|
The deflation of the commodity bubble, which we called too early six weeks ago, is continuing nicely, and leading to stock market bullishness, reinforced by the Fed’s decision to keep interest rates on hold. The fixed-income market is more cautious, and has every reason to be: the rise in equity markets may be short lived because the very reason the Fed stayed on hold and that commodity prices have fallen is that the economy is in such trouble: |
|
|
- Whilst Commodity prices (as measured by the S&P GSCI) may have fallen nearly 20% from their peak, they are still 50% higher than one year ago
- US manufacturing industry has no pricing power, but neither does labour, as overtime is eliminated and unemployment rises. Thus both profit margins and household spending power are being squeezed
- The credit crisis is becoming more severe. Households with home equity credit lines may no longer draw on them (never mind obtain new ones). Car leasing has been discontinued or drastically cut back. Indeed, the continued collapse of the US auto industry is as much a credit phenomenon as a reaction to high fuel prices (although high fuel prices do explain the demise of the SUV)
- Retail spending is slowing, although credit cards are allowing households to maintain their spending while running up debt a little longer than we first supposed. Earlier this week, Citigroup reported credit card delinquencies up 16% since the end of last year
|
|
|
|
About the best that can be said is that negative real interest rates are just allowing the economy to sputter along. Tell that to the people in Detroit who have been hit by the double blows of the collapse of the automotive industry and the sub-prime crisis! Whole neighbourhoods there are derelict as a result of foreclosures. Even Greenscam observes that a recovery cannot come about (and what he calls “this insolvency crisis” end), until house prices have stopped falling (while omitting to mention that he created the housing bubble in the first place). |
|
|
|
Earlier hopes that Europe could escape lightly from the US recession are proving forlorn. The German “engine” is slowing, tourism in the South of the Continent is greatly reduced. Families are struggling to make ends meet. True, Europe may not have any Detroits, but what is this about German pawn shops doing a roaring trade? The economic slowdown is like a black cloud which started in the USA and is rolling across the world. It is now enveloping Europe, but Asia will be next, as both HSBC and Standard Charter are warning. Will anyone escape? Possibly Russia and Brazil with abundant raw materials and energy. |
|
|
|
The US authorities are brilliant at providing temporary relief to major problems. Often the problems are forgotten, yet they return. Thus the insolvency of Fannie Mae and Freddie Mac is removed from the worry list by the taxpayer being forced to absorb future losses (but not participate in any upside). Credit card defaults are appearing but are being played down. Perhaps worst of all are the latent problems of Credit Default Swaps. If Swiss Re and AIG, as regulated insurers, announce so many losses in this field, how many losses may be expected in the CDS market from players who are not regulated like insurers? Credit defaults are set to increase as the crisis continues. |
|
|
|
Thus we find ourselves, as is so often the case, as seeing stock markets engaged in wishful thinking. As we said last week, this is not a quick-fix cyclical economic slowdown but a major and long-term adjustment to the US and world economy. The adjustment would be hastened if US authorities were to face up to the truth that the damage caused by years of profligacy can be repaired only by prolonged frugality. |
|
|
|
Our recommendation for fixed-income investors remains the same: quality plus selected lengthening, although we admit that most of our clients are very reluctant to move far from the short end of the yield curve. |
|
|
|
Focus |
|
|
|
(+) USA: unemployment rate the highest in four years at 5.7% |
|
|
|
(!) Seychelles: (not often we write of them!), they have been downgraded and spreads have moved from 650 bps a fortnight ago to 2110 |
|
|
|
(+) New Zealand: The RBNZ has opened the door to further rate cuts from the current 8% overnight rate in view of the economic slowdown |
|
|
|
(!) Currencies: commodity currencies are down (NZD and CAD lowest in a year, and AUD lowest in four months), contrasting with MXN at highest in six years and BRL highest ever |
|
|
|
(!) Autos: GM and Ford discussing possible alliance in engines and transmission systems |
|
|
|
(+) positive for bonds (–) negative for bonds (!) watch out (?) begs the question |
|
|