Equity Strategy: A Mid-Year 2010 Perspective

- "The first half of the year reflected earnings strength and then slowing momentum. Better-than-expected 4Q09 results initially buoyed skeptical investors and the robust trends were further confirmed with 1Q10 earnings. But, typical slowing economic momentum following a reflexive bounce off of the anomalous early 2009 trough has generated a new sense of unease about the future which has been further complicated by government austerity and unanticipated FX swings. To some extent, the pattern was partially predictable, as investors had become trend followers rather than forecasters."
- "Powerful 1Q10 EPS growth was unsustainable, with margin pressures mounting. As noted in mid-April, the rapid acceleration in earnings growth projections reflected both increased executive confidence and a catch-up element. Upward EPS estimate revisions climbing above the 70% threshold was a clear indicator that the data was getting too virtuous and was unsustainable. The impressive margin rebound was due to incredible cost containment and a moderate revenue uptick, but maintaining such elevated profitability needs to be questioned."
- "Sentiment shifted from panic to complacency but now is back in panic mode. In early 2010, there was deep anxiety that the recovery rally from March 2009 had come too far given Greek debt fears, Chinese monetary policy tightening moves and perceived unfavorable policies out of Washington. By early February, the Panic/Euphoria Model had slipped back into panic territory. Yet, after 15%-20% appreciation in equity indices, this proprietary sentiment gauge advanced into complacency in April, leaving markets vulnerable to a pullback. In the past weeks, the model has collapsed back into panic, suggesting a high probability that the S&P 500 climbs in six months, supporting out 1,175 year-end 2010 target."
- "Uncertainty about 2011 trends is likely to cap any major summer rally efforts. While some may look for guidance out of the 2Q10 reporting season, which begins next month, it seems doubtful that issues including tax policies, government spending programs, housing trends, unemployment, trade disputes and currency trends will be settled that quickly. Ambiguity around capex is being resolved, but 2011 clarity is likely to be found later in the year rather than over the summer."
- "A late 3Q10/early 4Q10 market surge seems most likely driven by several catalysts. The start for a renewed rally appears probable in the September/October time period with the midterm elections, the bipartisan commission’s report on US deficit reduction and a better sense of how the Bush tax cuts expire all contributing to some increased clarity for 2011. In addition, there may be greater visibility regarding the impact of the European austerity initiatives relative to stronger economies such as Germany’s. Thus, the slowing economic momentum can be seen as settling in for more normal global growth rather than the traditional initial cyclical bounce."
Citigroup Equity Strategy 20100629


Europe's fiscal dystopia: the "New Austerity" road - Counterpunch
Employment report preview - Calculated Risk
Is monetary policy too expansionary or not expansionary enough? - FT Wolfexchange
RBS tells clients to prepare for 'monster' money-printing by the Fed - Telegraph
Parenteau: Marching to Austeria* and Other Neolib Fibs - Naked Capitalism
Wall Street's New Reality - Daily Beast
The risk of recession - Credit Writedowns
Study: Nearly One in Five Mortgage Defaults Are ‘Strategic’ - WSJ
How Far Underwater Do Borrowers Sink Before Walking Away? - WSJ
UK banks’ funding fun has just begun - FT Alphaville
Quantifying the ECB overdraft - FT Alphaville
Whoa. Look at the Yield on the 10-Year - Wall Street Journal
Owning the Banking System - New Deal 2.0
Three debts: A view from emerging Europe - Vox EU

Germans and fiscal deficits, monetisation of public debt, inflation

- "Remembering the traumatic experience of the 1920s and '30s, the great majority of Germans sincerely believe that it is absolutely essential to prevent:
• fiscal deficits, which can result in forced monetisation, and which divert savings to the detriment of companies;
• the monetisation of public debt (monetary creation), which inevitably leads to spiralling inflation;
• Inflation, which is destructive for society by despoiling savers."
- "One can therefore understand Germans' reservations regarding:
• the euro zone if there are no strict budgetary rules; without such rules, countries other than Germany could have excessive fiscal deficits that the ECB would in the end have to monetise; Germans' savings would be used to finance the fiscal deficits of the other countries;
• the monetisation of public debt by the ECB;
• the loss of competitiveness of the other countries which could, at fixed exchange rates, push up inflation in Germany."
- "The need to prevent the destruction of the euro zone (in particular due to sovereign defaults) and the need to accept different productive specialisations in the other countries therefore face resistance in Germany, because they force it to accept developments (monetisation of public debt, divergence of wage costs and trade balances) that it normally rejects."

Natixis Flash Economics 324 20100623

Towards a "Japanese" model in the euro zone?

- "There is currently a clear economic recovery in Asia, Latin America, the large Central European countries, Europe apart from the zone euro, Japan, India, oil-exporting countries and even in the United States, despite the deterioration in households’ financial situation, Canada and Australia. The euro zone is an exception, and we actually expect sluggish growth in domestic demand in the euro zone due to:
• the slowdown in wages,
• the rise in household savings,
• offshoring,
• the reduction in fiscal deficits;"
- "The euro zone could therefore evolve towards the "Japanese model": weak wage incomes and household demand, growth due to exports and associated investments."
- "This new model would be a major trend break for many countries, would be favourable only in countries that have kept a large industry and exports and would also raise the question whether the distortion of income sharing at the expense of wage earners can be accepted."
Natixis Flash Economics 323 20100623

Local regulation in global markets?

- "The last couple of weeks brought about some breathtaking developments. Who would have imagined a few months ago that center-left governments in Greece, Spain and Portugal would come up with draconian fiscal belt-tightening, while a center-right government in Germany implemented drastic regulatory tightening? Both factors have (potentially negative) implications for credit markets. However, while the deleveraging of sovereign balance sheets seems to be inevitable, an improved regulatory framework should address the formation of a bubble rather than preventing tools to hedge against a bubble."
Macro Outlook: "Financial markets play an essential role in the economy as intermediaries. However, asymmetric information, moral hazard and adverse selection make regulatory intervention indispensable for efficient functioning."
Micro Fundamentals: "Regulation has managed to become the main concern of investors due to poor political response to the capital markets shake-up in May. Tighter credit conditions could be one implication that negatively affects borrowers."
Debt-Equity-Linkage: "The new regulation measures will potentially impact the link
between debt and equity financial instruments, not only reducing liquidity in these markets but also disturbing the relative pricing of debt and equity instruments."
Credit Quality Trend: "Increasing the credit quality of banks is the ultimate goal of regulators to improve systemic stability. The easiest way would be to increase bank capital, but this has negative implications for the economy, as it would increase the cost of credit."
Market Technicals: "The sovereign debt crisis impacts primary markets. With the risk of a substantial repricing of credits in the cards, investors are not ready to add credit exposure."
Valuation & Timing: "Markets will behave less jumpy but spread widening pressure will persist."
Other Credit Markets: Credit Derivatives: "The actual usefulness of the German short-selling ban on CDS remains a mystery. EEMEA Credits: Accelerating inflation, surging housing prices and economic growth reaching almost 12% have increased pressure on Chinese authorities to undertake steps preventing a hard landing, with potentially negative implications for EEMEA credits. Regulation overkill in securitization illustrated by two new rules, i.e., CESR money market regulation, US-SEC Rule 17g-5."
Allocation: "Having missed the opportunity to cut our exposure to the more cyclical basic resources sector on time, we are also reluctant to implement this reversal during a panic phase. Nevertheless, amid mounting evidence of slower economic activity in China, we plan to reduce our exposure in the next few weeks. The rest of the portfolio remains unchanged as it already reflects our defensive stance."
Model Portfolio: "Our financials portfolio underperformed the benchmark by -67bp, while the non-financials portfolio underperformed by -32bp due to our exposure to basic resources."
Unicredit Euro Credit Pilot June2010

Get ready for the 12M LTRO expiry

- FI Strategizer: "Weak US data along with uncertainty ahead of the 12M LTRO expiry should create a favorable environment for Bunds and UST. Pressure on periphery should stay high in the coming days."
- EU Portfolio Strategy: "We stay long duration: the G-20 over this weekend and next week’s US data should not change much the positive mood for FI."
- 12M LTRO: "Next week, the 12M LTRO held in June last year will mature. The amount to be rolled over will send an important signal about the health of European banks, will affect excess liquidity in the Eurosystem and will be crucial for the dynamics of MM rates."
- German Q4 funding: "Due to a decline in its deficit, Germany cut bond supply by EUR 2bn in 3Q vs. what was previously planned, an overall modest amount. We expect a more sizeable cut (ca. EUR 10bn) in 4Q."
- UK Budget: "This week, the UK released its emergency budget, which contained strong measures to cut the deficit. As a result, this year Gilt supply may be 28% lower than last year."
- MM: "Bids at the 1W MRO reached EUR 151bn. Data released by the CB of Portugal showed that Portuguese banks bid EUR 35bn of liquidity in May at the ECB, almost twice as much as in April."
- Supply Corner: "Next week, there will be ca. EUR 20bn of redemptions and EUR 14bn in coupons (from Germany), while gross supply should be EUR 18/20bn. Net supply should be slightly negative (EUR 0/-2.6bn)."
-FX Strategizer: "Choppy trading on FX majors should continue also in the aftermath of the G-20 meeting. Resuming global risk aversion should remain the key driver ahead of a sluggish US employment report on Friday, favoring both the JPY and the CHF."
- EUR: "Although the euro held the line despite falling stock markets and widening yield spreads & CDS across the eurozone, EUR-USD should face more downward pressure due to the renewed clouded risk picture."
- JPY: "Market euphoria for Beijing’s decision to allow the yuan greater flexibility has faded, but the JPY should stay firm as risk aversion persists: we wouldn’t rule out EUR-JPY to slide again towards 108, also helped by a stronger BoJ Tankan report."
- CHF: "Jordan’s explicit remarks that the SNB has no need to intervene in the FX market were clearly taken as a “green light” for more intense EUR-CHF sales: the full break of also the 1.35 wall is approaching fast."
- GBP: "The UK Emergency Budget proved to be tough enough to boost sterling. Cable should definitively break through 1.50 and move towards 1.51, while EUR-GBP should fall below 0.82 if EMU woes persist."
- Pacific Rim & CAD: "While resuming risk aversion may weigh further on the three commodity units, political uncertainty may represent a unique source of volatility for the Aussie dollar, after Gillard became the new PM and debate on the mining tax abruptly returned to the spotlight."
- Nordics: "The SEK and NOK trends may diverge for the time being due to monetary policy at home. The Norges Bank sounded cautious on more intense tightening, while the Riksbank should hike rates next Thursday."
Unicredit Curves&Crosses 20100625

How fragile are debt holdings in EMU?

- "74% of Euro debt, issued by EMU residents, is held inside the Euro area and underlines that debt portfolio shifts are predominantly an intra-EMU story."
- "Intra-EMU non-resident debt holdings are a source of financial fragility for the periphery as rollover is likely to prove tough, especially in private sector debt."
- "Divestment risk from US and Japanese holders of € debt is interesting but ownership of the periphery is rather limited, tough illiquidity amplifies market impacts."
- "A dearth of data makes assessment of reserve manager shifts out of periphery paper hard to forecast, but this looks to be the trend. Caution on some core EGB names can rise but reserve managers are likely to increase exposure to the likes of Germany."
- "There little reason to think Bunds face a systematic risk of non-resident selling, unless the crisis envelops Germany to the point of much higher default risk."
RBS European Rates Strategy 20100625

Cult of the equity will disappear; Sub 2% US 10s

- Overview: "Get ready for the cliff-edge. Be maximum long duration of nominal government bonds in safe haven markets. This means US, UK, Germany, in that order, and perhaps others. Be long gold. Think the unthinkable. Get ready for sub 2% on 10-yr USTs; sub 2% on 10-yr bunds; and the UK not far behind, 2.5% 10-yr Gilts. We strongly believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe), and for the global economy (particularly in the US/Europe). We like the risk/reward. Surely risks associated with us being wrong are low (ie, rates just stay where they are, yields back up a little bit). But risks associated with us being right are >10% returns in 10-yr USTs at the same time that equities/commodities will collapse far beyond what even some equity bears anticipate."
- Euro Area: "The run-off of the 1y LTRO is unlikely to see marked impact on periphery short end or a material rise in EONIA, though the OIS curve can steepen. In addition to this subject, in this issue we looked at the Periphery vulnerability via external debt."
- UK: "We update funding numbers post-Budget. We still like Gilts against Europe as a trade & theme, but acknowledge the mere meeting of Budget expectations, coupled with quieter market with less events risks, implies a slower outperformance."
RBS European Rates Weekly 20100625