Friday, 30 March 2012

Dividend stocks. Firewall. Spain.

Dividend stocks and other retail products
The stock market is ever busy in the eternal search for new “themes”, i.e. stories that can persuade investors to buy and sell and thereby generate the commissions needed for the business.  As interest rates have fallen, one particularly hyped theme has been “dividend stocks”.

The story has been that if you could not count on stocks to appreciate steadily each year, then at least you could borrow money at low interest rates and invest in stocks that would give you a better cash flow, i.e. dividends. I have never met any theoretical explanation that could make me understand why “dividend stocks” should be more attractive than any other stocks.

In Germany a group of researchers have now worked for a bit on the “dividend stocks”. Their verdict is clear: dividend stocks do not offer a better return on investments over any relevant time horizon than any other group of stocks. But for sure the many new products based on “dividend stocks” have generated a nice commission (plus loan margins) for the finance sector.

Caveat Emptor. We’re just saying.

Another “new-new thing” is investment in volatility. For private investors who do not even know what it is all about! With the predictable results.

The EU summit in Copenhagen seems set to decide that the total emergency facility to help troubled countries (and banks) will end up at EUR 800bn as the Germans finally seem to understand that the larger the facility, the smaller the probability that it will ever be used.

Yesterday, I referenced a study from the Swiss National Bank. There you would find a chart indicating that the Spanish residential property market is still significantly overvalued, and we are NOT talking holiday property here. When that information is combined with PM Rajoy’s new inititatives to cut the public sector deficit by a whopping 3.2 per cent of GDP we have all but a guarantee that Spain will remain mired in recession for a while. Personally i have a hard time believing that Spain will meet the German-imposed deficit targets in 2013. When will they ever learn?

At the same time Spanish trade unions are demonstrating against reforms that would actually make it easier to create new jobs.

Not funny at all. We will hear more of that story soon.

Thursday, 29 March 2012

Queen. UK. EU M3. US jobs.

Pity the poor elderly. Even the British Queen Elizabeth II cannot celebrate her 60 years of ribbon-cutting, crowd-weaving, and banqueting, without having bad conscience that the celebrations will “push the UK economy back into recession”. The press has eagerly sunk their teeth into the story.

The warning words come from another elder, Sir Merwyn King of BoE. His point is simple. By giving the entire country a(n extra) day off, UK will miss one day of economic output in Q2. One day out of 65 working days is about 1.5%. So if the UK lose 1.5% of output in Q2, for sure it would turn out a negative quarter, given the sluggishness of the UK economy. My advice to the worried central banker is to invite UK consumers to buy as many flags, mugs, hats, memorial medallions and what not to give the retail trade a boost.

UK growth
GDP growth for Q4 in the UK came out negative and we have a hard time being really surprised. UK consumers have been among the most leveraged in Europe, the housing bubble have been among the biggest, and the impacts on the public finances of the faltering banking sector among the largest in Europe.

Looking at the underlying data, it is clear that the UK consumers continue to consolidate. In combination with continued spending reactions in the public sector, it will take a long time to get the growth going again. For some food for thought, about house prices, look at this little study by a couple of economists from the Swiss National Bank.

I continue to be worried about the growth of the Eurozone money stock (M3). The headline number came out positive (+2.8% yoy), but dig a little, and you will find out that banks’ lending is still slowing and grew only by 0.3% in February. Bank lending to the public sector grew by 0.6%.

Does this prove that the huge amount of 3-year loans given to the banks “does not work” as in particular the UK financial press have been trumpeting?

No, The LTRO loans were not even intended for that. Their purpose was a) to avoid a major liquidity squeeze in the European inter-bank market, and b) to allow the banks to receive a colossal subsidy by using the money to buy government bonds. In that respect the LTRO loans work just fine.

But it does prove that when banks are reluctant to lend and borrowers are reluctant to borrow, the limits of monetary policy have simply been reached.

US Jobs
There is no doubt, the US economy has created more jobs than expected due to “unseasonably warm weather” – the methods used for seasonal adjustment of the employment data all but guarantee this result.

But is this enough that we should call off the optimism about the recovery in the US labour market. I think not. In fact, if one sums up all the micro data, it is surprising that the unemployment rate is not falling any faster than is the case. We may see a sharp drop in the months leading up to the presidential elections.

Given that the Republicans seem bent on choosing an unelectable candidate, falling unemployment would all but guarantee Obama’s re-election. My pious hope is that he would use a second mandate more constructive than the first. 

Wednesday, 14 March 2012

Dirrty. Bank Stress. Italy.

Dirty underwear
My, my. At Goldman Sachs things certainly are not as they used to be. One Greg Smith, an executive director with GS’s London office resigned today and felt it necessary to publish his goodbye to the firm as a Op-ed in New York Times. His point is that the company’s culture has turned into one of short term maximisation of profits instead of building long-term relationships to the clients.

Smith agrees perfectly with William Cohan, who in a book last year gave the same picture of the firm. Are we surprised? No, or at least we ought not to be. But the cabal of greedy bankers will just close ranks. As said a commentator: “Maybe he’s made a sufficient amount of money in his life that he isn’t particularly bothered if he isn’t employed in financial services again and works in a completely different world like teaching.”

With this kind of attitude, it is clear how much work the banking sector still has to do to position themselves as a part of the broader society and not as the gods who have the right to rip their clients off at will.

US bank stress test
Federal Reserve has subjected 19 banks to stress tests, and in the aftermath of the test, it has become clear that Fed wants to use it as a verdict on the bank’s desire to pay dividends.

Under a rather severe set of assumptions regarding the economy and the markets, 15 out of 19 banks were found to be able to keep their capital while continuing to pay dividends and re-purchase its own stock. Citigroup was found not to meet the capital requirements, together with Wells Fargo, Suntrust, and Ally Financials.

Interestingly, the take from the financial markets were that Fed’s required capital is waaaay to high, that the companies should be allowed to proceed with paying dividends, and that they are now so strong that nothing can break them down.

We rest our case. One ought to remind readers that Citigroup received most help of all US banks in 2008.

No talk of needing to adapt to a new reality, where banks have to accept living with lower RoE.

In January, Italy’s industrial production fell by 2.5% from December. That is not good news and again turns attention to Italy as a potential problem after a good run that saw the country’s refinancing costs fall strongly since late November.

For Europe, the number was an increase of 0.2 per cent, pulled by Germany’s positive reading of 1.5%. Europe may be pulling out of the recession, but significant differences persist between North and South. 

Tuesday, 13 March 2012

China. Spain.

China I
Since China last week announced that its new target for growth was 7.5% and not 8%, the financial markets have been busy discussing with themselves if this was a good or a bad thing. The verdict is mostly that it is a bad thing.

I do not agree. It is only natural that after a 10%-a-year growth target 15 years ago, and years of growth in the 8% to 9% range, growth will slow further. China still generates new jobs at a blistering pace as a growth rate of 7.5% in the world’s 2nd largest economy generates a lot more $$$ than growing the world’s 20th largest economy by 10%.

And 7.5% growth is not just 7.5%. In national accounting, increased imports count as a negative growth element. So China’s long and slow turn towards a growth driven by domestic demand and higher imports rather than exports will necessarily see a negative contribution to growth coming from a steadily worsening trade balance.

So all in all, the slower growth rate is nothing to be worried about. Guess we can sell them some luxury goods...

China II
But there is something else to worried about. China’s reorientation of the economic growth will inevitably lead to a worsening of the current account position. Pulled by its incredible export success over the last decade and a half, China has become one of the largest creditor nations on earth.

The gigantic trade surpluses paired with a fixed exchange rate has given China a huge need to purchase US treasury bonds. If they had not done so, the currency would already have been dramatically stronger than it is now.

The flip side is that China by this policy effectively has allowed the US of A to run similar trade deficits without suffering the traditional consequence of a weaker currency and (much) higher bond yields.

The stock market manages to spook itself when China comes out with a monthly current account deficit. In fact, the US bond market ought to be the most concerned. This asset class has profited the most from huge Chinese demand. It is in that space the adjustment to a smaller Chinese surplus will happen.

Unless of course the USA suddenly falls in love with savings and postponed consumption. When pigs fly.

Spain’s PM Rajoy challenged the new EU budget orthodoxy by announcing that Spain would end up with a higher budget deficit than expected in 2012. His statement last week was initially met with a deafening silence.

But now, some days later, the Euro-zone members are recovering from the surprise, and predictably, they now demand further cuts. Rajoy pointed out that deep cuts already had led to slower-than-expected economic growth, and appears unlikely to cave in, at least not without provoking a debate about the wisdom of punishing depressed economies with further cutbacks.

The outcome of that debate will be interesting as a measure of the strength of the backlash against the German dominance in EU budget matters.

Thursday, 8 March 2012

Risk-on/risk-off is off. Weidmann

The rather dramatic market movements in the past days can of course not be explained by the stories in the headlines since nothing this week is different from what it was last week.

This caused us to go over the totality of our indicators to see if there was something new. It has led me to slightly revise my view on the world. Ignoring some of the fine print, my new contention is that the risk-on rally is over. Instead we have entered a more normal phase where rotation between asset classes will be the normal driver of dynamics. There will again be room for stock picks, value investing, ratings arbitrage, automatic trading algorithms and what not.

We have come to understand the risk-on/risk-off as something that applies in extraordinary situations. Those situations are when the correlation between asset classes increases enough to make diversification irrelevant. All of our risk indicators have dropped sharply and have now begun to stabilise at “normal” levels. It means that risk-on/risk-off slides into the background.

The financial markets react to changes, relative and absolute. Now that the risk situation has nearly normalised, it is only normal that market attention moves on to something else. The market, after all, is the ultimate ADHD child.

Will risk-on/risk-off trades come back into fashion? Probably. There are enough things out there that have just been plastered over. But it is impossible to predict, so we just reserve the right to react when it happens.

Another Weidmann
Quite a spat is building between Bundesbank and ECB. Bundesbank chief Weidmann is intensely critical of ECB’s policy of covering everything and everybody in cheap liquidity. In particular, Weidmann is worried that the cheap liquidity could create a situation where “banks are discouraged from taking action to restructure their balance sheets and strengthen their capital base”.

Since Weidmann can safely be assumed not to be a complete idiot, this statement shows in all its horrifying clarity how much Bundesbank ideology is isolating the institution from seeing what is going on in the real world.

ECB is trying to counter the strongly negative effects on economic growth coming from thedisastros demands that the banks strengthen their capital base right at the point where German-driven budget cuts bite the hardest. With such friends in Bundesbank, the European economy will certainly not need enemies anytime soon.