Reading list

Some stuff I've been reading / watching

David Einhorn video
http://wealthtrack-appletv.blip.tv/file/4406653/  
ht: http://www.eurosharelab.com/

http://pragcap.com/three-things-i-think-i-think-20

http://www.creditwritedowns.com/2011/01/european-debt-dynamics.html
European debt dynamics.  Borrowing at 5% and growing at 3% just digs a deeper hole.

http://www.creditwritedowns.com/2011/01/cautiously-optimistic-into-2011.html
Address says it all.

http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100009218/the-dam-breaks-in-portugal/
Has Portugal already asked for IMF help and no-one noticed?  Would be ironic if this episode of Euroland bailout occurs quietly.   Long term the trend is NOT Portugal's friend:
http://www.bloomberg.com/apps/quote?ticker=GSPT10YR:IND
(Look at the 5 year history)

Portuguese recycling & Iceland recovery -- Why the Chinese and Japanese are buying EU debt

The recent news of both China and Japan buying EU debt provides a very interesting window into the various motivations of investors.  While most investors are leaving the PIIGS debt markets, China and Japan appear very willing to invest.  Why?  It appears the Asian nations' motivations are different than return of principal.  Both are exporting nations and if more European trading partners are forced into austerity measures of higher taxes and lower government spending their own export industries will suffer.

American policy makers should be mindful of this when negotiating with China. It may appear they have the upper hand when looking at their massive foreign exchange reserves, but China also needs our markets to keep their factories running.

Unfortunately Portugal looks to be the next domino to fall, Asian assistance notwithstanding.  FT's blog lays out the timeline I have previously alluded to: It appears once a PIIGS' bond yield pierces the 7% level a bailout eventually follows.

However even with these 'bailouts' and Euro Central Bank assistance the problem has not been solved. As austerity measures and budget cuts drag GDP down the burden of debt grows ever higher in a nasty feedback loop.
From Satyajit Das:

Cuts in government spending and higher taxes have mired the economy in recession. Falls in tax revenue necessitate increasingly deeper cuts in spending to try to stabilise public finances. In 2010, the budget deficit was forecast at 12% of GDP, even after spending cuts and tax rises worth Euro 14.5 billion   The problems of the banking sector are increasing due to the poor economic conditions. Hitherto largely confined to commercial property, problems are now spreading to the broader economy. Unemployment and lower incomes mean that householders are unable to meet payment obligations on mortgages and other loans. Weak economic conditions have affected businesses, increasing default levels. In the absence of strong economic growth, inflation and a massive devaluation, the peripheral economies, such as Ireland and Greece, may be unable to shrink themselves to solvency. A simple relationship demonstrates the unsustainable position:

Changes In Government Debt = Budget Deficit + [(Interest Rate – GDP Growth) X Debt]

In order to restore solvency, overburdened borrowers must stabilise debt and begin to reduce the level of borrowing. This requires GDP Growth exceeding interest rates, a budget surplus (through spending cuts and/or tax cuts) or a combination of these. EU/ IMF assistance to Ireland was designed to address the high yields on Irish bonds, which curtailed the State’s ability to borrow. But the 5.80% cost of the bailout debt requires an equivalent growth rate and a balanced budget simply to stabilise debt at current very high levels.

Meanwhile the recovery in Iceland provides contrast to the current austerity and higher tax drudgery in the weaker European countries:

The Nordic economy grew at 1.2pc in the third quarter and looks poised to rebound next year. It ends a gruelling slump caused largely by the "New Viking" antics of Landsbanki, Glitnir and Kaupthing, the trio of lenders that brought down Iceland's financial system in September 2008. . .

This has led to vastly different debt dynamics as they enter Year III of the drama. Iceland's budget deficit will be 6.3pc this year, and soon in surplus: Ireland's will be 12pc (32pc with bank bail-outs) and not much better next year . . . 

The pain has been distributed very differently. Irish unemployment has reached 14.1pc, and is still rising. Iceland's peaked at 9.7pc and has since fallen to 7.3pc.

Housing -- Been down so long, it looks like up to me

The home market appears to be taking another leg down after the tax rebate induced spike earlier this year.

More details on home prices can be found here:

http://paper-money.blogspot.com/2010/12/s-october-2010.html

http://paper-money.blogspot.com/2010/11/more-pain-less-gain-s-preview-for.html

Paper-economy tracks (2nd link) the Radar Logic index which appears to lead the more well known Case/Shiller index.

Unfortunately if home prices fall further this may set up a feedback loop as more households with negative equity decided to strategically default.  Furthermore the recent rise in long term interest rates will not help affordability either

Housing permits are falling again and coming very close to putting in an all time low for the time series (The all time low was hit just a few months ago)  Looking at the graph you will also notice how in previous recoveries housing permits quickly rebounded.  Not this time.  Considering home values are falling this puts pressure on new home construction.  Lumber prices are also going up.

Eventually home prices will fall enough for demand and supply to finally balance but it doesn't look like we are there yet. For now the downward trend appears it will continue.

Disclosure: Short housing related stocks

Ahead of schedule PIIGS bond yields make new highs

Ahead of schedule bond yields in the PIIGS of Europe have reached new highs.   'Risk Free' interest rates have risen as well since November so the relative spread may not be at a new maximum yet but the trend is going the wrong way.

Taking away the punchbowl one way or another, Chinese version

The Chinese sense of humor was evident as they raised short term interest rates on Christmas Day by 25 basis points. (Bloomberg) What is interesting about this Saturday surprise is what happened a few days before with their failed treasury bill auction.

The ministry sold 16.76 billion yuan ($2.53 billion) of 91- day securities, falling short of the planned 20 billion yuan target, according to traders at the lead underwriters of government debt, who asked not to be identified. The average winning yield was 3.6769 percent, according to the traders. That compared with 3.22 percent on the debt of similar maturity in the secondary market yesterday.

Since the Chinese central bank was not able to drain enough cash out of the markets via Tbill sales, they raised interest rates instead.   One possible reason why the Tbill auction was not well received is there appears to be other demands on short term money in the Chinese banking system.  Short term bank repo rates are spiking higher as the year comes to a close. Why buy 3 month Tbills at 3.7% when you can lend out at 5.60% in the 3 month repo market?

As you can see there were spikes in the repo rates just before the end of previous quarter ends and I wonder how much of this current rise is due to squaring the books before year end.  We'll know soon. . .

Something to watch in the new year

The year is wrapping up and the US stock market continues to grind higher in a Christmas rally. While the US is in a much calmer state as compared to a year ago, not all is well across the pond in Europe.

The fiscal crisis in the PIIGS of Europe (Portugal, Ireland, Italy, Greece, Spain) has not been 'fixed' in my opinion and will most likely move up to the headlines in America very shortly.

Here you can see a chart of the PIIGS bond yields  (Bloomberg) and they are not going in the right direction. The spike and fall in May 2010 was due to Greek financial difficulties and the spike in November was from Ireland. Note how much faster the fall in yields after the Ireland event has been retraced as compared to the Greek event.

As this chart shows the absolute yields and not the relative 'risk' of the PIIGS regions looking at the combined CDS for the PIIGS (Bloomberg) provides a clearer view of perceived risk.  It too is almost at new highs and could very well exceed previous peaks before the new year.    I suggest you keep an eye on both of these indicators and if you see them shooting higher you will most likely see weakness in the equity markets as well.

Hugh Hendry December Commentary

Mr. Hugh Hendry's December commentary has been floating around the internet for a few days and I thought I'd share it with my loyal readers.  As always his letters are an interesting read, seamlessly combining the literary and financial.

Hugh Hendry / Ecletica Fund December 2010 commentary





His main thrust is the monetary stimulus by central bankers is not enough to outweigh the massive consumer deleveraging going on right now.  It is an epic tug of war and Hugh Hendry is on the side of further deleveraging and deflation (for now)  Please read.

ht: ZeroHedge