The Marta Report April 18, 2010
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Comment:
The economic recovery in the US continues to spread and appears to be on a decent trajectory. However, significant headwinds stem from a lack of confidence among small business owners and another round of foreclosures of homes. Furthermore, sovereign financial problems in the EU, UK and even here in the US continue to threaten the real economy.
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Asset commentary:
Equities, vulnerable to a needed sell-off, might have gotten more than they bargained for in the Goldman charge. Interest rates are lower on declining expectations for Fed hiking as well as safe haven buying. In FX, the JPY outperformed on carry trade unwinds, while the major carry trade beneficiaries - AUD, NZD and CAD - underperformed.
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Growth is here!
The US recovery story gained more momentum last week. Business inventories rose more than expected (0.5%, consensus 0.4%; prior figure revised higher from 0.0% to 0.2%), suggesting that businesses were increasingly reacting to ongoing sales rather than just inventory restocking. The disappointing industrial production headline report (0.1%, consensus 0.7%) was misleading, as it was driven by natural gas production, which collapsed 10.1% - indicative of the turnaround in weather after the extremely wintry February. In contrast, manufacturing rose 0.9%. The downcast consumer managed to help out, with retail sales for Mar rising more than expected on top of upwardly revised Feb prints. Geographically, the Beige Book noted growth in all but one of the reporting districts. Finally, housing showed some signs of life, with housing starts and building permits exceeding expectations. All of this good news led the cautious Janet Yellen to opine that the economy appeared to be on the "right track."
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So what ails the Fed?
With the cumulative good news on the economy, markets began circulating a rumor that Bernanke would use his testimony this week to prep the market for a removal of the "extended period" language. However, Bernanke disappointed, sticking to his guns on the extended period language. Bernanke's dovishness is not all about bad news.
Not all bad news - inflation is tame
For all the liquidity that the Feds have dumped into the financial system, inflation remains tame, and so the Fed need not adopt a hawkish stance just yet. Import prices rose less than expected (0.7%, consensus 1.0%) in Mar, and core CPI did not rise at all m/m (unchanged, consensus 0.1%). The unchanged core CPI allowed the y/y rate to fall to 1.1%, tied with the prints of late-'03 and early-'04 for the lowest inflation rate since the mid-1960's. As to inflation expectations, those also remain benign. The U. Mich. 5-yr ahead inflation expectation remains pinned at 2.7%, tied for the 3rd lowest reading in data back to 1998. The 5yr, 5yr forward breakeven stands at 2.65%, near the high since early-Feb, but still well off the Nov high of 2.89%.
But some of the Fed's dovishness does stem from bad news
The small business optimism index, which had managed to stabilize at admittedly very poor levels in late-2009, sank to a new low since Jul'09, and the U. Mich. Confidence survey for Apr unexpectedly dropped to 69.5, a low since Nov'09. Perhaps some of this gloom stems from the ongoing deterioration in balance sheets. And foreclosure filings jumped 16%y/y in Q1 and bank seizures hit a record, with one in 138 households being impacted, according to RealtyTrac. Worse, the company forecasts that the Q1 pace will remain in place for all of 2010, resulting in over 4m foreclosures filings and more than 1m bank seizures. Only in 2011 does RealtyTrac expect foreclosures to level off.
And so the headwinds facing the private economy remain significant, Unfortunately, as we have repeatedly warned, the dangers to the private economy do not stem only from economic headwinds.
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Greece situation devolving - no good solution
Greece, leaders of which stated as recently as weeks ago that they had no need to international financial assistance, have apparently had a change of heart. Greek leaders have now begun communications with Brussels, the IMF and ECB in order to initiate the request process for aid from the EU and IMF. Furthermore, local press was reporting the required aid package could double from EUR45 to EUR90bn. German professors are fighting the package in the courts on the ground that because it involves loans to Greece at roughly 200bp below market rates, it violates the no-bailout-clauses of EU treaties.
We see no "good" solution - just a range of bad ones - to the Greek tragedy. If the bailout does go through, it will sap European countries of capital that could have gone towards productive endeavors. Furthermore, even a "successful" bailout will require draconian budget measures that will weigh on Greek - and Euro Zone growth. Finally, a successful bailout will encourage other countries such as Italy and Portugal to consider reaching for EU support to save them from their profligate ways. In the event the bailout is not successful, either because it is blocked by the German courts or because one or more countries (i.e. Germany) balks at providing the required support, then the Euro Zone will suffer a crisis. This crisis could involve either Greece dropping out of the common currency or perhaps even Germany voluntarily leaving in order to resurrect the Deutschemark or create a new currency union.
The Greek tragedy is important to US market participants because in this globalized financial system, untoward events in Greece are only a couple degrees of separation away from one's own financial interests. Unfortunately, Greece's aren't the only significant problems overseas.
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UK election - no fiscal difference among the candidates
The UK held the first televised debate among PM candidates this week. The leader of the weakest of the three parties (Clegg, Liberal Democrats) apparently won the debate, with the leaders of the two main parties (Brown, Labour; Cameron, Conservatives) tied. The increased uncertainty created by the debate caused market participants to sell the pound sterling. But the uncertainty added little to the real problem, which is that none of the three parties have expressed any vision for putting the UK onto solid fiscal footing. The main likelihood regardless of whomever is elected on May 6 is that some combination of spending cuts and tax hikes will be implemented, and that will be negative for the UK economy and the GBP. Of course, another potential outcome is that the elected government fails to address the budget deficit, allowing the country to drift into a debt crisis. None of the outcomes looks that much different from those for Greece and the EU. As we stated above, American investors cannot ignore developments overseas. However, we need not look that far to see sovereign problems here at home.
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US federal and state fiscal situations continue to deteriorate
The federal government reported a $65.4bn deficit for the month of March. This is less than the $191.6bn deficit the year before because of declining outlays to shore up financial firms. However, it still represents the 18th consecutive monthly deficit and highlights the expected $1.6tn record deficit for this fiscal year. For those believing that the world will continue to absorb any necessary debt the US needs to rack up in order to keep things running, consider this week's TIC report, which showed the Chinese to be net sellers of US assets for the seventh consecutive month in February.
The state level fiscal situation also made news for the wrong reasons during the week. The National Conference of State Legislatures issued a report noting that the states have a budget collective budget gap of $89bn they need to close before fiscal year 2011 begins on Jul1. Additionally, the report forecasts gaps of $73.5bn for FY2012 and $64.7bn in FY 2013. Combined, the states will have had to overcome budget gaps of $531bn from the beginning of the Great Recession to FY2013.
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Equities: Sell-off - more than just flushing weak longs
Last week, the S&P500 was headed for yet another new high since Sep'08 when news that the SEC charged Goldman Sachs with fraud over a CDO the company issued took the market sharply lower. The market has been due for a healthy pullback - if only to cleanse it of weak longs and speculative froth. However, the charge against Goldman is another beast entirely. A number of moving parts might be involved with the SEC's charge against Goldman. The charge could represent merely a bargaining chip in financial reform legislation, with the government communicating to Goldman to back off some of its lobbying. The charge could represent an attempt by the SEC to retrieve its lagging reputation after having missed the Madoff scheme. It likely also reflects an actual problem - that as monstrous as it might seem, Goldman Sachs, and perhaps its peers, actually conspired to fraudulently induce a bubble and then to benefit when the bubble inevitably popped. The perception of such opaque, Machiavellian, downright evil intentions on the part of major financial actors with access to information most others in the market lacked will provide the banking system and American "jungle capitalism" with yet another black eye, and it could even bring an even sharper regulatory backlash by government bureaucracies that slow down business growth.
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