SATISFACTION GUARANTEED OR YOUR MONEY BACK
After spelling out our macro non-thoughts for the past few posts it's about time we pulled our focus back from the horizon to the pot-holes right in front of us.As we mentioned on our first set of "Nons", this time of year is full of trading peculiarities, as themes and trades for the year are discussed and executed, alongside the micro news-following tunings. As a result, we usually end up with a "wrong way first" move turning around the start of the third week. With the US on holiday for Martin Luther King day next Monday, TMM think this is lining itself up as a suitable turn date to target. We have always had a background belief that US holidays make good general turn dates.But if we are looking for turns against consensus we need to have a think about what that consensus is. And that isn't so easy.Europe - As far as we can make out the trade coming out of December was to position for another major attack on Europe kicking off in January. Thus far the news flow and focus has indeed been on the restructuring of the Portuguese and Spanish debt, with their financing calendars being used as the road atlas. But if we think about the chatter/effect ratios in the short term markets then today they appear to be getting stretched again. Nearly all commentary is focused on the doom-mongering side of things with any positive news being studiously avoided. The Greeks, for example, appear to have achieved the impossible in cutting 2010 deficit by more than planned. It's down 36.5% vs 2009 against a planned reduction of 33.2%. Perhaps the bounce against Europe consensus happens immediately after the Portuguese, Italian and Spanish auctions at the end of this week, i.e. slightly before our general 17th turn date?In equities we think we are detecting the biggest double bluff to have occurred in the markets for some time. It appears to us that the majority is convinced that the market is far too bullish, with all the analysts calling for higher levels. Having learned to do the opposite of what equity analysts say during times of strife, the majority of discretionary investors have in fact stayed out and are looking for a pull back. So we think the consensus is in fact for a move lower exactly because they think that everyone else is looking for a move higher. TMM think the path of pain and risk for next week's turn date is for a rally to really take off.In commodities we are noticing that flows are really picking up in "recovery" trades and have been weak in Gold. While TMM are not quite calling for the clavadista d'oro, the fact that this is going on quite consistently, with almost no coverage, is leading us to think that the consensus here has gotten quite lazy. If indeed European deflation works along the lines of Greece and we get the Spain solution sooner rather than later, the hyperinflation trade is going to look really, really ridiculous. US real rates are keeping it supported for now but many of the "braindead" drivers of the metal are looking quite a bit weaker.The "Asia to continue to outperform the West" theme is also still high on the favourite trades lists. We have mentioned Indonesia before, specifically as a barometer of the general Asia leverage trade and potential first sufferer re EM bonds. So to suddenly see inflation concerns causing a rout with their stock market down 8% since Thursday was interesting, to put it mildly. Our Asian alarm bells are ringing in general. This won't be any help to the Aus, which is really beginning to look weak. Its double props of commodity exports (hit via the floods) and a ramping Asia now look more wobbly.Tomorrow we will turn back to horizon gazing and, despite our conviction that trying to call FX 1 yr out is a mug's game, we will post the last of our 2011 Non-Predictions: FX. For now we await Alcoa's results, as the earnings season opens up. Considering last Friday's headline that they are reopening US smelters, we think they should be positive enough to refocus the markets away from all the negatives they are currently fascinated by.
We need a breather from the gravity of our market non-predictions and were having a think about everything else that may not happen in 2011. Apart from the blindingly obvious along the lines of: not winning the lottery, not being able to retire to a yacht or not expecting the BBC's Robert Peston to be anything but a complete *^%£, we came up with the following.
11) The UK's Alternative Vote referendum will NOT pass, but the coalition will NOT break-up before the end of 2011.
One of the cornerstones of the UK's coalition agreement was to have a referendum on changing the UK's voting system to the Alternative Vote (AV). But with the vote coming shortly after the Royal Wedding - which will dominate the media in the weeks coming up to the vote - it is likely that arguments both for and against the system will be drowned out. Given the Lib Dems are currently polling their worst vote shares since the 1980s, the AV vote is likely to be seen by those who care about politics as a referendum on the Lib Dems, and to those with little interest, the likelihood is to vote for the status quo. Thus, TMM reckon it is very unlikely that AV passes. As far as the coalition goes, it has worked remarkably well to date, and both partners need each other, regardless of how the AV vote goes: the Lib Dems need to stay in the coalition to avoid electoral annihilation (given their current poll ratings) and to stand a chance of sharing in the credibility should the fiscal programme be a success, and the Tories need the Lib Dems to share the blame for the inevitable backlash against austerity.
12) Ed Miliband will NOT be leader of the UK Labour Party by end-2011.
Red Ed has thoroughly disappointed since taking over the reins of the Labour Party, moving to the left and already having a public spat with his shadow chancellor regarding the 50% tax. The latest in a long run of screw ups was yesterday's BBC Radio 2 call-in, with callers criticising him. TMM's sources in Westminster reckon if things don't improve by mid-year that the Parliamentary Labour Party will turf him out.
13) Belgium will NOT break-up by end-2011.
Much focus in recent months has been upon the Belgian political situation where an inability to form a government for a long time is colliding with weak fiscal fundamentals. However, TMM note that Belgium has coped with this situation for a long time and that Sir Humphrey would argue that government is best left to the civil service and radio/TV appearances to the politicians. As a result, Belgian government will continue to be led by experts rather than squabbling politicians. As far as agreeing to break up goes, given the diversity of opinion within Belgium, it seems unlikely that consensus will be reached within the year to split, but TMM's mates in Brussels reckon it is inevitable on a 2-3yr time-scale.
14) Darth Weber will NOT replace Baron Von Trichet as the new ECB President.
The leading contender for the job of ECB President has been Darth Weber for the past couple of years, but given his inability to "play ball" and work to the "common good" of saving the Euro, TMM find it hard to believe that the Eurostriches would be happy with his appointment. Although the Germans are trying to talk tough, it seems unlikely that the French or Club Med would accept the commander of the Bundeathstar running the economy. TMM's guess is that a "non-candidate" from Belgium or Luxembourg or wherever gets the job, much like the recent appointment of Baroness Ashton (who?) as EU Foreign Minister.
And finally...
15) At least 1 member of TMM will NOT have the same employer by year end.
TMM feel that there is about to be another round of musical chairs in the world of finance with quite a few more being removed.
16) The UK 2011 X-Factor winner will NOT make UK No. 1 for Christmas.
We feel that the X-Factor phenomenon saw a blow off spike in popularity last year and cannot believe that even the gullible UK public can fall for the same old con any longer. We would also like to make Ben Elton's book "Chart Throb" compulsory reading for anyone wanting to view the show.
17) Australia's Cricket team is NOT.
Today TMM move on to their Rates Non-Predictions...8) The Bank of England will NOT continue to ignore upside inflation surprises.
Readers will remember TMM is running a crusade against the Bank of England's Mervynflation policy, but there are a few signs that things maybe about to change at Threadneedle Street. Recently, the hawkish group on the MPC has been gaining traction with consistent upside surprises to inflation that are becoming a bit more difficult to shrug off as a result of "one off" factors. Sentance, Dale and Bean have all broadcast their worries about inflation expectations that have been continuing to drift higher (see chart below), especially the fact that professional forecasters have begun to move their medium to long term inflation expectations higher in recent months, when previously these had been anchored firmly at 2% for the entirety of the independent BoE's history.
One of the main differences between the US and UK, something not particularly appreciated by our friends across the pond, is that the UK has a great deal less spare capacity, despite what Professors King and Posen try to claim. Partly as a result of the exchange rate falls and dramatic fall in interest rates, the labour market did not deteriorate anything like what might have been expected for such a deep recession, and a corporate sector flush with cash that has begun to invest and ramp up hiring, both the fall and recovery in capacity utilisation has been very different to that in the US. The below chart shows the deviation of Capacity Utilisation from its mean level since 1985 in units of standard deviation (red line) versus RPI ex-Food lagged 6months (blue line) and is TMM's version of the Output Gap model. Due to time constraints we've not been able to adjust the RPI measure for the VAT effects, but as a rule of thumb, it would probably be around the 3.4% level (75% basket *2.5% =1.88% difference) which is about consistent with the output gap (in terms of the deviation of Capital Utilisation from its mean) at about zero. Anyway, you get the point: there isn't much spare capacity (if any) in the UK right now.
The BoE have been clinging to the argument - which TMM accept is potentially a valid one - that as the fiscal consolidation both domestically and in the Eurozone begins to bite that the economic risks are to the downside. Today's weak Services PMI supports this line of reasoning, but could easily just be due to the weather. As the very talented Ben Broadbent at the Vampire Squid points out, private sector hiring is more than enough to offset the fall in public sector jobs, and this mornings IDS wage settlements data accelerating from 2% to 2.2% suggests that the lack of capacity is beginning to show up in wages. So, unless the data in Q1 disappoint significantly, TMM reckon that the Bank of England will be forced to capitulate and react to the persistent upside inflation surprises and begin a hiking cycle.
9) 10yr US Treasuries will NOT beach their 2010 yield lows, but will also NOT rise above 4%.
In 2010, the market panicked that we might be headed for a double dip recession, sharply marking down 2011's growth prospects both in bond yields (see chart below of the 5y5y forward real UST yield - white line, vs. consensus economist 2011 GDP forecasts lagged 2months). As data has improved in recent months, it looks to us as though the growth scare was merely a mid-cycle slowdown and the economic recovery is becoming self-sustaining. TMM reckon that the only things that could dislodge the recovery would be a complete policy-driven collapse in the Eurozone (someone leaving), or an involuntary restructuring of senior bank debt in Europe (although we would exclude Irish banks from this as there is a widespread expectations that senior creditors will take a bath here), both events that TMM views as rather unlikely.
TMM's long-run fair value model for 10yr USTs, based upon debt ratios, the output gap and medium-long term inflation expectations (see chart below, orange line, 10yr USTs - white line) has yields as close to fair value, and given the output gap is (slowly) closing and the renewed fiscal stimulus will push up the debt ratio, it is hard to see much room for this measure to move much lower...
...persistently low core-CPI (see chart below, lagged 12months - orange line) prints are likely to keep inflation expectations subdued as the output gap (OECD measure - white line) is still very large, predicting core-CPI to only reach about 1.6% by year-end. It is also worth noting that it is rather difficult to get to a 4% yield number without real rates rising significantly (something the Fed is eager to prevent), given that 10yr TIPS Breakevens at 2.4% are already at the highs they were at in April 2010 when 10yrs were trading 3.98%. Add to that the probability that Republicans force Congress to put in place a long-term deficit reduction plan and it is hard to envisage a material break higher in yields. On the back of all that, TMM reckon bonds are range-bound.
10) Spanish 10yr yields will NOT hold below their 2010 highs, but Spain will NOT need a bailout.
One of the consensus trades for 2011 is the continuation of all things Eurobllx and a seeming inevitability that Spain will need to tap the EFSF. While TMM expect a good old fashioned bit of Eurotrashing in Q1, resulting in Portugal running into the arms of the EFSF and a spike wider in Eurobond spreads, they find it hard to believe that EU policymakers would let the next domino fall given the ever-increasing costs of inaction. Indeed, in policy circles, talk of a pan-EU bank recapitalisation fund is amok (as mentioned before, this was always TMM's favoured solution to the crisis because bank capital can be leveraged). Regulators are currently preparing for a new and tougher round of stress tests, and clearly understand that national solutions to the undercapitalisation of national banking systems are untenable due to the extreme pressure they put on the sovereign's balance sheets. The beauty of a pan-EU bank recapitalisation fund is not just that it allows the leveraging of equity (which will create a positive feedback loop in peripheral bonds), but that it avoids a direct bailout of Spain, which would surely push the market to attack Belgium and Italy. In such a format, the pan-EU fund would also be exposed to the upside in terms of a recovery in bank equity and be less likely to result in a backlash in Germany against the Euro, instead, merely adding to the anger against bankers (a convenient distraction for politicians to point to).
We know that plenty of work has been published on Spain's refinancing calendar and the relevant dates are being used by market players as this year's roadmap to Eurodoom. But these dates are just as clear to the Eurostriches and we cannot believe that even they can ignore their oncoming thunder and must have some sort of plan... Surely?
We crack on with our Non-Predictions, but first we were amazed at yesterday's fall in gold prices. We thought it had fallen about $40, but when we checked the UK's latest market for gold at Tesco Gold Exchange,we found , to our shock , that it had absolutely collapsed. An ounce (31.1gm) of 22 ct gold, according to them, is only worth £593.39 or $925 which we estimate would be about $1000 for 24 ct! Either the market has collapsed or someone might be taking the piss with a hefty 37% IRR.
But back to equities. God knows why anyone is trying to put out calls governing a whole year when we heard on Monday that apparently the average holding period for a US equities is currently... 22 seconds. Positively macro compared to last year's 20 seconds. But here we go...
5) SPX will NOT trade below 1150.
Readers will know that TMM are very bullish of Equities, and US equities in particular, as a function of both very cheap valuations and an incipient CapEx cycle as the economic recovery changes gears from the initial inventory and fiscal-led bounce back into a self-sustaining business investment-led expansion as in the early-1990s. While equities are not as cheap as they were on a forward P/E basis, trading at around 14.9x 2011 earnings (see chart below)...
...on TMM's version of the Fed Model (see chart below), which compares the 10yr real bond yield with the trailing earnings yield of the S&P500, equities are still extremely cheap relative to bonds. Of course, much of this is due to historically low real bond yields (partly on the back of the Fed's QE2), but as TMM will discuss in the coming days, we expect the Fed to continue to purchase its full $600bn quota of USTs, and with the output gap still very large, it is hard to imagine real yields rising dramatically.
A corollary to the above is that with free cash flow yields higher than debt costs for a great number of corporates, managements are likely to pursue more (ego-boosting) M&A transactions (see chart below - globally announced M&A transaction values), Private Equity are likely to arbitrage the debt-equity gap, and reallocations out of bond funds into equity funds are likely to gather pace. Even if the expected 19% increase in SPX EPS does not materialise (an outcome TMM struggle to envisage), at 1150 that would leave the market trading on a still inexpensive ~14.3x multiple. Absent a complete European melt-down, TMM cannot see the SPX trading below 1150.
6) The DAX will NOT outperform the IBEX.
In 2010, amongst the backdrop of the European crisis, the large real money reallocation out of peripheral equities into those of Germany resulted in an eye-watering 40% out-performance of the DAX to the IBEX (see chart below).
TMM is of the view that this "one off" portfolio shift is now done, and that valuations for the IBEX plumping their May-panic lows (see chart below) of ~9.6x 2011's earnings (see chart below) look exceptionally low given that (as we have discussed before) a good chunk of the index is Telefonica and Santander. Given these two companies depend more on Latin America and the UK for their earnings and the fact that the US is undergoing an upswing, while the economic data shows persistent strength in the UK (despite the UK media's best efforts to paint it as a catastrophe), TMM reckon it might be worth betting that the IBEX outperforms, perhaps by a margin, the DAX this year.
7) Emerging Markets (MSCI EM) will NOT Outperform Developed Markets.
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