Tuesday, January 31, 2012

European Policy By Sloth

Team Macro Man apologise for the lack of service recently. Last week saw their technical pullback first get Apple'd and then FED'd. And though there were glimmers of the technical turn, it looks as though it has morphed into a "technical pause". Despite the fizzling out of yesterday's Euro summit there has been little sell-off which leaves TMM thinking that there is a chance of the European "Policy by Sloth" may work.

TMM wrote back in December about what they believed the necessary conditions were to bring about an end to the crisis. The classic Anglo-Saxon view (TMM cannot resist the French line) is that the only way out of the crisis is fiscal union. But TMM believe it is far more nuanced than that - strictly, that measures that confirm the path to some sort of fiscal union in the medium term are in place. Specifically, as we wrote back in December, TMM reckon we need to see the following:

(i) A large enough amount of cash to cover Spain & Italy's financing needs for the next two years,
(ii) Incentives to longer term investors to buy Eurozone government bonds,
(iii) Structural reform measures aimed at rebalancing within the Eurozone and, lastly,
(iv) Clarity on the growth outlook.

In TMM's view, clarity on the first three of these conditions is enough of a firewall for the rest of the world to chug along, and the last of these would be enough to unwind at least some of the under-performance of European assets and loosen financial conditions significantly.

TMM also highlighted the Silver Bullet Fallacy: there rarely exist simple solutions to solve complex problems. The alphabet soup thrown by US policymakers at the the 2008/9 GFC is point in case. What is more important for markets, is to be able to see the exit. And, as many have noted over the past couple of years, the exit can only come with growth, and that is why the last of the above conditions is arguably the most important.

The Street was generally surprised at how strong the take-up at the December 3yr LTRO was, and this morning's FT report that several banks are likely to double or triple their request for 3yr money at February's LTRO seems to slot nicely in the framework of providing adequate liquidity both for the banking system and Spain & Italy in particular - conditions (i) above. Putting this in the context of the EFSF and ESM and the seeming probability that the March summit will confirm ESM and EFSF to run alongside and the numbers have begun to add up. It is only the end of January, yet Spain has already funded about a fifth of its 2012 funding needs. The expanded collateral pool similarly means that French banks will be able to fund a large amount of their balance sheets with the ECB, incidentally, reducing the power that the Germans have over France going forward. The private sector money that would have funded these banks but has now been crowded out will have to go somewhere.

The second point, of providing incentives to longer term investors to buy Eurozone government bonds is not there yet. The treatment of the ECB in the Greek PSI is particularly important here, to avoid markets confirming the suspicions they already have regarding de facto subordination. While the ECB's LTRO provides time, and the promises of "No More Greeces" with respect to the approach to PSI which is supposed to be "over" evokes the post-Lehman policymaker consensus, only actions (in the form of ECB participation, or an explicit lack of PSI in the upcoming second Portuguese EU/IMF programme) will convince longer term investors.

The Fiscal Compact, while rightly criticised as being too centred on austerity, is a structural reform (iii). Additionally, the measures in Greece and Italy in particular will raise medium/long-term potential growth and aid rebalancing. More needs to be delivered here, but each incremental measure will help. By far the most important, in TMM's view, is the enactment of structural debt brakes in national legislation, to cement the credibilty of fiscal restraint in the future. In particular, TMM would regard the French enactment of this as the most important structural measure that lays the groundwork for future fiscal union. Of course, Sarkozy has delayed this until after the April election and, with the Socialist Francois Hollande ahead in the polls stating that he would renegotiate the fiscal pact such that France would not cede sovereignty, this is a significant hurdle for markets. TMM cannot get BOLIVIAN bullish until this is passed, but it does seem like much of the plan is coming together.

Finally, the growth outlook (iv). Markets are discounting machines, and they have already discounted fiscal austerity in Europe. The PMIs have begun to move higher which shows the exit... Greenshoots 2.0, the fabled second derivative. Late last year, the Squid published an excellent piece of research comparing Asia in 1998 with the current situation. TMM found particularly interesting the conclusions they came to, which were that market underestimated significantly the degree of demand weakness in those countries at the epicentre (ASEAN). However, the market also significantly overestimated the impact of the crisis upon the rest of the world, resulting in a grab for risk assets in late 1998 and especially in 1999. This is all of a sudden seeming all too familiar... the economic performance in the Euro-periphery has continued to disappoint, while that in Germany & France, the US and increasingly the rest of the World has exceeded expectations.

To sum up, while TMM expect the new month to bring a new bear attack on Portugal, they fear that they have been too cautious on the risk front. The strength in US equities, despite a relatively tepid earnings season, speaks volumes. And if the liquidity emitted from the upcoming 3yr LTRO is indeed large enough to restart animal spirits, then it is not hard to imagine equities finishing the year a lot higher.

TMM will finish by noting that GDP fell in most countries in 2009, yet equity markets and risk assets in general put in an incredible performance. It is not about what is happening *now*, it is about where markets can see we are going. And it increasingly looks like they can see the exit. TMM think that while just about anything US cycle linked looks cheap (Spoos, Korea, SGD, TWD, you name it) there are some things that have run on just about nothing - spec longs in AUD being case in point. TMM wouldn't advocate going BOLIVIAN but we think the equity perma-bears are in for a rough couple of months.


Anonymous said...

Apart from being the currency of Venezuela, what else does BOLIVAR stand for?

Polemic said...

Sorry , should have been BOLIVIAN in both cases.. see glossary.. will link it in a min above.

Anonymous said...

TTM, how do you reconcile equity outperformance woth corporate profit margins at these levels given they've done just about all the firing they can?

Anonymous said...

Given the number of major bluechips who have now reduced outlooks for 2012 you appear to be saying that the market disagrees with a substantial part of the forcasts made by the very businesses they are buying shares in. So is the market better at looking forward than the companies?

cpmppi said...

Anon @ 11.43,

Margins are not everything. Even if they have peaked (which bears seem to have been looking for since at least 2006), what is arguably more important for equities is growth. And arguably, the US has reached exit velocity in this respect. As an aside, we would disagree that equities have outperformed. If anything, they have underperformed what one would expect based upon earnings growth, with the multiplier taking a dive last year. TMM reckon this should reverse as Euro-related risk premia falls.

cpmppi said...

Anon @ 12:23,

Company executives do not drive their share prices, markets do. TMM have not found a statistically significant result when comparing insider buying/selling metrics, for example. And, as per our comment above, it is not just earnings that matter for equity prices, but the multiple put on those earnings. TMM expect the multiple to expand this year as Euro-related risk premium falls.

abee crombie said...

TMM, how much reliability can we put in PMIs, when increasingly (to me at least) PMI's are almost so closely linked with stock market direction? I think equities could also have a big year, just simply on the 'confidence' feedback loop

A successful FB IPO would be a good sign too

Amplitudeinthehouse said...

So, basically we're in pre QE JBTFD mode again..don't have a good enough guide on how euro players throw the dice with cheap liquidity.A tactical trade may be.

From my eye at moment, the markets going through the same old motions when the taps are pouring ( or in line too)

Be interested if the Squid mentions in their research how the bucky is diametrically opposed in the r0\ro cycle now.I think those macro synapses are saying that those dollars went chasing for whatever was left.

ahh...i get macro, every cycle is unique.

Anonymous said...

"Company executives do not drive their share prices"
That a fact ? Perhaps they should take a pay cut then. That aside though you miss the point. The companies are using sales data to put together forecasts and on that basis many have concluded 2012 will be harder than they had hitherto thought. By comparison I would suggest markets ,as you allude to them anyway, are actually trying to second ,or anticipate policy responses to front run price.
Again I ask the question does corporate data serve as better forecasting tool than your ability to front run your anticipations re policy etc? Surely if it doesn't then comapnies can surely despense with forecasts and just leave the market to do what it already is superior at which is anticipating the future.

Anonymous said...

I believe you're too optimistic on the "debt brake". Debt brakes come and go as it suits the politicians. They are equivalent to clapping your hands as a Tinkerbell-saving-device.
That said, it's likely that your reaction is going to be market's reaction, thus short term it would have postive impact on asset prices.

Steve said...

Welcome back guys.

I think Europe isn't anywhere near over given the level of denial. Merkozy is still working on a "fiscal pact" for Greece etc but how that would work without total fusion of govts is hard to see. Greece, Portugal are being choked off by the strong euro, they need their own brand so they can get competitive.

And look at the French, taxing transactions, raising the VAT above 20%, and now Hollande wants to roll back retirement from 62 to 60?

And this guy is winning at the polls?


Leftback said...

Your US based readership isn't exactly Perma-Bearish at this point, but some of us take a more jaundiced view of US employment prospects. This looks like a time to be a little cautious and employ some hedges. After all, we don't think the Fed said 2014 for no reason at all. We also think that we are way overdue for another episode of European TEOTWAWKI, this time featuring Lisbon, a lovely sunny place for some emergency meetings during the cold winter weather.

With the shopping mall Santas having traded in their red suits and beards for another year, LB fears a spot of mean reversion might be ahead. We fully expect the PermaTool US economists such as Swank and Zandi to miss to the up side this month after comically failing to include seasonal workers last month and missing to the down side. US jobs and Chinese PMI are probably THE data points these days.

Bleichröder said...

Not sure I agree on 1. 2, Yes.

LTRO compensates for the evaporation of repo in the past 3-6 months and does not really add much net new money into the system, if at all. As LTRO was largely taken up by banks with big near term rollovers, I don't see it stimulating a lot of demand for sov. debt, especially given the EBA's unhelpful demands for capital raises (the recent pullback in Italian yields notwithstanding, which I have my doubts about the permanency of). While I suppose they could rotate out of higher RWA into Italian debt, the EBA has suggested that it will not look fondly on this.

Fiscal compact is not structural reform. Structural reform requires attacking the position of a long list of entrenched insiders so that people under 30 have a future. I think for austerity to work it needs to be offset with REAL reforms that will loosen up labor and service markets and convince buyers that the near-term restructuring drag will be ultimately beneficial and not just a desperate round of Sears-like cost-cutting.

That said, there is a lot of room to boost the maximum potential of Southern Europe, provided you can get around obstacles that have been in place for decades.

WellRed said...

Everybody knows about the economic downside of austerity, but what about the implementation shortfalls?

Greece hasn't even come close to estimates and neither has Portugal. Spain said they'd run a deficit of 4.4% this year, but the IMF's latest forecast says 6.7% this year and 6.3% next. Sure Ireland is doing well, but they were actually a relatively competitive economy once.

If Italy fails to deliver on their austerity promises, the math very rapidly falls apart...

Anonymous said...

"US has exit velocity"? On what basis is TMM making this assertion? There are a handful of economic data points that have shown improvement, however a marginal improvement does not make the case for 'exit velocity'. The labour market is still depressed - look no further than today's Chicago PMI employment component. Home prices continue to decline as per today's housing data (lowest since 2003) and housing starts are near the lowest since the 1940s. Has TMM become victim to a mental model they have of the 1998/99 asian crisis and is trying to fit the current circumstances in that light?

CV said...

I think US growth will definitely slow down here. The market seems to be driven more by chasing here as people need to catch up with their benchmarks.

I think the healing process has started, but I think the US macro picture will deteriorate significantly in the next few months.

Europe seems priced in, but Greek and Portugal could still blow a hole in it if it gets really nasty. Italy is long term insolvent but Monti is saying and doing the right thing for now.

Oh and lest we forget. Let us see what a trillion euro at the next LTRO does to the bears. The ECB will be backing about 10-15% of the European banking system by then (assuming I am right of course).


Anonymous said...

I guess the question comes down to when Merkel will abandon her austerity ruse. I'm now convinced she's not delusional, but rather playing an ugly long game. There's no way she doesn't *get it*.

I'm sure 15-20 years from now most of Europe will wake up speaking German. The seeds are being laid now.

Anonymous said...

"Company executives do not drive their share prices"
That a fact ?

YES IT IS. that's why no Hester not anyone should demand any bonus for a job well done (-48%). Next please ...

"For example, conventional wisdom holds that the fate of a company is tied to the smarts of its CEO. A CEO's specific contribution to a company's overall success is hard to quantify. In order to examine the effect of hiring a rock-star leader to run an existing company, Kahneman compared various pairs of similar firms that had hired CEOs perceived as "strong," which he defined as one whose strategy had been widely influential. The results suggested that such leaders have only a minuscule effect on a company. "A very generous estimate of the correlation between the success of the firm and the quality of its CEO might be as high as .30, indicating 30% overlap," Kahneman wrote, noting that the respected CEO would be running the more successful firm in about 60% of the pairs-10 percentage points better than a coin toss. "



Anonymous said...

will someone save me from dimwits who cannot understand nuances and insist on taking everything in it's literal sense !
The 'argument' was not whther Ceo's contribute alpha ..duhhh frigging economic policies deliver alpha by creating opportunities for middle of the road corps to climb onto and that did not require a thesis.
The argument was IF corps analyse their incoming numbers and state our next numbers need adjusting down then is this generically likely to be more accurate than something we know has 'market' second guessing ?.Otherwise known as front running price anticipating policy responses that will invalidate corp analysis?

Anonymous said...

The Silver Bullet Fallacy (no simple solution for a complex problem) may be useful for the euro-crisis. But I wonder if this assertion applies to all financial crises. In cases there is a proven solution that is elegantly simple, but takes hard work, uses people we don't like, and doesn't protect the powers that be from taking any financial hit or facing any accountability. Thus the whole range of policies that cleaned up the US financial system after the Depression are off the table.

Intrinsic said...

anyone else think NFP is going to be a miss today?

Anonymous said...

"Thus the whole range of policies that cleaned up the US financial system after the Depression are off the table."

What policies are you referring to? Most of the things the government did actually made the Depression worse.

"anyone else think NFP is going to be a miss today?"

Uhhhhh, no.

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