In similar fashion, the financial crisis and the consequent burst of the housing bubble which had taken aback the beliefs of some forefront central bankers such as Alan Greenspan; have clearly shown that Central Banks are not omniscient either (omniscient being the capacity to know everything that there is to know).
Containership lines have increased rates five times by a total of $2,200 along west-east routes from Hong Kong to Los Angeles. The latest was a $500 peak-season surcharge effective Aug. 7. This has helped prop up rates by 63% ytd. In the Bear Case, excess capacity and a weak global economy may drive rates down even with price increases, pressuring margins." - source Bloomberg
"The relationship between container shipping and consumer spending, traffic is indeed driven by consumer spending" - Macronomics - August 2012
We have been sounding the alarm for a while when it comes to the importance of maintaining credit conditions in Europe to avoid a deflationary spiral and the fact that LTROs amounted to "Money For Nothing" but overly ambitious budget deficit targets" in conjunction with accelerated bank deleveraging courtesy of the stupid EBA (European Banking Association) requirements of reaching a Core Tier 1 ratio of 9% before June 2012 have had the desired destructive effect. Well done...
"The deteriorating economic situation in Europe, together with BASEL III capital requirements, have led to a number of shipping banks with large portfolios to exit the sector. High profile restructurings and payment defaults have started to take their toll on the few remaining lenders. This comes at a time when we have significant capital expenditures to finance our dry bulk and tanker new building programs. The lack of liquidity is further exacerbated by falling assets values, which continued to decline during the quarter." - Dryships Financial Report - George Economou, Chairman and Chief Executive Officer of the Company.
"Credit growth is a stock variable and domestic demand is a flow variable" as indicated by Michael Biggs and Thomas Mayer in voxeu.org entitled - How central banks contributed to the financial crisis.
2. A deity is able to do anything that it chooses to do.
3. A deity is able to do anything that is in accord with its own nature (thus, for instance, if it is a logical consequence of a deity's nature that what it speaks is truth, then it is not able to lie).
4. Hold that it is part of a deity's nature to be consistent and that it would be inconsistent for said deity to go against its own laws unless there was a reason to do so.
5. A deity is able to do anything that corresponds with its omniscience and therefore with its worldplan." - source Wikipedia.
"The gazing populace receives greedily, without examination, whatever soothes superstition and promotes wonder". - David Hume
Back in our conversation "The Uneasiness in Easiness" we concurred with David Hume's approach when discussing the latest ECB OMT (Outright Monetary Transactions):
"People often lie, and they have good reasons to lie about miracles occurring either because they believe they are doing so for the benefit of their religion or because of the fame that results.
An indicator we have been monitoring has been the 120 days correlation between the German Bund and its American equivalent, namely the US 10 year Treasury notes. On the subject of asset correlation (see our post "Risk-Off Correlations - When Opposites attract"), in "Risk Off" periods we have noticed that the 120 days correlation had been close to 1 in 2010, 2011 and 2012, whereas in "Risk On" periods, the correlation was falling to significantly lower level. Currently the correlation is now rising towards 80%, indicative of the recent weaknesses witnessed in the equity space, which is validating somewhat a switch towards "Risk-Off" - source Bloomberg:
The Game of The Century": "By managing to keep Germany’s liabilities unchanged Angela Merkel appears to us as the winner of the latest European summit (number 19...). Question being for us now, can Europe survive in the current form (number of countries) without making material sacrifices in true Bobby Fischer fashion? One has to wonder."
The current European Bond Picture - source Bloomberg:
Both the Eurostoxx and Itraxx Financial Senior 5 year CDS index representative of financial risk (25 European financial institutions risk gauge) have been converging indicative of a deteriorating picture - Top Graph Eurostoxx 50 (SX5E), Itraxx Financial Senior 5 year CDS index, German Bund (10 year Government bond, GDBR10), bottom graph Eurostoxx 6 month Implied volatility. - source Bloomberg:
Back in our previous conversation "The Uneasiness in Easines" we argued:
It will depend on the credit conditions for small market firms given credit conditions for commercial and industrial loans were tightened both for small and large companies during the crisis as indicated in a recent report by Dr Torsten Slok from Deutsche Bank - Do Small businesses worry about the fiscal cliff - published in November:
- Firms with less than 20 employees make up 90% of all companies in the US
- Small and medium-sized firms employ half of all workers in the US
- Small and medium-sized firms generate half of all revenue in corporate America
- Small firms create around 3mn jobs every year
- Job growth during this recovery has mainly come from small and medium-sized companies
- Global total employment in S and P 500 companies is only 17% of total employment in the US
- S and P 500 companies have been hiring significantly over the past 2 years but mainly outside the US.
Small businesses are a critical part of the US economy and have been a very important source of the US recovery over the past three years. The reason is likely that the US is a closed economy where small businesses worry less about macro risks, including the fiscal cliff."
Given credit investors are anticipatory in nature, in 2008-2009, credit spreads started to rise well in advance (9 months) of the eventual risk of defaults as indicated by the below graph from UBS in their European Credit Strategy 2013 Outlook entitled - All yields are not created equal:
The uncanning similarity between the US leveraged loan cash price index versus its European peer and the US PMI and European PMI index - source Bloomberg:
"The empirical relationships between lagged economic indicators (e.g. global PMIs) and defaults suggests zero growth should move default rates up towards the 5-8% context over the next 12 months" - source UBS:
With the Eurozone technically back in recession with GDP contracting in Q3 by 0.1% q-o-q following a 0.2% q-o-q contraction in Q2, not only the contraction in the Eurozone is going to last but it will as well accelerate in the last quarter of the year. In that context, default rates will undoubtedly rise in 2013 given the surge in recent profit warnings. Q4 will therefore be worse than Q3.
Moving on to the subject of the risk of the "Profits Cliff", we believe the biggest risk is indeed not coming from the "Fiscal Cliff" but in fact from the "Profits Cliff". The increase productivity efforts which led to employment reduction following the financial crisis means that companies overall have reached in the US what we would call "Peak Margins". In that context they remain extremely sensitive to revised guidance and earnings outlook as we moved towards 2013. As we discussed in June in "River of No Returns", 56.5% of discretionary stock have a Beta greater than 1.1 and consensus for 2013 were the highest in discretionary stocks. We quoted Morgan Stanley's research note at the time of this conversation: "Earnings, like trees, don't grow to the sky".
We would like to repeat last week's conclusion namely that:
"high expectations + strong consensus = danger".
As indicated by Citi's recent credit research note "Strong growth requires more than just liquidity":
Not only this but Private Equities power house so apt at raising money are struggling in finding ways of deploying their cash stash.
For instance, 3i Group Plc the private equity house announced in June it was restructuring its private equity business and that it would cut a third of its workforce. 3i Group Plc is planning to more than double its debt-management unit moving away from investing in buyout deals as reported by Bloomberg by Patricia Kuo - 3i Boosting Debt Business:
"New private-equity investments have shrunk in a “subdued”market for mergers and acquisitions, 3i said today in an earnings statement. The firm spent 138 million pounds ($219million) on new investments compared with 448 million pounds in the same period a year earlier, it said. It reduced headcount by 104 employees and closed offices in Barcelona, Copenhagen, Hong Kong, Milan and Shanghai, according to the statement. 3i will avoid mezzanine financing, distressed debt and real estate, as well as asset-backed deals for the time being. “I am not convinced there is room for growth for real mezzanine financing, ” Ghose said. “It will become more difficult to get buyout firms to see the merit of using mezzanine debt now that required returns almost match that of equity.”" - source Bloomberg
So not only the Zero Rate policies induced by our "omnipotent" Central Banks are destroying capitalism in the sense that capital because of lack of return cannot be deployed efficiently, but it is as well to some extent neutering volatility as indicated by the volatility in Japan which has returned to pre-quake levels - graph source Bloomberg:
The other subject of conversation is the broken credit transmission mechanism in the Eurozone. Eurozone companies are, according to CreditSights recent note (Eurozone Corp Debt - Broken Banks or Weak GDP?) net of borrowing, repaying bank debt for only the second time on record and yet net bond issuance is at close to record levels. Why is so?
Banks in Europe are "broken" and unable to lend, or unwilling given the weak outlook for companies revenues which is as well undermining the demand for credit:
"The Eurozone's latest national economic accounts show that over the past year non-financial corporates have been repaying loans, but borrowing near record amounts of bonds. Over the past year, companies in the euro area have repaid a net €45 bn of loan debt and increased their use of bond financing by €90 bn, respectively equivalent to -0.5% of GDP and 1% of annual GDP. Euro area companies have only made greater use of bond financing than they are currently making in 2010 when loans were shrinking dramatically following the banking crisis, and in 2001 when the euro-denominated credit markets were still developing and the dotcom and euro high yield boom were in their final days.
The most obvious explanation for this shift in funding from loans to bonds is that banks are broken and unable to lend and therefore these companies are large enough to turn instead to the bond markets are using that option. The rest are being forced to deleverage or default. If that is the case, then the obvious answer must be to fix Europe's banks in order to ease the pressure on corporates and allow those too small to access to the bond markets to rely once again on the banks. But there are reasons to doubt that fixing European banks alone will be enough. While it is a necessary condition of returning European Corporates to borrowing and investing it is not by itself, a sufficient condition. And although the financing conditions of Europe's smaller and medium-sized companies may seem irrelevant to investors in bonds, it should be remembered that these SMEs are the suppliers to those large companies, the distributors of their products and the employers of their customers. If European SMEs are cutting spending, that will redound to the detriment of large European companies revenues."
On a final note revenue shortfalls as indicated by Bloomberg's chart of the day does indeed bring Profit-Margin caution:
“The heat is on for companies to preserve margins,” Zyblock wrote yesterday in a report. Their success will depend on pricing power, or the ability to raise prices without losing business, the Montreal-based strategist wrote. Broadcasters and cable companies, business-service providers, homebuilders and tobacco producers are most likely to sustain profitability, the report said. Zyblock based his conclusion on an analysis of industry price indexes and net margins, or net income as a percentage of sales. Automakers, chemical companies, paper producers and software makers are most at risk, he wrote. These industries suffer from a combination of reduced pricing power and falling net margins." - source Bloomberg
We think we have reached "Peak margins" as far as US earnings are concerned. so "Mind the Gap"...
So, we do not really care about the "Fiscal Cliff", we'd rather much care about the "Profits Cliff", but then again, we might be lacking faith, trust, or both, in our "Omnipotent" Central Banks and governments altogether.
"Omnipotence is not knowing how everything is done; it's just doing it."- Alan Watts, English Philosopher.