TODAY’S S&P 500 SET-UP - January 13, 2011
Equity futures remain close to fair value in what has been a quiet morning as we await fresh MACRO catalysts ahead of the earnings season.
MACRO DATA POINTS:
TODAY’S WHAT TO WATCH:
CREDIT/ECONOMIC MARKET LOOK:
Treasuries were weaker today with the pickup in risk appetite. However, some support came from a strong $21B auction of 10-year notes.
OTHER COMMODITY NEWS:
The Macau Metro Monitor, January 13, 2011
NEW MEASURES FOR PROPERTY MARKET AGAIN Strait Times
New Singapore property measures, effective Friday, include:
1) Increasing the holding period for imposition of Seller's Stamp Duty (SSD) from the current three years to four years
2) Raising the SSD rates to 16%, 12%, 8% and 4% of consideration for residential properties which are bought on or after Friday, and are sold in the first, second, third and fourth year of purchase respectively
3) Lower the Loan-To-Value (LTV) limit to 50% on housing loans granted by financial institutions regulated by MAS for property purchasers who are not individuals
4) Lower the LTV limit on housing loans granted by financial institutions regulated by the Monetary Authority of Singapore from 70%to 60% for property purchasers who are individuals with one or more outstanding housing loans at the time of the new housing purchase
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Conclusion: The U.S. Federal budget deficit sees little improvement with the December numbers reported today. The Congressional Budget Office’s estimates for the deficit will likely be going much higher when its new projections come out in the coming weeks.
Positions: Long the U.S. Dollar via UUP; Short 1-3YR Treasuries via SHY
While the U.S. budget deficit for December came in line with consensus at a deficit of -$80BN, the question is really whether consensus matters. As it relates to the budget deficits, we would argue that where the number comes in versus consensus is really irrelevant as compared to the degree of change sequentially and on a year-over-year basis. The key takeaway for the first three months of the federal budget year is that deficit issue is not getting better.
As it relates to the key line items for the first quarter of the fiscal year, this is what was reported:
To be fair to the federal government, they offered that a number of timing issues that may be distorting this year’s numbers versus last year (calendar issues and the timing of insurance payments). From our perspective, we would expect these timing issues to normalize over the course of the year and have no real way of backing them out. Therefore, when we look at the numbers we normalize for 1-time payments or expenditures only, which in the case of our analysis are TARP and payments to GSEs.
A key take away from this report is that the Congressional Budget Office is going to have to take up its budget deficit projections for fiscal 2011. The last update on annual budget projections came in August of 2010 and fiscal 2011 was projected to have a budget deficit of -$1,066BN, which would have been more than ~ -$230BN less than the actual budget deficit in fiscal 2010, or a 17% improvement. Given that we are seeing minimal improvement in the deficit the CBO will likely have to dramatically take up its estimates for this year and perhaps the next couple years. The new estimates are expected to be released later this month and will be a catalyst to be focused on.
Just as a refresher, the current budget deficit projections for the next three years are:
These projections will be going higher, and likely dramatically so in the coming weeks.
This report and its implications that future estimates need to go higher will be coming at a very opportune time for Republicans in Congress who have made deficit reduction one of their hallmark issues heading into the 112th Congress. This report only adds more credibility to the case of deficit hawks like Ron Paul who will have the conch in coming weeks.
Daryl G. Jones
Conclusion: The $2.9 trillion municipal bond market is poised to make headlines and rattle global financial markets in 2011. Keep this threat front and center on your “white board” of interconnected risk.
Position: Short Muni Bonds via the etf MUB
Quite frankly, it amazes us at Hedgeye how little attention investors are paying to interconnected risk over the last 2-3 months. While the trajectory of US economic fundamentals over this time frame can be debated, we don’t see any signs of abatement in some key domestic risks playing out literally right under our collective noses.
Housing Headwinds, originally introduced back in 2Q10 by Josh Steiner, our Managing Director of Financials, continue to matriculate. US housing prices are declining at an accelerating rate in 3 of the 4 indexes we track – even from depressed levels of comparison. We expect something in order of 15-20% further downside by year’s end.
Identifying the interconnectedness of this risk as it relates to the muni bond market leads us to another interesting chart. Local Government Property Tax Receipts grew +7.7% YoY in 3Q10, the second consecutive quarter of growth. Since their tax assessments and property appraisals operate on a ~3YR lag, this trend is not sustainable, as State & Local Property Tax Receipts correlate positively with a 0.97 r² to the S&P/Case-Shiller Home Price Index when lagged three years.
Given that local governments collect roughly 97% of all Property Tax Receipts, representing ~26% of their revenue, we smell trouble on the way for already-strained municipal budgets. Further exacerbating budgetary headwinds is the accelerating amount of fiscal austerity going on at the State and Federal levels, roughly 30% and 4% of municipal government revenues, respectively.
Since January 1st (LESS THAN TWO WEEKS), we’ve seen a drastic amount of fiscal conservatism and budget-slashing proposals at the State & Federal level. Some highlights include (not at all limited to):
Just last week, House Budget Committee Chairman Paul Ryan (R. WI) had this to say on the prospect of a Federal bailout for a distressed States:
“We are not interested in a bailout… Should taxpayers in frugal states be bailing out taxpayers in profligate states? Should taxpayers in Indiana, who have paid their bills on time, who have done their job fiscally, be bailing out Californians, who haven’t? No, that’s a moral hazard we are not interested in creating… If we bailed out one state, then all of the debt of all of the states is not just implied, it’s almost explicitly put on the books of the federal government.”
In all reality, the likelihood of the Federal government having to bail out a US State in this fiscal year or the next is extremely low (no disrespect to Meredith Whitney, who is calling for 50-100 “meaningful defaults in 2011 on the order of “hundreds of billions of dollars”). In fact, no State has defaulted since Arkansas did back in 1933.
Where this hard line on future aid really impacts the US economy is at the municipal level, where both State aid and Federal support are running dry after two years of stimulus spending. Given this headwind and the upward trajectory of interest rates, we do believe there is a substantial risk for a meaningful amount of local governments and local authorities to default or declare bankruptcy in 2011. By meaningful, we mean enough to make negative headlines and rattle the US debt market, which has far-reaching implications beyond that.
According to Chapman & Cutler, as Chicago Law firm, only five municipalities sought bankruptcy protection in 2010 (-50% YoY), with the largest being a South Carolina toll road restructuring $300M. We are essentially witnessing (with some ignoring) the calm before the storm. It’s important to note that we don’t think all municipal issuers are created equal; there will certainly be a dichotomy formed amongst issuer credit quality – much like there is in Europe’s Sovereign Debt Dichotomy (PIIGS vs. Germany, Sweden, and Norway).
In light of the Municipal Debt Dichotomy, some of the biggest buyers of municipal debt (including Berkshire Hathaway, Liberty Mutual and Allstate Corp.) have been using the current “calm” as an opportunity to decrease their exposure, unloading muni bonds to some investors who view the 5.67% average YTM as “an excellent source of yield” and “a terrific bargain”.
When it all said and done, everything has a price. What makes this game fun is figuring out what that price will be at the end of a specified duration. Over the intermediate-term TREND, we at Hedgeye think muni bond yields are poised to continue their upward trajectory at an accelerating rate in the face of material deteriorations in their fundamentals. How much this shakes global financial markets is a question we will attempt to answer each day along the way.
As the world is tuned in to Europe again this week due to the numerous bond auctions and the region’s ever-present sovereign debt risks, an important policy decision was reached on Monday regarding the looming issue to contain the influx of illegal immigrants to Europe via Greece along its border with Turkey.
While Greece had outlined a plan over the weekend to construct a fence or wall along its 206km (or 128 mile) border with Turkey, a stretch of land where the majority of refugees enter the EU, on Monday Greece revised its plans and said it will construct a defense barrier along a 12km stretch prone to the most illegal crossings located in the north-east of the country.
Greece has already made it clear to the EU that it cannot cope with the numbers of migrants (in particular from Asia and Africa) arriving illegally. The European Commission estimates that more than 80% of illegal immigrants enter the EU via the border with Greece, and according to Frontex, the EU border agency that patrols the area, there was a 369% increase in the number of illegal immigrants crossing the northern Greek border in the nine months through September 2010 versus the previous year.
Obviously, the figures are staggering and the problem is real. As it relates more broadly to Europe, we’d expect governments to push measures to limit illegal immigration as growth forecast are strained in 2011 and 2012 and as governments push through budget consolidations (austerity) over the next years.
While this subject can be debated from a number of angles, the German publication Der Spiegel did a wonderful job presenting commentary from various German media sources that express differing viewpoints, all of which help to frame the debate. We include this commentary below:
The center-right Frankfurter Allgemeine Zeitung writes:
"The fact that Athens is considering the construction of a massive wall along its border with Turkey is absurd, given that both are members of NATO. It gives us a foretaste of what would happen if Turkey is, one day, accepted into the European Union. Europe's doors would be thrown wide open. At the same time, no one should kid themselves that a fence would stop people wanting to cross the border."
The weekly Die Zeit writes:
"This is a trouble spot: More than 100,000 illegal immigrants crossed the border here last year. Nine out of every 10 refugees fleeing poverty arrive in the EU via this route. The placement of 200 border guards here in November has stemmed the number of immigrants but not halted it. Now around 200 illegal immigrants arrive every night, but before the deployment of European Frontex guards, that figure was as high as 450."
The center-left Süddeutsche Zeitung writes:
"The Greek plan was clearly an act of despair… There are clear signs that the erection of a fence or a new wall at the Evros border river will not solve the core problem but rather shift it elsewhere. Illegal immigration does not take place along clearly defined routes; it is controlled by those criminal gangs for whom people smuggling is a profitable business."
"Illegal immigration is closely connected to organized crime -- that is the sad reality. Mafia groups in Turkey, Ukraine and Italy run their human trafficking as an industry. Propagating illusions is a key part of the industry, illusions about what awaits an African or Asian in the rich European countries of France, Germany or England, which are the end destinations of most immigrants. In addition, there is also the fact that people smugglers rarely operate without the complicity of corrupt border officials, who gladly turn a blind eye to some things for the right money. From this perspective, the European Commission is correct to react skeptically to Athens' construction plans and to demand that the Greeks first do something to deter and discourage the traffickers."
But the law is clear: (...) asylum applications can only be made in the country of entry. And so Greece continues to cram more and more refugees into its overflowing camps..."
Clearly, Greece and the EU are just at the tip of the iceberg in determining solutions to the inflow of illegal immigrants via Greece. As Greece is now known for its excessive public debt, we thought this topic is additive to the larger assessment of Europe’s economic health and the issues surrounding the union and policy making of unequal states.
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