Wednesday, September 16, 2009

The good and the bad

Following is a summary of the pressure points in the market over the nearish term.  It's not intended to be exhaustive nor particularly prescriptive...more the impressionist in me trying to find expression (shudda picked up a paintbrush rather than a HP12C?).

The objective was to get some clarity around some of the path critical events that may or may not happen.  For example:

  • Liquidity tightened - is a near certainty in the near term.  The Fed has $14.9 billion left in the POMO kitty.  The Europeans remain as disfunctional and disjointed as ever, don't expect the ECB to keep underwriting the periphery indefinitively.  The Chinese caused a tremor in their market when they hinted at tightening credit standards back in June.  Question is whether the rally can sustain its bid without the cash injections?
  • Banking regulations - mutterings from the G20 suggest consensus that banks will be required to hold more capital and more liquidity and be allowed less off balance sheet leverage.  It may take some time to unfold but all these things work counter to the money multiplier and banking profits.
  • US mortgage stress - Meredith Whitney is one of the clearest thinkers on the US banks and housing markets - she expects another 25% down in house prices with banks really struggling from here given they are at their reserve limits at current price levels.  She observed that to date no one has been prepared to hit the bid - meaning that the state sponsored approach has been to paper over the problems and hope to maintain an orderly selldown.  The implication is that this round (should it happen), there is a risk that the fire sales begin.  The Evil Speculator has put together an interesting chart that shows the upcoming reset mountain (and his own interpretation of a snail crawling along a razor's edge).
  • End of fiscal stimulus - Fiscal stimulus has probably peaked across the major economies (Cash for Clunkers ends and auto sales down in September, China steel prices down in September due to stockpiling for example).  The strength of the rebound in economic activity will be tested as the fiscal stimulus rolls off - some like David Rosenberg say the recovery is all due to the fiscal measures.
  • Bailout of Europe - the likes of Italy, Greece and Spain are truly pickled.  The Euro might survive, but the political cohesion required to fund the bail-out of one or two of these countries will be something new for Europe.  This is a reasonable likelihood and would not be good for the EUR.
  • Eastern Europe collapse - probably more likely than not that one of the Baltic states will fold under its debt burdens or from civil unrest or maybe a combination of both.  The Latvians must be pretty pissed that they are the only country around the world that is being subjected to the rack (while everyone else gets the fluffy pillow around the face treatment).
  • China bubble - are we at the start of a bubble or the end of one?  From this distance, and looking through the red veil, it's too bloody hard to tell.  In the one camp, there are the likes of Andy Xie and on the other articles like this from Soc Gen (via The Pragmatic Capitalist).
  • US government credibility fails - worst case scenario is that faith in the oval office fails and the USD makes a quantum leap into another universe.  It's unlikely but possible - if the government keeps pumping in the cash like it has some.  At the limit, the threat of this type of event will constrain US government actions (it's probably more likely that the government starts a new war).
On the positive side, it might be a bit short, but what it lacks in volume it makes up for in substance...
  • Loose monetary policy - zero interest rates for as far as the eye can see.  If there is a hint of a self sustaining recovery, those companies that are positioned for it will enjoy low interest rates - both at the near and far end of the curves.  Don't expect inflation until some of the world output gap has been closed.
  • Corporate earnings - again companies that are able to leverage economic activity will benefit from rising productivity and lower labour unit costs.  This is a good thing if you can get it.
  • World GDP growth at 3%Credit Suisse in a report published by TPC point to the arithmetic that would deliver the world GDP growth of around 3%.  It rests on the emerging economies steaming ahead.  If China can continue it's recent form who knows?  They have deep pockets and like to build things...

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