Login

Posts Tagged ‘Monetary Policy’

Economy versus Politics

Tuesday, June 8th, 2010

We wrote earlier that the steady state for the economy is being reached.  Profit growth is still the base case.  What could offset this strong profitability? It seems far fetched that the declining Euro will put a huge dent in US profitability, given that approximately 18-20% of US revenues are from the eurozone.  What are some potential catalysts?

  1. tax increases by state / local governments
  2. collapse in the EUR to below parity
  3. aggressive tightening in China or Europe (for different reasons!)
  4. policy mistake in the US

It is clear that the economy is chugging along, and that some of the biggest risks are how the markets will punish policy mistakes.  It reminds us of a quote from Schumpeter:

“As a doctor is unable to predict whether his patient will be run down by a motor car, so the economist is unable to predict in a situation in which so many political motor cars run about …”

- “Depressions, Can We Learn from Past Experience?”, Schumpeter, 1934

 

Tags: , ,
Posted in Business Cycle, Monetary Policy | No Comments »

Will liquidity offset the foreclosure crunch?

Wednesday, February 17th, 2010

A great but largely unknown resource for investment advisors is the “Monetary Trends” publication by the St Louis Federal Reserve (stlouisfed.org).  Their site is a vast collection of great research and speeches. 

How does this resource help?
At Covert Analytics we adopt a market forecasting and asset allocation approach which is based on simple, easy to understand principles. One of our principles is that an expanding liquidity base and credit creation usually leads to a favorable environment for economic expansion, and in turn a healthy climate for stocks and bonds.  “The rising tide lifts all boats” is an apt metaphor. As most of our readers know, our entire approach to investing is buy when the climate is ripe for appreciation, and sell when the climate is risky. many of the indicators we analyze to evaluate the monetary conditions are distributed by the St Louis Fed. (click here to open publication)

$473 billion in loans set to hit the market?
We were intrigued by a research piece put out by Standard and Poors.  Thanks to Barry Ritholtz at The Big Picture for distributing such an interesting piece.  The most important conclusion of this piece was that approximately $473 billion in loans will eventually need to be liquidated, which amounts to an estimated 1.75 million properties (or about 50% of all the houses available for sale as of December 2009). In other words, it is ugly! The dollar amount is estimated based on their categorization of the loans under analysis into four categories: performing, recently cured, seriously delinquent and REO.  Finally, the tally of $473 billion comprised of seriously delinquent, REO and likely to redefault loans, will need to be liquidated unless met with a substantial pick up in demand.

Why is this important?
This is important because it will likely hang on house prices for a very long time.  No matter how you slice it, Real Estate (technically a component of “tangible assets”) is the most important component of Household Net Worth.

So lets make the assumption that due to the foreclosure estimates from the S&P study, there is a 10% decline in housing prices coming.  This would result in a household contraction of $2.3 trillion. The National Bureau of Economics Research says there is a 10% pass through effect to consumer spending as a result of declines in household net worth. This would be an economic contraction of $230 billion (which represents 1.6% of GDP).

Can excess liquidity help offset this contraction?
The Monetary Trends publication shows some disappointing trends: the velocity of money is sluggish …

 

And bank credit growth is actually contracting!

In other words, it is unlikely that we will see a pickup in demand to offset the foreclosure crunch.  The data definitely does not suggest it, and given still high loan requirement standards, lower credit scores due to inability to meet payments, and deleveraging by banks and consumers, common sense confirms it!

Here is Barry’s post:   http://www.ritholtz.com/blog/2010/02/shadow-inventory-of-troubled-mortgages/

Federal Reserve balance sheet data:  http://www.federalreserve.gov/Releases/Z1/current/z1r-5.pdf 

Thanks for reading!

The Covert Analytics Team

Tags: , , , , , ,
Posted in Monetary Policy, Our Approach | 1 Comment »

Is China or US the new Japan?

Thursday, January 14th, 2010
 Reading an article yesterday in the FT discussing the problems that still plague Japan after their meltdown since the early 1990s led us to some interesting analysis.  The question posed was: is the most similar comparison between US and Japan post bubble, or China and Japan pre bubble?

Market commentators are often referencing how the US will face a Japanese style deflationary bust given the over indebtedness of the economy (government and individuals) and the deleveraging that will occur. A credit fueled bubble propelled Japanese assets to dizzying heights in the 80s. A similar, primarily-US, credit fueled bubble propelled assets across the world to new highs.  The retrenchment that occurred in Japan led to two decades of lethargic performance, in both the markets and economy.  The Nikkei is still 75% below its 1980s peak.

We often hear comparisons to how the US is in the unfamiliar process of deleveraging.  That after excessive credit growth for decades a retrenchment is uncomfortable, but 100% necessary.  Nomura here describes this as a “balance sheet recession” and is what happened in Japan :

“According to Mr Koo of Nomura, an economy in which the overindebted devote their efforts to paying down debt has the following three characteristics: the supply of credit and bank money stops growing, not because banks do not wish to lend, but because companies and households do not want to borrow; conventional monetary policy is largely ineffective; and the desire of the private sector to improve balance sheets makes the government emerge as borrower of last resort. As a result, all efforts at “normalising” monetary and fiscal policy fails, until the private sector’s balance-sheet adjustment is over.”

This would seem to be counter to what is occurring.  Companies are in better shape than ever and only in a doomsday scenario do you see the largest consumer market in the world, reverting to Japanese – style saving characteristics.  We for one think govermnent action to date has done one very important thing: restore Mr. Market’s confidence. Back to Japan for a second, Martin Wolf, whom we respect thoroughly describes the root problem of Japan’s weak economy for the past two decades on the corporate sector:

“My own view is that the underlying structural problem has been the combination of excessive corporate savings (retained earnings) and diminished investment opportunities, once catch-up growth was over.”

And here is where Mr. Wolf makes an interesting conclusion: could it be that China is facing a similar bubble risk like Japan was in the 80s?

“Yet Japan’s experience also has a lesson for quite a different economy. It indicates that when very fast growth begins to slow in a catch-up economy with very high corporate savings and comparably high fixed investment, demand may well prove extremely difficult to manage. This is particularly true if the deliberate promotion of credit growth and asset price bubbles has been part of the mechanism used to sustain demand. And who needs to learn this vital lesson now? The answer is: China.”

Please click here to read the full article.

Tags: , , , , , ,
Posted in Business Cycle, Monetary Policy | No Comments »

BCA on the business cycle

Wednesday, January 6th, 2010

BCA is one of the great research houses in the world.  They are usually spot on and great at separating the hysteria from reality and translating noise into signals to drive investment decisions.  They recently have made interesting parallels between historically sharp recessions and the corresponding vigorous recovery in Equity markets. In other words the sharper the drawdown in the economy, the fiercer the recovery rally when it comes. 

Here they differentiate between a normal economic cycle downturn and one associated with a financial crisis.  Their conclusions indicate that they believe that this will not be a V shaped recovery.  One of our previous posts pointed to the fact that “bad news is good news” in that bad news (or news confirming a weak recovery) is good for asset markets because it implies that the governments will be there eager to provide liquidity and stimuli. 

BCA: Financial crisis recoveries (red) vs Normal

From BCA:

Economic cycles associated with financial traumas such as banking crises or asset price collapses tend to have deeper downturns and weaker upturns. The current uptrend in U.S. economic growth should be sustained, but the rebound will remain subdued compared to recent recoveries.

In the past, there has been a close correlation between the severity of downturns and the vigor of subsequent recoveries, arguing that a V-shaped expansion in the U.S.  may be in order. In this context, the consensus forecast of 3% growth in U.S. GDP in 2010 seems low relative to past cycles. For example, the economy grew at an average 7.7% annualized pace over the six quarters that followed the deep 1981-82 recession. Optimists also note that the slope of the yield curve historically has been a good indicator of the economic cycle. Thus, the current steep yield curve in the major economies would be another reason to expect a vigorous economic expansion. However, the lingering after-effect of the financial bust will remain a serious headwind to growth in much of the developed world for the next few years. Indeed, recoveries that follow financial recessions tend to be much weaker than what follows non-financial recessions. Significant damage was done to the financial infrastructure in the past year, consistent with a weaker-than-normal economic expansion. Bottom line: While the global economic recession has ended, growth in the major developed regions will be slower than would normally occur after such a deep recession. This should limit consumer price pressures and keep policy conditions constructive for risk assets.

 Hope you enjoy the read,

The Covert Analytics Team

Tags: , , ,
Posted in Dynamic Rebalancing, Monetary Policy | No Comments »

Japan playing catch up

Monday, December 28th, 2009

Japan’ s problems are well known: major underperformance of the stock market, sluggish domestic economy, strong currency, aging population, high fiscal deficits, etc.  What is interesting is the uptick in performance of the Japanese stock market compared with the global benchmark.  Is this a sign of things turning around for Japan? Looking at the MSCI numbers for December (through Dec 24) we see that Japan is up 8.9%, compared with 2.9% for the S&P 500, and 4.8% for Europe.

Lets take a quick look at Japan.  First and foremost, it should matter to any investor. It is the second largest economy in the world. Second the stock market is down nearly 75% from its peak in 1989 and investors should be monitoring this economy closely to see if structural forces are in place to spark a rally. Note that this year there was an important shift of power in Japan: the Democratic Party of Japan (DPJ) took over after 54 years of rule by the Liberal Democratic Party (LDP). Could this serve as a catalyst for Japan to do what is necessary to ignite the economy?

Forget for a moment that Japan has the highest debt to GDP ratio in the world (near 200%).  They unveiled a 7.2 trillion yen stimulus package on Dec 8, a week after a 10 trillion yen credit program to support the economy. This is looking more and more like Japan is trying to play catch up and start quantitative easing in the British / American sense.

Tags: , , ,
Posted in Market Talk, Monetary Policy, Stocks | No Comments »