“Asset price inflation is not growth.”
I know. You probably need something more profound than a quote from me to kick off your morning. As Bernanke and Draghi unite this week, how about we all take a deep breath and channel our inner Shakespeare? Since in neither the short nor the long run we aren’t all yet dead, we’re best served to always remember that “expectations are the root of all heartache.”
When it comes to performing day-to-day in our centrally planned markets, those expectations obviously go both ways – and fast. On Thursday morning at 5AM EST, US Equity Futures were down 5 handles and Spain’s IBEX was crashing (-33% from its YTD top). This morning, the SP500 is +4% (53 points) higher, and Spain is still crashing (now only down -25%).
Great short-term inflations of asset prices are awesome, right? So is pretending the Fed and ECB can “smooth” and suspend economic gravity. As we continue to make a series of lower long-term highs versus those established when #GrowthSlowing started, globally, again in March 2012, our governments continue to A) shorten economic cycles and B) amplify market volatility.
Back to the Global Macro Grind …
First, let’s go through that ‘inflation slows growth’ thing again with a real life example, US GDP:
- Q4 2011 US GDP Growth = 4.10%
- Q1 2012 US GDP Growth = 1.97%
- Q2 2012 US GDP Growth = 1.54%
So, let’s do more of what has not worked (whatever it takes really), to make sure we keep that asset price speculation (stocks and commodities) in play. Just so that we end up with no real (inflation adjusted) economic growth at all!
Look on the bright side, even though your run of the mill sell-side anchoring “economist” has been off by 33-57% so far with their 2012 US GDP Growth estimates, the stock market went up for the last 48 hours, so they can say they were right on the bull case anyway.
That line of storytelling is as ridiculous as the assumption that begging for Bernanke to give you $1700 Gold and $100 Oil is a “growth” policy for the economy.
That doesn’t mean I can’t be completely wrong here. Evidently this market isn’t short-able, until it is. Meanwhile the Correlation Risk signals are starting to go hog wild (again), doing exactly what they did in February/March.
Got Great Expectations? Here’s last week’s CFTC data on commodity contracts leaning to the long side:
- Oil +6% wk-over-wk to 140,636 contracts
- Sugar +17% wk-over-wk to 128,093 contracts
- Ag (farm goods basket) +4% wk-over-wk to 856,446 contracts
All in, we’ve crossed the proverbial Rubicon again of > 1.0 million CFTC contracts (1.17M this past week), where the entire Street is expecting Great Inflations from Bernanke and Draghi. *Note: these are all time highs in contracts outstanding.
As most of these perma-commodity bulls learned in April/May, what is expected to keep going up, comes down – and hard. Maybe this time is different though? Maybe this is going to be like Venezuela where a centrally planned stock market (up +109% YTD) is governed by explicit currency debauchery?
I am hearing the Venezuelan commoner’s life is mint these days. Also hearing that if Bernanke goes all-in Obama with Qe3, life for the 71% is going to be just rosy too.
Who knows. All we know is that the biggest loser in all of this is what were our “free” markets. Sadly, some still think the stock market is the real-time economy. All the while, these Great inflations continue to deflate both growth and The People’s trust.
My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Spain’s IBEX, and the SP500 are now $1, $105.18-108.26, $82.40-83.26, $1.20-1.23, 6, and 1, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
Our macro team has taken a cavalcade of data and examined it with an objective viewpoint to determine just how well we’re doing since the 2007 housing crisis that led to the 2008 financial crisis. The results? A meaningful housing recovery is years upon years away but the US market seems to have stabilized – a positive catalyst for the US dollar and economy.
Mortgage rates are absurdly cheap right now. Perhaps you read about Facebook Founder and CEO Mark Zuckerberg refinancing his estate at a 1%. If the government’s plan was to flood the US with cheap money, it’s certainly working out quite nicely.
It’s important to understand that the US housing market has two large underpinnings to it. First, a house is the primary asset for many Americans. As the value of a house increases, so does their net worth, and their confidence related to future spending. Second, homebuilding and construction is a major driver of employment in the U.S. As the chart below highlights, more than 2 million jobs were shed in the construction sector since 2006, of which almost none have come back.
According to recent data from the National Association of Realtors, housing inventory is at the lowest level since June 2002. Looking at the chart below, you can see that 2011 saw a massive drop in the amount of available homes. The recent uptick is merely cyclical and inventory is expected to continue to improve.
One of the biggest metrics of course is home prices. If anything, the perception alone is a major concern for the US homeowner as a person’s house is their single largest asset they own. Home prices go up, net worth goes up; it’s a beautiful thing – even if it did lead to a bubble that popped in the late 2000s.
The chart below highlights the Case-Shiller national median home price going back three years. The national median home price, at least according to this series, bottomed in the first couple of months of 2012 and has been on the rebound for the last few months according to data through April. This is corroborated by data released from Zillow that shows the median home price nationwide was up 0.2% year-over-year in Q2 2012 for the first time in five years.
So what does this all mean? It means we’re a lot better off than we were five years ago. The overall enthusiasm in this recovery is a good thing, but we would caution on expecting an accelerating recovery from these levels because of both the large amount of shadow inventory and artificially low level of interest rates.
CONCLUSION: By authorizing BOJ purchases of foreign currency assets, Japanese policymakers risk materially elevating the risk of sustained yen depreciation and inflation within the JGB market. Though we have yet to receive anything concrete on the policy front, we will be paying close attention to the next two BOJ monetary policy board meetings for signs of official movement in this direction.
As both economic growth and inflation slow from a cyclical perspective in Japan, nominal JGB yields are trading at/near multi-year lows across the curve (8yrs for 2s; 9yrs for 10s; 2yrs for 30s) on heightened expectations for BOJ balance sheet expansion. While we continue to anticipate they’ll be on hold throughout the immediate term (next meeting AUG 8-9), we do think such speculation is warranted and will ultimately prove prescient by the BOJ’s SEP 18-19 meeting. Then, the BOJ will have had the opportunity to mull over a heaping helping of [likely] nasty economic data and incrementally dovish inflation data in making its policy decision. Key catalysts on this front include:
- 7/29: JUN Industrial Production;
- 7/30: JUL Manufacturing PMI; JUN Jobs Report;
- 8/7: JUL Economy Watchers Survey;
- 8/8: JUN Machine Orders;
- 8/9: JUL Consumer Confidence; JUL Machine Tool Orders; JUL Manufacturing PPI;
- 8/12: 2Q GDP;
- 8/21: JUL Trade Data;
- 8/23: JUL Services PPI;
- 8/29: JUL Retail Sales;
- 8/30: JUL Jobs Report; JUL CPI; JUL Industrial Production;
- 8/31: 2Q Corporate CapEx;
- 9/9: 2Q GDP – 2nd reading;
- 9/10: AUG Economy Watchers Survey; 3Q Business Sentiment Index; and
- 9/11: JUL Machine Orders; AUG Manufacturing PPI.
We reiterate our bearish TRADE and TREND fundamental thesis on Japanese equities; more details can be found in the hyperlinked note above. Turning back to JGBs, we received two very interesting data points in the last 24-36 hours that pose varying degrees of risk to this market. The first risk is an acceleration of sales by Japan’s Government Pension Investment Fund (GPIF). The second, and far more serious risk, is outright BOJ purchases of foreign currency denominated assets, such as Eurozone periphery sovereign debt.
On Thursday, Takahiro Mitani, president of GPIF (the world’s largest public pension fund, overseeing 113.6 trillion yen ($1.44 trillion)), plainly stated: “Payouts are getting bigger than insurance revenue, so we need to sell Japanese government bonds to raise cash.” While this trend (i.e. waning pension and insurance fund demand for JGBs) in and of itself is not new news (they’ve been selling JGBs intermittently since 3Q10), it is a stark reminder that the clock is indeed ticking from a demographics/household assets perspective as it relates to the Japanese economy’s ability to domestically absorb incremental stock of JGBs. Our generous calculations give the Diet ~10yrs before they pass the “point of no return”.
For reference, GPIF has ¥71.9 trillion of its assets in JGBs or 8% of all JGBs outstanding; the other pension funds in Japan own an additional 1.3% of outstanding JGBs and Japanese insurance firms own an additional 22.4%. JGBs remain at risk over the long term to the extent these market participants are incrementally forced to supplement cash balances by chasing yield abroad or by selling what they can (i.e. what’s been working; i.e. JGBs).
Regarding these points, Mitani agrees that liquidity may increasingly become an issue – forcing some combination of the aforementioned strategies: “To boost returns, we may have to consider investing in new assets beyond conventional ones.” We’ve been vocal in our work on the JGB market in lauding the inflation-adjusted, FX-adjusted returns JGBs provide to domestic Japanese investors. With the yen’s secular appreciation story still intact (up +50.8% vs. the USD and +67.3% vs. the EUR over the last 5yrs), it has made little economic sense for Japanese investors to chase returns offshore. As such, it’s no surprise to see that, despite such low nominal yields in the Japanese bond market and poor domestic equity returns, less than one-fifth (19.7%) of the GPIF portfolio is in foreign currency denominated assets.
That could potentially change in a major way over the intermediate-to-long term, leaving both domestic equities and JGBs at risk of increased institutional selling pressure. The key catalyst on this front takes us to the second, more material risk we alluded to above – outright BOJ purchases of foreign currency denominated assets, which former Ministry of Finance official Takatoshi Ito is urging his cronies at the BOJ to consider. His logic is simple: sustained BOJ purchases of foreign currency denominated assets (like Spanish and Italian sovereign debt) should, in theory, sustainably weaken the yen and boost exports, while at the same time coming to aid of the Eurozone – a key source of global economic demand.
Obviously, the key side-effect of pursuing such a policy (and perhaps why the BOJ has yet to openly consider it) is that it would, in fact, weaken the yen – perhaps too much too soon. Secular currency depreciation and inflation are two risks that haven’t been priced into the JGB market for many, many years and we’d be remiss to not flag the downside risk of investors having to account for those factors at current, historically-elevated prices.
For more details specifically on these and other catalysts that pose a material threat to the JGB market, please email us at ; we have a compendium of work that we’d be happy to share. The word “catalysts” is specifically bolded because we continue to see heightened risk in lazily succumbing to the consensus bearish thesis on Japanese sovereign debt (fiscal imbalances, yada, yada, yada…). Rather, we continue to mine for and vet specific catalysts – like the ones documented above – to determine whether or not investors should be adequately hedged for a sharp JGB sell-off. One key long-term risk we see is the APR ’13 term expiration of current BOJ Governor Masaaki Shirakawa. Replacing him with an aggressive dove would, in fact, put the risks of secular currency depreciation and inflation squarely on the table.
Have a great weekend,
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