Thursday, March 31, 2011

Technology – Making Stuff Redundant Since the Dawn of Time

We were pleased to see the feelings we expressed yesterday backed up by this, our "Quote of the Day".
The boss of electricals group Dixons said that government cuts were having a "chilling effect" on consumers as wilting high street demand for flatscreen TVs, sofas, jewellery and even takeaway pizzas pointed to deteriorating confidence.

As long as retailers continue to believe that the UK economy runs on sales of TVs, sofas, bling and takeaway pizza, the UK is doomed. It was being hooked on that stuff (+ houses) that got the UK into the mess it’s in and those comments hark of a drug dealer moaning that his clients are dying of overdoses and the methadone they are on is killing trade.

TMM’s translation: “where is my bailout?”. The issue of course is not the government policy, its Dixon’s. Much of Amazon’s international segment is and look at the comparison between revenues for the two:



Its not the economy, stupid, it’s a redundant business model.

With Eurozone inflation printing higher, people getting thoroughly terrified of sticker shock at the pump and all those other things that tend to terrify consumers TMM would like to remind ourselves and our readers that inflation shocks tend to sow the seeds of their own destruction by inspiring people do do the same thing cheaper and better and ultimately eat the commodity rentier’s lunch, much as Amazon et al have eaten Dixon’s. For example – everyone is terrified of oil prices at the moment and assumes they are going up forever. While TMM are still pretty bullish crude we are seeing some technological developments that make one think that 5 years from now one could go to the local car dealer and ensure that you don’t use any oil to travel anymore. Tesla and the likes of this awesome toy are all well and good but nobody likes having to charge a car for a long time. Thankfully, some very clever people have come up with a solution that is commercially viable for fast charging and uses some fairly standard tech outlined here in the economist. Peak oil? Maybe, but we might also reach the peak of caring about oil prices sooner rather than later. We might also find the auto industry becomes consolidated at the auto parts level and very diffuse at the end car assembly and design level as things like this come into play when drive trains are standardized… but that is a post for another day.

This EV trend is not just about oil but also other things that are conventional internal combustion dependent – platinum groups metals as we noted previously here, and lead which is pretty inefficient for batteries and has no use in a car which already has a whopping big battery pack. (TMM cannot work out what is giving the lead the bid right now given how weak demand is looking from Chinese Ebikes – anyone who has an answer do let us know). No doubt there are more implications of this but human history is rich with stories of people myopically not developing resources, getting gouged, and then innovating them out of relevance.

It is hard to pick the turn in these things and trading the short side of commodities based upon long term trends is generally a good way to get taken to the woodshed but TMM find that valuations in mining equities are now reflecting some serious long term scarcity which just might not be there when all is said and done even assuming all is well on the demand side.

Wednesday, March 30, 2011

Old Themes and Retail Schadenfreude

The past two days have seen a return to good old fashioned data and CB watching with the market entranced with the tussle between the ECB and FED over who, what, how much and when rates will start to move. Shock headlines of global strife are just "So passé, darling". Just look at today, "*PORTUGUESE 5-YR NOTE YIELD ABOVE 9% FIRST TIME IN EURO ERA", but it's looking as though Portugal could fall off Spain and vanish, Atlantis style, into the ocean and the markets wouldn't care. IRISH LIFE CLOSES SOMETHING? Bothered?

As far as Fed watching goes, the market appears to have its opera-glasses focused on the peanut throwing galleries occupied by the "ers" of Plosser, Fisher, Lacker etc and their buddy Bullard, rather than on the stage and the main players of Bernanke, Dudley and Yellen. The heckling, for us, does not yet drown out the chorus from the stage which points to 2012 being the earliest likelihood for hikes.

As for data, we wondered last week if this is all the more important, post Japan and Libya, as we need to see how sentiment has been touched. We also surmised that we don’t think it has. Obviously the spinning brass balls on the governor of sentiment and growth is Oil. TMM note that while interest in energy equities remains strong, open interest at NYMEX has dropped for crude. Perhaps the recognition that in Bahrain and Saudi, as one political scientist noted, "suppression works" and in Libya the major oil producing areas are conclusively in the hands of the rebels lowering the risk of a super spike. The recent price rises have seen little change to demand but have poured and extra (guesstimate) $300 bio to OPEC producers coffers but the latest BBCBlx figs have it at 1 trillion (BBCBlx - similarly reliable source of data to the ONS).

And talking of the ONS, as this post lunges between topics, they have just announced that "ONS ESTIMATES UK BUDGET MEASURES WILL ADD 0.29 PERCENTAGE POINTS TO CPI, BIGGEST IMPACT FROM TOBACCO DUTY". Unsurprisingly, Short Sterling Interest Rate Futures got smoked. TMM think this could be a new twist of government policy. If you want lower inflation and the BoE not to raise rates, then stop smoking.

But one headline that TMM were particularly interested in today was Dixons' profit warning and resulting price fall of 20%. We are sad that the UK retail sector is still showing signs of stress, HOWEVER, we are mightily pleased to see an organisation that has for years been responsible for so much of TMM's shopping ire, finally take a kick from the markets in exactly the same spot TMM have many times considered hoofing their sales staff. Dixon Group's "PC World", is, in TMM's eyes, the spawn of the devil. Its continued existence selling overpriced electronic basics in cavernous retail warehouses populated with staff less knowledgeable than nearly all of its customers, had TMM thinking that the whole set up must either have been a Triad money laundering operation or the retail equivalent of a CDO squared - i.e. had lost track of the underlying asset (the customer) and was running on fresh air and accountancy. Dixons is very HMVesque. Both have been competing with online stores for years and instead of adapting to become fonts of "go to" knowledge and expertise have instead just alienated their client base with a "we know best" arrogance. Management genius can only take you so far before the inevitable kicks in.

So perhaps we should see any demise in the old fashioned retailer, not as a sign of worry, but as a sign of a turn for the better. A cleaning out, a part of the process that is already being discussed with respect to the USA where, after 2 1/2 years of life support, some difficult decisions need to be taken and final farewells said to old loved ones.

Or in the case of PC World, Not. TMM are fighting each other to get to the plug.

Tuesday, March 29, 2011

Steppe-ing out

To Ulaanbaatar did Nemo's boss
A business trip decree:
Where copper mines and collieries
Countless dug in series
North of the Teal Sea
(apologies to Coleridge)

TMM recently travelled to Mongolia and thought it might be worth a post, as it has moved from geopolitical buffer zone between Russia and China and a USAID afterthought to front and center for commodities analysts and a point of focus for the EM crowd. The country now has a couple of large listed equities, including the Mongolian Mining Corporation, Ivanhoe Mines, South Gobi, as well as a number of up and comers, including the much awaited Tavan Tolgoi deposit. With rumors of a sovereign bond, the country might even have a local currency issue (whisper around 8% coupon), which would be a pretty compelling story to the EM set:

Small previously poverty stricken nation with a population of around 2.5mm that will become a combination of the Australian Bowen Basin in coal and Chile in Copper seeks to borrow in its domestic currency with a limited FX intervention policy at a rate slightly inside of the policy rate - 11%.

In a world of people looking for FX carry, appreciation and low sovereign leverage this is a comically easy sell. It is no wonder that the "will they/won't they" and "in what ccy" is a favored talking point among the EM bond manager set.

There are of course the skeptics who look at Mongolia and don't see venture stage Chile with none of the dictatorship legacy and crushing inequality, but instead see Kazakhstan. Kazakhstan has a similarly ample resource endowment (oil, copper, gold, uranium, etc) and yet it managed to go from EM wonder to Coyote ugly in the space of one year. Kazakh banks went on a binge of asset growth that was entirely unrelated to mining and the core competencies of the country. Instead they focused on what all those smart guys in London and New York were doing around 2005-2007: lending a boatload of cash to fund real estate projects and when they couldn't get enough of that they decided to own the assets themselves. Last time TMM went to Almaty, there were plenty of “see through” skyscrapers and office blocks – and we gather not much has changed since then. This strategy worked out even worse for the likes of Bank Turanalem, Kazkommertsbank and Halyk Savings Bank than it did for Lehman. Almost every single bank in Kazakhstan went through a restructuring as the eurodollar issues dried up in 2007, causing the domestic credit bubble to collapse. As any bank analyst will now tell you, making market bets on a stable deposit base is risky, but doable up to a point; making similar bets on a flighty international bond market with substantial FX risk is insane. Recoveries were low to abysmal (55% on senior, depending on your discount rate for BTA’s various tranches) and by all accounts the banks have not been the same since and are still crippled by NPLs (see below - Central Asia bank comp table):

The Kazakh Tenge took its pain as well and is only slowly coming back after a 30%+ depreciation, much like the Mongolia Togrog – only the MNT is coming back a lot faster because it does not have a crippled banking system.

So, with those two radically divergent schoools of thought in mind, how does TMM see Mongolia? First, take a drive along Chinggis Khan Avenue in Ulaanbaatar:

But first things first. Banking regulation – Mongolia is a real democracy with a quite colorful media and reasonably good governance. Unlike Kazakhstan, which when TMM visited in 2006-2007 seemed to have no prudential banking regulation to speak of, Mongolia has some fairly common sense banking limits – they actually do seem to risk-weigh assets properly and have 10% exposure limits for single borrower groups (includes related parties and subsidiaries of borrowers). TMM’s discussions with the banks were a lot more positive than they had been in Kazakhstan – not least of all because all the Mongolian banks, and particularly the larger players, seemed to know the sorry story of Kazakhstan.

Diving further into the bank aggregate data, TMM found the quarterly lending report on the Mongol Bank website interesting, to say the least. NPLs and arrears are still very high in the system, even for Mining and Quarrying, which is odd in the midst of a mining boom:

Thankfully, real estate seems low, though anecdotal stories about Ulaanbaatar housing prices are a bit of a worry – they are rising fast and Mongolia appears to be toying with a government-sponsored Fannie Mae. TMM are not fans and, while it would be nice to get people out of the favela-like ger neighbourhoods around UB, lending money to those who can’t pay it back is never that good an idea. Thankfully, that risk does not appear to be on banks’ balance sheets as yet, judging by outstanding mortgage loans and average loans size:

The story on NPLs appears to be the one of different banks’ ability to lend properly – TDB seems fine, but some of the smaller players don’t. Watch this space as banking consolidation is easier during the good times than the bad.

One of the drawbacks of having a colorful democracy in a country with relatively low educational attainment is that it is very easy for fiscal policy to become a pro-cyclical disaster zone, when put in the hands of local politicians who, quite literally, were raised in a ger and aren’t quite of the quality of the Prime Minister. In this regard Mongolia has not distinguished itself to date. The country required an IMF program as recently as 2009 as FX reserves were depleted in 2008/2009, not by imports but by loose fiscal spending. As part of this program, Mongolia now has a Fiscal Responsibility Law for implementation in 2013 and a stabilization fund for excess mining revenues, though ultimately whether this gets done comes down to the parliament – something which TMM will watch closely as the mooted $500mm sovereign bond issuance comes up.

Inflation and Central Banking is Mongolia’s weak point however. Local color suggested that capital inflows related to Ivanhoe Mines’ Oyu Tolgoi development were around $7mm per day or about 14 bps of 2010 GDP. To understand just what that means for a small country with a relatively inexperienced central bank, that’s like pushing an additional ~$500mm of AUDUSD through the market every day (~14bps of Australia’s GDP). To date Mongolia hasn’t managed this at all well with regards to inflation – the Central bank has a weak and largely unclear mandate (an inflation target of <10% is like saying real growth >0% to TMM). As can be seen below, policy rates (orange) have only loosely tracked inflation (white) historically, so this is one to watch as well.

This is not going to get any easier for the Mongol Bank (what a name!), especially given that the source of growth for their entire economy is going to be mining, which is a work in progress requiring a lot of financing – just look at what is happening to loan growth:

Which leads TMM to think that local monetary conditions and the like are going to be a pretty wild ride at best until some more solid policy comes from the Mongol Bank.

So with all that in mind, until 2013 when Oyu Tolgoi comes onstream and the government’s fiscal position improves, there is still some serious risk that a commodity collapse plus some reckless fiscal spending in the interim could do Mongolia some real harm. Judging by the NPLs at the Mongolian banks, 2008/2009 was not kind and even if there is no "sudden death" risk as was the case with Kazakh banks (due to their reliance on Eurodollar funding), the loan growth in the system does seem to be a lot more closely tied to real estate and construction than anything else. While this is fine when a country is urbanizing it does take you back to the problem with Mongolia: it’s a one-way leveraged ticket on the CRB index express at this time. As such, it is going to require serious focus and effort from the Central Bank and the Parliament to not get the whole thing derailed at some point.

In the interim it is a fun place to go out, as are most places when people go from grinding poverty to 10%+ p.a. growth in a short time. It tends to make people party like the good times aren’t going to ever end – or, alternatively, party while they still can. TMM hope that for Mongolians and investors alike the Mongol Bank and the Parliament learn when and how to take away the punchbowl.

Thursday, March 24, 2011

Euro Vinegarette

Whilst we decided yesterday to look at the US we were well aware that our old friend the Euro was gaining attention again as the ADHD market moved on from Japan and Libya news flow that was not showing any signs of getting worse. European negative news is all the more pertinent now as Euro has been a default, almost safe haven, buy over the past weeks of turmoil. So it is worth us having a better look at where we have got to with the TMM euro views.

The first thing we note is that, you may remember, we run a model that has been calling EURUSD to the 1.41-43 area for a while. This has now balanced up and is much more neutral in terms of valuation at these levels (see chart below).

The argument over how to trade the euro is composed of 2 parts: the core (good euro) and the periphery (bad euro). We could actually consider the Euro as a vinaigrette, composed of 2 immiscible liquids, the core as the Vinegar at the bottom and the periphery the Olive Oil on the top (somewhat appropriately). When shaken together they emulsify enough to appear as one homogeneous gloop. However, if left alone they will separate out into their constituent parts, but remain in the same bottle (the Euro). Whilst the last year has seen the Eurocrats and policy makers trying to shake the bottle enough to keep the two parts smoothly mixed, the market is sure that there is too much oil in the mix and is focused on the interface between the core and the periphery to detect if policy is actually working. That interface is still seen as being Spain.

And it is with interest that TMM note that despite a raft of tape bombs, ranging from the collapse of the Portuguese government, to Moody's downgrading various Spanish banks (to move them in line with the sovereign downgrade a couple of weeks ago), the Euro and European Equities have barely blinked. TMM were particularly interested to see the Swedish Fin Min mention that he expected a number of banks to fail their stress test. In our minds, given last year's disastrous failure to reveal a EUR30bn black hole in Ireland's banks, that the EU is already suggesting several banks will fail adds credibility to the process and provides a high likelihood of the banks being recapitalised. In particular, a key problem with last year's testing round was the wildly differing scenarios tested in different countries, the exception being Spain, which was alone in actually providing a realistic scenario with something like a 30% fall in house prices. More on Spain, later.

The EFSF/ESM provide a backstop to sovereigns that engage in providing new bank capital and can break the feedback loop between sovereigns and the banking system. As TMM have pointed out in the past, bank capital can be leveraged and thus result in a positive feedback loop into sovereign financing costs.

As far as Portugal goes, TMM was surprised at the fuss being made in the FX market, as a far as we can tell, everyone expected Portugal to go into EFSF anyway. Whether it happens now or in two months when a new government is elected is neither here nor there. Either way, with reports surfacing of an imminent EUR70bn bailout to be negotiated with the caretaker government, it seems as though the excitement is dying down there anyway. Given the recent agreement (or rather, postponed agreement) to allow the EFSF to buy in the primary market, TMM do not expect Portuguese auctions to go uncovered, either a result of a more speedy EFSF agreement or moral suasion behind the scenes to get banks to show up. TMM are sure readers can tell they are about as excited about Portugal as they were with the woollen sweaters their Grandmothers used to knit them when they were mere Macro Tots.

But back to the lack of more broad contagion. TMM would note that here is now no material leveraged long positioning in peripherals as there was in H1 2010. This is because volatility spiked and forced lower risk limits and management oversight in banks and funds, meaning that real money are the strong hands and that volatility now and moving forward is likely to be rather lower in places like Spain and Italy. As a result, the potential for volatility-driven contagion into other financial assets is also much lower. This is particularly important with respect to EURUSD etc because large tail risk hedging has been ongoing the past year, so exotics and other tail exposures do not have the potential to cause large moves. Like in equities yesterday, Real money were on the bid at 200bps over Bunds in Spain... Spain is increasingly trading like Italy. Since the beginning of the year, Spain (see chart below of spreads to 10yr Bunds: pink - Spain, green - Italy, yellow - Portugal, orange - Ireland, white - Greece) has actually tightened, even as Greece, Ireland and Portugal have been widening.

In fact, a closer look at the chart indicates that the market has repriced Spain and Italy's credit risk to be around 200bps and 150bps above Bunds, respectively, and have merely oscillated around these levels. For a while, the market has considered Spain to be the "one that matters", and this can be seen quite clearly in the below chart, which shows 1m rolling return correlations for Spanish 10yr spreads with Italian spreads (red line), French spreads (green line), Itraxx Senior Financials CDS (purple line) and the average cross-correlation with Ireland/Greece and Portugal (blue line). It is notable that during the systemic phase of the Eurocrisis in April-June 2010 that these were all very close to one, whereas post the stress test results these fell somewhat. But what TMM are particularly interested by is the fact that since last summer, aside from January's failed Eurobear raid, Spain appears to trade like a slightly higher-yielding Italy. Indeed, it is also worth noting that Spain's correlation with the rest of the PIGs, France and Senior Financial CDS in general are largely indistinguishable... correlated yes, but more a result, TMM would argue, of generalised credit risk premia than any particular Eurozone issue. As long as this is the case, TMM reckon that EURUSD, and Euro-area financial assets in general, will trade in line with factors that have been relevant in the past... for EUR/USD in particular, that is rate spreads. And with the ECB refusing to divert from its "core" Europe hiking strategy, that means the risks are still for higher prices.

Of course, this all rests upon the macroeconomic picture in Spain remaining fine. The data here has been mixed (see chart below: white line - IP, orange line - retail sales, yellow line - OECD Spain Leading Indicator)and the data here so far has been mixed. Industrial Production and Retail Sales appear to have double-dipped recently, but the OECD's Leading Indicator is pointing to a near-term rebound. The bear argument is that ECB tightening will crush the periphery, but TMM would point out that monetary policy works with long lags 12-18months for cuts/hikes to feed through, so we reckon it is too early to play for this yet. We do, however, reckon that it is evens that the A-Team have to do an "about turn" at some point in the next year or so, but that is a trade for another day...

So back to the vinegarette...

There are 3 outcomes:

  • Bottle shaken enough to blend the contents ready for serving to the market.
  • Not enough shaking, end up with an oily mess. Market sends it back.
  • Pour some of the periphery oil out to make an easier to mix more palatable blend.Market enjoys it but slip on the oil spilled on the floor.

The Euro:

Wednesday, March 23, 2011

What about US?

We have now had a couple of days of relative market calm and, as the dust settles, it's time to emerge from the bunker and see if the map in TMM's hand still reflects the landscape in front of them. We were originally thinking of doing another hatchet job on Mervyn King, but instead decided that he was doing a good enough job of that himself. TMM reckon Gaddafi stands more chance of winning the Nobel Peace Prize than Merv does of ever hitting the inflation target. Needless to say, were the Governor in the employ of a private company, he would have been sacked months ago.

As readers may recall, TMM had been inching towards positioning for a growth scare as their Dr Copper-based ISM model was flashing a warning light, the bond market began to trade as though economists were too optimistic and about to downgrade their growth forecasts and Chinese exports - whether a result of the New Year or not - suddenly woke up those caught lazily long of risky assets. The ongoing MENA unrest and background bid to Oil are certainly bound to have a negative impact on the US consumer, and sure enough, the recent Michigan Consumer Confidence numbers showed something of a collapse... Indeed, TMM's US consumption model (see chart below - based upon consumer credit growth, consumer confidence, income growth and household net worth), having diverged from Real PCE growth during 2010 was showing signs of re-accelerating prior to the recent calamities, but has now dived back to the 2010 lows as Gasoline marches towards $4 a Gallon. It is not looking promising for Joe Sixpack...

The eyrar of Dusky Swans TMM mentioned two days ago had them expecting what began as a de-risking episode to morph into a fully-fledged growth scare. However, despite all of the above, Real Money refused to be shaken from their positioning (through either skill or rabbit+headlight functions) and instead we sit 4% off the intraday lows in Spooz. So what is clear to TMM is that in order for markets to undergo a more meaningful growth scare, Real Money will need to be persuaded that the macro outlook has changed materially. And while TMM reckon the outlook has certainly changed negatively for the global production cycle (given Dr Copper's dancing and China's sequential growth slowdown) and also for the consumer (as a result of MENA spill over into Gasoline prices), they were forced to reassess their view with last week's exceptionally strong Philly Fed survey. In this, the 6m ahead CapEx expectations component rebounded to multi-year highs, pointing to a re-acceleration in Non-Residential Investment (see chart below)...

...and TMM's private payroll model is also consistent with a second month of ~220-250k job growth...

...which means that they are forced to turn neutral on growth given the mixed messages.

Of course, the other wild-card that a few of TMM's smart mates have highlighted is the potential knock-on effects to the global supply chain as Japanese IP collapses due to plant shutdowns. Now, TMM do not have a clear idea as to the effect of this, and will have to do some work on it before deciding whether it is a game changer or not.

But, as a result of the past week, the market has been reminded that Real Money is the strong hand out there and until the economic message turns more decisively, then the pain trade for markets has to be higher as HFs are forced to chase. That economic messsage may not appear on the real money radars for a couple of weeks as post-swan data starts to be released. But until that happens the real money mob will continue playing Achilles and buy equities.

Tuesday, March 22, 2011

Disgusted of Tunbridge Wells

TMM are beginning to question their sanity. Or rather their age, attire, smoking paraphernalia and location, because what they are beginning to feel definitely belongs in the realm of the retired, blazer wearing, pipe-smoking Tunbridge Wells resident. For our international readership, this stereotype is synonymous with conservatism and signs letters complaining about falling social standards to The Times or Telegraph as "Disgusted of Tunbridge Wells".

For today, if we didn’t know better, we would suggest that the Media is running the world. Journalists are currently thriving on the exceedingly fertile ground of natural disaster, nuclear disaster, social unrest, war and international discord. In Tokyo the western media appears to have done their best to whip up panic with a barrage of bent and twisted statistics and now Libya has been a classic pump and dump exercise. Demand action, criticise its tardiness and then tear it apart once done, all the while offering opinion based on emotion rather than fact.

The BBC has been particularly guilty of this emotional manipulation recently and as TMM come to work in the morning the BBC Radio's landmark current affairs program, "Today", will offer at least twice every hour, an interview that goes along the following lines.

Interviewer - "So tell me what has happened to you"
Person - "{ insert person/ organisation/govt} has stopped giving me {insert something cheap/free} that I always got before"
Interviewer - "So how do you feel about that?"
Person - "Well, it's terrible and I'm worse off now without the free things"
Interviewer - "Should this have been allowed to happen?"
Person - "It should never have been allowed to happen"
Interviewer - "What do you think should happen now?"
Person - "I should be given {insert cheap/free thing} again"
Interviewer - "And whose fault is it?"
Person - "It’s all {insert govn, large corp or rich person}'s fault"

Repeat the above process replacing Person with Person's close relative.

What has happened to reporting FACTS? Not emotions or cherry-picked factoids designed to influence emotions in a precalculated manner or opinions of non-experts, but just the hard facts. TMM of Tunbridge Wells feel that they are big enough to come to their own conclusions and don't look to news services to tug on their heartstrings. It's meant to be News, not "how do you feel about losing" X-factor.

Can someone please point TMM towards their most highly recommended factual Radio and TV news sources that are manipulation and emotion free? Oh, and finally whilst on the subject of media, who at Bloomberg sent out a writ decreeing that all Earthquakes from here on in will be referred to as "Temblors"? The only temblors TMM want to experience are Knee Temblors.

Rant over, let's move on to the BoE monetary policy......

{TMM suffers Heart Attack, is carried off, stage left, by stretcher bearers. Curtain}

Monday, March 21, 2011

The Sky is Black with Swans

Last week we wondered what the solution would be to an equation we posted. We have since added a few more major variables that at any other time would be classified in their own rights as black swans. But as we stand today, looking at where bonds, fx and equities are you would imagine that the Grand Unified Theory of black swans gives a surprisingly simple answer.
Earthquakes x 2 + tsunami + rebuild + sentiment +/- GDP + capital flows + reinsurance flows + borrowing - nuclearpower + energy substitution - exports + imports + G7 intervention + Libya + Bahrain = 0

We like black swans in general and consider them a wake up call to those that insist on driving the market's highways with the windscreen covered up, only using the speedometer and a highly expensive, well polished rear view mirror to guide their way. That works fine on gentle bends, but a sharp deviation has you in the ditch in moments. The last couple of weeks have seen this back fitting of historic scenarios go into overdrive and the desperation to make them fit reminds TMM of their youth, when trying to get the last 2 pieces of their convoluted Scalextric track to meet up. If you bend it all enough you MAY get it to fit.

So far we have been told that the ECB is rerun of 2008, the bond market a rerun of 1994, the equity market is a rerun of 2001, which was a rerun of 1987, which all were/are a rerun of 1930's. But did the traders of 1930s say "this is the 1870s again" and try and model that? Did the 1870s traders model the South Sea Bubble, and originally in Babylonian times. did some wheat trader, when faced with a rust outbreak, cry "Oooh, it's just like the Mammoth Famine of 7000BC"?

TMM would like to think that although they know that human behaviour is pretty consistent in times of massive stress, maybe this eyrar of black swans is indeed different and NEW. The interesting thing is that, though the short term and spec market has been through hell and back, Mr Johnny Real Money player may well be starting to cry "You know what? If disasters A + B + C +..= 0, then I AM IMMORTAL AND CANNOT BE DESTROYED, FOR I AM UNCH ON MY AUD AND UNCH ON MY JPY and on my short bonds have only just got my feet wet and, as for equities, well they are screaming back too... WOOHAHAHAHA". That is, getting a wee tad cocky.

The Nuclear Physics PhD Q.E. program has achieved complete devaluation of nuke opinion and leaves TMM wondering which course will be popular next. Generals are back in fashion, but once again we've been here before. Rather than try and study a new fear function we wonder if the market is actually fed up with it all and is going to chuck it in and head for a bit of R+R in Ibiza. It certainly feels like that today with the few players left on campus hoovering risk assets again, playing the core theme of the past 3 months - Liquidity induced growth.

TMM are still very worried about where that will pan out as we return to a full "risk on" mode, as numbness from recent experiences hasn’t yet worn off. The same appears to be rampant in the household sector where Joe Public has been taught that money is to be forever free and, hey, so what? With what's going down in the world he won't need it, as there may be no tomorrow.

Lets just all enjoy today while we can.

Wednesday, March 16, 2011

Dog tired dog days

Can't even string words together. So here is a stream of disconnection.

Trading relative value in these markets must be like running a Lalique glass store on the main street in Pamplona on race day.

5% rally in Nikkei is NOT a massive bounce. Just look at a chart.

What IS your edge in these markets? Does leafing through the physics notes you made as a 14yr old help you any more than just having the fastest fingers on the e-platforms as news breaks?

TMM are getting REALLY pissed off with the blx being spouted by some of the market. Live streaming radiation rates in Tokyo from your friendly broker? At this rate you'd see the world markets fall 10% the moment someone flashes their 1970s luminous watch. Isn't there more radioactivity coming from the Americium in smoke alarms?

2433 lives lost in Chinese coal mines last year. Considered a huge improvement from the 1996-2000 average of 7619.

In light of what happened last time the European powers-that-be performed a stress test, evacuation is highly recommended.

The central banks are still in charge of FX at every level.

Have real money reacted to all this? Naturally laggards, we hear some have (in FX), and yet Equity land seems further behind.

Could Bahrain cede power to Saudi Arabia and solve their problems in a similar way to Ireland's Eurofication undermining the IRA (they never blew up Brussels).

Gaddafi is having a ball. His threats to cut all contracts to the West, apart from Germany, has us wondering what the hell Germany have been doing behind the scenes to curry favour. Tobruk part Zwei?

Sentiment is what is keeping the growth alive. Will the fall in sentiment be sufficiently influenced by recent market moves to turn the positive growth feedback loop into a negative feedback down spiral again?

Why are prestige marque car dealers having record sales in the UK, when TMM and their UK mates are NOT feeling at all flush?

Which Brit would possibly pay £2012 for an as yet unallocated ticket to hopefully watch a 10 second running race in a grim part of London. That's £724.320 per hour and not even TMM's gardener charges that much.

Tuesday, March 15, 2011

Meltdowns and Tipping Points.

TMM are really busy this morning trying to juggle falling knives with their hands whilst helping the market kick other things off cliffs with their feet. This is a good old fashioned position liquidation day with all the associated nightmares. For RV players, things that should correlate suddenly don't and for macro players things that shouldn’t correlate suddenly do.

Whilst the debate rages as to how the Japanese disaster will manifest itself as ripples of the, now financial, tsunami refract around the world, TMM are left in money management mode. Thinking about the next big trade is being swamped by protecting what we have.

Despite the temptation to look at the Japanese situation and directly extrapolate every function to justify meltdowns in everything else, we would rather see this event as a tipping point. We have been concerned for some time (and started playing for) a global growth shock, but were never really sure what would catalyse it. So perhaps the Japanese disaster is that tipping point in a super-critical market that has been leveraged via sentiment towards the inflationary growth story funded ultimately by cheap QE.

TMM have just finished reading a book by one of their mates and find the subject so very apt for today. As its forward pointed out:

"We live in a bewildering world of change, which splits naturally into steady progress punctuated by sudden disruptions - the two speed world. Steady progress ensures the survival of our species, but it is the disruptions that move us to a new level. Both types of change, slow and rapid, are important, because they mould and shape our lives, but because of their widely divergent characteristics it is sometimes difficult to recognise a major life-changer until it is too late. Even if we do spot the upheaval, we cannot deal with a change unless we understand it".

Loath as we are to be seen promoting books "Two Speed World" is an interesting view of the behavioural issues involved in explosive and gradual change.

It's been a long night and we have yet to see the US response to this sell off, so if we were to don Kevlar gloves then it would have to wait until tomorrow at least.

As for trades? You could go Long Tuna, Short Zirconium !

Monday, March 14, 2011

Armchair Nuclear Power Generation Experts

The weekend's TV footage from Japan was awful and as though all Hollywood disaster movies had been wrapped into one horrible reality. There are so many bases for discussion as to how this changes the world that we hardly know where to start. This morning is remarkably quiet whilst everyone tries to work out the solution to the equation:

rebuild+sentiment+/-GDP+capital flows+ reinsurance flows+borrowing-nuclearpower+energysubstitution-exports+imports+intervention+reoccurring

and getting bogged down with so many unknowns, ending up doing nothing. Our latest pressing research is into the correlation of TMM trades and associated natural disasters. With our recent long NZ and then long Nikkei calls we are expecting Paul the Octopus type fame with regard to forecasting natural disasters.

Is the market getting "bad news punch-drunk"? What with Aus floods, NZ earthquake, Japanese Earthquake, Libya, and the rest of the middle east (though you 'd have to say the Saudi "day of rage" was more like a "Day of Mildly Miffed"), the dormant Euroblx, the bankrupt USA and UK, you would think we might be a tad busier.

The Euro EFSF news was a bit of a blindsider. The cynic would suggest that it was sneaked out under the cover of the Earthquake because in normal times it would be headlining. As it is we can see a none too surprising Core/ Periphery pivot supporting the PIGS. But we really do wonder how long before someone takes a closer look under the carpet of EFSF and realise that without some other stunning follow up the inevitable has just been further delayed. Wake up world! Euroblx is back in season!

As for the Middle East and Libya. they appear to be only occupying about 10% of the markets attention now Gadaffi (who we know should be spelled with a fashionable Q these days but just call us old fashioned) is merrily pushing east effectively Tiananmen Squaring the whole country.

Putting all of the above together we have only one sure fire trade - DFS (known to some as Dreadful F’in Sofas), the UK’s high street armchair outlet – Basically the financial world is fast running out of armchairs to accommodate all the armchair specialist’s currently needed to pontificate on the diversity of major issues.

For today TMM are going to try out a nice mock chesterfield single-seater in a pleasant beige radiation retardant velour, as we throw in our pennyworth as armchair nuclear power generation experts:-

You know that feckless friend from high school, the one who is an artist/actor/whatever and who drives a 1975 Datsun claiming its retro-cool but really drives it because he has neither the means or inclination to replace his car? One of us bumped into him over the weekend and apparently the Datsun is kaput. Busted. Scrap metal at best. After clearing a particularly large speed hump the rear axle broke and the aging bomb-on-wheels is no more. Shocking.

That pretty much summarizes how TMM feel about this earthquake and the reactors at Fukushima. The reactors that have currently blown are all boiling water reactors designed by GE whose design dates back to the 1970s and whose lives have been repeatedly extended through procrastination more than anything else. You would think that moving to a better and safer design like a pebble bed meltdown proof design would be a good option in a place that was on a fault line. Sadly, like many important regulated industries over the last two decades regulatory action has been nothing more than pass the parcel and duct tape. TMM think its time to face up to solid cold hard facts about investment requirements and what technology is appropriate where. We are sitting on the knife edge of an energy crisis in the Middle East to say nothing of global climate change (largely because TMM are split on the issue). TMM are big fans of James Woolsey’s work on energy security and think that a few million electric cars and a lot of nuclear could go a long way to de-risking the planet. Sadly the reaction so far has been a lot closer to Jane Fonda 1970s hysteria so far, though we hold the faint hope for some more sensible dialogue soon. At the very least the lazy practice of rolling over permits and safety approvals past life-of-asset estimates for nuclear power plants elsewhere should stop.

With the editorializing done it’s worth asking where now for nuclear and what does this mean for commodities demand? Given the pretty binary world uranium companies are now living in they’ve taken a pretty big hit thus far. As Canada isn’t open yet TMM can only show you some Aussie names – suffice to say the situation is already looking pretty ugly.

In all fairness they weren’t cheap to begin with and some of TMM had some shorts on – better to be lucky than smart as the old saying goes. To peer into the “official” data for future nuclear demand look no further than the World Nuclear Association which while being the industry cheer squad does have some decent numbers for future reactor plans. The summary is below:

As you can see, the bull market case for nuclear is pretty generalized and isn’t just a BRIC thing at all – it assumes a lot of growth in developed markets and that countries like Japan do not run a million miles away from the industry. Anyone who is trying to broke you some story that US/Europe/Japanese politics are a rounding error for industry size by 2030 has not done the slightest bit of work on this. Politics matters *a lot* here as it is not just a China story where the technocrats will determine what happens.

So when TMM run their models assuming all’s well in China and the WNA projections for a mid case, we get a low single digit deficit in uranium out to 2015 as China builds plants like no tomorrow but mines aren’t built fast enough. But what happens if the Western world spurns nuclear and shuts down old plants? In that case we are looking at a ~12-15% surplus. Ouch. Suffice to say holders of uranium equities have an awful lot riding on this – cash costs are around $20-25 for major producers in the industry and there is no reason they would not cut prices down from $65 to prices of yesteryear to survive (chart below). While the end of weapons decommissioning taking some supply out that does not hide the fact that with a lot of reactor plans in the pipeline it really is do or die time in this industry.

For those in some of the most pollution-blighted cities around (Beijing, Delhi, Shanghai, Hong Kong etc) which already live with air quality that moves the mortality tables, taking a chance on nuclear still looks good - especially if you are using better technology.

Hmm... that armchair was OK, but have you got anything in "Plate Tectonics" please?

Thursday, March 10, 2011


Have you ever wondered why it's always more satisfying to shout "YOURS" than "MINE" aggressively at your counterpart or broker? Well, TMM reckon it's to do with enforcing your will over others and perceived worth. If you shout "MINE" it implies the other person has something that you want and hence he is, at that moment, in a more powerful position than a subservient you. However, shouting "YOURS" implies that you are imposing your will and inflicting a pile of unwanted detritus upon them leaving them wandering the world for ever more looking like a badly dressed compost heap. Hence, any quoted story of testosterone-fuelled Alpha Male Silverback Dealer-ness, will always include a liberal spattering of "YOURS" but never any "MINE"s.

As for today... Yours what? Well, just about everything that is measured against The Dollar.

The Chinese trade data overnight, while arguably due to New Year distortions got TMM thinking about whether markets are about to embark upon a growth scare. As readers will remember from yesterday, TMM have been dumping their metals holdings and are particularly interested in the performance of Dr Copper, the world's most consistent economic forecaster, as this morning we see it has completed the well-flagged Head & Shoulders pattern and its up trend form last June and is sitting on the 100day moving average. Indeed, TMM found this particularly interesting because their very basic model of ISM based upon Copper has been exhibiting a striking divergence over the past few months as ISM has surged to multi-year highs, while Copper has tried to rebound but in recent weeks failed somewhat, and is consistent with ISM falling to around 52 (the large spike and divergence in 2006 was the result of Bernanke's first Humphrey Hawkins testimony giving the impression he was soft on inflation, and sparked a global rally in metals which ultimately ended with a severe risk aversion event in EM). Now, TMM have been generally very constructive on the global - and US in particular - growth rebound after last year's mid-cycle slowdown, but this divergence is the latest in a number of warning lights that have begun flashing on their dashboard.

TMM had been intending to buy the dip in USTs in the aftermath of the current round of economic data, in a similar way to February, as punters having finally embraced the idea that the US recovery is self-sustaining had taken the mind set of setting shorts ahead of the data dump. Now, so far, that hasn't really happened, perhaps due to positioning, but also, with US Economic Surprises close to the highest level they have been for years, TMM reckon there is plenty of room for disappointment in the coming weeks...

Another warning light that has been flashing amber, has been the 5y5y forward US Real Rate (see chart below - white line), which tends to lead changes in Economist consensus expectations by a couple of weeks (orange line). It looks to TMM as though economists have gotten ahead of themselves given the peak in this metric... TMM also note that this measure peaked in early-April 2010 before plunging lower as the Eurozone crisis escalated and US economic data disappointed. TMM suspect that economists will start to lower their 2011 GDP forecasts in the coming weeks.

And with speculative positioning in Eurodollars now at its lowest since early 2007, TMM reckon that the front-end has plenty of room to rally should, as they expect, a growth scare begin to materialise. As a result, whilst TMM will continue to shout "YOURS" in Spooz and add to their shorts should they manage to close below the QE2 uptrend, they have managed to find small nuggets of "MINE" and begun to build a position in the Greens, and bought some USDs.

And if you still need further persuasion, what better than hearing that PIMCO, the world's largest bond fund, holdings of US treasuries are ... and the answer is... Zero. Ohhhh yessss...

Wednesday, March 09, 2011

Equities: “Bi-Winning” but for how long?

TMM have recently been bemused by the strength of equities and industrial metals in the face of some pretty dire developments in the Middle East and amused by the antics of Charlie Sheen. On the face of it, they do look rather similar in some respects: both hopped up and energized on forces known (QE and being able to date two women in their early 20s) and unknown (how China maintains an entirely investment driven economy and for Mr Sheen’s secret ingredient check TMZ). However, every silver lining has a cloud and TMM are growing increasingly concerned about what $100+ oil means for US consumers and what the National People’s Congress means for Chinese growth.

Let’s start with something everyone agrees on: $200 oil would put us into a double dip and then some. How odd it is that out of the money equity vols seem to be a long way from out of the money crude vols, which have gone all bid out all the way along the curve. It is nice to see that investors have picked up on the fact that middle class discontent in the Middle East is about as well contained as the collapse of the shadow banking system circa 2007. TMM are not so sure about being long oil here as a fair bit of risk is priced in even out to December now, but one-step-removed trades like being long energy assets in good jurisdictions or ones with high costs (Hellllooooooo Alberta….) do seem to have less downside despite a good run – PetroCanada Suncor PE (light blue) and stock price (dark blue) below. Suffice to say it doesn’t look that crazy to TMM, given that Saudi Arabia blowing up will make this the mother of all cash cows and it has only about 25% downside on valuation assuming all is well. It’s certainly cheaper than crude vol!

That of course assumes that it does not kill US consumer spending which has been a fairly important part of the recovery and will be more so once the government gets serious about deficit reduction. The problem is that this is coming as the 100% depreciation allowance for capex for 2011 expires and 6 month ahead capex intentions from Philly Fed seem to be rolling over (see below). Watch this space – channel stuffing can be driven by tax policy too. Without much “I” or “C” and assuming “G” gets under control, GDP is going to have a tough time recovering, which makes you wonder whether the deflation trade has breathed its last.

Which brings us to the subject of China’s 5 year plan and recent macroprudential changes. The big change in macroprudential regulation is to move from loan quotas, i.e. window guidance to bona fide M2 targets. This is a subtle distinction, because it covers not just bank lending, but general credit creation: bonds, commercial paper, and those trust loan structures that were all the rage for anyone who wanted to fund a massively loss-making local government investment vehicle. While this sounds all well and good, TMM are well aware that loans are still under the CBRC and trust loans are somewhat CBRC covered, as many are originated by banks, but many are also securitized and thus would come under the purview of the CSRC. Similarly, the bond market is pretty tightly regulated, but is under the CSRC, so TMM knowing a little about regulatory fiefdoms in emerging markets are wondering how well this will all be implemented. Time will tell, but we are more than a bit skeptical at this point in time. In the meantime though, TMM are noting that the channel checks were right and vehicle sales are slowing sharply in China – cue a run of people’s stops in Platinum and Palladium.

Which gets us onto the Five Year Plan and let's just say that one thing is abundantly clear: China’s going to have an awful lot of electric cars sooner rather than later. As a belated response to the 2008 oil spike and current events China is moving aggressively to roll out electric cars and reduce its dependence on oil. This is not particularly good for Platinum and Palladium, as we discussed previously here. While China is planning on continued urbanization (and iron demand along with it), growth is expected to be on the order of 7-8% vs mid teens growth in demand seen previously. Given some of the aggressive capex programs in the mining majors TMM feel that it might be high time for a fade of recent metals prices with the US seemingly close to rolling over, a large supply response coming along in iron and copper and prevailing tight policy in EM. Iron ore has come off, since it figured in our non-predictions, but TMM feel that now might be a good time to take a swipe at copper too. Lead in particular looks rich to TMM – according to some fairly exhaustive work done recently we are looking at the entire China E-bike battery market going to lithium over the next 3-5 years. That's about 45% of world lead demand. Gulp. There’s nothing quite so obsolete as an obsolete technology.

Pulling together all these micro strands TMM feel that the long commods game has likely seen its best days for the year until policy loosens up in EM. Or, we could take some inspiration from Mr Sheen and say, “if you’re still in commodities, you’re with the trolls”.

The only other alternative is that this run breaks just about every historical pattern TMM know and, even though we know that is exactly what some are hoping for, TMM just can’t see it.

Tuesday, March 08, 2011

Over-labouring Labour's labours

The past few weeks have definitely been a period of "buy everything" even if things haven't actually moved that much. Commodities of course, energy, base, precious, softs you name it. Equities too, which is a bit of a surprise considering that energy is getting hiked on fears of Middle East-inspired Armageddon. The only thing being sold is effectively cash and as indicated by the FX markets, USD cash specifically. Which means that if you hadn't noticed the Middle East unrest, the wobbles in Asia, the widening European periphery spreads, the earthquakes and floods in the southern hemisphere and just looked at prices alone, you would imagine that the only trade in town is the purest of them all - the QE induced USD Inflation trade. But its more complex than that, we just seem to have ended up at a simple solution to a complex problem. Much as e to the power of pi*i = -1.

Speculative positioning seems to be showing that this theme is pretty stretched as every punter has suddenly started waving the macro arguments for their short term trades. Now whilst we know that some believe that the macro is the macro and the micro is the micro, TMM do believe that the Macro is a sum of the Micro and the Micro is a fraction of the Macro. But we also know that when a Macro theme becomes a day trader's mantra, it’s gone Tabloid with a high TDI ( Taxi Driver Indicator) and the wheels normally fall off. So with everything going up against USD cash the interesting part should be if it all unwinds and then everything falls against it.

We should apologise for not having posted yesterday. The day started as usual with TMM debating the normal run of market developments and interpretations but the recent headlines on UK banks swiftly led us into a somewhat turbid debate again over the who/what/where and when, did/should/would and will happen in that sector. Unfortunately, the lack of consensus and agreement on a topic so widely and emotionally debated ended with us deciding we really didn’t want to air our dirty laundry in public. So no post, but instead TMM decided to share just a small part of the complex debate which occurred that doesn't really have too much relevance to trading.

Having become fed up by the naivety of much of the discussions around the issues both in the press and political sphere we thought it may be worth putting something together to try and address the myths on both sides. So today, the non-partisan TMM will attempt to look at the UK Labour party's involvement in laying the economic background and illustrate just what they did or did not do wrong as far as fiscal policy goes, in its 13 years in power. While intended to abstract a little further than the standard "they spent too much" or "they didn't spend too much", it is certainly well-beyond the scope of this humble blog to be anything approaching the exquisite analysis of TMM's mates at the IFS.

So... here goes...

One of the sound-bites that has flown around is that at over 50% of GDP, UK Government spending is too high. Now this may or may not be true, but simply looking at the overall government share of GDP is something of a misnomer and, while politically expedient for the Right, does not provide an accurate picture of how big the State is and whether that share of GDP was unsustainable. TMM reckon that to answer this question, we need to look at the main components that make up that 50%+ number:

  • Central Government Current Expenditure on Net Social Benefits ("Welfare Spending").
  • Public Sector Net Investment ("Investment Spending").
  • General Government Consumption Expenditure ("Current Spending").

On top of those are all the smaller things like depreciation, interest costs and various other things which are beyond the scope of this piece. However, any proper analysis of the government's share of the economy requires an analysis of the main three components above.

So, firstly, Welfare Spending (See chart below). Believe it or not, as a share GDP actually *fell* under Labour, only rising as the effects of the recession began to bite sending spending higher and GDP lower. Note also the spikes in the early-80s and early-90s recessions under the Conservatives. TMM is pretty certain that the Daily Mail would be horrified to learn this, as it has been certain that all those council tenants living in million pound houses were responsible for this "great big fiscal mess"... Whatever the rights and wrongs of welfare reform under New Labour, and loopholes that have resulted in an impossibly high share of people declaring themselves to be unable to work, it is not obvious to TMM that Labour did anything particularly wrong here. Welfare spending covers is defined by the moniker "Central Government Current Expenditure on Net Social Benefits" and covers pretty much all of what one might expect of the Welfare State in the form of automatic stabilisers and redistribution to the poor and needy. So it doesn't look to us as though Welfare Spending got out of control.

Moving on... Labour's big plan (and Golden Rule) was to "borrow to invest over the cycle and not to fund Current Spending". The idea being that investment in hospitals, schools and infrastructure by the government results in higher trend GDP as the discount rate that the private sector would have to apply to such investment would have to be so high to compensate for the risk of such projects would be way to high for them to be worth enacting (there are plenty of defaulted Railroad bond stock and bond certificates on Ebay to attest to this fact), and there is a clear benefit to business and society as a whole. TMM strongly agree with this view. The chart below clearly shows that investment was increased, though only to levels seen in the early-1990s by 2007, prior to the recession. The bulk of the spending share increase came in 2008-10 and is obviously mainly the result of the fall in GDP optically.

On top of this is depreciation and the PFI/PPP stuff which you can see in the below chart basically either were roughly constant or just increased a bit. Anyway, the main point here is that there *was* an increase in investment spending, but it was not a massive increase that could justify the very large structural deficit that was being run consistently over the past decade, as Ed Balls keeps trying to claim. TMM suspects that this would surprise many Guardian readers... TMM have avoided delving into the impact of the off-balance sheet aspects of PFI/PPP precisely for the reason that they are not included in the official debt figures. If anything, they undoubtedly worsened the UK's fiscal position, but TMM believe that to consider these here would risk over-complicating things.

Finally, General Government Consumption as a %age of GDP. This is the State's spending on current goods and services, and includes the public sector wage bill, the pension Ponzi scheme, non-welfare-related NHS spending (e.g. the Nurses, Doctors, Administrators etc), Defence etc. The chart below is where an international comparison is more appropriate as this is the type of spending that affects the Real Exchange Rate (more on that below) and also the extent to which fiscal policy was sustainable. TMM reckon the above argue that Welfare Spending was sustainable and Investment Spending was not out of line with historical norms, and generally provides an asset on the other side of the State balance sheet, and was not necessarily unsustainable unless one counts the off-balance sheet liabilities of the PPP activities. TMM's personal view is that the Government was ripped off by the various companies that won these contracts and figured they had a free put option to the Government if things went wrong (which sounds to TMM a lot like the Bankers...!).

We digress...

In the chart below of General Government Consumption Expenditure as a share of GDP, the white line is the UK, the yellow line is the US, the pink line is the EU average and the green line is France, the orange line is Switzerland and the blue line is Germany. As you can see, from 2000-onwards, Gordon Brown went to town, employing vast swaithes of administrators and wasting huge amounts of money on computers, electronic whiteboards and all manner of consumables which are now gone and wasted, take the consumption share of GDP up to levels not seen since Thatcher began a structural consolidation of the State in 1981. By mid-2009, partially as a result of the bank bailouts and recession this measure had risen *above* that of the mid-1970s, arguably the height of the Big Government and Statism. Not only did Britain do this, but it also overtook the EU average in 2003! In TMM's view, this was where Labour was irresponsible, because this was *NOT* investment as laid out in their 1997 and 2001 manifestos, but a pure expansion of the government's share of consumption spending within the economy, and was money wasted, not invested. The key with this metric is that it was already running at a ridiculous level prior to the recession and therefore there was not any room for a proper Keynesian discretionary stimulus in the worst recession for 80years and, as a result, the UK enacted one of the smallest fiscal stimuli globally at a time when it clearly needed a very large one.

An international comparison argues aiming for this share of the economy to sit somewhere around 17%. TMM pick that number because it is where Germany was prior to the recession, and above the level of the US (which does not have an NHS as such) but below the EU average because we are not one of the low growth and rigid Mediterranean economies. Given the presence of the financial services industry, one could also argue that this share needs to be even lower - Switzerland, for example, only runs 11%, but this was structurally rising prior to the crisis.

So that's the fiscal side of things, but what about other effects? Regular readers will recall the below chart, one of TMM's favourites (inspired by the BoE's newest member, GS's Ben Broadbent), showing the Mundell-Fleming framework of the effect of General Government Consumption Expenditure (white) line upon the Real Exchange Rate (orange/green lines - two overlapping BoE series). According to this theory, as the government's share of current spending increases, it pushes up the Real Exchange Rate because domestic goods, services & wages get pushed up relative to those externally. And vice versa for decreasing consumption shares. It is clear that as this share moves up and down the Real exchange follows. In 1997 the market anticipated this and rallied as the market correctly priced in a Labour victory and increased government share of spending, but from 2006 onwards, the market realised that fiscal policy was unsustainable and didn't rally much. And furthermore, during the crisis anticipated a very dramatic fiscal tightening, with the market consistent with this measure expected to fall to about 18% of GDP.

There are two main problems with increasing Current Spending: one is that it has often resulted in fiscal crises in the UK (1976 and the past year are clear examples, but also 1967), and the other is that, as demonstrated above, it forces up the Real Exchange Rate due to the State tending to buy domestic goods and services and push up real wages as a result of hiring a great many more people. This contributes to a fall in economy-wide competitiveness, export businesses face a harder time, their balance sheets deteriorate and this leaves them vulnerable to foreign takeovers or bankruptcy. A lot of UK manufacturing has fallen victim to this, and TMM note that a significant amount of UK Plc has been sold off over the past 10years in order to help fund the gaping Current Account deficit.

And that, dear reader, was just part of it... Enough said. We hope to be back to more markety things tomorrow. Especially as we think March is going to be open season for all things European. We may be a'goin' Eurostriche huntin'.

Friday, March 04, 2011

Euro Wars V : The ECB Strikes Back

Well yesterday went as badly as it possibly could for TMM, with just about the only thing right with yesterday's post being the title, as Mr T and the A-Team reminded them precisely why they try to avoid trading Euribor at all costs. The Baron Von Trichet was almost as hawkish as he could possibly have been, sending rates markets into a tailspin as memories of June 2008 flashed before the eyes of many a rates trader. But pain aside, what are the implications?

Ladies and Gentlemen, may we introduce the new (old) star of the G7 currency show: the Euromark. Ultimately, while currencies are driven by a multitude of factors, from Current Accounts to rate spreads to geopolitical events, over the long term, divergences from the Real Exchange Rate are largely explained by Real Interest Rate spreads, something TMM highlighted in their 2011 Non-Predictions with respect to their strongly held view that USDJPY is going nowhere fast despite the best efforts of punters to try and rally the USD (thus far, unsuccessfully). And it is in that respect that HMS TMM are viewing the U-ECB torpedo that sank them yesterday after heavy gun fire throughout the week from other quarters. While TMM and many market participants view an early hiking cycle from the A-Team as something of a policy mistake (more on this below) in terms of the Eurozone as a whole, it also demonstrates that unlike many central banks around the world (for example, the Fed, the Bank of England and most of the EM world) that their only two priorities are monetary stability and preserving the value of the currency in terms of inflation. While some have argued that this is more about trying to impress the Germans after Darth Weber's exit, stage left, it seems to us that Club Med are being sacrificed on the altar of the Bundeathstar. That is very bad for the periphery, however, it is very good for a Euro that is increasingly looking like The Deutschemark under ERM as higher rates are entirely appropriate for the German powerhouse.

The below chart shows the EUR (orange line), the nominal 2yr swap spread (green line) and the 2yr real rate spread (white line). While obviously not a perfect fit (certainly amongst the noise in late 2008), from 2004 until early 2010, in broad terms, the real rate spread did a much better job of explaining the Euro's valuation than the nominal spread did, and from July 2010 onwards, similarly so. TMM were originally going to throw the statistical toolkit at the below in order to strip out the credit-induced risk premia applied to the Euro in the first half of 2010, but after a heavy night's drinking this suddenly seemed like too much of a task given that the pounding of their portfolios has extended to their heads. So that will have to wait for another day. but if we accept the view that about 10% risk premia was added into the currency back then, it's not too much of a stretch of the imagination to imagine that the risk premia-adjusted EUR would have a 1.50-handle on it. But it would still be "undervalued" relative to the real rate spread. Given that the ECB is forcing real rates higher in Europe at a time that the Fed is unlikely to budge for at least another year or more, as headline inflation prints drift higher with Oil, TMM find it very difficult not to own the EUR when the real rate spread is pushing its highest since mid-2008 and prior to that, the mid-1990s. And it's not just the spread that is important in this respect, in the US, the absolute value is -1.39%, while the European equivalent is +0.21% - small, but positive, nonetheless.

For completeness, TMM's EURUSD model that includes the VIX & Spanish CDS is also pointing north:

So that's the Euromark, what about those Club Med countries pegged to it?

As TMM noted earlier this week, an increase in the ECB's Refinancing Rate is not materially different for the PIGS than a rise in their bond yields, and in keeping the yield curve steep, the ECB have in some respects been helping banks rebuild their capital. But clearly they have decided "enough is enough" and put the bank capitalisation problem squarely in the court of the fiscal authorities. Under the prism of this policy, the ECB is forcing the politicians that have, erstwhile, been dragging their feet with respect to recapitalising their banking systems properly and tightening the Stability & Growth Pact to act such that the Euro is no longer "soft" in terms of monetarism, and also in terms of fiscal prudence. Should politicians still reject further moves towards a North European fiscal policy, it is likely that Ireland, Greece & Portugal restructure, but given Spain's fiscal sustainability, this is not particularly bad for the Euro whether these countries stay or leave. In fact, it looks a lot to TMM like the Deutschemark under ERM. In terms of growth impact, obviously rates moving higher is a firm negative for those countries undergoing internal devaluation and can only mean an underperformance of their equity markets. And while TMM think that the easy money in the long DAX/short IBEX trades has been made and that - ultimately - as per their 2011 Non-Predictions, that the IBEX will outperform this year, in the short-term, at least, TMM believe markets will focus on the additional pain that the periphery will be forced to bear.

TMM were going to write a completely different post today answering the question "Is this February 1994?", but decided that that will have to wait until next week given their pounding heads. But the crux of the issue is whether or not yesterday's surprise pre-announcement of a rate hike will push the focus towards bringing forward expectations about a G7 rate hiking cycle. TMM are undecided on this, except for their view of the Fed on hold for a long time, but that does not necessarily mean that markets cannot price in such an event. And thus, in the short-term at least, the bias towards a more protracted front-end sell-off seems likely. As has been argued elsewhere, the Nikkei tends to outperform in rising yield environments so TMM pick this particular graveyard as their long, against which to sell Eurostoxx.

And with that, TMM wish all their readers the very best of luck with this afternoon's lottery.

Thursday, March 03, 2011

Mr T: I Predict Pain

So once again it is ECB day, when Mr T and the A-Team bitch slap punters for daring to bother trading in Eurozone asset markets. Since the crucifixion of Eurobears that entered the year all guns blazing in January, market participants have been generally trying to avoid selling the Euro, buying CDS protection or shorting Club Med bonds. Readers will know that TMM generally view "The Euro" and all things Eurobllx as one of those great religious debates that aren't worth expressing a view on, and even if one were to proffer an opinion as to whether it survives or not, those on both sides of the debate are deaf to opposing views. Suffice to say, the swing of the pendulum has swung toward those in the "pro-Europe" camp - if not for anything more than P&L cushions...

But we digress. Where punters *have* been trying to play the bearish Europe story is in the rates markets. For the past year or so, the ECB has repeatedly tried to exit its exceptional crisis-mode liquidity policy, through announcing an end to easy liquidity provision and hinting that rates will have to rise. Of course, the fiscal crisis in the periphery has on several occasions forced them to backtrack somewhat from this policy as wave after wave of EU policymaker incompetence has managed to screw up previous attempts at buttressing the periphery states. Of course, now, the ECB seem to be of the opinion that the war has been won, given that apart from the usual suspects (Portugal, Greece & Ireland), Euro-area capital markets appear to be performing pretty well. They also want to keep up the pressure on fiscal authorities to recapitalise their respective banking systems such that those entities currently unable to borrow in the interbank markets - such as NegativeAlphaBank Athens and All-In Bank Dublin - can.

Of course, the flaw in this strategy is that the results of the stress tests are not out for another few months, and given last year's fiasco, markets are bound to be rather more skeptical of the results unless they show a reasonable amount of new capital is needed. Additionally, markets are awaiting the reaction of the newly-elected Irish government to such results that are bound to show that the size of the black hole attached to the Irish banking system has increased to the point that it is not only the English cricket team that have been crushed by its gravity. And while EU policymakers appear to have managed to successfully manage expectations for a not-so-substantive "substantive" new EFSM package at the Ecofin meeting this month, TMM trust Merkel & Co. to monumentally screw it up somehow... after all, as the cliché goes, the trend is your friend.

On top of the above, as TMM noted earlier this week, while Germany is motoring ahead, ECB rate hikes have just the same negative effect upon the periphery in terms of higher financing costs as the evil anti-Euro speculators do when they sell Club Med bonds. With such intra-European divergence, TMM find it hard to see the ECB really doing anything other than talking tough to keep inflation expectations in check, with perhaps the odd hike later this year to show to wage bargainers that they "mean it". The move towards mopping up excess liquidity is likely to continue (see chart below from TMM's mates at Nomura) with 3m unlimited allotments ending, but TMM reckon that until said peripheral banking systems have been recapitalised (at least 6months away), that despite protestations about "liquidity addicted banks" that the ECB will have to keep at least the one week allotments and probably the one month allotments too.

And while Taylor Rules don't work as well in the Eurozone due to the ECB's reaction function being somewhat quaintly a function of money supply growth amongst other things, for what it's worth, TMM's model is shown below (white line) vs. the actual Refinancing rate (orange) and indicates that rates do not really need to rise given the Eurozone-wide output gap. But TMM admit, that this is unlikely to sway those arch-monetarists of the Bundesbank...

...perhaps it is interesting, then, that Darth Weber, erstwhile defender of the Monetarist Empire of the Eurozone has resigned and will not be attending today's meeting. Now, looking at what is priced into the curve is monumentally difficult given the subjectivity around how Eurozone liquidity conditions will progress over the coming months, with anything between one and three 25bps rate hikes priced in by year end, depending upon what discount (if any) one expects EONIA to fix at relative to the Refinancing Rate. And TMM reckon that, rather than being all purely rate hike expectations, the forward curve is more a function of significant risk premia resulting from the memories of June 2008, amongst other things.

TMM have thus far managed to sit on their hands (they have history with Mr T of the love-hate kind), knowing that many punters have tried to fade this over the past couple of months, and avoid buying the front-end, but it looks to them as though the risk reward for a punt on Trichet providing a dovish surprise today looks pretty good...

...they are sure they will be truly regretting this by the end of the day...


Where the hell did THAT come from? Darth Weber may not be getting Mr T's chair, but he hardly needs to be as the BundesECB meld appears to have already occured. Doc Trichet is taking us Back to the Future of 2008".

TMM probably in similar mood to Portugal, Spain and Italy and are wondering what Ireland's chances are of lowering their bailout interest rates...

The Good ship TMM after an encounter with U-ECB: