Technical & Macro Update - November 2011

8/3/2019 Technical & Macro Update - November 2011

1/53

November 122011

MARKET COMMENTARY BY NAUFAL SANAULLAH

Naufa l Sanau l l ahn a u f a l . s a n a u l l a h @ g m ai l . c o m@ n a u f a l s a n a u l l a h

Technical & Macro MarketUpdate


2/53

Bullish

US data is surprising tothe upside

The US consumer appearsto be back

US corporate profits atrecord highs

Chinese inflation is

easing Political hurdles to

European bailoutdisbursement have beenaddressed

Bearish

US incomes are declining andconsumption is being financedout of lower savings

US corporate margins havenowhere to go but down

Chinese data continues to comein weak

Beijing property prices down5.1% YTD

Still no mechanism to

sustainably keep Italian yieldsdepressed

EFSF paper seeing low demand

Eurozone recession is gettingworse

MARKET THEMES


3/53

Manufacturing indicators are leveling out

Composite PMI remains barely above 50, after contracting from above 60

New Orders are ticking up, and New Orders/Inventories difference sharply

ticking back above zero, signifying tailwinds

Trend direction remains to be seen, but recession calls are looking premature

in light of recent data

Advance Q3 GDP prints at 2.46%

Using BLS-based deflators, real Q3 GDP grew by 2.94% YoY

Wednesdays September wholesale inventory data printed at -0.1% vs +0.5%

expected, causing pervasive Q3 GDP downgrades from 2.3-2.6% to 1.6-1.8%

Consumer improvements in goods & services spending was the biggest factorin the upswing

Real GDP ticked up to 2.9% in Q2 2007, directly before recession began

Import prices from China rose 0.4% MoM, as EM inflation exported

from Fed policy (through FX & trade channe ls) come back home to

roost and boost domestic inflation

US GROWTH


4/53

US GROWTH

Source: Douglas Short


5/53

Is current consumption growthwhich drove

growth in Q3sustainable, considering:

Per-capita disposable income is declining by 2.32%

annualized?

US savings rate is back to pre-recession levels?

Prospects of rising taxes are growing?

Recent consumption data could be mainly due to

easing energy & food prices in Q3?

These same food & energy prices have reversed their

entire Q3 declines in October alone?

US CONSUMPTION


6/53

The gap between incomesand spending isworrisome

This is especially so whenconsidering that morethan 20% of personalincome is fromgovernment transfers

Are incomes set to dropeven further as deficit

worries subsume theWashington debate?

What would be theconsequent impact onspending?

INCOMES

Source: Street Talk Live


7/53

The US savings rate is now

back down below the 4%

level

This level has roughly

demarcated betweensustainable, organically-

financed consumption and

unsustainable,

overleveraged consumption

The savings rate stayedbelow 4% from 1999-2008,

which were years

characterized by excess

debt and unsustainable

consumption

US SAVINGS RATE

Source: Federal Reserve Bank of St. Louis


8/53

Household debt service(mortgage & consumerdebt) and financialobligation (auto & rentalleases, homeownersinsurance, and property tax)ratios to disposable incomeare still plunging

Household deleveragingdoesnt appear to benearing completion

Because of secular natureof current down cycle incredit, these ratios shouldremain near the lower endof their ranges for anextended period of time,even after finally bottoming

HOUSEHOLD DELEVERAGING



9/53

Household debt is stillnot growing

Money velocity mayfinally start ticking up

once YoY householddebt growth (see chart)breaks back above the0 level

Until then, rumors ofthe completion ofhousehold deleveragingappear to be greatlyexaggerated




10/53

Consumer debt as a ratio ofdisposable income has along way to fall yet

To unwind the greatleveraging of the 1990s-

2000s, this ratio must dropbelow the 1 level

If incomes are set to dropfurther, then debt will haveto decline even moreincrementally in order forany further necessarydeleveraging to occur

This timeframe andnarrative fits well with thethree to four years




11/53

ECRI leading index(chart on top) insharply negativeterritory, below mid-2010 lows

Unlike 2010slowdown, ECRIcoincident index

(chart on bottom) isapproaching a breakbelow the 0 level

ECRI INDICES

Source: Economic Cycle Research Institute


12/53

Initial claims continue tohave a difficult timesustaining a break below400k

Without sustained real

GDP growth above 2%,the unemployment ratewill likely not sustain abreak below 9%

Public sector employmentis a big question mark inthe current politicalclimate, especially onstate & local levels

EMPLOYMENT



13/53

WILL TOP-LINE CONTRACTION CAUSE

MARGIN COLLAPSE?

Source: Bianco Research via Barry Rithotlz


14/53

A US recession in 2012 seems possible, given: The implications of an escalating Eurozone crisis on investment

The unclear sustainability of strong consumption growth in the face of asavings rate back below 4%

Political uncertainty and prospects of fiscal consolidation

Weakening EM demand for US exports (mainly from infrastructure spending

that is now being unwound) Any such recession would be likely to be shallow, especially

relative to 2007-2009, given already existing excess capacityand nature of secular deleveraging-driven balance sheetrecessions

With homeownership rates still so high and ineffective policy

responses to address housing woes, a reversal of housingsimpact on GDP is unlikely in the foreseeable future

Without a major housing recovery, the overall recovery could loseits legs, particularly since exports & government expenditure(both facing major headwinds going forward) have been the twomost positive drivers of GDP si nce Q4 2007

For now, a strong auto sector and continued business investment

into software equipment & technology are allowing expansion

RECESSION?


15/53

Inflation (headline CPI almost at 4%, core at 2%) is be coming a

constraint on further Fed QE, at least at the moment

However, the prospects of outright MBS purchas es seem to be

rising, as policy from Congress & the Whi te House are proving futile

Many economists have suggested the Fed engage in nominal GDP

targeting

The implications of such a policy on inflation, as well as the exact

mechanism by which central bank asset purchases can dire ctly

impact NGDP, are impor tant questions regarding NGDP targeting

However, price/level targets as opposed to size/aggregate targets

are much more credible and ef fective monetary policies, as thetransitory effec ts of the various QEs can attest

Stil l , at this point the Fed seems politically constrained from furthe r

action and will be unlikely to step back in unless cond itions

deteriorate substantially further

I f and when the Fed does implement NGDP targeting, the great

inflation may finally begin

FEDERAL RESERVE POLICY


16/53

CEOS ARE LOSING CONFIDENCE

Source: Goldman Sachs


17/53

AS ARE CONSUMERS

Source: Conference Board


18/53

After spending October very closely tracking EUR/USD, the S&P 500

has now decoupled a bit from external macro ris ks

Whether this decoupling can be maintained likely depends on if the

Eurozone crisis can finally be contai ned (unlikely in my opinion)

Bull market leaders showing sharp underperformance and high

volume sel l ing, including breakdowns and fai lures at 55dmas

Unit labor costs bottoming (real unit labor costs at 60 year lows &

wage share of GDP at 50 year lows): corpor ate margins nowhere to

go but down?

Sentiment has shifted dramatically to now being excessively bullish

The market crashed due to the debt ceil ing debacles implication on

potential domestic austerity, as well as immediate threats ari sing

from Italy & Greece

Although political changes have been made, the structural problems

in Europe remain and con tinue to escalate as austerity impacts

growth, suggesting the market may be indicating complacency

US EQUITY MARKET


19/53

Stil l overvalued, as per

Shil lers CAPE index

Secular deleveraging should

return CAPE back to single

digits before a long term

bottom is put in

The key headwinds to multiple

expansion at this stage is

actually probably EM demand,

which is being weighed down

by a combination of stickyinflation and a tightening CB

cycle in response to massive

hot money flows

Overseas demand accounts for

half of the S&P 500s revenue

US EQUITY MARKET

Source: Robert Shiller/Irrational Exuberance


20/53

Currently in consolidation zone between S&P 1220 & 1300

and in between 55dma & 200dma

Whether 200dma provides overhead resistance or is broken

through will likely determine near-term trend direction

For now, cash appears attractive; break above 200dma couldsignal retest of highs, while break below 55dma could confirm

bear market

Tight holiday liquidity could allow for a market ramp into year -

end, but it is difficult to get constructive on the market for

2012

US EQUITY MARKET


21/53

AAII SURVEY % BULLS

Source: Cullen Roche/Pragmatic Capitalism


22/53

S&P 500


23/53

The US equity market priced

in gold remains in a firm,

multi-year bear market

Short SPY/GLD remains an

attractive position After breaking and re-

recovering the 2009 lows,

this ratio is consolidating

and unsuccessfully testing

the 0.83 resistance above Other equity markets, both

developed and emerging,

priced in gold appear even

better short candidates

S&P 500 VS GOLD


24/53

HY/EQUITY DIVERGENCES

Source: Tim Backshall/Capital Context


25/53

Wal-Mart (WMT), Autozone(AZO), and OReilly Automotive(ORLY) have been among thebest market leaders recently

As Mark Smith observes, theseare the same stocks that

ramped ahead of the 2007-09recession

To the right is a cha rt of therelative performance of aprice-we ighted basket of theabove stocks vs the S&P

Large-caps with pristine

balance sheets contin ue tooutper form growth stocks on atrail ing basis

This is a bearish divergence inthe medium term

LEADING STOCKS
http://www.fundmymutualfund.com/http://www.fundmymutualfund.com/


26/53

I tal ian PM Si lvio Berlusconi has now resigned, paving the way for austerity

implementation

Mistimed austerity has thus far only hurt growth; is a new administration a credible

solution to Italys financing troubles?

If likely successor Mario Monti fails in implementing required austerity or in garnering

the required majority for a coalition government, BTP yields would go right back up

Even if austerity is successfully implemented, how will deficit r atios be brought downwith austeritys impact on growth?

According to Edward Harrison, at 6.5% on t he 10yr, Italy would need a budget surplus

of 5% of GDP (laughable) to keep debt levels simply from rising, let alone falling to

sustainable levels

October Italian PMI at a very low 43.3

Greek PM George Papandreou has also resigned, el iminating the threat of

a Greek referendum rejecting the EFSF bai lout

Societal disruption continues to rise, especially since the introduction of a property tax

to be collected directly through the state power supply corporation

Although the bailout package is now set to be accepted, general elections in February

may bring more hurdles to Greeces inclusion in the EU bailout

EUROPE
http://www.creditwritedowns.com/2011/11/why-questioning-italys-solvency-leads-inevitably-to-monetisation.htmlhttp://www.creditwritedowns.com/2011/11/why-questioning-italys-solvency-leads-inevitably-to-monetisation.html


27/53

Three necessar y and eventual ly inevi table pol icy act ions:

Cut benchmark ECB rates to zero

Expand the ECB SMP ef fectively into an unsterilized QE program

Create a common treasury/fiscal union (possibly by turning the EFSF or ESM into one),

funded by the ECB

A fourth act ion may be to eject some countr ies f rom the euro a l lowing for more

feasible f iscal integrat ion

I ta l ian & Spanish debt rate cei l ings/targets seem to be the only credible way to

f i rewal l countr ies seen as too big to save

ECB bids have helped I ta l ian 10yr y ie lds drop bac k below 7%, but only a perpetual

bid or rate target appear s to be suff ic ient to keep rates f rom r is ing back

Is an ECB bazooka a l l but guaranteed at th is point , conside r ing:

174 billion in periphery bonds bought by the ECB through the end of October? 307 billion in Italian bonds alone to be rolled over in 2012?

Germany & the ECB remain hawkish however

I ta ly owes German banks 116 bi l l ion

Germany will have to choose between a domestic banking crisis and ECB monetization

The only question is: how much worse will things have to deteriorate before the ECB

relents?

EUROPE


28/53

Political turmoil in Athens & Rome is making a larger EFSF less

likely anytime soon

An attempted 5 bill ion, 15yr issua nce had to be modified to 3

bill ion, 10yr paper du e to poor demand and liquidity for EFSF paper

It is becoming clear that the EFSF in its current form was an ad -hoc

policy response that does little more than buy time

EFSF yields remain at record wides

S&P has warned of ratings cuts to several European na tions, the

most notable of which is France

A French downgrade would render the EFSF moot, as Germany would

become the sole backstopper left

This could be the catalys t for unlimited ECB intervention

Lots of bearish economic data recently:

German Industrial Production down 2.7%

Eurozone retail sales down 0.7%

Spanish GDP growth has stalled

EUROPE


29/53

Contagion is spreading, withSlovenia now seeing yieldsabove 7% as well

Non-EU eastern Europeannations could become threatsto financial stability due to

cross-currency liabilit ies onEurozone bank balance sheets

Fitch & S&P have both warnedof downgrades to Hungarysdebt

CHF/HUF is back near itshighs (see chart to right),

unwinding the entire SNB ratetarget selloff, making thecross-border funding problemsan imminent danger to analready sticky situation

EUROPE


30/53

October European Manufacturing PMIs showed surprises to

the downside

Italian PMI was 43.3 vs 47.2 consensus vs 48.3 prior

French PMI was 48.5 vs 49.0 consensus vs 49.0 prior

German PMI was 49.1 vs 48.9 consensus vs 48.9 prior

Eurozone PMI was 47.1 vs 47.3 consensus vs 47.3 prior

German PMI is at lowest level in two years, dragged down by

declining export demand, and now in contraction territory

Italian PMI is at sharply recessionary territory and bodes

poorly for any attempted increase in government revenues Austerity is clearly bringing about a sharp European recession,

causing a feedback loop by making deficit ratios even higher,

forcing further fiscal consolidation and so on

EUROPEAN PMIS


31/53

WHY THE EURO ITSELF IS THE PROBLEM

Source: JP Morgan


32/53

Currently being driven mainly by political and event risks,

which are near-term bullish due to Greek & Ital ian PM

resignations

1.40 level remains the line in the sand

If the ECB continues re fusing to step in, Europe could befacing a deflationary outcome that could boost the euro

However, I expect ECB intervention and see EUR/USD as a

medium- and long-term sell

If Italian yields jump back up despite Berlusconis departure,

1.29 could be in the cards within the next few months

Sustained trend direction will likely not develop until after

holiday liquidity tightening gives way to the new year

Below 1.35, EUR/USD appears a solid sell

EUR/USD


33/53

EUR/USD


34/53

Risks from overheated

property sector and

overreliance on Chinese raw

material demand may expose

themselves in 2012-2013

China bear theme finallygetting MSM exposure

Q3 housing prices print -2.2%

YoY growth, as per ABS

Household debt/liquid asset

ratio at around 170% as of Q22011 (chart to the right)

AUSTRALIA

Source: Australian Bureau of Statistics

Household debt/liquid asset

ratio


35/53

Real housing prices Housing prices per GDP per head

AUSTRALIAN HOUSING MARKET

Source: Steven Keen


36/53

AUSTRALIAN HOUSING POPPING?

Source: Steven Keen


37/53

Currently bouncing off of support around parity

1.07-1.08 should present significant resistance

I doubt AUD/USD will recover to new highs in the

next few yearsA breakdown below the channel support trendline

(see next slide for chart) could catalyze muchmore selling

Below parity = game overAUD/USD above parity may prove to be a

generationally attractive short opportunity

AUD/USD


38/53

AUD/USD


39/53

Rebalancing permanently altering Chinas growth trajectory is a theme picking

up momentum among market part ic ipants

The copper crash could have signif icant impacts on rampant commodity

col lateral f inanced credits and the pert inent bank counterpart ies

CDS spreads for Chinese banks have spiked in recent weeks

Chinese October PMI came in at a 50.4 print (anal ysis in fol lowing sl ide)

A new tax to hel p fund social safety nets is l ikely going to lead to expatriate

labor costs r is ing

A bipart isan bi l l in the US Senate may act to mit igate the effects of Chinese

trade pol icy, which would be damaging to global t rade as it would set of f

further protect ionism

Inf lat ion has eased to a mid- 5 handle, but growth has been hit sharply as a

result The easing of inf lat ion could set the stage for some easing, but I suspect this

would be the last attempt as:

In this event, inflation would rise right back, perhaps to new highs

The current growth slowdown is global and export growth would not off set the rise in

inflation

Chinas housing and overall fixed asset bubbles may be permanently popped

CHINA
http://ftalphaville.ft.com/blog/2011/03/31/530726/why-the-chinese-copper-financing-scheme-is-a-big-deal/http://ftalphaville.ft.com/blog/2011/03/31/530726/why-the-chinese-copper-financing-scheme-is-a-big-deal/http://www.economist.com/node/21530141http://www.economist.com/node/21530141http://www.economist.com/node/21530141http://www.economist.com/node/21530141http://ftalphaville.ft.com/blog/2011/03/31/530726/why-the-chinese-copper-financing-scheme-is-a-big-deal/http://ftalphaville.ft.com/blog/2011/03/31/530726/why-the-chinese-copper-financing-scheme-is-a-big-deal/


40/53

October headline PMI print of 50.4 vs 51.8 consensus vs 51.2

prior

New Orders decreased to 50.5 from 51.3 prior

Inventory increased to 50.3 from 49.9 prior

Input Price decreased to 46.2 from 56.6 prior

New Export Orders decreased to 48.6 from 50.9 prior

Lowest PMI since early 2009

The seasonality factor in Septembers strong PMI observed by

Also Sprach Analyst seems to have been proven true with

Octobers weak report

The global growth slowdown is negatively impacting Chinese

exports demand

Chinas PMI has not been below 50 since February 2009

CHINA OCTOBER MANUFACTURING PMI
http://www.alsosprachanalyst.com/economy/china-september-pmi-improves-for-second-month.htmlhttp://www.alsosprachanalyst.com/economy/china-september-pmi-improves-for-second-month.html


41/53

Real estate investment is driving 12% of Chinese GDP, up from 5% a

decade ago and 9% in 2008

Whether or not inf lation expectations become unanchored, PBoC wil l have

to return to tightening by H1 2012 to get real deposit rates back above 0,

according to Nouriel Roubini

Weakening US & European consumer de mand (already occurring) could

lead to underwhelming export f igures going forward

The Eurozone is Chinas biggest trade partner and peripher y austerity

measures bode very poorly for external demand for Chinese goods

Allowing for sharper RMB appreciation may turn out to be the only way to

successful ly f ight inf lation, but this in turn wi l l further hurt Chinese net

exports, and with investment f inal ly being curbed, government expenditure

would have to increase signif icantly or Chinese GDP would be at r isk of

slowing sharply

A new Bank of Japan report compares the current Chinese rebalancing to

Japans in the 1970s with some alarming conclusions:

The main factor behind the rebalancing was decline on the return of capital

Liberalization of bank lending rates occurred in Japan during the 70s and likely

to occur in China in the 2010s

CHINA
http://www.boj.or.jp/en/research/wps_rev/wps_2011/data/wp11e05.pdfhttp://www.boj.or.jp/en/research/wps_rev/wps_2011/data/wp11e05.pdf


42/53

Hong Kong is teeteringon the edge ofrecession (chart toright)

South Korea andVietnam are seeingsharp slowdowns inexport demand

India is getting hit hardby the European

slowdown India & Brazil have

inverted yield curves

EMERGING MARKETS

Source: Also Sprach Analyst


43/53

INDIAN INFLATION STILL RISING

Source: India Ministry of Labour


44/53

The Economic Surprise Index

crossed below the zero l ine in

late April , just as the market

was topping

Since, it has recovered back to

the zero line and implyingbullish momentum

However, the Eurozone-

specific index is in sharply

negative territory

The US-spe cific index hasclimbed dramatically to

almost 50, but whether this

consumption-driven boost can

be sustained remain s to be

seen

CITIGROUP ECONOMIC SURPRISE INDEX

Source: Bloomberg


45/53

US fins have come under a lotof stress lately

Balance sheet exposure toEuropean govys is a primaryculprit

Declining net interest income

has also been a beari sh driver,especially now that the Fed ispancaking the yield curve(which should lead to evenlower NII)

TLGP rolls could weigh heavilyon bank capital ratios and

expenses as interest expenserises

Large spike in maturities Q42011-Q2 2012 (see char t tothe right)

US BANKS

Source: Tim Backshall/Capital Context


46/53

California revenue came in $1.5 bill ion (6.5%) lower than

expected year to date

This may trigger automatic spending cuts

If this becomes a more pervasive phenomenon, especially if

the US recovery loses its legs, public sec tor employment maysee sharp headwinds

Increasing social inequality and unrest is also a likely

consequence of any austerity on the state & local level

States dont have monopolies over currency issuance, like the

federal government, as they are currency users

STATE & LOCAL BUDGETS
http://www.bloomberg.com/news/2011-11-10/california-revenue-collection-1-5-billion-below-budget-controller-says.htmlhttp://www.bloomberg.com/news/2011-11-10/california-revenue-collection-1-5-billion-below-budget-controller-says.html


47/53

Fiscal consolidation continues to be the na me of the game in Western

economies, exacerbating the underlying economic weaknesses in the

non-government sectors

European leaders are seeing sharp decl ines in voter approval, as is

Obama in the US

Jeffrey Gundlach summarizes the 2012 election perfectly, saying thereare two parties:

Taxes are too damn low party

Spending is too damn high party

Global geopolit ics is becoming increasingly important

Bin Ladens death saw a resulting spike in terrorism in the Af-Pak region

Al-Awlakis death is likely to carry even more revenge risk, especially in

Western nations and of homegrown varieties

The US war of words with Pakistan is escalating and could turn ugly

if/when the US shuts off remaining funding and prohibits remittances

(both of which are tactics being deliberated in a Congressional bill)

Israel and Iran are heating up their rhetoric against one another

POLITICAL ENVIRONMENT
http://www.thereformedbroker.com/2011/09/29/notes-from-the-doubleline-lunch-with-jeffrey-gundlach/http://www.thereformedbroker.com/2011/09/29/notes-from-the-doubleline-lunch-with-jeffrey-gundlach/


48/53

The Arab Spring has resulted in power vacuums that entities

like Al-Qaeda and the Muslim Brotherhood are trying to take

advantage of

Europe is seeing a variety of administration shifts:

Greece & Italy have seen their PMs resign Germanys Merkel is losing voter support and has lost her coalition

Frances Sarkozy is polling very poorly and set to lose reelection bid

The USs Obama continues to suf fer a high disapproval rating

In the current backdrop of a global growth slowdown and

acute crisis in Europe, regionally and globally coordinatedpolicy is paramount

This spells a lot of uncertainty and risk going forward,

especially if exogenous crises manifest

2012: YEAR OF THE POWER VACUUM?


49/53

The supercommittee is tasked with deciding on $1.2 trillion indeficit reduction by the November 23 deadline

If no agreement is reached, automatic spending cuts kick in inJanuary 2013

S&P has affirmed that a stalemate will not likely lead to another

credit rating downgrade If no agreement is reached, Congressional disapproval and voter

polarization will only increase

The automatic spending cuts are designed to come half fromdefense and half from public programs

Government austerity remains the biggest threat to US growth,especially at this time

If the US economy starts faltering in Q4 2011 into early 2012,the prospects of austerity in the pipel ine in 2013 will be a bigdamper on investor expectations

DEFICIT SUPERCOMMITTEE


50/53

Occupy Wall Street appears to have three main focal issues: Corporate influence on democracy

Growing wealth disparities

Lack of legal repercussions in fallout of financial crisis

The main fallout from OWS is that the status quo is increasinglyseeing disapproval and systemic changes are being demanded

This negatively impacts both President Obamas reelectionhopes, as well as some of the more traditional GOP candidates

However, it does serve to boost Democratic Congressionalapproval (especially relative to GOP), as poll s indicate

It serves to boost more radical candidates, as well as those whowalk the line between the GOP & third party

Occupy Wall Street has gone global

97% of Americas 99% a are part of the global 1% of topincome earners

OCCUPY WALL STREET


51/53

The annual US income share of the

top 1% of Americans is coming off

of a 2007 high around 24%

This 24% level was last reached in

1928, r ight before the 1929 crash

and ensuing Great Depression

Financial izat ion of the economytends to increase income

disparit ies

The share of the top 1% bottomed

in 1971, the year Nixon took the US

off of the gold standard

Although a return to the gold

standard may not be the best

course of act ion, the lack of checks

and balances to the Federal

Reserves l iquidity extensions could

have played a major role in the

capital al locat ion shif ts that led to

such high income disparit ies

INCOME DISPARITY

Source: Wikipedia


52/53

REQUIRED WORK HOURS TO BUY S&P

Source: The Chart Store


53/53

I am a 21 year old recent univers ity graduate who is always

interested in receiving comments, insight, analysis, and

commentary from market participants, observers, and

reporters

As such, feel free to contact me via: Email: [email protected]

Twitter: @naufalsanaullah

CONTACT ME
mailto:[email protected]://twitter.com/naufalsanaullahhttp://twitter.com/naufalsanaullahmailto:[email protected]

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Technical & Macro Update - November 2011