The Weekly T Report: BJ and the Bear
CB’s, CB’s, CB’s, everywhere you look people are writing or talking about central banks. The last time CB’s were this omnipresent in America, BJ and the Bear was on TV, Convoy was the movie, people had cool “handles” and said think like roger that, and 10-4 big buddy. Now it’s twitter “handles”, CYA’s and LOL’s, with Hunger Games as the movie, and the Kardashians on TV, but we are once again a CB culture.
The first part of the week was fun. Stocks seemed to move on the basis of earnings and guidance. AAPL had a wild ride, dragging the market around with it, but at least it could be explained by fear of an earnings miss, followed by exhilaration of crushing earnings. The outlook wasn’t great, but there was enough evidence of stocks reacting to company and industry specific news, that it briefly felt normal.
By Wednesday afternoon, it was back to the “new” normal. Not the one with 2% GDP growth (which got) but the one where markets are dependent on central banks for support and liquidity. From the moment the FOMC minutes hit the tape, the market reverted to looking to central banks for guidance on how soon we get another big shot of liquidity. Every slightly hawkish expression was met with selling, only to be followed up with buying on any hint that the Fed retained its extremely dovish sentiment.
Thursday mornings miss on jobs, a big miss, and much closer to the dreaded 400k number than the mythical 350k prints we were getting (mythical because none withstood the test of revisions). There was enough strength in the housing data that stocks didn’t sell off much, but the reality is that hopes of QE overshadowed the data. The belief that the Fed is watching every tick in the stock market and is ready to unleash a wave of liquidity at any moment prevailed. Who needs jobs when you have helicopter Ben? Actually, who even wants jobs when you have helicopter Ben? Hiring actually involves expenses, and means you need to produce more, and maybe even risk the Fed’s wrath. Much easier to not hire and let the Fed boost stock prices.
The irony of this is that virtually all the people who want QE for what it will do for stocks have no faith that QE does much for the economy. Bennie and the Feds (and maybe Krugman) are the only ones left who believe this Fed policy is truly benefitting the economy. The rest of us just try and figure out what it will do for stock prices – in the short term.
Not to be outdone, the other CB, the ECB, decided it needed to get involved to slow down the drubbing in European stocks and the bonds of Spain and Portugal. The economic data out of Europe was abysmal. France is seeing its economy falter, and Spain seems like it is tired of playing second fiddle to Greece and Portugal and came up with an unemployment number that is, frankly, shocking. 1 in 4 people are unemployed. I’m assuming there are some structural reasons for that, since their goal is to be at 22% by 2015, but it is still scary. The regions are a mess, and the plans they are coming up with for the banks and caja’s are somewhat laughable. I never thought the good bank/bad banks solutions would work, but the “sweep it under the rug and hope it goes away” bank/mediocre bank strategy seemed even more doomed to failure.
So what, when, where, and how will the CB’s and governments intervene?
That is once again the big question. You could know every bit of economic data coming out this week in advance and it might not make a difference. The market will be driven by central banks and governments and the amount of liquidity they throw at the market.
The Fed is the easiest to understand. We are not getting QE any time soon. The best we can hope for is that the data is weak enough that some new form of operation twist is launched, where the Fed sells treasuries to buy mortgage backed paper. That will be very good for all those institutions that have loaded up on mortgage backed bonds in advance of this, and it might briefly help stocks, but the impact on both housing and stocks will be minimal. Operation Twist showed that stocks respond much better to new purchases rather than shifting around existing positions. It may not be obvious given where stocks are now, but if you try to adjust for how much of the stock move is since LTRO came out, which is real serious money creation, then it seems more obvious that operation twist isn’t as important to stocks as real QE. It may take longer to figure out what that it won’t help the mortgage market or housing markets. Initially mortgage rates will move lower and the markets will cheer. The reality is that the Fed program won’t do much to encourage banks to create new mortgages. If you weren’t lending at 4%, why would you lend at 3.75%? Demand for mortgages will increase, but that has hardly been the problem. It is the supply, and there is no reason to see why that would increase at a lower rate. What will happen is that banks will trade mortgages around more aggressively. Existing mortgages will increase in price as investors trade around waiting for the Fed to step in and overpay. It is far easier to trade something when there is a big buyer, on a set schedule, who isn’t price sensitive (and in fact may want to overpay to give the perception that things are even better than they are). So mortgage trading will be profitable, those funds that loaded up on them will do well, and then, the economy will realize that nothing really makes it way down to them.
The ECB is much harder to figure out. It was rumors of some new program, or some new version of an old program, or something, that encouraged stocks to rebound fiercely off the lows (I do think Spanish stocks are oversold relative to German stocks). But what will the program be, and how long will it work?
I don’t think it can be another version of LTRO. Two large Spanish banks have already said they are limit long. Those banks that are willing to add to their exposure are already in so much trouble that they have no choice but to keep playing the game. There is growing reluctance by banks to buy debt of foreign countries. The “nationalization” of debt, where more and more sovereign debt is held by the banks, insurance companies, and pension funds within that country makes the path to exiting the Euro that much easier. Plan A may still be to keep the Euro, but some of the actions make a Euro break-up much less painful that it would have been 2 years ago (though back then, no one really thought Spain and Italy were in trouble).
LTRO has one set of problems, but the secondary market programme (SMP) has its own problems. Greece remains very disappointed with the stance that the ECB took on its Greek exposure. The unwillingness of the ECB to accept anything other than par is one of the two big reasons the post PSI Greek bonds trade as poorly as they do. The ECB was not willing to participate in any form of debt restructuring and that was and is a problem. Although Spain and Italy may be publicly saying that they have no intention of leaving the Euro, it would seem foolish to believe that they aren’t at least examining the possibility. They may be less excited to have direct ECB intervention than in the past, and may want to form some side deal with the ECB before encouraging them to buy bonds in the secondary market. That is very possible, but will take time. I don’t expect significant SMP activity this week.
That leaves the EFSF to pick up the slack. The EFSF is meant to take over the SMP anyways. While the ECB may not be willing to accept less than par in a restructuring, it is easy for the EFSF to agree to some loss. I expect the EFSF will buy some bonds, possibly as early as this week. It will be announced with much fanfare since it will be a new venture for this “illustrious” vehicle. In the end, it will stem the tide for a bit, but will increase the awareness that having the EFSF participate rather than the ECB makes it easier for these countries to restructure or leave the Euro. It is also makes it harder to hide from the citizens of Germany and France that they are funding the other nations.
The pink elephant in the room is what to do about bank recapitalizations. The banks need new capital and they are going to need to get it from a deep pocketed investor who isn’t too risk averse (ie, happy to throw some taxpayer money at the problem). The ECB isn’t really allowed to do this directly. Even the EFSF is only supposed to lend money to sovereigns who in turn recapitalize the banks. The problem with this strategy is clear. The countries and banks are both in trouble and forcing sovereigns to take on more debt to support the banks has been a failure. The amount Greece has to borrow from the Troika to recapitalize the banks is the other big reason post PSI debt trades so poorly. A big portion of the PSI debt reduction is being replaced by debt taken on at the sovereign level to give to the banks. Ireland has this same problem – I wonder if the crisis in Ireland would already be fully over had the citizens not taken on the obligations of the banks? The rules restricting the EFSF from a direct bailout of the banks could be eliminated, but citizens of Germany, already nervous about lending to the government of Spain may draw the line at using their countries remaining credit to zombify banks in Spain (or Italy). A solution to this problem would be big step for Europe in the near term, but the problem is very difficult, and the best the market can hope for is some headline that sounds great, but has zero chance of being implemented.
The governments appear to be taking two paths. There is a growing national movement in France and it seems elsewhere. While the elite, and those employed by the EU, may still want unity, there is growing discontent with the system. Hollande specifically wants to restrict travel and work within the Eurozone. If you ask most Europeans, they care more about easy travel and no limits on where to work, than the currency itself, so Hollande’s plan may be more dangerous than people realize. If they make movement within the Eurozone more difficult, the desire (or need) to stay in the currency union would drop quickly. Another small piece of the puzzle fitting together that makes the break-up of the Euro look more likely, if not inevitable.
Then there is the war on austerity and focus on spending. I am not sure when Austerity Died or when Austerity became a 4 letter word, but there is a vigorous attack on austerity (I’m also not sure when our website broke, and am trying to fix that). Somehow, the problem in Europe isn’t debt, it is the austerity programs that countries allegedly went on.
This attack seems wrong in so many ways. Just because someone says they are going to eat better and exercise, doesn’t mean they will. Buying a gym membership isn’t the same as going to the gym. I think blaming the deepening of the crisis on the alleged austerity programs, is like going to the gym once and wondering why you aren’t “ripped”. Austerity has not been implemented in a big way, and most of the austerity measures have a bigger longer term impact, so stop blaming them. The global economy is a mess. The Fed’s policy of easy money keeps the Euro artificially high, making Europe’s problems more difficult to deal with. It is a complicated problem, and no obvious right answer, but blindly dropping austerity is not the solution.
Furthermore, if it is so easy to achieve growth, why are we in this problem in the first place? Growth is not easy to attain. Growth worth more than the debt spent to create it is even harder to achieve. Using GDP growth as the whole measure of success leads to one obvious conclusion – spend – since it increases GDP. This is a debt crisis, where the amount of debt relative to GDP is out of control, and the current cost of servicing debt is hampering economies. Any GDP growth from spending must outweigh the cost of paying back that debt and servicing it. Virtually all of the debt accumulated in Europe (and the U.S.) was taken on in belief that it was doing some good for the economy and for growth. It is naïve to suddenly think that a problem created by poorly spent money will suddenly be fixed with the same people spending more money. The market is cheering “growth” but I don’t think we will see results, and we may find out that the austerity that is supposedly hurting the economy was never really enacted, and that the growth from new spending is hard to see (if not non-existent).
So if only we could go back to the beginning of last week, when it felt like earnings and economic growth were the key, but now it is back to anticipating the next CB announcement, and what the actual impact will be once the glowing press release is digested. Over and out.
E-mail: tchir@tfmarketadvisors.com
Twitter: @TFMkts