Preview from Europe: Stocks Find Solace in the Beige Book

by: The Mole

Déjà vu as there was a late rally yesterday evening spurred by the Fed’s Beige book which noted that 5 of the 12 districts saw “that the downward trend is showing signs of moderating”. The market had earlier dipped on news of a very stodgy 10 year US Treasury Bond Auction (where investors demanded 3.99%, the highest yield since August 2008 to buy the government securities) and worries about inflation and higher gasoline pump prices. Note also that figures yesterday showed new mortgage applications at a four month low. Hardly surprising given a 30 year mortgage now costs 5.57% from 4.61% in March.

Today’s Market Moving Stories

  • US foreclosures are still rising. The latest RealtyTrac data has shown that one in every 398 households in the US is in some state of foreclosure. May 2009 foreclosures are up 18% yoy although a slight improvement from April. The three month run rate is now more than 300k per month. With unemployment still not falling (9.4% in May in the US) coupled with falling house prices (down 19% yoy as at end-March 09) the trend is expected to continue with total foreclosure filings for the first half of 2009 possibly reaching 1.8m. This will continue to show up in banks’ credit losses for the foreseeable future, albeit near-term, the US banks have been much more proactive in pre-provisioning, with average coverage levels north of 100% for now, while the major European bank average is around the 55-60% mark.
  • Overnight we got news of Chinese fixed investment for May. Investment continued to accelerate, with annual growth reaching almost 33%, up from a low of 24% last year. The trade balance for May showed a 4% bounce in exports, although the trend in sales remains on a downward drift (sales are down a worse-than-expected 26% from a year ago).
  • For Asian equities key psychological barriers could keep equity markets capped for a while, with the Nikkei nearing 10,000 and the HSI closing in on 20,000. Whether the market conquers these markers ultimately depends on continued liquidity.
  • European stocks in the news are pharma giant Glaxo (NYSE:GSK) whose shares got a boost after they were rated “attractive” at Morgan Stanley while Electrolux (OTC:ELUXF) is also up after a buy recommendation from Goldman Sachs.
  • More gloomy tidings from the troubled airline sector. Both Iberia and Lufthansa (OTCQX:DLAKY) have released May passenger data which echoes the negative trends from other Flags. Iberia’s volume fell 11%, with domestic down 9.8% and Europe -10.3%. Lufthansa traffic in Europe declined 3.1% to 4.8m (including Swiss). It has been a tough start for summer trading across the entire industry.
  • Allied Irish Bank (AIB) today confirmed that it has initiated an exchange (buyback) of its subordinate bonds, following the Bank of Ireland initiative. In principle, bond holders will have the opportunity to swap current AIB bonds for that of a specified series of new notes. Up to €2.65 billion in bonds are being bid for by AIB as part of the exchange. The pricing of the exchange will take place on June 22 2009. AIB could benefit to the tune of €700m - €800m which would provide a 10% boost to existing Core Equity Tier 1 capital of €7.7 billion.
  • Give Us Back Our MoneyÉlan (NYSE:ELN) CEO Kelly Martin gave a little more colour last night on the timeline for the company’s long running and much commented upon strategic review. Élan is in the “last phase” of assessment, after initially receiving a lot of interest when the review process was begun in January. He reiterated the key goals of the review are to access more capital and a global commercial infrastructure, and to minimise dilution to current shareholders. Separately, he also remains very bullish on Tysabri prospects and sees potential for 100,000 patients on this drug within a 3-5 year timeframe.

Market Takes Positives From Downbeat Beige Book
The Fed’s Beige book released last night noted improved economic expectations in several districts. Indeed five districts noted that the downward trend shows moderating signs. Eight districts reported home upticks in sales (however most of these upticks in housing sales were concentrated in the lower-priced end of the market). The good news more or less stopped there. Overall lending activity remained stable to weak. Credit conditions were judged to be on the whole stringent or even tightened further. Financing for new commercial properties was harder to get. And the residential real estate market was still judged to remain weak. Labour market conditions are still judged weak, with wages flat or falling. No one at the Fed believes there will be much inflation till that changes. Moreover prices at all stages of production are flat or falling. Demand for non-financial services was judged down again, retail spending is still seen as soft and manufacturing activity declined or remained low.

So in sum, no substantial rise in economic activity is seen through year-end. Hard to see then where the market is getting its optimism from. Richmond’s Fed governor Lacker said there’s “no single bullet” to end the recession. Lacker is still talking as if there is and will be a recession, even if the market has decided otherwise.

The Joy Of Not Being Sold AnythingClick to enlarge

FT Blowing Swedish Loan Way Out Of Proportion
There’s a misguided headline in the FT saying that ECB has lent the Swedish Central Bank €3bn, as if without this, Sweden would implode. Tosh! Sweden drew down €3bn under a pre-existing swap line (which has been disclosed, well I knew about it and I’m no freakin’ genius) as a matter of precaution given the massive uncertainty position of the Latvian economy. It’s not like the ECB is now wading in outside its remit – the ECB was reactive here, not proactive. Meanwhile on Swedish banks, the stress test results were released yesterday, and while they were reasonably stressful scenarios, GDP Latvia minus 20% for example, the bottom line was that the banks could take SEK150bn of losses and survive. That’s not huge but it does provide a tangible buffer and, just as importantly, some time.

There’s an excellent comment by Mary Stokes in RGE Analysts’ EconoMonitor about the possibility of contagion from the Latvian crisis. She said a Latvian crisis would hit Estonia and Lithuania through trade and financial linkages, and it would affect Sweden through the exposure of Swedish banks in the region. The question is how would it affect the other CEE countries? Direct trade and financial linkages are not very strong. The main effect would be what she calls the “wake-up channel”, a wake-up call to investors to pull out of the region as a whole.

Data Ahead Today
US retail sales for May are released at 13:30 (all times UK). Activity should rise by 0.6%, helped by higher car and gas sales. Excluding the latter, sales should be up 0.2%. I continue to expect real consumer spending to decline in Q2 after posting a surprising 1.5% annualised advance in Q1.

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Disclosures: None