Macro Stocktaking Unearths 10 Questions

Thursday, July 12, 2012

It's one of those times when so many different things are happening with no clear direction that a brain dump is required. So today, TMM are going to think about what is going on and ask some questions that we hope to find the answer to over the coming week. So without delay...

First, it's pretty clear that the past couple of months have seen a material slowdown in the data globally - especially in Europe, but also to a material degree in the US, and now Asia. Why has this come about and to what degree might we expect a reversal? Or has the World already entered a dreaded Global Recession? As many have commented, the degree to which we have followed the 2010/2011 playbook this year is remarkable, but in contrast to those years, this has been the consensus view in the macro community, stemming partially from the X-12 2008/9 seasonal echo effects. Thus, shorts in risk assets & longs in the Dollar have been widely held, so while the PhDs have been caught out (see CESIUSD...), it's not entirely obvious that this expectation was not in the market already.

Of course, we cannot blame seasonals for everything, given the ISM surveys have been adjusted for this effect and it is pretty clear that activity has slowed. But that is only half the picture, as the service PMIs globally are not in such a poor state. It kind of appears to TMM that in line with constant fears of a repeat of 2008 that inventory liquidation has been particularly dramatic over the past several months, and the inventory cycle can have material impact upon growth (TMM would note that historically, mild recessions are usually the product of a sharp inventory cycle as it is pretty difficult to get the US consumer to stop spending - 1981 and 2008 are the exception...). So if the services side isn't quite as bad (at least outside Europe), then it could be argued that things are perhaps not as bad as they seem at first sight. Indeed, even using TMM's back of the envelope year ahead ISM-based forecast model would have consensus economists looking for about 1.5% in the US over the next year. Mathematically it is unrealistic for the World to be in recession if the US is not. But that is not to say the deterioration will not continue...

...So is it a case of "2010/2011 Again", in which case, the recent bottoming of US Economic Surprises will soon be followed by a turn back up in the data, and this has just been another inventory cycle laid upon the Eurobllx? Evidence in favour here would be the high frequency data like Initial Claims & Rasmussen Confidence. If the deterioration continues, then growth-related assets have a long way to fall. Don'tcha just hate those binary scenarios...?

Hmm... So if claims & confidence appear to have turned for the better, does that mean the consumer is back? TMM suppose a lot of this is related to Oil, which took quite a tumble last quarter and has evidently lowered gas prices and thus in tandem with the disinflation of recent months fuelled real income growth. The consistent growth in consumer credit (and not just student loans) perhaps supports this theory and thus consumer is replacing capex as the driver of final demand? This is something that would be pretty significant. Of course, confidence is a fickle thing, and if the labour market truly is deteriorating to the degree that Payrolls suggest, then this tentative consumer recover could quickly fizzle. TMM will take a closer look at Oil and the consumer next week.

The degree to which earnings expectations have been revised lower over the past month is dramatic, with flat growth seen. Now, TMM's model (more in the coming days) has about 5% YoY EPS growth for SPX, but that does not include Libor-fixing related fines which can clearly make a big dent in the numbers. And it also implies that Q3 will see flat YoY growth, which isn't exactly fantastic news... But given TMM are not micro-focused, they will decline to offer an opinion here. The worries around Asian growth have too been cited as quite a big contributor to weakness in many of the international names, but TMM do get the impression that given the poor guidance provided so far and the de-rating undergone, that there is probably an exceptionally low bar for the earnings season now.

Europe? TMM once again find themselves utterly disinterested, as the A-Team appear to have engineered at least some demand for carry with banks bidding negative rates in EUR. As the Squid pointed out yesterday, this is the first time that institutions have been faced with depositing EUR cash at negative rates and the effect of this is uncertain. Maybe it will keep going negative as most stick with the safety of Schatz, or maybe some funds will increase the amount of risk they are going to take. Either way, it is clear that this has pulled short dated periphery rates lower and that has to be a good thing in terms of financial conditions. What it means for the Euro is perhaps less clear. It is notable that peripheral bonds appear to have disconnected from risk assets more broadly the past week or so - what that means is also not clear. Perhaps short covering, perhaps related to the summit, perhaps related to negative rates. TMM do not know. But it does seem as though the Eurostriches may opt for the STFU strategy this summer in the absence of further progress nor the German Constitutional Court Ruling.

Does that mean that the Euro-funded carry trade can progress without obstacle?

TMM suppose that with the can kicked for perhaps a month or two in Europe that this depends entirely on the outlook for QE3. And on this front, the three months of poor payrolls coupled with a sub-50 ISM probably mean that this is forthcoming, despite the argument perpetuated by many that they have not quite been "poor" enough for the Fed to move to ease. TMM accept that this is a valid point, and to that one could also argue that 5y5y breakevens are also not in the region of where the Fed typically acts, and neither have equity prices fallen to such a degree either.

The trouble with this view, in TMM's eyes, is that historically - at least since the early-1990s (and probably before, but TMM couldn't be bothered to check) - there has only been one occasion where ISM moved below 50 when the Fed have not eased. And that occasion was December 2006. TMM would guess that if challenged, Chairman Bernanke and the rest of the committee would probably agree that they *should* have eased then, in hindsight. It is also worth noting that in contrast to last summer, when the Fed merely twisted, that Europe is in deep recession, partially driven by last summer's dramatic tightening of financial conditions. Most observers would probably agree that the Fed under Bernanke tends to out-Dove the market. And it is hard to avoid the conclusion that three months of poor data equals a trend. And TMM also think the committee are unlikely to be influenced by the upcoming election (the 2008 election did not stop them from acting, though TMM accept that that was a time of crisis), given that preventing labour market deterioration is part of their mandate. As a result, TMM reckon the Chairman will use next week's Humphrey-Hawkins Testimony (or whatever it's called these days) to hint that QE3 is coming or at the very least, the conditions for which QE3 will be enacted. August is probably too early, so TMM are thinking September is the likely time. Which means the rest of the summer is potentially set up to be a large "sell the Dollar vs. risk" trade. But that is obviously dependent upon Bernanke's testimony and/or the FOMC statement at the beginning of August.

The alternative scenario is that there is nothing specific from Bernanke and then markets begin to probe where the Bernanke Put is struck and/or the tug between data strength and data weakness that *will* trigger QE3 leads to a choppy several weeks as the QE3 undercurrent runs through markets. We also should probably address the possibility that policy is impotent... TMM are not really ready to go down that road yet, but also not sure which of the above scenarios is most likely.

So... plenty of questions:

1) Are we headed for global recession?

2) Have growth & earnings expectations been lowered enough yet?

3) What is going on with the consumer?

4) When will the inventory cycle turn?

5) Have European rates markets moved onto the complex plane?

6) Is Asian growth about to tank? What about monetary policy? Does it matter?

7) Has Europe done enough to get through the summer?

8) Is QE3 coming and if so, when?

9) Will the Euro-funded carry trade continue or is the Dollar about to get smoked?

10) When will the Debt Ceiling debacle kick off again?

We hope to tackle these questions in the next few posts.

Posted by cpmppi at 2:09 PM  

9 comments:

As the master shit-sandwich eater would say...it's just it's time - the current cycle is over....

Amplitudeinthehouse said...
2:56 PM  

Thanks for posting.

In the same spirit, I thought I'd share some off the cuff thoughts.

I see 2 catalysts for a rebound in economic momentum. A resolution of the tax issue and the inventory cycle. Regarding the latter, I'd just note that the ISM inventory index, at 44, is only a couple points below the long term average of 46, so it's not clear if the inventory drawdown is enough for a bounce yet.

The labor market deterioration may be the result of employment growth returning to 'trend' rather than a sign of an upcoming recession. Maybe we average 100k payroll growth for the rest of the year?

The libor fixing issue may more likely be an overhang over equities that is more likely to drive a small compression in p/e rather than impact earnings.

Re: ISM and the Fed, I suppose the main argument against it is that policy is constrained, and the uncertainly around the effects/costs of unconventional policy is higher than ever. So perhaps they need a stronger signal to do more. Hawks could also argue that since the drop was driven by Europe, which is outside the Fed's control, there is not much to be gained by additional easing.

Question: how much of the recent risk rally was driven by QE expectations? Is is possible that the recent sell off was driven by the fact that the minutes did not show a substantial bias towards more QE?

IMO, the upside for earnings growth is very constrained by the wide profit margins. Expectations could certainly go higher, but it's hard to see them in the double digit range without a strong pickup in employment.

IMO, Debt Ceiling debacle may hit markets in August, given that the Treasury runs out of money in early Sept.

3:35 PM  

Re QE3 - well, the question is whether Bernanke & co believe that anything but a truly massive QE3 would work, given the diminishing returns we saw. When I say massive, I don't mean a couple of hundred bns. Given that QE1+2 were about 1.5trn, I'd say that if BB goes for anything but 1trn+ it's not going to do much. Look at UK - BoE now holds about 40% of the gilts. If Fed wanted to reach similar levels, they would have to buy about another 2trn if I remember right.

While that could give a good kick to asset prices, I doubt that this would get past the rabid Republicans who might lynch BB for "printing money". I might play "guess the author" here with "In the United States it is almost inconcievable what rubbish a public man has to utter to-day if he is to keep respectable" (albeit replacing US by Brussels would be more appropriate).

Anonymous said...
4:10 PM  

1) Are we headed for global recession?

You betcha.

2) Have growth & earnings expectations been lowered enough yet?

Not even close.

3) What is going on with the consumer?

A pause in deleveraging. The consumer still has an unsustainable level of debt.

4) When will the inventory cycle turn?

Middle of next year.

5) Have European rates markets moved onto the complex plane?

Yes, but only for the half-life of some of the man-made elements.

6) Is Asian growth about to tank? What about monetary policy? Does it matter?

a. Yes

b. The world has recoupled. The most relevant monetary policies are being set by non-Asian entities.

c. No


7) Has Europe done enough to get through the summer?

Just enough to let all of the bureaucrats and politicians START their vacations - then it will all hit the fan. :)

8) Is QE3 coming and if so, when?

Might get hinted at soon, but I really doubt (barring a crisis) that they do much before the election.

9) Will the Euro-funded carry trade continue or is the Dollar about to get smoked?

The European periphery can not survive a stronger euro. Period.

10) When will the Debt Ceiling debacle kick off again?

Right after the Labor day recess ends. Normally, I would say that the desire to campaign for re-election trumps all other issues, but this is just too big of a political football to ignore.

Anonymous said...
9:12 AM  

Robert Brusca coined a useful term for any new QE from Bernanke:

Marginal futility

Donlast said...
9:52 AM  

1) Are we headed for global recession?

It seems to me that we may already be in one, or that we are about to enter one. However, b/c growth has been slow, and monetary policies are not excessively tight, it is likely that any such recession will be rather shallow. In fact it may not meet textbook definitions, outside of Southern Europe. US this Fall/Winter might be 0 and -0.2%, for example.

2) Have growth & earnings expectations been lowered enough yet?

It depends. The businesses that are exposed to Europe have probably already warned. Some of US retail has been bid up based on a US 3% growth story which is obviously not going to arrive. SPX 1365, trading at about P/E 13 based on $105 probably is not wildly off base.

3) What is going on with the consumer?

Patchy. Someone said pause in deleveraging, pause in spending is also true. US lower income folk are putting stuff on the credit card until things improve. US higher income folk are battening down the hatches ahead of higher taxes. Geographically there are some pockets of healthy recovery, the cost of living in North Dakota is up!

4) When will the inventory cycle turn?

As soon as the fiscal cliff issues resolve? US fiscal and monetary policy very cloudy here, so nobody spending, ordering, hiring or investing.

5) Have European rates markets moved onto the complex plane?

If Lewis Carroll had written about fixed income markets this is what it would look like. Clearly some people's returns will be imaginary, while others have decided to just get long peripheral debt. After all, if it all goes up in flames we will all be out of a job anyway...... IBG, YBG.

6) Is Asian growth about to tank? What about monetary policy? Does it matter?

[Insert requisite joke regarding Japanese machinery orders, which are already "Tankan"]. Chinese fiscal stimulus and domestic consumption more important to Asia than BoJ chess games?

7) Has Europe done enough to get through the summer?

Let's see... "Jacques? bonjour...." Hmm, no answer. "Guten Tag, Fritz..?" Out to lunch.... well, perhaps they have, since they are all about to go away for August. Nobody trading means nobody selling? STFU policy in effect among EU pols? Hope so!

8) Is QE3 coming and if so, when?

In view of the ineptitude of Congressional tossers, and their ability to stall and create a mini crisis, I would say QE3 is already overdue. September at the latest. But recall that BB can flag it ahead of time, in a Jackson Hole type speech, or at H/H testimony and then it will be risk on, Charlie.

9) Will the Euro-funded carry trade continue or is the Dollar about to get smoked?

Both currencies suck for good reasons, so how about a range trade of several months within a 4-5% range (EURUSD 1,21-1,28)? In the event of a global reflationary CB intervention, a resumption of Risk On will see JPY smoked, especially against USD and EUR, not so much against commodity currencies.

10) When will the Debt Ceiling debacle kick off again?

Congress are fully capable of causing a little debacle again but it will be an echo of last time. BB can cut it short with a QE3 announcement at any time. (Maybe this is why he has waited?)

Leftback said...
5:13 PM  

interesting thoughts TMM. It seems like every summer we are pondering the same questions and then every winter trying to chase or wait for a pullback..argggh

Personally I think we are headed for a global slowdown. US growth trajectory has stalled (but will not go down much more since it wasnt that high to begin with) but more importantly EM demand I think has been overestimated. The slowdown in basic materials/infrastucture/industry sector will lead to a slowdown in consumers there (though the rate of growth in EM consumer demand will still be much higher than in the US)

As for QE, even if the fed buys a trillion of treasuries, what is that going to do..sure S&P will rip but for how long? rates are already so low. I think the kicker would be nominal GDP targeting like the squid is talking about or exotic asset purchases like BoJ of ETFs

SPX who knows. Not shorting it yet..if we hold above 1400 for more than a few days I will probably re evaluate. Still invested regardless of the outlook as conviction is not that high

abee crombie said...
8:16 PM  

With negative/zero rates, even a sideways market with no volume or volatility delivers a dividend yield that is ahead of inflation.

So there isn't really much question that you have to be in dividend paying equities (I prefer Europe), preferreds or better quality junk bonds. Yields would have to rise quite sharply from here to change this equation significantly. This is one reason why the US equity market may rise a lot farther than most people think, and farther than perhaps it merits.

As for Qe3, you can make a decent argument that Euro aversion has already provided QE3 by forcing punters into Treasuries, so even a small recovery in confidence in Europe would promote rotation out of USTs and into risk assets.

Leftback said...
9:06 PM  

Very rare buy signal. Only 4 times in the last 15 years...


http://tinyurl.com/rarebuysignal

Anonymous said...
4:08 PM  

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