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