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Weekly Latin America Risk Monitor: Monetary Easing Cometh

Conclusion: Central banks are positioning themselves for monetary easing alongside a regional deterioration in capital markets activity, which should support continued weakness in Latin American currencies especially vis-à-vis the U.S. dollar.


Prices Rule 

Latin American equity markets had a particularly strong week, closing up +6.3% wk/wk on a median basis. Gains were headed by the high-beta Argentine equity market, which closed up +16.8% wk/wk. Despite the region’s benchmark equity markets being down -19% YTD, we are choosing to ignore the allure of perceived valuation and remain bearish here over the intermediate-term TREND. Our expectations of a pending Correlation Crash should eventually take prices lower and provide much more attractive entry points on the long side of LatAm equities.


Regional currencies also had a particularly strong week, closing up +1.9% wk/wk on a median basis vs. the USD. Gains here were capped by the Chilean peso, which advanced nearly 4% on the week. The Mexican peso, a currency we have had a negative fundamental view on since Q2, is down -11.5% vs. the USD over the past three months alone. We think there is more downside to come, as expectations of central bank easing continue to feed upon themselves (1yr interest rate swaps fell another -3bps wk/wk and are now pricing in a mere +8bps of tightening over the NTM – down from +63bps at the start of the year. This was reinforced across Mexico’s sovereign debt maturity curve, with 2yr, 10yr, and 30yr yields falling -5bps, -30bps, and -32bps wk/wk, respectively.


Regional CDS (5yr) broadly declined last week, narrowing -16.3% wk/wk on a median basis from a percentage perspective. Individual declines were led by Colombia, which tightened -35bps wk/wk for a percentage decline of -18.3%. We’ve been vocal in our call that the trend in LatAm credit risk is up as global growth slows and commodity prices deflate and prices are in confirmation of that – regional 5yr CDS have widened +52.4% on a median basis over the last six months, headlined by Chile’s +120.5% widening (likely related to its exposure to China/copper prices).


***price tables can be found at the bottom of this note***


The Least You Need to Know


  • The Senate budget committee sees what we saw: higher government expenditures in 2012 (by +R$25.6 billion to be exact), with lower growth (they lowered their 2012 GDP estimate to +4.5% vs. a previous forecast of +5%). Interestingly, they increased their inflation projection to +6%, which is confirming of the central bank’s private economist survey that showed a seventh straight weekly increase in their 2012 inflation projection (now at +5.61%). We’re bearish enough on commodities over the intermediate term to take a variant view on the CPI front.
  • External corporate debt sales by Brazilian companies have fallen below last year’s record pace for the first time ($32.3 billion YTD, down -1.2% YoY), as LatAm capital markets continue to dry up, on the margin. Given the headwinds of securing equity financing (Bovespa finished the week down -20.6% YTD), a closure of Brazil’s (and other regional) corporate bond markets would be an incremental negative as it relates to financing economic growth across the region.
  • Brazil’s securities and exchange commission (CVM) is stepping up investigations into and efforts towards combatting insider trading surrounding earnings releases, as well as central bank front-running in the interest rate futures market. According to Brazilian newspaper O Globlo, “two or three banks” completely and abruptly changed their interest rate exposure immediately before August’s “surprise” rate cut. We use quotations around the word “surprise” because neither the markets nor our research would’ve suggested to expect anything other than monetary easing out of Banco Sentral do Brasil at the time of the actual cut – which is now expected by the market to be added to at Wednesday’s monetary policy meeting.


  • As alluded to earlier, Mexican capital markets are indeed pricing in some form of monetary easing out Banxico over the short-to-intermediate-term. Last week, they kept their benchmark policy rate on hold at 4.5%, but opened the door to the possibility of a rate cut by saying: “[We] will remain alert to global economic growth perspectives and the possible implications for Mexico’s economy, which in the context of extensive monetary easing in the largest industrialized countries, subsequently could make it appropriate to relax monetary policy [in Mexico].” Having not raised rates once since the global economic recovery began nearly two years ago, we do not think IMF-trained central bank governor Augustin Carstens will be able to resist the Keynesian urge to ease policy in the coming months. As such, we remain bearish on Mexico’s currency, the peso, vs. the USD from a TREND perspective.


  • Chile also kept its benchmark policy rate on hold, at a respectable 5.25% (after having hiked +250bps in the LTM). Like Mexico, Chile’s central bankers opened the door for monetary easing later in the year, by acknowledging that growth is slowing more than expected due to waning global demand. Chile’s currency, the peso (CLP), remains at risk vs. the USD over the intermediate term due to the confluence of potential monetary easing (-77bps of rate cuts priced into the 1yr swaps market) and waning demand for Chilean exports (copper failed to overtake any of our key quantitative levels of resistance amid the global V-bottom rally we’ve just witnessed).


  • A poll published Oct 9 by Poliarquia Consultores showed that incumbent president Cristina Fernandez has the support of 52-55% of voters heading into the Oct 23 presidential election.  The closest challenger, Hermes Binner, garnered only 14-16% of the vote. A first-round win by the current leader continues to be the expectations of both the market and voters – many of whom she has bought off by increasing social spending and publically-negotiated wages in recent months.
  • Speculation surrounding a likely Fernandez victory and the likelihood that she will continue her late husband’s policy of systematically underreporting of CPI is handing investors in Argentina’s inflation-linked bonds the worst relative performance to the region since 2008 (-28.5% YTD vs. a regional average of -14.5% YTD).
  • As capital flight ensues (largely driven by speculation that Fernandez will seek to devalue the Argentine peso in coming months), the country’s benchmark deposit rate, the badlar (rate on 30-day deposits > 1 million pesos), has increased to the highest level since Jan ’09, closing the week at 15.7% and 11.4% on a 30-day M.A. basis (highest since Nov ’09). As a comparison, the yield on 30-day Brazilian certificates of deposit has declined -35bps in the past month to 11.45%.
  • In what is arguably a particularly ominous sign for the global economic cycle and capital markets activity, Argentine companies are selling the most asset-backed debt in 11yrs (+4.5 billion), while increasing the proportion of asset-backed debt to total issuance to the highest ratio since 2008 (67%). The growing inability for Argentine borrowers to economically price unsecured debt has contributed an -8% YoY decline in dollar-bond issuance YTD. A key risk to flag here is that banks and retailers are leading the issuance YTD (58% of the total) and are accelerating consumer lending heading into an economic downturn (revolving consumer credit increased +37.2% in Sept), likely in order to grow assets to back their debt issuance with – vaguely reminiscent of the U.S. subprime mortgage crisis. This isn’t the kind of data point you want to see if you are among the many who think they bought the bottom when we made our Short Covering Opportunity call on 10/4. 

Darius Dale



Weekly Latin America Risk Monitor: Monetary Easing Cometh - 1


Weekly Latin America Risk Monitor: Monetary Easing Cometh - 2


Weekly Latin America Risk Monitor: Monetary Easing Cometh - 3


Weekly Latin America Risk Monitor: Monetary Easing Cometh - 4


Weekly Latin America Risk Monitor: Monetary Easing Cometh - 5


Weekly Latin America Risk Monitor: Monetary Easing Cometh - 6

Digging Into Corporate Balance Sheets

Conclusions:  Broadly speaking cash on corporate balance sheet is up, though not meaningfully since 2008.  Moreover, with low risk-free rate of return, cash balances are actually a drag on earnings growth.

Commonly, the health of corporate balance sheets is cited as a reason to be supportive of higher stock prices.  The theory is that as corporations build cash on their balance sheets it is both a sign of operational health and also provides ammunition to make acquisitions.  Therefore as balance sheets get healthier, there should be an underlying bid to equities due to increased M&A prospects.


We spent the weekend looking at the progression of corporate balance sheets for the 50 largest market capitalized companies in the SP500 as a proxy for the health of corporate balance sheets more generally.  Collectively, this group of companies is just over 50% of the total market capitalization of the SP500, so clearly a reasonable proxy for corporate America.


In this analysis, we also removed the financials, which for the largest 50 companies in the SP500 includes Citigroup, Goldman Sachs, Wells Fargo, J.P. Morgan and Bank of America.  The point is obviously not to understate the relevance of the balance sheets of banks, but rather to simplify the analysis and focus on operational cash and debt versus trying to decipher the balance sheets of the major banks and the nature of their cash and debt obligations.


In the chart below, we show the quarterly cash (short term investments and cash equivalents), debt (short and long term), and net debt balances of the largest 50 companies in the SP500 by market capitalization going back quarterly from June 30th2011 to June 30th, 2008.  In that time period, cash has grown by $273 billion, or +49%.   Over the same period, debt grew by +$78 billion.  In aggregate, corporate balance sheets, on this basis, have seen meaningful improvement since June 30th, 2008 as net debt has declined by almost -$200 billion over the period.


Digging Into Corporate Balance Sheets - dj 1


Interestingly, if we back out General Electric from this analysis, the growth of cash on corporate balance is less positive.  As the chart below shows, after removing GE, cash grew by over +$200BN from Q2 2008 to Q3 2011.  At the same time, debt grew by a comparable amount.  So on the basis of net debt as a proxy for health of the balance sheet, the largest 50 companies in the SP500, excluding the banks and GE, look almost exactly the same today as they did three years ago.


Digging Into Corporate Balance Sheets - dj 2


None of this is to say that corporate balance sheets are in poor health.  In fact, based on longer term historical studies, corporate balance sheets are quite healthy.  A recent study by the Wall Street Journal highlighted that:


“Cash accounted for 7.1% of all company assets, everything from buildings to bonds, the highest level since 1963.”  

That said, it is just not clear, that cash on balance sheets should be considered a positive catalyst for stock prices.


Conversely, it is somewhat disconcerting that cash is growing and not being invested, especially given the low interest rates that cash and short term investments are earning.  In Q3 2008, the 90-day money market rate was roughly 3% versus roughly 0.4% now.  As a result of declining rates, the change in interest income on an annualized basis from Q2 2008 to Q2 2011 was a decline more than -$13 billion from $16 billion to just over $3 billion.  So, while cash balances growing are a positive, the decline in the return on cash has more than offset that positive.


Finally, in the two charts below we show the most improved balance sheet over the last three years and the worst performing balance sheet, all on the basis of growth of net debt.  As mentioned above, GE appears to have a dramatically improved balance sheet from (disclaimer: we have not done a deep dive on GE) three years ago, while on the negative side, Exxon Mobil has seen its balance sheet decline over that period going from $30.1BN in net cast to $6.5BN in net debt.


Digging Into Corporate Balance Sheets - dj3


Digging Into Corporate Balance Sheets - dj4


Clearly, corporate balance sheets in the U.S. are in decent shape, but we would caution against using that as a market catalyst.  Arguably, as well, it is actually a drag on earnings growth as long as cash sits on the balance sheet unproductively earning low rates of return.  In fact, by letting cash sit and earn low rates of return, corporations are actually signaling that they do not see meaningful growth opportunities in the future.


Cash is king . . . if it earns a return.


Daryl G. Jones

Director of Research

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European Risk Monitor: No Magic Wand

Positions in Europe:  Short EUR-USD (FXE); Cover Italy (EWI) today

The magical European Bazooka Wand didn’t come out this weekend, and we don’t expect to see it at the EU-Summit on October 23rd either. Eurocrats have much on their plate, including bank recapitalization procedures, expanding the EFSF, and broader measures to insulate risks to the PIIGS.  At odds remains the ECB’s unwillingness to take on more exposure, either directly through the EFSF or its bond purchasing program (SMP), and indecision from Eurocrats (and IMF) on Greek debt haircuts (21% vs likely reality of 50-60%), Eurobonds, higher capital standards for banks (including for future stress tests), and member nation default.


The European bag of risk continues to be directed by headlines, most particularly by the expectations that the “next” Eurocrat meeting will bring a positive solution to the region’s ills. Here we’ll repeat our bearish outlook on European capital markets. We think any relief rallies over the immediate term will be short lived, including for the EUR/USD – Europe has structural long term issues that will not be solved with the snap of a finger. We would however point to the November 4th G20 meeting as a likely date for additional direction to the banking and sovereign crisis. Quantifying last week’s bounce, European equity indices rose between +4 to 6% and the EUR-USD cross gained +3.8%.


In this light, we remain short the EUR/USD and find it prudent to be short select markets or on the sidelines until the details of Big Bazooka are revealed. The EUR/USD continues to be broken on its intermediate term TREND ($1.43) and long term TAIL ($1.39).  Today Keith tactically covered our short position in Italy (EWI) in the Hedgeye Virtual Portfolio, however longer term we remain bearish on Italy. It was just Friday that Berlusconi won a narrow confidence vote, demonstrating just how fragile his rule remains, which creates huge political headwinds as the market judges the broader Italian economy on his ability to secure budget cuts in the coming 1-3 years.


Below we show our typical Monday risk monitor charts. Of note is that Italian yields (currently at 5.78%) are creeping dangerous close to the 6% level, a historically significant break-out line for Greece, Ireland, and Portugal, and the spread between German bunds and the 10YR French yield is at a decade wide of 95bps today. As we've said before, a downgrade of France's AAA credit rating is a real possibility that would have disastrous effects across the region, including undermining the EFSF.  


A look at sovereign cds shows that Irish, Spanish, Italian and French spreads were slightly wider week over week, while Portuguese and German spreads tightened week over week. In particular, German CDS tightened by 8.9% (see charts below).


European Risk Monitor: No Magic Wand - 1. hm yields


European Risk Monitor: No Magic Wand - 1. josh cds1


European Risk Monitor: No Magic Wand - 1. josh cds2


Finally, our European Financials CDS Monitor showed that bank swaps mostly tightened in Europe last week.  Swaps tightened for 37 of the 40 reference entities. The average tightening was 7.2%, or 36 basis points, and the median tightening was 5.0%.  Spanish banks saw the least tightening of the group. 


European Risk Monitor: No Magic Wand - 1. josh banks


Matthew Hedrick

Senior Analyst

Bearish TREND: SP500 Levels, Refreshed

POSITIONS: Long Utilities (XLU), Short Consumer Staples (XLP)


Today’s failure at our intermediate-term TREND line of resistance is very consequential.


Across durations here are my refreshed levels that matter most: 

  1. TAIL = 1266
  2. TREND = 1231
  3. TRADE = 1189 

I don’t think failing at 1231 means we crash right here and now. What I have been saying about crashing stock and commodity prices (20% declines from YTD peaks) is that the probability of crashes occurring goes up as market prices do (on low volume and negative skew).


If 1189 (TRADE support) holds, that will be a healthy signal in the immediate-term. If it doesn’t, it will be another bearish one. This is why earnings season hasn’t been this important in years.


In the very short-term, earnings should help take some of the headline burden off of European sovereign risks. The problem with that is that earnings like JPM and WFC have been negative catalysts too.




Keith R. McCullough
Chief Executive Officer


Bearish TREND: SP500 Levels, Refreshed - SPX

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