Headlines feb 2010


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Headlines feb 2010

  1. 1. Headlines: Risks & Opportunities
  2. 2. Risks: SystematicStandard & Poors Ratings Services no longer classifies the United Kingdom (AAA/Negative/A-1+)among the most stable and low-risk banking systems globally due to our view of the countrys weakeconomic environment, the reputational damage we believe has been experienced by the banking industry,and what we see as the high dependence on state-support programs of a significant proportion of theindustry.Standard & Poors Banking Industry Country Risk Assessment: United Kingdom. January 28,2010US Housing OutlookCrumbling Gatsby-esque estates are a reminder of a former age ofNorth American excess. In the future, McMansions will probably serve thesame purpose. Wednesday’s weak housing starts data for November are areminder that, while the market had appeared to stabilise of late, there aregood reasons to think a fall in house prices may resume.Financial Times, Lex Column: January 20, 2010In response to President ObamasState of the Union Address 2010Something tells us that this goal ofdoubling exports in a five-year span isgoing to include a further depreciationof the U.S. dollar as that will basicallyallow U.S. producers to de facto cuttheir prices in the global marketplaceand as a result lift their market share.After all, doubling exports over fiveyears basically implies that they willgrow at more than triple the pace of global economic growth. So toreiterate, for this plan to work, sales abroad are going to need theextra boost to domestic competitiveness, as “artificial” as that liftmay be, from an ever-weakening U.S. dollar. All of a sudden, we feelmuch better, current corrective phase notwithstanding, in our long-standing bullish call on commodities in general, and in preciousmetals in particular. Breakfast with Dave, David Rosenberg, Gluskin Sheff: January 28, 2010The one thing we know about the Fed’s forecasting abilities during this particular cycle is that it has beensimply awful. Like Houdini, the Fed expects the economy to recover similar to pulling a rabbit out of thehat — a recovery where “bank lending continues to contract”, consumer spending “remains constrained”and “employers remain reluctant to add to payrolls.” Please do not forward
  3. 3. So, we have a forecast of an economic recovery without credit, housing, the consumer and employment.There’s never been a recovery that was perpetuated by inventories and capital spending. This is why it’scalled the Houdini recovery. It’s magic. Breakfast with Dave, David Rosenberg, Gluskin Sheff: January 28, 2010Consumer sentiment, in recessions, averages out to be 73.9. That puts the current 72.8 into context. Inexpansions, confidence averages 91.0; and when the economy is making the critical transition towards thenext cycle, at that inflection point, what is “normal” is that consumer sentiment is sitting at 78.0. So, asMr. Market declares that the recession is over, the respondents to these surveys are basically saying, “notso fast”. Brunch with Dave, David Rosenberg, Gluskin Sheff: January 15, 2010So here is what is happening on the U.S. political front. No more than two days after the Democrat defeatin Massachusetts, the President begins a full-scale assault on the banking sector. On the one hand, thepolicymakers want the banks to start lending money; and on the other hand, they want the banks to de-risk their activities. The banks obviously didn’t help their cause with a lack of contrition and bysanctioning a bonus boom during these difficult times after having been saved by the taxpayer’spocketbook, but the Obama attacks on the banks are very likely going to do more harm for the economythan good … but then again, this is an Administration that never did have an economic vision andhas so far decided to fight the prolonged period of post-bubble economic malaise with a string of short-term quick fixes with no multiplier impact on job creation and no long-run productivity benefits. Breakfast with Dave, David Rosenberg, Gluskin Sheff: January 25, 2010US Economic Digest: US Outlook 2010 in Pictureson Financial MarketsThe highly positively correlated financial environment seems already to be breaking down.If this continues, as we expect, it holds out the promise of more effective diversificationand risk management. Still, many financial sector business models, especially indeveloped economies, will be severely challenged by modest return opportunities. Neal Soss, Credit Suisse Economics Research: January 4, 2010US Economic Digest: US Outlook 2010 in Pictureson GovernmentState and local fiscal problems are intensifying, with potentially another $300 billionshortfall in fiscal years 2011 and 2012 combined. Net of the $40bn of fiscal stimulus funds,this would imply $260 billion of corrective measures needed to balance budgets. Themyriad school districts and other local government units only add to this severe problem. Neal Soss, Credit Suisse Economics Research: January 4, 2010 Please do not forward
  4. 4. US Economic Digest: US Outlook 2010 in Pictureson the Labor MarketThe drop in employment was disproportionate to the drop in output by post-WWIIcyclical standards. That does not assure that a disproportionate rebound in jobs isimminent. "Just-in-time inventory" on the real side of the economy was echoed by "Justin-time liquidity" in the financial sector. The enduring effect of the Great Recession maybe "Just-in-time headcount" (since this is a big claim on business working capital andliquidity.) Even though we expect a cyclical recovery in the labor market, it could beagonizingly slow given the frictions associated with large-scale permanent job loss. Neal Soss, Credit Suisse Economics Research: January 4, 2010Why we should expect low growth amid debtAs government debt levels explode in the aftermath of the financial crisis, there is growing uncertaintyabout how quickly to exit from today’s extraordinary fiscal stimulus. Our research on the long history offinancial crises suggests that choices are not easy, no matter how much one wants to believe the presentillusion of normalcy in markets. Unless this time is different – which so far has not been the case –yesterday’s financial crisis could easily morph into tomorrow’s government debt crisis.Another big unknown is the future path of world real interest rates, which have been trendingdownwards for many years. The lower these rates are, the higher the debt levels countries can sustainwithout facing market discipline. One common mistake is for governments to “play the yield curve” – asdebts soar, shifting to cheaper short-term debt to economise on interest costs. Unfortunately, agovernment with massive short-term debts to roll over is ill-positioned to adjust if rates spike or marketconfidence fades.Markets are already adjusting to the financial regulation that must follow in the wake of unprecedentedtaxpayer largesse. Soon they will also wake up to the fiscal tsunami that is following. Governments whohave convinced themselves that they have done things so much better than their predecessors had betterwake up first. This time is not different. Carmen Reinhart and Kenneth Rogoff, Financial Times: January 27, 2010Debt and Deleveraging: The global creditbubble and its economic consequencesSeveral features of the crisis today, including its global nature and the large projected increases ingovernment debt, could delay the start of the deleveraging and result in a longer period of debt reductionthan in the past. In past episodes, a significant increase in net exports often helped support GDP growthduring deleveraging. But it is unlikely today that the most highly leveraged major economies could allsimultaneously increase their net exports. Moreover, current projections of government debt in somecountries, such as the United Kingdom, the United States, and Spain, may offset reductions in debt byhouseholds and commercial real estate sectors. We therefore see a risk that the mature economies may Please do not forward
  5. 5. remain highly leveraged for a prolonged period, which would create a fragile and potentially unstableeconomic outlook over the next five to ten years. They may then go through many years in which, all elsebeing equal, GDP growth is slower than it would have been otherwise as debt is period down. McKinsey Global Institute: January 2010 SummitVIEW:Patient: Doctor, it hurts when I do this.Doctor: Well, dont do that anymore.The above Muppet-like dialogue metaphorically summarizes my vision of conversationsbetween constituents and elected officials. The mantra underlying US Congress initiatives is:first, take the easy path; second, take the easy path. Fiscal constraint is, obviously, notsomething elected officials are going to pursue with any vigor. As President Obamas State ofthe Union speech last week made clear to me, the hope for substantive approaches to solve theUnited States fiscal and economic woes remains limited. Voters will have their say on howelected officials are performing come November 2010.Although the results of taking an alternative path are unknown, I do believe propping up thefinancial system was necessary to avoid disastrous economic effects: substantially higherunemployment, even greater government involvement in the economy. How theadministration went about propping up the system will be analyzed for years to come.Unwinding mounds of debt will take many years. Without economic stimulus that generatesboth job growth and sustains high worker productivity the current economic malaise willcontinue for years to come. The recent 4Q09 GDP number (5.7% growth) points to economicexpansion. Expectations are the number will be revised downward, and the rate of growth isunsustainable. Based on the current steps taken to prop up the economy (negative real federalfund rate, quantitative easing to keep rates low), SummitView concurs with expectations ofminimal growth for years to come.Many are wont to continue to believe in the former regime when in fact the country is in a newregime. The current regime, I expect will be viewed as the beginning of the end of the USconsumer-driven economy. Please do not forward
  6. 6. Opportunities: New Normal InvestmentsFundamentals Still Positive for Brazil EquitiesInternational Strategy & Investment, January 27, 2010Brazil on Track for Strong RecoveryIncreases in commodity prices, ISIs Brazil economic diffusion index, and the brazil manufacturing PMIall help to validate the forecast from our regression model. And spending related to both the 2014 WorldCup and 2016 Olympics will also help propel growth. International Strategy & Investment, January 27, 2010Pensions Pour into Emerging Market DebtUS pension funds are poised to pour almost $100bn (£62bn, 70bn) into emerging market debt in thenext five years, according to JPMorgan. The impending buying spree will be augmented by strong flowsfrom central banks desperate to diversify out of the dollar, industry figures believe, bolstering theongoing rally in emerging market bonds and potentially pushing yields relative to US Treasuries to arecord low. "We expect a long-term structural bid [from US pension funds] for emerging market debt,”said Will Oswald, global head of emerging market quantitative strategy at JPMorgan. Steve Johnson, Financial Times, January 24, 2010Emerging Markets WatchPIMCO believes the crisis of 2008-2009 will have a widespread and long-lasting impact on globaleconomic growth, government policy and the interplay between developed and developing economies.This New Normal implies lower growth, greater regulation, and higher savings rates in the developedworld, as well as relatively higher growth and a more prominent role in influencing global economicpolicy for the developing world. Michael Gomez, PIMCO, December 2009Brazilian Bonds? Get Real!Brazil may well be the most attractive on the planet on a risk-return basis. Here are seven reasons why:• It is just about the only investment grade country where inflation is slowing, the central bank has beeneasing, and where you can pick up a yield of over 12% for 10-year paper.• Its most recent change was a credit upgrade last September (Moody’s) and overall the rating agenciesare generally favourable over the outlook.• The inflation rate is 4%, slowing down and at the low end of the range of the past decade.• The current account is in very small deficit, at just over 1% of GDP. Please do not forward
  7. 7. • The debt ratios are very well contained – 12 % gross external debt and 43% government debt as a shareto GDP (the US comparables are 95% and 62% respectively).• The real is on an appreciating track (+27% in the past year) and that is because Brazil’s terms-of-trade(export price to import price ratio) is flirting near a 12-year high.• Given that real short-term rates are around 4.5% and the consensus view is 5% real growth this year,there would be little reason to be bearish on the currency outside of a currency setback (and FX reserves at$240 billion are up 15% in the past year and 30% in the past two years.The biggest risk is if there is a global relapse that drags Asia into the vortex andimpair the commodity complex as this would undoubtedly reverse the impressivegains made in the currency -- after all, it’s not coffee that is Brazil’s primary exportbut iron ore; and it is not the USA but China that is the country’s largest customer. Breakfast with Dave, David Rosenberg, Gluskin Sheff: January 20, 2010Emerging Markets WatchRecently, Brazils BBB- rated US dollar debt traded in the secondary market at a significantly tighterlevel than single A rated "Build American Bonds" issued on the same day with similar maturity (138basis points versus 230 basis points over the 30-year US Treasury bond). However, valuations onBrazilian real-denominated local debt, offering nominal yields close to 13% for seven-year maturities,compare favorably with those of US high yield credits. Michael Gomez, PIMCO, December 2009Oh, Canada!My overall views continue to evolve but what has not changed are my opinions regarding the secular bullmarket in raw materials (hard assets) and income. At least now we are getting a better buyingopportunity with the recent giveback in most commodity prices, and by extension, the Canadian dollar. Istill emphasize that what investors get in Canada that they do not get in many other areas,specifically the United Sates, is exposure to the resource sector, and despite China’s recent restraintmeasures, and undoubtedly more will be coming, the country is unlikely to relapse back into a downturnany time soon from what I can see. Breakfast with Dave, David Rosenberg, Gluskin Sheff: January 26, 2010Investment Outlook: The Ring of FireInitial conditions are important because the ability of a country to respond to a financial crisis is relatedto the size of its existing debt burden and because it points to future financing potential. Is it any wonderthat in this New Normal, China, India, Brazil and other developing economies have fared far better thanG-7 stalwarts? PIMCOs New Normal distinguishes between emerging and developed economic growth,forecasting a much better future for the former as opposed to the latter. Bill Gross, PIMCO: February 2010 Please do not forward
  8. 8. SummitVIEW:The first quote in the Risks section of Headlines is Standard & Poors statement regarding thedowngrading of the United Kingdoms banking system. Is the United States next?After years of sitting idly and waiting to take action, the ratings agency companies are showingsigns of pro-activity versus prior periods of reactivity. SummitViews appeal to US investors isto take to heart the change in modus operandi of the ratings agencies, become proactive inmanaging systematic risk. Systematic risk, by definition, is the risk that cannot be diversifiedaway when allocating assets, for each financial system (market) has risk. As the marketsshowed in 2008 and 2009 risks correlate when prices reflect downside investor expectations,otherwise known as a downside risk framework.SummitViews belief is that an investor never could expect a single asset allocation paradigm towithstand seismic, systematic financial shocks. One has to create an asset allocation to reflectones inherent risk aversion. The asset allocation should weigh systematic risk across all viablefinancial markets which fall within the investors risk profile. The investor should be preparedto adjust the allocations based on the systematic risks developing in markets in which capital isallocated.Risk and reward. What are the risks and what are the rewards for a particular investment or aparticular asset allocation? As the above quotes in the Opportunities section highlight,investors should consider markets outside the United States to achieve the returns that arecommensurate with their risk profile. One needs to be proactive in protecting wealth and inachieving suitable rates of return. Old regime thinking likely will prove insufficient indeveloping effective systematic (and therefore portfolio) risk measurement and commensuratereturn opportunities. Please do not forward