Better German and French GDP data and US retail sales

BoJ minutes suggest that they are likely to introduce measures to increase monetary stimulus and to raise inflation (improbable) to their target 1.0%. Given the poor GDP data and continuing economic and fiscal problems, further monetary stimulus is likely;

Indian wholesale price inflation declined by more than expected in July to a 32 month low of +6.87% Y/Y (still the highest of the BRIC’s), lower than the 7.25% in June and expectations of +7.20%. The decline will increase speculation that the RBI will cut interest rates in September, though the RBI continues to warn that inflation levels remain too high. Analysts expect inflation to remain at these levels, though with higher oil and (poor monsoon, combined with global drought affected) food prices (both commodities representing a bigger component of the inflation basket), the risks remain to the upside, in my view. The Rupee weakened on the news. Analysts continue to reduce 2012/3 GDP growth;

Italian June public debt rises to 123% of GDP. June debt data reports that Italian debt rose to E1.973 tr, up from E1.966 tr. Worryingly, the 1st half 2012 budget deficit came in at E47.7bn, higher than the E46.6bn in the corresponding period in 2011, though mainly due to contributions to assist other EZ countries in a bail out programme – Italy’s contribution rose from E6.1bn in the 1st half of 2011 to E16.6bn in the 1st half of 2012. The forecast budget deficit of 1.7% for the current year will not be met – the economy minister Mr Grilli has admitted that. Some private sector reports suggest it will be closer to 2.4%. Italian GDP declined by -0.7% in Q2 or -2.5% Y/Y. The IMF recently reduced their debt sustainability percentage to 100%, from 120% previously. However, Italy has bumbled along with debts at these levels for years, most of which is held domestically;

Portuguese Q2 GDP Q/Q came in at -1.2%, worse than expectations of -0.7% and sharply weaker than the decline of -0.1% in Q1. Y/Y, the economy declined by -3.3%, worse than expectations of a decline of -3.0% and the -2.2% in Q1. Portugal will inevitably require a further bail out;

German Q2 GDP rose by +0.3% Q/Q, better than the +0.2% expected, though lower than the +0.5% in Q1. The economy benefited from growth in consumption and net exports, though both sectors will come under pressure this Q. Worryingly, investment declined. In addition, unemployment which has been at a 2 decade low of 6.8% looks as if it will edge up. In addition, recent data (PMI, for example) suggests that the economy will come under pressure in H2;

The German Constitutional Court has, as expected, reported that it will announce its decision on 12th September. There were rumours yesterday that the Court would delay it’s decision;

German August ZEW (investor) economic sentiment survey came in at -25.5, much worse than the -19.3 expected and the reading of -19.6 in July and the worst since December. The much worse than expected reading was a surprise, particularly given Draghi’s recent statement. In addition, it suggests weaker German 3rd Q GDP;

ZEW state that they expect the German economy to slow in H2, especially the export sector – personally, I would not be surprised if the economy contracts;

French Q2 GDP was unchanged Q/Q, slightly better than the decline of -0.1% expected. The French economy has flat lined for 3 consecutive Q’s. Government and (strangely) corporate spending helped to avoid a contraction, though, importantly, consumption declined. I remain deeply pessimistic in respect of the French economy, which Mr Hollande’s policies will make worse. PMI data, for example, suggests a deterioration in the Q3, which combined with lower government spending, will have a material negative impact, unless consumption rises, which looks unlikely. Furthermore, France has to reduce its budget deficit by E35bn in the budget to be announced in September to meet it’s targets – with no/declining growth, the impact on the French economy will be materially negative. July CPI came in at -0.4% M/M, in line with expectations. Y/Y, CPI came in at +1.9%, slightly lower than the 2.0% expected;

EZ Q2 GDP contracted by -0.2% as expected, as compared with a flat reading in Q1. Y/Y, the EZ contacted by -0.4%, in line with expectations and worse than the decline of -0.1% in Q1.

6 EZ countries (out of 17), at least, are in recession;

EZ June industrial production declined by -0.6%, slightly better than the -0.7% expected, and -0.6% in May. Y/Y industrial production was -2.1% lower, in line with expectations and better than the -2.8% in Q1;

UK July CPI rose unexpectedly to +2.6% Y/Y, higher than the +2.3% expected and +2.4% in June. On a M/M basis, CPI rose by +0.1%, sharply higher than the -0.4% in June. Airfares rose materially and clothing and footwear prices were higher than expected. The rise was the 1st since March. Cable picked up on the news, both against the Euro and even more against the US$, though is selling off at present;

Will the issue of the US “fiscal cliff” be resolved. MS suggests that the problem could reduce US GDP by 500bps next year. Some action is likely, but with the total lack of cooperation between the Republicans and the Democrats, the signs are that not all of the negative consequences will be resolved;

The US July NFIB small business optimism indicator came in at 91.2, slightly lower than 91.6 expected and 91.4 in June;

US retail July sales rose by +0.8% M/M, much better than expectations of +0.3% and the (revised) -0.7% in June. Ex gas and autos, sales were up +0.9%, once again higher than expectations of +0.5% and the (revised) -0.4% in June.

Essentially much better numbers and follows 3 months of declines;

US July PPI rose by +0.3%, higher than expectations of +0.2% and June’s +0.1%. Y/Y, PPI came in at +0.5%, in line with expectations and lower than June’s +0.7%;

Will there be opportunities for distressed funds in Europe. A number of private equity funds have and continue to raise funds to buy distressed assets from European banks. However, this appears to be a flawed strategy. European banks are reluctant to sell distressed assets of any size, as they do not want to crystallise losses which will negatively impact their capital ratios, which are seriously under pressure. Cheaper ECB funding and the lack of pressure from regulators (unlikely to change) to force banks to clean up their balance sheets, will not force the relevant banks to act in the near future either. European banks are, however, reducing lending, which is impacting the economy, particularly as European businesses are more dependent on bank financing than is the case in the US. Great theory, but no cigar;


Asian markets improved – expectations of monetary stimulus in Japan was a major factor.

Better than expected German and French GDP has helped European markets. In addition, the Dutch economy grew by +0.2% Q/Q, better than the decline of -0.3% expected. Recent polls suggest a far left anti austerity party is gaining in popularity in Holland, as voters moves to more extremist parties. However, in Holland, a coalition comprising many parties is the norm. Finnish GDP, the strongest of the AAA EZ countries, declined by 1.0% Q/Q. In addition, the periphery, by contrast is declining by more than expected. In addition, the economic data of the core countries are likely to deteriorate in Q3.

LCH Clearnet increased margin requirements on Italian and Spanish bonds yesterday, which has resulted in yields rising, though only marginally.

My friends at Stratfor (an invaluable publication which deals with geopolitical/intelligence issues) reports on comments by Israel’s defence minister Mr Ehud Barak. Essentially, Mr Barak stated that US intelligence reports are “closer than ever to Israel’s own intelligence estimates on Iran”. He added that it would be Israel that would decide on matters relating to it’s security. There is speculation that an attack on Israel is favoured by the PM and the defence minister (it will be a cabinet decision, according to Mr Barak), ahead of the US Presidential elections. However, Stratfor believes that such an attack is not imminent. Oil (Brent), however, continues to rise – currently around US$114, a 3 month high. Lower US inventories expectations has also pushed oil higher. Without the geo political risks, oil should be trading at much lower levels.

Economic, financial and earnings data continues to deteriorate. The market is holding up on expectations of Central Bank monetary stimulus from the US and the EZ, in particular, though also from China (also fiscal stimulus) and Japan. Personally, I believe China will have to increase both monetary and fiscal stimulus, in particular, if unemployment rises as I expect. The Japanese, well they act in mysterious ways, but I suspect that they too, will increase monetary stimulus – indeed they suggested precisely that this morning. The FED/Bernanke have not disappointed to date and hints of further monetary stimulus (QE3) at Jackson Hole is expected. That leaves the ECB, which is awaiting the German Constitutional Court. As you know, my analysis of Draghi last statement was far more positive than analysts/the press/investors believed. Markets have risen materially (particularly the higher beta stocks) since Draghi’s comments.

Having said all that, there are signs that whilst the German Constitutional Court is expected to allow the German President to sign off on the fiscal compact and the ESM, they may impose some conditions – the one being talked about is a cap on German exposure. If such a condition restricts (likely) the ability of the ESM to leverage itself (we all know that the current size is far too small for it’s intended task) and remember that the likely recipient countries (Italy and Spain, are expected to contribute around 30% of the ESM’s capital), the risks to the EZ/Euro are extreme. Draghi has stated that the ECB would only act if countries first asked for assistance from the EFSF/ESM and, in addition, the ECB would only consider buying short term debt. I believe that the risk of a conditional ruling from the German Constitutional Court is not negligible and, in any event, concern will increase as we get closer to announcement date of the 12th September.

The higher beta European stocks (banks, insurers and miners, for example) have risen materially since Draghi’s statement. In addition, whilst market momentum remains positive, markets have risen for quite a few days and are approaching technical levels. Interestingly, whilst US equity volumes continue to decline materially, European equity volumes are rising, confirming that the market is focusing on the EZ.

US retail sales data, just released were much better than expected, which has lifted US futures and European indicies.

Personally, I believe that risk/reward (particularly in the EZ) is not sufficiently in my favour any more and, as a result, will continue to reduce my holdings, particularly the higher beta stocks, which have performed extremely well recently.

Kiron Sarkar

14th August 2012

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