Preview from Europe: Treading Water Ahead of the Congressional Vote

by: The Mole

US stocks rebounded from their lows to record modest gains after news on ‘fiscal stimulus’. In short, the US House and Senate versions of fiscal stimulus plans have been reconciled into a single $789bn stimulus plan – one third tax cuts, two-thirds spending. We are led to expect votes today in the House and this evening for the Senate. However, given the price performance of government bonds this morning (they are bid to boots), I’d say the risk aversion trade is back with a bang and this spells trouble for equities. Much more on that below.

Overnight Market Moving Stories

  • The Nikkei, having been closed yesterday, played catch up overnight (down 3%) with financials the main drag. Japanese wholesale inflation numbers dipped into negative territory for the first time in 5 years, raising the very real prospects of a new bout of the dreaded deflation.
  • Meanwhile, South Korea’s central bank docked another ½% off rates to bring them down to 2%
  • The UK press, taking a breather from ‘Reykjavik-on-Thames’ and banker-bashing, is beginning to focus more on the potential cost of ‘toxic assets’ and bailouts. The Telegraph comments on a secret 17-page document discussed by finance ministers, which warns of the dire impact on public finances of bank bailouts
  • Thumbs down for Australia’s stimulus package

Irish Government Bank Guarantee Scheme
The Irish government is considering extending its guarantee scheme. Currently, most of the debt of the Irish banks is guaranteed until end-September 2010 which means that the Irish banks can currently only issue up to that day (i.e. max maturity is at the moment less than 20 months and continues to shrink). As part of its six month review (to be completed by mid-April 2009), the Irish government will examine how the scheme can be improved, including supporting longer-term bond issuance by the covered institutions.

They emphasised that the amended system would be in line with international and EU trends where the average term of state cover for bond issues extends beyond 2010. Denmark - which has a similar scheme to the Irish – has already said that it will change its system. We said from the beginning that the Danish and the Irish system is not a long-term solution for the banks and that both schemes have to be adjusted sooner rather than later. The Irish review is good news as it reduces the (refinancing) pressure on the Irish banks, but shouldn’t be any surprise to the market.

More Thoughts On The US Bailouts & Stimulus
The standard logic in terms of the policy response has been that size matters. It is not only important to take the right steps, but they must also be big steps. The “shock and awe” policy approach has had some success, but typically fleeting in terms of its impact on market sentiment. Yet increasingly, the scale of the response is not proving sufficient to placate markets.

Thus, a US package which had sums of potentially $2 trn in play, failed to deliver any fillip to the market. Instead, the focus fell squarely on the lack of detail, specifically the absence of any indications about how the purchases of the toxic assets would be conducted. How will the balance be struck between protecting taxpayers (by setting a low price for these toxic assets) and actually helping the banks (by paying a higher price for these assets)? Policymakers will argue these details will be hammered out over time, but meanwhile the economic and financial black hole is deepening. For the markets this means risk aversion will likely remain elevated, with attendant support for both bonds and the USD and JPY.

The lovely Meredith Whitney thinks it’s a waste of time.

UK Quantative Easing
The BoE is taking the lead in the race to implementing unconventional monetary easing. It is willing and (nearly) ready to buy gilts if necessary to stimulate the economy, and could start as early as next month.

The Bank’s EUR50bn asset purchase facility will be operational from tomorrow, and while the size of the plan looks miniscule this figure has scope to increase if the scheme proves to be effective. In contrast, the US is rather reserved on the idea of purchasing Treasuries, and with good reason, given the sheer size required for an effective operation. Credit easing, rather than quantitative easing, is clearly at the forefront of the US authorities' minds. Geithner’s comments suggested they are not in a position to give the green light yet. With the BoE ready to take super-easy monetary action, I think it should be one-way traffic for front-end gilts. It should also put a bit of a base under the pound sterling as one of the issues undermining the currency had be the justifiable fear that foreign investors wouldn’t underwrite the massive amount of issuance planned.

Equity News

  • The Short View in yesterday’s Financial Times drew attention to the 6% average annual real return on US equities since 1900, but noted that this gain had mostly flowed from reinvested dividends rather than price appreciation!
  • British Land (OTCPK:BTLCY) is doing a rights issue at 225p in order to raise (they hope) £740m.
  • Diageo (NYSE:DEO) has, not unexpectedly, cut its full year profit forecast but came in with first half 2008 numbers that beat market estimates.
  • Today’s earnings misses came from BT (NYSE:BT) and France’s Renault and power generating giant EDF while oil company Total surprised on the upside. However, oil companies are under pressure this morning after the sharp fall in US crude futures prices Wednesday.
  • UK bookmaker William Hill is considering a rights issue & sliming down their Irish operations. Irish stocks snippets this AM feature BoI who have cut their outlook for the 2nd half of the fiscal year. They now project a loss and have also increased their 3 year bad loan provisions to Eur 4.5bn (from Eur 3.8bn previously).
  • Moody’s Investor Services, the US rating agency, has said that Ireland & Spain are the 2 countries MOST vulnerable to losing their coveted triple A rating (out of the 18 countries who currently hold the top credit rating).
  • Greencore’s (OTCPK:GNCGY) trading statement this morning is somber but realistic. It recognizes the challenges from a weak pound, softening demand for convenience foods and more restructuring costs. Brokers are whispering about a possible cut in the dividend.

Data And Earnings
Today’s data highlights include US retail sales (estimated –0.8%); weekly jobless claims (estimated 610k) both at 13.30 GMT; business inventories (estimated -0.9%) at 15.00 GMT.

Earnings are from Coca-Cola (NYSE:KO) (EPS estimated $0.61), Aetna (NYSE:AET) (estimated $0.94) and Marriott (NYSE:MAR) (estimated $0.40) and Viacom (NYSE:VIA) (estimated $0.80).

And Finally … It’s A W(rap)

Disclosure: None