Q4 Review and a Look Ahead

Clients were reminded early Q4 (when 30% of economists predicted another recession) and since that consumer activity would continue to improve into year end, blowing through estimates and that next, although burning on at best 6 of 8, job activity will continue to improve, modestly perhaps, but improve, also exceeding estimates. (A good part of the reason for the renewed jobs activity is that employers are beginning to be cheered by developments in Washington.) More recently we added manufacturing as an anchor; that is, to expect results north of expectations.

All of these have held well. In fact, we said that ANY major surprises to US real sector activity would be to the side of relative vigor, not weakness. This was the result.

Thus equipped, a trading desk or a corporate planner could then prepare for this reality, spared of the unpleasantry of surprise.

Next, we reminded clients mid December that these anchors would hold into and through Q1. This is still true,  yet - KEY -  economists are beginning to catch on (which we find to be the normal two to three month lag after our anchors are set).  Thus, the Payroll read of Jan/6 does not carry the market-moving horsepower it might otherwise.

Next, clients were also notified early Q4 that US economic activity will eclipse that of other developed credits, including Germany, widening the gap into 2012. An economist we know at UBS noted recently, and with the flair of original discovery that, “There is a sense of decoupling.” Bless Maury’s heart, but  the horse is long gone. And since the US will also remain the primary harbor in the storm, we remain with the Euro strategy set out by Nick early November.

A very Happy New Year to all and see you next year.


Robert Craven

Week in Review

The E-Z continues to struggle as she finds the German shoe a tough fit. The Europe that the Kaiser lost in 1918 and Adolf destroyed in 1945 just fell to Merkel in 2011 without her ever firing a shot.

Still want that sophisticated medical care, the new Mercedes, the ultra-modern airport?  Fine, then drop the daily siesta, the 9 pm dinner, retirement at 50, the 10 - 4 work day and stop cheating on your taxes.  You want this stuff?  Then start behaving like Germans.

Forget it. They won’t. Thus, clients to remain short the Euro to the US (or Canadian $), as described earlier.

Back in the US, debt markets continue to be distorted by those seeking sanctuary from E-Z turmoil.

Yet real sector developments continue to improve. For example, this week’s Claims print reflected an improving labor market. After averaging 459M per week in 2010, new claims have averaged 410M in 2011.  Obviously the pace of layoffs has slowed. Next, continuing claims continue their 2-year long declining trend, as did the number of people collecting benefits under the federal extended and emergency programs, declining from the middle of 2010.

We are simply firing on more cylinders than the street expected, two or three months ago.

Clients were prepared for this reality.

As FI prices are artificially bloated, our insight better worked through FX or equity.


Robert Craven

The E-Z Mess - It’s our Fault!

One need only consult US debt prices today to know money cannot get out of the E-Z fast enough - there is fear and only fear. E-Z banks don’t trust anybody, including their own back office.

Who could have imagined a few years ago that an upcoming Italian 3 & 10 yr debt auction could strike pure terror into the hearts of world financial institutions?  That auction is tomorrow and that is exactly what it has done.

Background:  We can lump the E-Z together as one great big Canada under liberal/progressive leadership, or, a Sweden, both of which created unsustainable welfare states in the mid-90's; both countries were stagnating, heading the way of Greece - excess regulation, excess government spending, excess taxation.  In both cases it only took leadership which was free of pandering, and could explain the economic case to the voter, and, the required pain. Once accomplished, a reversal of course was endorsed; it meant reducing tax rates, reducing spending and destructive regulation, and privatizing much of what has earlier been nationalized.  Both countries are now experiencing real growth, and free of heavy debt.

But the lesson was lost on most of the E-Z. When we consider these types we cannot help but conclude that they’re still just a bunch of spoiled brats. And why not?  The US has protected them for 50 years; most don’t have to spend one dime on defense. After all, why bother? Better funds otherwise destined for this purpose, go to the entitlement zoo instead. Extravagance without a cost, and it’s our fault!

The lesson however was not lost on the US voter, finally seeing the left more in the role of lamprey than benefactor. Even Democrats are now talking about fiscal sanity, about saving money and paying off debts, doing so because their collective feet are being held to the fire, but doing so nevertheless.  Easy promises, the signature of this party, are seen now to be what they always were - theater.

On Nov/9 Nick set out the fundamental and technical case supporting a bearish strategy for the Euro vs the US $, then 1.3553. First target was a re-test of the Oct low of 1.3146; next, “to crack the Nov 2010 / Jan 2011 lows in the 1.2870/2970 zone...” Progress has been satisfactory, last 1.2937. The advice given Nov/9 to add to the position on any strength, worked well.

Finally, Nick has the longer-term target at sub 1.2000 “which is where we think the end-game should..lead to.”  

No doubt.


Robert Craven

The Week in Review and a Look Ahead

Anchors set for clients have performed satisfactorily.

Nick established the case for a weaker Euro vs $ on Nov/9 (1.3553). The recommendation was to use any strength as merely the opportunity to add to short positions.  This strategy has continued to perform well.  The Oct/11 low (1.3146) was the first objective.  Last, 1.3049.

We see no reason, either from a fundamental or technical view to alter course vs the US $.  In the broadest sense, the US (and Canada) will outpace the E-Z area, well into 2012 and most likely beyond. For background, see our Dec/6 piece - Investors, Politics and the Bottom Line. The ECB’s provision of 3 yr funds to troubled banks, the reed through which to breathe, does not alter this picture.

Next, as today’s UK Service sector data, combined with less-than-stellar holiday shopping illustrates, we were a tad too constructive for year-end activity, this credit.  She will get another look in the near term.

Finally, clients were directed early Q4 and reminded almost weekly since to set trades for surprising US vigor, not weakness (especially related to consumer activity and job creation) and/or to set trades for a US distancing of other developed credits.  With the typical lag of two to three months, other observers are now coming to understand.

Late Q3, when economists had the odds of another US recession at 30%, clients were prepped up front, sparing them the necessity of having to react. This foundation has held very well. As we stated then, these observers were driving forward with their eyes squarely in the mirror. Events have fallen nicely into place; we see that Holiday consumption has flattened estimates, that Claims for benefits are at a 3 ½ year low, far lower than observers expected - and - it’s not all just holiday hiring!

Some may say, “But wait!” “What about today’s Income and Spending print for Nov?” It is true that disposable income did not change, that tagged to a less-than-stellar employment market but one which we know is now on the mend. It is true that real consumer spending increased only slightly, but witness the Oct/Nov average which is 2.3% annualized above it Q3 level, making a solid contribution to Q4 GDP.

Not to worry. We are only interested in capturing price change ahead; this is not a history class.

Key to our service is that Qt / Qt , year to year we prepare our clients for economic reality just ahead vs expectations, thus equipped, the landscape in hand, they can anticipate financial headlines, spared of the necessity to react. Simple and effective.

Very little on the US agenda next week but - key - the view will continue to build for more US vigor, and, for the US distancing of other credits. This reality then can be worked by the way of FX, FI or equity.

Merry Christmas

Robert Craven

The Market Crowd - Desperate

Headlines in Tokyo last night - “Asia stocks set for biggest advance in two weeks on housing starts.”   This is too much.

Knowing investors would retire for the night more secure, the media trumpeted yesterday’s Starts print as the spark for a world recovery, not to mention the spark in equities.  Fine. Tucked in for the night, all are content. And, misled. And Tokyo, never given to original thought anyway, takes it from there.

In fact, housing contributes perhaps 17% of GDP, maybe 5% of that the investment itself, and 12% for housing-related services. This is not puny but not major. We have set well-performing anchors for our clients - jobs and consumption - which totally eclipse this contribution. Housing has not been an anchor for us as we expect no change in the dynamics of that sector over the intermediate term.  And most of the strength in Starts was in multis, because no one wants to buy a home anyway.

No one knows the answers to a market move; the press, as always, knows least.  But, in a world were any news regarding hope for one’s home price, where in some areas of CA for example, most home prices don’t account for the first, then it’s good news, even if it doesn’t mean much. So it was fuzzy warm stuff, nothing substantive.

We don’t know all the real reasons for yesterday’s great cheer (no one ever does) - the ECB 3 yr line was one, Spain’s auction another, Germany’s IFO read another, a no doubt, many others. But Nov Starts & Permits?  If so, the great cheer is to be short-lived.


Robert Craven

The Week Ahead

All eyes are on the E-Z.  Nick Kennedy is most qualified to discuss that region but he is still recovering from a nasty bike accident, one which would have taken most of us out.  

In a sketch Nov/9 Nick set out the combined fundamental and technical case for a weaker Euro (then 1.3553), the first aim to re-test the Oct/11 low of 1.3146, then the next objective, “..to crack the Nov 2010/Jan 2011 lows in the 1.2870/2970 zone..”  After that, to consider the longer-term targets sub 1.2000, “..which is where we think the end-game should...lead to.”

The currency ran counter for just a few days after Nov/9 on E-Z posturing, and then commenced to perform according to plan.  The advice, “The ebb and flow of news from the Eurozone should continue to provide periods of volatility and we’d recommend using any short-term reprieve to add to short positions” was spot on.


From the US side, Thursday’s Claims print is the key release for the week given last week’s very encouraging read - a 3 ½ year low.  Another result even close will send economists scurrying back to their desks in full revision mode.

Friday’s reports (Nov Durables, New Home Sales and Income) won’t deliver much impact one way or the other, our view;  few will be looking anyway.


Robert Craven

The Week in Review

We have seen “surprising” strength in real sector activity this week, US side; and as we witnessed this am, the trend year-over-year rate in inflation is accelerating; that is, moderate price pressures are building, with consumer prices now 3.4% above their year ago level.

Fine, yet where is the typical response from interest rates? Not to be found. Most link this to the quest for sanctuary - world investors in a rush to park in a spot where their VW won’t be swept away by maddened E-Z types.  This is a large part of it; certainly our E-Z friends continue to provide reason to seek cover, including bank funding problems this week.

Yet there is more.

That “more” is partly a Fed on hold, but primarily it would be the growing view among institutional investors that, ok, sure, they missed the relative vigor Q4 (perhaps as they failed to consult Hades Research) but that’s it; the US will succumb. “Can’t any steer weather that storm,” as ‘ol Walt our cowboy used to say, that storm being the next world recession.

Well Walt, you knew your stuff; there’s none that could have taken the licks you took, then got right back in the saddle at 89, back up on your favorite mule. We’ve got a mule right here Walt; just like yours, she’s tough, she’s bent on a vision; she’s indestructible. Those who believe she will succumb are mistaken.

Now then, what does this mean for the desk?  Over the near term it means to set trades at leisure, the US or Canada (piggy back) vs the E-Z zone, Germany included, and unfortunately, even the UK.  It is quite obvious now, not necessarily earlier when Hades first broached the point, that the US will distance this region, and, at an accelerating rate.

Next, we have highlighted the role of the Chinese consumer in providing horsepower over the near to intermediate term. And we can count on that, which when combined with US leadership will prevent another world recession. But over the longer term China will find itself in the role of “drag,” the role of cowboys who the trail boss put in the rear of the cattle drive. A dirty, dusty and dangerous job with few rewards. Some were destined for it - never quite able to learn how to get along with the rest, being rowdy, picking fights, stealing grub or cheating at cards. So eventually is China destined for it.

Robert Craven

Q1 and Desk Anchorage

Any major surprises in the US, Q1, to be to the side of relative vigor, not weakness.

Two primary anchors have been set for some time - consumer activity and jobs activity, meaning we could expect prints through expectations. We have experienced a bit of slippage with the consumer, but not much; that for employment has held very well.

Both will continue to hold into and through Q1. We will add Manufacturing for Q1. Here most economists will miss the boat because they will under-estimate export demand, thinking it to be completely dried up.

This then provides the landscape.

Naturally the E-Z and the Middle East are wild cards. This is why past many weeks we have recommended only a few trades, the most reasonable and conservative strategy, and entry only when odds of downside were far eclipsed by odds of upside.  This worked very well on two occasions with the UK curve, once with the US curve, and earlier, the US 10 yr to the Bund. The last exercise on the US side however, reviewed yesterday, was not satisfactory as we did not recommend an exit after substantial progress, late October. We were caught flat-footed by E-Z events.


Robert Craven

The US Term Structure - A Saga

We recommended Oct/11 that clients own (L-S) the US curve, with a reminder on Oct/13 that nothing had changed, to remain or get long, especially 2-30, despite that day’s very successful 30yr auction.

We try to keep things simple with our spreading activity. We had been watching the curve; it had come in some given disappointing real sector results, and, moderate quality flight tagged to E-Z worries. Our trigger was that we expected real sector results to exceed expectations in the near term. Next, we thought the recent operation “Twist” by the Fed, past a few days, would have the reverse impact desired. The E-Z presented the major threat to the trade as we had no idea what these types would be up to next.  But even given that, we thought the spread was narrow enough to weather most of it - that is, it had a contained down side and a substantial up side.

The strategy performed satisfactorily early on, expanding so that by Oct/27, 5-10 was better by 14 bps, 2-10 better by 12 and 2-30 by 37.  To be expected, given that we had an E-Z “deal” that day, and, given that recent data had cooperated. That is, absent world panic, fundamentals worked to expand the curve.

Then however, intensified E-Z worries impacted the spread; the panic on Oct/31 brought the wider trades in considerably, 5-10 less so. At the close Oct/31, 2-30 was 290 vs 313, Oct/27.  Further panic Nov/1 brought 2-30 in to 281; 2-10, to 178 vs 200, Oct/27.  By Nov/18 we were at entry level on 2-30, 13 better on 5-10 but 15 worse, 2-10; and again, even though US releases had cooperated.

Recently the spread expanded modestly, on better-than-expected US results and diminished quality flight. But at the close today we are narrower on the Fed’s report, on renewed E-Z concern and on the growing view that Q4 real sector improvement may have topped out.

Thus, we are not as enthused as we were in early October. Course of least resistance for this spread is to remain wider and we want to look for chances to own, not to sell it but we don’t expect a heck of a lot of progress over the near term. For those looking to enter this trade, concentrate on 5-10, the most reliable performer, the least likely to be stricken by world panic.


Robert Craven

US Consumer

Today’s Nov Retail Sales print was far inside of expectations; we predicted that the result would exceed expectations.

We were very wrong on today’s result, having missed the pause in food & beverage activity.  We set an anchor  to provide security to the desk; on this occasion it failed.

Perhaps we had grown complacent, having experienced satisfactory results past months.  We’ll take a look and be back on this one.


Robert Craven

The Week in Review and a Look Ahead

We’re not sure exactly why we were hit with the revelation this week, but it is what it is - the US economic engine is to remain without a rival.

It is clear now that Europe will never coalesce into an economic threat. Some draw a parallel between the E-Z and our colonies, seeing this week’s Brussel’s summit as the equivalent to our Constitutional Convention. Hardly. It is true that under the Articles of Confederation states threw up barriers to inter-state trade; it is true there was no central funding authority. The Constitutional Convention of 1787 addressed these issues.

But the colonies shared an abhorrence of centralized planning and power. The colonies shared also the belief that merit was sufficient qualification for success. These things set us apart from the E-Z. America has no particular national ethnic or racial profile; this ends the argument.

It is also quite obvious to us now that China will not become an economic substitute for America. She can ape but not create. The idea of a Chinese-invented Google for example, as a our neighbor Vic Hansen remarked, is a “a paradox.” (Similarly, “a Russian Facebook is a joke, a Japanese-inspired Walmart impossible.”)

China is an international commercial bandit; she lacks transparency and the rule of law; she has vast inequalities and no stable political system to transition the bulk of her population into an affluent citizenry. Central planning dooms her to failure. Bureaucrats cannot effectively allocate resources; they can only buy time.



We will be traveling so have wrapped our usual Week Ahead into this sketch.

The US economy will continue to surprise most economists to the side of vigor. The desk can count on this reality and would be best advised to set trades with this in mind if they have not already done so.

We were able to isolate this dynamic ahead of most others because of the 1) knowledge of flawed models and because of the 2) understanding of crowd behavior among analysts.  Once we have a better idea than consensus regarding the economic landscape ahead, we have captured price change.  Of course the world’s great rush to sanctuary has muted that a tad, for example our curve illustration - bloody nuisance those E-Z types!

The key US release next week is Nov Retail Sales. We look for the print to broach consensus.

We have the FOMC on the 13th.  Despite some wiser heads in the bunch, the bias is to further accommodate; not now but later. Such a move will spark commodity prices (again) and expand the curve. There is also talk the Fed will attempt to move to further transparency. They had better leave well enough alone. They can only get in trouble.  We appreciate the gesture however as we had a hand in bringing about some semblance of transparency under the Greenspan Fed when Greenspan fought it every inch of the way, when FOMC decisions were leaked to one of two WSJ reporters, when FOMC deliberations were recorded but Greenspan told Congress that they were not. That was an extreme. But if the Fed tries too hard, goes overboard, they will simply confuse the markets.  Few at the Fed have ever understood the connection between policy intent and market reaction.


Robert Craven

US

Let us leave the E-Z mess for a bit and return to the States.

We are very pleased with our results past several weeks.  We have been able to alert our clients up front to relative vigor while St economists and the rest were all looking the other way.  This is our job. It seems obvious now of course; they knew it all along; and so it goes.

The US will remain the world’s locomotive, with the consumer, and, increasingly into H1, the employer gathering momentum.  Our anchors will continue to provide a reliable trading background. Any major surprises to be to the side of strength, not weakness.

This describes the landscape ahead.  We can illustrate with a trade from time to time, but trust our trading clients can best see to that.


Robert Craven

UK

We have been long the UK term structure from Nov/9, 5-10, then, 108, last 132; 2-10 then168, last 188; 2 - 30 then 270, last 281.   We noted recently we were content to stay with the position, but today’s Ind Prod print, although dated, is worse than we had expected. Plus, the spread is not working as we had hoped given the E-Z situation.

This was a satisfactory experience. Others may want to stay with this position. For purposes of illustration, let us exit the trade and we’ll take another look in a bit.

Robert Craven

Investors, Politics and the Bottom Line

We want to exploit any major price change - elation -  associated with a near-term E-Z “cure.” This is especially true for investors/spreaders who may wish to take a long-term view of this region.

The E-Z template was imprinted on the US because a radical gained traction (McGovern, the only other radical to come up, thankfully failed). This was a first. Americans witnessed the repercussions and want no more of it (as demonstrated Nov/2010).  We have a statist, interventionist president who is an economic illiterate, one who had a direct hand (along with Clinton, Dodd and Frank) in creating the crisis of ‘08, and then went on to make it much worse.

At one point Obama was even being lectured by E-Z types for his reckless ways!  Now, our so-called “red” states, those which lean conservative and reject the way of the levelers, are healthy; our “blue” states are all broke. The anti-democratic and redistributive mentality of the E-Z is an experiment that failed here.

The US masses have begun to catch on and know now that “stimulus,” Obamacare, buying into GM, new regulations, all the rest were snake oil, something from a 19th century medicine show which came with a hawker, often called professor or doctor, who sold the magical elixir to cure all ills. In this case, none of it worked (except for unions). As a result, the majority of US voters now cannot quickly enough embrace the notion of less government, lower taxes, less intervention and a fair and level playing field.

There is no similar hope for the E-Z. The governing elites are about to impose policies that increase the power of government. There have been some spending cuts but these are more than offset by higher taxes. A significant contraction of the public sector (beyond a token), any major reduction in stifling regulations, a sound currency, lower tax rates - forget it. In fact policy on the whole will be set to penalize the private sector.

For those who make their living trading relative value around the globe, understanding this reality is key to success.

Thus, given the opportunity investors will want to spread N American credits (Harper’s crushing of the left in Canada provided a spark for that country’s economy), the UK and perhaps Japan to E-Z credits, including Germany.  For the near term we can include China but unless we have real reform, not for long.


Robert Craven

The Week Ahead

All eyes are on this week’s summit in Brussels.  We have no special insight regarding this event.

US releases this week pack only modest market-moving muscle. We can be certain however that the trend in the US vs the E-Z will continue into 2012; that is, growth in the US will outpace that of the E-Z, and, at an accelerating rate through H1. Key - this is true notwithstanding the outcome of the Brussels summit. The desk may want to take this consideration to heart in setting related spreads.

The UK is of course a different case, depending as it does on the E-Z for the hog’s share of its exports. Aside from an auto manufacturer or two, nothing seems especially rosy (sorry Starbucks, but those 5000 jobs won’t provide much of a jolt), with observers predicting the worst Christmas spending in years, with discounting so severe that stores won’t make any money anyway. Finally, UK firms must tackle the very real possibility of dealing with Club Med types who exit the euro. Folks more in tune than we figure a 40% devaluation, meaning profits for UK firms in those countries would tank when converted to Sterling.

But then all of the above is priced in. In fact, more than priced in because the UK consumer will eclipse expectations. We remain relatively constructive into 2012 given the fiscal prudence shown by the administration and a central bank ready to fire on all cylinders if necessary.  The most obvious (and safest) way to work our view has been the term structure. We had a  satisfactory exercise, ending late October. This spread then flattened given severe flight from the E-Z. We re-entered this spread at the same levels we entered the first trade.  The spread is now at levels of the last exit.  However, unless one senses an immediate and total E-Z melt down, stay with the balance until further notice.

China will continue to contribute over the intermediate term as she attends to her consumer, gradually abandoning her mercantilist ways (and why not as export demand has slackened anyway). In the longer term of course she is in trouble unless officials there read our last piece under Musings.

Finally, events in the Middle East remain a potent wild card, carrying in fact far more potential to wreak havoc than the E-Z could ever come up with. We know exactly what even $5 fuel will do to the world’s primary locomotive - stop it dead in its tracks.


Robert Craven

Obama - the Job Killing Machine

We have written for two years, and quite correctly we might add that Obama’s regulations and the threat of even more are the primary retardants to US job growth. This is an inconvenient fact for the left, but a fact nevertheless. It is not conjecture; we have it directly from CEO’s.

George Will brings the example of Carl’s Jr restaurants to mind in a recent piece.

Writes Will, “In 1941, Carl Karcher was a 24-year-old truck driver for a bakery. Impressed by the large numbers of buns he was delivering, he scrounged up $326 to buy a hot dog cart across from a Goodyear plant. And the war came. So did millions of defense industry workers and their cars. And, soon, Southern California’s contribution to American cuisine — fast food. Including, eventually, hundreds of Carl’s Jr. restaurants. Karcher died in 2008, but his legacy, CKE Restaurants, survives. It would thrive, says CEO Andy Puzder, but for government’s comprehensive campaign against job creation.”

Will continues, “When CKE’s health-care advisers, citing Obamacare’s complexities, opacities and uncertainties, said that it would add between $7.3 million and $35.1 million to the company’s $12 million health-care costs in 2010, Puzder said: I need a number I can plan with. They guessed $18 million — twice what CKE spent last year building new restaurants. Obamacare must mean fewer restaurants.”

But for all but the willfully blind, this is no surprise.

Finally from Will, “In an economic climate of increasing uncertainties, Puzder says, one certainty is that many businesses now marginally profitable will disappear when Obamacare causes that margin to disappear. A second certainty is that ‘employers everywhere will be looking to reduce labor content in their business models as Obamacare makes employees unambiguously more expensive’”

Let us look to the Nov/12 election for an end to this nonsense.


Robert Craven

China is Doomed, Unless.....

Suddenly the media is loaded with commentary regarding an end to China’s miracle if she does not discard the evils of central planning.

These authors are correct.

We stated that there would be no so-called “hard landing” in China (with growth at 9%, we suppose a hard landing there would be a welcome event anywhere else). In fact, we have highlighted the Chinese consumer as one locomotive to a world recovery.

The reason for that optimism is that we know that central planning can appear to work, up front. For example, it is well known that authorities deliberately deflated the property bubble by forcing lenders to cut back loans to developers. And we saw that the central bank acted reasonably with only modest lifts to combat inflation.

Yet however reassuring these things may be, the time frame is limited, short to intermediate term, within our normal window; that to which most desk trading decisions are confined.

Centrally planned economies sometimes thrive early on because central planners pump resources into sectors where market demand is nonexistent (in China, this may mean targeting the interior provinces next).  As a result, these economies avoid recessions for a bit; yet it is a phony fix. Eventually, as the Soviets learned, the mis-allocation of capital results in an ultimate tanking of the economy. And there will always and everywhere be mis-allocation of capital in a planned economy. Real prosperity is spawned only by economic and civil liberty; that is, the rule of law.

Thus, if we are to venture past our normal strategic time frame we would say that China is doomed if she continues to favor bureaucratic planning decisions over the unseen hand.  It won’t work. China’s absurd home purchase restrictions - controlling the number of homes each family can buy, whether they can afford it or not - is a perfect case at point.

In conclusion, we will look for near-to-intermediate term resilience from this credit but her life span is limited and her economy will implode unless adoption of free-market principles become not partial and cloaked by party jargon, but wholesale and transparent. If it is political change which precedes economic change, we may be hopeful. But it may take a new generation for this to happen, and it may be too late.


Robert Craven

The Week in Review

Evidence this week supports our view that the US remains the world’s locomotive, to be followed closely by China.  Finally, we remain constructive on the UK vs consensus view.

For either trading operations or for corporate planners, continue to rely on these anchors. However, violence tagged to the E-Z has provided some distortion to traders, making the translation to the bottom line a bit sluggish.

For example, we have highlighted the US and UK term structures as the very simplest way to illustrate our point.

We recommended owning the US curve from Oct/11, 5-10 then 101, 2 - 10 188, 2 - 30 then 289. The curve expanded well enough into early November, then came in with massive flight to safety, last 113, 185 and 284.  Remain with this or similar positions as fundamentals will continue to support the trade.

We likewise recommended owning the UK term structure on Nov/9, 5-10 then 108, 2-10, 168, 2-30, 270.  Last, 129, 193, 290.  Underpinnings detailed earlier remain in place, both fiscal and fundamental. Realize some profits perhaps, but remain with a majority of the position.

The new Fed-sponsored facility put in place this week does provide some solace, putting dollars to the Europeans at about 60 bps. Since this is cheaper than the 75 charged at the US discount window, there are rumors of a cut in that rate. “Why should Europeans get money cheaper than us?” ranted one banker. Because they don’t. US banks borrow at the FF’s rate, or about 8 bps.  So a cut is meaningless. Our banks don’t have funding problems.

Finally, despite the protests of Richard Fisher (perhaps the most qualified of the bunch) and a few others,  the Fed remains biased to stimulate further. The result will be to 1) bloat commodity prices, 2) spark equities, esp those of the less deserving type and 3) expand the term structure. That’s fine for the desk but it will backfire and retard consumption if indeed they pull this trigger.

Out of the spotlight, the Middle East remains a potent wild card.


Robert Craven

Caution

In making judgements regarding the US real sector one must be careful not to be drawn in; that is, the considerable hype pertaining to events in the E-Z can be a distraction.  Key is to not let these become something more.

It is very easy to get caught up in the headlines and to gift more weight to matters of contagion than they merit. Our secret, past few months, is that we did not.

For example, in today’s ISM report witness the major improvement in the new export orders index.  Unlike the E-Z, we are not experiencing a significant contraction in foreign trade.  We have always been able to grow without Europe and we will continue to grow, with or without Europe.

Robert Craven

Method

At this center we do things a tad differently. We are only concerned with FI price change ahead.  Thus, we don’t really care if we are right, just less wrong then everyone else.

Our method is to look at consensus, that which is priced in and scan for any major flaw.  We are economists but we don’t think like economists.  Thus, detecting this flaw is more tagged to understanding crowd behavior than it is analytics. Economists make up a crowd; they behave as such. They are prone to sometimes exaggerate an error as can happen with other types of incestuous behavior.

Example:  In the most recent case, these observers, partially swayed by headlines and victimized by flawed models, missed consumer resiliency in the US and to some extent in the UK.

There were others, but this is a primary reason that we urged clients to own both term structures, the US from Oct/11 and the UK from Nov/9.

Depending how our insight was worked  (and we are reminded by a colleague in the UK that, “..once the strategy ..is set,” one needs to isolate “..the best bonds on the curve, whatever is rich-cheap and sometimes the best bonds are not always the benchmarks.”) we now have moderate profits on the US set and more-than-moderate profits on the UK set.

Leave most of all of these positions in place.


Robert Craven

UK

We remain constructive on the UK; nothing fabulous of course, but something through expectations - all that counts in anticipating price change. This in spite of the recent IFS report which claimed the new growth policies “are really quite small.” Thank you very much sr research economist Hellen Miller but you couldn't find you way out of a wet paper bag.

After an earlier, satisfactory exercise, we recommended Nov/9 that clients once again own the term structure, the 5-10 spread then 108,  2-10 at 168 and 2-30 at 270. (There may be far more imaginative methods to work our view, yet the curve serves the purpose.) This spread did little at first, then expanded modestly, so that on Nov/29 levels were 118 and 180 but the 2-30, only 261.  Last, 120, 185, 268.

It is easy to criticize the administration. But in fact any surprises have been to the side of prudence, not profligacy, which includes eliminating public sector excess. (Indeed, we see that with traffic at Heathrow as “better than usual,” Border Agency types are about to meet the same fate as air traffic controllers under Reagan, who similarly thought they were somehow among the anointed.)

Finally, we believe there is much more to the UK consumer than most economists understand.

All of this supports our view.

UK strategies are to be set to the side of relative strength, not weakness.


Robert Craven

US

Clients are to continue to trade the US to the side of relative vigor; that is, any surprises are to be tagged to strength, not weakness.

We have set two anchors for the desk: job-related and consumer activity. Recent data have cooperated fairly well, including the last Payroll print, subsequent claims prints, and of course, consumer activity; witness the holiday brawl to acquire a $2 waffle maker: http://www.twitvid.com/QM7T7.

Friday will see the key Nov NFP report. Jobs activity has been stronger than expected - our prediction - but of course, not absolutely strong.  As we have explained before, an interventionist administration is the key to understanding this reality. The constant threat of regulatory change is the primary retardant to small-business job creation. Now researchers at the Cleveland Fed provide academic support to this otherwise common sense view. "While the downturn and weak recovery certainly had a large negative effect on small business hiring plans, policy uncertainty has exacerbated this effect," researchers Mark Schweitzer and Scott Shane said in their report.

Clients could work our insight in any number of ways; as an illustration, Oct/11 we  recommended owning (L - S) the US term structure, then (5-10, 101 / 2-10, 188 / 2-30, 276).  There was modest expansion early on, but most recent results have been impacted by the world’s flight to sanctuary. Nov/10, the spread at 114, 183, and 289. Last, 108, 176 and 273. Unless one expects a total E-Z meltdown, remain with this or related positions.

Robert Craven

The Week Ahead and the Final Clue

We understand now that our problem all along has been that we took the E - Z elitist types seriously.  Charlie, the cowboy who works our ranch in California, noted way back, “Are you kiddin' me.  This damn thing’ll never fly.”  That was our first clue.

The final clue is that we learn today that EU types claim water does not work, and they want that in print! The clowns in Brussels are now banning drinking water manufacturers from claiming that water may help to prevent dehydration. The poor soul who dares print that water may help the body along faces two years in the slammer!  And somebody thought these morons could manage a combined currency of 17 nations?  Hah, hah.  Too much.

And the mess? The ECB will not cave to a full blown QE.  It rightly does not consider as part of its mandate the rescue of sovereigns. That is not its understanding of lender of last resort.

Next, the EFSF is going nowhere as its finances depend on the very same characters it is meant to bail out.

Thus, we think we’ve been right all along - we are headed to a smaller and more manageable E - Z. Tough to get there but nothing compared to what we face otherwise - a meltdown.



Little market-moving muscle to US releases next week. The Durables print (Wed) can be put to its room as it is prone to violent behavior. The Michigan sentiment read the same day means nothing.


Have fun as we’re off to Arizona for the Holiday to see our daughter Kim, husband Carter and granddaughter Reagan.


Robert Craven

The Week in Review

We have observed world credit markets for over 25 years; rarely have we witnessed an event so stunning as we did this week - world investors in a sudden rush to throw Germany’s debt to the wolves.

We recently recommended to short US debt to the German equivalent, this based on our view of relative fundamentals. That part worked fine, but our colleagues in London warned us there was something else.  Something else indeed. Our Chinese friends and the rest decided to lift anchor and pitch Germany in with the rest. It is not surprising then that this week the biggest percentage increase in insurance cost for default, was for German debt!

What our colleagues sensed, and we did not is that investors would look to the Germany after fiscal union, or to the Germany after a break up. Reuters, “The first outcome would imply higher borrowing costs for Germany while the second would saddle Germany with a new national currency that would appreciate so sharply that it would cripple exporters and therefore the economy.”

Never too old to learn.

Robert Craven

US Consumer

One of two desk anchors - the significant flaw to St estimates regarding US consumer activity. This anchor was set in September when observers were preparing their estimates with their eyes in the mirror.

Because our job is to isolate price change ahead, we are not so much interested in results in the absolute as vs expectations. Thus, clients knew the odds were very high that spending results would flatten estimates. This is what happened.

Now most economists, having been caught with their pants down, have hitched up and corrected their models.  Not by enough.  Thus, clients are to expect spending results to strengthen into year and through Q1, and, by more than forecast.

Fed recklessness (QEII) spiked commodity prices. Earlier, the so-called Arab Spring played its role. Now that price pressures have eased, and key - now that consumers have accepted the E-Z mess as a permanent fixture, not to worry, they are back at the malls. (Consumers may have something there.  As E-Z banks contract lending, which they will, US banks will swoop in.)

Finally, based on this surprising consumer activity economists have now elevate their Q4 GDP forecast from an average of 2.4%, Nov/1 to an average of 3.3% today.  

Better to anticipate, than to react to such a change.


Robert Craven

Tug Of War

Having had our fill of the E-Z by 7 am our time, let’s re-focus on the good ‘ol US.

Key to understanding price change just ahead, always, is to understand consensus flaw.  We have known for several weeks that economists, behaving as a crowd  - holding hands, crying out together in the dark - have mis-understood the consumer and labor sectors of our economy.  Recent releases have of course played out nicely; yet our rule still holds - if there are to be any surprises ahead, these will be to the side of vigor, not weakness.  Simple.

Despite the US downgrading by one of the now thoroughly discredited rating agencies, despite this awful reality, world investors cannot own enough of our IOU’s.  This has abated what would otherwise be increased tension in our credit markets.

Not understanding what the E-Z will cook up next, we want to avoid out rights like the plague. But our sense of risk and events tells us that clients should at least retain reasonable strategy to fit our view. The curve of course is one. A cooling of E-Z events and it will expand abruptly; any further Fed tinkering will only further such an expansion.


Robert Craven

Sanctuary

The world’s mad dash for sanctuary has proved to be corrosive to recent strategies set for purpose of illustration. As always, strategy is based on our view of economic reality just ahead, vs St consensus, that which is priced in. Clients of course can work our insight in any number of ways.

Our US anchors have held very well, today’s Claims print a fit. We have been long the US curve from Oct/11; this progressed modestly, spreads expanding, but now back to entry levels on 2 - 30, better by 12 bps on 2 - 5 but worse by 12 on 2 - 10, beat to death in the flight to safety.

We have once again been short US debt to the German equivalent, set Nov/2 with the US 10 yr then plus 16 to the Bund, then out to 28 or so, or 30 target re-set to 40 (what?) but last print, plus 17.  We will abandon this trade.

Finally, given our relatively constructive view on the UK (today’s Oct Retail Sales print fit our anchor nicely) and what we understand will be the impact of any further Bk of Eng firing, we have been long the UK curve from Nov/9.  Most levels along the curve are unchanged but 2 - 30 is worse by 8 bps.  Here again, beat to death by E-Z events.

If one understood that an E-Z Armageddon were just ahead one would abandon these, or related positions. Today’s events in the E-Z perhaps qualify!  If one feels that we may return to the link to real sector developments, one would then maintain the US and UK positions or similar. But if by a returning to normality one expects the ECB to launch a full fledged QEI, forget it. It won’t happen.

Wild cards remain the E-Z and Middle East.

Robert Craven

Piano Overhead

We have been constructive on the US consumer for some time; most others have now come to join us.

But maybe at the wrong time.

Oil is at 5 month high, the WTI benchmark up 3.2% today alone to $102.59.

Recall the spike, March and April of this year.  Economists’ models didn’t flash red until too late. Not being similarly handicapped because we never use models, we predicted ahead of this crowd that the spike (as translated to gasoline prices) would slow consumption substantially.  This was the result.

Now, the same bunch, caught flat footed earlier, are reluctant to get rolled again. This time they may luck out.

Nigerian cutbacks and bloated demand from emerging credits (China, India, L America) are frequently sited culprits. Speculators are another. So is potential conflict, Middle East. In fact, our view is that this is the primary culprit. It’s easy to say it’s mere saber rattling over there. Odds are very good that it is something more.

WTI at $102 + does not impact gasoline immediately as it would in the summer. But if prices hold, then move higher - which we have as the course of least resistance - then we’ll all have to sober up.


Robert Craven

Snapshot

UK: With price pressures subsiding, and the Bank of England about to release a sour report, first appearance is that it does not seem too bright to be long (L - S) the UK curve. In fact, our last exercise has been disappointing, an entry recommended Nov/9 yet levels are either unchanged (5-10, 2-10) or in 3 or 4 bps (2 - 30).  We don’t sense a violent leveling, so let’s stay with this one for the time being.

E-Z: We want to remain short US Notes to the German 10yr.  Consensus view was caught flat footed; most recent German releases were weaker than expected, our earlier predication. It’s true that today’s Q3 GDP print was better by a tad (0.5%) but that’s ancient history. E-Z hysteria will wear and the contraction of bank lending will wear.  The US suffers neither of their maladies.

US: The US (and China) will remain the primary engine through H1. Clients are best advised to set trades with that in mind.

Past many years we’ve averaged about 70% on sensing economic reality ahead; that is, reality vs a mistaken Street view.  The odds simply do not favor a view contrary to that provided from this center. Therefore, at the very least, use our insight as a backstop, last check before entry.

Robert Craven

Overview

Continue to set US trades for surprising vigor, not weakness.

Tomorrow’s Oct Retail Sales result will not be much to write home about, but that hesitation is priced in and tagged to E - Z violence.  Shoppers will become accustomed to this reality, if indeed it continues to be a reality, adjust, and then head for the shopping center into year end.

A headline this pm has SF Fed staff putting the odds for a recession H1, at over 50%.  Good. Since Fed staffers are the least capable of closing the pattern ahead, since they aren’t trained for it they deliver a gift from time to time.  Thus exploit, do not join any price change tagged to this well publicized story.

Finally, another leg of relative strength, and a desk anchor, is the US jobs market, but note relative, not strong. In the US the jobs market will improve despite the hindrances placed on employers by Obama. Without these, we would be hitting of 7 of 8 at the moment.  The flip side of Obama’s profoundly flawed policy is that employers were forced into efficiency; that is, they made investment decisions put off for years because new employees, even if needed, are freighted with unknown risk (Obamacare for ex). CEO’s are paid to take risk but not on an uneven and undulating playing field. This reality delays our recovery. That, in distilled form, is our jobs story.

The UK’s jobs story is illuminating, and something else altogether. Many UK employers are also on hold (witness today’s CIPD and CBI surveys) but not due to an uneven playing field at home, but to E - Z uncertainty, not a clueless administration. We note too from the CIPD that hiring in the private sector will hold up, it is the public sector which will take the hit.  Worse things have happened.

This reality is one reason we remain constructive on the UK.


Robert Craven

The Week Ahead

US releases this week carry considerable mkt-moving muscle: Oct Retail Sales on the 15th, Oct Ind Prod and CPI on the 16th, then the Nov Philly Fed survey result on the 17th. Nov/1 we said to look for a very active consumer. Correction: Now it appears that - very active - is for later. Instead, we would expect the Sales pace to fade just a little, temporarily, given the whiplash recently delivered by our European friends and the media’s role at expanding on the violence.

However, for the balance of Q4 any major surprises to be delivered from the US economy to be to the side of vigor, not weakness.

Next, we noted earlier that the German economy would slow more than anticipated.  That was the result. Others have now come to understand this reality.

Next, the West demands the ECB launch a QEI. But the ECB, unlike the Fed or Bank of England has a single mandate - price stability. Anything beyond that is planning, that is, non ruled-based activity. After witnessing the Fed’s exercise and resultant commodity price increases, not a chance. That means that Germans and other members of the willfully blind, those who pretend the euro is something it is not are soon to surrender and decide to banish the miscreants.  This is close to what we can expect - a smaller and more stable E - Z.

Back across the Channel, there’s more to the UK economy than is priced in, our view. The UK cannot escape the impact of a collapsing single currency but she will survive it. We are further cheered as it has become obvious that Osborne and others learned something from Obama’s “stimulus” tragedy. For example, the proposed $80 bln housing and road-building program will be financed through the private sector, IF of course it can be demonstrated that the return is there.  But the spirit is spot on, that is what is key.

Government-funded jobs programs have never created new jobs on net because they amount to taking water from the deep end of the pool and pouring it into the shallow end.

Henry Morgenthau Jr. was secretary of the Treasury to FDR and key architect of FDR’s New Deal: “We have tried spending money,” he said before Congress. “We are spending more than we have ever spent before and it does not work. I say after eight years of this Administration we have just as much unemployment as when we started. … And an enormous debt to boot!”

Finally, we do a bit of backpacking in the Sierras. Over the near term, the market view will grow that the US and Chinese consumer are quite capable and willing to pack the load for the rest as these recuperate at trail side.

Naturally the E-Z and Middle East remain potent wild cards.

Robert Craven

The Week in Review

We have had two US anchors set for clients, past several weeks.  From these was birthed the maxim that trades are not to be set based on disappointment, that is, on US weakness.

One of these is that job related activity will broach estimates, indicating more vigor than expected. This week’s Claims result fit perfectly.

The other anchor is that consumer activity will broach expectations. We have come in a tad on this one; EU developments combined with the media fetish for bad news have been corrosive to US consumer activity. Most consumers take it at face value that the US is not directly involved (forget about indirect exposure, they never heard of it).  Nevertheless, the aspect of contagion is now all over the news - Greece to Italy to France - and is beginning to scare them; they don’t know exactly why but it doesn’t matter; it is beginning to directly impact discretionary spending.

We think that is why chain store results last reported were a bit south of expectations, not as conventional wisdom would have it, because wages lag, or savings are depleted.

So we get it directly in the grocery line, and directly from our local hot dog stand - “What in the world is going on over there?”

In order of magnitude, this will shave consumer activity 10 - 12% of what it would otherwise have been, Q4. Still pretty good spending, just down to about 63 mph from an honest 70, 100 top side.

Finally, to review strategy set in place, all of which is based on our view of economic reality just ahead.  Nov/2 we recommended clients sell US treasuries to the German equivalent, to be illustrated by the 10yr, the spread (‘Old Faithful’) then US +16, last +28. Initial target set at +30, now +40. Next, we have been long the US curve from Oct/11. Given quality flight tagged to the EU, progress has been modest, 5 - 10, then +101, last +114; 2 - 30 then +276, last +289.  Finally, we recommended Nov/9 that clients once again own the UK curve. Levels are unchanged.


Robert Craven

The Two Engines That Could

Lost to many given the EU circus is in town - today’s Oct Import print for China, at +28.7% Y/Y, blowing through estimates. We featured China considerably earlier in the year, highlighting the government’s ditching of the old policy of mercantilism, for one reflecting a little more care for the consumer.  This is faithful to the latest 5-yr plan (2011 - 2015) aimed at boosting internal consumer demand as the main engine of growth.

We also note that consumer and producer prices are easing, throwing a bit of slack to the Bk of China.  As we have stated repeatedly for the past 15 months, there will be no hard landing. The rest will come to join us in this view.

The US and China will remain the world’s two primary engines through Q1.  Events in Europe, first amusing, next an irritant and now a worry, will have limited impact on both these credits.

Robert Craven

UK

Oct/6 we advised that clients own (L - S) the UK curve and, or sell the Gilts outright. That trade performed very nicely and a full exit was recommended Oct/28 (10 yr, 2.62%, 2 - 10, +202). Since that date of course the curve has come in with prices much firmer (10 yr, 2.19%, 2 - 10, +166).  Leave outrights alone but it is now time to again own the curve. There is more muscle to the UK than most understand, even including likely negative impact from our EU friends.

Robert Craven

US Term Structure

We advised clients Oct/11, with a reminder Oct/13: Today’s auction of the 30yr went well at 3.12%. "It’s the only place to be," say strategists, and, "we know the Fed is a buyer."  No matter. Remain long (L - S) the curve.

Past many years, our favorite diagram or photograph of tension in the US real sector has been the term structure. Analysis and subsequent strategy can be very complex, or, in our style, comfortably simple.

Thanks to quality flight triggered by our EU friends, progress has been modest from Oct/11. The 5 - 10yr, Oct/11, +101, last +116.  The 2 - 30 yr, Oct/11, +276, last +290.  The 2 - 10 spread however has done poorly, Oct/11 at +188, last +184.

Nevertheless, our view is for continued expansion through year end and into Q1. This is due to anchors set earlier for surprising vigor ahead and it is due to the fact that the Fed may be foolish enough to launch a QEIII.

Thus, clients long are to remain long.  Those with no position are to consider entry at the earliest opportunity.

Robert Craven

Not up to US Speed

We noted Oct/31 that Germany would not be up to US speed, reminding clients Nov 1 that we had set an anchor, that near term growth in Germany was to come inside of economists’ estimates, Q4, Q1. Since then most German releases have cooperated quite nicely. This, along with the likely shrinkage of loans in response to the EU 9% core capital rule, is motivation to our strategy to sell US debt to this credit.

On Nov/2 we noted that those who felt much of the EU poison had been priced in should set this spread (if not set already). A convenient measure is the 10yr, but of corse the strategy can be worked in any number of ways, FI, FX. Yields in the US, Nov/2 were +16 to Germany, last, + 20.  First target, +30.

Robert Craven

The Week Ahead

Although we experienced some slippage this week, it was modest; we expect clients anchors, set weeks back, to hold into year end.

US Treasury prices weakened just post Friday’s Oct Payroll release as observers were quick to note just sub-surface, signs of motion (those debt prices soon reversed on news of more Greek shenanigans). The rise in av hourly earnings by $0.05 to $23.19 was part of that.  The substantial upward revisions to the August and September reads were another. Finally, the results of the so-called “household survey” (a tad more volatile and a tad less reliable than the payroll survey) showed that the number of people with a job jumped 277M while the number of unemployed fell, resulting in a  9% print.

Naturally the barn is not alight. But why in the world anyone could have predicted a double dip is beyond us; this read should silence those types. But then, for them, it’s too late. The horse is long gone.

The recommended approach then has not changed. It is best described as one in which traders/planners do not by any means set trades or strategy based on US disappointment, but those based to gain on surprising vigor (there are however no releases next week with market-moving muscle). And part of that “surprising vigor” will be from employers who are cheered by recent developments in Washington, where for an interventionist administration and statist president, their jig is about up.  

Our EU friends will keep us entertained, representing a wild card. The elites who installed and the elites who now oversee this machinery won’t accept the fact that it can’t work; they are willfully blind, in a state of complete denial.  So we will be gifted no doubt with more violence before this thing is past.

It is in the desk’s advantage to exploit panic to acquire value, as earlier described.


Robert Craven

The Maddened Crowd, Value, and the Raptor.

There are approaches to be taken, traction to be gained even as equity, FI and FX prices fluctuate in violent fashion. This can be done by those who have a grounded view of fundamental developments just ahead. The most cerebral approach, our view, is to be free on encumbrance, ready to strike after value is inserted by the maddened crowd, and then ready to get away in the fashion of the male black widow.

For example, Monday morning’s massive quality flight put debt prices far out of range of what we considered fair value.  This distortion presented opportunity to those who were ready to pounce, as we explained Tuesday.  And the best way to do that is spreading relative activity, vigor, one sovereign to another, or, within a credit.

So the lesson is that in times of violence, unless one is an insider, then remain at the sidelines,  set to exploit exaggerated price change, raptor style.

Never, on pain of death, join the crowd; wait for them to deliver the gift.


Robert Craven

Week in Review

We had anchors set past few weeks, for clients to look for more than expected (not real strength, just relative result) for both consumer and jobs related activity. These worked very well early on. But not this week.  Instead, although chain sales reported this week were higher, they were inside of expectations.  And although the claims for unemployment benefits cooperated a tad, today’s Payroll result did not.  Finally, we expected PMI results for manuf and services to just exceed expectations but they were just inside of consensus.  So not a satisfactory week for us.

Still, we can expect US and Canadian growth to eclipse that of Europe, including Germany.  Thus, clients are urged to place that strategy recommended Tuesday, when they may free of violence spawned by our EU friends.  That would be to own the US and UK term structure, to sell the US or Canada to Germany.

Update

Those who may own some comfort regarding events in Europe, may feel that a collapse is not around the corner, or, that the potency of this wild card has diminished, are then advised to 1) buy the UK curve, 2) buy the US curve and 3) sell either the US or Canada to Germany, perhaps by the way of the 10yr, or any of the many other ways this view can be worked.

Robert Craven

Calm, Always

Over the years we have found that it is imperative one remain tethered during a whirlwind. Not that we know how the Greek deal will evolve; we don’t but we do own something of value and it is not to be lost due to a distraction, even one of this caliber.

Aside from a US curve trade (now back to entry levels) we have the luxury of being on the sidelines.  We have recommended very few trades past weeks exactly due to the EU wild card.  Others with more insight, a handle on matters over there, no doubt have done much better than we but then we know our limitations.

So it may not be the time quite yet to act on our anchors, but these are anchors nevertheless:  Growth in the US, Canada and UK will push through estimates, Q4, Q1.  We can look for growth in Germany to come inside of expectations, same period. Key - We are speaking of relative relationships, not absolutes.

For example, there is a flaw to consensus regarding UK growth ahead. This, when coupled with the expanded Bk of England operation is what motivated our very successful early October trade. We then advised exiting the last portion of that trade on Oct/28 after considering the recent CBI report (which showed manufacturing optimism dropped to the lowest level in 2 ½ years).  Then today we see Manuf PMI results far south of expectations, especially new orders.

Yet under no circumstances do we want to look to sell this spread.  Past two days it has come in considerably (2 - 10, +169, vs +202, Oct/28 / 10yr 2.21 vs 2.62) tagged to quality flt.  Fine.  We want to again look to own (L - S) the UK curve not only because of the Bank of England firing, but because we expect further cheer from the Administration, for example, the streamlining, or outright removal of regulatory and tax retardants. This is not priced in at the moment, and, this consideration will eclipse any perceived or real manufacturing weakness.

We expect the market crowd to come to agree with us; we encourage clients to set trades accordingly when the time is right.

In the meantime, back in the colonies, continue to look for a very active consumer.  This week’s chain store sale results will cooperate with that view.


Robert Craven

UK

October 6, the day King announced an expansion by $120 bln to existing stimulus, we immediately recommended selling UK debt or owning (L - S) the term structure. Such a jolt in this particular environment could not help but weaken prices and expand the curve. The strategy worked very well.  Half was taken in earlier and we recommended an exit 10/28.

Today of course prices are richer and the curve has come in a tad.

Europe is a wild card for us but past the noise and bullets there we are looking for the opportunity to repeat this exercise, to again own this spread, certainly not the reverse.

But then timing is always key is it not? Consider the gentleman black window spider. He’s a midget compared to the lady spider.  During times of romance he’d better not forget his tennis shoes because just following the conjugal visit, he becomes dinner.  Timing is everything for this guy.

The crisis may pull the spread even further away from fundamentals, stretched like a rubber band. We want to take advantage any distortion. The Bank of England’s approach, combined with an enlightened administration means more vigor than observers expect into Q1.


Robert Craven

Update

We advised clients not to take trades based on disappointment into the EU decision because we expected the market crowd to be cheered. That was the result.  We did not predict a real solution, only the market reaction, our job. Key is that one can be right at the wrong time and converted to crow bait in the process.

Sure enough, there’s been a bit of sobering up over there. We’re not sure how things will turn out in Europe but remain keen to sell the US or Canada to the Bund. Germany is a stand out in Europe of course, relatively healthy, but that credit won’t be up to US or Canadian speed, Q1. It doesn’t feel quite right just yet, but the opportunity will come, and, can be worked any number of ways.

Next, we have been constructive on the US relative to expectations. In that spirit, we predicted that today’s Chicago Purchasing Managers Index would broach consensus.  It did not, coming just inside.  Oh well, we were getting to be spoiled.

The general landscape ahead can be picked up in the term structure.  We advised Oct/11 that clients own that curve or sell US debt (we almost always prefer spreads). The 10 yr then 2.14%, 5 - 10, +101, 2 - 30, +276.  Modest progress, last 2.23%, +118, +300.  We don’t have a complete explanation for the recent firming of prices following the EU decision; it is not all due to disappointment with our friends there.

Robert Craven

The Week Ahead

Recent US consumer activity caught the Street flat footed. This bunch note that this spending was on the back of savings (as income growth was modest) which is why they missed it.  After being thoroughly beaten about the head and shoulders, these observers now claim that since savings won’t hold, neither will spending and no way we will continue to see improved consumption into year end - hoping they eventually will be right!

Consumer activity will continue to improve into year end, again blowing through estimates.

Next, although burning on at best 6 of 8, job activity will continue to improve, modestly perhaps, but improve. A good part of the reason for this is that employers are beginning to be cheered by developments in Washington.

Therefore, our anchor set weeks ago will continue to hold. (Our positive view however is not linked to Friday’s buoyant Michigan sentiment read. We know from years of personal observation that the correlation between survey results and spending just ahead is zilch.)

This week we have the ISM survey for manufacturing and services. The risk is that both will flatten estimates. And we have Oct Payroll on Friday.  We cannot assign a risk to the headline but private sector jobs will exceed estimates.

Key to our purpose then is the provision that banks are to establish a core-capital ratio of 9%. But why will so many want to raise new equity and dilute their shareholders’ stakes, when their share prices are only about ½ book anyway?  They won’t.. Suspecting the same, officials warn banks not to cut loans to get to 9% the back-handed way (which is exactly what they will do) but instead “seek national government support” if needed.  Right.  Traders can then expect relative vigor, US or Canada to Germany or France and are to set trades accordingly.

Finally, the Mid East remains a potent wild card; if not a Saudi / Iranian conflict, certainly the potential for an Israeli strike on Iran, the rattlesnake nearby.  As reported in the Washington Times, military analyst Amir Oren of the Ha-aretz newspaper noted that, “...until recently, Mr. Netanyahu had faced opposition to attacking Iran from Army Chief of Staff Gen. Gabi Ashkenazi and Mossad intelligence chief Meir Dagan.  Both retired earlier this year and have been replaced by men believed to hold a different view on Iran.”  

Such a strike would translate in the US to negative growth for at least a quarter as it would place WTI through 130 and keep it there for some time.


Robert Craven

Week in Review

Evidence this week (including today’s Real Consumer Spending print, the Q3 average now 2.4% above its Q2 average, the fastest growth in a year) adhered to that anchor provided earlier as a backstop, as security to clients - forecasters underestimated US vigor. These folks are in the process of correcting their models now. If we expect to do well as strategists, we must anticipate such a change, not react.  The pattern must be closed early, while others are looking elsewhere.

Next, clients were reminded Oct/9 and again Oct/15 to look for what would be perceived by the market crowd to be a solution, matters of the EU and most certainly not to set up trades which would do well on disappointment. That worked satisfactorily.

That celebration expanded the UK term structure a bit, providing a window for an exit.

That celebration also expanded the US term structure (2 - 30) 15 basis points or so and now 40, same spread, since recommended Oct/11.  We recommend that position, or something similar be held into next week’s FOMC. Anything from the Fed, as “anything” will be reckless, will further expand the curve.

Robert Craven

Goodbye UK Curve

Goodbye UK Curve

We have been long the UK curve since King’s surprise, Oct/6 (10 yr - 2.31% / 2 - 10, 171 / 2 - 30, +266, 5 - 10, +102.). We told clients just after that announcement to either sell UK debt outright, or own the curve (L - S). The trade performed satisfactorily, and half the gains were taken in 10/14 (2 - 10, +200 / 10yr - 2.61%).

We told clients to take the remainder of the position into the EU decision.  Last, 10yr, 2.62 / 2 - 10, + 202 / 2 - 30, +291 / 5 - 10, +119.

We recommend exiting this trade.  We’re not especially happy with the CBI read of Oct/26, something we did not anticipate. Plus we simply don’t like the feel, past few days.

It’s been a fun experience.  Let’s put it to rest and go on.


Robert Craven

Sit On Your Hands Please

We have been critical of planning in any theater, especially the Fed. Non rule-based activity will never work. Thus, ahead of QEII, we predicted the impact would be corrosive.  This was the result, triggering a surge in commodity inflation and the collapse of consumption, Q2.

We set an anchor for clients a few weeks ago. Any surprises were to be to the side of growth, not weakness and trades were to be set with this in mind. We have used the term structure to illustrate this reality.

If we look at today’s advance Q3 GDP print, we receive further support for our anchor. Some may have noted that service spending was up 3%, the most since Q2 ‘06, suggesting broad improvement.  Next, auto sales will slow Q4 but that’s alright; we see that ex-vehicle activity was up 2.5% vs 1.5%, Q2. Guess why? Because the impact of destructive Fed policy has faded; that is, income growth is keeping up with price increases.

Bernanke - now sit. Good boy.

Robert Craven

Opportunity

As expected, European banks are told to raise capital. But raise capital in this market where even the stronger contenders see share prices at about ½ book value?  Maybe not. Some will simply withdraw, tortoise fashion. If these guys have to backstop capital to 9%, they will do it by shrinking the balance sheet. Goodbye credit.

This reality underpins the act of once again spreading the US (S) and Canada to Germany and others.  We will do just that, next window.


Robert Craven

Back to the USA

With our EU friends center stage, the rest is on the back burner but assuming (as we do) there will be no Armageddon, let’s get back to business and take a look at the US.

We had set an anchor weeks back and it remains in place - there is a flaw to consensus regarding US vigor ahead.  Knowing that to be the case gives our clients a leg up.

Today’s Sep Durables print was consistent with our view, suggesting as it did that capital spending expanded strongly in Q3.  We expect the GDP advance tomorrow, and the Claims print to further cooperate.

This reality can be worked in any number of ways, none of which call for complexity.

The option is one of the most versatile of tools in this regard. For example, the bear call spread on the 10 yr would be a nice fit. This is a vertical credit spread, with limited profit and loss potential. This is conservative, but of course options offer the alternative (uncovered call write, with unlimited loss potential) so it’s all there for the desk.

In this situation, we would be in no hurry to place a trade.  Look for a window. For example, if the Michigan read on Friday is extremely weak the FI market will firm. Then consider that event to be a gift and set the trade.  (A real window of course would be total EU failure. In that case, all bets are off.)


Robert Craven

Cowboy Wisdom and the Euro

We’re optimistic we will get past chapter I.  Of course King rightly notes that this is no cure. That’s right. It’s not meant to be.

To most folks observing from afar the single currency never made much sense. We recall back in 1999 when the idea came up that Charlie, the cowboy to whom we lease 118 acres of California foothill land, noted that, “Hell, that don’t make sense. They’re none of ‘em the same. It’ll blow up.”

Indeed it will. All but the willfully blind understand that the only way to have a bunch of currencies lumped together is if these sovereigns are culturally close. Charlie might have miscued on Germany and Austria but he has Germany and Portugal, and the rest of the south, spot on.

What else is there to understand?

The folks who put this thing together may have had an education but they couldn't find their way out of a wet paper bag. Charlie’s never seen a college classroom, but in a pinch, you’d want him on your side.


Robert Craven

UK Interest Rate Landscape

While we’re on hold for our EU friends, best to revisit the UK term structure.

On the announcement of King's surprise, Oct/6, we alerted clients that the curve would expand, debt prices weaken and to take advantage of that reality.

That is, the lay of the landscape just ahead suddenly took on a different shape. Investors, traders, planners were to navigate that landscape with tools that fit their needs the best.

Pre-announcement, the 10 yr  2.31%, 2 - 10, +171, 2 - 30, +266.

We recommended Oct/14 that clients realize half the gains on this trade and remain with the balance.

Last, 10 yr, 2.60%, 2 - 10, +202, 2 - 30, +292.

We expect progress in Europe and see no reason abandon this position.



Robert Craven

The EU and Attitude

We told clients on Oct/9 and again Oct/15 to expect progress towards a solution, that EU leaders were on to something and that - key - the market crowd would come to agree. Clients were then not to set trades which would benefit by the way of disappointment. There were no odds in such of move.

Timidity, half measures are corrosive but this has not been lost on EU policy makers; they have known that for goodness sake; this is not just the stuff of critics. But suddenly, late Sep they realized they’d approached the point of no return. There was a sea-change in attitude then when policy makers came to understand the wisdom of Ben Franklin, that they had better pretty quick find a way to hang together, or they would all go down together.

And of course we know that the tools have been there all along. We’re not smart enough to know which will be chosen but that doesn’t matter for our purpose. It was only sensing the change in attitude and intent ahead of most others which mattered for our clients.

Irish Prime Minister Edna Kenny, in today’s WSJ, "For the first time, I found leaders of the Eurozone focusing on the fundamentals here in respect from the situation arising from Greece and the fear of contagion. There was clearly an understanding the world was watching and there wasn’t any point in doing this in a half hearted fashion."
　
Indeed.
　
Robert Craven

The Week Ahead

When most had the US economy sideways at best, we predicted more. Now, others are coming to agree. But the horse is long gone. We want to anticipate change, not react.

There are plenty of releases with the horsepower to move the market this week, among these Durables, Claims, the advance Q3 GDP, and Michigan sentiment. We cannot assign a risk to the Durables print. The risk is for Claims to come inside of expectations, for GDP to just exceed expectations (+2.3%).

We advise that clients read nothing into the Michigan result. This and other confidence measures carry little by the way of leading characteristics. For example, September confidence reads were weak, but Retail Sales improved nicely that month.

Our friends at the Fed meet Nov 1 and 2. There will be more chatter from officials ahead of that meeting, most of it designed as cheer leading.

“We are prepared to employ our tools as appropriate to foster a stronger economic recovery in a context of price stability,” Vice Chair Janet Yellen said last week. Come on Janet dear, leave well enough alone.

Finally, to Europe. It's been too easy to find fault with EU types. Observers got into that habit, past two years. Gloating, they now missed the turn. We highlighted Oct/9 that there was a change in dynamic. This positive dimension will continue to unfold this week.

Robert Craven

Week in Review

We’ve been at this business for a number of years and the present situation is one of, if not the toughest we’re ever had to navigate. We’re thankful for no major casualties along the way.

Coming into this week, clients we advised to look for more US vigor than that which was priced in; that is, than consensus. There was/is a flaw to St estimates, a result of the clubby nature of that environment and thus lack of independent research. One of these types changed his view after seeing the data, noting today that, "A recession now seems a lot less likely." Of course the horse is long gone.

If there were to be surprises this week they were to be to the side of more vigor, not less and clients were to prepare for that event. That was indeed the result as PPI and the Philly Fed flattened estimates. Industrial Production (+0.2%), CPI (+0.3%) and Claims were about as expected.

Recent crude price activity might represent a threat to our constructive view on the consumer. Recall that it was crude as tagged to the Arab Spring which crippled US consumer activity late Q1, Q2 by the way of gasoline prices. Now we must look no further than the recent work of our colleague Nick Kennedy to see that crude prices represent perhaps less of a threat, and are likely to move lower over the intermediate term.

Finally, clients were advised Oct/9 to expect positive results from the EU, not to position for disappointment. Events last week made us out to be seers; this week it seems we’ve lost some traction. We still expect events there to congeal, and in a positive fashion. It is in fact those in the cheap seats who will be disappointed.
　
　
Robert Craven

Handy Tool

As part of this service we regularly review key releases for each week, and assign a risk to each. This exercise enables the client to have a good idea of mkt response, ahead of the fact. We aren’t always right, but past years, something on the order of 65 - 70% (past records on file).

To see how this works, let’s review. Last week we predicted that Claims and Retail Sales would both cheer the market. Claims was just inside of estimates but Sales blew through consensus, cooperating very nicely. This week, we predicted that CPI, Ind Production and today’s key Philly Fed would exceed estimates. CPI was at consensus, Production only a tad through, but the Philly Fed blew through estimates, also cooperating very nicely.

Thus, although we missed on a few, it was not because the result was in the extreme reverse, but at consensus. This is a key point. Rarely in the many years we have produced this product has the result gone radically in the reverse of our prediction.

Thus, clients acquire a good deal of security from this exercise.
　

Robert Craven

US Term Structure

Coming into "twist," Sep/21, we advised owning the curve, looking for an expansion (contrary to Fed intent). Instead, 2 - 10 for example, at +178 pre-announcement, contracted to 169 by the end of the day. On Sep/22, it printed +160. Not a satisfactory experience as we were rolled by the mkt crowd so that traders, depending on risk control, would most likely have to realize a loss.

Investors were advised to sit still as nothing had changed. Dynamics for expansion remained in place.

Next, in an Oct/11 update we told clients to continue to look for cheaper prices, US debt, and a more expanded curve, especially 2 - 30. The 10 yr then 2.14%, 2 - 10, +184, 2 - 30, +276. Last, 2.20%, +192, +294.

Most feel still that the consistent right trade on Europe is to position for disappointment. We have disagreed (see our 10/9 piece - Kicking The Can). There will be more US price pressures than expected over the intermediate term; there will be more consumer activity and employment activity than expected over the intermediate term. Thus, the course-of-least-resistance for the US curve to remain steeper, even now. This defines the landscape ahead.

Clients are left to their own devices to best lever this reality.
　

Robert Craven
　

Backstage with the Fed

Europe is front and center but investors and corporate planners are to remain anchored, not to ignore other key dynamics which have not gone away and will help define the US economic landscape ahead. One of these is Fed policy. Naturally clients need to know how to figure policy into the equation.

We are more constructive than most others on the US economy but in spite of, not due to recent Fed activity. We predicted QEII would simply fire inflation and less-deserving equities. Most now understand that was the result. We noted that "twist"would accomplish little past some trading opportunities. The jury is still out but will no doubt return with our verdict.

One of the most qualified of Fed officials is Jeff Lacker, president of the Richmond Fed. Speaking recently of QEII and Twist, Lacker noted: "The effects of these operations is uncertain, but is likely to be relatively small. My sense is that the main effect will be to raise inflation somewhat rather than increase growth," he argued in his prepared remarks and noted a risk of inflation to the upside.

Agree.
　
Lacker said MBS purchases, which got a fresh boost in September as the Fed decided to reinvest maturing mortgage bonds back into that market, were not well-advised. "It's simply inappropriate, in my view, for a central bank to attempt to channel credit toward some economic sectors and away from others," he said.

Correct again. These types are not planners; nobody is; it doesn’t work.


Thus investors and corporate strategists when setting strategy for H1, 2012 are not to include recent Fed policy change as a spark but as a wash at best, if not a retardant.
　
　
Robert Craven

Week Ahead

We suspect that European policy makers will continue to make progress.

The corrosive result from timidity in policy making is now crystal clear to most of them. Their new determination however is naturally complicated by the fact there are 17.

In the US we had 13. Ben Franklin, when pondering the threats of King George III noted that the 13 had better, "..all hang together, or most assuredly we will all hang separately."

King George has been replaced by 21^st century market tyrants but most of the EU get the point. This is why we could say in our Oct/9 sketch that we thought this time (Merkel / Sarkozy meeting) was different, that leaders were on to something and that we expected the market crowd to come to agree.



Stateside, let us look for releases next week to support our view that St forecasters have been caught with their pants down. Thus, the risk is that CPI will alarm. We expect Industrial Production to exceed estimates, along with the Philly Fed survey later in the week.
　
　
Robert Craven

Review

We earlier advised clients to look for more from the US real sector than expected, especially the jobs and consumer sectors. Yesterday’s Claims release was only a tad inside of expectations yet today’s Sales result was far through expectations, thus cooperating very nicely.

Ongoing, we can expect this anchor to remain set; there remains a flaw to St estimates.

Next, we have advised that both the UK and US term structures will expand and that clients are to either sell that debt outright, or, own both curves. This has performed satisfactorily. We advised buying the UK curve Oct/6, the day of the Bk of England’s surprise, and exactly because of it. The 2 - 10 was then 171, the 10 yr, 2.31%. Last, 2 - 10, 200, the 10yr, 2.61%.

Of course exercising this view or navigating the landscape we set for the client can be done in any number of ways, the weighted futures spread perhaps the simplest. However it was done, we recommend clients take in half the trade, stay with the balance.
　

Robert Craven

Long End

Today’s auction of the 30yr went well at 3.12%. "It’s the only place to be," say strategists, and, "we know the Fed is a buyer."

No matter. Remain long (L - S) the curve. We noted Oct/11 to look for more from the 2 - 30, then, +276, last, +288.
　

Robert Craven

Five-Legged Calf

One of the reasons we want our clients to own (L - S) the US term structure is that we expect price pressures over the intermediate term to increase. The Fed’s link to core CPI as a policy guide simply puts off the inevitable.

St. Louis Fed president James Bullard writes in the Bank’s July/Aug 2011 Review: "One immediate benefit of dropping the emphasis on core inflation would be to reconnect the Federal Reserve with households and businesses who know price change when they see it."

Nixon got Burns to convince Congress it was best to drop the headline because he, Nixon, wanted Burns to fire on all burners.

Bullard continues, "There are several..arguments...used to favor a focus on core inflation.....all of them are essentially misguided." As we have argued for years.

Thus, the mkt crowd obediently accepts the core and will eventually get bush wacked as a result.

The FOMC might recall the Lincoln story, and the case of the boy who, when asked how many legs his calf would have if he called its tail a leg, replied, "Five," to which the response was made that calling the tail a leg would not make it a leg.
　

Robert Craven

Crude

We have maintained a wild card all year; that is, the overlay of risk from the Saudi - Iranian dynamic.

We did not know how this might manifest itself, but had the risk that it would. That of course translates to crude and we can do without that burden right now.

The plan to take out the Saudi ambassador (and perhaps others) may be the manifestation we had feared.

Let’s put the odds of violence at 30% at the moment.

Figure this into the desk’s operations.
　

Robert Craven

US Releases

We expect consumer and jobs-related releases to broach expectations over the near term.

There is nothing really strong about the US economy of course, but since we are interested in price change, we are not interested in absolutes, only reality just ahead vs St consensus.

Thus, look for tomorrow’s Claims result and Friday’s Retail Sales to cheer the market (worry debt prices). This is the risk, our view.




Robert Craven