“The state is the great fictitious entity by which everyone seeks to live at the expense of everyone else.”
In Frédéric Bastiat’s 1950 essay, “That Which Is Seen and That Which Is Unseen”, he describes the impact of opportunity costs on economic activity. In his essay, a small boy breaks a window in a store. The glazier comes to repair the window and is paid six francs for the job. Some observers would suggest this is a positive economic event as it increases the money circulating in the community.
There is, of course, no free lunch. In the case of Bastiat’s essay, the unintended consequence is that the store owner with the broken window must pay for the repair of the window. In using six francs to pay for the repair of the window, the shopkeeper no longer has six francs to expand his inventory, advertise for the shop, or purchase personal goods. In effect, the transaction has two sides and it is not even certain to be a zero sum transaction, especially if the glazier does not spend his incremental six francs within the local community.
In modern economic theory, the key current debate relates to the role of the government in transactions. The Allowance Rebate System (more commonly known as Cash for Clunkers) program is a prime example of this dilemma. Under this program, car buyers were incentivized to purchase new cars by being given a $4,500 rebate for their old cars, which then had to be scrapped. Practically, this was a transfer of money from tax payers to car buyers. In the short term, new car sales skyrocketed. Meanwhile, older vehicles, which admittedly produced more pollution, were taken out of the national car population.
Akin to Bastiat’s essay, the question in the case of Cash for Clunkers Car is whether destroying an otherwise productive asset, such as a working car, actually benefits the economy. In looking at some key results of Cash for Clunkers, the implication is at best inconclusive. Specifically,
- The program led to market share gains for Japanese and Korean car manufacturers at the expense of U.S. manufacturers. (Incidentally, the equivalent Japanese program did not include U.S. produced cars.);
- A study by the University of Delaware concluded that for each vehicle trade, the net cost was $2,000, with total costs exceeding benefits by $1.4 billion; and
- A study by economists Atif Mian and Amir Sufi indicated that the 360,000 additional purchases in July and August 2009 were pull forwards that were completely reversed by March 2010.
So, once again, no free lunch.
On the back of rumors of an IMF bailout of Italy, global equity markets rallied in a big way yesterday. Not surprisingly, the Italian equity market was one of the global leaders yesterday up an impressive +4.6%. While we would suggest this was more of a short squeeze than anything, there is perhaps a fundamental case to be made if the IMF rumors finally come to fruition . . . or is there?
Our trusty research intern Josefine Allain pulled together some detail around the rumored IMF plan. According to the rumors, the IMF would provide €400-€600B to Italy at a rate of 4-5%, which would allow Italy up to 18-months to implement reforms without having to refinance.
Setting aside the fact that the IMF denied it is in discussions with Italy, the plan has two main issues. First, the IMF only has $285 billion currently available. Second, an expansion of the IMF, or an explicit Italian bailout fund, would require a substantial contribution from the United States (likely more than $100 billion). Clearly, given the current political environment in D.C. and on the back of another tacit U.S. debt downgrade this morning from Fitch, the likelihood of the United States stepping up to bailout out Italy is slim to none, absent a global financial crisis.
Indeed, European credit markets continue to signal that no free lunch from either the ECB or IMF is imminent. Specifically, the Italians “successfully” sold €7.5 billion of bonds this morning versus a maximum target of €8.0 billion. The 3-year yield was 7.89% versus 4.93% on October 28thand the 10-year average yield was 7.56% versus 6.06% on October 28th. Success is a relative term.
In the Chart of the Day today, we’ve highlighted the Euribor-OIS 3-month spread, which measures the spread between what banks charge each other for an overnight loan of their excess reserves versus what they could earn by lending it risk free to the central bank. The key take away is simply that risk, not surprisingly, has accelerated dramatically in the last three months in the European banking system. In early July this spread was less than 0.20 and it is now at 0.94. No free lunch there, to be sure.
This afternoon Keith and I are going to take a much needed break from the grind and go across the street to play a quick game of hockey at Yale’s Ingalls Rink. Ironically, it will cost us $10 each, so there isn’t even free lunch time hockey.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
THE HEDGEYE DAILY OUTLOOK
TODAY’S S&P 500 SET-UP - November 29, 2011
We are once again seeing the “fun and games with month-end markups” on no volume. Buyers beware of the US economic data Wednesday-Friday - expectations are too high. If you want to get bulled up on something into the start of the new month, go with US Dollar (UUP) or Long-Bond (TLT) on red today.
As we look at today’s set up for the S&P 500, the range is 32 points or -1.81% downside to 1171 and 0.88% upside to 1203.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: +2044 (+2429)
- VOLUME: NYSE 958.60 (+116.99%)
- VIX: +33.13 -6.79% YTD PERFORMANCE: +81.01%
- SPX PUT/CALL RATIO: 2.71 from 1.88 (+44.21%)
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 50.66
- 3-MONTH T-BILL YIELD: 0.03%
- 10-Year: 1.97 from 1.97
- YIELD CURVE: 1.71 from 1.69
MACRO DATA POINTS (Bloomberg Estimates):
- 7:45am/8:55am: ICSC/Redbook comp sales
- 9am: S&P Case-Shiller, est. -.10% M/M, -3% Y/y
- 10am: Consumer Confidence, est. 44.0 (prior 39.8)
- 10am: Home price index (prior -0.6%)
- 11:30am: Fed’s Yellen speaks on global recovery in SF
- 11:30am: U.S. to sell $35b 4-wk bills
- 12:15pm: Fed’s Raskin moderates panels in SF
- 12:27pm: Fed’s Lockhart to speak on U.S. economy in Atlanta
- 12:30pm: IMF publishes paper on capital flows
- 4:30pm: Fed’s Williams speaks to reporters in SF
- 4:30pm: API inventories
- 7:30pm: ECB’s Stark speaks in Dallas
- 8pm: Fed’s Kocherlakota speaks to reporters in Calif.
WHAT TO WATCH:
- Facebook said to consider raising ~$10b in IPO that would value it at more than $100b
- Italy sold 6% 2014 bonds to yield 7.89%, up from 4.93% at Oct. 28 auction for 4.25% 2014 bonds; Italian-German 10-year yield spread shrinks 6 bps to 493 bps after auction
- S&P may revise bank credit ratings within next week
- Silver Lake said to be working with Microsoft to bid for minority stake in Yahoo!; Andreessen Horowitz also weighing possible bid
- President Obama in Washington, meets with Dutch PM Mark Rutte
- Secretary of State Clinton traveling to South Korea, Myanmar
- House, Senate in session
- Supreme Court in session, hearing arguments at 11am in case involving securities suits
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Speculators Cut Holdings to Lowest Since July 2009: Commodities
- Stocks, Commodities Advance on Europe Outlook, U.S. Retail Sales
- Oil Drops From One-Week High on Forecast U.S. Stockpiles Rose
- Stopping Turkey Tails at the Border Pits Trade Against Health
- Japan Extends Rice-Shipment Ban After Sales of Tainted Grain
- Gold May Climb for Second Day With Equities Before European Meet
- Chemicals Seen Boosting Odfjell as Demand Swamps Fleet: Freight
- Copper Drops as Moody’s Considers Downgrading European Bank Debt
- Oil Rises a Third Day as Euro, Stocks Signal European Confidence
- Copper Mining ‘Issues’ Support Shortage Outlook, Citigroup Says
- Thai Sugar Production to Reach Record as Floods Spare Crops
- Copper Falls as Moody’s May Downgrade Europe Banks: LME Preview
- Rio Wins Battle for Hathor as Cameco Says It Won’t Raise Bid
- Oil Pares Decline Before European Debt-Crisis Talks; Brent Gains
- Palm Oil Has Longest Losing Streak in Two Years on Europe Crisis
- Icahn Bids for Commercial Metals in Deal Worth $1.73 Billion
- Freeport Cerro Verde Workers Vote to End Two-Month Strike
- Copper May Gain in London on Speculation About Supply Shortfall
EURO – another day, another hope that a USD selloff and a Euro rally is real. Unfortunately, the math is getting in the way of that; EUR/USD has an important short-term line of resistance that it’s been fighting for 48 hrs at 1.34; ultimately, the bigger lines that matter are TRADE and TAIL resistance of 1.36 and 1.40, respectively.
ITALY - On its shortest duration (the 2014 bonds) Italy Sells another €3.5B at 7.89%; a few months ago 6% was the "critical" line, then 7%, now I guess its 8%? C’mon. Let’s get as serious as Spread Risk is telling you to be here – Italian stocks are barely up this morning – and more importantly, down -37% since FEB (crashing) – no support for the MIB Index to 13,422
- Eurozone Economic sentiment 93.7 vs consensus 94.00 and prior revised to 94.8 from 94.8
- Eurozone Business Climate (0.44) vs consensus (0.30) and prior revised to (0.19) from (0.18)
- Eurozone Industrial Sentiment (7.3) vs consensus (7.6) and prior revised to (6.5) from (6.6)
- Eurozone Consumer Sentiment (20.4) vs consensus (20.4) and prior revised to (19.9) from (19.9)
INDIA – stocks decided a 1-day rally to a lower-high was enough. Inflation isn’t going away on EUR/USD up days because Oil prices aren’t going down (Brent $110/barrel last), and Indian stocks don’t like sticky stagflation – down -1% overnight, taking the Sensex to 16,002 (down -22% for 2011 YTD).
- Broad, Gagosian, Qatar Sheikha, Ai Weiwei Make Art Power List
- Bangladesh Bank Rules Lure Standard Chartered: Islamic Finance
- U.A.E. Starts Investing in U.S. Treasuries With Better Rates
- Heroin Hidden in Raisins From Iran Seized in Sydney, Police Say
- Syria Says Sanctions Are ‘Economic War’ as UN Reports Abuses
- Iran Blast Reports in Nuclear Province Fuels Sabotage Suspicion
- First Gulf Bank of Abu Dhabi Raises Foreign Ownership to 25%
- Qatar Shares Climbs to One-Week High Before Europe Debt Meeting
- GCC Banks Aim to Focus on SMEs, Youth and Women, Accenture Says
- Hindustan Times: Iran threatens to bomb Turkey if US or Israel attack
- Narrow-Body Engines Roar at Dubai Airshow, Led by CFM
- Saudi Cable Won Orders Valued at 1.1 Billion Riyals This Month
- Qatar Said to Sell Dollar Bonds Maturing in January 2017, 2022
- Abu Dhabi Maintains Cuts in January Supply of Murban Crude
- Kuwait Government Resigns Amid Growing Opposition Protests
- Balfour Beatty Unit Wins GBP104m 5-Yr Qatar Consultancy Contract
- OPEC Likely to Cut Output in December
- First Gulf Gains Most in 2 Weeks on Foreign Ownership Limit
The Hedgeye Macro Team
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Conclusion: We are firm believers in the year-end Santa Claus rally – in the long-end of the U.S. Treasury bond market.
Earlier today, Keith reopened a long position in the iShares Barclays 20+ Year Treasury Bond Fund (TLT) in our Virtual Portfolio. We’ve been trading around the volatility in long-term U.S. Treasury bonds with a bullish bias since 2Q and we continue to have conviction in our belief that U.S. growth is slowing from a cyclical perspective and structurally impaired from a secular perspective absent a shift towards strong dollar policy in D.C. This is a position that has worked throughout much of 2011 and our research suggests it will continue to work over the intermediate term.
Today, our quantitatively-driven risk management process signaled to us that, while consensus remains hopeful for a year-end Santa Claus rally in equities (SENTIMENT), domestic and international economic growth is still slowing from an intermediate-term TREND perspective (DATA/CATALYSTS). But don’t just take our word for it:
“Rather than saying interest rates are too low, investors should be more concerned about what low rates are telling them about economic growth and expected returns on risky assets.”
- Robert Mead, Portfolio Manager at PIMCO
Treasuries are “expensive” for a reason and a great many stocks appear “cheap” for similar reasons. Moreover, as Keith penned in his Early Look this morning, Dynamic Risk Management (i.e. fluid asset allocation and trading the ranges) has been the winning strategy in 2011. Buy & hold isn’t the best short-to-intermediate term P&L risk management strategy with a VIX > 30 (yes, performance pressures do exist in our business). Eventually, the time will come to get really long of U.S. equities – our models are merely suggesting that time is not now.
Conclusion: The concurrent events and associated risks of King Dollar strength continue to be showcased across Asian financial markets and economic data.
Inclusive of today’s global short squeeze, Asian equities had another soft week (11/21-11/28), closing down nearly a full percent on a median basis. The spread between the best performer (Thailand; +2%) and the worst performer (Australia; -2.5%) was a healthy 450bps.
Asian currency markets were generally flat on the week, closing down -0.1% on a median basis. Gains were led by the Queen’s currencies (Aussie and Kiwi dollars), which closed up +1.2% and +1.3% wk/wk vs. the USD, respectively. The Japanese yen closed down -1.4% wk/wk vs. the USD and JPY weakness slightly lead today’s rally in global beta.
Asian sovereign debt markets were generally weaker on the week, as a combination of ratings threats (Japan), better-than-expected economic data (Hong Kong) and illiquidity (Asian Tigers) drove up yields on various issues. Indonesia saw its 10yr yield back up +51bps wk/wk; Japan and Hong Kong also saw double-digit gains (+10bps and +12bps, respectively). Australia’s bond market continues to price in additional monetary easing: 2yr yield down -12bps wk/wk; China’s swaps market continues to price in the commencement of easing in the mainland: 1yr O/S swaps rates down -13bps wk/wk.
Asian 5yr CDS had a generally mixed week, highlighted by the +15bps widening of Japanese swaps on the rumors of an eventual S&P downgrade.
CHARTS OF THE WEEK
THE LEAST YOU NEED TO KNOW
If you didn’t get a chance to review our 11/22 research note titled “Asia Isn’t Buying Into Santa Claus”, please email us for copies. The analysis below picks up where that piece left off.
- HSBC’s preliminary manufacturing PMI for China (85-90% of responses) ticked down to 48 in Nov vs. a final reading of 51 in the month prior. The final HSBC and official CFLP readings are due out this Wednesday evening and could shock global macro markets if they are in-line with the aforementioned sneak peek.
- Japanese small business confidence ticked down in Nov to 45.8 vs. 46.4 prior.
- The Reserve Bank of India cut its domestic growth forecast for the current fiscal year to +7.6% YoY from +8% prior. While it’s easy to say they were a step closer to easing as a result, India’s domestic inflation situation is set to remain among the least accommodative in the world over the next 3-6 months based on our models and imprudent monetary policy (i.e. implementing QE with WPI > +9.5%). “Inflation is a regressive tax that hurts the poor the most in a country like India where food is a large share in the consumption basket,” per RBI Governor Duvvuri Subbarao. Moreover, the FX depreciation detailed below suggests he might be forced to hike rates again and risk slowing Indian economic growth incrementally from here.
- On the heels of slowing commercial sales and industrial production growth (to +1.8% YoY and +1.4%, respectively – the latter at a 26-month low), Taiwan’s statistics bureau cut its 2011 and 2012 growth forecasts to +4.51% and +4.19% (from prior estimates of +4.56% and +4.38%, respectively).
- At face value, Singapore’s Oct industrial production growth looked quite healthy (+24.4% YoY vs. +11.3% prior). Peeling back the curtain, however, we see that the pickup in growth was entirely driven by pharmaceutical output (+117.5% YoY), while electronics production (iPad and Kindle parts, etc.) slumped -20% YoY.
- Though largely a function of nationwide flooding which shuttered factories and caused capacity utilization to tick down to an all-time low of 46.4% in Oct, Thailand’s manufacturing production growth tanked in Oct to -35.8% YoY vs. -0.3% prior. Hard disk drive production (of which Thailand is the world’s #1 supplier) fell -52.4% YoY and electronics parts fell -45.5%. Thailand’s Office of Industrial Economics added that it may take 1-2 months before plants can resume normal operations after the flood waters recede.
- The PBOC said in a statement last week that it will continue to implement “prudent” monetary policy. Sticky inflation that remains well above target continues to slow China’s monetary easing process, despite their pledge to promote “reasonable growth” in credit and money supply. While the PBOC will do what it can in the interim (last week it cut RRRs in Zhejiang and 20 rural credit cooperatives), we remain of the view that substantial monetary easing in China is 1-2 quarters out absent a strong deflationary shock (i.e. a dramatic, expedited breakout in King Dollar).
- Chinese industrial profit growth slowed in October to +12.5% YoY, which was less than half the YTD run-rate of +27% (Jan-Sep). The impact(s) of slowing growth on top line trends, inflationary margin compression, and credit tightening continues to weigh on industrial activity in China.
- Hong Kong CPI held at +5.8% YoY in Oct.
- The Chinese yuan continues to gradually weaken, closing down -0.3% wk/wk vs. the USD and is now trading at a ~30bps discount to 1yr non-deliverable forward rates. Expectations of yuan weakness continues to be a headwind for the dim sum bond market as investors demand more interest rate return to offset less FX appreciation; average yields rose +32bps in the month-to-date and +197bps over the last six months. We saw this play out via growth in offshore yuan deposits in Hong Kong, which slowed in 3Q to +69.6 billion QoQ vs. +102.2B in 2Q.
- Japanese CPI slowed in Oct to -0.2% YoY from 0.0% prior; core CPI slowed to a -1% YoY from -0.4% prior. This easing of inflation, particularly on the core side, is one more supportive data point for additional easing out of the Bank of Japan – which just recently shifted its tone on the margin towards supporting incremental accommodation. Per BOJ Governor Masaaki Shirakawa: “In the current time of high uncertainty regarding the future prospects of overseas economies, due attention is necessary to the risk that the yen’s appreciation will dampen future growth… This is the very reason that the bank has embarked on monetary easing measures twice since this summer.” Speaking at an anti-strong yen groupthink convention in Nagoya today, this the third time over the last few weeks the governor has spoken out regarding the threat Europe’s sovereign debt crisis poses to the Japanese economy. His comments were delivered to us this morning concurrently with data that shows the BOJ capital adequacy ratio hitting a 32yr-low of 7.23% after suffering a $1.2 billion loss from its asset-purchase program in the six months through September.
- Last week, India’s rupee touched an all-time low of 52.375 per USD, prompting the Reserve Bank of India to pledge managing the associated FX volatility via intervention in the spot market. On the flip side, R. Gopalan, secretary of economic affairs at the finance ministry, suggested last week that the RBI’s ability to aggressively stem the rupee’s slide is limited because of the tightness of interbank liquidity and the likelihood that USD-selling would lead to an even higher call-money rate (30-day average of 8.49% is a near 3yr-high). Another sign of interbank illiquidity in India: banks borrowed an average of 1.13 trillion rupees per day from the RBI’s overnight lending facility over the last week – the highest rolling 7-day average since January. The rupee weakness is being fueled by a foreign investors dumping of Indian assets (bond holdings down -$213 million wk/wk; equity holdings down -$1.8 billion since July) and a near closure of India’s dollar debt and international syndicated loan markets (the latter down -87% MoM in Oct in terms of issuance). In recent weeks, the RBI and central gov’t have implemented new rules designed to spur dollar inflows, including increasing the cap on foreign investor rupee debt ownership by a total of +$10 billion, loosening rules for overseas corporate borrowing, and removing a $100 million limit on corporate FX sales via currency swaps . King Dollar manifests itself in many ways across the Global Macro landscape.
- Singapore CPI slowed in Oct to +5.4% YoY vs. +5.5% prior – inching the Monetary Authority of Singapore a mere 10bps closer to another currency band compression.
- Jesse Wang, executive vice president of China Investment Corp, the nation’s sovereign wealth fund, recent comments affirm our conviction in the view that China will not be a source of dumb, unlimited capital to finance the Eurozone bailout, but rather a source of smart money looking for attractive investment opportunities in distressed real assets: “The fund wouldn’t be the main channel if China helps tackle the sovereign debt crisis... However, if during such a process there are good investment opportunities in Europe and if CIC’s investment helped the destination company or country to recover and developed the economy, that would be indirect support.” Commerce Minister Chen Deming shared those views in his recent remarks: “While China has always been supportive of Europe’s rescue efforts, these will mainly depend on the euro zone itself… China will definitely be a part of any help offered by the global community… We are willing to further reform and further open our market, but other economies must be more open to us in return.”
- Analyzing commentary out of China and Australia, it appears the global community is growing increasingly tired of Europe’s inaction on adequately addressing its sovereign debt crisis. Per China’s Commerce Minister Chen Deming: “So far we have yet to see a step towards success… We have only seen a reshuffling of leaders in some European countries.” Per Australian Treasurer Wayne Swan: “EU politicians have been frustratingly slow in tackling the region’s sovereign-debt crisis that has dragged on global economic growth and cut Australian government revenue, causing asset prices to fall and households to spend less… Europe needs to understand that financial markets don’t work on political timelines, and they are already a long way behind the curve. The global economy has already paid a very high price for the failure of Europe to get its house in order.”
- Japanese asset managers are blowing out of European sovereign debt (including German and French paper) in the year-to-date, opting for U.K. gilts instead – +$19.1 billion in direct purchases and another +$37.4 billion channeled through the Cayman Islands.
- Bucking the recent trend of slowing export growth domestically and across Asia, Hong Kong saw an acceleration in export growth in Oct to +11.5% YoY vs. -3% prior.
- Philippines real GDP growth accelerated in 3Q11 to +3.2% YoY – after a downward revision to the 2Q report to +3.1% from +3.4%. Growth still slowed outright on a QoQ basis, which may add to pressure on Bangko Sentral ng Pilipinas to ease monetary policy later this week.
- A read-through on the weakness of China’s property market (absent more-reliable official price data): 80% of construction companies said developers were behind on payments, per a recent Credit Suisse survey.
- Standard & Poor’s said the leadership in Japan, led by recently-elected Prime Minister Yoshihiko Noda, hasn’t made enough progress in tackling the nation’s public debt burden. “Japan’s finances are getting worse and worse every day, every second,” according to Takahira Ogawa, director of sovereign ratings at S&P in Singapore. “[Consensus] may be right in saying that we’re closer to a downgrade. But the deterioration has been gradual so far, and it’s not like we’re going to move today.” Be it S&P, Fitch, or Moody’s, which all have Japan’s long-term, local currency sovereign debt rated at some form of AA-, the next downgrade of Japan is likely to trigger capital raises across Japan’s banking system to the tune of $75-81 billion based on Basel II requirements and Hedgeye calculations. Perhaps that’s yet another reason why the Topix Bank Index is trading a mere +1.6% off its 20yr-low (established on Friday).
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