Steen's Chronicle: No more Silver Bullets?

24 May 2011

Steen's Chronicle: No more Silver Bullets?

Steen Jakobsen, Chief Economist

Madrid or Cairo?
I could give you a song and a dance rooting on how there is risk of both upside and downside from here, but let me instead cut straight to the chase:
 
I am turning net negative on the markets from here – my old call was for 1380/1400 in the S&P cash index and with the recent high of 1371, I now deem this to have been effectively reached. This negative outlook risks coming at a local low in the market, but there are several factors that make me make this call despite this risk:
 
Gold and S&P have started to move in opposite directions -This is a key indicator – In order for this to be a “proper correction” we need them to move in opposite directions as gold should find buyers nervous about stocks, politics and the general outlook. The correction so far this year has been general risk-on / risk-off on liquidity, etc. Things are looking different this time around.

China leads and has led since the crisis in 2008 – Every single turn: down and up has happened in China first.  On that note, the Shanghai composite index took out long-term support over the last three sessions.

Spain – scoring its own goal – Despite the consensus that the risk to Spain comes from the “reprofiling” of Greece debt, it’s more likely to be self-induced – I.e: the economic- and poltical environment deteriorates faster than the political will to resolve it. The local elections are a sign of increasing pressures.

Social tension - I have travelled extensively in Asia, the Middle East and Europe over the last two months and the social tension everywhere is rising. The social cohesion or lack of it is not something the market deals with as it is seen as too “unacademic”. But trust me in the talks, speeches and customer talks I have had it’s a real concern and nothing says it better than the recent surge of youth determination to show their disapproval of their government and their plight in Spain.

Technical patterns. I use a “back-bone” model which essentially is a momentum model – it’s simple but it keeps you honest (and long when needed!). This model is throwing out huge warning signals as it has entered a short on EMG-Markets and is now looking close to shorting the SPX Index.

SPX – support lines broken

SPX moving avg. model close to going short

 Emerging Markets (EEM ETF) already short

Valuation - My colleagues Mads Koefoed and Peter Garnry have developed an extremely interesting model which combines valuation with momentum of earnings in a consistent bottom-up way. The model indicates we are seeing “stretched” valuations. This model will soon be available for a general audience.

Chart 4: Saxo Bank valuation model (CAPE + Piotroski based) – showing expensive valuation

Finally, despite fundamentals being of no relevance, my negative view on Asian growth especially and world growth generally are being slowly vindicated – with the first derivative being one of increased fiscal deficits due to lower growth and tax revenue. Yes, the world may be prepared to deal with fiscal spending cuts, but the negative economic gravity seems to be outperforming the political will to deal with the problem. Another fundamental fact lost on most analysts is that in order for austerity(spending cuts) to work, they must ALWAYS be accompanied by loose monetary policy – the one thing we are not getting, no matter what happens from here.

Citigroup Index and Saxo weighted model

A local low in the stock market is clearly a risky proposition – the first obvious risk being that the G-8 at the end of this week creates some sort of consensus on how to solve the issues, but it is a risk I am willing to take as the ECB and Finance Ministers battle it out about Greece, Portugal and soon Spain. The other risk being some major Marshall plan secretively being worked out behind the scenes – again I am willing to risk 5-7% upside to be conservative.
 
In my notes above I have only indirectly included the clear and present risk of the situation in Europe getting worse – the reason being that it’s clearly priced in to some degree. What I do not see priced in are most of the other factors I have described. Market trends change more often than not on political events. I see this week-end’s Spanish election as a key catalyst. When watching people camping out in Madrid’s squares, it’s hard not to remind yourself that this is how things started in Egypt and the rest of MENA. A youth unemployment rate of 45% and a general unemployment rate of more than 21% is clearly not socially sustainable.
 
It may be this social dimension which is the real trigger for change and reason for a correction, and if so the market will prove unprepared as I am yet to see any trading model or statistical projection that includes social cohesion in its regressions. It could be the case of it's not what you do see, but what you don’t see that is most important.
 
The new target for the S&P cash index will be 1225/35. If we take out 1350 again on the upside, on the other hand, I will clearly need to revisit my overall call, but for now caution is recommended.

 

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Steen's Chronicle: Wrestling with a lack of liquidity

18 May 2011

Steen Jakobsen, Chief Economist

The market has many victims these days and I see this continuing as it wrestles with less liquidity, troubled by concerns about China's growth stalling, the end of QE2 in the U.S. and the Eurozone's peripheral debt woes being now played out in the Greek tragedy. In this chronicle I touch on all of these issues, which combined point to tough times ahead.

The Chinese slow-down factor
The key conclusion from my Asian visit last week was that Asia has reached peak growth. This entails refocusing on social dimensions and a wish to engineer a soft-landing. I’m confident that China will avoid a hard landing but more skeptical than consensus on how China will fair in terms of growth in the second half of 2011 and in 2012. Inflation will continue higher, precisely because China is currently witnessing peak growth and hence production capacity levels are at extremes where the pool of cheap labour has almost been exhausted and electricity and energy resources overall are at a maximum price level. Added to this is the major drive in the five-year plan to create “inclusiveness” and there is a growing risk that the 50% of net new growth added to world growth by China will stall or maybe even contract (as measured by its velocity).
The best hedge for a slow-down in growth China remains Australia. Australia is showing clear signs of bubbles in housing with some estimates saying house prices are 25 per cent above long term sustainable prices (Source: ABC.NET.AU). Australia remains a powerful force in producing resources, i.e., mining, and a main exporter to China. We are negative on AUD assets overall.

Source: Bloomberg: Interest differentials of the two main currencies against AUD
(JPY and USD).
We, at Saxo Bank, will cover the China slow-down factor and its impact as one of our major themes for the second half of 2011. We think the headline is about liquidity withdrawl.
Less risk capital
The exit from QE2 in the U.S. will mean net less risk capital for banks as the Federal  Reserve's balance sheet will remain unchanged to slightly lower. Add to this is the role of the European Central Bank, which is determined to force politicians in Europe to make structural changes via the continuation of interest rate hikes (by 25 basis points at least) for another two quarters. Finally, and again, China and Asia whom are busy curtailing inflation through a combination of higher currency and interest rates. The peak in liquidity may be near.
Neutral to defensive calls on equities
We still need to see our back-bone of generic models turn around, but both for Emerging Markets and the G-10 countries it looks like this week could force us to have an outright negative view on equities and valuations. If this is confirmed you will hear more from me, but for now we advocate alertness on risky assets. I have called for 1280/1330 as the medium-term objective for the S&P cash – the high has been 1271, so though we are not truly there (but still too close for comfort), this leads us to neutral to defensive calls on equities for the next month or two.
The role of the EU and the IMF in the Greek tragedy
Finally, a short comment on the European Union and the International Monetary Fund.  The political theory we use is one which states:  'politicians will do nothing as long as the cost to political opportunity remains zero for their re-election, and only when the opportunity changes will there be a political will to change'. This is the reason why I argue Greece will see “reprofiling” or soft-restructuring happen before the consensus view of 2013 (and most likely in Q4 2011 or Q1 2012). Chancellor Merkel in no way wants to be out and about on her election campaign while trying to safeguard Greece.
The key thing to watch for in the EU remains Spain. Not for the contagion risk of Greece (no matter whether a soft or hard default occurs, which is priced in), but more because of the underestimated risk of a deteriorating fundamental picture in Spain. Housing and unemployment in Spain are still in deep trouble, so it is quite likely that contagion could come from no progress in underlying fundamentals there and that Greece purely becomes the catalyst.