Friday, February 27, 2009
We take some perverse comfort from the numbers as they show that we are in for a sharp recession that is much more likely to be brief and fiery rather than a Japanese 1990's style recession which was long and gradual. By Q3 we should be seeing some marked slowdown in US economic contraction with stabilization emerging in Q1 2010 and an upturn thereafter.
If true this has a number of important effects:
1) The US budget is too optimistic in its revenue assumptions - the deficits will emerge larger than currently forecast
2) Banks that have weathered the Q4 storm should only have one more quarter of dire contraction ( 6% annualised ) to face before the storm starts to ease - this should make provisioning easier
3) With the worst numbers since 1982 there can be some confidence that this is not going to be a long drawn out mild recession - it is going to be red in tooth and claw , brief and savage. The epicentre of the storm is upon us and it won't be too many more months before the cash sitting on the sidelines starts looking for a new home. The US was the first in to the downturn and should be the first out .
Of course with higher taxes on the way, cuts in government spending, and a propensity for households to save rather than spend the upturn when it comes may disappoint. As I used to say about the cheese plate in my local hotel 'there is less to this tham meets the eye'.
Tuesday, February 24, 2009
Markets seem to be in denial about the state of the banking industry. In H1 2008 nearly a third of UK short term corporate debt was provided by foreign, largely EU based banks. They are now retrenching as fast as possible to deal with their own domestic liquidity problems. Add to this the near 30% mortgage market share of Bradford and Bingley and Northern Rock and the chance of boosting domestic lending in the UK is absolutely zero. To replace these two gaps in the lending market would require the remaining loan books to grow at double the rate seen in the bubble years! This is before the defaults on corporate and credit card loans start to kick in. Lending will contract across Europe this year and banks, all banks, will need to raise their capital base again.
Fear of hyper-inflation has been a factor in the surge in gold prices. This last week has shown that it is an overblown fear. We are witnessing an economic downturn the like of which hasn't been seen since the early 30's but this time at a faster rate and with a more widespread reach.LDV, Volvo, SAAB are just a few of the companies that teeter on the brink. A large number of Euroland and US companies that have been relying on China, Russia and other emerging markets to bail them out will shortly join this list. Widespread corporate consolidation and the erasure of the weaker players will leave those still standing in a much stronger position - there will come a time when investors flee the corporate debt market and rush back into equities - that time simply isn't here yet.
Sunday, February 22, 2009
Love CNBC - so much more interesting than the alternatives. But, am I the only one who thinks that they seem to be blaming everything on Obama's stimulus package or his mortgage foreclosure amelioration plan? Was very worried about the widely broadcast rant against the mortgage plan - yes it could lead to moral hazard but it might also help prevent a collapse in house prices that could wash away many, many more households and financial institutions. This ill tempered sniping undermines market confidence.
UK government revenues in January were a nightmare. For the next fiscal year starting in April it looks as if the government will only be able to raise £2 out of every £3 it plans to spend. That can't go on for very long. The contraction in public spending when it comes will be severe - the hike in tax rates equally bitter. The recovery when it comes will be shallower than predicted.
Commercial property prices in the UK fell by 3.5% in January after a 27% fall in 2008.1600 smaller property firms with £1.1 billion of assets are expected to face liquidation this year.
Moody's forecasts corporate bond defaults will rise to 16.4% by 11/09 - the highest since the Great Depression and 3x the current rate.
Only 25%-30% of ex-Bush administration officials seeking full time employment have succeeded.
Saturday, February 21, 2009
Random thoughts picked up from today's press:
UK January car production down 58.7% from year ago levels. Commercial vehicle production down 59.9%.
S&P says the credit crunch may only be in its early stages and a bigger contraction in lending in coming months could have serious implications for the US economy.
Over the last year, first as Senator, then as President Obama has seen the largest outlay of federal money -$2 trillion - since World War II.
Sources close to the Obama administration say they remain open to nationalizing selected banks as a matter of last resort.
Although the Dow has given back all its gains -and more - from the five year bull market that ended in 2007, it is unlikely the market has hit bottom.
Coupled with slowing tax collections because of the recession the budget deficit is being pushed to $1.4 trillion or 10% of US GDP. Trillion dollar deficits are forecast for much of the next ten years as the skyrocketing costs of caring for the retiring baby boom generation start to arrive.
Heard a marvellous phrase in Zurich yesterday. A fund manager said he had a portfolio fitted with ABS. ABS , I asked. Anything but Sterling came the reply.
UK car production was down nearly 58% in January. There are rumours that a major producer is set to announce closure of its manufacturing ( Ford,Honda,Toyota ?) in the UK. With collapsing output, rising unemployment, and tumbling tax receipts the tax burden of the British taxpayer is going to rise and remain high for sometime to come. What's the betting that this government won't take any of the necessary steps to curb government spending, or cap public sector wages and pensions? Much better to leave the harsh and needed political and budgetary decisions to someone else. Meanwhile as Nero fiddles....
Tuesday, February 17, 2009
Airline as a reflection of the health of the economy - Thoughts from the Association of European Airlines.
Ryanair's Chairman has said that he is still in negotiations with Boeing and Airbus for a $7bn, 200 aircraft order. However, he is happy to wait 'until their order books collapse' in order to negotiate a better deal.
Monday, February 16, 2009
Spoke to an old friend in Moscow last night. Industrial output was down 20% in January. Gold and diamond output is falling sharply because the mines can't access finance either from the government or the banks. With the scale of the slowdown in Russia now apparent I'm coming round to the view that both Germany and Italy will see their exports to the country fall off a cliff - look for German and Italian GDP growth of -4% this year. Civil unrest in Russia may rise as the number of unpaid workers in the state sector skyrockets.
Sunday, February 15, 2009
It seems to me that the City has failed to raise its commentary game to address the severity and speed of the proto-recession - there is still far too much standard thinking. I would like to see some fresh thinking about the possible structural market impact of political banana skins that are being thrown out by the current economic downturn and the series of uncoordinated government and half baked responses to it. What would happen to currencies , equities and fixed income markets if one of the following was to play out ?:
What if Israel decides that the US administration is fixated on the economy and ignoring the threat posed by Iran? Will a new government in Jerusalem take the view that Iran is close to developing a workable nuclear warhead and attack Teheran's nuclear facilities? The recent election results seem to have boosted the hawks. Where would oil trade? Would the economic and psychological benefits of the stimulus be choked off leading to a second major leg of the downturn?
The lack of policy response at the weekend G7 meeting in Rome shows that the market state is dead. What will replace the political consensus of the last 60 years in the UK? Socialist safety net, Thatcherite austerity or something new? What does this mean for equities - will higher tax rates of say 60% on income slow corporate growth or will new high margin and strengthened corporate entities emerge to drive market valuations?
What if Ireland defaults (see previous posts)? Will the ECB bail them out or will German voters surprise us all and say no to their government and no to bail outs for the other PIIGS - what would the ECB do then? Would the Euro survive the withdrawal of its key economy? 49% of Germans want a return of the Deutsche Mark according to the latest polls.
Clearly government austerity is on the cards for the UK. Will the UK be forced into a major reduction of defence spending? If Trident is cancelled will the UK have any justification for retaining a seat on the UN security council?
What if Russian foreign policy continues to trend towards nationalist goals? Will Moscow use the economic crisis to destabilize Ukraine in the belief that gas hungry Germany and Italy will prevent any concerted action against it?
Saturday, February 14, 2009
There has been and still is a widespread view in Europe that the downturn would hit the UK and Ireland but would leave the continental economies relatively unscathed. That outlook is only now beginning to change and be replaced by a growing sense of despair. This is warranted .The current downturn will be deeper than previous recessions and modern information technology will force it through the system very quickly. By 2010 things should have stabilized , but some 10% of installed capacity will be wiped out.
The UK has been in the doldrums for some time - it looks to me as if the contraction will continue there until the tail end of this year before stabilizing. In Europe there will be a rapid forced reduction in manufacturing capacity as credit dries up- steel, shipping and electronics are already feeling the pain and consolidation, closures and steep write downs in goodwill,inventory and plant and equipment will hit the reported numbers over the next three quarters.
Governments are throwing money at the car sector - in the short term this helps maintain employment but the distortions created by this failure to deal with excess capacity will stay with us in the form of subsidies for years to come.
Savings rates are rising across the EU. The consumer is increasingly frightened. In this environment industries dependent on discretionary spending or status are to be avoided. A return to the growth levels seen in the '80's and '90's is impossible against a backdrop of government regulation of the banking industry with higher credit and reserve requirements . Welcome to an EU where 1% annualised growth will become the norm.
Thursday, February 12, 2009
Monday, February 9, 2009
The scope for a further round of major job cuts is made all the more likely by the snail like progress of the US stimulus package. Allowing for a bad tempered and decidedly partisan passage of the $800 billion today the final legislation is unlikely to be drafted and signed into law until the end of the month. The vast majority of the funds are unlikely to start flowing until the tail end of this year and a turnaround or stabilization is unlikely until early 2010. Shops,autos,banks,airlines and hotels all face further layoffs. A major worry will be if the profitable sectors of the economy like health care,pharmaceuticals , tech and media follow Boeing and decide during Q2 that the outlook is looking bleak and opt for a further round of job cuts . Instead of 9% unemployment the number might grow to 12%.
There is some good news. Press reports over the weekend hint that the Treasury is set to guarantee a floor value on contaminated assets. This would enable pension funds to step into the market and enable markups on written down assets at some banks. However, the lack of transparency in the banks year end numbers would indicate that they will have to bite the bullet and take more write downs and raise more capital. Pre-privatization of the banks still looks likely.
Saturday, February 7, 2009
Economic news has been as dire as might be expected at the front end of a deep recession or a proto-depression as a number of City folks are now calling it. Everyone seems to be panicking about the downturn but the Darwinian laws of economics are simply re balancing the economy after a decade of excessive debt extension. This isn't much fun for the 20 million laid off in Guangdong and Shanghai in last years final quarter but is a necessary step in forming a base.
My guess is that we will see a 10% destruction of global installed capacity within the next year with weaker players going to the wall and consolidation reinforcing the stronger market participants who will be able to hike operating margins. Governments will of course try to keep some of the no hopers like Chrysler and Saab going but the writing is on the wall. Taxes will need to rise to pay for structural unemployment levels of 10-15% ( excluding those deemed unfit for work ) and a reversion to the 60%+ tax rates of the pre-Thatcher era in the UK are just a matter of time. This draining of personal cash into the governments coffers to pay for all the new debt issuance would indicate that the recovery when it comes will be more gradual than many are forecasting with the consumer yoked to debt repayment for the next decade.
After talking to those at the coal face in the markets I'm more than ever convinced that the banks will still need to be taken into government ownership - pre-privatization is a new moniker for the unspeakable term 'nationalization'. So far we've seen write downs by the banks of $1 trillion of which 68% has been taken by the US firms with the Europeans only writing off 29% of this total. It can't be long before the Europeans and the continentals in particular start to match their American peers - a total deleveraging through the global banking system of $2.5 trillion isn't impossible.
Weaker companies are also likely to find this a challenging environment. 30% of installed US factory capacity is idle - a figure not seen since the early 80's. Too much capacity and too little demand underlies the implied 40% default rate over the next five years in the corporate bond market. Government debt is also a worry. Italy with a debt level of 109% of GDP has to refinance Euro 377 Billion of borrowing in 2009 so expect yields on Rome's debt to balloon.Ireland is perhaps the most exposed Euro member and continues to worsen- 25% of exports go to the UK and have become prohibitively expensive since sterlings fall against the Euro- further help from Europe will be needed if the Lisbon treaty is to be passed. At least Ireland has a modern educational system and will ultimately be able to work its way out of the problems - countries like Italy have much greater challenge ahead of them.
Sunday, February 1, 2009
I've written before that the real threat to the global economy and financial order would be a 'W' shaped recession where the stimulus creates a minor recovery followed by a further major leg downwards when monetary and fiscal policy have to be tightened. It looks as if the emphasis on capital spending with the required long lead times and planning approvals will delay the impact of the stimulus for a year or two and might turn the 'W' into a 'V'.
What's becoming abundantly clear is that with the government setting the agenda any business model that relied on access to easy capital or substantial leverage is going to be reporting red ink for a while yet. The deleveraging that has been going on through the banking sector is likely to accelerate through the rest of this year before stabilising next year. At some stage the market is going to recognize this and make a clear distinction in company and sector valuations.