“Increasing taxes on successful risk takers will slow the accumulation of equity and discourage risk taking.”
This weekend I finished reading Edward Conard’s “Unintended Consequences: Why Everything You’ve Been Told About the Economy is Wrong.” On an ABC scoring scale, I’ll be nice and give the book a B (minus). The book’s title is a borrowed one – and the “truth” is written from a partisan perspective (Conard was a Managing Director at Bain who made a million dollar contribution to a Romney Super Pac).
If you are well versed in Global Macro markets, economic history, and frameworks of economic thought, you don’t have to start reading this book until page 195 where Conard asks 3 important questions: “How does America protect its economy from another crisis? How does it reduce unemployment and revive growth? And how does it balance the federal budget – by raising taxes or cutting costs?”
Good questions; average at best answers. Not once did he use modern day math (Chaos or Complexity Theory) or any aspect of current Behavioral Economics (Kahnmen/Tversky/Taleb). He focused mostly on how bad the likes of Keynesian “multiplier-effect” economists like Christina Romer have been in advising Obama. But everyone who doesn’t do drugs knows that just as well as an MBA from Harvard does.
The only question Conard answered really well (that I haven’t read anywhere else) was the unemployment question. That’s why I gave him the Hedgeye Quote of The Day. Central planners like Ben Bernanke and Tim Geithner (who have never had to take on risk with their own after tax capital and meet a payroll in their life), do not get this very simple relationship between risk capital and hiring.
Take it from me (a small business owner in America). It’s one of the main reasons why US Unemployment is high and US Consumer Confidence is low. People don’t trust this will end well.
Back to the Global Macro Grind …
In the last 3 weeks, the USA has had some terrible economic data related to hiring and confidence:
- NFIB Small Business Survey in June plummeted to a fresh YTD low of 91.4 versus 94.4 in May
- US unemployment rate of 8.2% for June didn’t budge as non-farm payrolls missed badly (again) at 80,000
- University of Michigan Consumer Confidence for early July got smoked to another YTD low of 72 (versus 73.5 2 weeks ago)
That last data point actually came at 10AM EST on Friday morning after the US stock market was already up +1% on the day. Bad news for America is obviously bullish for the only part of the bull case that’s left (Qe rumors and bailouts). Throw a little China “rate cut” rumor on top of that fire into Friday’s close, and you had yourself one mother of a no-volume rally. It was the market’s 1st up day in the last 7.
Hooray. Now what?
1. ASIA: After the Chinese didn’t deliver on the USA manufactured lie of the day (Premier Wen actually told the media he wants it “clearly understood” that China’s #GrowthSlowing continues at an accelerating rate), stocks in Shanghai closed down another -1.7%, hitting fresh YTD lows. Like US Small Business and Consumer Confidence, fresh lows are great, right?
2. EUROPE: Despite the no-volume rally in US Stocks (down 29% volume day versus my top 10 down days in Q2) on Friday, Europe opened like a wet Kleenex. Spanish, Italian, and Russian stocks all remains in crash mode this morning at -25%, -22%, and -20%, respectively, from their YTD tops. More bailout debt is only going to structurally slow real (inflation adjusted) growth further.
3. COMMODITIES: while US stocks were flat to down last week (depending on the index), Commodity Inflation had some rip-roaring fun in the sun, with the CRB Index up a full +2.4% on some good ole fashioned food (corn!) and oil (+3.1% wk-over-wk) inflation. Better yet, the CFTC weekly options data showed a +8.9% wk-over-wk pop to 1.05 million contracts!
To put that commodity price speculation into perspective, that 1.05 million number is the highest level of commodity inflation betting since, you guessed it, April 3rd, 2012. The Chinese, just fyi, aren’t going to cut rates if food/energy starts to rip again. That perpetuates civil unrest.
Q: What else peaked on April 2nd, 2012? A: The SP500 (at 1419).
And so it begins…
Another week of storytelling and fun at the gong show that has become our centrally planned market. Will Ben Bernanke deliver the elixir of #BailoutBull drugs at this week’s Senate and House meetings? Will US Housing not slow from its epic Q1 weather highs? Will earnings, un-adjusted for guys marking up their books into month-end, matter as they slow?
Only time and price will tell. All the while, the Unintended Consequences of a No Trust; No Volume marketplace will continue to play a much larger role in whatever centrally planned life someone writes a book about next.
My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Spain’s IBEX, and the SP500 are now $1, $96.95-102.91, 83.01-84.33, $1.20-1.23, 6, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
CONCLUSION: We maintain conviction in our view that Chinese economic growth is not poised to meaningfully inflect over the intermediate term. Furthermore, we can’t stress how much the late-year transition in leadership or the growing official realization that the 2008-09 stimulus package and central plan (i.e. state-directed lending) contributed heavily to a rapid and potentially unhealthy expansion in credit (+96.6% since the end of 2008) may slow Chinese policymakers’ fiscal/regulatory response [if any] to an incremental deterioration in economic growth. Remember, Chinese banks have yet to see a material deterioration in credit quality (the industry-wide NPL ratio is at a measly 0.9%), so it’s not unreasonable to believe that Chinese policymakers could be saving their “bullets” for a potentially more worthy cause than a purposefully-engineered slowdown in Real GDP growth to +10bps above their official 2012 “target” of +7.5% (announced in MAR).
The Data: Setting aside the JUN Industrial Production, Retail Sales and Fixed Asset Investment YoY growth rates – which, on balance, slowed very marginally from MAY – Chinese Real GDP growth slowed in 2Q12 to the weakest pace since 1Q09 – a disturbing thought, given that in 1Q09 the global economy was mired in the deepest global recession since the 1930s.
The Reaction: The benchmark Shanghai Composite Index closed flat on the day and remains in a Bearish Formation. The Chinese yuan traded down only marginally on the day (-0.1%) and the non-deliverable forwards markets continue to price in 60-140bps of incremental weakness vs. the USD over the NTM. A critical divergence to note is the more bearish expectations in the offshore market (i.e. USD/CNH cross), which is likely a sign of international investors holding a more bearish long-term view of the Chinese economy than mainlanders (more easing and/or more capital outflows expected). Moreover, this has been the case since the start of the year. Please refer to our APR 16 note titled: “FLAGGING ASYMMETRIC RISK IN THE CHINESE YUAN AND DIM SUM BOND MARKET” for our bearish TAIL-duration thesis on the Chinese currency.
The Context: It’s worth remembering that this was a policy-induced slowdown. As we initially suggested way back in our 1Q10 Macro Theme “Chinese Ox in a Box”, the Chinese government has engineered a fairly dramatic slowdown in domestic economic growth (the rate of Real GDP growth has fallen -36% since its 1Q10 cycle peak) – largely on the strength of subsequent introductions of property curbs and post QE2 rate-hikes. Net-net, we don’t see any reason for Chinese policymakers to overreact and respond with any major fiscal stimulus or loosening of the aforementioned macroprudential measures currently weighing on demand in its property market. Our view is supported by recent commentary from key Chinese policymakers and central planning agencies:
- Premier Wen Jiabao (JUL 7):
- “Restricting speculative demand and investment in property must be made a long-term policy.”
- “We must unswervingly continue to implement all manner of controls in the property market to allow prices to return to reasonable levels. We cannot allow prices to rebound, or all our efforts will come to naught.”
- “Market expectations about property prices are changing and citizens are worried prices will rise again. Signals in the market are chaotic and misleading and speculative information must be stopped.”
- “Local governments that introduced or covered up a loosening of curbs on residential real-estate must be stopped.”
- “Property controls are still in a critical period and the task remains arduous.”
- “The government must promote the study and implementation of changes to the property-tax mechanism, and to speed up the establishment of a comprehensive long-term mechanism and policy framework for controlling the property market.”
- Ministry of Housing and Urban-Rural Development (JUN 19):
- Identified media reports about changing policies as “distorted” and pledged to “steadfastly continue existing policies”.
- China Banking Regulatory Commission (JUN 14):
- Issued a three-sentence statement on its website labeling media reports about relaxed restrictions on home lending as “complete misunderstandings”, “sheer fabrications” and/or “deliberate misinterpretations possibly intended to manipulate the market”.
- Peoples Bank of China (JUN 14 – roughly one week after the first rate cut):
- Issued a brief statement calling allegations in the media that the central bank had loosened restrictions on the property sector “deliberate misinterpretations” that “sensationalized” the bank's policy.
- The National Development and Reform Commission (JUN 12):
- Publicly deemed an article about a real estate development “sheer fabrication”.
All told, we feel comfortable maintaining our guidance to not expect much from the Chinese economy over the intermediate term – especially given that Fixed Capital Formation accounts for roughly half of Chinese GDP at 46.2%, having taken a fair amount of share from both Private Consumption and Net Exports over the last five years. As an aside, when the central plan calls for growth at all costs (as it did in the years leading up to 2010) an overreliance on incremental CapEx tends to be the most natural route, usually resulting in a speculative boom in property prices as the supply of credit expands faster than the discretion of those institutions responsible for extending it (a la China circa 2009-10). More on this later…
While our predictive tracking algorithms do suggest that the slope of Chinese Real GDP growth may base and potentially inflect here in 3Q, we are not of the view that any infection would be meaningful or the start of a sustained uptrend in Chinese economic growth. Refer to our OCT 18 thought piece titled: “PUTTING CHINA INTO PERSPECTIVE” for more details behind our thoughts that the Chinese economy has more than likely undergone a structural downshift in rates of economic growth.
The aforementioned conclusions on China’s property market and overall economy carry negative implications for industries and sectors that cater to the supply and demand dynamics of China’s domestic real estate market. The following micro data point lends credence to this view:
Sany Heavy Industry Co., China’s biggest maker of excavators, lowered its sales forecast for the equipment as slowing economic growth and government curbs on property market sap demand. Excavator sales may increase 10 percent this year, slower than a previous target of 40 percent, Vice Chairman Xiang Wenbo said in a July 11 interview in Changsha, Hunan province, where the company is based. Sany will still outperform the industry, which may see a fall in demand, he said. (Bloomberg; JUL 13)
Prices in China’s domestic rebar market also lend credence to this view:
Net-net, we maintain conviction in our view that Chinese economic growth is not poised to meaningfully inflect over the intermediate term. Furthermore, we can’t stress how much the late-year transition in leadership or the growing official realization that the 2008-09 stimulus package and central plan (i.e. state-directed lending) contributed heavily to a rapid and potentially unhealthy expansion in credit (+96.6% since the end of 2008) may slow Chinese policymakers’ fiscal/regulatory response [if any] to an incremental deterioration in economic growth.
Remember, Chinese banks have yet to see a material deterioration in credit quality (the industry-wide NPL ratio is at a measly 0.9%), so it’s not unreasonable to believe that Chinese policymakers could be saving their “bullets” for a potentially more worthy cause than a purposefully-engineered slowdown in Real GDP growth to +10bps above their official 2012 “target” of +7.5% (announced in MAR).
Keep these thoughts front and center as you ponder the TREND and TAIL slopes of Chinese economic growth. Have a great weekend,
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No Current Positions in Europe
Asset Class Performance:
- Equities: The STOXX Europe 600 closed up +0.6% week-over-week vs +1.3% last week. Top performers: Cyprus +3.3%; Romania +2.9%; Norway +2.1%; Slovakia +2.0%; Germany +2.0%; Portugal +2.0%; Netherlands +1.3%. Bottom performers: Greece -2.7%; Spain -1.4%; Czech Republic -1.3%; Poland -1.2%.
- FX: The EUR/USD is down -0.50% week-over-week vs -3.14% last week. W/W Divergences: RUB/EUR +1.25%; PLN/EUR +1.20%; CZK/EUR +1.19%; GBP/EUR +0.75%; NOK/EUR +0.71%; SEK/EUR +0.28%; CHF/EUR +0.03%; DDK/EUR -0.01%.
- Fixed Income: 10YR Yields were mixed to down across the countries we track. Week-over-week, Greece’s 10 YR yield declined -51bps to 25.22%, followed by Spain at -34bps to 6.66%. French and Belgian yields both dropped -19bps to 2.22% and 2.66%, respectively. Portugal was a notable outlier to the upside, gaining +35bps to 10.56%. Italy was relatively flat on the week, declining -5bps to 5.99%.
ESM (and European) “Clarity” Pushed Out:
I encourage you to read Friday’s Early Look titled “Crumble Cake Europe” in which I step back to assess the Eurozone’s political landscape in the context of the on-going “crisis”, including the implications for the common currency. In short, given the German Constitutional Court’s lack of decision on the ESM and fiscal compact this week—and a follow-up statement from Finance Minister Wolfgang Schaeuble that a decision may not come until the Fall—there’s potentially a long runway of indecision on the bailout facility and the lack of scheduled Summits (i.e. catalyst) over the summer leaves a lot of uncertainty on the table, including Spain’s bank bailout that hangs on both the EFSF and ESM (which was scheduled to be operation on July 1) and the firepower behind the Eurozone’s bailout facility, as the EFSF has only €120-220B remaining, depending if you factor in Spain’s bank bailout or not.
As we show in the chart below, the EUR/USD cross broke our intermediate term TREND Line of $1.22 this week and is nearing 2010 lows, back when Greece received its first bailout in May. We see the cross as a relative loser until more decisive action is taken from Eurocrats.
Spain - PM Rajoy announced budget measures worth €65B over 2.5 years this morning (VAT will rise to 21% vs 18%). He also announced a reduction in unemployment benefits, the elimination of the year-end bonus for some public workers, the consolidation of local governments and the scrapping of a tax rebate for home buyers. Rajoy also said that he may privatize airport, railway and port assets.
Germany - The country’s Constitutional Court ended its hearing on the ESM and fiscal pact and did not give a date for a ruling, but Finance Minister Wolfgang Schaeuble says he hopes it will come before the fall.
Norway - The Norwegian government stepped in at the last minute to force arbitration and avert a lockout of ~ 6,500 offshore oil workers.
Eurozone - Finance Ministers announced further details around the €100 billion plan to recap Spanish banks. Under terms of the “political understanding” - €30 billion will be released by the end of the month via Spain’s existing FROB (on Spain’s balance sheet).
European Commission - Will propose easing Madrid's deficit goal for this year to 6.3% of economic output (versus a previous target of 5.3%), and 4.5% in 2013 (versus 3%) and 2.8% for 2014.
Greece - Deposits in Greece’s banking system have increased by more than €8 billion since the government formed.
Italy - Prime Minister Monti ruled out running for office when his term ends next fall. He also reiterated that Italy may want to tap the Eurozone bailout mechanism to help lower its borrowing costs.
Ireland - The Financial Times, citing an interview with Irish Finance Minister Michael Noonan, reported that Dublin will unveil a multi-billion euro stimulus package later this month in an effort to boost its economy and reduce unemployment.
ECB - ECB on Thursday showed that banks held €324.9B in the ECB's overnight facility on Wednesday, the first day that the central bank's recently announced zero deposit rate went into effect, down from €808.5B on Tuesday.
Italy - Moody’s downgraded Italy's government bond rating to Baa2 from A3.
France - European Affairs Minister Bernard Cazeneuve said that France is ready to cede sovereignty to its European partners if it helps to bolster the tolerance for debt mutualization.
The move in sovereign CDS was mixed on the week. Portugal fell -18bps to 835bps week-over-week, followed by Germany at -13bps to 87, France -12bps to 173bps, and Italy -9bps to 505bps. Ireland rose 18bps to 551bps and Spain was flat on the week.
Eurozone Sentix Investor Confidence -29.6 JUL vs -28.9 JUN
Eurozone Industrial Production -2.8% MAY Y/Y (exp. -3.2%) vs -2.4% APR [0.6% MAY M/M (exp. 0.0%) vs -1.1% APR]
Germany Exports 3.9% MAY M/M (exp. 0.2%) vs -1.7% APR
Germany Imports 6.3% MAY M/M (exp. 0.8%) vs -4.9% APR
Germany CPI 2.0% JUN Final [unch vs previous estimate]
Germany Wholesale Price Index 1.1% JUN Y/Y vs 1.7% MAY
France Bank of France Business Sentiment 91 JUN vs 92 MAY
France Industrial Production -3.5% MAY Y/Y (exp. -1.6%) vs 0.8% APR [-1.9% MAY M/M (exp. -1.0%) vs 1.4% APR]
France CPI 2.3% JUN Y/Y vs 2.3% MAY
UK Industrial Production -1.6% MAY Y/Y (exp. -2.1%) vs -2.0% APR
UK Manufacturing Production -1.7% MAY Y/Y (exp. -1.9%) vs -1.5% APR [1.2% MAY M/M (exp. -0.1%) vs -0.8% APR]
Italy Industrial Production -6.9% MAY Y/Y (exp -8.6%) vs -9.3% APR [0.8% MAY M/M (exp. -0.6%) vs -2% APR]
Italy CPI 3.6% JUN FINAL [UNCH]
Spain House Transactions -11.6% MAY Y/Y vs -9.9% APR
Spain CPI 1.8% JUN FINAL [UNCH]
Portugal CPI 2.7% JUN Y/Y vs 2.7% MAY
Switzerland Unemployment Rate 2.9% JUN vs 2.9% MAY
Switzerland Producer and Import Prices -2.2% JUN Y/Y (exp. -2.2%) vs -2.3% MAY
Norway CPI 0.5% JUN Y/Y (exp. 0.8%) vs 0.5% MAY
Denmark CPI 2.2% JUN Y/Y vs 2.1% MAY
Finland CPI 2.8% JUN Y/Y vs 3.1% MAY
Finland Industrial Production -1.7% MAY Y/Y vs -2.8% APR [1.2% M/M MAY vs 0.6% APR]
Netherlands Retail Sales 1.6% MAY Y/Y vs -8.7% APR
Netherlands Industrial Production -0.5% MAY Y/Y (exp. -0.5%) vs 0.4% APR [-0.3% MAY M/M (exp. -0.5%) vs -2.5% APR]
Sweden Industrial Production -2.3% MAY Y/Y (exp. -6.9%) vs -6.4% APR [ 3.5% MAY M/M (exp. 0.4%) vs -0.2% APR]
Sweden CPI 1.0% JUN Y/Y vs 1.0% MAY
Greece Industrial Production -2.9% MAY Y/Y vs -2.2% APR
Greece CPI 1.0% JUN Y/Y (exp. 0.8%) vs 0.9% MAY
Greece Unemployment Rate 22.5% APR vs 21.9% MAR
Ireland 1Q GDP 1.2% Y/Y vs 2.8% in Q4
Ireland CPI 1.9% JUN Y/Y vs 1.9% MAY
Czech Republic CPI 3.5% JUN Y/Y vs 3.2% MAY
Czech Republic Unemployment Rate 8.1% JUN vs 8.2% MAY
Czech Republic Construction Output -3.5% MAY Y/Y vs -2.7% APR
Czech Republic Industrial Output -2.4% MAY Y/Y (exp. -2.3%) vs 2.2% APR
Turkey Industrial Production WDA 5.9% MAY Y/Y vs 4.2% APR
Latvia Unemployment Rate 11.9% JUN vs 12.3% MAY
Slovakia CPI 3.6% JUN Y/Y vs 3.4% MAY
Hungary Industrial Production 1.9% MAY Y/Y vs -3.1% APR
Interest Rate Decisions:
(7/12) Serbia Repo Rate HIKE 25bps to 10.25%
(7/12) Latvia Refinancing Rate CUT 50bps to 3.00%
(7/13) Russia Overnight Deposit Rate UNCH at 4.00%
(7/13) Russia Overnight Auction-Based Repo UNCH at 5.25%
(7/13) Russia Refinancing Rate UNCH at 8.00%
The Week Ahead:
Monday: Jun. Eurozone CPI; May Eurozone Trade Balance; May Italy Trade Balance, General Government Debt
Tuesday: Jul. Eurozone ZEW Survey Economic Sentiment; Jun. Eurozone New Car Registrations; Jul. Germany ZEW Survey Current Situation and Economic Sentiment; Jun. UK CPI, Retail Price Index; May UK ONS House Price; May Spain Trade Balance
Wednesday: May Eurozone Construction Output; UK BoE Minutes; Jun. UK Claimant Count Rate, Jobless Claims Change; May UK Average Weekly Earnings, ILO Unemployment Rate, Employment Change; 2Q Spain House Price Index; Italy Chamber of Deputies Votes to Approve ESM, Fiscal Pact; May Italy Current Account
Thursday: ECB Governing Council Meeting; May Eurozone Current Account; Jun. UK Retail Sales; May Italy Industrial Orders, Industrial Sales
Friday: Jun. Germany Producer Prices; Jun. UK Public Finances, Public Sector Net Borrowing; May UK Current Account
Extended Calendar Call-Outs:
19 July: ECB governing council meeting
18-19 October: Summit of EU Leaders
Chart of the Day
- Backlog to build ratio declines consistent with expectations for production cuts
- Historically, very low backlog to build ratios have coincided with buying opportunities in shares of OEMs
- Declining production should keep the Class 8 truck fleet old
- An older fleet with high utilization (mid-90s in May) is typically associated with outperformance for OEM shares
The Mining Investment Bubble
Yesterday’s Industrial Indicator on Caterpillar’s exposure to mining investment attracted some interest. The Resources division is CAT’s most profitable and has the highest margins and returns on assets. CAT even added Bucyrus to this division, apparently with poor cyclical timing. This is not to say that Bucyrus is a bad fit inside of CAT, just that it was purchased during a period of (very) abnormally high investment in mining equipment. The first step of our investment process separates cyclically driven results from secular/sustainable results. The resources division at CAT, along with other mining exposed equipment producers like Sandvik, Komatsu, JOY, and Terex, could see that source of demand evaporate. Global mining output could continue to expand with much lower levels of capital spending, so a commodity crash is not required for revenues in these divisions to contract.
Over the past 5 years, the Dollar Stores experienced a notable shift in both private label and consumables right when the consumer needed it which drove massive margin expansion. This happened alongside accelerated unit growth and a tailwind from food inflation. Now, private label and consumables penetration are hitting a ceiling and food prices are deflated relative to last year. With margins now at peak, we don’t need profitability to deteriorate but rather for these tailwinds to fade in order to build the short case.
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