View: Mid-term European index charts remain bearish, prefer US exposure
Equity markets have begun to look shaky again, the usual catalyst driving things namely the simmering Eurozone debt crisis with Spanish bonds pushing to yet higher ‘unsustainable’ levels while the Troika’s visit to Greece has rekindled Grexit chatter, a scenario where one should be thinking about ‘how’ rather than ‘if’. For the moment the moves in the main markets still look corrective within the broader up move we’ve seen since the start of June but support does look vulnerable. The fundamental story carries so many risks that expecting the market to be able to sidestep all of them is just hope. We also don’t subscribe to the view that equities are ‘cheap’ as the bulls continue to plug and that the macro backdrop is priced in, particularly with regard to the European bourses. The other bullish pillar of support is even more perverse from an investment perspective, the expectation of another injection of liquidity from those modern day alchemists the central banks, seemingly oblivious to the factors motivating these interventions. It might be kinder to say this demand is being driven by fear of missing out on the next rally, not that we’d expect one.
Full report below…
View: Negative Schatz yields to become the norm, equity correction a selling opportunity
There seem to be two scenarios currently; the first being that European ‘can kicking’ will continue, and despite things looking like they might totally implode at any moment, they will somehow manage not to for the visible future. Quite what this can kicking achieves of course is beyond us, it’s a bit like that drunk who knows that tomorrow is going to be a write off, so might as well plough on with those Jaeger bombs regardless. If we had to nail down the date of tomorrow in this context we’d say between the start of September and end of October 2013, the probable dates of the next German election and Octoberfest. The alternate is that can kicking is actually no such thing, it merely reflects policy paralysis and that the core/periphery divide is unbridgeable. The steps that appear after EU summits are vague and tied to such extended timelines directly due to this. The hard line taken by both Finland and the Dutch is telling, neither seem willing to compromise on the austerity driven solution despite the fact that we’re way past the point where this is really a valid crisis response. Signs of German compromise seem to have hardened their stance if anything. The ECB meanwhile refuses to act, believing that it is the responsibility of politicians, oblivious to the fact that consensus politics can’t achieve much with such disparate agendas. Some might say there is a third scenario where a workable strategy that allows the Eurozone to rebalance and grow slowly emerges, we’d just say good luck with that.
Full report below…
View: DAX bounce should be used to rotate to US equities
You have to admit the equity bulls have control when a batch of very dire European PMI releases are shrugged off when a modestly higher US equivalent turns up later in the afternoon as was the case on Monday. It is perhaps more surprising given that this was the manufacturing survey, when we all know that in the US services make up 70% of the economy and the (currently rather cold) boiler room of the European economy is those hyper-efficient German manufacturers. Of course the market had already had a heads up following the flash European numbers but it’s hardly as if US consumption is going to come to the rescue of Europe, in fact there has been debate on how weak European demand is dragging on growth in Asia.
Full report attached:
View: Tighten stops on DAX longs, start looking for a trigger to sell EUR/USD
Approving the Greek bailout failed to create that watershed moment that we had earlier hoped for, political bickering seeing to that. In the end, the whole process proved another example of how deep the divisions in the Eurozone are, to the point that opposing sides are happy to elevate what are effectively irrelevant points to the level of deal breaker. Indeed, it seems ridiculous to place so much weight on what Greece’s debt/GDP ratio might be in 2020 when the measures forced upon the country to get there will simply reinforce the downward spiral the economy is already in, ensuring the target is missed. The fact the Troika think 120% debt/GDP level is sustainable following what would amount to a decade of austerity is even further outside the box of rational thinking.
Full report below…
View: Chinese stocks look good value on a 6-12 months view, offer diversification
After being bombarded with bad news for months we’ve been digging around to find something more upbeat to chew over. Rather poignantly given the date (11/11/11) and their fondness for numerology our eyes turn to China. As ever there is a school still plugging the hard landing scenario as local asset (property specifically) bubbles deflate and a weakening export outlook pushes the economy over the edge. But looking at the data things might not be quite so bad.
There are a number of factors at work; firstly inflationary pressures are easing off, in part due to Bank of China’s earlier interest rate hikes feeding through as well as other less traditional steps taken to reign in the government fuelled credit boom. Additionally there is a helpful base effect at work and one of the principle drivers of the earlier inflation spike – the surge in commodity prices which resulted from the Fed’s QE2 programme – is also abating. This drop off has already been seen in the CPI data and is supported by the money supply stats which have been trending lower since the start of 2010. This, in our view, creates a decent amount breathing space should any side effects wash over China from the Eurozone debt crisis and/or soft US demand.
The trade figures released on Thursday morning were also quite supportive of the resilience argument. Although there was a weakening in exports (15.9% y/y vs. 16.1% median estimate) the import component continued to show robust growth picking up to 28.7% y/y vs. market expectations of 22.2%. It was this that drove the trade deficit below consensus rather than any surprise export collapse the wires editorial seemed to focus on. While there are often one off factors at work – the Chinese do after all have a habit of stockpiling goods when it suits them, as seen in the copper and oil import numbers this month – the broader domestic demand story continues to look encouraging.
This can also be seen in the divergence between services and manufacturing PMI’s and has no doubt also been helped out by accelerating wage inflation which may have eroded some Chinese competitiveness but looks to be an essential step to longer-term rebalancing away from savings to consumption. This should please the leadership, after all the focus of the twelfth five year plan (2011-2015) is to address both wealth inequality and increase domestic consumption. Such an outturn might look optimistic based on the risks stalking the global economy but we expect any material threat to be met forcefully, harking back to the aggressive stimulus (CNY4trn or approximately USD548bn) enacted in 2008 to combat the financial crisis and ensuing collapse in global trade. The government obviously has the financial firepower to enact similar measures should the need arise, unlike its developed peers. Additionally it has room to act on the currency, CNY appreciation already running at a slower pace than many expected.
Those fretting about bubbles deflating should also bear in mind the relative performance of the Chinese stocks since the S&P500 hit its low back on 6th March 2009. As can be seen on the chart Shanghai is up just 13% over this period vs. a gain of 59% for the Hang Seng and 60% for the DAX, most exposed to the European crisis. The mighty S&P meanwhile stands 81% above that famous 666 low. From an earnings perspective the SHCOMP doesn’t look particularly expensive either, trading on a forward P/E of 11.8 while the Hang Seng, a suitable proxy (correlation 0.56) is now in single digits, in part due to the battering of the heavily weighted financial stocks. These multiples are not too far from the DAX it has to be said but the difference is the growth outlook is far superior out east. Chinese stocks also offer something of a diversification play. There is of course a correlation with core markets but the relationship is far looser than one might imagine, for example a daily correlation between Shanghai and the S&P is a measly 0.16 and to the DAX just 0.25.
Given our bearish stance on global markets overall a buy recommendation looks premature and the immediate technical picture shows near-term pressure to the downside too. Indeed, the index is now running into channel resistance around 2,550 which has contained the market since the spring and above there faces a further block at 2,610. It’s difficult to see a clean break near-term given the hostile European picture. On the plus side the market has managed to hold support at 2,280/2,320 where the longer-term weekly uptrend intersects the lows from June 2010. We will watch this marker closely as a failure here exposes the 2008 lows sub 1,700. We think a move back above 3,000 is possible if global markets can find a foothold, but at this juncture risk is rather asymmetric. Accumulating weakness is probably the best strategy for real money types, particularly if we see a price failure at 2,280 and volatility picks up. A better scenario however would be a break higher and pyramiding into a developing bull move.
- Hong Kong stocks rally after China inflation data (marketwatch.com)
- Chinese M2 Growth Dropping To 9 Year Low Means More Pain In Store For SHCOMP (zerohedge.com)
View: France next in the firing line. Stocks, EUR should also feel the pain
Berlusconi or no Berlusconi, Italy looks in dire straits. The immediate focus is on blowing out bond spreads as the remaining liquidity in BTP’s evaporates, sending 10-year yields jumping through the 7.0% level (the 4.75% Sep 2021 bond trading 7.23% as we type). Recent buying from the ECB has just provided investors with liquidity to exit rather than helping shore up confidence in the market. But even before these death throws the picture for Italy was bleak; confidence measures have been in free fall for months and the decline in the purchasing managers’ indices has signalled recession since the summer. Average growth of barely 0.6% since 2000 highlights the fragility of the situation; recessions having the potential to play havoc with finely balanced debt dynamics.
Whether the immediate crisis is one of solvency or confidence is academic now (although those in Berlin, Paris and Brussels still probably don’t see it that way). It looks increasingly probable that Italy will be frozen out of debt markets, certainly at levels that are needed to fulfil its financing needs without blowing a huge hole in the budget and in turn triggering greater pressure from core governments and markets to enact aggressive austerity. Such steps would exacerbate growth pressures of course and one only has to glance towards Greece and Portugal to see how this would eventually play out. The Treasury needs to rollover a further EUR37bn debt by year-end, which by the looks of it the ECB will find itself reluctantly on the hook for, and for 2012 rollovers alone are just shy of EUR307bn. It’s no wonder that the EFSF (ratified at EUR440bn, plans to leverage it to EUR1trn are not really workable without pledges of more capital from the core) already looks like a relic.
There had been hope that the removal of Berlusconi would provide some breathing space but politics is fractured in Italy meaning the prospect of a strong government emerging out of the turmoil is slim, especially given the usual core/ECB prescription of ever more demanding austerity measures in return for aid/support. The IMF – whose arrival looks imminent – would have similar demands. We struggle to see what could really stabilise the situation now, to us it looks as if Eurozone politicians have past the point of no return, Italy (and the world’s third largest bond market) was too big to fail and the consequences will be pronounced and lasting.
BTP’s are likely to remain untradeable as this all plays out, but there still looks to be good trading opportunities elsewhere, in particular in French sovereign paper, contagion leaving its treasured AAA rating ever more exposed and with it the creditworthiness of the whole bailout mechanism. While Sarkozy announced a raft of new budget measures totalling EUR65bn over five years on Monday to shore up confidence, which should pull the deficit back to the 3% of GDP Maastricht threshold by 2013. Given the perilous state of the French banking sector though (which has nearly EUR500bn exposure to Italy, BIS Q2 stats) pressures won’t abate. We still like spread wideners vs. bunds to capitalise on this noting that 12-months ago Italian spreads were not too dissimilar to where French spreads vs. Germany lie today. From current levels of 146bps a push towards 200bps (bunds steady and OAT’s continuing to retrace back to the March/April yield highs) is a reasonable first objective. There is clearly more room for a significant spike higher if the crisis continues to snowball than for conditions to normalise.
Outside of bonds European markets have sold off for the past two sessions but overall have been rather resilient to this crisis specifically; the rally we saw in the region’s stock indices throughout October the most notable peculiarity although euro strength is not that far behind. Indeed, just based on macro trends and the probability of recession in the region we continue to expect that stocks will trade at much lower levels, favouring our sell rallies call, and the single currency itself needs adjust back to a price that would fit more closely with a broader rebalancing, certainly sub EUR/USD1.20 and probably closer to parity.
- ECB Issues Ultimatum To Italy, Threatens To Halt Bond Purchases (zerohedge.com)
- Italian Bond Yields Pass Key 7% Level (online.wsj.com)
- Goldman Sachs On Italy: “What’s Next” (zerohedge.com)
View: Mario can’t stave of recession, austerity drive flawed, markets to remain tough
It was a good start to what should be an 8-year Presidency for Mario Draghi, the 25bps rate cut showing some degree of pragmatism from the ECB and the press conference was well conducted, indicating a smooth transition from Trichet – not that we expected otherwise. Of course Super Mario is well versed in the routines of the central bank, stepping up from his existing seat on the governing council, and was unlikely to fall into any traps even in these testing times. While median expectations were for unchanged rates, expecting Draghi to wait until December before delivering the much needed rate cut (the perception being he won’t want to upset the German’s), a good chunk of the market was still calling for a cut and given the extreme uncertainty surrounding not just Greece but also Italy and the block as a whole the decision is not really surprising even if Euribor traders thought so. Something needed to be done and in these times the only body with any firepower is the ECB.
Unfortunately expecting the central bank to take more aggressive steps under Draghi’s helm might be wishful thinking, it seems unlikely we’ll see any imminent U-turn in the bank’s policy towards Securities Market Programme through which it has been purchasing peripheral debt – namely that it is temporary – and even then there is a clear carrot and stick with purchases conditional on meeting required reforms to aid policy transmission, i.e. fiscal consolidation. Liquidity will continue to be provided as necessary to the regions banking sector although we’re not quite sure how this will fit with the counter-weight of banks increasing tier one capital, which can only restrict credit availability going forward. There was nothing in the recent EU-17 agreement to suggest any formal help to banks raise capital (EUR106bn needed) which we think would have been sensible, after all the prospects of bank raising such sums in private markets is not much better than fiction showing once again a high degree of ignorance from the EU17 leadership.
It is this leadership vacuum that is really at the heart of the crisis, the risk of a Greek default hogs the headlines but really it’s as much a symptom of poorly directed policies to deal with the sovereign debt crisis which began nearly two years ago. Perhaps the biggest irony of the current flare up is that even if Greece manages to escape from the clutches of the current Papandreou induced crisis another one is just around the corner. The medicine Sarkozy et al. are advocating can only add to the problems Greece faces. Austerity will fail as a policy, simply because the results of that pain are insufficient to bring the country back to a position of fiscal sustainability (120% of GDP based on the latest projections). It is another futile can kicking exercise.
We would have hoped the economic landscape was warning enough. But no. Prescribed fiscal tightening will merely magnify what looks to be an inevitable Eurozone recession. Draghi may have described his expectations of “a mild recession” this afternoon but given how little focus there has been on growth throughout this entire process risks are skewed to the downside. A recession also raises the spectre of a French downgrade which would pull the rug from the EFSF’s so called AAA rating (spreads already telling us this). On the positive side inflation should moderate leaving room for the ECB to take a more proactive stance on rates in 2012 but the poor health of the banking sector means the transmission mechanism won’t improve.
This has interesting implications for markets. It doesn’t bode well for equities in the region over the coming months so selling rallies looks sensible. DAX 6,000 is not a level we’d associate with a real crisis. It should also exacerbate the need for a weaker euro over the medium-term (no matter what the Fed might think). Despite the current mess the single currency is still 3.3% stronger against the dollar than at the start of the year and comfortably above (11.0%) its average since launch which sits around EUR/USD1.21. But even a move back to here would be insufficient to help restore some of the periphery’s lost competitiveness, closer to parity might. The (German) yield curve has steepened since the start of October and may have room to move out a little further if this week’s Greek fears can be put back into the bottle, but looking at the 5/10’s spread levels above 90bps looks too steep to us, even if you buy into the idea that German credit quality will be compromised by bailout costs. This is perhaps the trade where we closest too in terms of timing based on the current story.
- Five Highlights of Mario Draghi’s First Press Conference (blogs.wsj.com)
- Economists’ Early Reactions: ‘Decisive Move’ in Draghi Debut (blogs.wsj.com)
View: Tactical equity shorts on Greek moves look smart, 200-DMA the stop for SPX
While the world frets over renewed frictions in Europe it’s worth a quick look at where the Greek developments leave markets from a technical perspective. Looking at the S&P500 in particular it makes things look very interesting indeed. The Elliot Wavers had already identified the sell off from the April highs as a five wave down move but this was all contained within the first wave of a larger bear move down. The recent recovery (ABC rally) then took us to a wave two top based on this count, which should now develop into wave three down, the largest move in the sequence.
The malleability of the Elliot rule set doesn’t sit that well with us but it does at this juncture allow us to create some clearly defined risk reward parameters for trading from a short base, lining up the 200-DMA at 1,270 as the stop level, aiming for a break of support at 1,175.85 in the first instance but really looking for a more aggressive retracement back toward 1,100 where we’d look to reassess the picture. Based on our longer-term charts an Elliot style wave three would have the power to take the S&P down towards the 900 level which doesn’t look that unreasonable given the backdrop.
US data hasn’t been printing so great this week either, Chicago PMI and the Manufacturing ISM number both coming out towards the bottom end of market estimates, which might add credence to the move (note at least a chunk of the recent recovery was due to the market pricing out prospects of recession due to better data). There are still a handful of important releases to go this week, payrolls included, but as we noted in our recent piece on the Q3 GDP performance, economic conditions will remain hostile so it’s unlikely they will be enough to offset the European crisis.
Those looking for more of a kicker could do worse than taking another look at the DAX. Although this index fell 5% on Tuesday at 5,834 it is still trading at levels that don’t fit with a disorderly Greek default and the risks this throws up for the Eurozone. Volatility looks set to remain elevate which might bring higher selling levels but while the cash market stays under 6,165 on a closing basis the bears have room to run. We’d remind that as of Tuesday’s close the index is still 17% above the September lows (4,966).
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