No time to be stressed

- "Irrespective of the outcome of the banking sector stress tests, the fundamentals of the European banking industry have improved considerably over the past several months."
- "Balance sheets are expanding again as a result of new loans, and improved values for banks’ debt securities and these trends are dominating a ‘late cycle’ increase in traditional loan losses."
- "Banks have been raising capital so that leverage ratios have declined below their trough in the last cycle.""
- "Given these improving trends, this is an odd time for the market to become overly concerned by ‘stress’ scenarios. There are still institutions that will need to be recapitalised, and it is important that these weak links are dealt with transparently, but the ‘big picture’ is one of incremental improvement."
- "In the final analysis, European banks remain closely tied to the condition of the wider economy. With recent data surprising on the upside, there are grounds for mild optimism here too."
- "With European banks trading on 0.9 times their reported book, and other ‘cyclicals’ on 1.9 times, we continue to recommend an overweight position, whatever the outcome of the stress tests."
Nomura European Strategy Weekly 20100723

Reducing Japan, increasing Europe and (some) emerging markets

- "We are reducing our recommended weighting in the Japanese equity market from an overweight 17% to a neutral 8%. We are raising our exposure to Emerging Markets from an underweight 10%, to an overweight 16%, while raising our already overweight 20% exposure to Europe ex-UK to 23%.""
- "Despite the fact that Japanese profitability remains well below peak levels, the recovery is already losing momentum. This contrasts with strong growth in emerging market earnings and impressive Q2 results elsewhere."
- "Performance and valuation varies considerably across EM, but it is in Asia, and especially China, where valuations now appear most attractive. Conversely, several emerging markets sell at lower implied risk premiums than their developed market peers."
- "The relative common performance of the Japanese market remains closely tied to the fortunes of the yen, which may now be vulnerable to a correction."
- "In Europe, improvements in the economy and especially in the banking sector, suggest further outperformance is possible."
Nomura Global Strategy Weekly 20100723

Squaring the Fiscal Circle: Could a Fiscal Rule Help?

- "The cyclical case for additional monetary and/or fiscal stimulus is very strong in light of the weakening economy, but it is hard to see how sufficient support will actually be delivered. Monetary policy is hampered by the zero bound. Meanwhile, some market participants and much of the public worry that additional fiscal stimulus could lead to a budget crisis down the road."
- "A credible commitment to fiscal sustainability could help overcome these concerns on the fiscal side. In particular, the implementation of a well-designed “fiscal rule” could be an effective way to square the circle in signaling a commitment to consolidate from 2012 onward, while creating room for additional stimulus now."
- "International experience shows that fiscal rules can help deliver effective stimulus and
achieve successful fiscal consolidations. In particular, fiscal rules are associated with (1) fiscal expansions that are more effective at reducing unemployment while avoiding spikes in long-term interest rates and (2) larger and more sustained consolidations, particularly when they contain a constraint on government spending."
- "Our results suggest that a US fiscal rule should (1) target the ratio of federal debt to GDP as the ultimate goal, (2) include expenditure constraints and (3) allow for a transition period in which additional stimulus is permissible."
- "We recognize that fiscal rules are only as useful as the underlying political commitment to fiscal sustainability— because Congress can always abandon the rule when it starts to bind. Nonetheless, a fiscal rule could strengthen credibility by promoting transparency and accountability."
GoldmanSachs US Economics Analyst 20100723

Earnings preview: Strong numbers but market expectations weaken

- 43% of the reporting market cap results are due over two weeks "In the US, 55% of companies reporting have beaten estimates so far. Consensus now expects 32.6% earnings growth in Europe for 2010 (closing in on our 38% forecast). The rise in expectations has all been in margins, while sales assumptions have remained unchanged."
- 2011 Revisions stalling, we remain more positive than consensus "2010 earnings revisions remained positive ytd, but revisions for 2011 have started to stall reflecting increased macro concerns and prompting a shift in focus in 2Q on outlook statements and regional trends. However, we expect growth of 28% in 2011, well above consensus (18%)."
- Equities already discount a deterioration of earnings sentiment "The market has moved with earnings revisions, but we see disconnects at the sector level; Basic Resources enjoyed the strongest upward revisions ytd but underperformed by 5%. Our BRICs and Stable Growers baskets (GSSTBRIC and GSSTGRTH) should provide strong earnings resilience."
GoldmanSachs Europe Portfolio Strategy 20100723

Interpreting the stress test results: spanish banks and cajas

- CEBS / Bank of Spain publish the stress test results "On July 23, the CEBS published the results of the stress tests run on 27 Spanish credit institutions (90% of the market). This report analyzes in detail the assumptions used in and conclusions drawn from the Spanish banks and saving banks’ tests."
- Mixed feelings on the assumptions; disappointed by the results "We regard the impairment assumptions (both on sovereign and the different credit buckets) as sufficiently severe and consistent. We are, however, less convinced by and have lower visibility on what is included in and how the regulator arrived at some of its forecasts on PPP, capital gains and other “impairment buffers”. This is particularly relevant as under a marginally tougher set of assumptions in this area, a larger number of institutions would have failed the test (nine instead of five, with another six below 6.5% Tier 1), although admittedly the incremental amount of capital is limited to E3.5bn. The system’s total capital shortfall under the “adverse
+ sovereign shock” scenario stands at E2bn. Note that this figure is incremental to the E14.3bn already injected, making a combined total cE16.3bn. This falls below our estimate of E35bn, the IMF’s E22bn and similar figures from other market participants. Out of the 27 institutions analyzed, five (all of which are saving banks) ail to maintain a Tier I ratio above 6% under the “adverse” scenario. Listed names have all passed the tests, with Santander and BBVA the most resilient and Pastor, with a 6% Tier 1, the weakest. Discussions on whether a 6% Tier 1 threshold was sufficiently challenging will continue. Under a more severe 8% threshold, 21
institutions would fail, with a hypothetical system capital shortfall of E13.2bn."
- Has Spain missed an opportunity to restore confidence? "Out of the 22 banks that exceeded the 6% Tier 1 threshold, there were six below 6.5% and another three between 6.5% and 7%. Our concerns are therefore not so much related to the size of the capital shortfall (under some tougher hypothetical scenarios the amount would increase by only E3.5bn), but the potentially missed opportunity by Spain to use the stress test as a catalyst to promote a second wave of recapitalizations (especially considering that the potential incremental amount would have been easily manageable for the FROB). Whilst acknowledging that the assumptions in the adverse scenario may never materialize, we fear that the stress test results have left the door open to further speculation about whether the resolution of the issues surrounding some smaller institutions’ solvency levels are being delayed. This might interrupt the restoration of market confidence (in light of market performance over the last few weeks) and, more importantly, make it difficult for these institutions to access term debt markets, one of the main issues the stress test was originally meant to address."
- Cautious on domestic, but positive on SAN and BBVA – valuation and risks "Spain’s macro outlook is no doubt challenging and Spanish financial institutions are facing what might be their toughest year in a decade. With the disappointing stress test results, still-poor sentiment and visibility may prove the main short-term headwinds. A very cautious general approach is necessary, especially with respect to Spanish domestic banks (all rated Hold). Stress test results reinforce our preference for Santander (Buy) and BBVA (Buy). The main risks relate to developments and newsflow regarding the Spanish economy. We derive our target prices from single-stage P/Tangible Equity and SOTP models."
DeutscheBank Spanish Financials 20100725

Interpreting the Stress Test results

- What should we make of the stress tests? "In this report we analyse the outcome of the CEBS stress tests on European banks. These stress tests applied two scenarios to forecast 2011 Tier 1 ratios, including an adverse economic outcome and a sovereign risk shock. Our overall conclusion is that the stress tests were a missed opportunity, and will not increase confidence in the sector. We expect the stronger national champion names to continue to fund (and see value in these names), but risks from uncertainty and volatility will likely continue, in our view."
- A flawed stress test? "We were disappointed with the stress test in three areas. First, we do not find a 6% stated tier 1 ratio target particularly challenging. Second, we have found it difficult to reconcile some banks’ assumptions (some banks have forecast that they will make more pre-provision revenue in an adverse scenario than they did in 2009; we believe that too much reliance has been placed on Q1 2010 run-rates). Third, we think that trading book shocks have not been sufficiently conservative, even before considering sovereign risk. In the adverse scenario, Euro 473bn of impairment (banking book) losses were included, and just Euro 26bn from trading losses, which does not match the experience of 2007 to 2009, in our eyes."
- 7 banks failed to meet the 6% threshold, 31 were between 6% and 8% "Seven banks failed, with an aggregate capital shortfall of Euro 3.5bn versus a stated Tier 1 ratio target of 6%. We do, however, see a risk that banks will be pressured to recapitalize to 8% rather than 6%, and that “near misses” may also end up being expected to raise capital. If we apply an 8% stated target tier 1 ratio, then 31 additional banks would fail, and the aggregate shortfall in capital would be Euro 27bn (and this could rise towards Euro 100bn if we were to disallow hybrids). This may be more representative of the long-run outcome, in our opinion."
- A missed opportunity "We were also disappointed by the stress tests because the capital was available for the banks had a more stringent approach been taken. Between Soffin, FROB, funds available for the Greek banks’ recapitalisation, and already-planned capital raises, we believe that a Euro 100bn recapitalisation requirement could have been met. Indeed, given that FROB and Soffin are expiring at the end of this year, we think that the best chance for a relatively straightforward recapitalisation of the sector has passed."
- Valuations: stuck at 1.0x P/TBV "The European Banks remain stuck at 1.0x price to tangible book value. But differentiation within the sector remains low. Even under a tough stress test, we believe that most of our banks under coverage would have passed. We also still see value within the national champion European banks, especially Lloyds Banking Group, Intesa, Société Générale and Credit Suisse, all of which we think are secure on both funding and capital. But a double-dip recession remains a risk for the sector and our top picks. In our view the CEBS stress tests were a missed opportunity to strengthen weaker banks in the sector in advance of any future potential problems."
DeutscheBank European Banks Strategy 20100725

European Bank Stress Tests: Tough overall and Transparent

- "The European Bank stress tests released Friday evening delivered on both toughness and transparency. The more surprising element was that the capital shortfall of the 7 failed banks “only” amounted to €3.5bn. The one disappointment was that the sovereign stress test was only applied to the banks’ trading books. Counterbalancing this, however, the adverse scenario was tougher-than-expected on commercial, consumer and real estate loan losses."
- "While we find the stress tests to be good news on balance, several headwinds loom. First, European banks still have €197bn of government support. Second, there is still substantial uncertainty surrounding the types of capital needs that will result from Basel 3. Finally, the challenge of taming public finances still lies ahead."
- "Against the backdrop of a still frail economic environment, we still see a bumpy road ahead. Ultimately, the key variable for both banks and sovereigns is market funding conditions. If these deteriorate, the ECB would be ready – if necessary - to offer more liquidity to banks. Moreover, the ECB could also increase the SMP. Finally, the EFSF is now operational and could offer support to weaker euro area member states (and we would not be surprised to see some of the weaker sovereigns apply for assistance)."
SocGen European Bank Stress Tests 20100725

U.S. Healthcare Expansion, Full Employment at Odds

- "The prevalence of permanent layoffs and sustained cost cuts clearly sets the present and recent labor market downturns apart from those of earlier decades. If firms can sustain their higher output and profit levels without hiring back costly workers, they won’t hire them back."
- "For workers permanently displaced from their previous vocations, net improvements in employment will require job creation in new businesses or new business activities within existing companies. This takes far more time than quick snapbacks of the past when employees were simply furloughed."
- "The variety of small business tax, depreciation savings, and loan initiatives appear particularly well targeted to stoking employment gains where they actually occur. However, like "cash for clunkers" and the “first-time homebuyers credit,” most of these steps expire at the end of this year."
- "By contrast, costs would rise with new healthcare mandates going forward aggravating cost and competitive issues in the years ahead."
- "National business costs are complex and range far beyond wages. But for the $4,950 that private U.S. employers paid on average for an employee’s health insurance policy in 2009, a global employer could pay the annual wages of roughly four workers in Brazil, China or India."
Citigroup Portfolio Economics 20100722

FX Strategy Weekly

- "A decline in US 3-month libor below 0.50% coupled with solid Q2 company earnings have buoyed demand for carry trade strategies, driving high yielding and commodity currencies through key resistance levels vs the USD. It is debateable how long momentum can be sustained in a context of faltering momentum in the US. The idea that additional policy stimulus by the Fed could be required and would re-flate risk assets appears misplaced when elsewhere fiscal stimulus is withdrawn and liquidity is unwound. With the EU bank stress tests finally behind us, we look ahead to a G10 calendar next week dominated by the MPC testimony to the TSC and the first estimates of US Q2 GDP. Month-end implies currency and bond portfolio rebalancing. In five of the last six months, the re-weighting resulted in EUR/USD firming an average 0.5%. In contrast, GBP/USD only gained in month-end fixings in March and May."
- "The recap for fx this week reads very similar to that of two weeks ago. A rally in global equities propelled the AUD to the top of the G10 table, helping the currency to gains of 3.3% vs EUR, 2.6% vs USD and 2.5% vs GBP. A 1.1% q/q jump in UK Q2 GDP boosted GBP and helped the pound to record a 1.3% gain vs the JPY and 1.2% vs the EUR. GBP/USD ended the week above 1.5350, having traded as high as 1.5450. EUR/USD was equally unable to cling on to the best levels above 1.29 as profit taking emerged on the release of the EU bank stress tests following earlier bidding on a 3-year high for the German IFO."
- "UK Q2 GDP surpassed the most bullish estimates as the ONS reported a 1.1% q/q jump in output vs 0.3% in Q1. This still leaves the economy 4.7% below the starting point of the recession in 2008, and will not tempt the MPC to change its view that the economy may weaken in the second half of 2010. The MPC minutes were remarkably more dovish on growth and members Posen and Dale did not hold back to warn of the dangers ahead. Retail sales also beat consensus estimates by climbing 1% in June. A marked decline in the retail deflator to 1.3% and a fall in inflation expectations back below 3% will comfort the MPC about the inflation outlook. Public finances recorded a bigger deficit in June, with borrowing reaching £14.5bln and data for May revised up to £17.0bln."
- "A good start to the week for UK rates reversed on Friday on the strong GDP release, causing yields to end the week on a high. 5y swaps climbed to 2.47%, up 6bp on the week. 10y yields rose above 3.40% to a 3.43% high. A deceleration in inflation pressures should keep yields capped going into August, with downside risk to the US macro data providing better levels to buy. The 3mth Libor/Ois spread widened one bp to 24bp. The 2y/10y swap spread widened 2bp to 198bp, and 10y swap spreads stayed flat at 2bp. A disappointing 2016 gilt sale drew lower than previous cover of 1.38x (1bp tail) ."
LloydsTSB FX Strategy Weekly 20100723

Data Full – Not Stress Full

- Results – "The results of the long-awaited CEBS stress test were published today. As expected, the European banking system is “sound”, with its 2011 expected Tier 1ratio declining from 11.2% under the baseline scenario to 9.2% under the most severe scenario (this includes 1.2% of government-provided capital as of 1 July 2010)."
- Failing banks – "At the 6% Tier 1 minimum, seven out of 91 banks fail the test and will require immediate recapitalization of €3.5bn under the adverse scenario: Hypo Real Estate (€1,245m), Agricultural Bank of Greece (€243m), and five cajas (€2,043m)."
- "Near Misses" - "As well as the seven banks that "failed" the Stress test, another eight banks barely scraped passed the 6% Tier 1 ratio hurdle. This group of "near misses" includes two of our quoted banks - Piraeus Bank and Monte dei Paschi di Siena. A few notches higher but still in the bottom quartile of the sample are Deutsche Postbank and Bankinter."
- Tiering – "Banks have provided detailed disclosure of their exposures to EU-27 sovereigns, on a country-by-country basis. We believe investors and analysts will welcome this thorough disclosure and will estimate capital needs on their own assumptions. We believe the funding, equity and debt markets will tier banks based on banks’ perceived solvency position under a market-realistic stress scenario (ie, one which is harsher than the CEBS test and includes stressing the banking book)."
- Market Reaction – "The EURUSD weakened immediately preceding the stress test and strengthened following the release; it is now almost flat relative to yesterday’s close. The ADRs of BBVA and SAN also strengthened into the release and are up on the day. The ADR of NBG strengthened into the release but is slightly down on the day. This early market reaction supports our view that, while the banks sector may not react excessively, there is likely to be tiering within the 91 names."
- Methodology – "The methodology is as expected (see European Stress Test: Not Much New News, 8 July 2010) but more detail has been provided on the specific assumptions used for macro variables, loan losses, trading losses and sovereign haircuts. No surprises here."
Citigroup European Banks Stress Tests 20100723

Japan: Economic Outlook

- Growth has been a pleasant surprise
• "Growth in Japan has increased significantly again following the recession that ended in the second quarter of 2009. Exports, stock adjustment and strong private consumption via fiscal-policy stimulus have boosted the economy. Small signs even indicate that the recovery is about to spread to investment growth and ’real’ private consumption."
• "We raise our growth estimates for 2010 and 2011 to 3.3% and 1.9%, respectively."
- Unwinding temporary stimulus
• "The temporary stimulus measures are about to fade away. Exports are still expected to be supported by solid growth in the remaining Asia but are under pressure from the weaker euro and slower growth in the euro zone."
• "We expect that growth will be supported by investment in the second half of the year."
- The labour market is improving slightly
• "Unemployment has declined since it peaked, the number of job postings has increased, the job-perapplicant ratio is growing, etc. Wage increases have changed from a negative to a positive figure. It remains to be seen, whether the improvement is solid enough to boost private consumption, but there are small such indications."
- Deflation for some time yet
• "There are still many idle resources in the economy, and this will continue to put a downward pressure on prices. The pressure will abate gradually, but we do not expect positive inflation until late 2011. Consequently, interest-rate hikes will not be on the agenda until 2012 at the earliest."
- Political reforms are uncertain
• "The newly-inaugurated (June) Prime Minister Naoto Kan had announced that he would do an effort to deliver a surplus on the public finances in the course of a ten-year period and that he would take measures to increase the consumption tax and reduce corporate taxes, etc. In the election for the upper house on 11 July, the government lost its majority in the house, which may make it difficult to implement reforms although the government still has the majority in the more powerful lower house."
JyskeBank Japan Economic Outlook 20100715

Stress reliever

- "The CEBS stress tests have, in our opinion, achieved a sufficient level of rigour to be taken seriously. Not all banks passed, and although the aggregate capital shortfall was small, this largely reflects the amount of capital that has already been put into the European sector (we estimate that this might amount to €220bn including retained earnings, RWA reductions and capital increases). Although the sovereign stress test disappointed many commentators by only stressing trading books, we find that the additional stress placed on the banking book in the “additional sovereign scenario” actually compensates for this; the aggregate amount of loss in the CEBS sovereign scenario for our coverage universe (c€40bn) is actually very similar to the loss that would be delivered in a more realistic assessment of the entire sovereign book."
- "We have re-engineered the CEBS criteria to deliver the stress test we believe investors wanted to see: We have changed the basis for measurement from headline Tier One to Equity Tier One, and incorporated a more realistic sovereign risk scenario. On this basis, the majority of the quoted European banks still pass the stress test; the exceptions being the Greek banks (which are affected by a large exposure to their own sovereign) and KBC (where the stress test model does not give credit for planned disposals). We find that the sector in aggregate would have surplus capital of €247bn of surplus capital relative to a 5% stress case Equity Tier One standard, half of this being in the UK."
- Stock Calls: "In our opinion, the important catalyst here is not so much the stress tests themselves as the transparency provided, which is impressive, in our opinion. We would highlight amongst our Outperform-rated stocks BNPP, Unicredit and Santander. Other stocks which we have on Neutral but that may also benefit form a sector bounce would probably include Societe Generale and BBVA."
CreditSuisse European Banks 20100723

Speculative investors reduce long JPY positions

- "The latest IMM data covers the week from 13 July to 20 July."
- "During the week covered by the data JPY longs were reduced, following a four-week period in which longs had been built up. The reduction may have been sparked by profittaking,
as the past week saw a halt to the previous downward trend in USD/JPY."
- "Speculative investors added to net short US dollar positions for another week. This reflects
further unwinding of EUR and GBP shorts, as well as a build-up in long AUD, NZD and MXN positions. The shift in speculative investor interest toward the US dollar has coincided with a further decline in the effective USD index, although the fall has since stopped at levels just above 82."
- "Speculative investors continue to reduce short euro positions, reflecting a general improvement in sentiment toward the single currency. While the market awaited the results of the stress test, EUR/USD broke above 1.30 for the first time since early-May on a string of strong European data releases. Although speculative investors are still short in terms of euros, positioning risk has arguably become much more two-sided."
- "The largest build-up in long positions versus the USD was seen in AUD, with an USD800bn increase, although as a share of open interest, this was surpassed by the NZD. With long positioning close to 50% in both NZD and MXN, significant downside positioning risks persists. The CAD was unable to capitalise on an increase in the Bank of Canada’s policy rate and long positioning decreased."
DenDanske IMM Positioning 20100726

Consumption restricted by the sharp slowdown in income, as it emerges from the crises

- "French household consumption has slowed sharply since the financial crisis hit. The accompanying recession led to a severe deterioration in the labour market and hence to a slowdown in income from activity and increased uncertainty as a result of a rising unemployment rate."
- "The crisis also led to a sharp fall in asset prices, with stock market indices and interest rates falling, lower house prices, etc., and hence a reduction in the value of household wealth."
- "Since the pick-up in activity which began in early 2009, the labour market has continued to deteriorate, but at the same time, asset prices have risen."
- "In view of this, it is worth asking how household consumption is behaving as France emerges from the crisis. In this article, we look at the factors determining private household consumption in France."
CreditAgricole Eco News 20100721

Social welfare, economic progress and happiness

- Money can’t buy you happiness... Or can it? "Wealth doesn’t ensure happiness, but it helps"
- Values in equity portfolios: socially responsible investment "Can investors be both virtuous and prosperous?"
- Is GDP a measure of happiness? "Proposals for gauging and comparing levels of progress and social welfare"
- Smiling’s more difficult when the economy doesn’t smile "The cost of recession in welfare terms"
LaCaixa Monthly Report July2010


America's AAA Rating Is Cut in Land of Bubbles - Bloomberg
The Great Recession is just the beginning - Washington Post
Social Security age 'fix' may not live up to expectations - Los Angeles Time
Economists = Idiots? Part 1829 - Angry Bear
Ten Stock-Market Myths That Just Won't Die - Wall Street Journal
ECRI Growth Rate Index Hits Threshold, Signals Recession... - Bondsquawk
MOVE Index suggests 10-Year is Not Moving Lower… - Bondsquawk
US Treasuries - FT Lex
Five myths about unemployment - Washington Post
Chinese Central Bank Outlines Plan To Ditch The Dollar... - Money Game
Iran won't trade with countries imposing sanctions - Reuters
Goldman coughs up counterparties on AIG hedge - Reuters
An A.I.G. Failure Would Have Cost Goldman Sachs, Documents Show - NYT
Jean-Claude And The Invisibles - Paul Krugman