Bad EZ and Chinese PMI data

HSBC Markit reported that it’s flash estimate of May Chinese PMI came in at 48.7, as compared with a final reading of 49.3 in April, the 7th consecutive number below 50. The decline reflected a weakening export sector, especially for new orders, though new orders in respect of the domestic economy also declined. The Chinese authorities “must proactively take policies and measures to expand demand and to create a favourable policy environment for stable and relatively fast economic growth” according to the State Council. The worse than expected news weighed on Asian markets;

The number of Chinese nationals seeking to exit China is increasing, as is capital flight. This issue is highly important, as wealth is ever so concentrated. The FT reports that applications for the US investment programme, in exchange for a green card, have surged from 772 in 2010, to 2408 last year and account for 70% of all applications. YTD, the US has received some 1675 applications. I continue to believe that capital flight will increase materially, with a consequential impact on the value of the Yuan, something which the market does not seem to be focusing on. In addition, if the Chinese authorities are forced to liquidate their holdings of US Treasuries to meet demand for US$, when inflows are weakening……. (Source FT);

Russia has removed 3 energy companies, together with the power grids FSK and MRSK and the hydroelectric company Rushydro from its proposed privatisation programme – seen as a win for Mr Igor Sechin, the recently deposed Minister, who has been against privatisations – seems that he has retained his influence.
The WSJ quotes a report by the influential Russian Think Tank, the Centre for Strategic Studies. The report suggests that popular support for Putin continues to decline – now below 50%. Will Putin survive his full 6 year term – a question that is now being asked !!!!;

Greece is using the ELA to the tune of E100bn, much to the annoyance of the Bundesbank. The Bundesbank warned of “considerable risks” and that use of the facility should not increase – too true, Mr Weidmann/Bundesbank;

As expected, no decisions were taken at yesterdays EU Heads of State Summit – the 18th meeting since the crisis began. However, Euro Zone project bonds (by the EIB) and an increase in the capital of the EIB were discussed and are likely to be implemented. The big issue relating to Euro Bonds (pushed by Hollande) was firmly parked away, by Mrs Merkel. The bureaucrats were given instructions to establish plans for further fiscal union (an EZ wide deposit insurance scheme and, in the longer term, Euro bonds) to be discussed at the next meeting in June. Having said that, the June meeting is likely to be yet another waste of time, unless deposit flight from peripheral banks continues (likely), or worse increases, in which case the EZ will be forced to act – they will have no alternative. The Heads of State reiterated their commitment to keep Greece in the Euro, subject to them sticking to their commitments, though are working on contingency plans, in the event of an exit.
There seems to be more support for an EZ wide deposit insurance scheme, as proposed by Mario Monti and, in addition, using the ESM to recapitalise banks directly.
Politicians focused on Mr Draghi at the ECB to take the necessary policy action to bail them out. At the end of the day, the ECB will be forced to act, including:
buying peripheral bonds;
a further LTRO programme – possible, but will it be effective – I doubt it;
reducing interest rates; and
embarking on a QE programme;
Cant see any alternative, but for the ECB to pull out all the stops (particularly on bad news re Greece) in spite of Draghi’s protestations;

Yet another corruption scandal in India – this time in respect of the Delhi International Airport. The Comptroller and Auditor General has reported that the Government gave up some US$29bn in potential revenues by awarding a long term lease at a bargain price.
Indian State owned companies increased petrol prices, the 1st time in 6 months – the market responded positively;

Spain is to fully nationalise Bankia, through the injection of approx E9bn into it’s parent company. However, Bankia has some E37.52bn of construction/property loans, of which E17.85 are considered problematic. Other mortgages and loans must also be problematical. The final bill for a rescue of Bankia, now the responsibility of the Spanish authorities, is going to much, much higher. Looks like Spain has not learnt from the Irish experience
Yesterday, Mr Rojoy called, in effect, for ECB purchases of their Sovereign bonds – fell on deaf years, though I believe that ECB will be forced into the Spanish (and Italian) markets in due course. Support by the EZ in respect of the Spanish banking sector is coming – Spain cant afford to bail out it’s banks. Mr Rojoy was hinting? at that yesterday – really can’t understand why he is waiting;

French flash manufacturing PMI came in at 44, sharply lower than April’s 46.9 and lower than the 47 expected – these are truly dreadful numbers.
Flash services PMI came in at 45.2, unchanged from April, though slightly weaker than the 45.7 forecast;

German May flash manufacturing PMI came in at 45.0, down from 46.2 in April and much lower than the 47.0 expected. However Services PMI was better at 52.2, unchanged from April. The composite PMI declined to 49.6 in May, from April’s 50.5.
The important German IFO business climate index declined to 106.9 in May, much weaker than the forecast of 109.4 and the lowest reading in 6 months. The current situations component fell 4.2 points to a 21 month low of 113.3. Expectations declined as well – they were down -1.8 points to 100.9. The IFO economist highlighted uncertainty relating to Greece and a new French President as a reason for the decline. However, he added that export expectations rose in May.
Should not have come up as a surprise and just proves that Germany is not immune either.
The PMI data suggests that EZ GDP could decline by -0.5% in the 2nd Q, according to Markit. The EZ composite PMI fell to 45.9 in May, from 46.7 in April;

1st Q UK GDP was revised lower to -0.3% Q/Q (-0.1% YoY), rather than the -0.2% previously reported. A significant reduction in construction (-4.8% in the 1st Q, more than double initial estimates) by the ONS’s suggested such a move which, as a result, should not have come as a surprise, but apparently is. Household consumption expenditure rose by just +0.1%, as compared with an increase of +0.4% in the previous Q and lower YoY. Inventories declined, which reduced GDO by +0.7%, which suggests that this is a temporary drag, which should reverse, improving GDP data, possibly considerably. Sterling is weakening on the news;

JPM state that regulators would suggest that it’s CIO is the banks largest risk are. In addition, in it’s latest regulatory fining JPM stated that the CIO would require US$74.9bn “to address regulatory capital requirements” if the unit “were operating independently”, almost the same as the banks capital requirements for its retail, corporate and investment banking operations. Wow;

Better US existing and new home sales data, which seems positive to me. Others disagree vociferously. However, with improving employment, record low mortgage rates, the incentive to buy (subject to getting financing, which I understand remains a problem) is overwhelming;

Outlook

Yesterdays rebound by US markets was certainly impressive – on expectations by US markets for some (positive) movement by the EU Heads of State meeting – clearly not delivered.

Asian markets closed mainly lower, though India is up near 2.0%.

European markets opened higher and continue to strengthen, in spite of bad EZ and Chinese PMI data. Very interesting.

The Euro is weaker, yet again – currently US$1.2580 – heading towards US$1.20 (or indeed weaker), I certainly think so. In addition, I continue to believe that the A$ (on a weaker China) and the Indian Rupee (on a worsening fiscal position) will decline further, against the US$.

Spot Brent is around US$106.65, with Gold at US$1554.

Personally, the downside risks outweigh the upside given the current data and the EU’s inability to act. However, I believe that the EU/EZ/ECB (ECB), in particular) will have to change it’s current policy, which, personally, I believe is a distinct possibility (particularly if there are further problems re Greece), as there will have no choice. In addition, if, for example, deposits continue to exit peripheral EZ banks (quite possible/likely), the game is up and the EZ/ECB will have to act, which suggests to little old me that the current German position is untenable. The resulting easing will be positive for markets, irrespective of Greece – personally, I hope Greece exits (I believe it will be market positive), though I fear that they will vote to stay in, which should ease market concerns – though for how long? A number of people are forecasting an exit of Portugal from the Euro – I could not disagree more. In my humble view, Portugal will get a 2nd bail out by September this year and will remain in the Euro.

I will continue to nibble away, buying a few stocks, though will remain relatively cashed up.

Interestingly spreads between French and German bonds are narrowing – markets believing that the EZ will have to move to cope with the crisis?

Kiron Sarkar

24th May 2012