Rebel Traders – Analysis Without The Hype

So far, we have managed to get back to the highs of the year on the S&P 500. Emerging markets have also participated in their boom.

As the markets are now reaching overvalued territory considering the current growth, the question now remains lingering in the mind of many traders: where are we headed from here? Different theories have been thrown around some basing themselves on the same elements but deriving very different consequences. The answer to that question divide themselves in four, according to the analysis (bearish or bullish).

The Two Schools of Double-Dippism

Two type of analysis predict a double-dip recession on contradictory hypotheses: one on a deflationary thesis, the other on an inflationary thesis. Needless to say, with the hike in gold these last weeks, the inflationary double-dipists have obtained a few points in their favor. You may count in that group analysts such as Andy Xie or Nouriel Roubini. In recent economic news, their thesis seems to have been somewhat comforted by some level of higher spending in retail. Some of the inflationary double-dippist maintain that higher retail spending is not necessary; it is enough that the markets “anticipates” inflation to automatically realize it (cfr. the writings of Andy Xie).

The double-dippists on a deflationary view (Denninger for instance) postulate that the expectations of the markets are too high to be fulfilled and that the US consumer will not be able to be a frantic spender as before. As credit remains contracted, the money unleashed by the Fed remains locked up and does not circulate in the economy. This should ultimately bring about a shock (by some weird coincidence both the schools of double-dippists have now moved to Q1-Q2 2010 as the time of reckoning – which is a notable evolution for the deflationists who were expecting a crash since last March), crashing the markets a second time and opening all hell loose. Unfortunately, the double-dippist also remain very silent as to what follows after the apocalypse they predict. Of course, I left aside a lot of nonesense on “manipulation” and government intervention that is often added up to the mix of the deflationary double-dippists.

The Inflationist Bulls

The bullish analysis generally is an optimist variant of the inflationary double-dippist. Only, instead of seeing the markets crash under high assets prices and the economic cost associated, the bullish view sees inflation as the answer to all the issues of the US and the resolution of the spending contraction. As credit will slowly unfreeze, demand should pick up and we should end in a wonderful bubble of all assets giving way to wonderful growth all over the place (and at the same time, a devaluation of the cost of the US debt). US demand will pull ahead the global production, thus launching a “virtuous circle”, and so on. Needless to say, in periods of inflation you are better off both with a credit and/or with tangible assets rather than money. You can file hereunder the “Inflationary Bulls” all the hedge funds buying gold or commodities right now.

What the Inflationist Bulls often omit to say is that, eventually, you get another deflationary bubble burst… or another protracted agony of the housing and stock market with high taxes over several years.

The Savings Bulls

That analysis misses the big issue of deleveraging and the fact that the credit crisis has essentially brought the US on its knees. With the trauma of the credit crunch, many Americans have taken to saving in big proportions. These savings can become an essential tool for helping industrial investment in the US. However, the recent stats pointing out a resumption of spending cast a serious doubt on how much this change of heart really entered the American habits.

There is no question that compared to last March, the general mood is more optimist; And it is worth noticing that this week no single bank has gone into failure, a remarkable piece of news when you think that the “Black Angel” of bank analysts, Meredith Whitney was predicting 300 + bank failures by the end of 2009.

The “savings bulls” postulate that we are going to revert to a virtuous circle, where high savings will allow the development of industry and a recovery from the spending binge of the Greenspan era. Maybe even a partial answer to the US debt issue, as money invested into T-bills may help keep the debt proceeds within the country. The problem being that we are in unprecedented times, with an unprecedented debt and with unprecendented amounts of liquidity out there.

In addition, all the tools for investment are already out there. Why isn’t there a fury of investment then? Because most banks park their money either at the Fed or play with it on the markets, in a schizophrenic game of low risk/high risks game.

So additional savings will be a great thing – in the future, a few years from here. Short-term, it is not sure that this will have any tangible effect on the economy except invalidating any keynesian policy.

Conclusion: Any Prediction On the Future will be a bet

Are we out of the through then? The most prudent analysts point out that while Q3 may be still positive for the companies, thanks to an extension of the cost-cutting measures and an amelioration of the overall economic situation, the most likely scenario will be a U-shaped recovery. In short, whomever missed the huge rally from the lows of March should not hope for a continuation of those violent and miraculous progressions in the markets – unless, of course, the inflationary double-dippists get their way. So far, we can expect only a long and protracted recovery, while deleveraging follows its course, and maybe, a new culture of frugality pervades the US.  So we may still go higher… But the road will be much more bumpy now even if the conditions are not reunited for a dramatic crash too soon. But any prediction can only be a bet.

In that respect, Ben Bernanke admittedly confessed to maintaining liquidity in the system to encourage spending by companies and individual consumers through the expansion of credit. We know this credit is remaining frozen for now.

However, as time goes by and the economy strenghtens itself,  the Fed will have to pull out the excess liquidity from the system… Thus encouraging a continuation of the credit contraction (which may favor any of the deflationary double-dippists and the savings bulls depending on the ultimate effect).

In the meanwhile, the lower dollar encourages US exports, and maybe even foreign investment in the US, as the current desperate condition on the labor market may encourage people to accept lower-paid jobs.  So there is a bright side, even to the dollar’s depreciation.

Given the number of variables at play, it is very difficult to predict the economic future with any clarity. There are many black swans hatching around the world that may pronounce the doom of the markets… And there are just as many white swans that may blind bears with hope. In these conditions, it is difficult to make any call except a very cautious call to be pragmatic and trade the market as it is. The question remains open: “who wants to fight the Fed?”

So far, the best thing to do is for traders to play the swings with a certain love of risk and without pre-established prejudice; and for investors who have long positions to hedge them against unexpected reversals. The market rewards cynicism towards it, not naive beliefs.

From Ambrose Evans Pritchard at the Telegraph

China’s banks are veering out of control. The half-reformed economy of the People’s Republic cannot absorb the $1,000bn (£600bn) blitz of new lending issued since December.

Money is leaking instead into Shanghai’s stock casino, or being used to keep bankrupt builders on life support. It is doing very little to help lift the world economy out of slump.

Fitch Ratings has been warning for some time that China’s lenders are wading into dangerous waters, but its latest report is even grimmer than bears had suspected.

“With much of the world immersed in crisis, China appears to be one of the few countries where the financial system continues to function largely without a glitch, but Fitch is growing increasingly wary,” it said.

“Future losses on stimulus could turn out to be larger than expected, and it is unclear what share the central and/or local governments ultimately will be willing or able to bear.”

Note the phrase “able to bear”. Fitch’s “macro-prudential risk” indicator for China threatens to jump from category 1 (safe) to category 3 (Iceland, et al). This is a surprise to me but Michael Pettis from Beijing University says China’s public debt may be as high as 50pc-70pc of GDP when “correctly counted”.

The regime is so hellbent on meeting its growth target of 8pc that it has given banks an implicit guarantee for what Fitch calls a “massive lending spree”.[...]

China’s Banking Regulatory Commission fired a warning shot last week. “The top priority at the moment is to stop explosive lending. Banks should carefully monitor the process of credit approval and allocation, and make sure that loans flow into the real economy,” it said.

Unfortunately, 40pc of the “real economy” consists of exports, mostly to the US and Europe, the consequence of a mercantilist export model that has qcrashed and burned. Chinese exports were down 26pc in May.[...]

Protectionism is a risky game for a country that lives off global trade and runs a surplus near 10pc of GDP. Mr Pettis said he fears China is nearing its “Smoot-Hawley moment”, repeating the US tariff blunder of 1930 that brought the world crashing down on Washington’s head.

Two facts stand out about China’s green shoots. While the Shanghai composite index is up 70pc since November, Chinese imports are down 25pc from a year ago. China is still draining real stimulus from the global economy.

If the world’s biggest surplus state ($400bn) is too structurally deformed to help offset the demand shock as Western debtors retrench, we are trapped in a long deflation slump.

The indices are down, the Dow off it’s low (for now).  Not a great deal of fear in the markets, but selling is definitely there.There’s still a lot of talk that we’re not in a recession until we see bad numbers for months on end, but since the Fed’s are cutting rates aggressively, we probably won’t even have a recession.  I don’t want a recession, either, but talk about blanking-out reality.  Oh,yeah, and remember, it’s not a global problem.  Right.  Just a few of the economic reports from around the globe:

China:

JAN PMI MANUFACTURING: 53 V 55.3 PRIOR (LOWEST READING SINCE OCT).  They are battling inflation,too.  CHINA’S INFLATION HITS AMERICAN PRICE TAGS – INTERNATIONAL HERALD TRIBUNE.  Their banks have subprime exposure (though we don’t know how much).

Hong Kong:

HKMA’S Yam says he is skeptical on “Asian decoupling”  (Good)

DEC RETAIL SALES VALUE Y/Y:  16.8% V 19.3%E; VOLUME Y/Y: 12.4% V 14.0%E

Germany:

DEC RETAIL SALES: M/M -0.1% V 1.7%E; Y/Y -6.9%  V -4.2%E
- Prior m/m revised from -1.3% to -1.9%
- Prior y/y revised from -3.2% to -3.4%

Spain:

JAN UNEMPLOYMENT CHANGE: 132.4K V 69KE

Finance Minister Solbes says they must be worried about the US economic problems, as it will affect Europe.

India:

JAN INDIAN PMI MANUFACTURING: 60.7 V 61.9 PRIOR (4-MONTH LOW)

South Korea:

CPI MOM: 0.5% V 0.4%E; YOY: 3.9% V 3.8%E; THE Y/Y PACE ACCELERATED FOR THE 5TH CONSECUTIVE MONTH
- The prior mom CPI was 0.4% and the prior y/y was 3.6%.<USD/KRW

According to S.Korea’s Financial Regulator, local banks posted $563M In subprime related losses (crap is everywhere!)

Australia:

JAN AIG PERFORMANCE OF MANUFACTURING INDEX: 49.2 V 57.6 PRIOR; First reading below 50 since May 2006
- Data shows inflationary pressures remain: Input cost prices remained strong during the month, while selling prices continued to rise.
- “How events unfold in global financial markets and the future course of interest rates will be important in shaping the prospects for the industry in the months ahead,” the AiG CEO said.

AIG PERFORMANCE OF SERVICE INDEX: 54.9 V 56.9 PRIOR

DEC BUILDING APPROVALS MOM: -16.0% V -4.0%E; YOY: -0.9% V 14.6% PRIOR

DEC RETAIL SALES: 0.5% V 0.6%E  The prior retail sales figure was 0.8%