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Thaler's Corner 15-07-09: And the supply chain?!

                        And the supply chain?!  15 July 2009
 
            This is one of the issues on which we have been working for some time now via the collection of microeconomic data to validate our macroeconomic scenario.
 
            Given the Minsky path taken by western economies since June 2007, Big Government measures have largely focused on the TBIFs (companies considered to be “too big to fail”), whether in the financial sector (insurance and banks), manufacturing (automobile) or via the direct injection of funds via exceptional lending.
 
            However, the microeconomic situation has become much more complicated for the suppliers of these giant companies, as testified by the relentless flow of Chapter 11 filings in the US, or those in Europe and Japan. In the US, 15 auto parts makers have already filed bankruptcy in 2009.
            Less visible than the major firms, suppliers like Lear (link on their Ch 11), TMD Friction, Acument, AutoCast (link for an exhaustive list in France – truly scary), are either filing bankruptcy or are making massive job cuts to reduce costs, thus, transmitting and magnifying the contraction in aggregate macroeconomic demand throughout the entire economic fabric.
 
            As such, it is easier to understand the recent exhortations by German leaders and ECB officials for banks to « do their job », i.e. start providing credit to needy businesses whose orderbooks remain desperately meagre and whose cash position is diminishing by the day.
 
            The President of the Association of German Exporters, the BGA Group, declared this morning:
            “I am pretty sure that they will do this...before the German economy will get massively into a credit crunch," Boerner said. "They must do this because if they don't do this we will see the effect [of a credit squeeze] at the end of the third quarter, with a drastic deterioration in 2010."! (link for readers of little faith).
 
            I know the ECB is not going to appreciate this, but it is worth noting how they stick to the softer sounding credit Squeeze, as opposed to “credit crunch”; After all, the German Finance and Economy Ministers have already declared that there is no credit crunch in Germany.
            We see the same PC verbiage in Portugal this morning, where the Bank of Portugal confirmed that negative inflation does not amount to deflation.
 
            If I continue to insist on the semantic aspect of these terms, it is because the refusal of officials to calls things by the real names helps them avoid taking the required measures to confront this crisis!
 
            It is worth noting the ECB feat this morning, which saw €162bn deposited in its overnight window at 0.25%, after lending €100bn at its 1% refi rate a week ago.
            But, as Yves Mersch said yesterday, “One has always to be mindful of the negative effects stemming from excessively low interest rates”.
            This makes perfect sense when real estate prices are rising at 10% per annum, but its seems equally questionable in the current context.
 
            The great Asian mystery still has us concerned.
            While China ‘s currency reserves have bloated and the country’s M2 money supply surge at a record 28.46% per annum, how is it that it Japanese neighbour is not gaining from this situation.
            As we suggested yesterday, the BoJ announced last night that it was extending its unconventional measures to prop up financial markets (CP and Corp Bonds) through 31/12/09, and left open the option of prolonging them further, if need be.
 
           Although it is possible to make a tactical bet on a lift in stock markets, as we suggested Monday with the 2400 July Eurostoxx calls bought on the cheap at €6 of premium, from the standpoint of strategic allocation, the unfolding of the present macroeconomic process continues to lead us to advise for a medium-term overweighting on government fixed interest rate bonds.
 
            I suggest you take a few minutes to consult the latest prose of PIMCO’s Paul Mc Culley (link) on central bank policy for the coming years.
            This is one of the best texts I have read in recent months. It is a far cry from the bond bubbles worries which so surprised us at the time (even if their timing on this issue was perfect).
 
 
  • Less Positive on interest rates on eurozone government debt(2- and 5-year segments), now with less potential as we crossed  our target of 1.25% on generic German debt. Unfortunately, hitting our goal of 1% would imply other dislocations which we hope will not occur.
     We advise clients to begin shifting to longer durations in bull flattening positions.
 
  • Neutral to negative on stock market indices, but virtually all options positions have been cleaned out (expiry too close). We are studying with our clients the opportunity of re-establishing portfolio fund hedging strategies on August options.
 
  • Still Negative euro against the dollar.
Erwan Mahé
Asset allocation and option strategy