Report from Europe: Dollar Down Stocks Up Trade Continues

by: The Mole

I was going to write today that on the eve of Thanksgiving it almost looked as if bulls and bears are too busy to do their Christmas shopping and have agreed to not do any harm to the other for the rest of the year. Whenever risk markets look set to test the lower boundary of a narrow trading range, nobody seems to be really interested in selling the market the next day. We’ve been in this deadlock for six weeks now and it is difficult to figure out what could finally cause a breakout of this range trade. Decreasing volume towards Christmas could be a factor which would on the other hand question the validity and sustainability of a potential break. That said key-triggers like 1121 (S&P 500) and 1.5164 (EUR/USD) are still valid but might again lack follow-up once taken out.

But it has been a very bad range breakout session for USD, which is lower across the board as European equities extended their gains seen in Asia. AUD, CAD and JPY have led the way and the EUR/USD is firmly above the key $1.50 (at 1.5080), on comments from the Russian Central bank that they plan to diversify into Canadian Dollars and a warning from Japan’s former point man on currency Eisuke Sakakibara that USD/JPY may reach 85 “quickly”.

At the US open we had a pre-holiday deluge of data which has caused quite the chopfest in markets. Durable Goods orders data disappointed with a big miss versus estimates the back revision to the previous month should be noted as a positive. But the big takeaway is the most welcome large and unexpected drop in the weekly jobless claims to -466 (the first dip sub 500k for 54 weeks) and continuing claims pointing to a stabilisation in the US jobs market. This is giving equities a further early leg up while Goldman Sachs is increasingly confident in the end of year rally. This good news was tempered by reports that Dubai World (the government owned holding company with a 59 billion Dollar debt mountain) will delay repayments due to spooking an illiquid market. The CDS spread on Dubai has ballooned 111BP on the news to 4.29% and sent stocks back basically flat for the day after their earlier perkiness. The last two US data release at 3pm have brought some solace to stocks. The University of Michigan Confidence index came in at 67.4 (beating expectations of a 67.0 read) and, more importantly, New Home Sales climbed to 430k units (up 6.2% month on month) easily beating Street estimates which had been looking for 404k. Stocks are back in the black on the news.

Today’s Market Moving Stories

  • The second reading of Q3 UK GDP was in line with the advanced estimate though the breakdown of the report showed that private consumption and investment were stronger than expected, whilst government spending was weaker than expected.
  • After Medley on Friday, now Bloomberg is running a story about ECB discussions concerning a variable 12m LTRO in December. The “Governing Council is leaning toward sticking with a fixed rate of 1%”. Moreover, the frequency of 3M (NYSE:MMM) and 6m LTROs is likely to be reduced to 1 per quarter. Can’t see them rocking the boat in December myself. Confidence in the banking system is brittle enough without creating an unnecessary year end panic.
  • European Central Bank President Jean-Claude Trichet said banks should strengthen their balance sheets and add profits to reserves instead of paying dividends. Trichet also called on European governments to cut their budget deficits.
  • Crude oil demand may not show a “big seasonal increase” this year because of warmer than average weather in the US and Europe and strong non-OECD consumption, disappointing “bulls” Morgan Stanley said. Incremental global demand for oil in the fourth quarter may be 700,000 barrels a day compared with an average 1.4 million barrels a day increase in third-to-fourth quarter consumption in 2000 to 2007.
  • A story in the local Indian press suggests India is set to buy more Gold following on from its big purchase three weeks ago. Gold remains bid and has traded up to a high of 1180.80 so far this morning and looks set to target $1200/oz.
  • China may increase banks’ reserve requirements next year rather than Interest Rates to strengthen liquidity management and so prevent asset bubbles, an opinion piece in the official China Securities Journal said. “Compared with the historical high of 17.5%, there is plenty of room to raise the requirement reserve ratio, which is now 13.5% – 15%”. It said the possibility of an increase in Chinese Interest Rates in the near term was very small.
  • Ba Shusong, a deputy director with the Development Research Centre, a think-tank under the State Council, said separately that the Central Bank would be relatively cautious in adjusting both Interest Rates and exchange rates for fear of attracting speculative capital inflows. The Central Bank would not raise required reserves until the economy was flashing very clear growth signals. These included GDP growth above 9% and a return to consumer price inflation.
  • Bernanke mentioned the dollar the other day and Tuesday’s FOMC minutes had more to say, reporting that, “participants noted that the recent fall in the foreign exchange value of the dollar had been orderly and appeared to reflect an unwinding of safe-haven demand in light of the recovery in financial market conditions this year, but that any tendency for dollar depreciation to intensify or to put significant upward pressure on inflation would bear close watching”. This means that a gradual slide in the USD is OK by the Fed, but a rapid slide is not. Now that’s a tricky balancing act to pull off.

The US FDIC Is Broke
I’m not sure how one should feel when the bail-out fund of the world’s largest economy closely represents a Norwegian Blue – is off the twig, has joined the bleedin’ choir invisible and ceased to be. I guess you feel nothing, as it’s all going to be a fudge anyway. Still, as of Q3 data released yesterday the FDIC is in the red to the tune of $8.2 billion. It has increased the list of problem banks in the US to 552 from 416 in June. We know that living banks in the US (obviously with a huge skew towards the big banks) have been strong-armed into prepaying $45 billion worth of fees to recapitalise the FDIC and yet seemingly we are unfussed by the impact on earnings from this – I guess the fudge will extend to how the banks will have to account for bailing out the bail out fund.

Demographics – No Longer “Married with Children”
Over the course of the downturn there have been many questions about how demographic trends such as household formation, interstate mobility and immigration can positively or negatively impact the demand for housing. Many of these questions are difficult to answer, either from lack of data or complicating factors. However, the household formation question was partially addressed in July as the Census Bureau reported that new households grew by only 772K from March 2007 to March 2008 compared to an increase of 1.6 million the year prior. Assuming a 65% homeownership rate, that implies about 500K potential buyers as a result of household formations – or less than 10% of the current sales pace. And that was mostly in 2007.

On Wednesday, the Pew Research Center released a report on related data: the percentage of grown children moving back in with their parents, as well as other demographic household decisions. The data suggest that there is some household destruction occurring as families re-combine, leading to weakening demand for housing. Not only that, but the report shows that traditional decisions that boost housing demand, e.g. marriage and/or children, have been postponed due to economic reasons.

An optimist might say that today’s household destruction is tomorrow’s pent-up demand. But if you’re going to follow this line of reasoning, don’t forget to factor in the pent-up supply. Not to mention vacant homes held off the market but really for sale (primary, second and investor properties), and owners who want to sell to rent but have held off on doing so as prices decline (retirees).

Company News

  • Barclays initiated Wolters Kluwer, WPP (NYSE:WPP), ITV, Yell, Daily Mail, Aegis, Mediaset, ProSiebenSat.1 at Overweight, Reed Elsevier (RUK), Havas at Equalweight, Pearson (NYSE:PSO), PagesJaunes at Underweight; Credit Suisse cut Saipem, SBM Offshore to Underperform; ING upped Boskalis, Smit Internationale to Buy, from Hold.
  • Publishers of the Denver Post and the Dallas Morning News may pull some of their stories from Google’s (NASDAQ:GOOG) news site, a move that would emulate News Corp’s (NASDAQ:NWS) Rupert Murdoch. News Corp is considering blocking Google’s search engine from displaying its news articles and is talking to Microsoft (NASDAQ:MSFT) about displaying stories on its Bing site. Rupert Murdoch vs. Google.
  • Rentokil (OTCPK:RTOKY) is thinking about selling its Citylink subsidiary. Given that it is currently lossmaking I think that i) they would have difficulty finding a buyer and ii) would be reluctant to sell the business before it had been restored to profitability given they would be likely to obtain a much higher price. In the unlikely event that this is true it would be a credit positive given Citylink has been the source of many of the Group’s problems over the last couple of years.
  • UK press reports have resurrected speculation of a takeover bid for International Power (IPR), with GDF Suez (GDFZY.PK) said to be sounding out the French Government about making a potential £4 a share/£6 billion cash bid for them, while Warren Buffet is also reported to be interested.
  • Greencore’s (OTCPK:GNCGY) adjusted EPS out-turn for FY 2009 of 17.4c was 1c ahead of mid-year guidance. It was unchanged year-on-year in constant currency but down 14.3% on a reported basis. The group has made a good start to the year with a continuation of an improving performance in UK convenience foods and progress in the US offsetting a weaker performance in malt and higher finance costs. Greencore says that it is on track to deliver modest earnings growth in FY 2010. The key impediment to share price appreciation remains the 29.9% stake held by two banks though.
  • Ryanair (NASDAQ:RYAAY) has announced its 37th base – another example of driving growth through the recession and building a very strong pan-European franchise. The base, at Oslo Rygge, 60km from Oslo, is Ryanair’s second in Scandinavia and involves the launching of 16 new routes (22 in total) with three based aircraft. With the stock up a mere 3.6% from its March index lows (compared with 76% for BA), more certainty seems to be needed on growth and returns before the market gives then due credit. This starts with the Boeing (NYSE:BA) deal, with a likely announcement of a deal or no deal to happen sometime in December.

And Finally… The Dollar Bubble

Disclosures: None