Wednesday, July 14, 2010

Was that a sign of life? Or just a death twitch...?

Yesterday looked as though the markets were making a break for it - the wrong way at that. But did anyone actually put ON any high conviction trades? It felt as though the preponderance of trades were exits of positions with a combination of pleasure and pain. The relief of profits taken on trades that have been underwater, or the pain of stops being driven. Thank you Intel. CHF has been a class example, with SNB LLC posting some sizable book profits overnight (well, lower losses). Is Mr. Market trying to tell us something?

But this spiky squeeze doesn't run against the rangy summer theory. In fact, at this point it can reinforce the argument. A nice top range squeeze flattening core positions further followed by a roll over would be another red hot poker to the nether regions. Looking at Mr Soothsayer's charts, they have been working remarkably well recently in the likes of FTSE and suggest a roll-over weekend is ahead. Which ties in nicely with a pet theory that the weekend of 16th-18th July-ish produces a general turn in equities. OK, it’s a bit of an old theory emanating about 12 years ago but it still lurks in the back of TMM's mind.

It also looks as though the gags are holding with Europe's STFU policy and it may be a wait until September for the Spanish 2011 budget vote time bomb to blow a hole below the waterline. And if there is a season for crises it's Sep/Oct.

But back to Intel. A long-held view of Team Macro Man is that the demand baton would have to be passed to corporates given the consumer deleveraging, the limited ability of governments to enact fiscal stimulus and a general skeptical view of the extent to which China & the rest of the BRICs can get us out of this mess. We are taught that the government's financial deficit is the flip side of the private sector and external sectors' financial surpluses. And today is no different, governments are running very large deficits, whilst China et al. are stubbornly running surpluses, as is the private sector. But the private sector contains both households and corporates. The former, we know, needs to gradually delever and rebuild its balance sheet, but the latter has pretty much been repairing them for the past decade since the DotCom bubble burst, running very large financial surpluses and, as recent press reports attest, holding the largest amount of liquid assets as a share of balance sheet since the early-1960s. The billion-dollar question is whether corporates will actually put this to use or not, and Team Macro Man will have a go at trying to determine this.

Now, TMM certainly does not want to get caught in the cross-fire of the cat-fights between Neil Ferguson and Paul Krugman, but it seems to us that there is quite a big difference between Corporate America today and the Zaibatsu of 1990s Japan (who were just beginning their deleveraging). As the below chart shows, corporate investment growth in that period just went sideways, with the odd cyclical recovery snuffed out by either poor policy decisions (1997's consumption tax) or external factors (2000's DotCom burst).The below chart shows the equivalent US numbers over the past 30yrs. What is especially interesting to TMM is just how weak business investment following the DotCom burst, growing at an essentially flat rate of 0.25% YoY over the business cycle. In contrast, during the 1982-1991 cycle it averaged 3.66% YoY and during the 1991-2002 cycle averaged 5.55%.

A very wise hedge fund manager once said to TMM with respect to the punters' favourite, the Yen, that "if you want to know when it will weaken, you first have to find out why it has been strong". Wise words, indeed, and they certainly apply here - why was corporate investment so weak over the last cycle? TMM believe this is simply the side-effect of the massive over-investment of the 1990s when businesses expanded aggressively into IT-related projects, and then were forced to write these off and rebuild their balance sheets. A desire not to be caught out again by liquidity factors (exacerbated by the 2008-9 experience) has also led them to keep more cash on balance sheet. But we note that much of the infrastructure investment of the late-90s is now, largely, out of date. Which is why they were especially interested to read the following headlines:


Now, one swallow does not make a summer, but if this trend continues it would be very positive. The trouble is that the signs elsewhere are not so promising. The Philadephia Fed survey's 6m-Ahead Capital Expenditure expectations component (chart below, white line) is pointing to a double-dip in capital formation (brown line, lagged 3m). Worrying, but Team Macro Man also notes that the survey double-dipped in mid-1993, but actual investment (and the economy) continued to improve... The evidence is thus mixed and the answer unclear, and Team Macro Man would like to invite readers to present their own views on the subject.A corollary to this is that should USD & USDAsia weakening send jobs back to America, a reversing of the general "out-sourcing" of the past decade or more would give a further driving force to a recovery in corporate capex. Compare the collapse in US capex to the supercharged Fixed Asset Investment in China over the same period:

However, for now, the stalemate between bulls and bears may continue. But in reality there are no Bulls and there are no Bears: only Sheep. And 'tis better to be the Shepherd than the Sheep.


Игры рынка said...

Yen has been strong because it has been deflating vs USD for several decades now. We live in fiat world and the question is who is more fiat relative to each other.

cpmppi said...

Hi Игры рынка,

Yes, sorry, I was using the expression as a generic example of having to understand both sides rather than anything Yen-specific.


Игры рынка said...

btw, low capital formation is the result of outsourcing. Another by-product of outsourcing is the so popular these days theme of corporate cash balances. Well, the bottom line is that this cash has been financialized and recycled into the "capital" markets. And these markets are now decoupled from broad macro.

Just a thought which is teasing me

cpmppi said...

Игры рынка,

Yes, I think that is a good point, and that recycling has largely financed fiscal deficits. As far as markets decoupling from macro, I am not smart enough to have an opinion. Perhaps there is some other factor at play...


Bob_in_MA said...

It isn't clear to me how there can be strong capex growth without strong final demand growth. And final demand growth in the West will be anemic at best.

One explanation is that China, the rest of Asia and the commodity producers decouple (personally, I don't believe it.) But if that happens, isn't it likely most of the capex occurs in China and the rest of Asia?

Leftback said...

A squall in the China sea will sink all boats.... or at least cause more than a few of the leaky ones to take on water. Then again, the Baltic Dry suggests that most of the ships are in port.

US corporate cash levels are indeed high, which is a plus for US corporate bonds in what is likely to be a slow growth environment. We are now getting to the flat part of what Soros described as the inverted square root sign recovery, after the inventory rebuild. So it's likely that they will simply hold the cash for later M&A activity, no?

cpmppi said...


Normally that would be the case, but this is a case of corporates updating their own (out of date) infrastructure - one group of corporates creating demand for the goods of another group of corporates. No need for final demand there, though I accept that there is only so much updating that you can do without customers stepping up and buying.

I am definitely skeptical of the idea that China et al can fill the void or decouple, though their FAI numbers have clearly roofed it over the past few years (and especially last year).


k1 said...

LB- it would appear that high yield bonds are approaching the levels of our last discussion. Might it be time to load up the flamingo gun again?

Leftback said...

k1: There are any number of flamingoes out there right now, but the GOLDEN FLAMINGO seems to stand out from the flock at the moment. Unless Bernanke announces that dollar bills are now flowing out of his arse it's hard to see what could possibly drive that market higher. The Euro hedging seems to have abated, for one thing.

Deniz said...

i guess a complimentary way to think about is short-life capex vs long-life capex .. with no final demand in sight firms do not invest in things with long shelf life .. but only in short-life things like software etc which does not create too much employment ..

the mere fact that corporates are cash rich is very deflationary indeed ..

FX said...


Well, I found this interesting.

Not an expert in this angle of analysis but,If I had the resources I'd overlay Japan - USA interest rates over this period.

Lets face it , everyone loves to chase yield,in one form or another.

FX said...

Not sure the first one printed, so I broke it up.



- said...

FX: thanks for the report link! It needs a small modification - ".pdf" must be added to the end, like so: ...July2010.pdf

Thanks also to cpmppi and others for keeping this blog up - it is definitely one of the best and most informative blogs around today.