Week-end Round Up

Location Date: 
September 9, 2011

My apologies for a week between blog postings. The markets have been so fluid that I thought a wrap for the week and some context would make more sense. On the macro front, let's do a quick tour around the world.

In Euroland, the big news this week was not the German court decision allowing the EFSF to participate in the "bailouts" - that was a foregone conclusion. The big news was the SNB's action to effectively "peg" the Swiss franc (CHF) to the Euro around the 1.20 level (see chart below) after repeated intervention failed to stem the rise. 

Swiss Franc Moves 20% in a Month!

The impact on Swiss business has been a steady erosion of profit and competitiveness, especially in many of its superb multinationals. Many economists have highlighted the "Big Mac" price comparison between countries (Purchasing Power Parity theory) - it is $17.19 for 540 glorious calories in Zurich! CHF was viewed as a safe place to park liquidity - in fact, it has even outperformed gold while yielding you a mere 7.5 bps (yes - 0.075%) for the next 2 years, which is about the same yield as gold! There are two short-term implications; One, we would expect more demand for gold, as the alternatives for the "flight-to-quality" and "strong currency" trade just lost a good alternative. Secondly, the pressure is now focused on the yen - after repeated currency interventions it stands at 77.75 to the USD, which is much lower than the post-quake low of 79.40. While the Japanese situation is clearly different from the Swiss experience (they have lived in the land of the setting sun and rising yen for what seems like forever), we expect the yen to depreciate from these levels. Many prognosticators, including yours truly, have bet against the yen (there is a reason they call it the "widow maker") but perhaps now is the start - hope springs eternal!!

Japanese Yen vs US $ - the Widow Maker



In Euroland, today is supposedly D-Day for the private sector to take up a portion of the Greek debt deal. If it goes through, then fine, but Greece is still very unlikely to meet its' austerity targets in any event. Greece aside, I read a very interesting piece on European equities from Societe Generale's well-known bear, Albert Edwards. He has coined a terrific new term, "minimum bullishness"! I quote from his September 8th "Popular Delusions":

"After recent price declines, eurozone markets reflect more accurately some of the downside risks. I'm feeling slightly more bullish. Indeed, I think it now makes sense to look at selective involvement. Nevertheless, the downside implied by what I think remains a plausible worst case scenario is still too big and scary for me to feel comfortable going "maximum bullish." So I'm turning, err... "minimum bullish" for now."

Edwards is a big fan of buying companies "cheap" and in the graph below, he shows that Shiller P/Es for France and Germany are at multi-decade lows. 


I had to put this in today because, of course, out of all of the bad news comes opportunities for profit. For equity investors on our side of the pond (that do not hedge currency), we will need to wait further as the euro has substantial room to fall. The resignation of ECB "hawk" Jurgen Stark this morning and the departure of a grumpy Trichet likely spell a significant "dovish" shift coming in ECB monetary policy - about bloody time if you ask me! Spanish and Italian homeowners with a mortgage will finally have something to be positive about.

In South America, the Reserve Bank of Brazil cut rates after raising them earlier in June - they are still amongst the highest in the world (12%), as the battle to contain inflation had taken priority. However, this move may further signal that, like the CHF move, the "race to the bottom" in the "currency war" may be moving into its next phase. The global economy is experiencing a synchronized slowdown. The Brazilian real has fallen to a six-month low today versus the U.S. dollar. Those investing in EM debt and equity take note!

Now let's turn to China. Lost in the Obama speech, the plunging euro and the Greek fiasco is news this morning out of China: headline inflation for August came in at 6.2% (YOY), down from the 6.5% high print in July. While this is welcome news, those expecting China to ease monetary conditions or to provide a new stimulus package, that seems highly unlikely. House prices remain very elevated and key foodstuffs (vegetables, pork, etc.) are also still very high in price. 

Finally, the big speech from Obama, as expected, was long on flare and short on anything really new. The usual bickering between Dems and Repubs means that whatever was presented is likely to be ground down into some form of further toxic waste for U.S. taxpayers to pay for down the road. Business will like the payroll tax cut extension (though anything temporary has little effect) and together with extended UI benefits and further infrastructure spending, the impact on 2012 GDP will be positive but modest. Of course we will have to wait on the final details. 

So that's a wrap. For disclosure purposes, our overlays at Arrow on our various Portfolio Series are short the euro and yen and long gold.

Have a great weekend!

Jim McGovern