Global Gl b l Tactical T ti l A t Allocation Asset All ti
GTAA Macro
First Quarter January 9th , 2009 Damien Cleusix d i @ l 6
[email protected]
Clue6
First Quarter 2010
Quotes
1
“It’s frightening to think that you might not know something, but more frightening to think that, by and large, the world is run by people who have faith that they know exactly what’s going on” A. Tversky
“The best investors do not target return; they focus first on risk, and only then decide whether the projected return justifies taking each particular risk” S. Klarman
“Risk means that more things can happen than will happen “ E. Dimson
“The more you bet, the more you win…when you win” Las Vegas saying
Clue6
First Quarter 2010
Executive Summary
2
Macro The collapse has been avoided thanks to the resolve of Central banks and governments around the world but we will still have to deal with the aftermath of the biggest credit bubble in history. history They have managed to prop up assets prices (buying them, them changing accounting rules and providing huge amount of emergency liquidity) and lower interest payments pushing debt to asset lower and improving interest coverage but they can not do this forever… The recession which p probablyy ended sometimes during g the summer was not a typical yp inventory-led y one were more that 75% of the decline is due to de-stocking. It was the beginning of a "balance sheet" recession which is going to haunt us for many years with poor growth and intermittent relapse into recession (here we are talking about developed leveraged countries, financially unleveraged developing countries will suffer because of their operating leverage but will end up as winners if they do the right reform) The deleveraging process in unavoidable. Analysts have spent a great deal of time commenting on the collapse of credit availability but we think the biggest problem for growth in the medium-term will be a lack of credit demand. Many households and companies have realized that they could go under and they are going to build a buffer... Nationalism and protectionism will gain in popularity while there is a big risk of regulators going on a rampage (we see a strong risk of this cyclical ERROR like the commercial banks reserve increase in the 30’s or the VTA hike in Japan in the 90’s here) after doing too little for so many years…Populism will be a winning strategies for politicians, even more than before… The current macro data has surprised on the upside with the success of the cash for clunkers schemes around the world (which probably added up to 4% to US growth in the third quarter), various forms of help for first time home buyers, the socialization of the credit market in the US and Europe or the credit explosion in China... We continue to see the current improvement as a normal snap back from the worst macro environment since the 30's. It should not be confounded with a strong recovery.
Clue6
First Quarter 2010
Executive Summary
3
The traditional swing factors I.e. inventories, residential investments and autos which have historically accounted for almost all the volatility in GDP are not expected to have the same impact as in the past (and the autos part is probably already behind us, us in the US and Europe at least). least) Consumption should continue to be a drag in the developed world for some times. Aggregate disposable incomes and net worth evolution and their influence on savings should be followed carefully as they will be the keys on how quickly the consumption p behavior will change. g The fate of the current recovery hangs on the exit strategies for the monetary and fiscal stimuli, how the financial markets will interpret them and the unavoidable errors which will be made… Fiscal Stimuli have been helpful but their long-term effect will be sub-optimal as long as they are considered as a shortterm fix and that they are not constructed to foster future productivity and labor market growth. Much more is needed as they have, for the moment, only been able to compensate for the loss of other income in the US. Central Banks will have to first give clear guidelines on how they are going first to exit the qualitative phase of their easing now that markets have normalized. They should do the same for the quantitative part. The QEs were legitimate (even in our eyes...) to avoid a total freeze and collapse of the credit markets and a debt deflation dynamic to develop but not otherwise. Deflation is still a real risk (we would even say a fact…) and we would thus like to see the quantitative part continuing a bit longer. Central Banks might even start charging instead of paying interest on the reserves they hold on behalf of the commercial banks. This would encourage them to put the money elsewhere into the economy. The Swedish Riksbank has started such a scheme and the BoE is discussing the same...
Clue6
First Quarter 2010
Executive Summary
4
Expect macro numbers to continue to move in the right direction (and in the next 3-6 months the rate of change is likely to be increasingly positive as it will be calculated against 12 month old data...) until Q2 2010 at least. After that… we should remember that we are living in the aftermath of the biggest credit bubble in history. This does not necessarily imply a double dip as much will depend on the behavior of households and the impact of fiscal and monetary authorities policies or lack of policies... Europe should be the focus of your attention as there is a high probability that the next “crisis” will have its epicenter there… In the next few years the world economy will be more volatile than in the 20 years pre-2007… with dramatic consequences on assets valuation ratios (cheap tomorrow will be much cheaper than what was deemed cheap between 1990-2007)…
Clue6
First Quarter 2010
Macro: The Causes of the Current Crisis – Another Repeat
5
Once more, but needed to put the rest of our macro analysis into perspective… The NYT recently published an article by R.Shiller titled "An echo Chamber of Boom and Bust". He wrote: "What happened? Economic analysts often turn to indicators like employment, housing starts or retail sales as causes of a recovery, when in fact they are merely symptoms. For a fuller explanation, look beyond the traditional economic links and think of the world economy as driven by social epidemics, contagion of ideas and huge feedback loops that gradually change world views. These social epidemics can travel as swiftly as swine flu both spread from person to person and can reach every corner of the world in short order." That's it... At turning points, markets trends change as the investors universal beliefs are proven wrong while during trends the markets make the opinion... At turning points, the triggers are often hard to identify (in hindsight it always seems a self evidence). It is thus important to try, as much as possible, to identify the potential triggers before they occur. Finally the key is to see how the markets react when they happen to see if they really are the “turning point”. Market perception is the key and the less it can discount the consequences the larger the consequences… What did cause the current crisis? Since the Spring of 2006 we have been warning that the credit build up the world economy (mainly US and Europe) was experiencing would lead to a major shift in governments, banks, investors and consumers perceptions and behaviors. A shift that would be a generational event (so it should last for approximately pp y a ggeneration). ) Regulators g would wake up, p banks behave like banks, investors rebalance, byy reason or constraint, their portfolio toward less risky assets and consumers spend less than what they earn. The chain of events have unraveled as expected and should continue to do so. As with every trend, this development will not be linear and we will have phases when investors will believe that the sky is the limit but they will be proved wrong. We will surely see some bubbles develop and pop along the way but the wash out will take much more time than one thinks. (As we said some emerging economies will be able to do quite well if they have the courage to make the necessary domestic reform and let Bretton Woods 2 die away) This credit bubble was a bad bubble...It was mainly financed by banks and impacted unproductive assets, houses. The end result is that banks can not lend while there has not been any addition to the productive capacity… This bubble will also generate new regulations which will imperil financial innovations in the future (some will be good and necessary, some bad) and lower banks capacity to lend. Money velocity will decline…
Clue6
First Quarter 2010
Macro: The Causes of the Current Crisis – Another Repeat
6
The bubble was born out of the belief that Central Banks had tamed the business cycle and that they would use any means to prove it. Yes, technological advances, the imagination of the investment banks and hedge fund quant desks or the semi-coma in which regulators seemed to have fallen allowed it to reach unheard of proportions but without this deification of Central Banks it would not have reached such a monstrous size. Apparent, believed stability, led to too much risk being taken and instability. A. Greenspan called it the "Paradox Paradox of Credibility Credibility“.. The confidence in the system has now been eroded but not as much as one would have expected... Indeed, many believe that the Fed has saved the day… once more. The bubble also submerged g a high g number of countries,, enterprises p and individuals with debt obligations g which can not be p paid or onlyy byy living frugally and probably killed the “consume now save later or never “ mentality which was prevalent in many developed economies ex-Japan. Borrowing will be a dirty word and consumers will retrench to build up their savings. Finally it led, by artificially lowering the cost of capital, to a global expansion of capacity which is going to haunt us for some time. Overcapacity p y will dramaticallyy reduce the “earningg ppower “ of the gglobal economy, y, especially p y where the operating p g leverage g is high. g This will in all likelihood encourage new protectionist measures around the world (not to be compared with the 30’s but…
The consequence will be what Pimco’s B.Gross calls the “New Normal” I.e. deleveraging (both financial and operating), deglobalization and reregulation… g But now for the present and near future... We continue to see the current phase as simple normalization from the panic experienced at the end of last year and earlier this year on the back of an aggressive rise in excess money (monetary expansion over GDP growth or industrial production) and huge fiscal stimuli (even if beside China, a big chunk of the announced stimuli is yet to be spent). The impact has been much stronger on non-financial leveraged economy were the multiplication effect was in full swing (and was also helped by some government directives in less democratic countries like China). Trade was frozen as letters of credits could not be emitted, companies panicked slashing down production (with industrial production falling much more rapidly than sales) and laying off workers en masse. The latter point applies especially to the US. So now let's look at the various elements in more details…
Clue6
First Quarter 2010
Macro: Leading Indicators Chart 1
7 US Leading Indicators Smörgasbord
Chart 2
We are starting to see some divergences appear in leading indicators (Chart 1). The Chicago Fed National Activity Index YoY momentum has turned down. The same is true for the NFIB index (and we will have more to say on small companies latter...). The NFIB current level is consistent with an ISM manufacturing Index of 44... almost 10 points below current levels… levels The non-manufacturing ISM is continuing to print significant lower reading than the manufacturing survey. This is an excellent leading indicator of the ISM manufacturing survey
S Source: Bloomberg, l b Clue6 Cl
as noted last September and imply a continuing deterioration here...
Japan ,Euro and China Leading Indicators ISM Manufacturing New Orders to Inventories Ratio
S Source: Bloomberg, l b Clue6 Cl 6
Chart 3
US Real-Time GDP Estimation
The Conference Board leading indicator monetary and financial indicators remain strong while the real economyy indicators are risingg much less vigorously... g y The Japan Economy Watchers Expectation survey has continued to deteriorate (Chart 2). Remember that Japan is leveraged to the global cycle and has tended to lead other countries (note that the Yen strength should also be taken into account... so maybe not as bearish as otherwise...). As an aside, the Topix correlation with this survey is extremely high so use it when looking at your Japanese market exposure… All in all, growth expectation could be too low for Q4 2009 and Q1 2010 while the expectation for Q3 2010 and forward are probably too high... but a lot depend on the evolution of the fiscal stimuli, the Central Banks stance and, partly as a consequence, when the next shoe, probably Europe, drops...
Clue6
Source: J. J Hamilton
First Quarter 2010
Macro: Leading Indicators Let's call them the swing factors. They are inventories, residential investment and autos. They might represent a low percentage of the overall GDP but believe it or not they have contributed to all of the GDP decline in previous recession before the current one (without them we would not have had a recessions…). recessions ) They also contributed to a big part of the initial rebounds (Chart 4)... 4)
8 Chart 4
US GDP and Swing Factors
Inventories have less influence as they represent a smaller share of GDP and they remain high (Chart 5). But one has to remember that it is the inventories quarterly rate of change which counts so even if inventories continue to decline in Q4 they will only have to decline less than in Q3 to have a positive contribution to GDP… They will add up to 4.5% to the growth announced for Q4 2009 and Q1 2010. Note that ISM inventories indices are falling again (to 8 months low) despite the fact that the supplier deliveries is above 50… Inventories are hard to finance which leads to potential sales lost… For autos,, the cash for clunkers scheme ((and similar pprograms g in Germanyy and other countries)) has, beside encouraging people to take on more debt (yes more...), pushed forward future sales. This is the past, history and the only lasting mark is a relative increase in consumer leverage and some auto manufacturer stocks slowly becoming attractive short again (Ford, Fiat,…)
S Source: Morgan Stanley S l
Chart 5
Census Bureau Businees Inventory to Sales Ratio
Residential investment is not likely to be a major drag for future growth now that it represents 2.3% of GDP from a 6% peak and a historical 4.5% average but the first time home buyer tax credit has been extended both in time and scope which will be helpful. Previous rebounds have been the result of short supply and as we will show later, supply is plentiful even if the visible one has decreased substantiallyy in the p past few month, courtesyy of the tax credits... Let's not forget that the last 2 factors are usually debt-financed and debt is harder to come by these days (and actors not necessarily willing to borrow… see balance sheet recession later)...even if governments are directly or indirectly lending money.
Clue6
Source: Bloomberg, Bloomberg Clue6
First Quarter 2010
Macro: Leading Indicators It leaves us with government spending, private investments, consumption and export...
9 Chart 6
US Fixed Investment to GDP Ratio
Government spending and consumption will be analyzed in more details later. We will show that ggovernment spending p g will have a major j ppositive impact p in the short-term but then… while consumers spending, while it might continue to rebound in the medium-term, will slow again as soon as their net worth starts to decline again… Private investment have been declining rapidly recently (Chart 6). This is a global phenomenon for developed economies. Even in Japan, the perennial "over-invester", fixed capital investment as a percentage of GDP have declined to 20% from 24% a year ago and a 32% peak in 1991. In the US there are no net private investments (Chart 7)... despite the fact that companies have a positive financing gap. This is typical of balance sheet recession where debt reduction is more important than profit maximization... S Source: Bloomberg, l b Clue6 Cl 6
Anyhow, we should witness increase capex in the quarters to come with the Conference Board CEO Confidence index recently rising above 60 which is consistent with YoY 8% capex growth in the quarters to come...
Chart 7
US Net Private Investments
For exports, we might have a positive surprise given the very low USD and the fact that the US labor force has declined much more than the GDP while it has only declined by 1% in Europe and UK and 2% in Japan. Higher productivity, lower currency and companies eager to find new market to compensate for the sluggish domestic one, what more could you ask for... Source: Morgan Stanley
Clue6
First Quarter 2010
Macro: Trade Global trade has finally started to rebound with growth accelerating in the recent past (Chart 8). It is still 14% below the April 2008 peaks but the September MoM increase was the biggest on record…
10 Chart 8
World Trade Volume
We thought the decline was exaggerated by the almost impossibility to get letters of credit for trade late last year and that it would warrant at least a small snap back… so far so good… Export growth in South Korea (more timeliness and strong correlation with the world trade data) has continued to improve but the recent rebound into positive territory is mainly due to the base effect (November last year was horrible). horrible) In fact export are lower today than in September… September Manufacturing companies have been underperforming relative to the KOSPI for some time and it has been a good leading indicator of deteriorating exports… The underperformance has accelerated recently… S Source: Netherland h l d Bureau for f Economic i Policy li Analysis, A l i Clue6 Cl 6
Protectionism has been again on the agenda recently (many fiscal stimuli had a buy domestic bias but this was not a bilateral measure so less likely to make the front page). We are also seeing a lot of new capital control measure being instituted (Brazil, Indonesia, South Korea, Taiwan, Russia…) and some devaluation (Vietnam).
Chart 9
South Korean exports
Expect this trend toward greater protectionism and/or competitive devaluation (even the SNB does it nowadays) to continue going forward, especially when the growth cycle will turn down again...but do not expect a return to the 30’s tariffs and trade wars… Remember that protectionism is one of the five government cardinal sins according to Charles Gave. The others are war, monetary policy mistakes, increase regulation and tax hikes. We will have more to say on them later… Source: Bloomberg, Bloomberg Clue6
Clue6
First Quarter 2010
Macro: Credit Since last year, we have used R. Koo's "Balance Sheet Recession" framework.
11
Balance Sheet Recession
It was developed d l d when h analyzing l i the th economic i agents behavior following a credit bubble (see "The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession“ by R.Koo). In this environment, environment household and business reduce their debt despite massive monetary accommodation as many individuals and companies have bigger liabilities than assets. The economy relapses every time the government tightens its belt as has been the case in Japan during the past 20 years Stimuli can only been removed when the deleveraging phase is completed and balance sheets are repaired… … but unfortunately government in the US, Europe and Japan won’t have the luxury to wait wait… The markets will force them (and the stronger the recovery the quicker government will feel the market pressure) to put their finance in order (if it is possible… which we doubt on a longer-term perspective with the potential exception of the US)
Clue6
Source: The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession, R. Koo
First Quarter 2010
Macro: Credit The west is overleveraged… and it will take a lot of time for leverage to normalize… Welcome to the “balance sheet recession”…
12 Chart 10
Bank Credit to the Private Sector
Chart 11
US Household Debt Burden
There are many metrics one can look at as for example bank credit to the private sector as a percentage of GDP (Chart 10) or the household debt to total asset (stock) and personal disposable income (flow) (Chart 11). Note that households would have to pay back USD Tn 4.35 to get back to their 1990-2000 average leverage... and that is hard for them to lower their leverage quickly except by using personal bankruptcy so this will be a long story... S Source: Morgan Stanley S l
On Chart 12 and 13 one can see that the credit markets have mostly normalized from the panic levels of late last year…
Chart 12
Euro and US Libor-OIS Spread
S Source: Bloomberg, l b Clue6 Cl 6
Chart 13
Moodys BAA Spreads
We are even seeing W i new issuances i off cov lite lit (few (f conditions attached), pig toggle (debt principal and interest paid with more debt) or dividend recaps (debt to pay dividend) bonds and loans. We are also seeing new CLO tranches being launched. I Investors t memory mustt have h shorten h t even more than what we feared… As in 2007 look attentively when PE firms come to the market to sell the shares they own or even better when they become public company (some have yet to do it)…Blackstone marked the peak in 2007… Clue6
S Source: Bl Bloomberg, b Clue6 Cl 6
S Source: Bl Bloomberg, b Clue6 Cl 6
First Quarter 2010
Macro: Credit Bank are still tightening credit standard in the US (Chart 14) and Europe (none are easing…) while demand remains low (Chart 15).
13 Chart 14
Fed Senior Loan Survey C&I Credit Standard Tightening as a % of Total
Chart 15
Fed Senior Loan Survey C&I Credit Demand Increasing as a % of Total
Small companies are feeling especially hit. Did you know that 82% of small companies consider credit card has a vital form of financing along with loans from local banks… Credit card line have already been cut from usd 4.7 tn. to 3.5 tn. and they are expected to decline by 1.5 tn. more in 2010… Local banks will be hardest hit by the coming wave of default (commercial real estate which represents up to 40% of the loans’ book, loans to companies,…)
S Source: Federal d l Reserve, Clue6 Cl 6
Chart 16
NFIB Expected Credit Conditions
S Source: Federal d l Reserve, Clue6 Cl 6
Chart 17
Consumer Credit Outstanding % Change YoY
The NFIB credit condition index which measure loan availability compared to 3 months ago is at 15 just 1 point away form the all time low of 16. 29% of companies said their borrowing needs have been satisfied (one of the lowest reading in the history of the dataset while 10% responded that they were not (same level as in March 2009…)) Consumer credit, revolving and non-revolving is declining at a historic rate (Chart 17). Even the amount of mortgage outstanding is declining... Source: Bloomberg, Bloomberg Clue6
Clue6
Source: Bloomberg, Bloomberg Clue6
First Quarter 2010
Macro: Credit Mortgage rates are kept down thanks to the origination spree of government-backed entities (with the FHA taking the lead) (Chart 18) and the buying of the emitted paper by the Fed (which has already bought more than usd 1 tn. of the usd 1.2 tn. it has said it would buy before the end of Q1 2010). “In the fourth quarter of 2006, approximately 10% off originations in our sample l were labeled l b l d by b originators as "subprime." For the entire universe of mortgages, subprime loans are estimated to have made up about 20% of originations in 2006. By the first quarter of 2008, the subprime share was effectively ff ti l zero. Since Si th increased then, i d FHA
14 Chart 18
Investor Type Share of New Loan Originations
Source: “Recent Developments in Mortgage Finance “, J. Krainer , Federal Reserve Bank of San Francisco
Chart 19
Scheduled Mortgage Resets
Source: Credit Suisse
Chart 20
US Loan Loss Reserve
lending—identified here by Ginnie Mae's share—has revived this segment of the market…. he share of borrowers with FICO credit scores lower than 660 has returned to just higher than 20%, the same share as when subprime securitization peaked in 2006 2006” (J. Krainer) Delinquencies are still rising and we are entering in the second phase of exotic mortgage resets (Chart 19) which will have a dramatic impact (bank loss, increase in foreclosure,...). A relapse is a possibility (but not a certainty). In this regard one has also to note that many great investors (D. Tepper, L. Ainslie) and some of the most prominent member of the "those who saw it coming" group (J. Paulson...) are positive on the large bank stocks... So the jury is still out... We will have to monitor carefully bank relative performance (stocks and CDS)... Source: FDIC
Clue6
First Quarter 2010
Macro: Credit There are other risks one should keep in mind…
15 Chart 21
High Yield and Leveraged Loans Refinancing Needs
Regulations imposing lower leverage on banks, minimum standard funding liquidity, counter cyclical capital buffer or off balance sheet entities ban will lower lending capacity and could cause a new wave of volatility in the markets. FASB 166-167 which should start to apply during Q1 2010 will bring back more than usd 500 bio. off balance sheets assets into the "big 4" sponsoring entities balance sheet in the US (and we now know that SIV assets can be of dubious quality...) Basel II should also start to be implemented at the start of 2010. When one see that Japanese banks can rise more than 10% on an article implying that the rules implementation might be delayed, one can see that they won't be optimal on a bank profit maximization angle... The imposition Th i iti off compulsory l contingent ti t convertible tibl debt d bt for f banks b k andd the th affirmation ffi ti that th t government assistance will only be junior to depositors would also increase banks funding costs…
S Source: Barclays l
Chart 22
Banks Debt Average Maturity
There is also the refinancing risk with refinancing needs rising strongly just when government andd central t l banks b k will ill be b forced f d to t tighten ti ht the th grip i by b markets k t (well ( ll governmentt att least)... l t) 10% of the US high yield market will mature in 2011, 15% in 2012, 17% in 2013 and 20% in 2014. In 2014 alone usd 350 bio. of high yield and leverage loans will have to be refinanced in the US and eur 60 bio. in Europe (Chart 21)… Some insiders are predicting that up to private equity owned companies, employing 3.75 mio. workers, will go under between 2011-2015 (“The Buyout of America”, J. Koshman) as they struggle to refinance the almost usd 1 tn. dollar that will come due... Banks debt average maturity has also declined from 7.2 7 2 years 5 years ago to 4.2 4 2 years today. today Usd 7 tn. of their debt will mature by the end of 2012 (Chart 22)... Clue6
Source: Moodys
First Quarter 2010
Macro: Credit Emerging markets refinancing needs will also be very important (especially in Eastern Europe) (Chart 23). One has also to take into account the need to finance the budget deficit on top of that and here again, Eastern Europe come into mind...
16 Chart 23 External Debt Refinancing Needs
On Chart 24, one can see that European banks are most exposed to this risk, with more than 75% of the loans to emerging markets. We have long argued that the next phase of the crisis will have its epicenter in Europe... There are sovereign problems (Greece, Spain, Irland, Italy, Portugal, Austria), banks have been much more timid to recognize their loss than their US or Japanese counterparts and are very exposed to Eastern Europe (which will experience an Asia 97-98 like crisis... not a question of if but when...). S Source: S Source: ““World ld Economic i Outlook” O l k” , IMF, April A il 2009
Furthermore as we will see later, European government are likely to tighten their budget first, European companies are less competitive (high currency, not enough firing,...) and the housing bubble has yet to pop.
Chart 24
Liabilities to Advanced Economies’ Banks (% GDP), 2007
The market is now starting to realize the sovereign problem with Greece (but it is just a beginning) and the bankruptcy of Hypo Group Adria (HGAA) in Austria is putting European Banks and their Eastern Europe exposure back on the table. Note that while HGAA might seem small, for Austria it is equivalent to a bank with usd 2.5 tn. in assets... Will a bank bankruptcy in Austria be one more the first domino to fall... fall remember Kredisanstalt in 1931... As always, once we have identified potential risks, our role will be to monitor the indicators which will show if they materialize...
Clue6
Source: IMF
First Quarter 2010
Macro: Inflation
17 Chart 25
US Core CPI and Unemployment Rate Momentum
Deflation... Inflation is low (Chart 25) and with the deleveraging induced fall in money velocity, going to fall further. The ECRI future inflation gauge, unemployment momentum (Chart 20), falling rent (30% of the CPI) are all pointing toward outright deflation next year. year This will be the Kondratieff's "fall from plateau" we described in the past... With deflation nominal incomes are likely to decline or only grow slowly, increasing the need to pay back debt. Real rates will also be positive even if nominal ones are at 0… But as J. Bullard, president of the St. Louis Fed, recently said, productive capacity might have fallen (our no net investment graph before and the fact that many of the job losses are not cyclical are confirming this hypothesis), the output gap might be much lower than what is currently believe… S Source: Bloomberg, l b Clue6 Cl 6
Psychologically one should also take into account that the base effect will be negative in the months to come (rapidly declining price 8-12 months ago). We could have 5-10% inflation rate on a YoY basis in some emerging market countries (India,…)… Will be interesting to see of the Central Banks and markets react… Especially if food prices continue to rise (remember 2008 and the consequence it had in emerging markets…) But ultimately we still think that deflation will prevail… when we relapse at the end of 2010 beginning of 2011… A potential scenario, as in 2008, would be an initial inflation scare (with rising inflation expectation, which will pave the way to a new phase of deflation)
Clue6
First Quarter 2010
Macro: Consumers – Employment The broad Th b d U6 unemployment l t rate t had h d improved i d somehow (Chart 26) while job opening have, at least for now, ceased to fall (Chart 27).
Chart 26
Broad U6 Unemployment Rate
18 Chart 27
US Job Openings By Industry Total and Temporary Help Services
As said in our last 2 presentations, one should not put too much weight on those 2 numbers as they are lagging. We prefer to look at the number of hours worked and the temporary help index. Indeed, firms will first move workers from parttime to full-time full time and overtime employment, employment increase labor hours and hire temporary workers before hiring new workers. Both have been improving recently (Chart 27). The Conference Board Employment Trend Index has also turned up up... Nevertheless both the duration (Chart 28) and the percentage of unemployed not on temporary layoff (Chart 29) indicate that there is a fair amount of structural losses (credit related jobs created during the boom are gone...)... Did you know that there has not been any net private job creation in the past 10 years in the US Yes productivity has been rising fast but what US... if it ceased to be a major driver of growth (as we expect... it has long cycle and we are near/at the top)... In 2007 we wrote that the US potential growth was overestimated... It still is... and we prefer not talking about Europe... while for Japan it is so low that we are almost certain that it will grow quicker than estimated… Clue6
S Source: Bloomberg, l b Clue6 Cl 6
Chart 28
US Unemployment Duration Over 27 Weeks % of Total SA
Source: Bloomberg, Bloomberg Clue6
S Source: Bloomberg, l b Clue6 Cl 6
Chart 29
Percentage Of Unemployed Not On Temporary Layoff SA
Source: Bloomberg, Bloomberg Clue6
First Quarter 2010
Macro: Consumers – Employment
19 Chart 30
Distribution of Net Gain in Employment
Small companies (less than 500 employees) are employing 65% of the US workforce (Table 1)... In the past 18 months, the smaller companies (less than 50 employees, less than 30% workforce) have accounted for 45% of the job losses while in the previous recession it lost only 9%... Given the readings of the various NFIB survey components, they do not seems to be ready to hire... This is a development to follow closely as it is different than previous cycles... Nevertheless, the employment picture should improve in the medium-term (the models presented in September is still indicating net job creation for Q1 2010). Do not forget that the government will ill hire hi up to 1.5 1 mio. i persons for f the h 2010 census (this ( hi could ld add dd up to 700'000 00'000 jobs j b to the h May nonfarm payroll), those jobs will be temporary but sometimes the market see only what it wants...
S Source: BLS, S x
Table 1
Employment Distribution
Longer-term the job picture is grimmer...but we will analyze this in due time as it does not really influence the near-term markets movement
Source: Clue6, BLS
Clue6
First Quarter 2010
Macro: Consumers – Disposable Incomes
20 Chart 31
Aggregate Income and Consumption
The correlation between wage growth and consumption has been high historically (Chart 31). Consumption can only deviate from incomes if savings are drown down and/or credit is contracted… Aggregate paycheck should increase in the next quarter or 2 at least so this will support at least some consumption (but note how depressed it is)… Then… the balance sheet recession dynamic will prevail and consumption will grow less than aggregate income… There are other important elements to take into account to get to the personal disposable incomes aggregate... Indeed total personal disposable income is composed of: compensation of employees received (~68%), Proprietor Incomes (~9%), Personal interest and dividend incomes (~16%), Personal current transfer receipts ((~15%) 15%) from which one has to subtract the contributions for government social insurance (~8%) less taxes which are less tan 10% today.
S Source: Bloomberg, l b Clue6 Cl 6
Chart 32
Disposable Incomes Growth Components
As one can see on chart 32, transfer and tax cuts have added more than usd 670 bio. (290 and 380 respectively). Without those contributions, disposable income would now be more than 5 % lower than 12 months ago... Note that Americans are now receiving 2 times more in transfer that they are paying in taxes… It is doubtful that taxes and transfers contribution to total disposable income will continue to have the same positive contribution going forward. They might stay where they are but will not add usd 670 bio. more next year… Wage growth will thus be determinant as proprietor income and personal interest are likely to continue to fall while dividend incomes could rise some but not much… But there are other elements impacting disposable income and its discretionary use... Source: Bloomberg, Bloomberg Clue6
Clue6
First Quarter 2010
Macro: Consumers – Disposable Incomes On table 2, courtesy of Goldman Sachs, one can see the various elements which can impact discretionary disposable income.
21 Table 2
US Household Discretionary Cash Flow Sensitivities
Commodity C dit prices i can have h a non-negligible li ibl impact. i t We W have h l long said id that th t last l t year’s ’ financial fi i l crisis masked the negative impact commodity prices had on global growth... We might have had a commodity price induced recession even without the financial crisis... At usd 2.6 per gallon unleaded gasoline is usd 1 higher than at the start of the year and much higher than the level which were deemed to be impacting consumption negatively pre-2005. It has removed usd 110 bio. bio out of the consumer’s pockets. pockets Credit which we talked about earlier is removing usd 25 bio. for each % point of decline so given the current 3.5% decline it has already removed usd 90 bio. Source: Goldman Sachs
The other main element going forward will be savings (Table 3). 3) Will US households start to save more or not. If one regresses net worth to saving, savings seems to be were they should. Table 3
Our contention has been that the bursting of the credit bubble would change mentalities for a generation at least. Never before have they seen what over-leverage could do. They might have heard about it but there is nothing better than real experience to grasp an abstract concept... concept So our most bullish guess is that saving will rise to 5-7% next year and disposable income will fall 1-3%. The impact on GDP will be between 2.46-5.98%. One could add a 0.5-0.75% impact from continued consumer credit fall for a grand total of 3-6%. If we were forced to we would bet that we will be in the middle range... range Ceteris paribus, paribus the non-private consumption GDP components would have to add as much for GDP to be flat...
GDP Change given Various Personal Disposable Incomes and Saving Rate
Source: Clue6
So going forward we will have to follow closely how total compensation evolves... For the saving rate net worth , perceived or real, real will be one of the key so... so
Clue6
First Quarter 2010
Macro: Consumers – Wealth Nett wealth N lth has h risen i b usdd 5 trn. by t during d i the th pastt 2 quarter (Chart 33).
Chart 33
22 US Household & Nonprofit Organizations Net Worth
Chart 34
Ratio US One Family House Sold Annual Median Price to Median Household Income
The net worth to GDP ratio is once again hovering above 4... As we said this ratio is expected to fall to 3.2 3 2 or below before any structural bull market can start... This implies a >20% decline in net worth (depending on the timing) to come or approximately usd 10 trn. The most volatile components of net worth are equities which represent approximately usd 23 trn and real estate with usd 17 trn... As we will explain, we would expect real estate prices to fall 10-15% from current level so equities will have to fall by usd 7-8 7 8 trn... trn Not tomorrow but at some point before this cycle ends...
S Source: Bloomberg, l b Clue6 Cl 6
Chart 35
New Housing start and NAHB Market Index
S Source: Bloomberg, l b Clue6 Cl 6
Chart 36
US House Prices YoY
So why should housing decline more, the downside momentum seems to be abating (Chart 36)? We are approaching fair value (Chart 34) but we are not there yet and with such an overshoot an undershoot is likely (and at this time our 10-15% decline would be too conservative)... Affordability is at an all time high (fine for first time buyers, even more with the extended tax credit, credit but existing owners do not really care except if they want to buy a more expensive house...) Activity is failing to really pick up outside of existing home sales (Chart 35)… The MBA purchase index remains very depressed as are new building permits… Clue6
Source: Bloomberg, Bloomberg Clue6
Source: Bloomberg, Bloomberg Clue6
First Quarter 2010
Macro: Consumers – Wealth As said, there is a large discrepancy between existing and new home sales dynamic... The current improvement is concentrated in new home sales and...for existing home sales, only 29% of current buyers are existing owners, 29% are investors and 43% first time buyers. Only 30% of current sales are non real estate owned (foreclosed) and of those only 31% are unforced... so only 10% of current sales are "normal". Of all the markets it is the low end market which is booming as the rest has yet to recognize that prices have fallen and are trying to postpone sales as long as possible... The higher-end of the market will see much larger price decline... New home are hard to sell (Chart 38)...
23 Chart 37
Visible vs. Pending Month’s Supply
We also have to repeat what we said in June and September... There are 5-8 mios houses sold every year in the US. US The 8 mios units were reached while homeownership rose from 64% to 69% during the pas 15 years (against an historical average of ~64.5%). We expect homeownership to fall back to 64-65% in the coming years which implies that we will have demand for 4-6 Mios houses during this period. If you consider that there are approximately 7 months of sales in inventory, this limits the potential for prices to move up but there is more to this… Indeed, we can expect to have approximately 2 mios foreclosed homes to hit the market on a yearly basis in the next 3 years (Chart 37)…
S Source: First i American A i C CoreLogic i
Chart 38
US New One Fam. Houses Median Nbr of Months For Sale Since Completion
Things could get even worse as US household percent owners equity in real estate has fallen to just above 40% recently. If you consider that, according to the Census Bureau, 32% of house owners did not have a mortgage one can estimate that mortgage owners have, mortgage, have on average approximately 20% equity in their houses. T2 Partners estimates that 24% of mortgage owners owe more than the house is worth (up from 6% at the end of 2007). Moody's estimates is the same. If home prices were to decline by 20% more we would have more than 45% of homeowners underwater... Deutsche Bank forecasts 48% homeowners underwater in Q1 2011... and that this time it will hit the prime market (80% of the mortgage market in the US, 65% for conforming loans and 15% for jumbos). 41% of conforming loans are forecast to be underwater against 16% today (47% vs. 28% for jumbos)... One important element here will be how homeowners react when underwater... In a recent paper Moral and Social Constraints to Strategic Default on Mortgages Mortgages" the authors see that strategic default "Moral (default even if you can afford to pay your mortgage bills) is likely to increase dramatically when homeowners are more than 15% underwater... Clue6
Source: Bloomberg, Bloomberg Clue6
First Quarter 2010
Macro: Governments and Central Banks
24
Source: The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession, R. Koo
Clue6
First Quarter 2010
Macro: Governments – Fiscal Stimuli The US has followed most of the remedies proposed by R. Koo both on the fiscal and monetary side...
25 Chart 39
ARRA Spent Money
As we have said the fiscal stimuli should be oriented toward growth-enhancing investments and should be temporary for the non-productivity enhancing reforms (need a new vote to be prolonged). Th should They h ld be b temporary to limit li i the h increase i off the h reall interest i rate which hi h would ld decrease d the h stimuli effect on the economy. Its main goal should be to increase productivity and encourage people to work, the 2 motors of growth. In the US, many reforms are permanent and as J. Hussman puts it: “…our policy makers have aggressively crowded out private investment through this bailout policy, which allocates good capital to the worst stewards, and they have done virtually nothing to abate the housing downturn.“. Furthermore the cash for clunkers and tax credit for first time home buyers y are encouraging g g present consumption at the cost of investments...
S Source: stimulus.org, i l Clue6 Cl 6
Table 4
With regard to housing we repeat that we favor a debt to equity swaps where over-indebted homeowners would give a participation to the future value of their house in exchange to a diminution to their debt balance today. The more details we get from the moratorium on foreclosure and HAMP program instigated earlier this year, and the clearer it becomes that it is not working... Anyhow for the short-term it is the amount of money which is spent which count (unfortunately) and there are plenty more to spend (Chart 39) and Table 4. Only a third of the ARRA has been spentt to t date d t while hil there th are almost l t usdd 400 bio. bi Extended E t d d provisions ii t come… to And keep in mind that there is a lag between the fiscal thrust and the fiscal impact… When looking at the cyclically-adjusted budget balance (Chart 40, next page), one see that it is expected to improve next year, year but we would not necessarily consider it as a sign of tightening if the improvement is due to a rebound in tax revenues not provoked by a rise in tax rates… Source: Stimulus.org, Clue6
Clue6
First Quarter 2010
Macro: Governments – Fiscal Stimuli The fate Th f off the h recovery later l next year will ill depend d d on the decision of the government. There are 3 main scenarios:
Chart 40 Cyclicaly Adjusted Budeget Balance
26 Chart 41
Cabinet Appointments: Prior Private Sector Experience
“The Liquidation Scenario: decreasing aggregate demand and precipitating a major depression in order to liquidate zombie companies and malinvestment. This would cause a massive wave of defaults and decrease debt burdens significantly through bankruptcy and debt repudiation. or; The Glide Path Solution: increasingg aggregate gg g demand by maintaining government spending while trying to liquidate zombie companies and malinvestment. This would allow the private sector to decrease debt burdens significantly over time through increased savings. It also has the benefit of reducing dependency on foreign sources of capital. capital The downside is a major increase in
S Source: C O Idea: CBO d A.Edwards A d d
government debt, the specter of big government and a long muddle through.
S Source: JP Morgan
Chart 42
Japan GDP Real Chained Price Public Demand SA YoY (lhs) and Topix
The Hoover Status Quo: decreasing aggregate demand and precipitating a double dip recession in order to reduce government deficits. This would cause a wave of defaults and decrease debt burdens through bankruptcy and debt repudiation. Meanwhile they will try to prop up zombie companies and maintain malinvestment. This would simultaneously prevent the private sector from decreasing debt burdens through increased savings and maintain dependency on foreign sources of capital – all without ending the spectre of big government.” (E. Harisson) We will see… the fact that there are few in the current administration with a private sector experience (Chart 41) increase the risk that solution 1 and especially p y 3 will be chosen… But then the market might g force their hand… Keep in mind what happened in Japan every time spending momentum faltered on a 12 months YoY basis…(Chart 42) and spending will have to be cut and/or taxes be raised as soon as the economy show any sign of durable growth. >3% real for 12-18 months) Beside there are 2 elements which needs to be taken into account… account State and local finances and the real unfunded obligations…
Clue6
Source: Bloomberg, Bloomberg Clue6
First Quarter 2010
Macro: Governments – States and Locals
27 Total States Budget Shortfall
Chart 43
Only 2 states have balanced budgets and 9 are in distress... One can almost read daily on California woes in The Journal (and remember California is would be in the top 10 world GDP if it was a country...). Deficits are estimated to reach usd 180 bio. in 2011 and usd 120 bio. in 2012, if the economy recover (Chart 43)... One of our past concern was that part of the federal ARRA stimulus would be used to fill state and local budget. One can see that states and locals expenditure have yet to be cut (well once again if you do not live in California...) because the federal government has been helping (Chart 44). S Source: C CBPP
And do not only look at the recession induced problems but the more structural cost structure with extremely high health care and retirement benefits for public workers and as a consequence the grossly underfunded pension and "other post employment benefits" (OPEB) funds...
Chart 44
States and Locals Tax Revenue, Expenditures and Federal Grant in Aid
So this is not only an income statement problem but also a balance sheet problem...keep an eyes on them...
Source: BEA, x
Clue6
First Quarter 2010
Macro: Governments – Real Fiscal Burden
28 Table 5
Fiscal Imbalance as a Percentage of GDP (2004)
Sometimes we know something is not sustainable, yet it continues in the same direction unabated... There are countless episode of bubbles in financial history and in political history... It continues (and you hear " it has been so in the x past years and we did not have a problem so why worry now...") until... it stops... Could investors and the public start to price the real fiscal imbalance their countries are facing (Table 5, note that this ratio is above 500% for the US too) sometimes in the next few years now that the "traditional deficits" the press is always talking about are exploding? This is a distinct possibility... The consequences will be a big increase in savings as citizens will slowly come to realize that they won't get what they were promised and increase in real rates as even if the system is reformed (increase pension age, lower pension. higher contribution...) it won't be sufficient to avoid a fiscal crisis in manyy countries... Time to realize that the "acquis q sociaux" were not a right but something which the state provided when they could... they can not anymore... A risk to keep at the back of one's head (and as always the market will probably give clear signal when to really worry about it as an investor... but as a citizen it is already too late...) Another area were many emerging markets (ex Eastern Europe and some Latin American countries" have a big comparative advantage...
Clue6
Source: Measuring S M i th the Unfunded U f d d Obligations Obli ti off E European C Countries t i JJ. Gokhale
First Quarter 2010
Macro: Central Banks – A Repeat
29 Chart 45
Fed and ECB vs. Japanese Quantitative Easing
Last year we said that Central Banks would have to become, temporarily, commercial banks in order to avoid an extremely destructive debt deflation spiral. When the market literally closed, spreads p moved so high g where even conservativelyy managed g companies p were facingg bankruptcy p y as they could not access short-term financing. The Fed and the BOE have been exemplary in this regard and have managed to restore some sort of calm to the market. This is not to say that everything is rosy now but that only those who should will go under (another way to say it is that it is OK for the Central Banks to deal with the “confidence problem” but that It should not forget that there is also an important “Solvency Problem”. Spreads should be normalized but not pushed too low. The market should be given back its role of price fixer as soon as possible. The deleveraging phase should start, debt reduced and not only socialized in government balance sheet. Central Banks are now facing a strong dilemma to decide when to normalize and how to communicate it...
S Source: Bloomberg, l b Clue6 Cl 6
Risky assets are rising strongly while the economic recovery is still in its infancy. By tightening too soon they risk killing a weak recovery. By tightening too late they risk re-inflating the same kind of bubble which brought us where we were 6 months ago... Furthermore they also must to take into account that many unconventional measures have been implemented and that there are no prior record on how or when they should be exited... exited The exit should be coordinated with the government so that both fiscal and monetary stimuli are not exited at the same time. This adds another layer of complexity where errors could be made… The Central Banks should first exit the qualitative easing measures. measures Qualitative easing can be defined as changing the mix of the asset side of the Central Banks. One part was active while the other was passive I.e. accessed at the private sector’s discretion. The exit of the passive part should not be considered as tightening but rather as a positive sign that the private sector feels strong enough not to need the Central Bank's hand. For the active part, programs should be run down slowly and its impact on risky spreads analyzed carefully. The quantitative easing measures, measures which aims at increasing the Central Banks balance sheet (note that some qualitative and quantitative easing can not be totally separated as the CB have also increased their balance sheet by buying "private" paper), should continue for now (but the mix should Clue6
First Quarter 2010
Macro: Central Banks
30 Chart 46
Federal Reserve Balance Sheet
slowly move toward only government bond paper...) (Chart 46) to fight deflation... This is legitimate but here again the exit condition should be defined clearly. The risk is that it comes too late when the velocity of money has already started to improve markedly and that inflation late, overshoots (but that is probably a risk Central Banks , in countries where indebtness is high, are ready to take). Central Banks could also start to charge interest instead of paying it on reserve held on behalf of commercial banks to force the money into the economy. The Riksbank is the first one to have done so… Short-term rates should be last to move... As an aside, failure to communicate on the exit strategies, would be very detrimental to the Central Bank national currency (but this might be something they aspire to but do not dare to say…). S Source: Federal d l Reserve Boardd
Clue6
First Quarter 2010
Macro: Rest of the World
31 Chart 47
Eastern Europe External Flows
Europe looks less leveraged but is it really? Its financial system is more leveraged (even after correcting the difference between the IFRS and US-GAAP accounting rules) and holds more than 75% of the usd 4.7 trn. loans which have been made to emerging markets (see chart 24). Its housing market has yet to correct (See later). The commercial side has corrected in some places notably in the UK but the residential market is still near bubble highs (with the exception of Germany). It is more dependant on export, its currency is overvalued and its central bank was rising rate late last summer... It lacks the flexibilityy and the culture of success ((defined as a failure beingg an experience and not a stigma) of the US. The labor force only declined by approximately 1% compared to 5% in the US… Guess who will be more competitive… The Eastern Part is on the brink and a crisis (Chart 47) much more severe than what happened in South-East Asia will onlyy be avoided if the IMF and the EU show strongg resolve... In Japan, the leverage problem has corrected during the last 20 years and if we do not take the high share of banks assets invested in equities, the situation looks better than in the US and Europe. The Yen is too strong and as long as trade flows remain low do not expect a strong recoveryy and this is what the Economyy Watchers Expectation p index ((Chart 2)) is confirming… g
Source: IMF
Chart 48
Topix and Nominal GDP
Gross capital formation has slowed rapidly recently and this is a positive going forward as Japan continued to overinvest long after the bubble burst in 1990… It should find a way to increase the number of people working (more women in the workforce and more openness to immigration). We expect productivity to be a positive surprise in the next 5-10 years as the country slowly turns shareholder friendly. The DPJ victory might be a catalyst but reforms will take time, lots of it to be implemented… So rce: Daiwa Source: Dai a
Clue6
First Quarter 2010
Macro: Rest of the World
32
South-East Asia has experienced its debt deflation approximately 10 years ago. Balance sheets at all levels are healthy. The problem remains too high a dependency on external demand. The big stimuli should be used to rebalance their economies toward less capital intensive industries and toward labor intensive service, easier access to credit and improvement of welfare. With regard to China, honestly, we do not know as we can’t trust… It is still a relatively young economy which is likely to experience some booms/busts in the years to come. We are puzzled by the admiration many have for the influence the government has on the market and its perceived proficiency… Never confound luck with talent… Theyy have pprofited a lot from the gglobal explosion p in liquidity q y as their bankingg system y was not “officially” y impaired p ((low loan to deposit p ratio)… ) One should also keep in mind that J. Chanos has started to be a very vocal bear on China… We will write a chapter on it in the next quarterly were we will see if there is/are bubble(s) or not as a crisis would have enormous consequences on many assets… Latin America remains dependant on commodities but one could have genuine hope that the region won't fall back to its ills of the 80's and 90's. Their fiscal stimuli should have the same aims as the South-East Asian ones. So, the US needs to save, Europe to revolt, Japan’s consumers to wake up and Asia/Lat Am to spend…. We would avoid large CA deficit countries with high need of foreign capital as foreign investors are in a lose/lose situation. Either they devalue or they do nothing and the domestic economy collapse. We would favor CA surplus countries with high domestic savings and low leverage. They will be long-term winners but are likely to suffer greatly from the fallout of the above-mentioned. It will be important to see which countries in this group will be making reforms that encourage the emergence of strong domestic-oriented economies and ready to let their currencies appreciate. This group will be the big winners in the next 10-15 years…
Clue6
First Quarter 2010
Macro: US Total Net Saving
33
One of the area which was identified as a potential growth engine in the future in the US was investments. Investment needs to be financed and while companies are saving a lots(but they have high absolute debt to equity levels), the US total net saving has turned negative for the first time… Thi is This i nott goodd for f investments i t t on a medium di t longer-term to l t b i especially basis, i ll when h so much h off the th US liabilities li biliti are already l d on foreigners f i h d hands… Time to axe future potential growth even more… Clue6
First Quarter 2010
Macro: Housing
Source: OECD, Clue6
34
Source: IMF
The housing bubble has bursed in the US but not elsewhere (except in Japan, Germany and Switzerland)… In many countries the initial loan to value ratio is similar as in the US and you often have the possibility to loan the rest at a higher rate… An important difference is that in the most affected US states mortgage are nonrecourse loans I.e. secured by a pledge on the real property but for which the borrower is not ppersonallyy liable,, this encourage g the lender to find a solution and,, above all,, limit both in time and length g the impact p of a housingg decline on consumption p ((wealth effect is lower)… The triger for a correction in Europe are probably higher interest rate and/or fiscal tightening… To observe attentively… especially in Europe including the UK and Australia Clue6
First Quarter 2010
Macro: Consumption
35
We saw this circulate on the web recently… Interesting to see that healthcare account for all of the increase I spending in the past 50 years… As the ppopulation p ggrow older the pproportion p spend p on healthcare is likelyy to rise,, leavingg less for the rest… Maybe the healthcare sector will be the victim of a witch hunt sometimes in the future… Clue6
First Quarter 2010
Macro: Conclusions
36
Macro The collapse has been avoided thanks to the resolve of Central banks and governments around the world but we will still have to deal with the aftermath of the biggest gg credit bubble in history. y Theyy have managed g to ppropp upp assets pprices ((buying y g them,, changing g g accountingg rules and providing huge amount of emergency liquidity) and lower interest payments pushing debt to asset lower and improving interest coverage but they can not do this forever… The recession which probably ended sometimes during the summer was not a typical inventory-led one were more that 75% of the decline is due to de-stocking. g It was the beginning g g of a "balance sheet" recession which is ggoingg to haunt us for manyy yyears with ppoor ggrowth and intermittent relapse into recession (here we are talking about developed leveraged countries, financially unleveraged developing countries will suffer because of their operating leverage but will end up as winners if they do the right reform) The deleveraging process in unavoidable. Analysts have spent a great deal of time commenting on the collapse of credit availability but we think the biggest problem for growth in the medium-term will be a lack of credit demand. Many households and companies have realized that they could go under and they are going to build a buffer... Nationalism and protectionism will gain in popularity while there is a big risk of regulators going on a rampage (we see a strong risk of this cyclical ERROR like the commercial banks reserve increase in the 30’s or the VTA hike in Japan in the 90’s here) after doing too little for so many years…Populism will be a winning strategies for politicians, even more than before… The current macro data has surprised on the upside with the success of the cash for clunkers schemes around the world (which probably added up to 4% to US growth in the third quarter), various forms of help for first time home buyers, the socialization of the credit market in the US and Europe or the credit explosion in China... We continue to see the current improvement as a normal snap back from the worst macro environment since the 30's. It should not be confounded with a strong recovery. The traditional swing factors I.e. inventories, residential investments and autos which have historically accounted for almost all the volatility in GDP are not expected to have the same impact as in the past (and the autos part is probably already behind us, in the US and Europe at least). Consumption should continue to be a drag in the developed world for some times. Aggregate disposable incomes and net worth evolution and their influence on savings should be followed carefully as they will be the keys on how quickly the consumption behavior will change.
Clue6
First Quarter 2010
Macro: Conclusions
37
The fate of the current recovery hangs on the exit strategies for the monetary and fiscal stimuli, how the financial markets will interpret them and the unavoidable errors which will be made… Fiscal Stimuli have been helpful but their long long-term term effect will be sub sub-optimal optimal as long as they are considered as a short short-term term fix and that they are not constructed to foster future productivity and labor market growth. Much more is needed as they have, for the moment, only been able to compensate for the loss of other income in the US. Central Banks will have to first give clear guidelines on how they are going first to exit the qualitative phase of their easing now that markets have normalized. Theyy should do the same for the qquantitative ppart. The Q QEs were legitimate g ((even in our eyes...) y ) to avoid a total freeze and collapse of the credit markets and a debt deflation dynamic to develop but not otherwise. Deflation is still a real risk (we would even say a fact…) and we would thus like to see the quantitative part continuing a bit longer. Central Banks might even start charging instead of paying interest on the reserves they hold on behalf of the commercial banks. This would encourage them to pput the moneyy elsewhere into the economy. y The Swedish Riksbank has started such a scheme and the BoE is discussingg the same... Expect macro numbers to continue to move in the right direction (and in the next 3-6 months the rate of change is likely to be increasingly positive as it will be calculated against 12 month old data...) until Q2 2010 at least. After that… we should remember that we are livingg in the aftermath of the biggest gg credit bubble in history. y This does not necessarilyy imply py a double dip as much will depend on the behavior of households and the impact of fiscal and monetary authorities policies or lack of policies... Europe should be the focus of your attention as there is a high probability that the next “crisis” will have its epicenter there… In the next few years the world economy will be more volatile than in the 20 years pre-2007… with dramatic consequences on assets valuation ratios (cheap tomorrow will be much cheaper than what was deemed cheap between 1990-2007)…
Clue6
First Quarter 2010
