Monthly Archives: August 2011

quick update

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Below are various commodity indices.
If China was in fact melting down in the second half of this year due to cut backs in state spending and lending, and that front loaded into the first quarter, it would look something like that before breaking further.

chart

The Australian dollar is likewise falling, indicating shifting circumstances at China’s coal mine as well.

While good for the US consumer and US domestic demand, it’s not good for the earnings of quite a few
major corporations.

It’s also good for the dollar, which is also not good for corporate foreign earnings translations.

It also brings down headline inflation and could help moderate core CPI as well.

And if China doesn’t like US Fed style QE, ECB style QE- buying member nation debt- has to be all the more distasteful,
and could shift their reserve preference away from the euro.

Especially as the ECB check writing escalates much like it did when it supported the banking system’s liquidity. In theory the ECB’s check writing for the national govts could approach the size of the US budget deficit. Somewhat as ECB liquidity support for the euro member banks is analogous to FDIC insurance for the US banking system.

With the US budget deficit chugging along at about 9% of GDP, domestic demand and earnings should be no worse than they were in the first half of this year, as previously discussed, which means equities should be ok in general, though with some names benefiting as others get hurt.

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SCM Client Note: S&P Downgrade, Monday Market Action

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I tend to agree with this update from Art.
The global equity sell off seems beyond anything related to the S&P downgrade
and more likely China and commodity related. Note the recent fall in the $A for example.

There’s a new post on our site discussing the terrible performance of Asian stock markets this morning, on the first major trading day following Standard & Poor’s downgrade of the U.S. government’s credit rating. The media is widely assuming the selloff in Asia is all related to the downgrade, but I think that’s a pretty flimsy argument. Seems more likely to be related to China and/or Europe. We’ll have a better idea once European markets open. The post is linked and excerpted below. If you have any questions or concerns, let me know. Have a great week!

Asia Down Big: US Downgrade or China Cracking?

Market chatter has been focused on the impact that Standard & Poor’s downgrade of U.S. government’s credit rating on Friday afternoon would have on markets this week. If you follow our blog, you already know where we stand on S&P’s decision—it’s an utter joke. And while other markets have shown some volatility since Friday, it didn’t seem to have much of a negative impact. That’s as we expected.

However, Asian markets sold off brutally at the start of this week’s trading. The knee-jerk media interpretation is that it’s S&P-driven, but that’s not a satisfying explanation in my view. Given how the sell-offs are unfolding, it looks like it could be China-related. The Shanghai stock market is now officially in bear market territory, and smart market watchers have been predicting that China could soon experience a financial crisis, as its system is reportedly quite levered-up and fragile.

If so, this is NOT good for the global economic and risky asset outlooks. Throw one more nut on the bear claw. And China is a big nut—a lot of companies around the world depend on demand out of China, either directly or indirectly, to support current operating performance. Take that down significantly and stock market valuations suddenly look a lot richer.

Of course, it could be Europe too. And we’ve recently seen short-term interest rates go negative, an occurrence that presaged the last global financial crisis. We’re keeping a close eye on things as they unfold.

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In other news, Friday saw what appeared to be rather healthy payrolls and consumer credit reports. However, digging below the headlines, temporary hirings (along with measures of temp help demand from other sources) are still falling, and they tend to lead payrolls higher or lower. And underlying trends in consumer confidence indicate that the notable jump in consumer credit, though it could run for another few quarters, should be short-lived.

Work that I did with some of our strategy models over the weekend indicates that recession is going to be almost a sure thing as July and August data is fed in, and we’re currently predicting a start date between February 2012 and January 2013. Also looks, based on NYSE margin data, like the S&P 500 could fall another 10% to 30% from here, with a bear market running from May 2011 (some would date it back to 2007) through as late as mid-2013. A bear market starting roughly half a year before recession would fit historical patterns rather well, unfortunately.

One piece that is arguing emphatically against recession is the Treasury curve, which is still historically steep after last week’s flattening. However, (1) Japan’s first follow-on recession started with the term spread at around 200 basis points (unheard of up until then) and it has had two additional recessions without its yield curve ever inverting, and (2) we simply don’t expect term spreads to have much predictive power in a zero interest rate environment. Interbank funding in the U.S. is still at safe levels, but there are definitely incipient signs of stress. Everything else is on the verge of triggering a recession warning.

Depending upon what unfolds in China, Europe, and the upcoming U.S. austerity negotiations (and the ever-present unknown unknowns), recession could unfold far sooner and faster than almost anyone thinks. Forceful policy actions could do a great deal to stem the tide, but there seems to be almost no political will to do anything, probably due to the mistaken belief that governments everywhere are ‘out of bullets’.

At levels below 900 on the S&P500, we would probably start to lean heavily toward equities—unless a balanced budget amendment to the U.S. Constitution makes significant progress, in which case we’ll recommend cash and long-term Treasuries across all or most of our clients’ accounts.

Best regards,
Art

IMPORTANT DISCLOSURES: Symmetry Capital Management, LLC (“SCM”) is a Pennsylvania registered investment advisor that offers discretionary investment management to individuals and institutions. This publication is for informational, educational, and entertainment purposes only. It is not an offer to sell or a solicitation to buy securities, or to engage in any investment strategy. The firm and some of its clients hold some positions that are expected to increase in value if stock markets decline.

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Jimmy’s legacy

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Had dinner with him way back.

He plays to the crowd:

Jim Rogers: Don’t See How US Can Ever Pay Off Debts

By Deepanshu Bagchee

May 25 (Bloomberg) — The U.S. doesn’t deserve a AA-plus credit rating, much less triple-A, commodity bull and noted investor Jim Rogers told CNBC on Monday.

Rogers said the country was unlikely to be able to pay off its debt and Standard and Poor’s rating cut had come too late and should have happened long ago.

“It seems to me it’s physically, humanly impossible for the U.S. to ever pay off its debt,” Rogers said. “They can roll it over and continue to play the charade, but the U.S. is bankrupt.”

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MMT to Moody’s- confirm US as AAA on ability to pay

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This is an opening for Moody’s to gain a competitive advantage over S&P.

Moody’s can announce that whereas any issuer of it’s own currency can always make nominal payment on a timely basis,
ability to pay is absolute and beyond question for the US government.

Therefore, when reviewing the US government’s credit rating, only willingness to pay is a consideration.

And given the recent Congressional proceedings regarding the debt ceiling,
an entirely self imposed constraint,
Moody’s is putting the US on notice with regard to willingness to pay.

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Buffet: US downgrade doesn’t make sense

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From FOX Business:

Berkshire Hathaway Chairman and CEO Warren Buffett told the FOX Business Network that S&P’s downgrade of the United States’ triple-A credit rating “doesn’t make sense.”

“Think about it. The U.S., to my knowledge owes no money in currency other than the U.S. dollar, which it can print at will. Now if you’re talking about inflation, that’s a different question.”

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China Tells US ‘Good Old Days’ of Borrowing Over

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China and others buy US Treasury securities primarily to support the dollar vs their own currencies, and thereby drive exports to the US, and not because they are looking for safe investments per se. That is, it’s a consequence of their drive for ‘competitiveness’.

And with no Treasury securities China would be forced to buy state debt, corporate debt, equities, etc. which is highly problematic for them for a variety of reasons.

Note this is what they face in the euro zone where they’ve become holders of the debt of the national govts to support the euro vs the yuan and drive exports to that region. And I’m sure they are feeling a lot more insecure about their holdings of that paper vs US Treasury securities.

So their choice is to either keep buying US financial assets or give up their export market.

And their exporters are most often very powerful, single minded individuals, who play the game hard to further their interests, to say the least.

China Tells US ‘Good Old Days’ of Borrowing Over

August 6 (Bloomberg) — China bluntly criticized the US on Saturday one day after the superpower’s credit rating was downgraded, saying the “good old days” of borrowing were over.

Standard & Poor’s cut the U.S. long-term credit rating from top-tier AAA by a notch to AA-plus on Friday over concerns about the nation’s budget deficits and climbing debt burden.

“The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone,” China’s official Xinhua news agency said in a commentary.

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Fed on bank capital post downgrade

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Fed statement: No additional capital raise.

Earlier today, Standard & Poor’s rating agency lowered the long-term rating of the U.S. government and federal agencies from AAA to AA+. With regard to this action, the federal banking agencies are providing the following guidance to banks, savings associations, credit unions, and bank and savings and loan holding companies (collectively, banking organizations).

For risk-based capital purposes, the risk weights for Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities will not change. The treatment of Treasury securities and other securities issued or guaranteed by the U.S. government, government agencies, and government-sponsored entities under other federal banking agency regulations, including, for example, the Federal Reserve Board’s Regulation W, will also be unaffected.

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S&P downgrades US on ability to pay

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“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in a statement late yesterday after markets closed.

Credit ratings are based on ability to pay and willingness to pay.

David Beers of S&P knows this and has discussed this in the past.

Including direct discussion with me where he acknowledged a nation like the US always has the ability to make US dollar payments.

Therefore any downgrade would necessarily be based on willingness to pay.

In fact, I downgraded the US on willingness to pay several months ago on this website. And the debt ceiling debate more than demonstrated a willingness to default by far too many members of Congress for even consideration of a AAA rating.

So why then did David T. Beers decide to downgrade the US on ability to pay, and not explicitly on willingness to pay?

Sure looks like a case of intellectual dishonesty.
And I have no idea why.
So much for his legacy.

And, as previously discussed, markets probably won’t care, much like when Japan was even more severely downgraded.

A credit rating simply needn’t be applicable for the issuer of its own currency, as David should well know.

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Consumer credit up, Friday update

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It doesn’t look to me like anything particularly bad has actually yet happened to the US economy.

The federal deficit is chugging along at maybe 9% of US GDP, supporting income and adding to savings by exactly that much, so a collapse in aggregate demand, while not impossible, is highly unlikely.

After recent downward revisions, that sent shock waves through the markets, so far this year GDP has grown by .4% in Q1 and 1.2% in Q2, with Q3 now revised down to maybe 2.0%. Looks to me like it’s been increasing, albeit very slowly. And today’s employment report shows much the same- modest improvement in an economy that’s growing enough to add a few jobs, but not enough to keep up with productivity growth and labor force growth, as labor participation rates fell to a new low for the cycle.

And, as previously discussed, looks to me like H1 demonstrated that corps can make decent returns with very little GDP growth, so even modestly better Q3 GDP can mean modestly better corp profits. Not to mention the high unemployment and decent productivity gains keeping unit labor costs low.

Lower crude oil and gasoline profits will hurt some corps, but should help others more than that, as consumers have more to spend on other things, and the corps with lower profits won’t cut their actual spending and so won’t reduce aggregate demand.

This is the reverse of what happened in the recent run up of gasoline prices.

Japan should be doing better as well as they recover from the shock of the earthquake.

Yes, there are risks, like the looming US govt spending cuts to be debated in November, but that’s too far in advance for today’s markets to discount.

A China hard landing will bring commodity prices down further, hurting some stocks but, again, helping consumers.

A euro zone meltdown would be an extreme negative, but, once again, the ECB has offered to write the check which, operationally, they can do without limit as needed. So markets will likely assume they will write the check and act accordingly.

A strong dollar is more a risk to valuations than to employment and output, and falling import prices are very dollar friendly, as is continuing a fiscal balance that constrains aggregate demand to the extent evidenced by the unemployment and labor force participation rates. And Japan’s dollar buying is a sign of the times. With US demand weakening, foreign nations are swayed by politically influential exporters who do not want to let their currency appreciate and risk losing market share.

The Fed’s reaction function includes unemployment and prices, but not corporate earnings per se. It’s failing on it’s unemployment mandate, and now with commodity prices coming down it’s undoubtedly reconcerned about failing on it’s price stability mandate as well, particularly with a Fed chairman who sees the risks as asymmetrical. That is, he believes they can deal with inflation, but that deflation is more problematic.

So with equity prices a function of earnings and not a function of GDP per se, as well as function of interest rates, current PE’s look a lot more attractive than they did before the sell off, and nothing bad has happened to Q3 earnings forecasts, where real GDP remains forecast higher than Q2.

So from here, seems to me both bonds and stocks could do ok, as a consequence of weak but positive GDP that’s enough to support corporate earnings growth, but not nearly enough to threaten Fed hikes.

Consumer borrowing up in June by most in 4 years

By Martin Crutsinger

May 25 (Bloomberg) — Americans borrowed more money in June than during any other month in nearly four years, relying on credit cards and loans to help get through a difficult economic stretch.

The Federal Reserve said Friday that consumers increased their borrowing by $15.5 billion in June. That’s the largest one-month gain since August 2007. And it is three times the amount that consumers borrowed in May.

The category that measures credit card use increased by $5.2 billion — the most for a single month since March 2008 and only the third gain since the financial crisis. A category that includes auto loans rose by $10.3 billion, the most since February.

Total consumer borrowing rose to a seasonally adjusted annual level of $2.45 trillion. That was 2.1 percent higher than the nearly four-year low of $2.39 trillion hit in September.

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