Sunday, November 30, 2008

What I Want to See Next...

Jim O'Neill from Goldman wrote a great piece in the FT about the impact of the US consumer on the WW economy. To summarize, US consumer spending represented about 72% of the US GDP and about 20% of WW GDP as of 2007. Over the next few years the US consumer will save more, spend less and maybe only represent 65% of US GDP.

Mind the Gap: that's a big hole for the rest of the world to fill. The less they fill the harder the whole world's economies fall and the longer it takes them to get back up. O'Neill suggests that between China, India, Germany and maybe Japan, the gap can easily be filled. But this will take some major policy changes to mobilize consumer spending in those countries.

China made the first move, and given how big an impact the US slowdown is having on their economy, expect more heavy lifting from the Chinese government to push consumer spending. Now we need to see something big out of Germany; euro rates are coming down fast and that's a start, but we want to hear about legislation that somehow promotes consumer spending. These are some of the road signs we will look for to begin building a longer term case for a market recovery.

And on a Shorter Term Basis...

Bond issuance looks like it is making a comeback. Another great road sign to an equity market rally, as well as longer term recovery. There is a huge backlog of financings that need to be dealt with and with the capital markets in lock down over the past two months, insolvency for a lot of companies has begun to look more and more likely. CDS spreads for US and Euro companies has either widened or remained massive.

There are now early reports that suggest the higher spreads over T's offered in the market are beginning to pull investors out of their bunker. This from Bloomberg: "The extra yield on investment-grade debt over government bonds in the U.S. rose by 0.33 percentage point to an average 6.39 percentage points, the highest since Merrill started collecting the data in 1996. Spreads on European bonds rose 0.21 percentage point to a record 4.14 percentage points...

"Investors bought $127.5 billion of bonds in the U.S. and Europe this month after governments guaranteed banks’ debt sales to kick-start lending, according to data compiled by Bloomberg. Credit markets froze this year following almost $1 trillion of losses and writedowns by the world’s biggest financial companies since the start of 2007.

"U.S. companies issued $49.7 billion of debt in November, almost twice the sales last month and the most since June, when they sold $74.3 billion, Bloomberg data show...

"JPMorgan Chase & Co., Morgan Stanley and Goldman Sachs Group Inc. sold $17.25 billion of bonds under the Federal Deposit Insurance Corp. guarantee started this week. Credit-default swaps on Goldman fell after the sale, indicating an improvement in the perception of credit quality, according to CMA Datavision prices for the contracts.

"Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

"JPMorgan also sold 1.5 billion euros and 600 million pounds ($923 million) of bonds due 2011 this week.

“I think next week you’ll see quite a bit of issuance, and you’ll see that right through Christmas,” said Paul Spivack, global co-head of the investment-grade syndicate at Morgan Stanley in New York. “You’re going to see more and more investors participating in this,” he said, commenting on bank- bond sales under the FDIC program."


We will get buffeted by lots of news reports going in opposite directions. Get ready for positive retail comps for the holidays, but incredibly bad margins for the retailers. Later this week the November sales reports will be out; expect a lot of commentary on sales numbers and not much talk on profitability. But hey, if that lifts stocks, so much the better.

Commodity prices are expected to keep falling, as the WW slowdown makes its way through the supply chain and inventory piles up. But how much of the price declines are businesses driven and how much are investor driven? Delevering is forcing all of the commodity funds back to zero leverage or to close their funds. When that ends, and it may be close, then we'll have a real picture of where commodity prices are based on business alone. Yea, it's bad, but is it as bad as prices suggest?

The bellwether name is copper, and after a monster run the metal is trading down 60% from it's peak. Oil is down 67% from its peak, and the CRB is down almost 50% - all in five months. I am a believer in the bubble and the impact of declining marginal demand, and I recognize the peak prices were not a real reflection of business, but the word 'oversold' is starting to come to mind.


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