Report from Europe: Stocks to Make It 7 Up

At the beginning of the week I said it would be interesting to see how markets performed as US investors returned from their summer holidays. After three days back, the price action in equity markets is looking pretty definitive, with the S&P500 up another 1% overnight to record a new closing high. The cyclicals were key drivers. The rally in stocks continues to be underpinned by increasing conviction that central bankers and Governments will retain accommodative policy settings for an extended period – a message that was certainly reinforced by Fed Governors Kohn, Lockhart and Treasury Secretary Geithner overnight.

The nature of the ongoing recovery is such that nothing can be taken for granted. After all, rising demand has been underpinned by government spending initiatives in a number of countries across the world, and it remains to be seen whether private demand can stand on its own once the ‘pump priming’ processes have concluded. Indeed, this week’s poor retail sales report from Australia is food for thought for a central bank that has openly encouraged the growing belief that interest rates will be on the rise before year end.

Accordingly, politicians from a number of states (interestingly, including France’s Christine Lagarde) have reassured that exit strategies will remain on the shelf for a little while longer; but in the face of growing concern about the scale, and hence ultimate cost, of the world’s deficit-financing endeavours, it remains to be seen just how long the vestiges of unanimity on this front will last (if unanimity is the right word following last week’s G20). At the very least, the data must continue to reassure. In addition, the US CPI is becoming an increasingly important focal point, limiting the Fed’s remaining scope for its ultra accommodative policy, the future equanimity of the Treasury market and hence its implications for US-Sino relations.

Today’s Market Moving Stories

• Looks like we are set for another up day as bellwether stock FedEx has said that earnings will exceed its own forecast due to better than expected international volume, a lower fuel bill and cost management savings.
• While we slept a series of Chinese economic releases overnight confirmed the resilience of the Chinese economy, with retail sales, industrial production and fixed investments all coming in above consensus. The Shanghai composite index dully rallied 2.2%, pulling other Asian and European markets higher in its wake. The main exception was the Nikkei which dropped -0.8%, partly due to a relatively large downward revision to Japan’s 2Q GDP. JPY nonetheless traded firmly and USD continued to underperform. USD/JPY is now at its lowest level since mid-February and we are positioned for continued JPY appreciation due to the recent compression in rate differentials and possible JPY-buying from corporate repatriation and retail stop-losses.
• The news that Chinese yuan loans for August exceeded expectations and this has supported Chinese A-shares overnight. However, short-term discount bills, which I believe to have been the key component of credit expansion that has been driving the equity market, actually fell in August. While this should mean that loans created are channelled into the real economy, it also means that the “excess liquidity” that has been pushing up both stocks and property could be nearing an end. I will be watching for more indicators of slowing liquidity in the weeks ahead.
• Oil is back above $71 barrel on a story that world demand is likely to average 85.7 million barrels a day next year, according to a monthly report from the IEA. That’s 450,000 barrels a day more than estimated in August. Spain’s Repsol, Norway’s StatoilHydro and BG Group are seeing some buying. Bodes well for names like Schumberger this afternoon in the US.
• Easy on the eye, hard on the ear. Meredith Whitney says home prices could fall by another 25%.
• Five reasons the rally is built on quicksand.
• A hot new trading tool – the Cramer-Roubini Xtreme Index.

Opel Saved Just In Time For The Election
This is how the political-industrial complex works in Germany. As every newspaper in Germany reports on its front page, Opel was sold to the government’s favourite bidder just in time for the elections. It emerged also yesterday that the government’s representative in one of the boards that had to endorse the decision actually voted against the deal on the grounds that this offer from Magna would lead to a bankruptcy of the company within a few years, which would render the government’s €4bn financial support as a waste of taxpayers money. Under the Magna deal, all of the four German factories would be miraculously saved, while the Belgians, who have refrained from bribing the GM board, are now preparing for the gradual closure of the Antwerp plant. Both Merkel and Steinmeier, who had favoured the Magna deal from the start purely on grounds that it saved German jobs irrespective of the costs, claimed victory yesterday. The FTs Lex column makes the point that the result will be continue overcapacity in the European car industry, which will face a similar plight than the US car industry in the next downturn.

Mid September Macro Thoughts
The widely touted September sell-off in stocks has not happened (so far), probably because it was so widely touted. Meanwhile, recent central bank commentary has come in a bit softer than people had expected, reinforcing the G20 growth support message, which has probably helped real asset prices. The Beige book showed an improved picture of the US economy from the previous edition. However, if you can get excited about flat retail sales, downward pressure on house prices, moderate increases in manufacturing new orders, and “minimal” wage pressures when labour market conditions remain weak, then you need to get out more. Comments by Chicago Fed President Evans rang true in pointing to expectations of a weak recovery and suggesting that falling unemployment would be required before rates could rise.

In Europe, J.C. Trichet’s comments at last week’s press conference about being “cautious” and “prudent” and suggesting a possibly stuttering recovery were in a similar vein. As was evident at Jackson Hole, central bankers are far away from feeling that a self-sustaining recovery has reached take-off. Outlining an exit policy is a bit like an aircrew going through the emergency exit procedure – it is good to be prepared, but it’s not a signal to disembark. Thus since the beginning of the month, risk premia have declined, with the VIX moving from the high to the low twenties: inter-bank rates have continued a slow drift down. Stocks may also be benefiting from the effects of ultra-low rates and unconventional policies. When banks are still not flush with capital and when loan demand is soft, how is ultra-accommodative monetary policy supposed to work if it’s not through asset prices?

More NAMA(rama)
Liam Carroll, the once mighty developer, lost a court ruling yesterday to appoint an examiner. ACC bank (part of Rabobank) is a big creditor and will push to appoint receivers to start liquidating the company. The Irish press says Liam Carroll has €1.2bn of debts in total and a host of UK and Irish banks have interest in the developer. AIB and Lloyds have the largest exposures. The eventual impact to the banks as far as loan impairment provisions go might not be so bad (it would have been manageable anyway in all cases) as most of the Liam Carroll loans are set to end up in NAMA rather than being subject to fire sales. I’ve said it before but NAMA = TINA (there is NO alternative).

A story running parallel but losing out to NAMA (although is somewhat dependent on NAMA outcome) in the headlines is the possible merger of the three smaller Irish banks to form a so-called “third force” in Irish banking. Bank of Scotland (Ireland) has approached the Irish government to be included in the new possible merger involving IL&P, EBS and Irish N’Wide. Once NAMA gets going the focus will shift to consolidation in what’s left of the Irish Banking sector (think of all the branch closures) and it is very likely that a government capital injection of some size will be required and therefore a stake in the merged company as well. From Lloyds’ perspective merging their Irish unit would ease some of the EU concerns on competition (possible forced sale of core as well as non-core units) and gives them an alternative to exiting Ireland completely. BoS (Ireland) has a €32bn loan book but more than half of this is in property developer type loans and is thus ending up in NAMA so it will be a much reduced bank that will eventually merge. Definitely a story gathering traction and one to keep an eye on but remains a post-NAMA focus at the moment.

Equities On The Move Today

• Air France-KLM Group (AKH) surged 7% after French paper Les Echos reported Europe’s largest airline is planning to restructure its cargo activities, lifting tariffs by between 20-30%.
• Fiat (FIATY.PK) climbed 4.8% as Credit Suisse recommended the Italian carmaker.
• Steelmaker ArcelorMittal (MT) is up 4.6% on the back of Steel Dynamics (STLD), the third-biggest US steelmaker, saying that third-quarter profit will be higher than the company forecast in July, helped by strong orders for flat-rolled steel. A Goldman Sachs report is forecasting 17% higher steel prices. Salzgitter and ThyssenKrupp are up in sympathy.
• Axa (AXA) advanced 3.2% after Bank of America raised Europe’s second-largest insurer to “buy” from “neutral”.
• Tesco (TESO) has agreed an insurance joint venture with Belgium’s Fortis bank.
• Miners Rio Tinto (RTP) and BHP Billiton (BHP) were also bid on the better than expected economic news from China (a key market for them of course).
• Some good news on the credit front for Ireland’s AIB, with the CEO of AIB’s Polish business indicating to the press there that he now expects provisions for FY09 to be 1.5% of loans compared to his earlier forecast of 1.5-2.0%. Loan loss provisions in H2 “may be even lower” than H1. The stock is well bid today.

And Finally… Henry Rollins’s New Opener

Disclosuers = None

Comments

[Old Trader:]

Fed Ex's numbers and guidance are, as far as I'm concerned, about the first "green shoot" worthy of the name. Granted, a part of the improvement was "cost control" (nothing new there, since that's how the bulk of the last round of "beats" was achieved), but oil seems to have found a range that's "comfortable" for all parties concerned, meaning that fuel costs will remain managable, and the uptick in the international shipping business is helpful.

Sep 12 10:16 AM