2013 issue 23
Winter Crosscurrents
Just shy of the new year, financial markets continue to be dominated by the extent of monetary accommodation. Especially in major advanced economies, bonds and stocks have shrugged off the summer sell-off and posted gains on the view that low policy rates and large-scale asset purchases would persist longer. Accordingly, markets took in stride a two-week US government shutdown and uncertainty over a US technical default. By contrast, a wide range of country-specific strains weighed on several large emerging market economies, preventing a full recovery of local asset valuations and capital flows. Much attention has been given to the hope of a strengthening in the U.S. economy. Key elements include an very slowly improving labor market and amazing moves in asset markets. Real estate values and equity market valuations have bolstered both business and household wealth -- and the outlook for spending in 2014. The perceived postponement of Fed tapering gave rise to significant gains in global bond and equity markets. Indeed, some have questioned whether the recovery in home prices in some areas has moved too quickly. Any move to normalcy, however gradual, will test markets. The dreaded tapering will remain a key focus of markets As the accommodative monetary policy stance persisted in all major currency areas, so did investors desperate search for yield. The unnatural easing stance, though necessary, spurred an aberrant demand for assets in the riskier end of the spectrum. By and large, such assets have so far lived up to their promise. The new year may again challenge that assumption.
US industrial production jumped 1.1% in November, the greatest gain in 12 months. The November reading was up 3.2% year-over-year. Utility output increased 3.9 percent after declining 0.3 percent in October. Falling temperatures prompted Americans to adjust their thermostats last month, the Fed said.
EURO currency at growth-crushing levels Fedtaperconcernboostsdollar,weighonstocks Willitburstbondbubbleanddampenmortgagefinance? Bracing for bumpy ride in emerging markets Some apparel Retailers:highenddoingwell,lowendcautious
The European Central Bank issued a stark warning over the threat posed by the scaling back of US monetary stimulus, calling on eurozone policy makers to do more to prepare for the market shocks from Federal Reserve tapering.
Europe faces moment of truth on banks, with flawed defenses
U.S. car sales rose 9% in November from a year earlier, aided by promotions
The year is not ending on a high note in the small business sector of the economy. The bifurcation continues, the Fortune 500 are performing well with the stock market hitting record high levels. But the small business sector is showing little growth beyond that driven by population growth.
Brazil reported its third quarter GDP contracted 0.5% from the second quarter. More alarmingly, Brazils 10 year yield shot up and its spread over the U.S. Treasury is now at the highest level since the summer of 2009
Budget negotiators reach deal could restore some order to the nations chaotic budget process and avoid another government shutdown on January 15
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In This Issue
Winter Crosscurrents
Just shy of the new year, financial markets continue to be dominated by the extent of monetary accommodation. . Especially in major advanced economies, bonds and stocks have shrugged off the summer sell-off and posted gains on the view that low policy rates and large-scale asset purchases would persist longer. Accordingly, markets took in stride a twoweek US government shutdown and uncertainty over a US technical default. By contrast, a wide range of country-specific strains weighed on several large emerging market economies, preventing a full recovery of local asset valuations and capital flows. Much attention has been given to the hope of a strengthening in the U.S. economy. Key elements include an very slowly improving labor market and amazing moves in asset markets. Real estate values and equity market valuations have bolstered both business and household wealth -- and the outlook for spending in 2014. The perceived postponement of Fed tapering gave rise to significant gains in global bond and equity markets. Indeed, some have questioned whether the recovery in home prices in some areas has moved too quickly. Any move to normalcy, however gradual, will test markets. The dreaded tapering will remain a key focus of markets As the accommodative monetary policy stance persisted in all major currency areas, so did investors desperate search for yield. The unnatural easing stance, though necessary, spurred an aberrant demand for assets in the riskier end of the spectrum. By and large, such assets have so far lived up to their promise. The new year may again challenge that assumption. (pg 1)
Data Detective The Return to Normal You Cant Handle the Truth The Likelihood of Unlikely Events... Dislocation Households Some Job Specs Credit Credit Credit Matters The New Geography of Business Deal or No Deal in Europe Pumping iron The DNA of Business Real Estate and Construction More Construction Will Life Ever be the Same?
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Easy money and the timing of the Feds shift continues to dominate across the globe. Repercussions from various political stalemates and serious geopolitical concerns are aggravating the problems of clearly insufficient growth in the world economy. And lets not forget that many of the challenges cannot be resolved easily (pg 4)
Contact information:
Abraham Gulkowitz
phone: 917-402-9039
email:abe@gulkowitz.com
Headlines and data appearing in The Punch Line came from widely available publications including national and international newspapers, trade journals, economic and industrial bulletins and news websites.
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Engine Drivers
China's rich starting to flee the countrywith their fortunes
US and EU demand boosts China trade
Exports rise faster than expected in November New wealth taking art market to new heights
Was November's Upbeat Jobs Report Enough to Push the Fed to Taper?
U.S. Economy Grew Faster Than Expected 3.6% in Q3 The US economy grew at an annual rate of 3.6 percent in the third quarter, significantly more than initially estimated, the Commerce Department reported
German consumer confidence at 6-year high Germanys two major parties reached the longwaited deal to form a grand coalition government.
At its November meeting, Thailands central bank unexpectedly decided to lower its benchmark interest rate, the policy rate, by 25 basis points to 2.25%, noting that the economy was growing at a slower pace than previously assessed and that downside risks to growth were greater than at the October meeting of the Monetary Policy Committee. The policy rate had been unchanged since July.
US growth for the past four years has been startstop and subpar. Persistently high global oil prices, a credit system that was deleveraging, slow global economic growth and a moribund housing sector undermined growth and caused performance to disappoint. However, budget battles, a recent government shutdown and political gridlock may have diverted attention away from the fact that the fundamentals of the US economy are quietly strengthening. Key elements include an improving labor market that should boost consumer confidence and steadily higher equity market valuations that could increase both business and household wealth and therefore spending.
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Growing EU Risks:
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HOUSING BUBBLES frothiness, if not outright bubbles, are reappearing in housing markets in Switzerland, Sweden, Norway, Finland, France, Germany, Canada, Australia, New Zealand, and, back for an encore, the UK (well, London). In emerging markets, bubbles are appearing in Hong Kong, Singapore, China, and Israel, and in major urban centers in Turkey, India, Indonesia, and Brazil. U.K. Mortgage Approvals Near 6-Year High; House Price Growth Accelerates U.K. mortgage approvals increased to the highest level since February 2008 as banks lend more to housing, siphoning away funds from lending to businesses, given the strong confidence in the property market on the back of government scheme. Moreover, house prices registered the strongest growth since July 2010, flagging fears of a housing bubble.
China companies borrowing costs are rising as money-market interest rates increase amid the central banks efforts to rein in credit growth. The seven-day repurchase rate, a gauge of funding availability in the banking system averaged 4.54 percent in November, up from an average 3.57 percent in May.
Chinese shares fell for a four consecutive day on Friday amid growing speculation the government may cut its 2014 economic growth target to 7% from 7.5%. The benchmark Shanghai Composite Index fell 0.3%, extending its weekly loss to 1.8%. Investors are concerned about uncertainties regarding government future direction as the countrys policy makers seem to struggle between growth and reform agendas.
China manufacturing growth eases in December, prompts job cuts and lower prices
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Global QE led to hot money flows into some emerging economies - - with loose financial conditions, higher wages and widening BoP deficits the result
Natural Disasters in Asia
Typhoon Haiyan (called Yolanda in the Philippines) follows a series of natural disasters in Asia, especially Japan's 2011 earthquake and tsunami, Thailand's 2011 severe flooding and the 2004 South Asian tsunami. All these experiences demonstrate that cleaning up after a massive natural disaster spread over a large geographic area takes time -- even in well prepared, wealthy countries such as Japan. The disaster also highlights risks to supply chains in the region and heightened concerns over physical security of both people and investments.
Fragile Five
Forget the BRICS: what's really concerning investors now are the "Fragile Five". The spectre of "global contagion" from Brazil, Indonesia, India, Turkey and South Africa is looming, As the cost of employing workers in these countries has risen, there has been less investment from foreign companies, fewer exports and slower economic growth. This has hit those countries' balance of payments which measures the balance of a country's transactions with the rest of the world. If a country's exports, including financial transactions, are less than its imports it runs a current account deficit. Coupled with relatively weak economic growth in the Fragile Five, these current account deficits are causing alarm among investors.
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Buying a home hasnt gotten any easier for Spaniards, even after home prices tumbled as much as 40 percent. Rising borrowing costs, currently more than one-and-a-half times the cost in Germany, the end of mortgage tax breaks, and shrinking disposable incomes are making it increasingly difficult for Spanish families to own their own home. Fewer than 15,000 mortgages were granted in September compared with about 129,000 at the September 2005 peak, according to the National Statistics Institute. Spanish homeownership -- at 83 percent the third-highest among countries that share the euro after Slovakia and Estonia - - is under assault as the nations banks and government threaten to delay a real estate recovery. The collapse of a decade-long property boom, when mortgage lending surged almost four-fold, pushed Spains economy into a five-year slump and forced banks to take impairment charges of 87 billion euros ($118 billion) last year to help clean up soured assets linked to real estate. The average rate on a new mortgage with a term of more than 10 years was 5.19 percent in October even as 12month Euribor, the benchmark used to price most Spanish home loans, has dropped as low as 0.51 percent, according to data compiled by the Bank of Spain. That compares with a mortgage rate of 5.84 percent in 2008, when 12-month Euribor was as high as 5.38 percent. The same mortgage in Germany would cost 3.14 percent, 3.19 percent in France and 4.77 percent in Italy, according to the European Central Bank.
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Health Care Costs become increasing burden for Americans Massive sign-up for Medicaid... If that trend continues, it could bankrupt both federal and state governments. Medicaid is already Americas third-largest government program, trailing only Social Security and Medicare, as a proportion of the federal budget.
Suggesting that the holiday shopping season began on an upbeat note, the Commerce Department released a report on Thursday showing that U.S. retail sales rose by slightly more than expected in the month of November. The report said retail sales rose by 0.7 percent in November following an upwardly revised increase of 0.6 percent in October.
HolidaySalesSagDespiteBlitzofDeals
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Credit Directions
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VolckerRulereceivesallnecessaryapprovals
CMBS issuance at highest since crisis Borrowers refinancing loans at ultra-low interest rates
AAA:gradedeflation Inahuntforyield,ratingsbecomeirrelevant EQUITY MARKETS BUBBLE UP While the recent surge lacked many aspects of a bubble there is no single industry that has captured investors' imaginationthe rally smacked of a rush to buy almost any stock to compensate for the Federal Reserve keeping interest rates so low. The 27% gain in the S&P 500 in 2013 has come even though revenue growth is seen at a little under 2% and earnings growth at 5% for the full year. Investors are simply willing to pay more for each dollar of earnings. There are more-traditional signs of froth, too. The latest Investors Intelligence poll of newsletter writers puts the percentage of bears at 14.4%, the lowest since 1987.
Borrowing money at bargain basement interest rates may seem now like a nice way to pad profits and share prices, but it may not be as much fun in a few years. Companies face three consecutive years where more than $1 trillion each will come due in the form of maturing bond issues that have been used during the free-wheeling, zero-interest days courtesy of the Federal Reserve. When that happens, corporations will have to choose between rolling over, or refinancing, debt at interest levels likely to be higher than the present day or using cash on their balance sheets to pay off their creditors.
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Surge in risk assets held by US banks Structured finance investments up 45% in third quarter
US banks accelerated their purchases of structured products in the third quarter of the year, pushing their holdings of the higher-yielding assets to record levels as they seek to offset continued profit pressure from ultra-low interest rates. Structured finance investments surged to $69bn in the three months to September, according to data released this week by the Federal Deposit Insurance Corporation a 45 per cent increase on the same period last year and the highest level since the FDIC began breaking the individual figure out in 2009. The FDICs definition of structured financial products covers a broad range of securitizations including collateralized loan obligations (CLOs), commercial mortgage-backed securities (CMBS) and collateralized debt obligations (CDOs). Banks have been snapping up such higher-yielding products to offset the effect of low interest rates on their bread-and-butter lending business, analysts have said.
The business development company has changed from Congress's original vision. Instead of investing in equity, the companies invest largely in the debt of private companies. Different companies specialize in different kinds of debt, but the mainstay has been mezzanine debt and collateralized loan obligations (pools of leveraged loans). This debt is often issued in connection with private equity buyouts and is of the riskier ilk
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Annually, GDP increased 2.2 percent in the third quarter, slower than second quarter's 3.3 percent growth.
Political turmoil in Ukraine has driven its CDS spreads to the widest levels in almost four years as the government resisted calls for it to step down. A no-confidence motion was defeated in parliament, meaning that the government survives to fight another day. But the protests that began a week ago prompted by the government walking away from a deal for closer integration with the EU -- show no sign of dissipating. Ukraines spreads are now trading at around 1,100bps, well over 500bps wider than where they quoted in the first quarter of this year Five-year credit default swaps on the countrys dollar debt rose 21 basis points (bps) to 1,119 bps today, the highest levels since January. The yield on Ukrainian sovereign dollar bonds due in 2014 climbed 75 bps to 10.15%. It has been reported that Ukraine needs at least $10 billion of external funding to avoid possible default.
Japans salaries extended the longest tumble since 2010, increasing pressure on household finances as inflation begins to take root.
China's state sector braces for creative destruction
The detailed policy document published after the Communist Party Central Committees Third Plenum (912 November) contains a raft of decisions that lend substance to the Xi Jinping leaderships pledge to deepen and accelerate economic and social reform. The Resolution on Certain Major Questions regarding Comprehensively Deepening Reform (hereafter Resolution) explicitly states Xis commitment to marketorientated economic reform and qualified social liberalisation. It contains an impressive range of policy proposals, which, if successfully implemented, will transform Chinas social and economic landscape.
Mexicos two biggest political parties are moving to open up the oil sector. Voted to to break the nations 75year oil monopoly by amending the constitution to allow production sharing contracts and licenses for outside producers.
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Swedish Housing Surges to Unsafe Value as Debt Soars Paris Office Market Wilts to 10-Year Low as Taxes Crimp Spending
Non-bank lenders step up UK funding deals Funding by alternative lenders, which allows companies to sidestep banks, has grown rapidly in the UK this year, according to a survey released on Tuesday that showed a rush of lending activity in the past few months. Since October last year, alternative non-bank lenders debt funds financed by institutional investors took part in 55 deals with mid-market UK companies, said the survey by Deloitte, the advisory group. Of those, 24 were in the three months to September this year. Ultra-low interest rates have left institutional investors chasing yield and as a result the European leveraged finance mid-market is moving towards a US model, said Fenton Burgin, head of UK debt advisory at Deloitte.
Banks' Troubles Echo Across Italy
The financial woes of smaller Italian banks are leading to cuts in lending that are hammering businesses, while communities contend with lost jobs and reduced charitable donations.
Ireland has endured a torrid few years since the onset of the financial crisis, but it took a major step toward stability today. The government confirmed that it would exit the EU/IMF bailout on Sunday, making it the first peripheral country to emerge from an international rescue package. Whats more, it is making this important move without the safety net of a precautionary credit line from the European Stability Mechanism (ESM).
The Netherlands dropped out of the exclusive club of "AAA" rated countries after Standard and Poor's agency downgraded it to "AA+", citing weakening growth prospects. The surprising downgrade leaves only three remaining countries in the 17-nation eurozone with the coveted top rating from all three of the world's major agencies. S and P on Friday also upped Cyprus' long-term rating to a B- and improved Spain's BBB- negative outlook to stable.
The combination of relatively favorable market sentiment and gradual economic recoveries, supported by accommodative monetary and fiscal policies, should allow Central Europe (CE) to manage fallout from the US Federal Reserve's planned exit from its program of quantitative easing (QE). While a renewed flareup of the crisis in the euroarea remains a key risk, countryspecific vulnerabilities, particularly with regard to the cleanup of Slovenia's banks and the overhaul of Poland's privately managed pension system, are bigger concerns. Hungary's parliamentary elections in April could also prove to be a focal point for market anxiety
Several issues are becoming increasingly salient in Russian politics ahead of parliamentary and presidential votes in 2016 and 2018. They include presidential succession and the manoeuvring between rival camps; the strategic electoral choices made by the Kremlin and opposition forces, which will become evident in regional elections over the next year; and the Russian economic slowdown, which could have far-reaching consequences for the leadership.
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The U.S. oil boom will vault the country into first place among crude producers within two years, the International Energy Agency says, which will pose a stiff challenge for the Canadian energy industry as it faces rapidly declining American demand for imported oil.
Lumber prices are getting chopped after notching seven-month highs, as the market hunkers down for a seasonal decline in construction and expected higher production next year. But demand for U.S. boards and planks from China, Japan and the Caribbean to structure home interiors and to build shipping pallets and furniture is expected to keep the market from a deep slump. U.S. lumber exports overseas have grown sharply, rising 22% in the first nine months of this year from the same period a year ago, to 701 million board feet. China, which accounts for 35% of the U.S.'s offshore exports, increased its purchases in the same period by 67%.
The commodity slump that spurred bear markets in everything from gold to corn to sugar this year may still deepen
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Companies looking to put cash to work could boost the climate for deal-marking in 2014. Dow Chemical Co. said it is exploring a possible sale or spinoff of its commodity chemicals businesses, in a continuation of the company's push to refocus its efforts. The assets include about 40 manufacturing facilities at 11 sites and nearly 2,000 employees, accounting for up to $5 billion in annual revenue.
Televisions hold on advertising budgets is beginning to falter, with forecasts indicating its share of global advertising is to peak after three decades of growth. Television is expected to capture 40.2 per cent of the $532bn global ad market in 2013 before falling to 39.3 per cent of the total market in 2016, according to Publicis ZenithOptimedia. WPPs GroupM is also predicting that TVs share of the global advertising market will decrease slightly in the coming year. The transition is the result of digital media chipping away at televisions dominance amid broader upheaval in the industry. ZenithOptimedia forecasts that the internet will boost its share of the ad market from 20.6 per cent in 2013 to 26.6 per cent in 2016. Within that category, mobile advertising will grow by an average of 50 per cent a year between 2013 and 2016, contributing 36 per cent of extra ad spending. TV will account for 34 per cent of new ad spending, with newspapers and magazines declining by an average of 1 per cent and 2 per cent a year.
Steel Giants to Buy ThyssenKrupp's Alabama Plant US coal-fired power sector will decline, not disappear
The change in Senate filibuster rules last month is the latest sign that President Barack Obama's second-term agenda will flow from executivebranch regulations, rather than new legislation. One key plank of the White House's climate change plans is the Environmental Protection Agency's (EPA) proposed coal power plant regulations, released in September. This coincided with major US energy producers preparing changes to the resource mix of their electricity generation portfolios. For example, the Tennessee Valley Authority (TVA) announced in November that it will close eight coal-fired generation units -- representing nearly 20% of its total coal consumption -- and will ultimately drop its resource mix from 38% coal-based electricity to 20%. The change occurs against the backdrop of flat or falling electricity demand in regions within the United States.
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