Keep an eye on China and Japan.

China Condemns Japan Shrine Visit — NY Times      

Weekly Bull/Bear Recap: January 23-27, 2012

Bull

+ The ECB’s Long-Term Refinancing Operation (LTRO) has clearly quelled fears of an imminent liquidity crisis; Spanish and Italian 10-yr yields have plunged.  The operation will provide time for policymakers to forge ahead with structural reforms.  Germany is opening the door for pro-growth policies in the periphery.  Furthermore, Greece is an isolated case.  A Greek default is already priced in and a climax would actually lift the air of uncertainty.  Says billionaire investor George Soros, “I think we are on the verge of putting the acute phase of the crisis behind us,” adding that he believed Italian sovereign bonds represent a “very attractive” speculative investment.  Finally, business confidence in Germany increases for the 3rd month in a row, while record low unemployment boosts consumer confidence.  The bloc’s largest economy will avert recession and support investor confidence in the Eurozone region.

+ U.S. economic data continues to shine.  The Richmond Fed’s manufacturing survey increases from 3 to 12, lead by New Orders and expectations of improved business conditions (we have the same bullish result from the Kansas City Fed); note that all regional surveys have improved in January.  Moreover, the ATA Truck Tonnage Index spikes the most in over a decade in December.  Chief Economist Bob Costello hints that a wave of inventory restocking has begun.  Core Durable Goods Orders reestablish their bullish trend, which bodes well for Q1 manufacturing performance.  On the jobs front, state unemployment rates continue their trek lower.  Finally, consumer confidence improves to 75.0 and is the highest in almost a year. 

+ The global economy has clearly stabilized after a brief air pocket in the prior quarter.  According to the Markit PMI, economic activity in the Eurozone unexpectedly grew in January, led by Germany and France.  Meanwhile, monetary easing; such as India’s unexpected decision to cut their Reserve Ratio, Thailand’s interest rate cut, and Brazil’s upcoming rate cut, will further support economic growth.  Copper and comments from Caterpillar support the global re-acceleration thesis.  Even Japan had some good news on the consumer front.  

+ The Fed announces that interest rates will be held low throughout 2014 and state that they will step in with QE III should the global economy deteriorate further.  Risk assets spike as investors are reassured that the Fed will maintain vigilance for any economic slowdown.  Criticism of the program won’t be nearly as intense as QE II due to slowing economic growth in Emerging Markets.  

+ Obama clears the way for an economy that’s “built to last,” by explicitly stating in his State of the Union address that domestic companies will receive government assistance to create jobs.  Leaders understand the grand opportunities that lie ahead. The U.S.  manufacturing renaissance is in its infancy.     

Bear

- Global growth is slowing to a stall.  Japan’s central bank cuts its 2011 and 2012 economic growth forecasts, citing strains from balance-sheet repair in the U.S. and weaker growth due to the European debt crisis.  On a grander scale, the IMF slashes its global growth forecasts and expects the Eurozone to enter a recession.  Meanwhile, Australia and the UK are teetering on the brink of recession, while South Korea reports its slowest economic growth in 2 years.  In China, officials want to see a 30% decline in residential real estate to reach a “reasonable” level —(and in the process cause an uprising of the middle-class).  Meanwhile, protests in Tibet are spiraling out of control.  Finally, Obama ups the ante on protectionism with his State of the Union address.

-  The Eurozone crisis is worsening.  There is still no agreement on the Greek Private Sector Involvement (PSI) negotiations, raising the specter of a credit event and uncontrolled default (how many times have we heard that a deal is close?).  Making matters worse, EU leaders and banks are demanding further austerity on the depression-racked country due to missed targets.  How long before peripheral citizen’s say “The hell with this” or creditor governments say “This isn’t working”?   Meanwhile, Portugal is fast coming down the pipe with 10-yr bond yields hitting record highs, as Antonio Saraiva, the head of the country’s industry confederation, confesses that the nation will need a bailout.  In Spain, recession is knocking at the door, while unemployment is far worse than expectations.  In Italy, Monti’s government is set to face its first real test as truckers have blocked the flow of essential goods into Rome and other large cities.  In France, S&P downgrades 3 banks and the country’s president acknowledges that he’s likely to lose the presidency in 3 months, unleashing a wave of uncertainty in regards to Eurozone economic policy.  Finally, “Trade unions plan (a) pan-EU action against (the) fiscal compact.”     

- Despite all the hoopla in the past month, the U.S. remains vulnerable to an exogenous shock.  4th Quarter GDP disappoints, growing 2.8% vs. expectations of 3.0%; note that the economy hasn’t grown over 3% since the Q2 2010.  Final demand registers a paltry 0.8% and Personal Consumption underperform expectations.  Meanwhile, Fed President Dudley sees “significant impediments” to economic growth this year.  Finally, weekly consumer metrics continue to flag a significant slowdown in January versus an already weak December.

- The probability of an oil price spike, likely upending the global recovery, grows.  The EU imposes an embargo of Iranian oil (to begin July 1st), despite Iranian threats of a blockade of the Straits of Hormuz or just cutting off supply immediately.  Meanwhile, oil producers are now content with $100 oil, saying that it won’t affect global growth; we’ve heard this before, but the threshold price keeps rising.  Azerbaijan police foil another Iran plot to assassinate the country’s Israeli ambassador.  

- Japan reports a trade deficit for the first time since 1980.  While sporting a debt to GDP ratio of over 200%, any consistent trade outflow from the country would conjure anxiousness towards its real paying ability (not printed Yen, which implies a loss of real value of interest payments).    

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Be sure to check out my latest macro outlook and market forecasts.  Thanks for your support.

Weekly Bull/Bear Recap: October 24-28, 2011

Bull

+ The bears are furious as Europe once again, to their disbelief, unites and puts forth a €1 trillion package to backstop banks and sovereign debt markets.  Eurozone officials also negotiate a voluntary haircut of 50% with banks to put Greece on a sustainable path forward and create time for real reform to take place.  The avoidance of a credit event as well as a recapitalization fund of €106 billion ensures that there will not be a disorderly default and that infected banks will be ring-fenced thereby stemming the contagion. The effectiveness of the package results in global equity markets rallying to finish off the week and the Euro rebounding above the important 1.40 mark.  The greatest impediment to the global recovery has been lifted.  Societe Generale strategists said, “the agreement was likely to prove sufficient to ease financial stress and should be comprehensive enough to give the euro area a ‘window of opportunity’ to put its house in order”. 

+ 3Q GDP grows at its fastest pace this year in a marked rebound from the prior quarter.  The gains are lead by…. the resilient consumer.  Double-dippers are finished.  Ignore the consumer confidence surveys.  Yes, people are glum about the economy but life goes on.  People are learning to live with the current circumstances, which by the way are slowly getting better.  The holiday shopping season will pleasantly surprise judging by this news and the most recent uptick in confidence as per the University of Michigan Consumer Sentiment Survey.  Moreover, according to the Chicago Fed National Activity Index, the economy isn’t in recession, only a soft-patch.  The 3 month moving average rose to -0.21 in September from -0.28.  The improvement was centered around employment-related indicators.  And finally, the Philly Fed State Coincident Index increased in September and shows continued improvement from this summer’s soft-patch.      

+ The S&P 500 has broken through its 200-day moving average.  It has also penetrated the neckline resistance.  The Dow Theory is also back into effect as both the industrials and transportation averages have broken through their prior highs.  How was the breadth in the latest rally?  I would say healthy.  Credit has also participated in the rally.  These are signs that the technical picture has improved substantially.  The index is poised to challenge the bull market highs.  Shorts are getting decimated.  Money managers are hopping on board as seasonality is supportive of positive returns to finish the year (Santa Claus rally!), they don’t want to miss the boat! —(S&P 500 below)

+ Yet more signs that the global economy remains on firm footing: Caterpillar (CAT) scores an A+ in its earnings release, reporting a net income/share of $1.71 vs. estimates of $1.57, while guiding higher in its forecast.  Order backlogs remain at an all-time high;  China’s always salient flash PMI moves back into expansion territory, rising to 51.1 from 49.9.  Even better, more signs surface that inflation has indeed peaked and Mr. Wen has signaled a in shift in policy, geared more towards growth.  No hard-landing in China = supported global growth picture.  Copper rockets over 11% this week.  Even Japan gives investors good news with September exports rising by 2.4% YoY vs. estimates of 0.4%, while household spending came in better than expected and the unemployment-rate fell.    

+ While the headline was negative, Durable Goods Orders showed broad strength under the hood.  Orders excluding transportation were up 1.7%, better than the 0.4% expected by analysts, while business capital investment rose 2.4% (this data series just hit a new all-time high).  Furthermore, we have the American Trucking Association (ATA) announcing that September’s tonnage index rose 1.6% after a revised -0.5% reading (was -0.2%).  Chief Economist Bob Costello believes that the economy will skirt another recession.  None of these data points are pointing to a double-dipping economy.  The manufacturing sector is hanging in and remains very resilient.      

+ There are more signs that the Fed is close to stepping up to support market sentiment and the economy.  William Dudley, Fed Vice Chairman, is echoing earlier speeches by Fed members Tarullo and Yellen last week on a possible QE3.  It’s a fantastic time to go long the market and commodities in particular (due to China’s soft-landing).  When will the bears understand that you “don’t fight the Fed”?  

+  New Home Sales popped 5.7% and inventory fell to the lowest in over 6 months as supply continues to whittle down.  Lower supply will eventually lead to stabilized prices and consumer confidence.  Additionally,  changes to the Home Affordable Modification Program (HAMP) will help make refinancing more accessible and streamlined.  Other programs to unclog the financial arteries related to the housing market are being discussed.  Slowly but surely the housing market is healing.  Have you seen homebuilding stocks lately?!      

Bear

- Consumer confidence as per the Conference Board plunges in October to the lowest since….(drum roll)…. March ‘09.  Both current nor future conditions are spared; the former dropping from 33.3 to 26.3, while the latter falls from 55.1 to 48.7.  Job-related measures also show deterioration with “jobs not so plentiful” rising to 49.5% from 45%.  Meanwhile, the Bloomberg Consumer Comfort survey corroborates.  Not the results you want to see headed into the holiday shopping season.

- The bull’s thesis that the global economy remains on firm footing belies the true nature of the recovery’s condition (or lack there of), especially when looking at the latest Eurozone Services PMI data.  October’s measure shows contraction for the sector at the broadest pace in more than 2 years (47.2 from 49.1). More austerity coming down the pipe doesn’t bode well in the months ahead.  While “CAT” may have scored an A+ in its earnings and outlook, a slew of other companies (one of them being 3M) don’t see the same scenario in the coming quarters.  Officials in Hong Kong report the country’s first drop in exports in almost 2 years and see the outlook as “bleak”.  India is dangerously approaching stagflationary conditions, evidenced by their recent rate increase coupled with a downgrade of their GDP forecast.  Japan downgrades its growth forecast as well.  

- Let’s simplify the opprobrium with regards to the Eurozone’s latest bailout (nitty gritty can be seen here).  1st) it fails to respect the laws of mathematics, such as factoring out pre-existing commitments and guarantees that won’t be paid (“stepping-out guarantors”: Greece, Ireland, Portugal, Spain, and Italy); 2nd) it fails to account for historical first-loss rates of 50% for sovereign defaults, not the 20% agreed; 3rd) it fully eliminates the possibility of Belgium getting its rating slashed, which would eliminate their contribution to the bailout fund—-we’re not even considering France yet, even though the OAT/Bund spreads are close to record highs; and finally 4) It decimates the Sovereign CDS market, which has its own unintended consequences.  The best method of protection now is simply not to buy/provide credit, or outright selling/shorting of sovereign bonds.   On a side note, this bailout result for Greece becomes an incentive for other countries who have fallen on hard economic times to demand the same treatment.  ”Why should we suffer when they got rewarded for not fulfilling their austerity promises?”.  The circular nature of this plan, the faulty math, and its the rosy assumptions make it unequipped to handle even a slight deterioration in the economic landscape; for instance, a recession in Europe (which would jeopardize France’s AAA rating), or a highly probable downgrade in Belgium.  The Chinese aren’t confident and are prevaricating in their commitment to fund the rescue.  To drive this whole point home, there was little follow-through from Thursday’s rally and doubts are already resurfacing.  

• On the subject of Italy, do the bulls really think that officials are serious about implementing the “required” austerity?  One of the “famed” proposals is to increase its retirement age from 65 to 67 by the year 2026.  And to achieve that, a fight broke out in the legislative chamber; imagine what actual near-term austerity would do.  Most importantly, the Italian sovereign debt market didn’t bite on the solution.  An acute sovereign risk remains.  

- Governments are incapable of allocating a nation’s resources.  These are the results of their actions.  And now they just doubled down by leveraging up to save a failed Euro experiment.  Europe, you are not defeating the speculators, you are making them stronger.  The specious plan of leveraging the EFSF is only working to infect the core of Europe and more importantly is beginning to seed a dangerous sense of nationalism as continued demanded austerity is slowly being seen as a (il)legal act of war.  The more hardship there is (Spain Unemployment just hit the highest in 15 yrs), the more fervid this sentiment it will become.  

-  Do you want to put stock in some PMI survey gauging peoples’ perceptions of the Chinese economy, or do you want to see hard evidence of a slowdown?  Here’s some disturbing activity in the property market.  The bubble is popping.  Time to choose one of two fatal poisons for the Communist party, Mr. Wen.  Clamp down on credit and you get increased protests as people’s life savings vanish as the property bubble pops leading to a subsequent collapse of the economy; or stimulate, leading to wage/panic-induced inflation spiraling out of control.  Material Yuan appreciation seems to be out of the question, to the chagrin of Congress.  Clock’s ticking Mr. Wen.  One thing you might want to remember is that the Fed is pondering another QE experiment (ie. exporting inflation).  Just thought you’d like to know. 

- A dangerous escalation took place between government authorities and “Occupy (You name the city)” movement.  The trend of this campaign is moving toward violence, not compromise. The country’s politics fell into disrepute long ago, but this may take it to a whole new level.  Politicians better start doing something and soon.