Preview from Europe: Risk Appetite Returning?

by: The Mole

Despite my (misplaced?) reservations yesterday one has to respect the price action! Tim did finally enchant and Geithner’s new bank balance sheet plan propelled stocks into the stratosphere. But it wasn’t the only catalyst at work yesterday as the bulls’ stars became aligned.

Credit spreads on financials narrowed, encouraging bank stocks to again power ahead. Commodities and commodity currencies rallied, which is usually a sign that risk appetite is returning favouring equities over bonds. US existing home sales unexpectedly rose by 5.1% (but driven mainly by cheap foreclosures and more worryingly inventory increased for the first time in seven months). Also Goldman Sachs soared 15% following a report that the bank may repay the TARP money it has received by selling part of its 4.9% stake in Chinese bank ICBC.

Today’s Market Moving Stories

  • Overnight, the latest Bank of Japan minutes showed a consensus to focus on lowering long term rates. Elsewhere in Japan data released showed that assets held by households fell by 5.7% YOY in Q4 2008; the second fastest fall since records began.
  • Record net Chinese imports of copper, zinc and iron ore supported commodity price gains. These imports represent price-induced stockpiling rather than signifying that consumption has returned. The strong run in base metal prices has been underpinned by buying from the Chinese State Reserve Bureau. With fewer supply cutbacks and a rollover in LME inventory growth this month for copper, lead and zinc, the base metal complex has seen its price cycle lows. Eventual inflationary pressure resulting from global quantitative easing may also persuade China to convert part of its FX reserves into commodities. And now China wants to ditch the US Dollar.
  • The WTO (World Trade Organization) expects world trade to fall by 9% this year. This would be the largest contraction since World War II. After the oil price shock trade fell by 6.2%, the highest reduction to date. The German economic institute RWI even forecasts a 12% fall.
  • More bad news for Germany, as the Ifo, DIW and RWI economic institutes revised downwards their growth forecasts. Ifo institute forecasts a 6% fall under a worst case scenario, that is if world trade continued to contract at its current pace. The DIW forecasts a contraction of 4-5%, the RWI 4.3%. The most pessimistic private sector forecast comes from Commerzbank, which is looking at 6-7%.
  • Martin Feldstein, currently a member of President Obama’s Economic Recovery Advisory Board, said: “I’m afraid that the economy will continue to slide down well into next year… I don’t know when it will end, but the forecasts that it’ll end later this year I think are too optimistic… The fiscal stimulus is just not large enough to offset the downward pressure that comes from reduced consumer spending. So unless somehow fixing the financial markets is enough to offset that, which I very much doubt, I think there will be a need for another fiscal stimulus package at some point.”
  • Rating agency Moody’s downgraded General Electric’s credit rating two notches from triple-A (which it has held for 42 years) to Aa2. A downgrade was expected following S&P’s decision to do likewise earlier this month.
  • Good news for financials (or at least those who work in them) came from a report that Republican Whip John Kyl would seek at least a one-week delay on debating bills for special taxes on AIG bonuses.

More Thoughts On The US Bad Assets Plan
The big stumbling-block hasn’t been how little banks’ so-called toxic assets are worth, but how to reach a politically-acceptable way of pricing them and putting them into a deep dark hole rather than leaving them on balance sheets. Tim Geithner is into public-private partnership solve the problem. It’s good for banks, who can get rid of assets rather than fund them and it’s good for money market functioning and helps tighten spreads. But it is not, of course, terribly relevant for the underlying economic reality of rising savings, falling demand, falling employment.

So we had a strong reaction from equities but this may look like an overshoot and we may see profit taking soon. My four main concerns are:

  1. Complicated program;
  2. Wariness to go near TARP-related money by private sector given lynch mob mentality in US;
  3. Will banks be able to sell assets at levels that are capital accretive or at least neutral?
  4. Is it big enough? Even with leverage, may only be USD500bn. Just have to wait and see, but something is better than nothing for now.

More broadly my key concern remains that US households are heavily loaded with debt, and will not be willing to borrow, even if banks start to advertise a greater willingness to lend (don’t hold your breath). The plan does not address consumer deleveraging. A broad cancellation of household debt would be the most extreme solution. That would be unfair, however, that the taxpayers pay such a high price for the folly of the adventurous borrowers.

The blogger Nemo has produced an interesting post on how the Geithner Plan works in more detail. It shows that from an investor’s point of view this is a “Heads I Win Tails You Lose” proposition. The only party that always loses, in all conceivable scenarios, is the tax payer. Nobel winner Paul Krugman also hates it.

Irish Sunrise Equity Snippets

  • Flogas, one of DCC’s brands, announced yesterday that it will start selling natural gas to commercial users in Ireland. The company already supplies liquid gas commercially and has also been supplying natural gas to Irish domestic users for a number of years. Flogas says that it will offer businesses a 15% discount on current prices. This will put Flogas in direct competition with the state-owned Bord Gáis and the Viridian-owned Energia.
  • According to Bloxham’s, Biogen may have found a treatment for PML, the deadly brain infection that has been linked to the use of Tysabri. A malaria pill, mefloquine, is being tested by Biogen on patients with PML. Biogen’s plan is to develop a PML protocol in which patients are first treated with a blood-cleansing method followed by a dosage of mefloquine, before a patient resumes taking Tysabri.
  • The National Treasury Management Agency (NTMA) is holding its first bond auction since 2005 this morning at 10am. This will be a key test of foreign appetite for Irish government bond debt. A successful auction would augur well for a smooth financing of the very large deficit Ireland faces this year and will take some of the heat off the spread and banking stocks (who may find it somewhat easier then to fund with the government guarantee if the State has successfully tested the waters). Note there has been a notable tightening i.e. improvement in the CDS levels being quoted against Ireland over the last week. This may now spill over into a tightening of the spread at which the country borrows new money vis a vis Germany.

Data Today
Today sees Eurozone PMIs, with the composite likely down to 35.2 from 36.2.

UK CPI/RPI is released at 09:30 GMT with the TV focus on the prospect of a 0.5% YOY fall. “Deflation, Official” the headlines will tell us for the first time since 1960 as mortgage interest payment cuts and lower house price inflation feed into the data.

Check For Bill

And Finally… The Bailout Rap

Disclosures = None