Unarmed

Although earlier insight re the E-Z proved to be satisfactory, we cannot at this time predict events in the E-Z, especially those of a political nature and so cannot isolate the impact on inter-credit spreads, and impact on the US by the way of flight to sanctuary.

Similarly, we have lost a sense of economic reality ahead for the UK; that is, pockets of opportunity created by forecast flaw.

Finally, after several quarters of satisfactory results, our insight regarding real sector activity for Q2 lost its luster; US activity has slowed more than we expected.

Our product is not designed for investors; it is designed for traders who can expect a trading window of from 2 – 5 weeks.  Thus, we need to deliver a more accurate picture of the economic landscape just ahead than the Street, which releases will “surprise” and why.

We’ve lost the sweet spot for the moment and so have had little to print; there is enough noise out there as it is.

Robert Craven

Insight Provided on the UK Disappoints

Insight delivered for this credit has been less than satisfactory.  We recently advised clients that observers would under-shoot, especially regarding the consumer. And on Apr/26 we recommended that clients look to own (L-S) the UK term structure in preparation for this event.

In fact, Tuesday’s Apr BRC chain sales print (-3.3% vs +0.5%, consensus, +1.3%, last) made a mockery of that advice.  And the 2 – 30 spread, 289 upon entry, is now 282.

Naturally fight to sanctuary (Greece) had something to do with the poor performance, but key was misjudgment on our part.

Robert Craven

US Anchor

There is plenty of noise from the E-Z but best for us remain anchored, centered regarding the US.

Developments in Europe will not provide serious impediments to US growth; in fact, they may provide a bit of a spark. Developments there have however provided impediments to strategy making as the US curve remains artificially impacted. Given E-Z events are of a wild card nature, at least to us, we have been out of this and similar illustrative trades for several weeks.

It is not of course only flight to sanctuary that is billowing US debt prices. After the last two NFP results, observers have the US in a repeat of the previous two years – a spring faint.

Not this time. We all know now, after the fact, that some jobs which are usually created in spring were created earlier given the weather, thus the dip. No doubt. But that is also history.

Our task is to identify the economic landscape just ahead. In fact there has been very little change applied to the US throttle – she will accelerate moderately into, and through H2.

We all know the consumer is key. But the consumer has been underrated. Because earned income has been flat, most economists figured spending would too. Early on we explained why they would be wrong, that consumers would go to savings and credit cards to take up the slack.  That was the result.  That pattern will continue over the intermediate term, until private sector jobs catch up.

Early Q1 we had crude prices as the piano overhead for the consumer. Gasoline peaked Apr/2. Iran is still capable of mischief but for the moment, cheaper gasoline naturally provides further spark to the consumer.

Much was made of the so-called “labor participation” rate, last Payroll print (Apr/4). It was a feast for the media and street economists. The low rate - 63.6% - is tied to demographics they said, and we’re all in trouble if this continues; malaise for years to come.

Instead, the primary driver of plummeting participation resides in Washington. For example, Obama’s policy of making the food stamp program more generous and more easily available, thus enabling more to qualify in the act of remaining unemployed is a prime culprit. Also, policies were invented to reduce mortgage debt for certain families, thus reducing the incentive at the margin, to work.

As we have highlighted for several years, Obama’s policies have both worried employers due to smothering regulations (and the threat of more of the same), and, discouraged job seeking through the creation of greater incentives to remain unemployed; that is, to stay out of the labor force. Not launching a satellite now folks. It is not a coincidence that the participation rate plummeted upon Obama’s election. He inherited a difficult situation, one in which he had a hand in creating, and then proceeded to make it much worse.

Robert Craven

The Week in Review

From what we learned this week, we may simply repeat from our last Review – relative dynamics, US / UK / E-Z remain in place: the US will continue to distance these two, the UK to nudge ahead of the E-Z, and the E-Z to continue to “disappoint.”  If there are “surprises” to UK numbers, these will be to the side of more, not less.  If there are “surprises” to E-Z numbers, these will be to the side of less, not more. 

This then represents the most general plan in capturing relative price change just ahead.

US - The US consumer may pause a tad, but will remain resilient; in fact, consumer activity will accelerate into H2, and this despite the less-than-buoyant trend in earned income (flat hourly earnings / flat workweek). Savings and credit cards will take up the slack, until… private sector employment comes to the rescue. This is the best kind of jobs creation, and is averaging 163M per month after 26 straight months of gain. This is pretty impressive given headwinds, those retardants pressed by the current administration (rampant Fed spending / rampant debt growth / huge tax hike due Jan/2013 / failed energy policy).

E-Z – Recent events have fit our earlier predictions – observers continue to over-estimate activity, this region, especially official observers (Mr. Draghi comes to mind).  We included Germany in this initial observation and still do.  Events will bear us out over the near term.

UK – The last Retail Sales result (Apr/20) fit our guideline to clients for this credit, along with the recent Construction PMI but of course Q1 GDP, and the Manuf PMI did not and we were confident that they would. We’re not especially happy with these results, although we are almost certain that the GDP will be revised to a +0.2 or 0.3%.  The recent CBI (Apr26) on the face did not fit either, but the outlook component was encouraging. 

All in, the odds continue to favor our approach, for the balance of Q2. That is, any major surprises to be to the side of relative vigor.  Crowd behavior applies equally well to economists as it does to the investment crowd. This bunch are still caught up in the malaise of the moment.

Robert Craven

What to Make of the US?

There has been the suspicion that we would replay the “Spring slowdown,” and now some releases would support that notion, including Mar NFP, Mar Durables, and recent Claims prints.  It’s easy to look for a repeat, and a mistake.

We came into March with 5, maybe 6 of 8 cylinders firing. Jobs creation, consumer activity and manufacturing activity had on the whole flattened estimates from mid Q4.  Clients were prepared for that reality and were able to capture price change as a result.

So suddenly this horsepower is gone, a dose of sodium pentothal in the main vein (having just put down a horse and a mule, the analogy comes to mind)?  Nope. Simply a pause.

This post is brief, as may be the next few as we are remodeling, and installing a new computer system.  No telling what might go haywire.

We intend to be on hand however to prep clients on the best way to trade Friday’s Apr Payroll print.


Robert Craven

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