Headlines Feb 2010

Headlines: Risks & Opportunities

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Risks: Systematic Standard & Poor's Ratings Services no longer classifies the United Kingdom (AAA/Negative/A-1+) among the most stable and low-risk banking systems globally due to our view of the country's weak economic environment, the reputational damage we believe has been experienced by the banking industry, and what we see as the high dependence on state-support programs of a significant proportion of the industry. Standard & Poor's Banking Industry Country Risk Assessment: United Kingdom. January 28, 2010

US Housing Outlook

Crumbling Gatsby-esque estates are a reminder of a former age of North American excess. In the future, McMansions will probably serve the same purpose. Wednesday’s weak housing starts data for November are a reminder that, while the market had appeared to stabilise of late, there are good reasons to think a fall in house prices may resume. Financial Times, Lex Column: January 20, 2010

In response to President Obama's

State of the Union Address 2010

Something tells us that this goal of doubling exports in a five-year span is going to include a further depreciation of the U.S. dollar as that will basically allow U.S. producers to de facto cut their prices in the global marketplace and as a result lift their market share. After all, doubling exports over five years basically implies that they will grow at more than triple the pace of global economic growth. So to reiterate, for this plan to work, sales abroad are going to need the extra boost to domestic competitiveness, as “artificial” as that lift may be, from an ever-weakening U.S. dollar. All of a sudden, we feel much better, current corrective phase notwithstanding, in our long-standing bullish call on commodities in general, and in precious metals in particular.

Breakfast with Dave, David Rosenberg, Gluskin Sheff: January 28, 2010

The one thing we know about the Fed’s forecasting abilities during this particular cycle is that it has been simply awful. Like Houdini, the Fed expects the economy to recover similar to pulling a rabbit out of the hat — a recovery where “bank lending continues to contract”, consumer spending “remains constrained” and “employers remain reluctant to add to payrolls.”


So, we have a forecast of an economic recovery without credit, housing, the consumer and employment. There’s never been a recovery that was perpetuated by inventories and capital spending. This is why it’s called the Houdini recovery. It’s magic.

Breakfast with Dave, David Rosenberg, Gluskin Sheff: January 28, 2010 Consumer sentiment, in recessions, averages out to be 73.9. That puts the current 72.8 into context. In expansions, confidence averages 91.0; and when the economy is making the critical transition towards the next cycle, at that inflection point, what is “normal” is that consumer sentiment is sitting at 78.0. So, as Mr. Market declares that the recession is over, the respondents to these surveys are basically saying, “not so fast”.

Brunch with Dave, David Rosenberg, Gluskin Sheff: January 15, 2010 So here is what is happening on the U.S. political front. No more than two days after the Democrat defeat in Massachusetts, the President begins a full-scale assault on the banking sector. On the one hand, the policymakers want the banks to start lending money; and on the other hand, they want the banks to de-risk their activities. The banks obviously didn’t help their cause with a lack of contrition and by sanctioning a bonus boom during these difficult times after having been saved by the taxpayer’s pocketbook, but the Obama attacks on the banks are very likely going to do more harm for the economy than good … but then again, this is an Administration that never did have an economic vision and has so far decided to fight the prolonged period of post-bubble economic malaise with a string of short-term quick fixes with no multiplier impact on job creation and no long-run productivity benefits.


US Economic Digest: US Outlook 2010 in Pictures

on Financial Markets

The highly positively correlated financial environment seems already to be breaking down. If this continues, as we expect, it holds out the promise of more effective diversification and risk management. Still, many financial sector business models, especially in developed economies, will be severely challenged by modest return opportunities.

Neal Soss, Credit Suisse Economics Research: January 4, 2010


on Government

State and local fiscal problems are intensifying, with potentially another $300 billion shortfall in fiscal years 2011 and 2012 combined. Net of the $40bn of fiscal stimulus funds, this would imply $260 billion of corrective measures needed to balance budgets. The myriad school districts and other local government units only add to this severe problem.




on the Labor Market

The drop in employment was disproportionate to the drop in output by post-WWII cyclical standards. That does not assure that a disproportionate rebound in jobs is imminent. "Just-in-time inventory" on the real side of the economy was echoed by "Justin- time liquidity" in the financial sector. The enduring effect of the Great Recession may be "Just-in-time headcount" (since this is a big claim on business working capital and liquidity.) Even though we expect a cyclical recovery in the labor market, it could be agonizingly slow given the frictions associated with large-scale permanent job loss.


Why we should expect low growth amid debt

As government debt levels explode in the aftermath of the financial crisis, there is growing uncertainty about how quickly to exit from today’s extraordinary fiscal stimulus. Our research on the long history of financial crises suggests that choices are not easy, no matter how much one wants to believe the present illusion of normalcy in markets. Unless this time is different – which so far has not been the case – yesterday’s financial crisis could easily morph into tomorrow’s government debt crisis. Another big unknown is the future path of world real interest rates, which have been trending downwards for many years. The lower these rates are, the higher the debt levels countries can sustain without facing market discipline. One common mistake is for governments to “play the yield curve” – as debts soar, shifting to cheaper short-term debt to economise on interest costs. Unfortunately, a government with massive short-term debts to roll over is ill-positioned to adjust if rates spike or market confidence fades.

Markets are already adjusting to the financial regulation that must follow in the wake of unprecedented taxpayer largesse. Soon they will also wake up to the fiscal tsunami that is following. Governments who have convinced themselves that they have done things so much better than their predecessors had better wake up first. This time is not different.

Carmen Reinhart and Kenneth Rogoff, Financial Times: January 27, 2010

Debt and Deleveraging: The global credit

bubble and its economic consequences

Several features of the crisis today, including its global nature and the large projected increases in government debt, could delay the start of the deleveraging and result in a longer period of debt reduction than in the past. In past episodes, a significant increase in net exports often helped support GDP growth during deleveraging. But it is unlikely today that the most highly leveraged major economies could all simultaneously increase their net exports. Moreover, current projections of government debt in some countries, such as the United Kingdom, the United States, and Spain, may offset reductions in debt by households and commercial real estate sectors. We therefore see a risk that the mature economies may


remain highly leveraged for a prolonged period, which would create a fragile and potentially unstable economic outlook over the next five to ten years. They may then go through many years in which, all else being equal, GDP growth is slower than it would have been otherwise as debt is period down.

McKinsey Global Institute: January 2010

SummitVIEW: Patient: Doctor, it hurts when I do this. Doctor: Well, don't do that anymore. The above Muppet-like dialogue metaphorically summarizes my vision of conversations between constituents and elected officials. The mantra underlying US Congress initiatives is: first, take the easy path; second, take the easy path. Fiscal constraint is, obviously, not something elected officials are going to pursue with any vigor. As President Obama's State of the Union speech last week made clear to me, the hope for substantive approaches to solve the United States' fiscal and economic woes remains limited. Voters will have their say on how elected officials are performing come November 2010. Although the results of taking an alternative path are unknown, I do believe propping up the financial system was necessary to avoid disastrous economic effects: substantially higher unemployment, even greater government involvement in the economy. How the administration went about propping up the system will be analyzed for years to come. Unwinding mounds of debt will take many years. Without economic stimulus that generates both job growth and sustains high worker productivity the current economic malaise will continue for years to come. The recent 4Q09 GDP number (5.7% growth) points to economic expansion. Expectations are the number will be revised downward, and the rate of growth is unsustainable. Based on the current steps taken to prop up the economy (negative real federal fund rate, quantitative easing to keep rates low), SummitView concurs with expectations of minimal growth for years to come. Many are wont to continue to believe in the former regime when in fact the country is in a new regime. The current regime, I expect will be viewed as the beginning of the end of the US consumer-driven economy.


Opportunities: New Normal Investments

Fundamentals Still Positive for Brazil Equities

International Strategy & Investment, January 27, 2010

Brazil on Track for Strong Recovery

Increases in commodity prices, ISI's Brazil economic diffusion index, and the brazil manufacturing PMI all help to validate the forecast from our regression model. And spending related to both the 2014 World Cup and 2016 Olympics will also help propel growth.

International Strategy & Investment, January 27, 2010

Pensions Pour into Emerging Market Debt

US pension funds are poised to pour almost $100bn (£62bn, 70bn) into emerging market debt in the next five years, according to JPMorgan. The impending buying spree will be augmented by strong flows from central banks desperate to diversify out of the dollar, industry figures believe, bolstering the ongoing rally in emerging market bonds and potentially pushing yields relative to US Treasuries to a record low. "We expect a long-term structural bid [from US pension funds] for emerging market debt,” said Will Oswald, global head of emerging market quantitative strategy at JPMorgan.

Steve Johnson, Financial Times, January 24, 2010

Emerging Markets Watch

PIMCO believes the crisis of 2008-2009 will have a widespread and long-lasting impact on global economic growth, government policy and the interplay between developed and developing economies. This New Normal implies lower growth, greater regulation, and higher savings rates in the developed world, as well as relatively higher growth and a more prominent role in influencing global economic policy for the developing world.

Michael Gomez, PIMCO, December 2009

Brazilian Bonds? Get Real!

Brazil may well be the most attractive on the planet on a risk-return basis. Here are seven reasons why: • It is just about the only investment grade country where inflation is slowing, the central bank has been easing, and where you can pick up a yield of over 12% for 10-year paper. • Its most recent change was a credit upgrade last September (Moody’s) and overall the rating agencies are generally favourable over the outlook. • The inflation rate is 4%, slowing down and at the low end of the range of the past decade. • The current account is in very small deficit, at just over 1% of GDP.


• The debt ratios are very well contained – 12 % gross external debt and 43% government debt as a share to GDP (the US comparables are 95% and 62% respectively). • The real is on an appreciating track (+27% in the past year) and that is because Brazil’s terms-of-trade (export price to import price ratio) is flirting near a 12-year high. • Given that real short-term rates are around 4.5% and the consensus view is 5% real growth this year, there would be little reason to be bearish on the currency outside of a currency setback (and FX reserves at $240 billion are up 15% in the past year and 30% in the past two years. The biggest risk is if there is a global relapse that drags Asia into the vortex and impair the commodity complex as this would undoubtedly reverse the impressive gains made in the currency -- after all, it’s not coffee that is Brazil’s primary export but iron ore; and it is not the USA but China that is the country’s largest customer.


Emerging Markets Watch

Recently, Brazil's BBB- rated US dollar debt traded in the secondary market at a significantly tighter level than single A rated "Build American Bonds" issued on the same day with similar maturity (138 basis points versus 230 basis points over the 30-year US Treasury bond). However, valuations on Brazilian real-denominated local debt, offering nominal yields close to 13% for seven-year maturities, compare favorably with those of US high yield credits.

Michael Gomez, PIMCO, December 2009

Oh, Canada!

My overall views continue to evolve but what has not changed are my opinions regarding the secular bull market in raw materials (hard assets) and income. At least now we are getting a better buying opportunity with the recent giveback in most commodity prices, and by extension, the Canadian dollar. I still emphasize that what investors get in Canada that they do not get in many other areas, specifically the United Sates, is exposure to the resource sector, and despite China’s recent restraint measures, and undoubtedly more will be coming, the country is unlikely to relapse back into a downturn any time soon from what I can see.


Investment Outlook: The Ring of Fire

Initial conditions are important because the ability of a country to respond to a financial crisis is related to the size of its existing debt burden and because it points to future financing potential. Is it any wonder that in this New Normal, China, India, Brazil and other developing economies have fared far better than G-7 stalwarts? PIMCO's New Normal distinguishes between emerging and developed economic growth, forecasting a much better future for the former as opposed to the latter.

Bill Gross, PIMCO: February 2010


SummitVIEW: The first quote in the Risks section of Headlines is Standard & Poor's statement regarding the downgrading of the United Kingdom's banking system. Is the United States next? After years of sitting idly and waiting to take action, the ratings agency companies are showing signs of pro-activity versus prior periods of reactivity. SummitView's appeal to US investors is to take to heart the change in modus operandi of the ratings agencies, become proactive in managing systematic risk. Systematic risk, by definition, is the risk that cannot be diversified away when allocating assets, for each financial system (market) has risk. As the markets showed in 2008 and 2009 risks correlate when prices reflect downside investor expectations, otherwise known as a downside risk framework. SummitView's belief is that an investor never could expect a single asset allocation paradigm to withstand seismic, systematic financial shocks. One has to create an asset allocation to reflect one's inherent risk aversion. The asset allocation should weigh systematic risk across all viable financial markets which fall within the investor's risk profile. The investor should be prepared to adjust the allocations based on the systematic risks developing in markets in which capital is allocated. Risk and reward. What are the risks and what are the rewards for a particular investment or a particular asset allocation? As the above quotes in the Opportunities section highlight, investors should consider markets outside the United States to achieve the returns that are commensurate with their risk profile. One needs to be proactive in protecting wealth and in achieving suitable rates of return. Old regime thinking likely will prove insufficient in developing effective systematic (and therefore portfolio) risk measurement and commensurate return opportunities.

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Headlines Feb 2010