just in in-tray
From: Alan's Weekend Briefing
Sent: Saturday, 14 January 2012 8:18 AM
Subject: Kohler's Week: French Soup, Greek Dips, Europe, My Warning, Australia, Cricket
Saturday, 14 January 2012
Week in View
By Alan Kohler
Last night
German DAX, down 0.6%
London FTSE, down 0.5%
Dow Jones, down 0.39%
Aust dollar, $US1.0305
French Soup
Markets fell last night because Standard & Poor’s has decided to downgrade both France and Austria from AAA to AA+. Investors sold euros, equities and sovereign bonds, especially those from Italy and Spain, which only a few days ago held a very a successful bond auction that saw their yields fall sharply.
It’s more a reminder that the problems have not been solved than some kind of new catastrophe. S&P had pretty well flagged that this was going to happen so it’s hardly a surprise.
More importantly, S&P did actually downgrade US debt last August and since then its 10-year bond yield has fallen from nearly 3% to below 2%. The markets showed through that reaction that they couldn’t care less what S&P thinks any more.
Europe, of course, is a different kettle of debt and things are much more tense there. In fact, US bonds are seen as a safe alternative to European sovereign bonds because they are denominated in the world’s reserve currency.
Greek Dips
This morning's other bad news is that talks have broken down between Greek bondholders and the IMF and ECB over a restructuring of Greek debt.
It's because the IMF and ECB are trying to force the private bondholders to cop bigger write-downs than the 50% they had already agreed to. That was never going to be enough to put Greece's balance sheet on a sustainable footing, but the IMF and ECB have been refusing to take any losses themselves, which has been infuriating the banks and hedge funds.
Greece has a 14.4 billion euro bond redemption due on March 20 but its own cash reserves are now close to zero. The trouble is that it has done badly in meeting its 2011 fiscal and structural reform targets, so there's not a lot of enthusiasm to give it more money.
It's a game of chicken now: the IMF and ECB are looking for more voluntary participation in write-downs by the private bondholders but are taking a hard line themselves. This morning the bank and hedge fund representatives put out a statement, saying: "Under the circumstances, discussions with Greece and the official sector are paused for reflection on the benefits of a voluntary approach."
The alternative is a disorderly default of Greece, and possibly its exit from the eurozone, which everyone is trying hard to avoid. But given the depth of its problems, and its inability to turn things around over the past 12 months, maybe it will be impossible to avoid.
Europe
Up until last night conditions had improved a lot in Europe over the past few weeks, but the latest action reminds us that it remains finely balanced and very risky. To me, the current situation looks more like the eye of a storm rather than the passing of one.
Markets have recently stabilised because of the massive amounts of cash that have been injected into the financial system on both sides of the Atlantic, and especially in Europe lately by the European Central Bank. In the US and the UK the central banks had been (in 2011) buying bonds and other securities outright from banks; in Europe the ECB has been conducting repo operations, which just means loans that are secured by bonds. The outcome is the same.
The effect of this has been to set up a massive "carry" opportunity for global banks: they can borrow cheap money from the central bank – at 1% – and then buy government bonds or even just deposit it back with the central bank at more than twice the interest rate. In Italy and Spain they are getting three times.
Thus are taxpayers recapitalising the world's banks and, arguably, rewarding them for their past lending mistakes and providing them with totally unwarranted bonuses. But the financial markets of the US, UK and Europe are awash with cash, and this liquidity is starting to have the desired effect. Volatility is calming down and sentiment is improving. This week Spain and Italy held bond auctions and managed to sell 18.5 billion euros worth of bonds at sharply lower interest rates than previous sales. The euro rebounded; sharemarkets stopped falling.
Will it last? Well, it can last for a while and markets could even see a sprightly rally, but the long-term picture remains grim and the risks high.
There are two reasons for this: the sovereign debt in Europe (and the US and Japan) remains colossal with the refinancing task in 2012 still immense, and the structural issues underlying the European crisis have not been dealt with, and can only be dealt with through a fiscal union or a break-up of the eurozone.
Last year the Bank for International Settlements produced a paper that showed that debt becomes a drag on growth when sovereign or household debt reaches 85% of GDP or corporate debt rises above 90%. If all three of those thresholds are breached, and the total is 260% of GDP, it's a triple whammy.
That's what has happened in almost all of Europe, not to mention Japan and the US. Australia stands at 234% – it's a bit less because of low government debt. Most of the discussion these days focuses on sovereign debt, but the problem for the economy lies in all three types of debt. All must be serviced and repaid and when it gets to 85–90% that requires economy-wide belt-tightening. And that's what is now happening across the developed world.
So the level of total debt is a drag on growth, as are the various attempts to reduce spending and increase taxes to rein in budget deficits. Low growth or recession in the case of Europe means debt actually increases.
Correction warning
In my last note for 2011 I warned that risks to the downside were extremely high and that I would be reducing my own exposure to equities, urging you to do the same. In fact I halved my allocation to equities from 60% to 30%, retaining shareholdings in a few high-quality, small companies for long-term growth (Greencross, iProperty Group, Clover Corporation) as well as Transurban.
There was a big reaction to that note, much of it positive and some negative. One subscriber said he thought I had almost certainly picked the bottom of the market (I'm glad to say I didn't do that, although this morning the ASX 200 index is sitting a bit less than 1% higher than when I wrote that note on December 16).
I have to say my only concern was that I would be too late, that the correction would beat me to it and I wouldn't get a chance to issue a warning. All of us at Eureka Report take very seriously our responsibility to tell you what we think so you can make up your own mind using our various views as input.
Is my view still the same? Of course. Nothing has changed, including the overall level of the market. As outlined above, the world is awash with cash, which is creating a kind of "sugar hit" via a carry trade for banks, allowing them to make a safe margin by borrowing from and lending back to central banks. But the structural problems remain, the excessive debt is still there and the growth outlook remains dreadful.
Yes, valuations look cheap on a 20-year view and inflation is low. But while valuations may not fall much further than the current market price/earnings multiple of 10.25 times, which compares with a two-decade average of about 14 times, earnings are likely to underwhelm. And if inflation begins to rise, the P/Es could fall further as well.
Bank profits will be pressured by low to zero credit growth and rising funding costs, the resources giants are likely to see commodity prices fall as China slows in the coming year, and retailers, as we know, are in all sorts of trouble.
So I firmly believe the bear market has further to go and that there are still grave risks to your wealth from further shocks as Europe and the United States attempt to deal with the debt problems.
A lot of investors I know prefer to be out of shares entirely because of this; I'm comfortable with 30% shares and the rest in cash, ready for opportunities as they arise. It's all about sensible asset allocation and spreading your risk.
Australia
As for this country, there's a bit of good and bad in the outlook. Unlike other central banks, the Reserve Bank of Australia has some room to cut rates and support economic growth, but whereas the currency has also boosted growth in past by depreciating rapidly, that may not happen this time.
As discussed, we are entering another cyclical global slowdown, which can either be seen as simply a continuation of the one in 2008 or a new one. In anticipation of it, the RBA has already cut interest rates twice and will probably do so at least twice more in 2012. It's a powerful tool because 85% of mortgages are still variable-rate, but it is possible that the banks won't pass the full amount of any cut because their wholesale funding costs are not falling. Nevertheless, Westpac's economists estimate the cuts so far would have increased disposable income by 0.75 percentage points and further cuts will make a big difference to construction and consumption.
On the downside, the dollar may not fall this time because of the global demand for safe assets. Investors are now focusing a lot of attention on Australia's AAA-rated government bonds paying, as of last night, 3.83%, which is a darn sight better than the 1.93% US bond yield.
In 2008, after the Lehman crisis, the Aussie dollar dropped 30% on a trade-weighted index basis, which played an important part in Australia withstanding the global recession that followed. It's very unlikely that anything like that will happen in 2012 – if anything, it will be the reverse.
Cricket
I had a two-week break and spent a large portion of it couch-bound in front of the cricket. I hadn't planned it that way, but it just turned out that week one was the Melbourne Test and week two the Sydney Test. In past years we had taken No. 2 daughter to Sydney for the annual test match there because she was born on the first day of it in Sydney, and the trip to her birthplace was an annual birthday treat. But this year she was somewhere else in the world having a cold Christmas and birthday.
I must say that cricket is a beautiful, hypnotic pastime but, speaking for myself, it is best left as a spectator sport. I tried to play it once with disastrous results, and so I've stuck to the traditional Christmas Day Test match in the park with a tennis ball wrapped in electricians' tape.
When I was in my early twenties, a work friend invited me to play with his suburban fourths team, a serious but fairly inexpert bunch of guys who nevertheless dressed in whites and had a proper umpire.
I showed up one Saturday looking resplendent in new white clothes and a large moustache, which I was sporting in those days. I had never held a cricket bat or bowled a ball, but I certainly looked the part – a bit like Dennis Lillee, in fact.
"Do you bat or bowl?", the captain asked, obviously awe-struck by the sight of me. "Oh, a bit of both," I mumbled. "Right," he said. "You can open the bowling."
I paced out a very long run up, starting somewhere near the boundary fence, and steamed in. The ball narrowly missed the square leg umpire. Next ball went straight to second slip. At this point I was breathing hard, having just run a couple of 100-yard sprints, and the captain sidled up and muttered: "Um, why don't you shorten your run up a little." I did that and managed two overs before being relieved of duty. My figures were none for many.
The captain obviously decided that if I couldn't bowl then I must be able to bat, because when it was our turn he asked me to open the batting.
I strode to the wicket confidently, prodded the matting with my bat as I had seen them do on TV and took guard to their opening fast bowler. The first two balls were a complete mystery to me: I did not see them. The third was bowled directly at my bat so I couldn't miss it and spooned an easy catch to mid-on. Out for nought. I can only imagine what I looked like – probably a bit like Mum on Christmas Day: no footwork and all bottom hand.
But I learned an important lesson that day, which is that self-confidence is not always enough. Sometimes you need to know what you are doing.
Readings & Viewings
In this 2002 speech, Republican candidate Ron Paul predicts almost every geopolitical event of the past 10 years. Click here.Delicious piece on car manufacturing by Annabel Crabb. Click here.This guy is amazing, or totally crazy. He has roller blades all over his body and speeds downhill. Click here.This is clever, although I might have shown it before: two dogs in a restaurant. But in case you haven't seen it, here it is. Click here.Asian candid camera set up – very funny indeed. Click here."The Financial System is a Farce." Click here.What's going on in Hungary? They're playing chicken. Click here.Cities used to be built for people. Now they’re built around parking. Click here.Behind the rise of a great power (China). China’s imprisoned Nobel Peace Prize winner asks what a TV mini-series can teach us about the direction of the new China. From his new book of essays. Click here.What it takes to survive in today’s America, and why the jobs crisis will be so hard to solve. Click here.Tennis: how to return a 200 km/h serve. Click here.Education and economic development: evidence from the industrial revolution. Click here.The solution to the "too big to fail" is to force the banks to become smaller. Click here.Google may have made the worst mistake in its history this week. Click here.Waleed Aly on Teresa Gambaro's deodorant stink. Click here.My piece this week on the Big Bash League and cricket marketing. Click here.
The week ahead
The economic calendars in the US and Australia are well stocked in the coming week. And in the US there is the added attraction of the profit-reporting season. Meanwhile, there also is key Chinese economic data to digest.
In Australia, the week kicks off with a bevy of economic data on Monday. Not only will ANZ release its job advertisement series, TD Securities and the Melbourne Institute release the monthly inflation gauge and figures on housing finance are issued.
Job ads have fallen in six of the past eight months and little improvement is expected in December. Inflation is well under control given retail discounting. And the number of home loans probably rose 3% in November in response to lower interest rates.
On Tuesday data on lending finance is issued. This enhances our knowledge on lending in the economy, providing figures on business, personal and lease loans as well as the housing figures released a day earlier.
On Wednesday, consumer confidence data is released, while car sales and data on imports are released the same day. The Federal Chamber of Automotive Industries estimates that car sales fell by about 6% in seasonally adjusted terms in December.
The December employment data is the highlight on Thursday. Employment has just been covering new entrants in recent months and we expect the same result in January with jobs up by 13,000 and the jobless rate steady at 5.3%.
And on Friday the inflation reporting begins with December quarter data on import and export prices to be issued. CommSec tips a flat result for exports with imports up 0.6% in response to a softer Aussie dollar.
In the US, the Martin Luther King holiday ushers in the week on Monday with the Empire State index issued on Tuesday. But then the economic data starts rolling in with producer prices, capital inflows and industrial production figures due on Wednesday. Economists tip only a modest 0.1% lift in core producer prices (excludes food and energy) while production may have rebounded by 0.4% in December after the 0.2% contraction in November.
On Thursday data on consumer prices are released alongside housing starts, weekly claims for unemployment insurance and the influential Philadelphia Fed index. Core consumer prices probably rose by a tame 0.2% in December while little change in housing starts is tipped. And on Friday, economists expect that existing home sales rose by about 3% in December.
Also in focus over the coming week will be Chinese economic data, with figures on economic growth, investment, production and retail sales slated for Tuesday, and home prices on Wednesday. Government debt auctions are scheduled in Netherlands and France on Monday; Spain, Malta and Belgium on Tuesday; Germany and Portugal on Wednesday; and Spain, France and the UK on Thursday. German, French and Italian leaders meet on Friday.
Best wishes,
Alan Kohler |
