banks...
3. And they have no central bank for support or act as lender of last resort.
4. Greek authorities increasingly have the upper hand...the more they're told they can not exit, the more they can bargain to remain.
5. Redenomination of debts has worked for others, most recently Argentina, which had a dollar peg, austerity programs that weren't working and bank runs, but who survived and thrived.
6. The steps to economic health - first devalue and inflate, second abolish a currency board and renegotiate principal payments and third internally devalue and start firing up exports - are not that complicated. They're just confounded by a byzantine legal structure around the EU.
The choices thus come down to 1) leave and manage a crisis response or 2) deal with a troubled Greece within the system and firewall as much as possible. The markets are betting on the latter. We would not bet at all in this game because there's no upside to either outcome. What concerns us is the "systemic" part of the banking system where money is pulled from weakest banks and the financial links come undone very quickly. According to the BIS, US banks claims on Greece amount to only 0.3% of Tier 1 capital but it is very much larger when it comes to European banks and, indeed, the ECB itself.
ECB: It's great sport to decry the Fed but the ECB takes the biscuit for bureaucratese nonsense. Last week, they stepped aside from the "macroeconomic imbalances" saying that unit costs must decline and competitiveness adjust but their focus was on price stability and integrity of the balance sheet. Thus, deftly passing the buck they assure us that the Macroeconomic Imbalances Procedure (MIP), the European Supervisory Authorities (ESA), the European Systematic Risk Board (ESRB), the European Financial Stability Facility (EFSF) and European Stability Mechanism (ESM), will all isolate the euro from financial turmoil (I feel better already). Last, one official said that there will be no policy action until July because that will focus politicians minds on reform. Way to central bank!
FOMC: There was a lot of "uncertainty" scattered through out the report. None of the participants sees much risk in inflation and the unemployment estimates cluster around the 7.5% mark. There was no discussion of any easing options. There was what looked like a plant story some weeks ago that they might engineer open market operations with sterilization, which in this case would likely mean selling an equivalent amount of any securities that they bought, but it was absent from the minutes. Nor was there any mention of mortgage purchases, which has kept MBS markets well bid in the last few months. So no easing or tightening. But with the two new Fed members on their way, more QE could come if the fragile condition in Europe deteriorates or we see a roll over in the economic stats. So stay tuned.
Economic Data: Most of the information last week, with the exception of the Philly Fed and the jobless claims, show a rebound. First up was housing, where starts broke through 700,000 and the March numbers were revised up 40,000. (For revisions, housing starts come second only to NFPs...they are nearly always off by 5% to 10%.) Here they are along with the 5-units or more starts. So we see a nice tick up in both measures and around 23% ahead of last year.
Source: Federal Reserve Bank of St. Louis, Economic Research
We watch the 5-units or more number because household formations are changing. For example, last week we saw non-revolving consumer credit by grow 5.5% but a good chunk of that was the federal government extending loans. And the only way they extend loans to consumers is through the Department of Education, i.e. student loans. These are now 26% of all non-revolving consumer loans and have risen four-fold since 2008 when they were 6% of loans. More loans mean less mortgage capacity. Which means less household formation. And here's another one showing how deleveraging works. This shows consumer credit as a ratio of personal income, which isn't growing much, coupled with a decisive drop in credit outstanding. Some of the drop is defaulting but either way, it's equivalent to about $900bn saved/not spent.
Source: Federal Reserve Bank of St. Louis, Economic Research
Other information this week broadly tells the same story of gradual rebound and "good under the circumstances," those circumstances being the net drag of government, deleveraging, unemployment and regulatory overhaul. Remember 87% of the US economy (i.e. GDP less the $2.6 trillion of imports) is domestic while the eurozone accounts for around 2.4% of total GDP. Any further damage in Europe will hurt S&P companies far more than the US as a whole.
Bottom Line: We touched treasury lows last week at 1.67%. The same happened with Bunds. Here they are.
Source: Federal Reserve Bank of St. Louis, Economic Research
They tell a clear story: 1) great concern on all assets except the most liquid and safest...even gold is down 12% since February 2) uncertainty on debt negotiations with ourselves in the US and intra-government with Germany 3) deflationary fears more resounding than inflation. The recent print on CPI showed lower gas prices helped keep a lid on prices but wages are not creating any upward pressure. With that, we have trimmed our long equity position and remain over weight in MBS. It's too dangerous to short treasuries.
Unless something breaks big this week, we'll probably skip TOTW for the upcoming week (Memorial Day).
Sources: J.P. Morgan Market Intelligence; FT Alphaville; ECB; Tim Duy's Fed Watch; Ian Shepherdson, High Frequency Economics; Federal Reserve Board; US Census Bureau; US Dept of Housing & Urban Development; Federal Reserve Bank of St Louis; Federal Reserve Bank of Philadelphia; Capital Economics; "Greece's Predicament: Lessons from Argentina", Peter Kretzmer and Mickey Levy; Sentinel Asset Management, Inc.
(c) Sentinel Investments
