Is this 2011 all over again?


Author Cam Hui

Posted: 07 Mar 2013

I am not a big believer in market analogues, but the current environment bears an eerie resemblance to the summer of 2011. Here are the similarities

Heavy insider selling
I wrote back in early February (see Insider selling, it’s baaack!) that insider selling was surging. Vickers reported that [emphasis added]:

Looking at a longer time frame paints a bearish picture as well. The eight week sell-buy ratio from Vickers stands at 5-to-1, also the most bearish since early 2012. What’s more, the last time this ratio was at these levels was June 2011, just before another correction in the stock market took place.

Apparently, insider selling has gotten worse since that report. According Charles Biderman of TrimTabs (via Zero Hedge), the ratio of insider sales to buys is skyrocketing, though I am unsure of how to compare the Vickers sell-to-buy ratio to the TrimTab’s one as I don’t know the differences in their methodologies:

While retail is being told to buy-buy-buy, Biderman exclaims that “insiders at U.S. companies have bought the least amount of shares in any one month,” and that the ratio of insider selling to buying is now 50-to-1 – a monthly record. “So far the mass delusion is holding.”

By contrast, Bloomberg reports a three-month average insider sales-to-buy ratio of 12 to 1, a two year high:

There were about 12 stock-sale announcements over the past three months for every purchase by insiders at Standard & Poor’s 500 Index (SPX) companies, the highest ratio since January 2011, according to data compiled by Bloomberg and Pavilion Global Markets. Whenever the ratio exceeded 11 in the past, the benchmark index declined 5.9 percent on average in the next six months, according to Pavilion, a Montreal-based trading firm.

Regardless of differences in methodology, the results are an ominous sign for the bull camp.

US political gridlock
Another similarity between today and the summer of 2011 is the rising anxiety over the consequence of political intransigence in Washington. Then, we saw the debt ceiling crisis of 2011, which led to the loss of the AAA credit rating from Standard and Poor’s.

Today, we have $85 billion in overnight sequestration cuts to the federal government and a looming debt ceiling crisis on March 27, about three weeks away. Fed chair Ben Bernanke projected that sequestration will likely slice 0.6% from GDP growth in 2013:

However, a substantial portion of the recent progress in lowering the deficit has been concentrated in near-term budget changes, which, taken together, could create a significant headwind for the economic recovery. The CBO estimates that deficit-reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points this year, relative to what it would have been otherwise. A significant portion of this effect is related to the automatic spending sequestration that is scheduled to begin on March 1, which, according to the CBO’s estimates, will contribute about 0.6 percentage point to the fiscal drag on economic growth this year. Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant. Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions.

A 0.6% slowdown in GDP growth could very well mean that the economy stalls and keels over into recession. What’s more, another debt ceiling debate with a drop-dead deadline of March 27 will pour gasoline on the fire and could lead to further market anxieties.

Risk-off, anyone?

News cycle turns down in Europe
In 2011, the ECB’s announcement of its LTRO program stabilized the markets. Mario Draghi’s “whatever it takes” remark in July 2012 and the ECB’s subsequent OMT program contributed to further stabilization. Today, the market consensus has evolved to the view that the ECB has taken tail-risk, or the risk of a European sovereign debt or banking crisis, off the table. The ECB, it seemed, had built a financial castle wall around the eurozone again.

Read the fine print. The OMT program depends on member states submitting to the ECB’s “conditionalities”, namely austerity and structural reform programs. The rise of anti-euro forces in the recent Italian election shows how fragile the ECB’s castle walls really are.

I fear that the news cycle is about to turn down in Europe. Consider these stories that are appearing:

  • The divergence between German and French economies (via Business Insider). This divergence is starting to raise the question of the viability of the French-German partnership in the EU. These are the two principal founding partners in the European Union and brings up the question of wage and productivity differentials between the two countries. If the two economies can’t converge and Germany is unwilling to subsidize France, the euro is cooked. Nothing else matters. It doesn’t matter what happens to Greece, Spain, Ireland, etc.
  • Political turmoil in Spain. The FT reports that Madrid is pushing for a constitutional challenge to Catalonia’s bid for independence, which puts the spotlight on political stability in Spain:

The Spanish government has launched a legal challenge against Catalonia’s recent “declaration of sovereignty”, in the latest move by Madrid to halt the region’s march towards independence.

The government said it would ask Spain’s constitutional court to nullify the Catalan parliament’s January declaration, which stated that the “people of Catalonia have, for reasons of democratic legitimacy, the nature of a sovereign political and legal subject”.

What’s more, Business Insider reports there are rumblings that the Army may not stand idly by and the possibility of a coup d’etat is raising its ugly head. While I believe that these risks will ultimately resolve themselves in a benign fashion, these stories are just further signs that the news cycle is turning negative in Europe.

Recall that in 2011 we had angst over Greece and the implications for the eurozone. We saw endless summits and crisis meetings until the ECB stepped in to stabilize the situation. Today, the fragile peace that the ECB has put together is starting to unravel. Europe is in recession and the tone of the news stories are turning negative.

These kinds of stories have a way of not mattering to the markets until it matters, especially when the market is in risk-on mode. Now that the tone seems to be moving away from a risk-on to risk-off, the market has a way of focusing far more on this kind of negative information.

A positive divergence
In 2011, the SPX cratered about 17% in response to these anxieties. While I am not saying that the downside could be the same, it is nevertheless a warning for the bulls. The key difference between the market weakness in 2011 and today is how the Fed acted then and now. In 2011, the Fed’s QE program was just ending, while we are seeing QE-Infinity today. The actions of the Federal Reserve today may serve to cushion the effects of the speed bumps that the equity markets are likely to experience.

Nevertheless, the current environment is likely to be more friendly to the risk-off crowd than the risk-on crowd.

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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Time for the Draghi and Bernanke Puts?


Author Cam Hui

Posted: 05 June 2012

This week is an important week for investors who are watching for central bank action in the wake of market angst over Europe and the American economy. On Wednesday, the ECB will announce its interest rate decision and Mario Draghi will hold the customary press conference afterwards. On Thursday, Ben Bernanke will be testifying before Congress.

What will they say?

Don’t expect too much
While I do expect that the ECB and Federal Reserve will intervene eventually, I do think that the markets may be getting ahead of themselves in anticipating another round of LTRO from the ECB or QE from the Fed. After all, Mario Draghi said last week that the ECB was reaching the limits of what it could do and it’s now up to the politicians:

Draghi told a European Parliament committee in Brussels that without more aggressive action by policy makers the euro “is being shown now to be unsustainable unless further steps are being undertaken.”

He said it wasn’t his job to make up for the failures of policy makers. “It’s not our duty, it’s not in our mandate” to “fill the vacuum left by the lack of action by national governments on the fiscal front,” on “the structural front, and on the governance front,” he said.

The ECB is likely to reduce interest rates in the face of economic weakness in the eurozone, but don’t expect too much more. If Draghi were to reverse course from last week and announce some extraordinary measure like another round of LTRO, it would not only erode the ECB’s credibility, but could paradoxically have a negative effect on the markets as it asks, “What looming disaster does the ECB know about that we aren’t aware of?”

QE3 in June?
Across the Atlantic, there is a lot of expectation built up that we are due for another round of QE at the June FOMC meeting in the wake of last week’s ugly NFP report. Veteran Fed watcher Tim Duy disagrees  [emphasis added]:

Bottom Line: At this point, the direction of US data, the pathetic state of Europe, and the evolving slowdown across the rest of the world all point toward additional action by the Federal Reserve. Assuming this continues, it is an issue of timing and tools. My baseline is steady policy at the June meeting (depending, of course, on the usual financial turmoil disclaimer), with a possibility of an extension of Operation Twist. The latter option is something of a tough sell for me; it is cheap, but will prove to be ineffective. If the Fed needs to move, they need to reverse course back into quantitative easing. They need time to build internal support for such a move, which argues for action later in the summer or early fall, much as we have seen in the past two years. I just don’t think they have enough to shift policy at this juncture.

Don’t forget that Bernanke and the Bernanke Fed is made up largely of conservative academics, who tend to wait for definitive evidence of a slowdown before acting. As I wrote before about the difference between the Bernanke and Greenspan Fed (see Yes to QE3, but not yet), both the Greenspan Put and Bernanke Put exist, the difference is in reaction time:

[P]ut yourself in Bernanke’s head. His academic reputation was built on the study of central bank action during the Great Depression. This is probably a little voice in his head telling over and over again, “Don’t let another Great Depression happen on your watch.” As a result, we have the Bernanke Put.

Greenspan had a long career on the Street as a forecasting economist and tended to be more proactive:

Greenspan’s approach as Fed Chairman was to stimulate whenever he saw signs of weakness – and he was far more market savvy than Bernanke. Therefore the Greenspan Fed tended to be more proactive and tended to get ahead of events. The Great Moderation was the result of the Greenspan Put – and those policies worked well, until they went overboard with the stimulus (and we are still paying the price for those policies).

My guess is that investors looking for hints of another round of QE from the Fed on Thursday are likely to be disappointed.

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.

2012 = 1998?

Posted: 04 Jun 2012 12:16 AM PDT

Weekends are a good time to think and reflect. After last week’s carnage in the stock market, some thinking and reflection was more than overdue. The question I had was, “What is the market headed?”

When I consider the different dimensions by which investors evaluate equities, they present a mixed picture that is, while bearish, does not point to disaster:

  • Sentiment: bullish
  • Valuation: neutral to slightly bearish
  • Momentum: bearish
  • Macro: bearish, but subject to policy-induced whipsaw

Sentiment models are screaming “buy”!
Let’s go through each of these one at a time. Martin T. over at Macronomics noted that Wall Street strategists are off the charts bearish, which is contrarian bullish.

As well, US 10yr yields are trading 3 standard deviations from the 30+ year downtrend, which indicates a crowded long in the Treasury safe haven trade.

Scott Grannis has noted the same level of exuberance when he asked “What record-low Treasury yields tell us“. His take:

If I had to sum up what all this means, I would say that the evidence of market prices points to a very high level of fear, uncertainty and doubt among global investors. Today’s record-low 10-yr Treasury yield is just the latest sign that investors are consumed by fears. When emotions reach such heights, as they did in the early 1980s and in late 2008/early 2009, investors willing to bear risk stand a good chance of being rewarded, provided the future turns out to be less awful than the market expects.

Valuation: Neh!
Typically, when sentiment is this bearish, Value investors are all crawling out of the woodwork and shouting, “I can’t believe that there are so many bargains!”

While I have heard that comment directed at a number of European companies, i.e. these are real world-class companies trading at bargain prices (see one example at the FT article While all around ar panicking…buy), the same couldn’t really be said of most markets. The Value investors just aren’t there.

Consider, for example, this Barron’s interview with Jeremy Grantham, who is known to have a value bias, on February 25, 2012 when the SPX was about 1360, which is about 6% above Friday’s close of 1278.

We do a seven-year forecast every month. On a seven-year forecast, global equities outside the U.S. are boring. They’ve been so nervous the last year that they mostly reflect the right degree of fear about European problems. Emerging markets and developed markets outside the U.S. are within nickels and dimes of fair value. This is very unusual. We are in the asset-allocation business, and we like to see horrific roller coasters: It gives us something to get our teeth into. What could be more boring than global equity markets at fair value?
About a quarter of the U.S. equity market—the high-quality, boring, great companies—is about fair price, too. The other three quarters are overpriced, and based on our numbers have a slight negative imputed return.

While Grantham doesn’t represent the final word in stock market valuation, he is a good bellwether for what Value investors think. As of the end of February, he believed that non-US equities were roughly at fair valuation. US equities are overpriced, with only a quarter, i.e. high quality stocks, at fair value.

His comments were not a stunning endorsement for the stock market.

A Dow Theory sell signal
The Dow Theory is one of the original trend following models, which is based on price momentum and looks for confirmations from different sectors of the market: industrials, transportation and utilities. Long-term market analyst and Dow Theorist Richard Russell recently flashed a major sell signal for stocks [emphasis added]:

IMPORTANT — Dow Theory — The D-J industrial Average recorded a high of 13,279.32 on May 1, 2012.  This Dow high was not confirmed by the Transports.  The two averages then turned down and broke below their April lows.  This action confirmed that a primary bear market is in progress — it was a textbook bear signal.

Could you be a little more clear, Richard?

Macro picture gets worse
Last week, the news flow from Europe continued to deteriorate. The latest Greek tracking polls have SYRIZA on top again:

Not only that, the markets are now getting concerned about Spain – a country that’s too big to fail. In the meantime, ECB head Mario Draghi stood aside last week and said that the ECB can’t do much more. It’s all up to the politicians:

Draghi told a European Parliament committee in Brussels that without more aggressive action by policy makers the euro “is being shown now to be unsustainable unless further steps are being undertaken.”

He said it wasn’t his job to make up for the failures of policy makers. “It’s not our duty, it’s not in our mandate” to “fill the vacuum left by the lack of action by national governments on the fiscal front,” on “the structural front, and on the governance front,” he said.

Last week, I wrote that investors should focus on China, not Europe. The news out of China is headed south. The latest PMIs are signaling a global slowdown, not just in China but in Europe as well. I raised the issue of when investors might focus on the question of capital flight out of China, when Tim Duy picked up on the same story. Should the market start to price in the tail-risk of capital flight, look out below!

Then we have the ugly US Non-Farm Payroll Friday. The only good news is that more data points of economic weakness will give the Fed political cover to act and unveil another round of QE. Despite what the central bankers say, don’t forget that when things get bad enough, there will a policy response. As an example of the anticipated response, Mark Dow at Behavioral Macro believes that the IMF is putting on the face paint for a rescue of Spain. While the response may not fully solve the problem, it will kick the can down the road and spark a stock market rally.

A repeat of 1998 in 2012?
Putting it all together, what does it all mean? The market is supported by washed out investor sentiment, but not by valuation. The macro backdrop and momentum looks ugly. Is this the start of another cyclical bear?

Probably not. Valuations don’t look excessively stretched, but they aren’t screaming “buy” either. Major bear markets generally don’t start with these kinds of valuation metrics.

My best wild-eyed-guess is that we will see a major air pocket like 1997 (Asian Crisis) or 1998 (Russia/LTCM Crisis) in which some macro event sparks a major selloff, but turns around based on policy response. There are plenty of macro triggers out there. Greece, Spain, China, etc.

Market analogues have limited uses, but look at the chart of the stock market in 1998. The market had an initial dislocation (Greece), stabilized and rallied (as we did a couple weeks ago) and started selling off again. At the nadir of the Russia Crisis that threatened to sink Long-Term Capital Management, the Fed came in and knocked some heads together to save the system.

Now look at the chart of the market this year and last year. See any parallels?

Don’t misunderstand me. This is not a forecast that stocks are going to plunge this week. Analogues are analogies and they are imperfect. Markets are extremely oversold on a short-term basis and I don’t think that we’ve actually seen the macro trigger for a waterfall decline yet, though there are lots of potential triggers.

Not enough pain
Nevertheless, were this scenario were to play out, it suggests that we haven’t quite seen enough pain and we need one more capitulation down leg to equities. For now, my Asset Inflation-Deflation Trend Model remains at a deflation reading, indicating that the model portfolio should be primarily positioned in the US Treasury market. I will be primarily using that model and some short-term timing tools to try to spot the turn. Here is what I am watching. The chart below of the Euro STOXX 50 is falling, but not quite at the lows delineated by the 2009 and 2011 lows. Wait until the index approaches that zone and watch for signs of a “margin clerk” liquidation forced selling in the panic.

Here in Canada, I am also watching the ratio of the junior TSX Venture Index to the more senior and established TSX Composite. While there is a lot of pain, utter and blind panic hasn’t quite set in yet.

When the blood starts to run in the streets, official intervention will be all but inevitable. At that time, that will be the opportunity to buy the pain in Spain.

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.

Global Debt Problems are Toxic and Likely to End Badly


Author Larry Berman

Posted: 16 May 2012 re-posted from etfcm

We have suggested the downside target for the correction phase is at least 1290, but we did think the 1340 area would initially hold—it has not. The Greek tragedy is manageable from what we understand, but the Portuguese squeeze and Irish break dance, followed by the Spanish paella and Italian salami, is too much for Germany to quaff given France’s new found “AA” foie gras.

Investors are forgetting that the reserve currency of the world, the mighty Greenback—is bankrupt and owes 800% of GDP in unfunded Social Security and Medicare. Even if they patch up Europe for a while with another LTRO or some other alphabet soup, the debt problems in the world are toxic and will most likely end badly. The Euro will likely break up and trillions in debt will need to be written off or monetized globally.

If anyone has another solution, we are searching hard for one, this will likely take years to fully play out. Don’t fret the day-to-day noise and miss the big picture. One needs to take money off the table when the markets are strong and have cash to buy the bargains when they develop.

 

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.

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.

Canadian Banks and Stress of the Housing Sector


Author Larry Berman

Posted: 28 Feb 2012 reposted from etfcm

Bank earnings start off with a slightly better than expected result, but there does seem to be at least some concern about the forward outlook. There appear to be notable stresses developing in Canada’s housing sector that are bound to have an impact on the banks in the coming years. The CMHC is about full on their loan books, and housing is simply becoming unaffordable for a conventional type mortgage. How many young couples have $100K or more needed for a down payment?

More important today and tomorrow is what the S&P 500 does at its 2011 high of 1371. There is obviously some hope that the ECB delivers another monster tranche of LTRO (QE), so there is room for some disappointing ‘sell the news’ type event as well.

Gold and silver look poised for a breakout type trade and all will know how badly gold and silver stocks have lagged their bullions. There are lots of potentially offsetting factors for the TSX, which should limit the upside in the coming weeks and months. We still see 13,000 as a reasonable target to take money off the table.

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.

Mario Draghi reveals the Grand Plan


Author Cam Hui

Posted: 26 Feb 2012

Policy in Europe has generally been done in the back rooms, with the theatre, e.g. PIIGS debt re-negotiations, done in the front rooms. Last year, the markets were panicked because they perceived the backroom elites had lost control of the situation and events were spiraling out of control.

Today, it appears that the elites have calmed things down and there had always been a Grand Plan. We got hints of this when Angela Merkel said that there was no silver bullet to the eurozone crisis, but resolution was a “long process”.

Now ECB head Mario Draghi, in a WSJ interview, reveals the Grand Plan. Not only does he speak on monetary policy, I found it more important that he touched on fiscal policy and micro-economics, which is an indication that he was speaking about the European Grand Plan.

The Grand Plan involves austerity, but it’s not all austerity all the time. Draghi distinguishes between “good austerity” and “bad austerity”.

WSJ: Austerity means different things, what’s good and what’s bad austerity?

Draghi: In the European context tax rates are high and government expenditure is focused on current expenditure. A “good” consolidation is one where taxes are lower and the lower government expenditure is on infrastructures and other investments.

WSJ: Bad austerity?

Draghi: The bad consolidation is actually the easier one to get, because one could produce good numbers by raising taxes and cutting capital expenditure, which is much easier to do than cutting current expenditure. That’s the easy way in a sense, but it’s not a good way. It depresses potential growth.

Lower taxes and less government expenditures? That sounds positively…Anglo-Saxon (excuse my French).

Draghi went on to say that the next step, after austerity, is structural reform “because the short-term contraction will be succeeded by long-term sustainable growth only if these reforms are in place”. Draghi went on to say [emphasis added]:

WSJ: Which do you think are the most important structural reforms?

Draghi: In Europe first is the product and services markets reform. And the second is the labour market reform which takes different shapes in different countries. In some of them one has to make labour markets more flexible and also fairer than they are today. In these countries there is a dual labour market: highly flexible for the young part of the population where labour contracts are three-month, six-month contracts that may be renewed for years. The same labour market is highly inflexible for the protected part of the population where salaries follow seniority rather than productivity. In a sense labour markets at the present time are unfair in such a setting because they put all the weight of flexibility on the young part of the population.

In other words, 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. It sounds positively Thatcherite. Draghi went on to say that the old days of the European social model are gone [emphasis added]:

WSJ: Do you think Europe will become less of the social model that has defined it?

Draghi: The European social model has already gone when we see the youth unemployment rates prevailing in some countries. These reforms are necessary to increase employment, especially youth employment, and therefore expenditure and consumption.

WSJ: Job for life…

Draghi: You know there was a time when (economist) Rudi Dornbusch used to say that the Europeans are so rich they can afford to pay everybody for not working. That’s gone.

Mario Draghi is an important central banker and chooses his words carefully. I can’t believe that he would go rogue and speak so frankly about fiscal and other government policy outside the ECB’s mandate without the consent, or at least informing, the likes of Merkel and Sarkozy. So you have to believe that he is speaking on behalf of either the Elites or at least Merkozy in detailing this Grand Plan.

Can the Grand Plan work?
Today, I see commentary about how austerity is biting and the people of Greece (followed by Portugal) cannot possibly survive with a policy of all-austerity-all-the-time. They are missing the point. Draghi said that structural reforms must follow because “short-term contraction will be succeeded by long-term sustainable growth only if these reforms are in place.”

This sounds like a long and hard road. Can it succeed?

The plan sounds like it was written out of the Maggie Thatcher playbook. It is also somewhat Teutonic in that it is well aware of the link between competitiveness and productivity, as well as the remarkable German technique of achieving a consensus between business, labour and government.

I am cautiously optimistic that the Grand Plan could work, which would lead to a period of European Renaissance. For it to work, however, many things have to go right. First of all, you need all of the actors to fall into line and no one to quit because “enough is enough”. So watch the upcoming Greek elections and watch the upcoming French elections for how much support Marine Le Pen gets as important barometers of discontent on the Street. I remain optimistic because we are not at that breaking point because, despite the mass content with the bailout plan, the latest opinion polls of Greeks show that 77% want to stay in the eurozone “at all costs”.

As well, you need to have an accommodative Dr. Draghi (and Dr. Bernanke) standing by to inject the patient with additional quantitative easing morphine if necessary while he is still in recovery. That appears to have been accomplished. Note how Draghi did not rule out another round of LTRO despite other quarters of the ECB voiced concerns about the banking system becoming overly dependent on ECB support:

WSJ: Would you be open to doing more, or longer, LTROs if needed?
Draghi: You know how we answer these questions. We never pre-commit.

Also notice how the ECB’s LTRO program amounts to de facto quantitative easing and money printing, but there hasn’t been a single word of protest from the German hardliners? That’s an indication that there is a Grand Plan which the elites are executing.

The jury is out on the Grand Plan but if this all works, Merkel could be lionized as the new Thatcher and Draghi as the new Maestro.

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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