Justifiably Concerned

By: Michael Ashton | Tue, Nov 30, 2010
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Back in July, when the EU bank stress test results were announced, I noted (in the commentary linked here) that the €3.5bln in capital the EU said was required of the banks which failed the test was "a fraction of the lowest arm's-length estimates." Moreover, it bears noting that of the seven banks that failed the test, none was in Ireland (only one was in Greece; one in Germany; five in Spain). In the bailout announced yesterday for Ireland, €35bln is earmarked for the Irish banks (€10bln immediately, and €25bln later) which had previously passed the test.

I think this means that if you own one of the seven banks who were considered to be worse than the Irish banks, you are justified in being concerned about your investment.

You are also justified in being concerned if you own Spanish sovereign debt, because after all five Spanish banks were among those seven which failed (to be sure, they were small banks - ones that apparently didn't get the memo about how to represent their assets so as to pass like the bigger banks did: see the Wall Street Journal article mentioned in my September 7th missive "Hard to Flunk When You Have The Answer Key". Spanish 10y note yields rose 23bps today (Italy: +21bps, Portugal: +14bps, Belgium: +20bps, Hungary +22bps). As many other observers have noted, Spain is a much bigger pill to swallow than Greece and Ireland (and Portugal, if it comes to that).

If you are an Irish worker, you might be justifiably concerned. The bailout includes €17.5bln from the Irish government, some of which is actually coming out of the National Pension Reserve Fund (and we thought that Americans were mad about the banks being bailed out!).

The EU also courageously committed U.S. taxpayers to the rescue, as the IMF is pitching in €22.5bln. The U.S. quota is currently around $56bln of the IMF's $360bln in total quotas, so around €3.5bln of the Irish bailout comes from U.S. taxpayers. By the way, the Executive Board of the IMF earlier this month approved a general doubling of quotas, although the U.S. share will not quite double.

Apparently, though, if you own U.S. shares you needn't be concerned. Although stocks opened up sharply lower, by the end of the day the indices had recouped their losses. For the fourth time in the last week and a half, the 1175 level on the S&P provoked solid buying. On what basis, I haven't a clue, unless it is that we're not Ireland. Late last week saw an awful Durables number, even including revisions, a very weak Home Price Index, and continued weak home sales. Initial Claims was much better than expected last week, indeed the best since 2008, and lower Claims figures are a necessary (although not sufficient) condition to an improvement in the Unemployment Rate.

Sure, the Fed is printing money, and somehow managing that trick while strengthening the currency besides. And perhaps that is the short-term legerdemain: as long as you can print unlimited quantities of scrip, each of which has as much (or more) value in exchange for foreign goods as that already in existence, then you really can create wealth by printing money. Methinks this is not a successful long-term strategy, however.

Also not a good long-term strategy: to tell everyone what you really think of them (or so my daddy always told me). The Wikileaks scandal, in which hundreds of thousands of supposedly-secure documents were stolen from the U.S. State Department and given to a handful of large media organizations to do with as they wished, will damage even further the current Administration's standing on the world stage and therefore at home. There is just no way to put a positive spin on your Secretary of State directing employees to gather credit card numbers of foreign diplomats, as it appears ours did. To be sure, just as with the exposure of the documents that weakened the main thrust of the global warming movement, those who are made to look the most foolish will do their best to redirect outrage towards the (assuredly criminal, immoral, and wholly vile) act of stealing state secrets and distributing them willy-nilly. However, as with Climategate this effort will not change the content of the documents, and these will weaken the Administration just as the Climategate documents weakened the global warming cabal.

However, unlike with the Climategate documents, this scandal has market implications. A weaker Administration tips the balance of power further towards the minority party in Congress, which already has considerable positive momentum. It increases the urgency of some positive showing from the lame duck Congress, which so far has done little to pass an AMT correction and even less to roll back the tax hikes scheduled for January. I don't think it is necessarily over-simplistic to say that the weaker the Administration, the better it is for the stock market and the worse it is for the dollar.

Now, the dollar is clearly in the grips of a bigger effect right now, and that is the European disaster. And stocks have significant problems (see above!) that are probably not solved by a marginal change in the power of the backbenchers. At the margin, however, those investors who are already marginally bullish on stocks have a small additional reason to be positive.

Tuesday brings the release of the Case-Shiller Home Price Index (Consensus: -0.4% month/month) - not to be confused with the FHFA Home Price Index, which was released last week. More importantly, the Chicago Purchasing Managers' Report (Consensus: 59.9 from 60.6) has been chopping between 56.7 and 63.8 for the entire year, and unless there is a move outside of that range (note that the consensus estimate is pretty close to the middle of that range) it is not likely to have much significance. Consumer Confidence (Consensus: 53.0 from 50.2) is nearer to the bottom of the annual range than to the top, and following the election results should see an improvement. As always, however, I remind readers to focus on the "Jobs Hard To Get" subindex, which tends to lead or at least be coincident with actual improvements in the Unemployment Rate (see Chart, source Bloomberg).

Consumer Confidence
The Man on the Street doesn't yet see employment improvement.

After all of the numbers are out, be aware that Minnesota Fed President Kocherlakota is scheduled to speak about monetary policy at 12:30ET. Kocherlakota occasionally has, er, interesting ideas, such as the one in August when he argued that the Fed may have to raise rates in order to increase inflation expectations. (I "discuss" this idea in this post). Partly because of those ideas, I don't think he is viewed as particularly influential, but one should keep an eye on the tape when someone with the potential for crazy talk - and about that, we may be justifiably concerned - stands at the podium.

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
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Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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Source: The Contrarian Take http://blogs.forbes.com/michaelpollaro/
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