This note was originally published at 8am on June 14, 2013 for Hedgeye subscribers.
“Shy and proud men are more liable to fall into the hands of parasites and creatures of low character. For in the intimacies which are formed by shy men, they do not choose, they are chosen.”
Tapeworm infestation is not something we would wish on our worst enemies. According to Wikipedia, tapeworm infestation is the infection of the digestive tract by adult parasitic flatworms called cestodes or tapeworms. Typically, consuming uncooked food is the way in which tapeworm larva find their way into humans. Once inside the digestive tract, a larva can grow into a very large tapeworm.
No doubt waking up to read about tapeworms is the last thing you need. Alas, we couldn’t think of a more appropriate analogy given the market’s recent fascination with the potential tapering of QE by the Federal Reserve. Yesterday, the market actually rallied on this tapering rumor based on a blog by Jon Hilsenrath in the Wall Street Journal that tapering, if it is to occur, would be a more manageable version, perhaps something akin to Taper-lite.
We haven’t been stock market operators as long as many of you, but we certainly don’t remember a period in which there has been such a fascination with, and focus on, the next move of the Federal Reserve. But until the market host rids itself of the QE parasite, this fascination and volatility associated with the next move of the Fed is likely to continue.
Back to the global macro grind . . .
Earlier this week, we reiterated our short call on emerging markets and China with a concise presentation by our Senior Asia Analyst Darius Dale. (Email email@example.com to get a copy of the presentation.) This short call has played out positively for us and has been backed by asset flows out of emerging markets funds. In fact, in the most recent week the exodus from emerging market funds was $9 billion, which was the third largest weekly outflow ever (after March 2007 and January 2008).
The key new research we provided in the presentation was related to short Chinese financials. We view this thesis as three fold:
- Credit growth is slowing – The increasing likelihood that the People’s Bank of China tightens will provide an impediment to credit growth;
- NIM compression is occurring – Based on the current NIM spread, we think this ratio can only tighten from current levels, which will pressure bank margins; and
- Non-performing loans are rising – Even though the data is very opaque, NPLs of 20% are a reasonable estimate given by many experts.
In the Chart of the Day, we’ve highlighted one of the more insightful charts in the presentation, which is the Chinese 7-day repo rate monthly average, which highlights how tight money is in China currently. This rate has gone from about 3.5% in May to 5.7% in June, which is the second highest monthly rate in the last five years and a staggering shift month-over-month. If money sustainably tightens in China, economic growth will most certainly take a hit.
Our Senior Analyst covering Europe Matt Hedrick also gave a very lengthy and thoughtful update on Europe this week (once again email firstname.lastname@example.org if you want to see this presentation). While we don’t see the financial sector risks in Europe that we do in China, the economic outlook does remain largely bleak in Europe. Some of the key points that we highlighted in the presentation included:
- Fundamentals in Europe remain challenged and we should expect long-term below mean growth;
- We see limited risk to any country leaving the Eurozone or the Euro being disbanded, so another Cyprus flare-up is unlikely;
- The bifurcation in Europe will continue and we are fundamentally bullish of Germany and the U.K. and fundamentally bearish of France, Italy and Spain; and
- ECB is unlikely to shift policy anytime soon, which should continue to support our strong dollar call.
A structural issue that makes it inherently difficult for Europe to recover quickly is the inflexibility of the labor force. In the United States, labor can flow freely from state to state based on employment opportunities. So, in theory, the U.S. would be very unlikely to have states where the unemployment rate was north of 26%, such as in Spain and Greece, and other states where the unemployment rate is below 7%, such as Germany and Denmark.
Given the inability of labor to flow easily through European borders, due to differing qualification levels, work quotas and cultural barriers, it is no surprise then that a recession in Europe should be more protracted. The bigger issue, of course, is that it creates unemployment hot spots, such as Greece, Cyprus, and Spain, that will have an inability to re-balance their economies, except over very lengthy time periods.
This dreary global growth outlook we have continues to push us back to the one economy and stock market we remain positive on – the U.S. of A. On that front, as it relates to macro data coming out today, the big one is Michigan Consumer Confidence which is released at 9:55am to the masses, and five minutes early for those that pay up for the early look! Regardless of who gets it ahead of you, it will still be a decent “tell” on how the consumer is feeling.
Our immediate-term Risk Ranges for Gold, Oil, US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1351-1418, $100.21-105.43, $80.26-80.24, 93.54-95.85, 2.07-2.27%, 15.21-1857, and 1605-1653, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research