Expect an L of a Recovery

Macro Man was pleased to receive plenty of kind feedback on yesterday's little hip-hop effort, though somewhat chagrined to see that "California Love" is apparently now considered "old school." Speaking of old school, "Going Back to Cali" was suggested as an alternative source of inspiration.....hmmmmm.....I don't think so.

Anyhow, we finally started to get some signal yesterday with the release of Alcoa's (AA) earnings after the close last night, which apparently means the return of sweetness and light. True, Alcoa's earnings losses were somewhat smaller than expected, which, for an aluminum producer like AA, might appear to have implications for the global economy.

At the risk of facing accusations of viewing the world through blood-tinted spectacles, Macro Man is sceptical. Last quarter saw an unprecedented action from the Chinese to support rally prices via unprecedented import activity. The chances of a repeat performance would appear sketchy. Moreover, even with this demand and price boost from China (presumably to keep Chinalco afloat), Alcoa's revenues barely budged....even though Q2 is seasonally their strongest revenue quarter. In fact, y/y revenues actually fell from 40% in Q1 to 44% in Q2.

So it would seem that the vast bulk of the surprisingly small losses was down to cost-cutting, a fact apparently confirmed in last night's statement. So you'll have to pardon Macro Man if he views Alcoa's "triumph" as a micro issue, not a macro one. From his perspective, that revenue curve looks decidedly L-shaped.

(Edit: Alcoa lost $142 in shutting money-losing operations, which has somehow been magically wiped from the headline EPS figure. If you add that back in, the actual loss per share was worse than expected. If only Macro Man could wipe the losses from closed, unprofitable trades from his headline P/L, this job would be a helluva lot easier....)

Earlier in the day yesterday, European asset markets were impacted by a "massive" rise in German industrial production (3.7% m/m), which comfortably exceeded expectations. While that certainly confirms the end of the production free-fall, it hardly suggests an imminent growth phase. Indeed, an index of the actual IP index shows a) that the May blip barely registers, and b) that up and down changes in monthly production are the norm.

A stabilization in demand, which appears to be the new bullish theme, doesn't actually imply growth of a V or a W shape. It actually implies an L.....which is hardly good news, and far from what is priced. It's an interesting coincidence, but two banks yesterday presented Macro Man with research that Asian equities are pricing in an ISM reading of between 55 and 60. That's a hell of a lot of good news (and growth) that is already in the price.

And despite today's Alcoa-inspired bounce and scepticism from many quarters, the head and shoulders patterns in a number of markets continue to work. Given the optimism embedded in prices and Macro Man's view on the likelihood of an L-shaped recovery, he looks for further downside in risk asset prices.

Finally, it's worth noting that today sees an announcement from one of the few CBs in a tighter spot than the Fed....the Bank of England. Inflation has consistently exceeded expectations, and a prior raft of better-than-expected activity data has recently receded into sharp declines. Oh, and the fiscal situation is worse than that in the US, and administered by a government that's now utterly bereft of credibility.

The market seems to expect a £25 billion extension of QE, with a risk that the BOE requests an increase in the size. Macro Man has no real view on the outcome, but it should make for interesting viewing. At the very least, it should take the market's near-term focus away from West Coast rap....

Comments

[User 353732:]

1. When you combine a growing Government with a shrinking economy you get.......an even smaller economy
2. When you combine declining profits with even more regulations, taxes and penalties you get.......even worse profits
3.When you combine increasing subsidies for those who do not work and do not pay their bills with increasing burdens on those who do work and pay their bills you get.........even fewer people working and even more debt defaults
4.When you combine big government with big money with big labor with big media you get.......an even smaller and more demoralized middle class
5. When you combine increasing misallocation of national resources with growing policy incoherence you get........declining national competitiveness

The governments of Indonesia and India, for instance, understand this: why not our Government?

Jul 09 08:53 AM

[morph366:]

The B of E decided against boosting its QE program (although the semantics and spin were designed to confuse as usual).
In terms of scheduling of gilt auctions there's a lot paper to be sold and not a lot more room for the Bank to keep on being the reliable buyer. But that could all change at the August meeting ... and so it goes on!

Jul 09 09:36 AM

[LilBob:]

Many have been predicting an L-shaped recovery for some time now. And, unfortunately, the backward tip on that L is only about 10 to 15%, so we're in for a long haul. Expect to see countries encouraging some degree of inflation-especially if oil continues to remain relatively low-as a means of improving the relative productivity of their workers. The achilles heel of promoting inflation-as I've said before-is that absent some significant decline in national energy consumption such a policy is not tenable. The US has declined somewhat in it's energy consumption-a recent NPR report cited that nationwide vehicle registrations are down almost 1.4%, but that's not quite enough to make an inflation-friendly economic policy feasible. That's why the Obama administration has been pushing for a combined approach of encouraging domestic energy efficiency, and discouraging the rest of the world from viewing the US as the ultimate market. Don't be surprised if once things stabilize we see at least a call for an increase in the minimum wage and possibly even US efforts to go with China and seek the development of an international benchmark currency.

Jul 09 10:13 AM

[Jason Rines...:]

I am your contrarian on a couple of points Macro (I like your stuff), Britain is in worse shape then the US and that the recovery will be a W shape, and the duration of this event last until 2012. Don't discount the $700 B sitting in reserves waiting to be unleashed on the market. But 2010 will be deflationary as well, expect the the middle of the W to be in 2011 and inflationary. User 353 makes good points about government so they certainly can make it worse and become an L shape and why I am divested from the market right now. W or L, sad that a W is our likely best case scenerio :(

Jul 09 05:46 PM

[expat in China:]

Aluminum is an indicator!

However there is a world wide glut and over capacity of production capability, so even if we get a recover Alcoa is marginalized going forward. Metal production is an emerging market product (EPA) and such!

China has greatly supported the infrastructure development of the domestic producers and will control the players in Asia. The central government is buying the commodities instead of long US treasuries as part of it's infrastructure planning for the future (long term planning). They have the raw material supply with the Yuan to settle trade and they provide nearly free electricity to the domestic producers.

Auto production will replace most Aluminum with EG electro-galvanized metal, also in a huge capacity planning stage in China (boa steel).

Companies grow or die! Alcoa is shrinking in all aspects.

Jul 09 10:40 PM

[jambo:]

Flat as Kansas. That leaves the market to highly seasoned traders snapping at crumbs whilst staying awake and unshaven. At some point in my life that visual would have brought a certain smug grin alas not today.

OR they could enlist the aid of our MEDIA and manipulate a decent living out of sucking in little fish. Hey... wait... isnt that what just happened.....?
some things never change, only the names.

Jul 10 08:39 PM