Macro commentary

1. MACRO
COMMENTARY
Stalos Capital
For independent investors
2011, n°34
July 1
This week….
 A second Greek bailout on the way
 Portugal, a second time bomb for the Euro
area
 Consumer confidence index fell in UK, USA
and Euro area
 Insolent German economy
 UK on the road to stagflation
 US ISM manufacturing rebounds in June
 Chinese growth continue slowing
Macroeconomic analysis
 United States
 Euro Area
 Other countries

2. United States Tax payers have financed the crisis leaving 2007. The report parallels other data on
corporate full of cash that they invest mas- consumer sentiment. The Thomson Reu-
sively in the emerging countries. In clear, ters/University of Michigan preliminary in-
the tax payers financed the development of dex of consumer sentiment fell to 71.8 in
national companies overseas without any June from 74.3 in May. The Bloomberg Con-
single compensation. The current system for sumer Comfort Index declined to minus 44.9
taxing foreign sources of income of U.S. for the week ended June 19 from minus
corporations makes no sense. In theory, 44.0 the prior week.
income earned by foreign subsidiaries con-
Home prices fell in the year ended in April
trolled by American companies is taxed at
by 4% to the S&P/Case-Shiller index, the
the U.S. corporate rate of 35%. However in
most in 17 months. From March to April,
practice, the Treasury receives no taxes on
values fell 0.1% on a seasonally adjusted
that income as long as it is held overseas.
basis, the smallest decline since July 2010.
US corporations have overseas cash hold-
The number of contracts to buy previously
ings of almost $2 trillion, which they are
owned homes rose 8.2%, almost three
encouraged to deploy by acquiring compa-
times as much as forecast as falling prices
nies and building facilities outside the U.S.
made properties more affordable. While the
The Congress has the project to change the
measure of contract signings has been vola-
current law to a corporate tax ranging from
tile this year. Foreclosures, unemployment
between 20% or 25% if the company repat-
at 9.1% and stringent loan terms are holding
riate or not the incomes made abroad to
back demand even as a decline in home
US.
prices attract some buyers. Mainly, the May
Nothing has been done yet and a lot of is- gain only looks good because the prior
sues have to be solved. However, such month was bad (-11%).
change could damage quite seriously the
The International Monetary Fund warned
final result for companies.
US government about a possible severe
Consumer confidence dropped to a seven- shock if the U.S. Congress fails to approve
month low in June as Americans grew con- an increase in the $14.3 trillion debt ceiling
cerned about the outlook for jobs and wag- and cautioned about the risk of a down-
es. grade in the country’s credit rating. The
market seems to have forgotten, but the
The Conference Board’s sentiment index
issue still exist.
decreased to 58.5 from a revised 61.7 in
May. It was higher than previously estimat- The report said a failure to reach a budget
ed. Unemployment hovering around 9%, and debt compromise could result in a sud-
deterioration in the housing market and a den increase in interest rates and/or a sov-
drop in share prices may restrain Americans’ ereign downgrade.
sentiment, raising the risk that the biggest
The IMF also warned of problems in the U.S.
part of the economy will stagnate.
housing market. Banks have resisted efforts
The index averaged 98 during the last eco- to force principal write downs and succeed-
nomic expansion that ended in December ed in defeating such legislative efforts.
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3. Consumer spending, which accounts for
about 70% of the economy, fell 0.1%i n April
and May after adjusting for changes in pric-
es. It was the first back-to-back decline since
March and April 2009, when the economy
was still in a recession.
It means that annualised real consumption
probably grew by less than 1% in the second
quarter as a whole, compared with 2.2% in
the first. It is not hard to see why consumers
have closed their wallets. Nominal incomes
rose by just 0.3% m/m in May and real in-
comes were up by 0.1% m/m. Real incomes
have been almost unchanged for the last
four months.
The modest rebound in the ISM manufac-
turing index in June, to 55.3 from 53.5 in
May, will ease fears that the US is heading
towards a double dip recession. More gen-
erally, the clear slowdown in activity in re-
cent months highlights that, even though it
began two years ago this month, the eco-
nomic recovery it is still very fragile and vul-
nerable. The rise in the headline index in
June reversed only a small part of May's fall
from 60.4. The rebound was widespread,
with the new orders (51.6 vs. 51.0), produc-
tion (54.5 vs. 54.0) and employment (59.9
vs. 58.2) indices all rising. Overall, though,
the ISM index still paints a picture of an
economy struggling to grow at anything
more than lacklustre rates.
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4. Euro area Irish Life & Permanent, the third biggest fault. The private sector is taking the risk on
lender in the country succumbed to state its back.
control after the government provided €3.4
The fact that the Greek parliament has
billion . Finance Minister Michael Noonan
passed the Government’s medium-term
said in March he expected the Government
fiscal plan clearly reduces the chances of a
would take control of the lender after the
near-term disaster. Greece should now re-
Central Bank ordered it to raise €4 billion
ceive its next bail-out tranche, worth €12
after a third round of stress tests.
billion, in early July, covering its financing
The lender has a market value of about
needs until at least mid August and averting
€16.3m, from a peak of more than €6bn in
an imminent default. But there are major
February 2007.
challenges still ahead. The next is to reach
France offered a radical solution for banks an agreement on a second bail-out package,
to roll over some Greek debt for 30 years the crux of which will be the plans for some
as the Greek government fought for political form of debt rollover. The French plan has
support of its five-year austerity plan to some supports, but we are far away from an
avert bankruptcy. Moody's said Greek agreement.
banks had lost about 8% of private sector
Under the terms of the new austerity plan,
deposits so far this year as customers
Papandreou has pledged to find buyers for
burned their savings due to unemployment,
state assets worth 50 billion euros and im-
transferred funds abroad or bought gold.
pose levies ranging from 1% to 5% on wag-
French banks will stretch out the loans over es. He also plans higher taxes on restaurants
30 years, putting (interest rates) at the level and bars, higher heating-oil taxes and low-
of European loans, plus a premium indexed ering the tax-free threshold to 8,000 euros
to future Greek growth. from 12,000 euros presently.
French government sources said under an Papandreou has already struggled to imple-
outline deal, banks would reinvest 70% of ment a first bailout agreed in April last year
the proceeds when Greek bonds fall due in as tax revenue persistently fell short of tar-
2011-14 and cash out the rest. Of the gets. I do not believe that the second plan
amount reinvested, 50% would go into the will meet any success.
new 30-year bonds and 20% would go into
Germany’s biggest banks and insurers and
zero-coupon AAA bonds with deferred inter-
the government agreed on a draft proposal
est. The new bonds would be placed in a
to roll over Greek debt, according to uni-
Special Purpose Vehicle, effectively remov-
dentified sources. The firms will commit to
ing Greek debt from the balance sheets of
providing financing for a Greek aid package.
participating banks. Banks would hold equi-
The German proposal may not address po-
ty in the SPV instead. Private banking
tential sticking points such as the maturity
sources said the new bonds could be guar-
of the new Greek bonds, whether investors
anteed by the euro zone's rescue fund
would face write-downs on their current
(EFSF) or the European Investment Bank.
holdings, and how rating companies would
The operation would be considered as de- view a rollover. So at this stage, things are
fault by the financial market and it is a de- still unclear.
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5. European confidence in the economic out- pretty much a done deal. It is likely to be the
look dropped to 105.1 from 105.5, the low- last one of the year.
est in eight months in June as policy makers
Unemployment figures provided more evi-
struggled to craft a second bailout package
dence that the labour market is starting to
for Greece.
respond to signs of a slowdown in the
The euro-area recovery will falter after ex- broader economy. The number of unem-
panding at the fastest pace in almost a year ployed rose for the first time in four
in the first quarter as governments toughen months, by 16,000. Admittedly, this did little
budget cuts to keep Greece’s fiscal crisis to reverse the much sharper declines of the
from spreading. The recent economic head- previous three months and the unemploy-
winds and the escalation of the Greek crisis ment rate was unchanged as expected at a
are clearly weighing on the mood of busi- near two-year low of 9.9%. Survey measures
nesses and consumers. of hiring intentions have already begun to
ease back as signs of a broader economic
A gauge of sentiment among European
slowdown have mounted. Likely, any slow-
manufacturers dropped to 3.2 from 3.8 in
down in private sector employment will be
the previous month. An indicator of services
exacerbated by hefty public sector job cuts.
confidence rose to 9.9 from 9.3, while a
measure of consumer confidence increased At the opposite, German unemployment
to minus 9.8 from minus 9.9. Sentiment declined for a 24th straight month in June to
among builders also improved in June. 7%, underscoring the resilience of Europe’s
largest economy amid the euro region’s
An indicator of German manufacturing con-
debt crisis.
fidence slipped to 11.8 in June from 13.3 in
the previous month,. A gauge of euro-area The number of people out of work fell a
manufacturers’ order books rose to minus seasonally adjusted 8,000 to 2.97 million,.
1.6 from minus 2.7 and an indicator of pro-
The German labour market has been im-
duction expectations slipped to 11.6 from
proving rapidly since the middle of 2009.
12.9. A gauge of employment expectations
With European governments from Spain to
declined from May and companies were
Ireland cutting spending, German compa-
also more pessimistic about their export
nies have relied on faster-growing econo-
order books.
mies to boost sales due to external demand.
Consumer price figures are unlikely to However with global trade slowing and do-
prompt the ECB to soften its hawkish tone. mestic demand still weak, this trend is un-
CPI was unchanged at 2.7% in May, a touch sustainable.
below the consensus forecast of a rise to
According to comparable data from the Or-
2.8%, but well above the ECB’s target of
ganization for Economic Cooperation and
2%. It looks likely that a small fall in energy
Development, Germany’s jobless rate was
inflation was offset by a rise in the food
6.1% in April while the euro-region average
component. With President Trichet recently
was 9.9%. France had 9.4% unemployment,
confirming that the Bank remains in strong
the U.S. 9% and Spain 20.7%.
vigilance mode another rate hike in July is
5 - Stalos Capital 2011

6. At the opposite of Germany, French econo- €30bn, 40% of which is guaranteed by the
my did not show any strengths. France ex- Government, representing about 8% of
panded less than previously estimated in GDP. But as they are unable to access mar-
the first quarter as rising energy prices ket financing, some SOEs are being entirely
squeezed household spending. GDP rose financed by the Government. Accordingly,
0.9% from the fourth quarter instead of a the Government may have to borrow to
previously estimated 1%. Consumer spend- fund losses made by the SOEs.
ing rose 1% in the first quarter instead a
In addition, about €30 billion has been in-
previously estimated 1.3%.
vested in Public Private Partnerships (PPPs),
The Portuguese government’s latest efforts creating increasing expenditure pressures
to implement extra fiscal measures to en- until 2016, the cost of which may not have
sure it meets its budget deficit target are been accounted for fully. Accordingly, the
encouraging. But even if the Government IMF’s assessment of the Government’s ex-
manages to push through the huge fiscal posure to both SOEs and PPPs in August
squeeze planned this year, there are hidden may reveal that Portugal’s fiscal position is
hurdles to Portugal’s fiscal progress. worse than expected. According to the EU/
IMF, if these risks were to materialise, pub-
This week, the Government delivered its
lic debt could potentially rise from its cur-
fiscal plan to parliament. While the general
rent level of about 90% to 125% of GDP in
government budget deficit narrowed in Q1
2013.
compared to the same stage last year, at
8.7% of GDP, the deficit still needs to be What’s more, the combination of high pri-
reduced by a further 3% of GDP to meet this vate sector debt and the need for bank
year’s target. The new fiscal measures still deleveraging could become a toxic mix. Por-
need to be fully detailed, but the focus is on tuguese banks have the highest loan-to-
quick implementation, with measures, such deposit ratio in the euro-zone, making them
as a one-off income tax collection or a VAT vulnerable to deposit outflows. And while
hike, to be pushed through as early as next there is a €12bn recapitalisation facility for
month. Encouragingly, the majority govern- the banks, credit conditions for the corpo-
ment should have no problems passing the- rate sector appear to be tightening sharply.
se measures.
But the government may face a challenge to
persuade the markets that its fiscal house is
in order before it has to return to the mar-
kets in 2013. The likely failure to narrow the
deficit so sharply, partly as a result of over-
optimistic growth forecasts, and contagion
effects from Greece suggest that Portugal
may still follow Greece in needing a second
bail-out or some sort of debt roll-over
State owned enterprises’ (SOEs) financial
position is fragile, with debt of around
6 - Stalos Capital 2011

7. Other countries IMF: Christine Lagarde, 55, was chosen by consumer credit in May was a bit weaker
the IMF’s 24-member executive board as than in the past few months. And the over-
new Managing Director and will start on July all money supply also edged up only margin-
5. She was picked over Agustin Carstens, the ally in May.
head of Mexico’s central bank, and will re-
Consumer sentiment fell more than econo-
place Dominique Strauss-Kahn, who re-
mists forecast in June to minus 25 from mi-
signed after his arrest last month on charges
nus 21 the previous month. All five
including attempted rape.
measures of the index declined, with confi-
Clearly the designation has been driven dence in the economic outlook for the next
more by political factors than competency year dropping 3 points to minus 18. Britons’
factors. Agustin Carstens had more experi- confidence in the recovery is faltering as
ence and knew better the institution and inflation squeezes incomes at the fastest
the current problems than Christine pace since the 1970s. Public-sector workers
Lagarde. With the major challenges ahead stroke to protest against government job
and the brilliant legacy of Dominique cuts and curbs on pensions. The economy
Strauss-Kahn, the job will not be easy. stagnated in the six months through March.
Strauss-Kahn, also a former French finance The overall PMI reading of 51.3 was below
minister, made the IMF a central player in expectations of 52.3 and the weakest since
Europe’s response to the crisis. He com- September 2009. The index has now lost a
mitted the fund to pledge a third of the whopping ten points in the last four
money for European bailouts, helped craft months.
Europe’s rescue mechanism and briefed
South Korea: inflation will exceed President
sceptical German lawmakers.
Lee Myung Bak target this year and growth
Before that, Lagarde was appointed finance will be slower than previously forecast after
minister in June 2007, she had no economic global demand weakened and energy costs
role experience. After four years in charge climbed according to Finance Ministry fore-
of the French economy it is still difficult to casts.
relate her views to any economic school.
Consumer prices are expected to rise 4%
Before she was the first female chairman of
exceeding the 3% projection. Growth esti-
Chicago-based Baker & McKenzie LLP, the
mates decreased to 4.5% from 5%.
world’s fifth biggest law firm by revenue last
year. President Lee declared war on inflation in
January, and the government imposed price
UK: data has been generally pretty medio-
controls and tolerated currency apprecia-
cre. The worst news is the 1.2% monthly
tion as part of the campaign, as the rising
drop in services output in April. Turning to
cost of living contributed to growing public
the housing market, the rise in the number
discontent. Lee’s approval rating fell to
of mortgage approvals from 45,200 to
28.8% in a poll this month, compared with
45,900 in May was a bit smaller than ex-
76% when he came to power in February
pected, and left the level of housing market
2008, according to Seoul-based Realmeter.
activity still pretty much flat over the past
18 months. Meanwhile, the £0.2 billion of
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8. China: two manufacturing PMIs added to
the weight of evidence that the economy
has continued to slow. But with price pres-
sures also weakening, policymakers should
soon feel comfortable loosening credit re-
strictions to shore up growth.
Most had expected both the official and
HSBC/Markit manufacturing PMIs to fall
further in June. But the monthly declines
were the largest in several months, fuelling
concerns about the strength of the econo-
my. The HSBC/Market index declined from
51.6 to 50.1, while the official figure de-
clined from 52.0 to 50.9 . A reading below
50 signals a contraction.
8 - Stalos Capital 2011