Draghi and Bernanke: A study in contrasts


Author Cam Hui

Posted: 16 May 2012

Barry Ritholz pointed out that the ECB is becoming concerned that Europe is becoming like Japan (see ECB: EU Economy Strikingly Similar to 1990s Japan).

The ECB appears to be understating the similarities between the weak growth outlook in Japan after its domestic asset bubbles popped in the early 1990s and that for the euro area in the present crisis. The performance of the Japanese economy 20 years ago was better than that of the euro area more recently. The Nikkei 225 peaked at the start of 1990. GDP was 7 percent higher 4.5 years later, according to the IMF’s measure in constant prices.

They diagnose the problem as the lack of structural reform:

European policy makers have failed to implement some of the reforms that also proved elusive in Japan. The staff economists stated: “The strong emphasis traditionally placed on job security in Japan may have reduced flexibility by hampering sectoral adjustments in the economy.” This time, only one word needs to be changed to describe the euro area. That is “Japan”.

And the fiscal problems plaguing Japan (and Europe):

The fiscal problems are also comparable. The analysts in Frankfurt said “deteriorating revenues and rising social security spending also contributed to the increase in the fiscal deficit in the early 1990s. To consolidate public finances, the government raised value-added taxes in 1997 with the onset of the Asian crisis, which some observers regard as having postponed the recovery.” Demographic similarities are striking as well.

While the diagnosis is interesting, what’s more interesting is the study in contrast in proposed response between the Draghi ECB and the Bernanke Fed, which is also concerned about the United States falling into a deflationary trap, to the problem in Japan.

Mario Draghi’s approach is to pressure member states to address these issues directly by offering an implicit carrot and a stick. The carrot the ECB can offer is easy monetary policy should eurozone governments implement these policies. The stick is that, should member governments stray from the prescribed course, to leave them to the mercy of the bond market vigilantes.

On structural reform, which he branded as a “growth compact”, he wants governments to implement structural reforms, or what amounts to an internal devaluation in the peripheral eurozone countries (see Draghi’s “growth pact” = Internal devaluation). In effect, he wants governments to change the rules so that it’s easier to fire people, to take away their pensions, etc.

On the fiscal problem, he wants governments to reduce their deficits through “good austerity”, namely lower government spending and lower taxes. Together, these two initiatives form his Grand Plan, which appears to have been endorsed by Angela Merkel, to rescue the eurozone and put it on the path of sustainable growth again.

Bernanke on Japan: Monetary policy can do it all
While the Draghi ECB prefers to operate indirectly, the Bernanke Fed’s approach is more direct. Ben Bernanke is known as a academic for his work in the Great Depression. His subsequent work on Japan also reflects his views on what is the appropriate central bank action in the face of deflation. An excerpt from his 1999 paper entitled Japanese Monetary Policy: A case of self-induced paralysis summarizes his opinion quite succinctly [emphasis added]:

I will briefly discuss the evidence for the view that a more expansionary monetary policy is needed. As already suggested, I do not deny that important structural problems, in the financial system and elsewhere, are helping to constrain Japanese growth. But I also believe that there is compelling evidence that the Japanese economy is also suffering today from an aggregate demand deficiency. If monetary policy could deliver increased nominal spending, some of the difficult structural problems that Japan faces would no longer seem so difficult.

In other words, Bernanke acknowledged that there are “important structural problems” in Japan, but he also wrote that monetary policy could conceivably address most of those seemingly intractable structural problems. In a recent news conference on April 25, 2012, Bernanke expanded on his views of what should have been done in Japan [emphasis added]:

Q: [S]pecifically, could you address whether your current views are inconsistent with the views on that subject that you held as an academic?

A: So there’s this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time.

I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation, that is, falling prices. The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are no longer — are not exhausted. There are still other things that — that the central bank can do to create additional accommodation.

In other words, do whatever you have to in order to avoid deflation. Lower interest rates. If rates are at zero, then go to quantitative easing and other additional tools to print money – all in the name of avoiding deflation.

Today, both the US and Europe appear mired in a deflation trap. The Draghi solution is to prod member governments to become more Austrian – lower deficits through “good austerity” and structural reforms at the microeconomic level so that it’s easier to do business and be competitive. The Bernanke solution is for the Fed to avoid deflation at all costs – ease and print money whenever its specter appears.

By contrast, the current wave of anti-austerity movement in Europe seems to be embracing the Richard Koo solution to Japan’s Lost Decades. Richard Koo, who is Nomura’s chief economist, has said that monetary responses don’t work because in a balance sheet recession, no one wants to borrow and therefore the economy will not grow. His prescription is extremely Keynesian. He calls for the government to spend until it hurts to stimulate aggregate demand – and then spend some more (see his recent presentation slides at an economic conference in Berlin).

It will be years before we know whose approach wins out.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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ECB Likely to Kick the Can Down The Road


Author Larry Berman

Posted: 14 May 2012 re-posted from etfcm

Risk is off this morning in Europe with rising Spanish and Italian bond yields and slower EU wide industrial production amongst the day’s catalysts. We still think the S&P 500 should hold initially at 1340, but eventually break and the odds are increasing we see a dip to about 1257 to 1290. We remain defensive with a short bias in our trading positions and 50% or more cash in our longer-term positions.

We expect the ECB to kick the can down the road with a larger QE package drawing a line in the sand for Spain. It is clear that Greece will likely be the first to leave the euro, and it should be destabilizing until it happens, and be the catalyst for a strong relief rally in the aftermath. Timing is impossible, but some speculate sooner rather than later if a government cannot be formed soon. This could push the S&P 500 towards these lower support levels far sooner than we thought.

Stay cautious and use bounces to raise cash or set new shorts. If the trend is going to head lower, we should not close back above 1400 and struggle above 1385.

 

How much more pain in Spain?


Author Cam Hui

Posted: 19 Apr 2012

The headline read: Ray Dalio’s Bridgewater Says Spain Is Worse Off Than It Was Before The LTRO. Simone Foxman reports Ray Dalio of Bridgewater Associates believes that:

The fund argues in a recent note to investors that Spain is even worse off than it was before the ECB announced its two LTROs in December.

Dalio argues that the tenuous circle of fragile Spanish banks providing funding for the Spanish government which in turn supports the troubled banks is swiftly eroding, if not vanished already:

I have argued in the past that the European Elites have a Grand Plan, consisting of austerity and structural reform, combined with a compliant ECB as long as the first two initiatives are followed. Foxman reports that Bridgewater believes that any policy response will be complicated:

  • Dalio and his team believe that since the burden is being shifted to the public sector and domestic banks, we will be less likely to see the kind of private sector debt restructuring used in Greece.
  • They also predict that EU leaders could soon tire of the slow progress of Spanish bank mergers meant to clean up Cajas’ balance sheets.
  • Dalio believes that EU policymakers remain committed to ill-fated attempt to “save almost everyone” by using under-capitalized bailout funds like the European Financial Stability Facility.
  • But they will also have to act in a much more of a hurry than they previously believed, given Spain’s predicament. This will show the inadequacy of currently budgeted resources to deal with the problem, and could pain EU leaders’ abilities to deal with crisis problems in a negative light.
  • Ultimately, Dalio thinks, trying to save Europe without restructurings will prove to costly, and EU leaders will have to accept that more restructurings will be necessary.

In other words, a policy response will have to be quick. It will be complicated, but not impossible. Megan Greene of RGE says that a Spanish bailout is pretty much inevitable:

If Spain is unable to regain market confidence, will it be pushed into a bailout programme? Not immediately, but this does seem inevitable. The good news as far as Spain is concerned is that the country has already pre-funded half of its debt rollovers for 2012. Even if Spain faces unsustainable borrowing costs, it will not actually run out of cash this year.

Furthermore, the ECB will not stand idly by while Spain is forced into a bailout programme. At the very least, the ECB will step up its Spanish bond purchases through the securities markets programme (SMP). While additional long-term refinancing operations (LTROs) are unlikely so soon after the three-year LTROs were offered, the ECB may take further steps to prop up the ailing Spanish banking system.

While ECB intervention could buy some more time for Spain in the short-term, it is extremely unlikely to fundamentally change Spain’s fiscal or economic trajectories. In the absence of economic growth, Spain will eventually be forced to request official financing, potentially as early as next year.

Italy, 2011
Consider the recent history of the eurozone. Despite the dire headlines, the eurocrats were able to avert a catastrophe in 2011. Take the case of Italy, which was considered to be too big to fail but too big to save. A look at the MIB Index, which represents a broad index of Italian stocks, show that the MIB plunged and tested the technical support level offered by the lows in 2008  2009 – and support held.

Spain, 2012?
If you were to believe that the eurocrats have a Grand Plan for Europe (and there seems to be convincing evidence that there is one), then the most likely scenario is the northern Europeans hold peripheral country governments’ feet to the fire in order to enact Grand Plan reforms, e.g. Spain plans to strip regions of powers in bid to calm markets. Were a real financial crisis were to hit, however, the authorities (e.g. the Troika) would come to the rescue and take steps to kick the can down the road a little bit more.

This would suggest a highly speculative trading strategy. Wait for the the IBEX Index, which represents Spanish stocks, to test its 2008 2009 lows – and then buy and wait for the cavalry to come over the hill.

Currently, IBEX has taken out its 2011 lows, but has not yet tested its 2008 2009 lows. Should such a test occur, the risk/reward ratio would likely be favorable enough to put on this highly speculative trade. For North American based investors, there is a Spanish market ETF available (EWP). Banco Santander (STD) is also US-listed.

If I am right, then there isn’t very much downside to European equities. If Dalio is right and the European authorities “have to act in a much more of a hurry than they previously believed”, then the crisis will be upon us sooner than anyone expects. In that case, maybe we should getting ready to buy in May?

Warning: Such a trade is highly risky and anyone who enters into it should size their positions carefully in accordance with their own risk tolerances (which may mean a zero position). If you were to put on such a trade, I would suggest that you enter a stop loss at 5-15% below your entry point in order to limit your downside. The risk/reward ratio should be favorable, but in this case, we would be playing the odds and the upside potential, though considerable, is highly uncertain.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Strategic Earnings Misses Not Showing Collateral Damage


Author Larry Berman

Posted: 19 Apr 2012 re-posted from etfcm

The important thing to note thus far in earnings season is that strategic misses by companies are not showing collateral damage across the sector and the market. The market seems like it wants to go higher, but stock by stock, we are seeing broader based weakness develop. The next top could take several weeks to months to develop, so much depends on the G20/IMF and the strings the ECB can pull to pacify the equity markets (Geithner seems to be holding back on the IMF support, we don’t know why, he knows they just have to keep printing in the short run).

Earnings are decent and the outlooks, thus far, are not terrible, though somewhat cautious. If the ECB can throw a few hundred billion in implicit buying behind Spanish, Italian, and Portuguese debt, we can stumble through the next few months, but in absence of a real solution, we are likely in for a 10-20% global equity market setback…once again. A shift into SPLV from SPY should help mitigate the downside (beta) in the coming months.

The Highs for the Year are Possibly In


Author Larry Berman

Posted: 11 Apr 2012 re-posted from etfcm

Back to back 90% downside days are rare and likely marks a few days of capitulation selling for late to the party longs. But the bigger message is that the highs for the year are possibly in and the next few quarters will be about consolidating the gains since last year’s October lows.

The key support trendline we have been following has broken, the 50-day average has broken, and VIX has finally turned up through its own 50-day average, although some of that is reversing this morning as the ECB looks to intervene in the debt markets to prop up Spanish debt.

Look for earnings to drive a bit of a bounce too in the next week or so, but it is evident that a distribution top is developing. The next key support is in the 1340 area with resistance very likely to build above 1390, though we cannot rule out an earnings inspired higher high as the bulls have their last gasp at irrational exuberance or benign neglect about the reality of the global debt problems.

 

How to be a better quant


Author Cam Hui

Posted: 2 Apr 2012

I have written extensively about what it takes to become a good quantitative analyst. It isn’t just about knowing the right technique or writing a better algorithm, though that is part of the skill set needed. What’s more important is situational awareness – awareness of the investment environment that we live in so that we can deploy the right model to take advantage of the environment.

To illustrate my point, if you are in the New York area on April 16, 2012, I would strongly suggest attending  the QWAFAFEW evening with Sam Eisenstadt. Here are the details:

My Life as an Empiricist: a Conversation with Samuel Eisenstadt,The stock market, its information, and the tools available to track and analyze it were far more limited during most of Sam’s 63-year tenure at Value Line than they are today. This conversation, in Q &A format, will explore the development of analytic tools, ranking systems, and indexes with a special focus on the Timeliness Ranking System. Other subjects will include capital market and market data observations over the years and interactions with luminaries such as Louis Rukeyser, Fischer Black, Rex Sinquefeld, Peter Bernstein, and more.

The questions will be posed by Herb Blank – formerly of Value Line, Deutsche Bank Securities, and Rapid Ratings. If you have any questions, you wish Herb to pose to Sam, please e-mail them in advance to hblank@qwafafew.org. (Please note that questions about the management of Value Line and its operations are strictly off limits and will be considered Grounds for Immediate Departure.)

Here is Eienstadt’s biography [emphasis added]:

From 1946 through early 2010, Eisenstadt worked with just one firm – Value Line, publisher of the Value Line Investment Survey. Hired as a proofreader after serving in the European theater during World War II, Sam moved over to research in production in 1948, then became the firm’s Director of Statistics, and eventually ascended to Research Chairman. There he played a major role in developing the Value Line Timeliness Ranking System – referred to by many as the industry’s first practical quantitative model for stock selection – and took charge of its weekly production. In 1971, the late Fischer Black wrote in the Financial Analysts’ Journal that the Timeliness Ranking System was the one provable anomaly to the Efficient Market Hypothesis that he had found to-date. Never satisfied with past accomplishments, Sam continued to work on improving the Timeliness Ranking System while also developing a Technical Ranking System along. Other developmental work included various asset allocation models and indexes. Personal highlights include a debate with Professor Rex Sinquefeld and appearances on Wall Street Week with Louis Ruykeyser. One common thread is that everything Sam developed was data-driven, preferring to let the data speak for themselves rather than super-impose pre-conceived theories upon them. Sam holds a bachelor’s degree in Statistics from the City College of New York.

Eisenstadt is a quantitative pioneers. He was a major force in the implementation of the Value Line Timeliness ranking system – which is used as proof by counterexample that the strong form of EMH does not hold. Yet the title of the talk is “My life as an empiricist”, an illustration that it takes more than just an advanced degree in the hard sciences to be a quant.

If you only have a hammer, then every problem looks like a nail
The real value of a quantitative technique is in its application, but when do you know to apply it? For most quants, who just know about techniques but lack in-depth market experience, the issue becomes one of the carpenter armed with a hammer. Every problem looks like a nail.

Consider, for example, the €conomia game that the Trichet ECB unveiled in late 2010 to explain its approach to monetary policy. Matthew Yglesias explained it this way [emphasis added]:

The game embeds a number of assumptions I would disagree with, but that seem telling. Short-term interest rates are your only policy tool. And their view of the transmission mechanism seems to be that inflation in QN is jointly determined by the change in inflation rate between QN-1 and QN-2 and the level of real output growth in QN-1. But a change in interest rates affects output immediately. So if the inflation rate is rising, whether because of demand-side or supply-side factors, the only way to prevent it from spiraling out of control is to raise rates enough to reduce real output. If inflation is plugging along at your target level, then bad weather causes crop failures and food prices go up and output goes down, you need to raise interest rates. If you don’t raise rates, then what happens is that inflation momentum pushes inflation up further in the next quarter and then the hit to output fades away which further increases inflation. Then since there’s even more inflation built into the system, you need to undertake a bigger rate hike down the road to drive output growth down enough to get inflation under control.

Long story short, the only responsible thing to do is to prophylactically raise rates in the face of adverse supply shocks. It shouldn’t stun us that this is what the game says, since it’s how the ECB behaves in practice. But the consequences have been disastrous in practice and I’m not sure what theoretical support they think they have for this view of how the world works.

I have no doubt that the ECB is full of economists with advanced degrees who are much smarter than I am. But do then have real-life experience?

If your only tool is interest rates, then every inflation shock looks like a nail. The Trichet ECB seemed to view the world through this lens. Here’s Yglesias’ view of the game as reflective of the Trichet ECB’s attitude:

That’s the ECB’s view of the world. Output doesn’t matter. Unemployment doesn’t matter. Having inflation close to 2 percent matters a little. But it matters more to be below 2% than to be close to the target. If forced to choose between full employment and 4.16% inflation and a years-long deflationary recession, choose the recession.

On the other hand, Mario Draghi has been more pragmatic, though his approach is fraught with risks.

Experience + Technique = Creativity and Good Analysis
Canada’s Globe and Mail recently featured an article that addresses this issue entitled How can universities teach students to think creatively?  The key is experienced based learning and figuring out how to apply what you learned to a problem [emphasis added]:

How can universities – key players in the process – teach students to think critically and creatively? Arvind Gupta thinks he has the answer.

Dr. Gupta is a computer science professor at the University of British Columbia and chief executive and scientific director of Mitacs, a national government-funded research organization that runs an internship program for Canadian graduate and postdoctoral students. The program brings together companies with students who help the organizations solve their research challenges. Dr. Gupta also sat on the federally-appointed Jenkins task force that recently completed a review of federal spending on research and development programs headed by Open Text Corp. chairman Tom Jenkins.

Dr. Gupta spoke to The Globe and Mail about how universities strive to foster creativity in their students, how Mitacs plays a key role in the process.

Q. Do universities stifle creativity in students, or the opposite?
A. I think there’s lots of challenges in an education system that’s got to be very broad based and has to both train young people for existing jobs and for future jobs. We’re trying to train people to be creative because they have to be very flexible in the kinds of jobs they might take on. We need to think about what the economy of the future will look like and what kinds of skills are easily transferable and there, at least I like to believe, we try very hard at universities to think about those kinds of issues.

Q. How can universities foster creativity and innovative thinking?
A. I’m a big believer in experiential learning. I think that in our university system we should engage society much more in the training of young people. I like co-op programs. I think they help give focus to more theoretical knowledge. At Mitacs we run programs where we get graduate students to go into society and look for emerging research challenges. We get young people talking to companies about what kinds of challenges these companies are seeing.

Q. Can you tell me a bit about how Mitacs does that?

A. For the more junior graduate students, Mitacs has staff that talk to companies about their challenges and then we bring a student and professor in to articulate clearly what the problem is. Then the student spends part of the time at the company. Seeing the problem for yourself is very different from having someone explain it to you. So we get the student to go to the company site, understand the problem first-hand, and then spend time tapping all the creative minds at the university on all the different possible ways to solve it. To me that’s really the best way to stimulate creativity.

In other words, university training isn’t just about talking someone to be book smart. It’s also about teaching someone to be street smart.

When you are only book smart, you get the Trichet ECB. When you are both, you get innovation and creativity. That’s what happened with Sam Eisenstadt.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Europe takes one step back?


Author Cam Hui

Posted: 29 Mar 2012

The story of Europe has been the story of two steps forward and one step back. Here are the two steps forward/

Since the eurozone crisis, the ECB has taken steps with its LTRO programs to stabilize the banking and financial system. Moreover, I wrote that Mario Draghi, on behalf of the eurocrats, outlined the Grand Plan as a way to fix the long-term problems within the eurozone. The Grand Plan consisted of two steps, which sound like pages taken from the Maggie Thatcher playbook:

  • Austerity in the form of “good austerity”, defined as lower taxes and less government spending; and
  • Structural reform, which is the European version of the China taking steps to smash the iron rice bowl, which translates to union busting and going after all of the entrenched interests of the old with their lifetime jobs and gold-plated pensions at the expense of the young jobless.

The one step back happens when Europe dilutes these grandiose object. In the wake of the German and Dutch failure to hit austerity targets, a step backward is inevitable.

Time for Grand Plan 2.0
Most recently, the OECD warned that the eurozone debt crisis is far from over. The organization indicated more work needed to be done, i.e. Grand Plan, and market confidence is fragile. At about the same time, Willem Buiter at Citigroup issued a warning on Spain:

Spain is likely, in our view, to be pushed into a troika (EC, ECB, IMF) programme of some kind during 2012, possibly by losing access to market funding on affordable terms, but more likely by the ECB making a programme for the Spanish sovereign a condition for continued willingness to fund the Spanish banks, which are currently the main buyers of newly issued Spanish sovereign debt. The existing and likely near future EFSF/ESM and IMF financial facilities are unlikely to be sufficient to both fund the Spanish sovereign fully and leave enough financial ammunition in reserve to deal with possible sovereign financial emergencies in Italy or in the ‘soft-core’ of the euro area. The Spanish sovereign would therefore likely continue to fund itself at least partly in the markets even if it comes under a programme. To ensure market access by the Spanish sovereign, the same combination of cheap ECB funding for periphery banks and financial repression of periphery banks by their national authorities that has been effective in lowering sovereign yields since the first LTRO is likely to be required.

Buiter did concede that the government is taking steps to implement structural reforms:

It did use this period to pass several important pieces of structural reform legislation. Among these were labour market reforms aimed at reducing severance pay in the long-term contract sector (while introducing or raising it in the flexible contract sector); reforms aimed at reducing the scope and incidence of industry-wide collective bargaining and replacing it with something closer to firm-level or establishment-level contracting; the imposition of an additional €50bn provisioning requirement on the banks; and laws aimed at strengthening central government control over the finances of the lower-tier authorities (autonomous regions and municipalities).

…though he was uncertain as to their implementation:

Passing legislation and implementing it are not the same thing, however, as we know from the Greek experience. In addition, both structural reform and a medium-term programme of fiscal austerity based on a politically acceptable formula for fiscal burden sharing look necessary to restore Spain to fiscal sustainability. The new government’s decision to wait 100 days to introduce its first budget, in the pursuit of electoral gain, did little to boost Spain’s standing in global markets.

Spain is a too-big-to-fail country within the eurozone. Market angst is starting to rise over the willingness of the Spanish government and the Spanish people to bear the pain of austerity.

Will Spain fall and bring down the eurozone in another crisis? I doubt it. This is the back-and-forth of the Theatre of Europe, but some form of Grand Plan 2.0 compromise will likely emerge. I agree with Gayle Allard at the IE Business School in Madrid who says to not count Spain out in a crisis:

[Allard] said Spain’s biggest problem is investors’ lack of faith in the population’s willingness to withstand austerity. “They don’t see the Spanish people in that way, they don’t understand how a country can put up with it,” she said.

“Having watched Spain through previous crisis, they are a pretty surprising country. They get behind things, hard things,” Allard said. “I don’t think this is ever going to look like Greece and that’s something the markets don’t understand.”

Italy does structural reform
Over in Italy, FT recently reported that Mario Monti clashed with the unions over structural reforms “that would give companies more flexibility to fire workers for economic reasons” and he is winning because of weakened opposition:

[W]ith the [labor union] CGIL considerably weaker than a decade ago and with the main political parties in no position to offer a coherent alternative to the present government, political commentators doubt Mr Monti’s technocrats risk being driven from office.

Opinion polls indicate strong public support for Mr Monti in general, although a majority of Italians opposes changing Article 18 which protects workers in the courts from wrongful dismissals for economic reasons. Under the proposed changes, employees would receive compensation but not reintegration back into their workplace.

Monti is also following the Grand Plan script of structural reforms which pit the young unemployed against their elders, who have secure jobs:

With nearly a third of young people unemployed, Mr Monti also wants to end Italy’s two-tier labour market that protects older workers on indefinite contracts but provides little or no security for mostly new hires on short-term contracts.

The politicians are indeed following through with painful structural reforms. In the meantime, there is doubt from the markets that they can implement them even if the legislation is passed. In a typical EU-style compromise, some of the legislation will get watered down, but I believe that the pendulum is swinging back and the momentum toward structural reform is inevitable.

For now, the message for investors is be prepared for some downside volatility out of Europe. But also know that it is likely a temporary hiccup out of which Grand Plan 2.0 will emerge.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

All of Europe’s a stage…


Author Cam Hui

Posted: 10 Mar 2012

Bloomberg had a good summary of Mario Draghi’s comments from the ECB press conference on March 8, 2012 in an article entitled Draghi Lays Groundwork for ECB Stimulus Exit as Inflation Takes Spotlight [emphasis added]:

Declaring that the environment “has improved enormously” and there are “many signs of returning confidence in the euro,” Draghi yesterday turned the spotlight on “upside risks” to inflation, which is now forecast to remain above the ECB’s 2 percent limit this year. That suggests policy makers don’t plan to cut rates further or add to their 1 trillion euros ($1.32 trillion) of long-term loans to banks, economists said….

The Frankfurt-based ECB must “go back to normal, classical central bank policy,” he said.

Draghi’s message to the politicians was, “We’ve done our part, it’s time for you to do yours” as he hinted that not only would there be no further LTROs, but the next ECB step would be some form of tightening.

How much of that is to be believed?

The Theatre in Europe
I wrote about how Draghi revealed the Grand Plan in a WSJ interview, which consisted of:

  • “Good” government austerity, in the form of lower taxes and less spending; and
  • Structural reform, in the form of the elimination of the European social model.

For the that Grand Plan to work, you need a compliant central bank to print money so that the system doesn’t seize up. So how much of what Draghi said is bluster and how much is real?

I interpret what Draghi said as being totally consistent with the message of: We will print more money if necessary, but on the condition that the politicians move forward with the Grand Plan’s reforms. Otherwise, be prepared for tightening.

It seems to me that even the Germans are on board with the Grand Plan. Despite the German cultural aversion to money printing, notice that there wasn’t a single complaint from either the Bundesbank or any of the German hardliners about LTRO, which has been documented to enormously expand the ECB balance sheet? Instead, we got a letter from Weidmann of the Bundesbank complaining about a technical point with LTRO, i.e. the quality of collateral.

Is this complaint about collateral quality just theatre? If so, then is Draghi’s comment about going “back to normal, classical central bank policy” also part of that theatre?

I interpret all these statements as part of the “show” that’s been going on in Europe as the elites proceed with the Grand Plan. The German complaint is part of the chorus of doubt that accompanies the main show and so is the ECB response, but they are not likely to be significant. No doubt, the ECB has the power to derail everything should any government step out of line, but my guess is that everyone pretty much knows the score. If needed, don’t be surprised if the ECB stepped up with further LTRO or LTRO-like programs. Recall that I wrote that analysis reveals that the European banking systems may need up to four LTROs in order to fund their liquidity needs to 2013.

I recognize that the ECB doesn’t want the banks to get addicted to LTRO, but do you expect the Draghi to allow European banks to fail as long as the Grand Plan is proceeding smoothly?

Expect more drama, but also expect a happy ending as long as all the players know their lines.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

The Last Bastion of a Broken Republic is Printing Money


Author Larry Berman

Posted: 28 Feb 2012 reposted from etfcm

Silver broke out while crude is showing some signs of cooling, though nothing that would suggest a breakdown. Gold is lagging a little on the breakout as are gold stocks, but there is clearly some breakout potential on the new tranche of cash the ECB is going to inject into the European banks. It was larger than expected, but so far has not excited the metal (could see a ‘sell the news’ type of reaction today).

We are simply amazed that some very smart portfolio managers in Europe feel that this QE will somehow fix the banks—it’s almost laughable if it were not so sad. To be fair, they are almost all taking the cash, why wouldn’t they, but like we saw with TARP, they do not have to lend it out.

The last bastion of a broken republic is printing money to dig their way out—it would seem that is the MO of all central banks. The good news is that austerity seems to be taken seriously, but the deleveraging process has years to run. The push and pull on commodity prices in the coming years due to the printing presses running overtime will be challenging to navigate.

 

We are all QEers now


Author Cam Hui

Posted: 27 Feb 2012

Richard Nixon famously said in 1971 that we are all Keynesians now. Within a decade, the unintended effects of Keynesian stimulus were plain to see for everyone as inflation raced upwards and out of control.

Today, as the world holds its breath for the results of the ECB’s LTRO2 auction later in the week, we are all Quantitative Easers. The Bank of Japan, Federal Reserve, the European Central Bank and Bank of England have all embraced quantitative easing, or money printing. Recently, both the BoE and BoJ have announced further rounds of quantitative easing.

In the short run, there are clear benefits to the US federal government of the Fed’s ZIRP and quantitative easing. In 2011, the US paid $454 billion in interest payments under ZIRP and, despite skyrocketing debt, interest expect was less than it was in parts of the 1990’s.

Moreover, L Randall Wray points out that the Federal Reserve holds assets equal to one-fifth of GDP. What’s more, an astounding 50% of its assets have maturities of 10 years or more.

Governments of the developed world are trapped by their central bankers dual policies of ZIRP and QE. If central bankers were to raise rates, interest costs would spiral out of control and overwhelm budgets. Just read Reinhart and Rogoff to see what happens next.

This has resulted in a binary investment environment of risk on, when central bankers are engaged in QE, and risk off, when they are not. The endgame will either inflation or debt default – and I don’t know what the result will be.

For investors, this means becoming more tactical in understanding the risk on/risk off backdrop and participating in the trend of the day. Right now, central bankers are engaged in another round of QE around the world. Despite what you may think of the ultimate costs of such policies, the right thing for an investor to do is to party and worry about the consequences later.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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