Equity markets are looking “dodgy”

A member of the Chinese Central Bank, Mr Song Guoquing, reports that Chinese 3rd Q GDP could decline to just +7.4% YoY, down from the +7.6% YoY in the 3 months to end June, the 6th consecutive decline. He added that the decline in GDP could be greater “if Beijing is not decisive enough in unwinding some outdated tightening measures and carrying out effective stimulus”. In addition, CPI inflation could turn negative for a “short period”, from June’s +2.1% YoY. Mr Song stated that “deflation is already a fact for the corporate world”. The increase in food prices (though, fortunately not rice) and oil could well increase inflation in coming months though.

Further cuts in RRR’s are very likely, together with a further decline in interest rates. Informed sources report that the last interest rate cut in China was demanded by the State Council (the guys who run China), rather than by the PBOC.

The only bit of good news is that sales of residential property sales are picking up, as are prices.

Yes, the Chinese are leaving it late, but they will introduce additional stimulus measures, though it is unlikely to be 1 headline grabbing major stimulus programme;

The situation in Russia, so far (mistakenly) ignored by many, is deteriorating. Putin is increasingly relying on strong arm tactics, though they are unlikely to work – indeed they will encourage more protests. Vested interests in the country are using the sense of insecurity to “rape and pillage” even more. Capital flight, as is the case in China, is rising materially. Will Putin survive his full term. Unless the global economy picks up in the next year or so, its certainly going to be a question on every ones lips;

The ECB, for the 2nd time this year, has refused to accept Greek debt, guaranteed by the government as collateral for its funding operations “for the time being”. The move adds to the pressure on the Greek authorities ahead of the visit by the Troika – no prizes for their conclusions. It is clear that the ECB wants to protect itself from a further (inevitable) Greek default and, in addition, the move increases pressure on the Greeks to start performing – some hope. As a result, Greek banks will be forced to access funding from their Central Bank, through the emergency liquidity assistance (“ELA”) arrangements. At present, Greek banks are borrowing E62bn from their Central Bank, which could increase by a further E50bn, following the ECB’s move. Greece is to repay E3.1bn to the ECB on the 20th August. It is going to be interesting to see how they make that payment, as EZ finance ministers will not decide on the next Greek bail out payment until September. They still hold a lot of gold reserves as I recall. The chances of a Grexit are well over 90%+, sometime in the 1st half of 2013, most likely. The only reason that Greece are still in the Euro is, I suspect, Mrs Merkel’s current fear that Grexit will result in contagion in the EZ. However, in due course………;

Yet more woes from Spain. The 10 year bond yield rose to a near record high of 7.28% on Friday. A disappointing Spanish bond auction and Valencia’s request for emergency aid, combined with a lowering of economic growth targets (still too optimistic), were the main reasons. A number of semi autonomous states are going to request aid as well.

Details of the bank bail out funds for Spain have emerged. The Spanish government will be forced to guarantee the debt – remember the end June statement by the Spanish PM that he had won a covenant lite deal on accessing bail out funds for Spain !!!!. What a joke. As a result, Spanish debt to GDP will rise to over 90% this year and will climb further next. However, I believe, quite firmly, that in due course, the EFSF/ESM will inject funds directly into Spanish banks, which will not increase Spain’s debt to GDP by the 10% points it would do otherwise.

A review of Spanish banks, ahead of a receiving bail out funds is going to reveal yet more black holes. I think that the possibility of a Spanish sovereign default is getting close to 50% at present and rising inexorably. I just cannot see how they are going to service the accumulated debt whilst trying to stabilise their economy. As a result, the possibility of Spain requiring a formal bail out is a near certainty. However, remember that the ESM will not be in place until the (12th September) decision of the German Constitutional Court is known – likely to allow the German President to sign off on the legislation approved by the German parliament. Yes the EFSF can cope in the interim, but……;

John Mauldin has written yet another a great note titled “lion in the grass” – you should read it. He makes all the sensible points which have been ignored by the political elite in the EZ. However, he also questions, in effect, the viability of France. He is totally right to do so. Mr Hollande’s recent policies are economic killers for France, which was already facing serious financial and economic headwinds. However, the weakness of France is a major reason that I believe that France will be forced to agree to the German demand for political union in the EZ;

Analysts continue to reduce US 2nd Q GDP forecasts. Whilst initial forecasts were nonsensical, the speed and the rate of downward revisions is frightening. Below +1.5% (+1.4%) seems to be the current consensus. Mr Bernke did not state that the FED would introduce further stimulus measures, but he outlined a number of possibilities – personally, I believe that the FED will be forced to act, quite possibly in September. However, cries from US politicians for the FED to act, because they are failing to do so, is simply amazing – why are they there;

It seems that the refusal by Mr Romney to release more than 1 year (a tradition of most Presidential candidates) of his tax returns will come back to haunt him. Even the conservative National Review reports that his refusal to do so is “unsustainable”. The FT speculates that one of the main reasons is that his retirement account, his IRA, is valued between US$21mn and US$102mn. Given the amount of money that can be transferred annually to an IRA (US$2k in most cases) it is impossible for such a large amount to be accumulated in his IRA. The speculation is that the amount is due to the practice, allegedly by private equity participants, to make transfers to their IRA’s on the basis of their “immediate liquidation value” as opposed to fair value. Reports of Swiss and Cayman island bank accounts don’t help either. Mr Romney is yet to be confirmed as the Republican Presidential Candidate, a number of my US friends advise me !!!!. However, its not all positive for President Obama. A recent CBS/New York Times poll reported that confidence in President Obama’s handling of the US economy was waning nationally. (Source FT);

With the worse drought in 50 years in the US, food prices are soaring. Corn and soybean prices have risen to record highs. Wheat is up 50%. The US supplies nearly 50% of the world’s exports of corn, which will impact livestock prices and ethanol production. The USDA reduced its forecast for corn production by the most in 25 years. Fortunately rice, a stable for S E Asia, has not been impacted. However, higher food prices could well result in further social tension and higher inflation – the Middle East is vulnerable, in particular – dangerous;


Markets are increasingly nervous and I cant see any magic bullet in the near term.

I continue to believe that the Chinese will increase measures to stimulate their economy, though.

However, in Europe, its all on hold until the result of the German Constitutional Court’s decision (on 12th September) is known – the uncertainty created will be negative, even though I continue to believe that the Court will allow the German President to sign off on the agreements approved by the German Parliament (very bullish) and therefore enable the ESM and the fiscal compact to come into force. However, with the pressure on Spain, can and will markets wait till September? Whilst the former Spanish administration resorted to lying as a government policy, the current administration is totally incompetent and in denial until forced to accept the obvious facts – a pretty stupid way to govern a country. There is increasing talk of Spain and, for that matter, Italy leaving the EZ – personally I just cant see it, though I accept that social and political tensions are rising materially in both countries. But an Euro exit?. a number of analysts are talking about Mr Berlusconi returning – unlikely in my view – he should stick to his bunga, bunga parties.

US economic data continues to deteriorate, especially spending – a bad sign.

The Euro, well no surprise as it continues to decline further – currently below US$1.22 (US$1.2156) and I cant see any reason to buy it – indeed being short against the US$ remains sensible in my humble opinion.

Investors continue to buy the better (US, Japanese, German and UK) sovereign debt, though at these levels looks total madness. However, in the short term, yields are likely to decline even further.

Short term, equity markets are looking fragile or “dodgy” as we would say over here in the UK.

May I take this opportunity of expressing my heart felt condolences to those affected by the shooting incident in Aurora, Colorado. Inexplicable. I note that Mayor Michael Bloomberg has called for both President Obama and Mr Romney to announce specific plans to curb gun related violence in the US, though in an election year stricter laws are unlikely.

Kiron Sarkar

22nd July 2012

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