Sunday 13 January 2013

Credit - If at first you don't succeed...

"Tis a lesson you should heed: 
Try, try, try again. 
If at first you don't succeed,: 
Try, try, try again." 
- W. E. Hickson, British educational writer (1803-1870)

Looking at Prime Minister Shinzo Abe's first major policy initiative to end deflation and "boost" growth by announcing a cool 10.3 trillion yen fiscal (USD 116 billion dollars for now...) "stimulus" program, we could not resist but refer to W.E. Hickson's proverb which became colloquial "If at first you don't succeed".

In a "Central Banks" world dominated by the "Sorcerer's apprentice" aka Dr Ben Bernanke and our "Generous Gambler" aka Mario Draghi, with impeding July elections in Japan, Abe's "fiscal alkaloid" shot, is no doubt politically motivated in order for the Liberal Democratic Party to gather support ("rising asset prices") before the upper elections in July.

We have seen this movie before, in fact in December 2010, in relation to the launch of QE2, in our conversation "Inception - Bernanke's QE2 Experiment" we argued:
"Like in the movie Inception, the Fed is trying to plant an idea into people's mind. Bernanke idea's with QE2 is to create a wealth impression which would increase consumption and economic growth, with the help of rising assets prices. We had the Greenspan put and the Bernanke put, we also now have to contend with the same bubble creation plan which was initially followed by Alan Greenspan.
We all know now the results of creating asset bubbles and the consequences.
It is a very dangerous game."

Truth is, Japan had decided it had some "catch-up" work to do with both the Fed and the ECB, and has indeed thrown in the gauntlet as indicated by Bloomberg's Chart of the Day indicating that Bank of Japan's easing is outpacing the Fed, for now:
"The Bank of Japan will outpace the U.S. Federal Reserve in printing money next year, putting the yen on track to weaken to about 90 per dollar, according to Bank of America Merrill Lynch. The CHART OF THE DAY shows the dollar-yen rate and, in the lower panel, the monetary bases of the world’s largest and third-biggest economies since 2007. While the U.S. system had $2.64 trillion in November, about double Japan’s 124.4 trillion yen ($1.44 trillion), the pace of change differed in the past year as the BOJ stepped up its buying of government and corporate debt amid a recession. Japan’s central bank voted on Dec. 20 to expand its asset-purchase program by 10 trillion yen to 76 trillion yen after Shinzo Abe called for unlimited monetary stimulus before becoming prime minister this week" - source Bloomberg.

In that context we could not agree more with a recent post from an entertaining blog we came across called "Deceptology", namely that in similar fashion to the woodblock print from 1866 by artist Tsukioka Yoshotoshi, displaying the magician Sangoku Taro (who traveled through India and China learning conjuring tricks), Japanese Prime Minister Abe's "conjuring tricks are more advanced than merely pulling scarves from his sleeves":
"This magician is about to fight a sword-wielding warrior and a nasty green demon using something up his sleeve." - source "Deceptology"

In the case of Japan the "nasty green demon" is a continuous serious bout of deflationary forces at play. Could it be that this "nasty green demon" is in fact the "Evil Emperor Zurg" we referred to in our conversation "QE - To infinity...and beyond?", we wonder?

From this specific conversation - Buzz Lightyear of Star Command (central bankers), space ranger protecting the universe from Evil Emperor Zurg (deflation):
"While Buzz Lightyear was indeed the most popular toy in the first outing of Toy story, it looks to us that currently QE is the most popular toy being used by our central bankers over the world. But, in similar fashion to our Buzz Lightyear from the movie Toy Story, it looks to us that central bankers are indeed as deluded as Buzz Lightyear was. Buzz Lightyear in the first movie believed he was a space ranger before realizing he was just a toy. It appears to us that, courtesy of "Zemblanity", at some point, central bankers will have indeed to realize that QE is just a toy and a dangerous one to play with for too long in fighting Evil Emperor Zurg (deflation). This is clearly illustrated by Japan's plight in fighting off "Zurg" for the last 25 years as indicated by Bloomberg:
"The Bank of Japan’s failure to halt yen gains through domestic bond buying over the past decade is pushing policy makers to consider a new tack, purchasing foreign debt to produce the currency weakness exporters crave. The CHART OF THE DAY shows the yen’s effective exchange rate climbing to about 5 percent above its 10-year average, ignoring BOJ asset purchases that helped swell the money supply to 124.33 trillion yen ($1.6 trillion), the most ever in data going back to 1970." - source Bloomberg

Emperor Zurg aka the "nasty green demon" aka deflation.

In that previous conversation we also indicated that based on the current output gap and the Fed’s economic projections, the Taylor Rule* would suggest that the Fed’s ZIRP should continue only until early 2014, so no wonder the recent comments about bringing to an end the "infinity" in the "insanity" have resurfaced:
"Some may put too much hope that our "Buzz Lightyear" central bankers have designed an escape capsule from their "infinity...and beyond" policies." - Macronomics, "QE - To infinity...and beyond?", 10th of October 2012.

*Nota bene:
A Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. In particular, the rule stipulates that for each one-percent increase in inflation, the central bank should raise the nominal interest rate by more than one percentage point. This aspect of the rule is often called the Taylor principle).

As far as Japan is concerned, no doubt, we have "lift-off in risky assets" or "Risk-On" that is; as indicated in the below graph we have been monitoring, displaying the USD/JPY exchange rate, the Nikkei index and the credit risk Itraxx Japan CDS spread (inverted) - source Bloomberg:
When the trend, is your friend...

So in this week's conversation we intend to slightly break our Magician's Oath:
"As a magician I promise never to reveal the secret of any illusion to a non-magician, unless that one swears to uphold the Magician's Oath in turn. I promise never to perform any illusion for any non-magician without first practicing the effect until I can perform it well enough to maintain the illusion of magic."

We have to confide, that since our October post, we have continued "practicing" the effect of our magicians "secret illusions" by having been short JPY against USD (via proshare ETF YCS) and we have been as well long Nikkei but in Euros via a quanto ETF from Lyxor (more on the reason below) but until you all become magicians, we have to stop revealing tricks unless, of course, dear readers, you all swear to uphold the Magician's Oath in turn*, but we ramble again...

*Nota bene:
"Once sworn to the Oath, one is considered a magician, and is expected to live up to this promise. Magicians who reveal secrets, either purposely or through insufficient practice, may find that other magicians are unwilling to teach them any more secrets" - source Wikipedia.

Our Japanese "magician" has been as successful as our "Sorcerer's apprentice" Dr Bernanke and our "Generous Gambler" aka Mario Draghi, in the sense that Japan has indeed validated the Central-Banks ties to stock gains as indicated in Bloomberg's Chart of the Day:
"Japanese real-estate stocks joined Greek government bonds and Italian bank shares in showing that central-bank moves to pour money into the global economy will lift asset prices, according to Michael Hartnett, Bank of America Corp.’s chief investment strategist. As the CHART OF THE DAY illustrates, the Topix Real Estate Index climbed as much as 24 percent during the past month. The rally occurred as the Bank of Japan stepped up bond buying for the third time in four months amid a recession. Gains among property developers show the central bank’s easing is leading investors to buy Japanese stocks and “ignore economic and earnings considerations,” Hartnett wrote yesterday in a report with a similar chart. “This apes the European ‘pain trade’” from last year’s second half, when Greek debt and Italian bank stocks gained as the European Central Bank took steps to avert a sovereign-debt crisis, he wrote. The securities rose even though the two countries were among the region’s weakest economies. Greek government bonds more than doubled in the last six months of 2012, according to an index compiled by Bloomberg and the European Federation of Financial Analyst Societies. The FTSE Italia All-Share Financial Index rose 21 percent. Both gauges appear in the chart." - source Bloomberg.

So we would have to agree with Citi's recent European credit outlook 2013 entitled "The Devil is in the Distribution" and of course in the details when it comes to equities return and central banks "generous gamblers", wizards or magicians or any word you would think fit the purposes of the analogy. When one looks at the wonderful magic at play between Fed holdings of securities over five year versus the S and P 500 performance it has indeed been a wonderful "magic trick":
- source Citi -European credit outlook 2013 - The Devil is in the Distribution.

In similar fashion to the 1866 artist depiction of 1866 by the magician Sangoku Taro, the rationale behind our "long Nikkei in Euros" stance was fairly simple given that until recently, arguably the Bank of Japan has been behind the curve when it came to "magic tricks" as indicated in the below Chart of the Day from Bloomberg which we used in the concluding remarks of our "Zemblanity" conversation in September last year:
"Yen printing by the Bank of Japan is trailing money creation by the Federal Reserve and European Central Bank, boosting risks the Asian nation’s currency will rise to record levels, according to Mizuho Securities Co. The CHART OF THE DAY shows that Japan’s monetary base, a measure of money in circulation, has grown more slowly than those of the U.S. and the euro area since September 2008 when the collapse of Lehman Brothers Holdings Inc. prompted central banks to buy bonds in a bid to stem a global crisis. The lower panel shows the yen has risen 27 percent over the same period, as measured by Bloomberg Correlation-Weighted Indexes, while both the dollar and the euro slid. The yen strengthened to a seven-month high of 77.13 per dollar on Sept. 13, nearing the post-World War II record of 75.35, when the Fed announced its plan to buy $40 billion a month of mortgage debt in a third round of so-called quantitative easing. The ECB unveiled its own unlimited bond-purchase program a week earlier." - source Bloomberg. 

One could as well play Japan equities more aggressively by buying Japanese bank stocks given that the recovery in stock prices will lift the value of the Japanese banks' equity investments and will substantially reduce their impairment losses they have been booking in their regular YTD results. We told you this several times, but, remember, a bank is a leverage play on the economy, it is the second derivative of a sovereign. As we indicated in the "Fabian Strategy",  the big beneficiaries of the "magic tricks" in 2012 have been European Banks. Could the big beneficiaries of 2013 be the Japanese banks? One has to wonder...

In our October conversation "QE - To infinity...and beyond?", (following what we commented in our conversation "Zemblanity"), what our Buzz Lightyear central bankers might find out in targeting the unemployment level (given the relationship between M2-velocity and the US labor participation rate over the years), we argued that the jobless rate can be a misleading gauge of labor market health as indicated by Bloomberg:
"One reason the Federal Reserve may be unable to reach consensus on an unemployment target: the jobless rate can be a misleading gauge of labor market health. While unemployment has fallen to 8.1 percent from 10 percent in 2009, the CHART OF THE DAY shows the percentage of people working, known as the employment-population ratio, has remained near its lows of the recession, suggesting limited progress toward a recovery in jobs. “In a better economy we would see an improvement in this data,” said Adolfo Laurenti, deputy chief economist at Mesirow Financial Inc. in Chicago. While the ratio has fallen as the baby boomer generation retires and because more students are returning to school “the tougher nut to crack is those people who are truly discouraged workers, who could be in the job market but are leaving.” The employment-population ratio climbed to a record high 64.7 percent in April of 2000 before falling as low as 58.2 percent in December 2009, the lowest level since 1983." - source Bloomberg.

How do you judge the quality of the magic trick, if not by the quality of the "misleading" we would like to ask?

Given, as we argued in back in August 2010 in "Fantasyland and the imaginary world of spending multipliers" (illustrated by a nice picture from Disney's sorcerer's apprentice), we indicated the following:
"It is impossible to calculate the effect of deficit-financed government spending on demand without specifying how people expect the deficit to be paid off in the future."

Arguably the strategy of our "Sorcerer's apprentice" has been to try to induce a rise in velocity, but, we have
shown in our post "Zemblanity" that the "relationship" between US Velocity M2 index and US labor participation rate over the years is clearly indicative of the failure of the theories of Friedman and Keynes because central banks have not kept an eye on asset bubbles and the growth of credit and do not seem to fully grasp the core concept of "stocks" versus "flows":
"We mentioned the problem of stocks and flows and the difference between the ECB and the Fed in our conversation "The European issue of circularity", given that while the Fed has been financing "stocks" (mortgages), while the ECB is financing "flows" (deficits). We do not know when European deficits will end, until a clear reduction of the deficits is seen, therefore the ECB liabilities will have to depreciate."

This concept can be easily illustrated if one take the shipping industry in general and the Baltic Dry Index in particular as an illustration in the difference between "stocks" and "flows" (following on our conversation of the 10th of January - "The link between consumer spending, housing, credit growth and shipping - A follow up"):
"We do not know when the Baltic Dry Index depressed level will end until a clear reduction of the shipping overcapacity is seen, therefore the Baltic Dry Index had to depreciate"

The below Bloomberg graph displays such a link between economic growth and shipping as well as housing (from our conversation "Froth on the Daydream"):

In similar fashion to the evolution of the velocity of money moving together with the level of economic activity and the US Labor Participation Rate, the "unintended consequences" of ZIRP (Zero Interest Rate Policy), meant that the slow "velocity" of capital (financial repression) has led employers to adjust their "labor employment levels". Shippers have adopted "slow steaming" (moving slower to conserve fuel) as indicated by this Bloomberg graph:
"Slow steaming, or moving slower to conserve fuel, has affected 90% of shippers' supply chains and 85% of them had to make changes to their operations, according to a survey by Centrx and St. Joseph's University. Given the longer transit times, shippers are increasing inventory levels and moving to multiple carriers to gain access to additional departure times." - source Bloomberg.

We can therefore argue, in similar fashion that as employment levels can be judged as misleading gauge of labor market health, the Baltic Dry index can be as well seen as a misleading gauge of economic expansion...

On a final note Air Cargo Volume is clearly indicating once again, all is not well in Europe for our "Generous Gambler" aka Mario Draghi as, Air Cargo Volume was down -6.3% in December, following a -3.9% in November and -1.5% in October as indicated by Nomura's latest Air Cargo Indicator published on the 11th of January:
It has been a very reliable indicator in relation to industrial production according to Nomura (see our conversation "Air Traffic is a leading deflationary indicator"):
"Over the past nine years' monthly data, there has been an 84% correlation between air cargo volume growth and global industrial production (IP) growth, with an air cargo lead of one to two months. In turn, this has translated into a clear relationship between air cargo growth and chemical industry volume growth."

Nomura’s proprietary air cargo indicator shows a high correlation (84%) with global industrial production:

So our "Generous Gambler" aka Mario Draghi, needs to come up soon with new "tricks" in his sleeves as currently the Japanese "magician" is stealing the show!

"The greatest trick Macronomics ever pulled on its readers was to convince them there is no "market tricks" displayed in their posts." - Macronomics

Stay tuned!

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