The Week in Review

We learned this week that relative dynamics remain pretty much in place, US / UK / E-Z. First to the US:

The Q1 GDP headline print came in a tad less than expected. Fine. Q1 is also history. Key is jobs-related activity ahead.

We had set employment as a chief anchor for clients; that is, they knew the odds were very good that results would flatten estimates. That worked well, until that is the Mar NFP result on Apr/6, and, recent Claims prints.

Job creation in Mar was much weaker than expected, partially due to weather variations. Still, hiring began to accelerate late 2011 and key - it will continue to do so. Over the past 3 months, job creation has averaged 212M per month vs 164M in the prior three months, and 128M in the 3 before. That sounds like acceleration to us. We have momentum. And private-sector employment increased for the 25th straight month. Not a barn burner, but pretty impressive given the obstacles the Obama administration has thrown up.

What we have witnessed past few weeks is pause, not trend (and a bit of seasonals too).  And the better the odds the present administration will be thrown out, the more likely regulations which have smothered payroll activity will be thrown out also. Just as employers were cheered by the Nov/10 election results (we had it from several, first hand) so they will be similarly cheered on this occasion.

Consumer activity (our other primary anchor, Q1) will not wilt Q2 as most expect. It is easy to come to this conclusion as real earnings have lagged. But attitude is key and attitude is not captured by economists’ models, the chief reason that results flattened estimates in Q1.  The consumer is not on a roar of course; the Q1 averages for both overall and core spending are only moderately above their Q4 levels. But this is a lot more than anyone expected given reported earnings. The answer is that the consumer is content to borrow the difference and or dip into savings, at least over the intermediate term until jobs catch up.

Next, to the E-Z:

We’ve found that things are generally a whole lot simpler than “the experts” would have you believe.  But that is understandable, as otherwise there would be no need for the experts. 

For example, the moment the EU elitists told banks to raise their core Tier 1 capital ratios to 9% by July, or be nationalized, in a flash those with even a passing interest in economics were handed the landscape ahead for the E-Z for H1. It was easy to predict then that results would fall far short of economists’ estimates and this, notwithstanding any EU fix for Greece or other sufferers. Sure enough, the IMF noted last week that the E-Z banks would cut their balance sheets by 7% by next year. And this estimate is conservative.

The alternative for banks is to raise capital but no way banks will do that given depleted share prices.

ECB generosity is at best a carry trade for the banks (as they acquire their own sovereign debt).  Certainly it can no longer be a secret that none of the money gets to real business. And there wasn’t a heck of a lot of business demand to begin with; there is less now.

A sorry state of affairs. 

The US will continue to speed away from this region, if for no other reason than we have yet to fully embrace the E-Z version of social democracy, the stamp of entitlement.

Set trades with that in mind.

Finally, to the UK: We refer readers to our earlier sketch. Any major economic surprises for this credit are to be to the side of more, not less.


Robert Craven

Trading the UK

UK:  Technically (at least until revisions) we have a recession. Instead of +0.1% as expected, Q1 was off 0.2%.  What does this mean; what is a 0.2% or so among friends?  Nothing, other than perhaps to George Osborne.

For opportunity, look to the UK curve. We have been at the sidelines past weeks. Spreads have come in. Some may have caught that move (ex., 2-30, 300, Mar/16, last 289).

From present levels, course-of-least resistance is wider for this and related spreads. Clients are to look for a chance to own (L-S) the UK term structure, not sell it. This is because observers will continue to be caught up in the malaise theme and miss surprising strength ahead.  Not real strength naturally, just something through estimates. This represents reality ahead for this credit.

Caution:  Today’s Apr CBI print showed expected sales for May up sharply, the highest since Feb/11. These results and other recent surveys seem to support our case (and contradict ONS results). Careful with consumer or business survey results however, even if they do support your case. We never use them for making strategy, here, the US or elsewhere. Only the work of our friend, the late, great Albert Sindlinger was reliable, and he is no longer with us. 

Our insight is based only on what we understand to be the flaw to economists’ models, this credit, especially with work directed at the consumer.  Simple as that. And now that the Bk of Eng has more reason to fire, all the more case for a steeper curve.

Thus, look for a window to own this spread, near or at present levels.


Robert Craven

Trading The Fed

Trading The Fed 

It’s easy to criticize the Fed. They’re plenty of folk out there shouting from the cheap seats. Better to translate 1) what we know to be policy error, and 2) the confusion which we predicted would go with the new policy of transparency, to the bottom line.

When Bernanke first announced that FF’s would remain at rock bottom into 2014, we knew that near term real-sector events would not cooperate (payroll, consumer and manuf activity). This was the result. The simplest of strategies was to own (L–S) the Eurodollar strip. Since the Fed is god to the market crowd, the strip converted Bernanke’s policy to economic reality. Thus, we recommended to clients on Feb/16 to own Sep/12–Sep/13, then -13. Target of -25 was printed Mar/14 and we recommended an exit. 

We also applied this insight to the US term structure, recommending Mar/9 that clients own (L-S) that spread, 2-30 then +284.  That worked satisfactorily and an exit was recommended Mar/20, +308.

Given the last, less-than-buoyant Payroll print, and, E-Z problems, these spreads have come in, last -10 on our sample Euro spread, and +287, 2-30. From this point, course-of-least resistance for longer Euro rates is higher (or more inverted prices).  Look to own (L-S) the strip again, given a window, or perhaps the Treasury curve. This is because economic reality ahead will not cooperate with the present market view for a repeat of the past two years, for a Spring faltering. It won’t happen. This is true even considering today’s disappointing Mar Durables print. And another “twist” is not in the cards.

A window may present itself today when Bernanke repeats the FF’s will remain near zero into late 2014. But key is not to rush on any of this, only to harvest at the margin.

Robert Craven

Reflection

For the first time in perhaps a year we are in neutral.  Our method is to set anchors for clients; thus equipped, clients can better anticipate economic reality ahead for key sectors, vs street consensus. They have a long leg up in capturing price change because they have in hand the direction of miss.

Since we have re-entered this arena (Spring 2011) results have been satisfactory; for example, we highlighted the impact of higher crude and the impact of a reckless Fed, H1, while the rest were looking in the wrong direction. Then early Q4 we were able to spotlight relative US vigor ahead, and in which sectors while most others were looking in the rear view mirror. Then, consensus had the US in the doldrums at best; there was a malaise cast over the market; many predicted a double dip. 

These and other exercises were very satisfying, both from a personal standpoint, and because we were able to enrich our clients. But strategy cannot be forced; each of us has our limitations. Those who realize that fact, prosper.

Over the near term, we will take a very close look at all key US sectors to determine just where may be the next opportunity.

Offshore:  Although the title of this report is US Economy Ahead we regularly fold in the UK and E-Z, as these may impact the US real sector.

UK:  Early Q1 we had predicted that on the whole results for the UK, especially those related to consumer activity would flatten estimates. That has been the result, including of course Friday’s “surprising” Retail Sales print (+1.8% vs +0.4%, consensus). Naturally we were not absolutely constructive on the UK; we were simply aware to the general flaw built into most economists’ work.  This flaw remains in place. Better to be prepared for these “surprises.”

E-Z:  Clients have known since late Q4 that results would disappoint for this region, H1, and the reasons why, notwithstanding any EU “solutions.” On the whole that has been the result. ECB generosity did not and will not translate; Draghi threw a life preserver and we commend him for the action but once ashore the distressed ran for cover.

Never before in our experience have we seen so much press given to a single topic. It has been a feeding frenzy for the media but few if any have settled upon the unpleasant truth.

E-Z government leaders are in denial, they’re willfully blind, the whole bunch. They manufacture complexity to provide camouflage. But world investors are not in denial, which is why US Treasury rates remain so low, even past any short-term E-Z cheer. There is good cause for investors to continue to seek refuge because 1) either we will come to a fiscal union or 2) the system will fall apart. Both outcomes spell havoc yet there is nothing in between.

Robert Craven

Sidelines

We stretched our Easter vacation a tad more than expected.  Plus, we are not especially inspired at the moment.  One is gifted with real, major insight perhaps three or four times per year; that is, if one is lucky. 

We have been lucky.

In the interim, we prefer to remain quiet – there is plenty of noise out there, plenty of children at play.

We’ll be back in a bit.


Robert Craven

The Week in Review

US – Well, son-of-a-gun, it appears that Mar jobs creation did not meet our expectations.

One thing’s for certain - last Friday was the day the majority of prophets have been looking for, and for months.  Now finally they can say, “I told you so.”  And so it goes with this bunch.

Despite our best efforts, we’ll miss a few.

Let’s take a look at last week’s Mar NFP.  We predicted that earnings would finally do well.  Hourly earnings cooperated but the workweek retracted, so weekly earnings followed suit, shedding 0.1%.  And the headline print was nothing to cheer about, although a quick look showed that unusually warm weather the prior three months and then more seasonal weather in March produced the payback. That is, the dry weather especially in Jan and Feb did allow some seasonal industries to keep workers on through the winter, reducing the need to hire in the spring.

Interesting thing about weather is it not?  It is not a secret to observers when they make their estimate. Most simply ignore it as it usually trips them up.

And then there was that Unemployment print of 8.2%.  That rate only fell because the labor force shrank by 164M. But then it is pleasing that the augmented unemployment rate fell too from 14.9 to 14.5% (discouraged, marginally attached and part-time). And private-sector employment increased for the 25^th straight month, an average of 162M per month; not bad at all given we have an administration which has done everything it could to inhibit jobs growth, this sector.

All in, job creation has accelerated over the past three months - a 212M average vs 164M average the prior three months. Our view is it will continue to accelerate the balance of 2012.

Finally, the disappointing Payroll result made Bernanke out to be a prophet. He lucked out. He went out on a limb with his NABE speech as Lacker, Fisher and others beat him severally about the head and shoulders.

E-Z – Results last week were an exact fit with our desk anchor as evidence continues to build that the E-Z is headed for the dumpster, and quickly. Others are coming to understand that which our clients understood early Q1. We have known for some time this sector would “disappoint” and why, and that included Germany. Indeed, as one news source put it last week, “An unexpectedly sharp slump in German industrial output in February fuelled concern that the economy…is on the brink of a recession…”   Better to anticipate than react. And the notion that the there is some sort of consumer “boom” in Germany is pure fantasy.

UK – We are also pleased with results for this credit.  Naturally things are slow, but our task is to determine where, if anywhere, a flaw may exist.  We have known that observers continue to just miss activity ahead – their collective bias is to underestimate.  Sure enough, following a surprise acceleration in manuf growth in March, we see that the construction sector PMI flattened estimates, rising in Mar to a 21 month high, orders at the fastest rate in 4 ½ years.

Thus, repeating from our last post, look for the US to continue to distance the E-Z; look for the UK to widen the gap to the E-Z.   This folks represents reality over the intermediate term.

Robert Craven

The UK and E-Z, a Closer Look

For several weeks now we have advised clients to look for just a tad more than expected, the UK; we have advised clients to look for considerably less than expected from the E-Z.

UK:  We’re not very happy with results, this credit.  Last week Q4 GDP came at -0.3, 0.1 lower than expectations; one would have thought the end was near from the mkt reaction. Q4 is long gone. But Feb Retail Sales were worse than expected, -0.8. That surprised us and did not fit our anchor. We expected more from the consumer, a definite error in judgment on our part.

The recent CBI Trade print, at 0.0 was nothing to rave about but - 6.0 was expected! Here is an example of group decision making. Economists  – shouting out, holding hands together in the dark. Today’s Feb Manuf PMI was far through expectations, at 52.1, and the fastest manuf pace in ten months.

And now?  The way to approach the UK release stream ahead, our view is to expect no vigor naturally, just a little more momentum than is priced in at this writing.

E-Z: We’re pleased with results for this region. From mid Q4 to present, we have advised clients to look for “surprising” weakness from the E-Z, even after a Greek “solution.” Key to understanding this region is to recall that it’s easy to lead a horse to water. Getting him to drink is something else again. Banks will sit on their hands. Until they rebuild capital, they will not make loans and it is nonsense to believe otherwise.  

The ECB reported a decline in lending in Feb.  This should have come as no surprise to anyone. So this factor, coupled with other well-known retardants, including crude, will see that this region enters a recession. Sure enough, today’s E-Z Feb Unemployment hit a 25 year high at 10.8%; today’s E-Z  Feb Manuf PMI at 47.7 vs 49 Jan was not the best of news either.

Look for the US to continue to distance the E-Z; look for the UK to just begin to close the gap to the US and to begin to widen that gap to the E-Z.

Robert Craven

Trading the Fed – Part II

Strategy can be made around Fed policy change if one recalls that any crowd demands a leader, a god. The market crowd is no different; their god is the Fed.

It got him in a heck of a fix just as we predicted it would, but we do at least commend Bernanke as he tries to sculpt an honest and open organization. A recent step was to tell the market that FF’s would remain in the cellar into 2014. He believed it, but it was also what he thought would turn out to be effective cheerleading. And this implied to the crowd that there was a reason for FF’s at rock bottom into 2014; since the Fed says so, it became a reality.

We knew instead that real sector developments just ahead would not cooperate with this view. One of the simplest means to translate that was to own (L – S) the Euro strip, that recommended on Feb/16. That position was taken into and through Feb NFP. The spread Sep/12 – Sep/13for example moved from -13 to -25, our target, on Mar/14. Modest, but better than a stick in the eye.

Since then spreads have come back; part of the reason is Bernanke’s speech last week to the NABE.

Background: Plosser, Fisher and Lacker have all criticized easy policy. Bernanke would not stand for that and so he gave strong hints of further easing in last week’s speech. Bernanke doesn’t think 2% growth can get us to the 5.5% - 6% unemployment target, but that something on the order of 4.5% is needed. Thus, when “twist” is finished in two months, he intends to ease.

But at that time real sector developments will make such a move look reckless. Thus, clients are to monitor the Euro strip for the next chance to strike. Developments ahead will show that FF’s at rock bottom into 2014 is an untenable position. If the strip comes in much further (richer prices, longer end), then look to own it again.



Robert Craven

We Begin a New Quarter - The Week Ahead

Beginning a new quarter seems to bring us cheer. We were a majority of about one when we isolated US vigor ahead, early Q4, the analytical horde then seeing only zeros, and some, a double dip. Then early Q1, when disbelievers said, “Ok, but no more,” we could tell our clients that, yes, there would be a good deal more and in which sectors.  This has been a very satisfactory experience. But then, it is also history.

What now?  We can repeat from an earlier post - In the most general sense clients are to look set trades to capture “surprising” US strength. That is, even now it is not all priced in.

Earlier, we recommended translating our view either through an equity index, or, FI spreads set to capture an expanding term structure, or, spreading the US note (S) to Germany. The equity side delivered better as world-wide flight to sanctuary bloated bond prices (and to a large extent, still does).

Our task is a simple one. To provide a map of the economic landscape just ahead; we’re certainly not perfect but if we can maintain roughly a 70% hit rate, it will do. Clients can take it from there.

Now we begin a new quarter. Observers sense a pause. Thus, this same bunch, rolled twice, seem to be asking to get rolled again. Short of a sustained spike in crude, reality will oblige them.

The US release stream this week is fairly deep, with Mar ISM Manufacturing and Non-Manufacturing surveys, Mar Vehicle Sales, Mar Chain Sales and of course, Mar NFP, Friday.  Other releases, such as Factory Orders, Construction Spending and Consumer Credit, although perhaps important to analysts, carry little market-moving horsepower at the moment.

And when the week is over?  We will see that business activity continues to accelerate, that the expansion continues in most sectors. Not a barn burner; in fact, there may be a little slowing in the pace of expansion, manufacturing.

As it was for February, so too job creation for Mar will be strong. But this time we will also see hours and earnings improve; indeed, so far “surprising” job creation has not been freighted with more income nor a much longer workweek. On a year to year basis, earnings have grown only modestly.  As private sector hiring increases even more, which it will, earnings will follow along.  One needs only to attend a campus career fair to see all the smiling faces, with 20 to 30% more companies in attendance.

We will visit offshore credits tomorrow, but for now, it is heartening to see that others are coming rapidly to agree with earlier client updates – the E-Z is going nowhere, and quickly.  Credit creation will remain impaired until E-Z banks shore up tier I capital. Indeed, the ECB recently noted that the flow of credit to businesses slowed in February. ECB generosity was needed as a life preserver; it will have little impact now that the imperiled have made it to shore.

Robert Craven