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MACRO: THE DEFICIT STILL LOOKS UGLY...

This insight was originally published on July 13, 2010.  Macro Select intraday updates are available to RISK-MANAGER SUBSCRIBERS in real-time.

 

 

 

MACRO: THE DEFICIT STILL LOOKS UGLY, NORMALIZE FOR TARP AND IT LOOKS UGLIER

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Conclusion: While June was an improvement for the deficit due to timing related to Memorial Day, the year-to-date numbers remain concerning.  On the other hand, the appointment of Jack Lew to OMB Director is a marginal positive.
 
The U.S. government reported a smaller monthly budget in June versus June 2009 with a deficit of $68.4 billion versus $94.3 billion last June.  In the year-to-date, the budget deficit is $1 trillion versus $1.1 trillion over the same period in 2009.  On a year-to-date basis, the budget deficit as a percent of GDP is 9.2% versus 10.2% in the same period in 2010.  While this high level summary suggests marginal improvement, the underlying facts still suggest dire fiscal issues in the United States on a number of fronts.
 
First, the June improvement in deficit can be attributed primarily to timing of revenues.  Due to the Memorial Day, a large amount of tax revenue was pushed into June.  In aggregate for the year-to-date, overall revenues are only up 0.5%, with corporate income tax contributing all of this increase growing 33% y-o-y.  Personal income tax, on the other hand, is down -4.4% in the year-to-date.  So despite the “economic recovery”, tax receipts from individuals are still lagging on a year-over-year basis (jobless recovery sound familiar?).
 
Second, while reported outlays were $73 billion, or 3%, lower for the first three quarters of the fiscal year, this decline included a reduction in nearly $350 billion from a combination of TARP, Treasury payments to Fannie Mae and Freddie Mac, and net outlays for FDIC insurance.  If normalized for TARP, so removing the $350 billion from last year’s numbers, then spending ex-Tarp is up 10.6% on a year-over-year basis!  Not a good trend.
 
While a large proportion of this was driven by unemployment insurance, every major line item showed a meaningful increase year-over-year.  Specifically,

  • Defense spending was up 5.8%;
  • Social security was up 6.0%;
  • Medicare was up 4.3%;
  • Medicaid was up 8.9%; and
  • And Other was up 9.1%.

Line item spending dramatically outpaced the economy vis-à-vis GDP growth and tax revenue growth.
 
In conjunction with this release, President Obama also named Jack Lew the new budget director.  While Orzag has a following amongst the paparazzis in Washington, Lew is actually an experienced hand in the budget area and has spent seven years in the OMB. He was lastly OMB director under President Clinton until 2001, and produced a budget, with the help of a healthy economy, that resulted in a surplus of $236 billion.
 
Given his prior experience, prior success, and proven ability to work across bi-partisan lines, President Obama seems to have made a solid choice in Lew.  Even though he spent some time as Chief Operating Officer at Citi Alternative Investments, we will still give him a free pass on that job choice for now.  He certainly has the wherewithal to take a tough stance on the budget, but the next few months will actually show how serious the Obama administration is about narrowing the deficit.

 

 

MACRO: THE DEFICIT STILL LOOKS UGLY... - chart 1

 

 
Daryl G. Jones
Managing Director


The Point of Collapse

“Perfection of planned layout is achieved only by institutions on the point of collapse.”

-Northcote Parkinson

 

Parkinson was a well known British scholar who specialized in naval history. Before he passed away in 1993, he authored 60 books, including “The Devil to Pay”, “Dead Reckoning”, and “So Near, So Far.” His writings recognized patterns of behavior in administrations and institutions in a way that makes we modern day chaos theorists proud. Patterns repeat.

 

The point of collapse is generally crystal clear in the rear-view mirror. Professional politicians in Japan have been telling stories for 20 years as to why they can prevent economic stagnation. In the US, the storytelling started in 2007. All the while, stock market and real-estate prices have every opportunity to rally to lower-highs, then collapse to lower-lows.

 

Despite all of the dissimilarities between Japan and the US, there is one similarity that continues to matter most in our risk management model – debt as a percentage of GDP. Now that the US can’t cut interest rates any lower, the “perfection of planned layout” to quantitatively ease, is also similar. We agree with Reinhart & Rogoff that crossing the 90% debt/GDP threshold is the equivalent of crossing the proverbial Rubicon of economic growth.

 

On July 2nd, as part of our Q3 Hedgeye Macro Themes presentation, we cut both our Q310 and full year 2011 GDP estimates for the US to 1.7%. At the time, these US economic growth estimates were about ½ the Bloomberg consensus estimate. Now we’re starting to see both the sell-side and the Fed gradually cut their estimates, but not by enough. Our estimate for 2011 is still too high.

 

Growth slowing, both domestically and in China, is core to our bearish views on both the US Dollar and US Equities. There will be a downward bias to our US growth estimates as long as debt-financed-deficit-spending continues to remain the answer to the Fiat Fools prayers.

 

Markets trade on expectations. Yesterday’s setup in the SP500 was unlike most Augusts in America. That’s because the ‘government is good’ crowd leaked an idea to the Wall Street Journal that QE2 was coming, and that Ben Bernanke was going to solve for buy-and-hope begging.

 

To think that we have institutionalized market expectations in this great country to this degree is downright frightening. All things rallies start and end with rumors about what a humble looking man of government will represent at 215 PM EST on an August afternoon. Sadly, this kick starts thoughts of what another thoughtful European mind, Alexis De Tocqueville, warned about American style democracy in the 19th century.

 

So now what?

 

What do we do with this big Keynesian intervention that has delivered the fear-mongering national marketing message? Have we sufficiently scared the horses? While we’ve been getting paid, has this “perfectly planned layout” of telling Americans that this is a “great depression” worked?

 

With 40.8M Americans on food stamps (record high) and 45% of the unemployed having been seeking employment for 27 weeks or more (record high), now what?

 

Should we start begging for QE3? Should we cancel the bomb of an Existing Home Sales report for public release on August 24th? Or should we get back on TV after checking our I-pads and drinking our $5 mocha-frap and tell Americans to bite the bullet on ZERO percent returns-on-savings while we pay Washington to continue to lever-up our future to the point of economic collapse?

 

Before the Fiat Fools run out campaigning for QE3, never mind decisions made in 1997 Japan, maybe they should analyze some real time market results to yesterday’s announcement of QE Light:

  1. The US Dollar is battling for resuscitation after 9 consecutive down weeks at $80.80 (down -9% since June)
  2. US Treasury yields are making record lows on the short end of the curve, with 2-year yields striking 0.49%!
  3. The Yield Spread (10yr minus 2yr) continues to collapse, down another 4bps day-over-day to 223bps
  4. US stock market futures are diving below the beloved 200-day Moving Monkey line of 1115
  5. US Volatility (VIX) is spiking from its intermediate term TREND range of support (22-23)
  6. QE Specialist (Japan) got smoked overnight, closing down -2.7% to down -11.9% YTD

Now what?

 

De Tocqueville’s answer: “The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money.”

 

My immediate term TRADE lines of support and resistance for the SP500 are now 1099 and 1138, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Point of Collapse - toc2


THE M3: JULY CHINA LENDING DROPS; GSS; PAGCOR; FILIPINO TOURISTS

The Macau Metro Monitor, August 11th, 2010


CHINA'S NEW LENDING DROPS TO 532.8 BLN YUAN IN JULY Xinhua

According to the PBOC, new yuan-denominated lending in July fell to 532.8 billion (US$ 78.6 billion) from 603.4 billion yuan in June.  The first seven months brought 5.16 trillion yuan in loans, compared with 7.73 trillion yuan during the same period last year.

 

M2 supply increased 17.6% YoY to 67.41 trillion yuan by the end of July, slowing down from the 18.5% growth in June.

M1 supply climbed 22.9% in July, a decrease of 1.7% points from June's.  The Chinese government fixed this year's target for new loans at 7.5 trillion yuan. 


GSS SPENDING UP: MASTERCARD Strait Times

According to Mastercard, spending during The Great Singapore Sale (May 28-July 25) jumped 28% YoY to US$893.2 million.

 

PAGCOR CHAIR DOUBTS $10-B OFFER; KUOK DENIES REPORTS Inquirer

PAGCOR chairman Naguiat does not believe Ramon Ang's offer of $10 billion is serious.  “They’re not even industry players,” Naguiat said of Malaysia’s Robert Kuok, Ananda Krishnan and Francis Yeoh, three of the richest men in Southeast Asia.  Naguiat noted that while Kuok owned the renowned Shangri-la chain of luxury hotels, none of them had a casino. 

 

A spokesperson for Kuok in Manila, Joy Wassmer, denied reports that the Malaysian tycoon was interested in PAGCOR.  Wassmer said that Kuok had never been involved in the gaming business and had “no intention of investing in the gaming industry in the future.”


FILIPINO TOURIST ARRIVALS IN MACAU CONTINUE TO GROW Sun Star

Narzalina Lim, general manager of Macau Government Tourism Office-Philippines, said that Filipino tourists continue to visit Macau because of its accessibility and affordability with two Philippine-based airlines -- PAL and Cebu Pacific -- offering direct flights to Macau from Manila and Clark, at the same time offering cheap promotional packages.  With the implementation of the "open skies" policy, which will be announced soon by the Aquino administration, she believes more Filipinos are expected to visit Macau, particularly travelers from Davao Region and its nearby provinces.


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THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP

As we look at today’s set up for the S&P 500, the range is 39 points or 2.0% (1,099) downside and 1.5% (1,138) upside. Equity futures are trading below fair value - disappointing data out of China and Japan has set the early tone and Europe is broadly lower. Today's focus will be trade and budget data for July.

  • ADVANCE/DECLINE LINE: -1400 (-2766)
  • VOLUME: NYSE - 980.83 (+24.14%)
  • SECTOR PERFORMANCE: 3 sectors positive - XLU, XLV and XLP - flight to safety
  • MARKET LEADING/LOOSING STOCKS: Akami +4.86, XL Group +2.68 and ADV Micro (7.95%) and Western Digital (6.12%)

EQUITY SENTIMENT:

  • VIX - 22.37 1.04% - The VIX now up for 2 days and bearish for equities.
  • SPX PUT/CALL RATIO - 2.49 up from 2.01 trending up (not seen since March) (low on 07/15/10 of 0.87)

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD - 24.87 -0.913 (-3.541%)
  • 3-MONTH T-BILL YIELD .15% Unchanged
  • YIELD CURVE - 2.2974 to 2.2359

COMMODITY/GROWTH EXPECTATION:

  • CRB: 272.28 -0.84% (down for the last 4 days)
  • Oil: 79.35 1.51%
  • COPPER: 331.25 -1.24% (currently trading at 327.25 below 332 - BEARISH for growth expectations
  • GOLD: 1,196 -0.32% (trading down for 3 days)

CURRENCIES:

  • EURO: 1.3117 -0.84%  - (trading down for 3 days)
  • DOLLAR: 80.799 +0.11%) - (trading up for 3 days)

OVERSEAS MARKETS:

  • ASIA - Asian markets fell after the Fed disappointed saying it would reinvest money from maturing mortgage bonds in government debt.  Japan fell (2.58%) broadly - The strong yen is hurting exporters and a slowdown in the US; worries about the domestic economy also dampened sentiment as core machinery orders came in below forecasts 
  • EUROPE - European are trading sharply lower following weakness across Asian and in reaction to the Fed's comments that the US economy is slowing and took new step to aid the economy.
  • EASTERN EUROPE - Trading lower - Russia down another 1.23% and Hungary down 0.84%.
  • LATIN AMERICA - Lower but Peru trading higher for the 2nd day - Argentina down 1%
  • MIDDLE EAST/AFRICA - Mostly lower with Saudi Arabia down 1.46% 
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends

 

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER


CHART OF THE DAY: HIGH-LOW SOCIETY

Giving Americans who live on fixed incomes a ZERO percent rate of return on their hard earned savings will continue to have many unintended consequences, for an “exceptional and extended” period of time

 

40.8 MILLION Americans, and counting…

 

Keith

 

CHART OF THE DAY: HIGH-LOW SOCIETY - Screen shot 2010 08 09 at 2.52.51 PM


EARLY LOOK: Bad to Worse

“I toil beneath the curse,
But, not knowing the universe,
I fear to slide from bad to worse.”
-Alfred, Lord Tennyson
 
Keith was off managing domestic risk last night taking his wife out for their anniversary dinner, so I’ve been handed the pen for the Early Look this morning.  Later today our firm will be having our annual picnic at our colleague Todd Jordan’s lake house in rural Connecticut.  It has just been over two years ago since we welcomed our first client, and the growth trajectory since has been meteoric.   On behalf of all of my teammates I’d like to thank all of our clients that have helped make this possible.  It has been a pleasure working with every one of you.
 
We now have close to forty employees.  We have three offices around the globe, with plans to open our fourth this fall.  And with the pending launch of Energy Sector Head Lou Gagliardi in September, we will have seven senior sector heads who cover close to 50% of the SP500.  Following our firm meeting yesterday, I can tell you this, we are just getting started.
 
So, as I was contemplating our firm’s growth yesterday at the Hedgeye Happy Hour following the firm meeting, I was also mulling over the future economic growth of the United States.  While I’m not in the double dip camp, I do “fear to slide from bad to worse”.  As Lord Tennyson would say.  (Incidentally, Tennyson is the second most quoted person in the English language after Shakespeare.)
 
Earlier this week, Keith and I presented to our clients on the topic of U.S. Sovereign Debt.  Debt and deficit issues in the United States are not exactly non-consensus as they are widely discussed and contemplated.  In fact, in the spirit of “watch what they do and not what they say”, we had the second Obama administration economic official resign today in Christina Romer, the chair of the Council of Economic Advisors.  This of course comes on the back of the July departure of Peter “The Paparazzi” Orzag, who ran the Office of Management and Budget.  Watch what they do and not what they say . . .
 
Undoubtedly, both Orzag and Romer have come to the same realization as us, which is that U.S. economic growth is poised to slow in coming years.  In our presentation on Tuesday, we narrowed this projection down to one key variable in our multi factor, chaos theory based model.  This factor is sovereign debt.  So if you are staffed with managing the budget or the economy in a slow growth environment, you better either wave the white flag and go back to teaching at Berkeley (Romer), or prepare your stomach for the new reality of Bad To Worse.
 
While many of you have read Reinhart and Rogoff’s book, “This Time is Different”, which studies the long term implications of large sovereign debt balances,  the professors also wrote a fascinating paper earlier this year, “Growth in a Time of Debt.”  This paper looks at over 210 years of data relating to sovereign debt balances and future economic growth.  The key conclusion is that as debt-as-percentage-of-GDP crosses the Rubicon of 90%, future growth slows.  And in dramatic fashion.
 
According to their paper, from 1790 to 2009, for 20 of the most modern economies, as debt exceeded 90% of GDP, average annual economic growth was 1.7%.  This was compared to economic growth of 3.7% at less than 30% of debt to GDP, economic growth of 3.0% with debt to GDP from 30% to 60%, and economic growth of 3.4% with debt to GDP of 60% to 90%.  In effect, as debt as a percentage of GDP passes the Rubicon of 90%, growth falls below the average by more than three standard deviations.  As the quants will tell you, that is statistically significant!
 
Being the industrious young analysts that we are, we actually applied this thesis to Japan.  In the attached chart of the day, we outline this point graphically. In the last three decades in Japan as we see a step up in debt, we see a corresponding step down of economic growth with the inflection point being . . . you guessed, it 90% debt-to-GDP.  Specifically,
1981 – 1989 – Japan has average economic growth of just 4.6% and an average debt to GDP balance of 64%;
1990 – 1999 – Japan had an average economic growth of 1.5% and an average debt to GDP balance of 92%; and
2000 – 2009  - Japan had an average economic growth of 0.8% and an average debt to GDP balance of 179%.
As they say, facts don’t lie, politicians do.  And the facts as it relates to debt and growth are quite clear, as debt climbs and exceeds the Rubicon of 90%, economic growth will slow.  If you don’t believe me, believe the 200+ years of data.
 
It is clear to me that, “The old order changeth, yielding place to new.”  With the new order being a meaningfully different growth trajectory for the United States than the prior thirty years.  
 
But as always, “Tis better to have loved and lost, than never loved at all.”
 
The Poet Laureate of Hedgeye,
 
Daryl G. Jones
Managing Director

 

EARLY LOOK: Bad to Worse - Screen shot 2010 08 09 at 2.48.16 PM


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