Many clients have found me lately to be highly optimistic in the latest Thaler's Corners, between my tactical bias in favour of equities (2900 on the EuroStoxx?) and negative bias on the Bund (127/126.50?), my optimistic view of European construction and my suggestion that US home prices may have finally hit bottom, with all the many caveats relating to this last point, used largely to highlight "Animal Spirits".
I would therefore like to take advantage of today's Thaler's Corner to point out that we are maintaining our long-term macro biases that we have held since June 2007.
Our attempts to identify currents that run contrary to these biases do not make them any less valid. It is just that the constraints of asset management (or trading) make it very hard for our clients to pass up over 10% valuations shifts on stock market indices or 30-bps shifts in 10-year bond yields without getting into the action. Moreover, we give particularly importance to the dynamics of capital flows and to technical considerations. Yesterday's example of the refusal of the 2800 obstacle on the 200-day average EuroStoxx was also impressive.
A number of Japanese statistics were released last night that put a cruel light on the country's heavy macroeconomic trends and which may be a bitter harbinger of things to come in Europe.
· Core CPI declined by another 1.2% y-o-y in June. Consumer prices in Tokyo dropped another 0.3% in July, after -0.2% in June. All this shows that Japan remains stuck in its Deflationist trap, despite 0% interest rates, a QE, recurring budget deficits and a debt/GDP ratio of 200%. Ah, if only the simple recognition of this situation were enough to convince the Austrian Ostriches to pull their heads out of the sand…
· Unemployment has climbed to 5.3%, vs. an expected 5.1%, with an extra 70,000 individuals out of work, breaking total jobless to 3.47 million. The ratio of job offers to job seekers is stuck at a recession level 0.52. That's better than the 0.40 in August 2009, but it was above 1 in 2006 and 2007, when unemployment was at 3.60%.
· Industrial production, which was expected to climb 0.2%, declined 1.5% in June, which is consistent with the slowdown in China and the end of subsidies to the auto market in September.
· Household spending grew 0.50% in June in real terms, but declined in nominal terms by 0.3%, providing a real life situation of deflation in which a gain in retail prices is converted into a loss.
In the graph below I have illustrated the lost decade (which is now at 13 years and far from over) vis-à-vis Core CPI and the active population in Japan.
We can clearly see the break of 1997 with the Asian crisis and the deflation created by the steep currency devaluations by Japan's neighbours, the Asian Tigers.
Despite the 55% contraction in the Nikkei from its peak of 38,900 at the end of 1989 (9,537 today), prices grew regularly at an annual 1.7% during 1986-1997, and although unemployment climbed to about 4% from 2.2%, the active population regularly grew by 1.1% each year.
In contrast, since 1997, prices have only declined by an annual 0.50%, while the active population, despite a small surge during the credit bubble years (2003-2007), has also been contracting by 0.50% per annum.
Deflation and unemployment
The machine is slowly grinding down…
Those who were surprised at the strength of the shifts on 10-year bonds yields in America and Europe in recent months should check out the following.
In 1997, 10-year yields were about 2.5% versus barely over 1% today.
The Nikkei stood at 19,000, versus 9,700 today.
If you had invested €1 million in government bonds in 1997, your investment would be worth €1,380,000 today.
If you had made the same investment in equities; well, I'll let you figure it out.
Asset allocation biases and advised option strategies (no change)
· The long-term macro biases remain downward on eurozone government yields and negative on risky assets (equities, European real estate, commodities) and a deflation/depression scenario, which will require much more effort by the ECB than a shame-faced QE.
· Our short-term biases: a tactical rebound of about 10% on Eurostoxx indices (2900?), accompanied by a narrowing of sovereign debt spreads, resulting in a 2-point decline on the Bund (127-126.50).
Disclosure: Long 20 years OAT and 30 years BTP Zero Coupons, EDF Corp 5 Years 4.5%, Grece 2 Y and 10 Y bonds, Long Eurostoxx50 ETF