Central banks – slow motion exit

- Central banks. "The global economy is losing momentum, while worldwide growth risks are on the rise. This benefits not only safe-haven investments like gold and government bonds but also money market rates, which will stay extremely low for an extended period. It will likely be late 2011 or early 2012 before major central banks start hiking rates, while the exit from the ultra-expansive liquidity policy is being pushed back."
- US. "Here, it is primarily the growth risks, i.e. the fear of a double-dip recession, that prompted the Fed to adopt a more cautious stance when it announced that it would reinvest all the proceeds from maturing and prepaid agency debt and MBS in longer-term Treasuries."
- Fed. "The US central bank has, therefore, not only abandoned its slight tightening bias but also opened the door again to additional quantitative easing measures. Things should not, however, go that far: Additional purchases of Treasury securities would lower the yield level only marginally. Moreover, the transmission channels of lower interest rates to the real economy are already clogged (pages 6-9)."
- EMU. "Here, it is still the ongoing sovereign debt crisis, the again surfacing concerns about the solidity of banks, and the strong real economic divergence that are making the central bank more cautious."
- ECB. "As a result, the European Central Bank will not be able to forge ahead, as planned, with its exit strategy, which would even not have to be completed before the first rate hike, not expected before the end of next year (pages 10-12)."

The Importance of M

- "Money matters, but it is better to look at money flows instead of money stocks, and sometimes it is necessary to look at the counterpart of money, credit, to see what is going on."
- "We argue in this note that if the equation of exchange—which is at the heart of the Quantity Theory of Money (QTM)—is recast in terms of money flows rather than money stocks, then the velocity of money proves to be more stable, and changes in money have more direct implications for nominal activity. We find empirical support in the euro area for this relationship. Latest money flow readings still point to an expansionary impulse, though its strength may be receding in coming months."
- "When non-bank sources of credit are creating non-bank money in significant amounts, as is the case in the US or the UK, measures of money relying on bank balance sheet data no longer capture actual monetary developments. In this case, it is necessary to analyse the counterpart of money, credit, as we have done with our credit impulse measure over the last two years. The latest data suggest that the credit impulse in the US and the UK has remained positive, giving continuing support to the recovery."
- "An important task for policy makers is to smooth the credit (and hence money) cycle, among other things by countering both excessive optimism and excessive pessimism in credit markets. Policy makers failed to do the former during the credit boom, but they were quick off the mark doing the latter when the bubble burst. After excessive optimism and pessimism a return to realism is now needed. As this happens, growth may well fall short of the levels reached during the credit boom as fewer but economically more viable projects will be funded. Monetary policy that ignores the diminished potential of the economy, risks fuelling another money and credit driven cycle."

Relative share price MACD maps

- "In this report, we consider the use of relative share price Moving Average Convergence-Divergence (MACD) maps as a sector rating and stock selection tool. Relative share price MACD maps can be used to determine which sectors or stocks are the most attractive candidates for long or short positions from a technical analysis perspective. For example, in the exhibit below, an MACD map based on share prices relative to the TOPIX (for TOPIX-17 Series sectors as of 3 September 2010) indicates that the electric power & gas, pharmaceutical, foods, real estate, automobiles & transportation equipment, and commercial & wholesale trade sectors are potential candidates for long positions. However, electric power & gas is at the top of the map and looks close to a turning point. Conversely, the energy resources, electric appliances & precision instruments, raw materials & chemicals, and retail trade sectors appear to be potential candidates for short positions. The map indicates that financials (ex banks) is another possible candidate for shorting, but we think this sector is also approaching a turning point and should actually be considered for bottom picking from now on. At the end of this report, we provide MACD maps based on share prices relative to the TOPIX for the top five companies in terms of market cap in each of the TOPIX-17 Series sectors."
• "Relative share price MACD can be used for sector ratings and stock selection: MACD is a technical analysis trend indicator that focuses on the widening or narrowing of the gap between a short-term moving average and a medium-term moving average. In general, although technical indicators are useful for helping to identify the optimum timing of transactions in individual indices or stocks, they are not easy to use for the purpose of a side-by-side comparison of individual sectors or stocks. MACD is no exception in this respect, but the use of MACD based on relative share prices enables us to avoid the problem of trading signals being affected by the direction of the market as a whole or being skewed toward a particular position."
• "Basic concept of relative share price MACD maps and how to use them: In this report, we present
relative share price MACD maps as a sector rating and stock selection tool. By plotting the relative  hare price MACD on the x-axis and the MACD histogram on the y-axis, we can see the relative status of each individual sector or stock at a glance. The MACD maps show movements in the various data series over time, and our basic strategy is that sectors or stocks that are either in the 1st quadrant or about to move into it are potential candidates for long positions, while sectors or stocks that are either in the 3rd quadrant or about to move into it are potential candidates for short positions. In addition, the direction of each individual data series can help identify which stocks to buy on dips and which stocks to sell to lock in profits, within a particular quadrant, by indicating the strength or weakness of the buy or sell ratings."

Comprehensive income and equity valuation, Part 2: Importance of corporate balance sheet management ability

- Hosting an IFRS seminar — "We will be hosting a seminar on October 13, 16:00–18:00, at the 9th floor conference room in the Shin-Marunouchi Building. Our guest speakers will be Mr. Ikuo Nishikawa, chairman of the Accounting Standards Board of Japan (ASBJ), and Mr. Takehiro Arai, Vice Chairman of the ASBJ. The theme will be Convergence with the IFRS and reform of Japan’s accounting system."
- What is profit? — "We believe comprehensive income, rather than NP, is coming to exert a substantial impact on share prices. This is in our view particularly pronounced when NP is positive and comprehensive income is negative. Companies with sizeable overseas assets, equity holdings, and corporate pensions see big swings in comprehensive income."
- The case of Mitsubishi Corp. — "Mitsubishi Corp. reported FY3/09 NP around the ¥370bn mark. However, comprehensive income was in the red to the tune of ¥384.9bn. The shares fell that year by 57.3%, while TOPIX was down only 36.2%. To our mind, this is a good example of the impact of comprehensive income on share prices."
- The case of April–June 2010 — "Mitsubishi Corp. reported NP of ¥140.4bn but a comprehensive loss of ¥59.4bn (other comprehensive losses amounted to ¥199.9bn). The shares fell 23.9% in the quarter. Sumitomo Corp. reported NP of ¥64.6bn but a comprehensive loss of ¥22.3bn. The shares fell 16.5%."
- The cases of Toyota Motor and Panasonic — "Leading companies that were in the red for comprehensive income but in the black for NP are Toyota Motor and Panasonic (Toyota does not disclose comprehensive income, so this is our estimate). In April–June, Toyota shares fell 17.8% and Panasonic 21.5%."
- Companies with few equity holdings — "Among other global Japanese companies, we consider balance sheet risk to be relatively slight at Hoya, Canon, Fanuc, and Murata. We think they offer more investment appeal in the current strong yen, low share price environment than companies with volatile comprehensive income."

The UK pound: Further recovery in store

- GBP: "We expect GBP to strengthen on a TWI basis into year-end. Our year-end target for EUR/GBP is 0.80 (our USDGBP forecast are under review)."
- Country-specific factors: "Key bullish factors include cheap valuation, favourable M&A and central bank flows, recovery in the financial sector, and a clear fiscal consolidation plan (and stable CDS spreads). The deteriorating housing market is likely to be the main negative influence over coming months."
- Global USD direction: "A dovish Fed along with below-potential growth in the US (but no double-dip recession) should facilitate USD weakening into Q4."
- Global risk factors: "After a period of elevated risk aversion, we expect the risk environment to shift to neutral for the next 3-6 months."
• "We expect the UK economy to grow at a slow pace in 2010 and 2011, at 1.7% and 1.9% respectively, following the announced budgetary spending cuts (this forecast is close to consensus)"
• "CPI inflation has been persistently high over the last few months – far higher than the Bank of England (BoE)’s 2% target rate. However, it has started to moderate. We expect inflation to remain high for the rest of this year and not to hit its target rate until 2012. The rise in the VAT rate in January 2011 should provide further upward pressure to consumer prices."
• "Nomura’s economics team forecasts the BoE to hike rates by 25bp in February 2011 to 0.75% and again in May 2011."

Japan: Costs of currency market intervention from a fiscal perspective

- Costs of currency market intervention from a fiscal perspective
• "The government intervened in the currency market, buying USD and selling yen."
• "As well as discussing the outlook for intervention, it seems worthwhile revisiting the costs of sustained intervention and the resulting further expansion of the government’s Special Account of Foreign Reserves mainly from a fiscal perspective."
• "First, the need for the Account to set aside provisions for unrealized losses from foreign security investment should mount unless the yen weakens, affecting the availability of so-called hidden reserves to reduce the amount of deficit bond issuance by the government."
• "Second, government debt would continue to expand with the Financing Bills outstanding growing in a non-stop manner."
• "Third, the autonomy of monetary policy would be substantially limited as any small rise in the short-term interest rate would lead to a major increase in debt servicing of Financing Bills."
- Another drop in manufacturers’ capacity utilization
• "Capacity utilization rate among manufacturers dropped for the second consecutive month to the lowest level since last December"
- Demand for Funds Remains Weak
• "Bank lending continued to drop, falling 2.0%yoy in August, reflecting the weak demand for funds among the private corporate sector"

U.S. Japan Comparisons Again: More than One Route to Perdition

- "Aspects of the U.S. outlook have become more reminiscent of post-bubble Japan than during other (merely) cyclically weak periods. However, structural and behavioral differences from Japan remain very significant, just as before." 
- "In the U.S., a reality of disinflation has won over simplistic “hyper-inflation” forecasts. The risks of insufficient demand and deflation aren’t entirely negligible. For housing assets, the U.S. banking and GSE sectors seem poised to hold and work off bad debt gradually rather than purge it quickly. Fiscal intervention has been repetitive and insufficient to permanently change growth expectations, all ostensible similarities to Japan."
- "Monetary policy in the U.S. has been strikingly different than post-bubble Japan, particularly in the early aftermath of the Lehman event. However, it seems possible that inertia and misunderstanding keeps monetary policy in the U.S. from a truly aggressive track, even if warranted."
- "Even optimal monetary policy can’t generate higher living standards over the long run. But it can avoid lasting deflation (a spiral higher in the purchasing power of currency). The long-run monetary policy track in the U.S. has been and is likely to be more inflationary than Japan’s, as chronic currency strength in Japan and mild U.S. dollar depreciation also suggest."
- "Private sector behavioral differences remain vast. The U.S. labor market and capex are far more cyclical than in Japan, and suggest an early and lasting bottom. Even amid structural growth slowdowns in both economies, we believe cyclical differences will be notable. In effect, the U.S. is more prone to “boom and bust” than slow and lasting stagnation."

Fading RUB's temporary MXN disease

- "When we talk about a disease in Russia, we usually mean “Dutch disease”, which is commodity-price-driven real effective rate appreciation. We use the term “MXN disease” to describe a recent underperformance unjustified by fundamentals, secular trends and recent recovery in risk appetite."
- "Hard currency external debt redemptions from the corporate sector in the past four months contributed to the RUB underperformance, but have been moderating in September and October."
- "In terms of fundamentals, the very benign inflation backdrop and rapid REER appreciation in Q1 resulted in the Russian Central Bank (CBR) treading cautiously and building up reserves relatively aggressively. When the collapse in implied yields was added to this RUB underperformed. But this is a phenomenon of the past, not the future and something we anticipated in April when we exited the RUB longs that we had been holding since December 2009."
- "Going forward, we think the inflation picture is likely to change this dynamic, driven by food inflation and Russia's recovery. We see the likelihood of a hike before year-end rising significantly and we would not be surprised to see a 25bp hike in mid-autumn. Additionally, we think the domestic hard currency redemption picture should be more benign until year-end and the rouble slightly weaker. We identify a 3% opportunity for the currency gains."
- "Foreign investors’ recent lack of interest in RUB, combined with its recent underperformance in relation to oil, strengthens our conviction."
- "We recommend fading this MXN-disease by buying a RUB basket – selling 3m USD/RUB and EUR/RUB (entry 34.75, stop 35.25, target 33.65, time horizon 1-month, US$5mn on the model portfolio). We intend to add to the position close to the top of the range at 35 depending on the price action."

Bad days for the basis

- Resi: Bad days for the basis
- CRE: Introducing the DB quality score "The DB quality score can be a useful benchmark in assessing the potential volatility of collateral and bond cash flows."
- Consumer ABS: Positive momentum in autos shows support for lending in middle-risk credit tiers "Auto lenders more comfortable with sector have started to reach further down the credit spectrum."
- Economics: Exports a key positive contributor to economic performance "Strong capex and robust exports will together keep real GDP growth modestly above trend."
- Rates: Who’s afraid of buying Treasuries? "We remain constructive on yields. Primarily this reflects anemic growth with outright deflation risk, but not a double dip view."
- Agency MBS: A new taste of seasoning "Seasoned 30-year 5.0%s look rich while low pay-up 5.5%s and 6.0%s appear attractive."
- Non-Agency MBS: Competing risks in jumbo MBS  "Interest rates have reached the point where jumbo MBS investors should expect a jump in old fashioned refinancing while credit performance continues to deteriorate."
- CRE: Loan in the spotlight: One Alliance Center "One of the larger specially serviced loans faces significant tenant rollover and refinance risk."
- Consumer ABS: Assessing the spread pick-up for FFELP student loan ABS vs. credit card ABS "Current levels argue for further FFELP tightening."

Defusing the tax bomb

- Macro viewpoint: Defusing the tax bomb "The dysfunction in Washington could cause a “growth pause” in the fourth quarter. However, we expect the Obama Administration to focus on economic growth in the run-up to the Presidential election."
- Fed watch: Taking their time "With the economy decelerating but not crashing into a double dip or outright deflation, we believe Fed officials are unlikely to rush into renewed QE over the next few FOMC meetings. By January, we expect weak economic conditions will allow Chairman Bernanke to forge a consensus supporting the potential for additional asset purchases."
- Housing watch: Spilling over "The construction industry has shrunk as a share of the economy, but the effects of the housing bust are still being felt. Nearly a third of total job cuts were in housing-related industries and a bulk of the drop in consumer spending was in housing-related goods. Bank repossessions have started to pick up steam and should continue to depress the housing market, and by extension, the economy."
- The week ahead: FOMC meeting and housing data deluge "The main event this week will be the FOMC meeting on Tuesday. We’ll be paying particularly close attention to the FOMC statement for any signs of QE2. Our forecast assumes they resume easing in the first quarter of 2011. Besides Tuesday’s FOMC meeting, the week’s data releases will center on the housing sector. Overall, the data should reflect the depressed state of the housing sector."

Which investment is preferable in the euro zone: Peripheral sovereign debt of reasonable credit quality (e.g. Italy) or investment grade credit (corporate and bank bonds)?

- "Euro-zone investors are faced with the following dilemma: they can obtain a yield that is at least as high on euro-zone peripheral sovereign debts of reasonably good credit quality that are reasonably liquid (Italy, possibly Spain) as on investment grade companies or banks. Has sovereign risk really become greater than corporate risk, or is there a discrepancy between the valuations of the two types of debt?"
- "We believe that:
• the sovereign risk on Italy is insignificant;• the sovereign risk on Spain is harder to evaluate;• corporate and bank default risk is 13 bp (A) to 30 bp (BBB) per year, and at present corporate profitability is rising again rapidly."
- "The best portfolio is probably one diversified in Italy, corporates and senior bank debt."

Economic slowdown confirmed: now what?

- "The global mid-cycle slowdown that we introduced in our previous Forecast Update has materialised further, but without pushing the pro-cyclical currencies lower. The slowdown is already priced in markets and if the outlook doesn’t deteriorate further, we don’t think the ‘smaller’ G10 currencies will lose ground against the ‘larger’ ones."
- "Risk sentiment remains an important – but rather unpredictable – driver to our forecasts and we regard financial markets as closely interlinked across asset classes. We recommend to consider a higher-than-normal degree of FX hedging."
- "We see both downside and upside risks to EUR/USD and foresee a bumpy ride around the current spot level with a moderate upward bias on the longer horizon as the most likely. We think the BoJ will prevent JPY from drifting much stronger in the short run and keep our bias for weaker yen in the long run. We remain positive on the Scandinavian currencies but acknowledge that levels may seem stretched and that risk-reward has been better."

Citizens in "non-exporting" euro-zone countries should be told the truth

- "In the euro zone, a number of countries (Finland, Netherlands, Ireland, Austria, Belgium, Germany) have a substantial capacity to export to high-growth countries, thanks to their innovation drive, improvement in the product range and cost control in the case of Germany. But other countries (France, Italy, Spain, Portugal, Greece) have a low exposure to countries enjoying rapid growth (emerging countries, oil exporters). We call them "non-exporting" countries."
- "The leaders of these countries should have the courage to tell public opinion that:
• growth in these countries will be subdued: shortfall in the innovation drive and therefore in productivity gains; inability to use indebtedness to boost growth in the wake of the crisis, lack of stimulation of the economy by foreign trade;• the standard of living will decline due to deindustrialisation, offshoring and the need to improve competitiveness and profitability;• the reduction in fiscal deficits will be difficult and painful due to the sluggishness of growth, and it will be necessary to adjust the generosity of welfare systems because of the modest long-term growth and more stringent European budgetary rules;• this improvement will take a long time: the time needed to create new jobs in potentially growing sectors;• inequalities will inevitably widen between employees in companies that are adapted to globalisation and the others."

No bond market bubble

- Recent market movements "Bond yields are trading roughly in line with the forecast we released a month ago. However, this hides a decline in the second half of August which has reversed in September. Changes in the market’s perception of double dip risks have been the key driver of yield movements. As such, the yield increase in recent weeks has been driven by slightly better indicators out of the US and Asia. Also, fluctuating demand from the European L&P industry has exacerbated yield movements. L&P companies were heavy buyers of bonds when yields declined but L&P bond purchases appear to have slowed a little as yields have moved higher. Illustrating this is the fact that yields in the 30Y segment saw the steepest fall when yields declined in August but have rebounded the most in recent weeks."
- Macroeconomic outlook "Economic indicators out of the US have surprised on the downside in recent months, although the past few weeks have seen a few positive surprises. Leading indicators are generally pointing towards a sharper slowdown, and in the past month we have downgraded our US growth forecast by almost one percentage point. We expect the US economy to grow 1½-2% in H2 10 and then to recover slowly to a 3% growth rate. Manufacturing ISM is expected to decline to the 50-51 region by the end of 2010. Payroll gains, which are generally very important for bond markets, are expected to average around 100,000 a month in the coming quarters, rising towards 200,000 by the end of 2011. All things considered, we do not expect a double dip in the US economy but the weakening of ISM data over the next 3-6 months should keep double dip fears alive. In the eurozone the news flow has been more positive in recent months, but we see increasing signs of growth losing momentum. German industrial orders and eurozone industrial production have remained flat for a couple of months, and the OECD leading indicator for the eurozone is still pointing downwards. We believe that GDP growth peaked in Q2 at about 4% q/q AR and we expect it to slow gradually to 2% q/q AR in 2011. Activity indicators such as the German IFO and eurozone PMI are set to decline in the coming quarters. We continue to expect very divided growth within the eurozone, with Germany outperforming while growth momentum remains subdued in southern Europe. Inflation is not giving much cause for concern. Core inflation in the US is running at a very low rate of 1%. In Euroland the inflation rate appears to have stabilised at roughly 1.5% in the eurozone and we expect it to remain there over the next 12 months."

Back to the Future

- What happens if we mean revert? — "We have run long-term commodity price assumptions through our models to determine what earnings and cash flow would look like under a mid cycle commodity price environment. On our analysis, the large diversifieds would be trading at an average PE of 12.6x, which is slightly ahead of the long-run PE multiple for the sector of 12.3x."
- Near-term commodity momentum critical — "The copper price has been trading in a $6,000 to $8,000 per tonne trading range since the beginning of 2010 (currently $7,486/t) and we expect it to remain in this range for the rest of the year. A breakdown of this range is likely to occur at some point and with inventory drawdown, lack of new LME inventory, and increase in cancelled warrants, the risk in the short term could be to the upside."
- What is being priced in — "The diversified miners are trading on an average PE of 8.1x spot 2011e earnings, versus 7x on our base case. Moreover, the mining sector is currently trading at a 20% discount to the market on spot commodity prices and on a historical basis it has traded at a 5% discount. In order for the sector to return to market multiples, then the copper price (along with the basket of commodities would have to fall by c15% or copper would have to fall to around $6,800/t ."
- Stress testing balance sheets and cash flow — "The key negative impact of the downturn in 2008 was the impact on cash flows and high debt positions of the mining companies. Under our long-term pricing scenario, free cash flow for the sector would fall by c70%, however the large diversifieds would be in the strongest positions, while the pure commodity companies would be impacted the most. Kazakhmys, for example, would experience difficulty given its $1.4bn capex commitment in 2011 and swing into negative cash flow under long-term prices. Once again the diversified miners look the strongest, with each able to maintain sufficient Free Cash Flow for expected capex under such a scenario."
- What to do — "We recommend investors sticking to the large diversified miners, with key picks of Xstrata and BHP Billiton. We are currently neutral on the sector, after being buyers in May and we would look to move to an underweight position on higher equity prices."

Why is the dollar not depreciating?

- "The trend in the dollar against emerging countries' currencies as well as the euro may seem surprising."
- "First, the outlook for the US economy has actually worsened significantly since the start of 2010: anaemic household demand, ongoing deleveraging, useless corporate profitability, deterioration in the labour market situation and in household solvency, still high external deficit and unbalanced public finances."
- "Second, some central banks (the People’s Bank of China in particular) have admitted that they are increasing the weight of the euro and the yen in their foreign exchange reserves to the detriment of the dollar. So why is the dollar so resilient? The possible explanations are:
• the dollar's role as a safe-haven currency when risk aversion increases, since the summer of 2008;• concerns also about the economic situation of the euro zone and emerging countries;• the perception that the valuation of emerging assets is too high;• the very sharp earnings growth among US listed companies."
- "We confirm the roles of risk aversion, concerns about the situation of the euro zone and the return of non-resident buyers of US equities."