Chart of the Day - European Car Sales and Consumer Confidence

"Confidence is contagious. So is lack of confidence." - Vince Lombardi

As we posited in our conversation "The Regret Theory" back in December 2012, in relation to European Consumption, Consumer Confidence is key (in continuation to our extensive look at car sales in Europe from our conversation of April 2012 - "The European Clunker - European car sales, a clear indicator of deflation"):

"One could also look at car sales and European Consumer confidence since 2007, the relationship seems pretty clear even though the cash for clunkers program have indeed been highly supportive of car sales whenever consumer confidence needed some government "artificial boost"

Strong macro drivers such as consumer confidence set the trends for the demand in the auto sector but for consumption levels as well as per the below Chart of the Day - graph source Bloomberg:

New car registrations in Western Europe have continued their positive trend in conjunction with European Consumer Confidence:
-UK +8.2%
-France +5.8%
-Spain +28.7%
-Italy +1.9%
-Germany -3.4% (slightly off this month)

European's five largest markets for passenger car sales have generated 817,158 units sale, up 4.1% from a year ago. The big winner has been Renault group reporting double-digit growth in sale in Spain (+43.3%) driven by the domestic market France with 18.4% growth according to CreditSights from their European Morning comment of the 8th of May.

"If you have no confidence in self, you are twice defeated in the race of life. With confidence, you have won even before you have started." - Marcus Tullius Cicero

Stay tuned!

The link between consumer spending, housing, credit growth and shipping. - A follow up

"Optimism is the faith that leads to achievement. Nothing can be done without hope and confidence." - Helen Keller, American author

As we had argued in our conversation "The link between consumer spending, housing, credit and shipping" back in August 2012:
"The relationship between container shipping and consumer spending, traffic is indeed driven by consumer spending".

In October, in our conversation "Credit Chadburn on full ahead" we argued the following:
"Moving on to the subject of looking at different indicators which could clearly indicate if effectively a proper rebound is on the way and if the credit bell has arguably rung three times which would mean an acceleration in global economic growth led by the US economy, we noticed recently a significant rebound in the Baltic Dry Index"

If there is a genuine recovery in housing driven by consumer confidence leading to consumer spending, one would expect a significant rebound in the Baltic Dry Index givent that containerized traffic is dominated by the shipping of consumer products.

As indicated in the below gaph from Bloomberg, the resurgence in international traffic is conditional to a more meaningful rebound in housing in the US:

"Containerized traffic is dominated by the shipment of consumer products, and a resurgence in international container volumes is dependent on the housing market. Furniture and appliances are some of the top freight categories imported into the U.S. and euro zone from Asia. Furniture demand has been picking up, after bottoming in 2009 following the collapse of the housing market." - source Bloomberg.

Any change in consumer spending trends is depending on a more pronounced housing market revival and will directly impact container traffic (as we posited in our August conversation in relation to the link between consumer spending, housing, credit and shipping). Therefore tracking consumer confidence is key to determine if a more potent global trade rebound is at play - source Bloomberg:

"Consumer demand drives Asia-originated containerized traffic and freight flows to Europe and North America. Auto parts, furniture, apparel and textiles, along with appliances and kitchenware, are some of top containerized product types imported into the U.S. and Europe. Any changes in consumer spending will directly affect global containerized traffic volumes." - source Bloomberg

 

But as far as the Baltic Dry Index is concerned, while US Family Housing Starts looks to be on the mend in conjunction with US Furniture sales, we have yet to see a pick-up in the aformentioned Baltic Dry Index:

 Since 2006:
- in yellow the Baltic Dry Index,
- in orange US Family Housing Starts
- in white US Furnitures Sales.

The most obvious reason behind the lack of rebound in the Baltic Dry Index is stemming from the ship owner's cost mostly affected by fuel oil (Bunker prices) and the lack of price elasticity for the shipping industry given the glut of shipping capacity which is slowly being digested following the bomm and bust of the container shipping industry fuelled by cheap credit with non-performing loans still encumbering major players in the structured finance space such as German bank Commerzbank.

As indicated by Isaac Arnsdorf in his Bloomberg article from the 2nd of January entitled "Shipping Loses as Faster Trade Means Record Fuel Costs":
"The glut of shipping capacity and unprofitable rates may discourage some owners from speeding up. The merchant fleet of 86,500 vessels moved at an average 5.94 knots last month, compared with 6.48 knots a year earlier, data compiled by Bloomberg show. A very large crude carrier hauling 2 million barrels of oil can earn about $12,000 a day more by sailing at 10.5 knots instead of the standard 14.5 knots, according to DNB Markets, a unit of Norway’s largest bank."

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While the trade pick up from Asia is good news, it is not enough to trigger a pronounce rebound in the Baltic Dry Index, given, according to the same article:

"Accelerating trade may also discourage owners from scrapping older ships, prolonging the glut. A total of 45.9 million deadweight tons of capacity will be demolished this year, compared with 59.3 million tons in 2012, Clarkson estimates. That implies a 4.9 percent expansion in combined carrying capacity this year to 1.15 billion gross tons, the shipbroker predicts. The Baltic Dry Index, a gauge of dry-bulk shipping costs, averaged the lowest since 1986 last year, according to the Baltic Exchange, which publishes rates on 61 maritime routes. The Baltic Dirty Tanker Index of earnings for crude carriers and a measure of charges for six types of containers were the smallest since 2009, according to the London-based Baltic Exchange and the Hamburg Shipbrokers’ Association. Mitsui O.S.K. Lines Ltd., the owner of the world’s largest merchant fleet, said in October that rising fuel prices reduced its income by 3.1 billion yen ($36.1 million) in the three months to Sept. 30. The Tokyo-based company reported a loss of 5 billion yen for the period. A $100-a-ton change in bunker prices increases or diminishes profit by about $100 million for A.P. Moeller-Maersk A/S, the owner of the largest fleet of container ships, according to its third-quarter earnings report." - source Bloomberg

 

Bunker prices in Singapore, the largest refueling port, averaged $664.10 a ton last year, the most in at least a decade, according to data compiled by Bloomberg.

 

The good news from a "credit growth perspective" for housing, consumer confidence and spending as well as "shipping" is that US Credit Growth is indeed indicating economic pickup as displayed in Bloomberg Chart of the Day graph from the 9th of January:

"Faster bank-credit and money-supply growth plus rising Treasury yields signal the U.S. economy is poised to pick up this year even amid the fiscal drag triggered by last month’s budget deal, according to MKM Partners LLC. The CHART OF THE DAY shows total credit of commercial banks in the U.S. rose at an annualized pace of 7.5 percent since the end of September while a Federal Reserve measure of money supply, known as M2, advanced at a 12.3 percent rate. Treasury 10-year yields reached an eight-month high this month as investors plowed into higher-risk equities amid signs labor conditions were improving and Fed bond-buying may end this year." - source Bloomberg

 

As we have argued in May 2012 (Growth divergence between the USA and Europe? It's the credit conditions stupid...), it will remain the case in 2013.

Back in our May conversation we indicated the following reasons behind the growth differential between both economies was due to credit conditions:
"In recent conversations as well we have been highlighting the growth differential between the US and Europe ("Shipping is a leading deflationary indicator"):
"We have long argued that the difference between the FED and the ECB would indeed lead to different growth outcomes between the US and Europe (US economy will grow 2.2% this year versus a 0.4% contraction in the euro area, according to the median economist estimates compiled by Bloomberg):

"Whereas the FED dealt with the stock (mortgages), the ECB via the alkaloid LTRO is dealing with the flows, facilitating bank funding and somewhat slowing the deleveraging process but in no way altering the credit profile of the financial institutions benefiting from it! While it is clearly reducing the risk of banks insolvency in the near term, it is not alleviating the risk of a credit crunch, as indicated in the latest ECB's latest lending survey which we discussed in our last conversation -The LTRO Alkaloid - 12th of February 2012."

 

As far as the ECB and our "Generous Gambler" aka Mario Draghi are concerned in relation to credit growth and consumer spending, we have yet to see meaningful changes in credit growth which would improve the growth outlook for Europe:
"There has been little change in credit growth, which remained weak in November. The annual rate of decline in loans to the private sector (adjusted for loan sales and securitisation) remained at -0.5% in November. This development reflects further net redemptions in loans to non-financial corporations." - Mario Draghi, today's ECB conference.

EU Lending Breakdown - Retail Lending - Source Bloomberg:

"Following three months of marginal growth, loans outstanding to euro zone households total 5.25 trillion euros, within 0.5% of September 2011 all-time highs. Within this, consumer credit outstanding continues to tumble and now stands below 600 billion euros for the first time since mid-2007, while mortgage lending remains resilient." - source Bloomberg:
  

"Beware of little lending. A small leak will sink a great European ship." - Martin T. - Macronomics

 

Stay tuned!
 

Credit - The Regret Theory

"In history as in human life, regret does not bring back a lost moment and a thousand years will not recover something lost in a single hour."  - Stefan Zweig

This year, we have on numerous occasions touched on game theory in our posts (The European iterated prisoner's dilemma, Agree to Disagree) and we also used an analogy relating to project management linked closely to the famous game of chicken, namely the Nash equilibrium concept (Schedule Chicken). We even ventured towards computational analogies in our title selection process (Bankers' algorithm). Given the latest raft of European PMIs, pointing to a continued (albeit much smaller) divergence between the United-States Growth and Europe (Growth divergence between the USA and Europe), reason being the lack of credit provided to the real economy due to:
-inappropriate European Banking Association decision of imposing banks to reach a 9% Core Tier 1 ratio by June 2012 
-unrealistic budget deficit targets (A Deficit Target Too Far), 

We came to the conclusion that we ought to use in our title a reference to the Regret decision theory.

The divergence between US and European PMI indexes - source Bloomberg:

The Regret theory (also called opportunity loss) being defined as the difference between the actual payoff and the payoff that would have been obtained if a different course of action had been chosen by our European politicians. The Regret theory is also a model of choice under uncertainty defined as the difference between the outcome yielded by a given choice (credit crunch, economic recession) and the best outcome (muddle through) that could have been achieved in that state of nature (deflationary forces at play). 

As far as Europe is concerned, one can wonder what would have been the "economic outcome" if a different course of action would have been undertaken. On that matter we wonder why our "European elites" did not use the minimax regret approach being a decision rule used in decision theory, game theory, statistics and philosophy for minimizing the possible loss for a worst case (maximum loss) scenario. One approach is to treat this as a game against nature (deflation in our case) and using a similar mindset as "Murphy's law" ("Anything that can possibly go wrong, does"), taking an approach which minimizes the maximum expected loss, but we ramble again...

And what could possibly go wrong in relation to European growth in 2013? After all, one might posit it is only a game of confidence. Well, looking at consumer confidence in Europe, "Murphy junior" would certainly comment that his father is probably too optimistic when looking at European Consumer Confidence.

European consumer confidence indicators for some European countries - source Bloomberg:

We already looked at the link between consumer confidence and consumption back in our June conversation "Yogurts, European Consumer Confidence and Consumption" where we undertook at an interesting exercise following Yogurt giant Danone profitability warning announcement (affected by Spanish woes), namely plotting Danone share price against consumer confidence - source Bloomberg:

We wrote at the time:
"Yogurts matter as an indicator? One has to wonder...

As austerity bites consumer spending and with Italy and Spain in recession, companies have been forced to lower cost to protect earnings so far. End of May the ECB also indicated that loans to households and companies in the euro zone grew at the slowest pace in two years as the on-going crisis curbed demand for credit."

In relation to European Consumption, Consumer Confidence is key. The latest data relating to car sales in Europe, confirms the deflationary forces at play in Europe with car registrations falling plunging 19.2% in November in France on a monthly basis and 13.8% in the first 11 months of the year and Italian care sales by 20.1% in November (for a lengthy analysis on the subject of the car market in Europe please check - "The European Clunker - European car sales, a clear indicator of deflation").
As far as 2013 is concerned, European car sales are at risk on weaker consumer consumption as indicated by Bloomberg:

"Bears suggest discounting by automakers may not be enough to boost unit sales in Europe. Austerity in Europe is straining disposable incomes, with consumer household expenditure falling for three consecutive quarters. Car sales in Europe fell 4.2% yoy in the first three quarters of 2012 and any sustained recovery will be challenging as economic pressures mount." - source Bloomberg

One could also look at car sales and European Consumer confidence since 2007, the relationship seems pretty clear even though the cash for clunkers program have indeed been highly supportive of car sales whenever consumer confidence needed some government "artificial boost" - source Bloomberg:

Weak economy, low consumer confidence and high unemployment are indeed the deflationary forces at play plaguing European consumption and impacting car sales in the process. 2012 will be the fifth consecutive year of declines in the European car market below 12.8 million units, 20% below pre-crisis levels.

Strong macro drivers such as consumer confidence set the trends for the demand in the auto sector but for consumption levels as well.

France Consumer Confidence and Household Consumption YoY since 2001 - source Bloomberg:

For instance, another indicator of the divergence between Europe and the United States, comes from the auto sector where demand for US light vehicle sales were up 7% year over year in October and 14% year to date, whereas Europe was the only region to decline in 2012, down 4.6% in October and down 6.9% in 10 months. Even China, passenger car sales were up 6.4% in October and nearly 7% year to date. In Europe the European Automobile Manufacturers Association, or ACEA, indicated in November car sales decreased 6.9 percent to 10.7 million cars. The ACEA indicated Europe’s car sales would reach a 17-year low in 2012. It also estimates that as much as 30 percent of production capacity is not used.

We think our European politicians would be wise to look at the minimax regret approach given Intrade is now putting a 30.6% chance of breakup of the Euro by December 31st 2013 as reported by Stephen Rose from Bloomberg on the 3rd of December: 
"Following is a table listing the odds that one country currently using the Euro will change its official currency by the expiration date, based on bets made at Intrade.com."

Europe is still a story of deleveraging and as pointed out by a recent note from Credit Agricole Cheuvreux from the 29th of November entitled "EU, The Road through purgatory", should our European politicians decide to tackle the minimax regret approach, there are indeed four possible recipes: "There are four basic recipes for deleveraging: austerity, inflation, growth, and default. The optimal is growth but Europe as whole cannot export its way out of its challenges and nor does it need to. Europe overall runs a current account surplus; the challenge lies in the balance within the Union. Europe needs further debt restructuring, inflation and a rebound in consumption (domestic growth). Deflation is the key risk here, but Draghi appears to understand this danger and has proved a better lateral thinker than his predecessor." - source Credit Agricole Cheuvreux.

Yes, our "Generous Gambler" aka Mario Draghi has been clearly a better lateral thinker in preventing a financial meltdown following the acute liquidity crisis of the financial sector in 2011. But as far as our Regret Theory is concerned, we previously indicated that in the case of Europe, causation implied correlation:
"Admittedly, a correlation between two variables does not necessary imply that one causes the other, but when it comes to European woes, not only did the ECB's LTROs amounted to "Money for Nothing" given the lack of transmission to the real economy as we posited in February this year, but looking back at the overzealous deficit targets set up by the European Commission which we discussed in our conversation "A Deficit Target Too Far", we are not surprised to see that the economic causation does indeed implies correlation to current European economic woes unsurprisingly due to poor loan growth."


Looking at the prospect for the younger generation of Europeans and high level of youth unemployment, maybe Murphy junior is correct in assessing his father's law after all:

-source CA-Cheuvreux / Eurostat.
"These unemployment trends are very worrisome and if they are not reversed in the short term they may lead to increased social tensions and structurally higher long-term unemployment, which has negative effects on a country's growth prospects as part of the workforce becomes impaired. Also, youth unemployment leads to emigration, which will have a negative impact on demographics, as will be seen in most European countries in the medium term." - source Credit Agricole Cheuvreux.

Deleveraging leads to lower domestic consumption while tax rates are increasing with a shift from income taxes to consumption taxes:
"As taxes increase, and penalise an already fragile economy, consumption decreases exponentially and corporate investment is postponed, which leads to lower tax intakes. This means that more taxes are levied on the economy to try to cover the shortfall and a vicious circle is perpetuated." - source Credit Agricole Cheuvreux.

Maybe the minimax regret approach is the right approach after all. Oh well...

On a final note and in relation to struggling peripheral countries, Spain has indeed very apt in avoiding "tapping out" for help in this European fight of the Century, given it has so far managed to retain market access with timely sales as indicated by Bloomberg Chart of the Day:

"The CHART OF THE DAY shows Spain, which has auctioned about 82 billion euros ($106.7 billion) of bonds this year, sold the most debt when borrowing costs were at their lowest. That’s allowed it to retain market access and so far avoid a sovereign bailout even as 10-year rates surged to a euro-era record. “Spain has been smart in timing the issuance in the market,” said Alessandro Giansanti, a senior rates strategist at ING Groep NV in Amsterdam. “A loss of market access in July this year could have easily driven Spanish yields to the 8 to 9 percent area.” The nation’s 10-year bond yielded about 5.32 percent on Nov. 30, down from 7.75 percent on July 25. The yield touched 5.20 percent last week, the lowest since March 20. Spain sold the biggest proportion of its debt in January, when the 10-year yield averaged 5.30 percent, and auctioned the lowest amount of bonds in August, when yields ranged from 6.15 percent to 7.44 percent. The Treasury completed its program of medium- and long-term debt sales earlier this month, and has used subsequent auctions to raise funds for 2013." - source Bloomberg

"Uncertainty is the worst of all evils until the moment when reality makes us regret uncertainty."

- Alphonse Karr, French critic

Stay Tuned!

Credit - Froth on the Daydream

"Do you think when two representatives holding diametrically opposing views get together and shake hands, the contradictions between our systems will simply melt away? What kind of a daydream is that?" - Nikita Khrushchev

Definition of froth:
noun - A mass of bubbles in or on a liquid; foam 
verb - to produce or cause to produce froth
source - Collins English dictionary.

Our reference in this week title is of two-fold. A froth being a mass of bubbles in a liquid form, looking at the quantity of liquidities injected in the system courtesy of central banks (see our post "QE - To infinity...and beyond"), and given the incredible rally in the credit space with more and more players looking at "stealing third base" (to use a baseball analogy), one can argue that many investors are really getting outside their "comfort" zone and investing once again in the riskiest part of the capital structure (Leveraged loans, High Yield, PIKs bonds, etc.), hence our froth reference. Yes, arguably once more, central banks are indeed "frothing".

But, our title is as well a reference to 1947 novel by French author Boris Vian, one of our favorite books of all time. It tells the story of a man who marries a woman, who develops an illness that can only be treated by surrounding her with flowers. We think the current global economic situation tells a similar story, namely that economies developed an illness (credit bubbles) that can only be treated by surrounding them with liquidities.

Credit Booms and Financial - Crisis - IMF

"The majority of the largest financial crises over the past three decades followed significant private credit expansion. While credit booms need not be followed by a period of bust (the IMF calculates that one third of booms sampled were followed by a banking crisis) it notes that many more were followed by sub-trend growth for the subsequent six years." - source Bloomberg

In Boris Vian's great poetic novel, the hero Colin marries Chloé, but Chloé falls ill upon her honeymoon with a water lily in the lung, a painful and rare condition that can only be treated by surrounding her with flowers. One can as well argue that a BSR (Balance Sheet Recession) is a rare condition that can only be treated by surrounding it with liquidities but if credit is not flowing to the real economy which is definitely the case in the Eurozone; a similar fate looms for the European economy as for Chloé in the novel. In the novel at some point, the flower expenses become prohibitive and Colin soon exhausts his funds. 

"The CHART OF THE DAY shows that the ECB’s assets have climbed to 33 percent of the gross domestic product of the nations that use the euro, exceeding levels for the U.S. and Japan. It also shows Draghi’s proposal could drive the central bank’s holdings to exceed 43 percent if policy makers bought all 1.01 trillion euros ($1.27 trillion) of Italian and Spanish bonds due by end-2015 and failed to sterilize purchases. Draghi will propose unlimited buying of government debt, while refraining from a public cap on yields, according to two central bank officials briefed on the plan before the ECB meets today. Sterilization involves draining money from other parts of the financial system to offset the new funds being added." - source Bloomberg.

We are very fond of Boris Vian's novel, and we can find many more analogies in this week credit rambling's title with his masterpiece. 

For instance, as Chloé becomes even sicker, the house they live in starts to shrink and becomes darker and gloomier on a daily basis although the little grey mouse that lives in the house does all its best to clean the windows in order to let the light in. When one looks at the future for Greece, it looks increasingly likely that Greece will become the euro's poorest nation in two years as indicated by Bloomberg:

"The CHART OF THE DAY shows Greek output per person adjusted for relative price levels is set to fall to 71.3 percent of the European Union average in 2014 from 79.8 percent last year, according to the commission’s Ameco database. Slovakia, the second-poorest euro nation, will surpass Greece as early as this year, while Estonia, the zone’s most impoverished state, will top Greece at the end of 2014. Greece is struggling to meet debt-reduction targets imposed by international lenders more than two years after receiving its first bailout. The need for more austerity measures is pushing the economy deeper into recession and more than one-fifth of output will have been erased by 2014, when growth is set to resume after six years of recession." - source Bloomberg

In Boris Vian's book, Colin struggles to provide flowers (credit) for Chloé to no avail and his grief at her ultimate death is so strong his pet mouse commits suicide to escape the gloom. Looking at how the ECB (Colin) is struggling at providing real flowers (credit) to the Spanish real economy (we have long argued that the LTROs provided by Mario Draghi amounted to "Money for Nothing"), we can only wonder about the accuracy of our reference when looking at the deflationary bust unfolding in Spain before our very own eyes - graph source Bloomberg:

"The CHART OF THE DAY shows that the 30 percent expansion of the ECB’s balance sheet since Draghi’s first meeting as President in November 2011 has reduced the Euribor-OIS spread, a measure of European banks’ reluctance to make unsecured loans to one another, to a five-year low. In that time, Spain’s 10-year borrowing cost has risen, even after Draghi channelled 1 trillion euros ($1.3 trillion) to banks via two rounds of Longer-Term Refinancing Operations in December and February. Draghi has also cut interest rates to 0.75 percent in three 25 basis-point reductions, and reinforced his July 26 pledge to do “whatever it takes” to defend the euro by announcing an unlimited bond-purchase program. Spain is yet to request aid, a precondition of central bank bond purchases. The ECB left interest rates unchanged on thursday's meeting." - source Bloomberg

"Maintaining lending and credit flows is paramount to avoid a credit crunch which would essentially impair GDP growth in the process." - Macronomics, Modicum of relief - March 2012

Euro Area Bank Lending Survey - source Thomson Reuters Datastream / Fathom Consulting:

When ones looks at the amount of consumer gearing in Europe versus the USA, no wonder that the amount of "frothing" or flowers from the ECB has been staggering. As indicated by Bloomberg in the below graph, the Credit Penetration has been falling from the 2009 highs, courtesy of the BSR and the deleveraging needed but the gearing of private households as fallen in the US whereas it has risen in Portugal for instance!

"Globally, domestic credit to GDP has fallen seven percentage points from 2009's all-time high, as banks deleverage and consumers pay down debt. While Portugal and the U.S. have the same 193% ratio, the Portuguese credit boom drove consumer gearing to 193% from 135% in 2005-09, unlike the U.S., where the ratio has dropped over the same period." - source Bloomberg

Looking at the recent surge of the Bloomberg US Consumer confidence Index from -34.7 to -34.4 in the period ending November 4, the best reading since April, we remain more positive on the US economy than the European economy. As we indicated last week in our conversation "The year of the empty hand", the divergence of growth between the US economy and the European economy is still reflected in credit prices such as the US leveraged loan cash price index versus its European peer - source Bloomberg:

When causation implies correlation...

In our previous conversation "The link between consumer spending, housing, credit and shipping", we indicated that Shipping is an important credit and growth indicator:

"The relationship between container shipping and consumer spending, traffic is indeed driven by consumer spending".

The below Bloomberg graph displays such a link between economic growth and shipping as well as housing:

"The Baltic Dry Index is a barometer of the health of the shipping industry and broader global economic activity. The daily index aggregates the costs of moving freight via 23 seaborne shipping routes. It covers the movement of dry-bulk commodities, such as iron ore, coal, grain, bauxite and alumina. It also gauges dry-bulk supply-and-demand dynamics." - source Bloomberg

Consumer Confidence is as well a barometer of economic conditions. When one looks at the Consumer Confidence evolution in the Eurozone, one can see the growing headwind for growth to resume which would alleviate the concerns in regards to solvency issues for some European countries:

Source Thomson Reuters Datastream / Fathom Consulting.

In similar fashion, we already touched at the link between European Consumer Confidence and Consumption in our June conversation "Yogurts, European Consumer Confidence and Consumption" where we argued: 

"Yogurts matter as an indicator? One has to wonder...As austerity bites consumer spending and with Italy and Spain in recession, companies have been forced to lower cost to protect earnings so far. End of May the ECB also indicated that loans to households and companies in the euro zone grew at the slowest pace in two years as the on-going crisis curbed demand for credit."

Yogurt giant Danone share price versus European Consumer Confidence since 2006 - source Bloomberg:

"Mind the Gap..."

Economic Sentiment is a well a leading indicator we think, when it comes to predicting GDP growth as in the below Bloomberg Graph plotting the evolution of both in Europe since 1998:

Another, "Mind the Gap".

No wonder GDP growth in Europe is indeed turning South for all:

Source Thomson Reuters Datastream / Fathom Consulting.

In relation to France, in our conversation "A Deficit Target Too Far" from the 18th of April, we argued: "We also believe France should be seen as the new barometer of Euro Risk with the upcoming first round of the presidential elections. Whoever is elected, Sarkozy or Hollande, both ambition to bring back the budget deficit to 3% in 2013 similar to their Spanish neighbor. We think it is as well "A Deficit Target Too Far" on the basis of our previous French conversation (France's "Grand Illusion").

As far as our new barometer of Euro Risk is concerned, all is not well. The 3% deficit target in 2013 is highly unlikely to be reached when one looks at a very simple economic indicator, namely France's industrial production and GDP growth since 2001 - graph, source Bloomberg:

French recession will happen. Industrial production slumped to -2.5% the lowest level since 2009 and the biggest drop since January 2009. More than the 1% decline forecast by economists in a Bloomberg news survey. Not only industrial production is cratering but sentiment among manufacturers executives was unchanged at 92 in October.

Should industrial production print fell to -3.3%, we believe France will no doubt be in recession, putting in jeopardy its overly ambitious target of 3% of budget deficit in 2013 (A Deficit Target Too Far").

What was that Standard and Poor's April note indicating with which we completely disagreed with in our April conversation relating to France - "France's Grand Illusion"? As a reminder:

"Apr 04 - Although the current recession in Europe will probably extend into the third quarter, we believe the economy may pick up modestly late this year and in 2013, said Standard and Poor's today in announcing the publication of its report "No Fast Lane Out Of Europe's Recession."

We did not share the same beliefs as Standard and Poors and we still do not share them.

France Fiscal Position - source Thomson Reuters Datastream / Fathom Consulting:

As far as France sovereign CDS is concerned, it trades at the same level as Belgium with Belgium being in a better fiscal position - source Bloomberg:

Back in our conversation "Spanish Denial", we indicated:

"When it comes to Net Financial Wealth of Households as a percentage of GDP, 2000 and 2007, as indicated by Eurostat, Italy is indeed a much richer country than expected, even compared to France and Spain. We could even go further in our analysis and compare Belgium to Italy, given their similar high debt to GDP levels (98.5% for Belgium, 119.6% for Italy), but very low household debt (around 53% for Belgium), very high savings rate (around 17% in 2011 in Belgium) as well as very high level of savings and a mostly domestically held government debt. Both countries enjoy massive private sector wealth, therefore foreign debt is negligible"

The current CDS level reflects our position that Belgium is a better risk than France having not only a much better Fiscal position but a much lower household debt and a very high saving rate:

"A wealthy private sector is significant when it comes to debt dynamics given that by broadening the tax base and introducing bigger transfers from the private sector to the public sector means the demand for government bonds in the primary market can provide a stable base as indicated by last year's report published by Danske Bank - Euro area: Why Italy is not Greece:

"The deficit in the peripherals, apart from Italy, increased sharply in 2008 and 2009. In Italy, however, it never exceeded 6% of GDP, and in 2010 the deficit of 4.6% was half that of Spain and Portugal and much better than Greece and Ireland."

On a final note in relation to France, BNP Paribas latest quarterly earnings has revealed the extent of credit contractions in France as indicated by Bloomberg:

"The appetite for loans in France is diminishing on stagnant growth. BNP said decelerating demand in its domestic retail network had edged loans down in 3Q, with consensus calling for GDP growth of just 0.1% in 2012. Net interest income at French lenders could be under pressure from waning demand and persistent low rates. French business lending contracted 0.5% yoy in September (ECB)." - source Bloomberg

"high expectations + strong consensus = danger."

"Both expectations and memories are more than mere images founded on previous experience."  - Samuel Alexander, Australian philosopher.

Stay tuned!

Credit - Chadburn, on full ahead?

"If the highest aim of a captain were to preserve his ship, he would keep it in port forever." 

- Thomas Aquinas, Italian Theologian. 

Looking at the epic capitulation in the credit space and the significant rally of credit indices recently, which could lead the performance of credit in 2012 to match the performance of 2009 in terms of total return (around 12.5% for Investment Grade credit), we thought we would refer once again to one of favorite theme of shipping in our title, namely a chadburn which is the communication device for the pilot on the bridge to order engineers in the engine room to power the vessel at a certain desired speed. As far as credit is concerned it has been on full ahead.

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. While touching again 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 still falling towards 78%, albeit at smaller pace than when the first LTRO was initiated at the end of 2011, validating further this "Risk-On" phase we have been following  - source Bloomberg:

The correlation between both the German Bund and US 10 year note is still falling (77%).

The below graph from the 2nd of June highlighted our reasoning behind our 30th of March "Risk-Off" call, displaying the various "Risk-On" and Risk-Off" phases which we have been witnessing with the on-going European sovereign debt crisis which increased significantly in May 2010 - source Bloomberg:

In similar fashion to the liquidity LTRO induced rally of late 2011, the "whatever it takes" stance from Central Banks (Fed, ECB, BOE, BOJ) means the markets are provided with some tremendous firepower. Fighting one central bank is one thing, but fighting all central banks is another as indicated by the below Bloomberg graph highlighting 3.7 trillion of asset growths.

"The combined assets of the ECB and the Fed rose 220% from the start of 2008, as they injected more than $3.7 trillion of liquidity into the global economy. The IMF claims that U.S. bank recapitalization and restructuring has outstripped similar operations in the euro zone, implying that fiscal consolidation and central bank asset shrinkage may occur faster in the U.S." - source Bloomberg.

We will not discuss the problem arising from QE in the long term as we have already approached this subject in our conversation "QE - To infinity...and beyond".

Arguably, some have called the latest programme OMT (Outright Monetary Transactions) by the ECB as a game changer. It is not. This much awaited bond-buying programme has had the desired effect on peripheral yields as indicated by the significant rally in peripheral bonds and the significant drop in bond yields source Bloomberg:

Spanish yields have receded from their summer heights of more than 7% to around 5.50%, whereas Italian bonds have fallen from 6% to 4.75%.

For us it seems that so far our "Generous Gambler" aka Mario Draghi has been very apt in applying some of General Sun-Tzu's greatest concepts:
“The supreme art of war is to subdue the enemy without fighting.” ― Sun Tzu, The Art of War

Peripheral yields have been subdued even without the OMT being triggered and Spain requesting help, given the looming regional elections, which in effect, we think are delaying Prime Minister Mariano Rajoy official request.

So, in this week conversation, following our credit overview, we would like to focus on our credit chadburn given you can always have a disconnect between the order given (full ahead) and the real situation or the urgency of the situation that is. Urgent orders requiring rapid acceleration means the handle on a chadburn had to be moved three times so that the engine room bell was rung three times. So we will look at different indicators which could clearly indicate if effectively a proper rebound is on the way and if the credit bell has arguably rung three times which would mean an acceleration in global economic growth.

But first our usual credit overview!

We recently argued that the severing of the link between Sovereign risk / Financial risk would not happen ("Pareto Efficiency"). The main concern of European authorities as indicated by the difference in spreads between the Itraxx SOVx 5 year CDS index and the Itraxx Financial Senior 5 year index has been trying to break that close relationship, expecting that the European Banking Union will finally break this relationship - source Bloomberg:

My God! Lord, my God! Please make the devil keep his word!" - Charles Baudelaire, French poet, "Le Joueur généreux," pub

We mused around the latest round of "easiness" and voiced our concern in our conversation "The Uneasiness in Easiness":

"But what in effect our "Generous Gambler" did previously with the two LTRO operations have been reinforcing in effect the link between weaker peripheral financial institutions with their sovereign country, causing some to pile up on their domestic sovereign bonds and in effect precipitating their demise for some."

This sovereign-bank "Feedback Loop" cannot be broken to restore growth in the Eurozone as indicated by the below table from Bloomberg indicating the exposure of the ECB's exposure to peripheral Europe:

"With the ECB's estimated exposure to peripheral Europe exceeding 1 trillion euros or 30% of its total assets (purchased sovereign bonds, plus lending to banks) the fate of Europe's central banks, banks and sovereigns has become more closely aligned. Breaking this "feedback loop," which is distorting the effectiveness of monetary policy, is essential for economies to expand." - source Bloomberg

As displayed by the latest Spanish misery index making new highs, the deflationary spiral is still playing out - source Bloomberg:

As far as Spanish banks third quarter provisioning are concerned, the recent surge in non-performing loans (NPLs) is seriously raising question on the adequacy of the level of provisioning.

Back in February in our conversation "Money for Nothing", in relation to Spain we argued the following:
"What analysts should be concerned about is that BBVA’s bad loans as a proportion of total lending has remained little changed at 4.07 percent in the fourth quarter of 2011. They also should be concerned as well that its Chief Operating Officer Angel Cano said in April 2010 that asset quality was probably going to be “stable from now on.”Really?". Evolution of NPLs in Spain, source Bloomberg:

"Spanish banks' non-performing loans (NPLs) grew more than 30 billion euros in the five months to August 2012, raising the question of how their 3Q provisioning will evolve in light of an impending bailout. Median coverage ratios fell to 56% in 2011 from 240% in 2006, and the trade-off between profit and falling coverage will be key to results." - source Bloomberg

Sorry Mister Angelo Cano, but, we cannot really see the stability in asset quality...and we tried. Spanish Non Performing Loans rate - source Bloomberg:

"Mortgages get paid in good times and in bad". - Santander CEO Alfredo Saenz April 2012

We "agree" to "disagree" on that point. Assessing the impact of Spanish real estate prices on bank loans is not that difficult given that a large portion are real-estate related as indicated by Bloomberg data:

"Assessing the Impact of Spanish Real Estate Prices on Bank Loans: Bad loans at Spanish banks increased to a record 10.5 percent of total lending, according to the Bank of Spain. A large portion are real-estate related, and Bloomberg data show house prices may be lower than those captured by official figures and projected in consultant Oliver Wyman's stress tests. 
 The Spanish house price index collated by Tinsa, Spain's largest home appraiser, is sometimes thought to better reflect reality than official figures. 
 The chart shows an annualized price drop of 10.1 percent on the official index and 14.2 percent on the Tinsa index. Both show price declines accelerating relative to 2011. 
To put these numbers in context, the recently released Oliver Wyman stress test exercise uses a base case move of minus 5.6 percent in the house price index for 2012, followed by minus 2.8 percent in 2013 and minus 1.5 percent in 2014. The adverse case scenario uses minus 19.9 percent in 2012, minus 4.5 percent in 2013, and minus 2.0 percent in 2014. 
 With a visible acceleration of the drop in house prices as banks attempt to sell properties and fiscal consolidation takes hold, the adverse case might start to look optimistic." - source Bloomberg

"Anyone raising this problem as one of the issues for the Spanish financial system is saying something stupid." - Santander CEO Alfredo Saenz April 2012

As far as Spanish woes are concerned, we think the latest European summit has not dealt with the growing Spanish issues, courtesy of the "Banker's algorithm" concept:
"The Banker's algorithm is run by the operating system whenever a process requests resources. The algorithm avoids deadlock by denying or postponing the request if it determines that accepting the request could put the system in an unsafe state."

So of course, our Banker's algorithm has avoided the deadlock in Europe because of Spain. Clearly by denying or postponing the request, it has determined the Spanish request could put the European system in a clear unsafe state! Indeed the worst-case scenario is playing out for Spain as indicated as well by Bloomberg article by Charles Penty from the 18th of October entitled - Spain Banks Face Pain as Worst-Case Scenario Turns Real:
"Spain’s request for 100 billion euros of European Union financial aid to shore up its banks is increasing concern about the nation’s growing liabilities. Standard & Poor’s downgraded the country’s debt rating by two levels to BBB-, one step above junk, from BBB+ on Oct. 10, saying it wasn’t clear who will bear the cost of recapitalizing banks."

Under Oliver Wyman’s worst-case projection, an economic contraction of 4.1 percent in 2012, 2.1 percent in 2013 and 0.3 percent in 2014 would contribute to 270 billion euros of credit losses and a 59.3 billion-euro capital shortfall for banks...
But maybe we are saying something stupid...

“If you wait by the river long enough, the bodies of your enemies will float by.” ― Sun Tzu

Request denied courtesy of the Bankers' algorithm:
"It is necessary that before we buy bonds, countries will apply to ESM" - European Central Bank Executive Board member Joerg Asmussen - 22nd of October 2012.
He also added:
"Let me say clearly, there is no automatism between an ESM application and our purchases".

Moving on to the relationship between the Eurostoxx volatility and the Itraxx Crossover 5 year index (European High Yield gauge), the divergence is back - source Bloomberg:

The HY risk gauge indicated by the Itraxx Crossover is still is moving towards expensive territory, but the recent widening has pushed back towards the 500 bps level. The gap between the Itraxx Crossover and Eurostoxx volatility has re-opened with volatility remaining relatively muted with the fall in systemic risk courtesy of central banks intervention.

In fact the "Risk-On" environment has clearly been supportive for our "flight to quality" picture given the significant fall we have seen in the German 5 year sovereign CDS versus the German 10 year government bond yield - source Bloomberg:

“Appear weak when you are strong, and strong when you are weak.” ― Sun Tzu, The Art of War

Back in July, in our conversation "The Game of The Century", we argued that Angela Merkel had been the big winner so far in this European game of chess, given that:
"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."

Moving on to the subject of looking at different indicators which could clearly indicate if effectively a proper rebound is on the way and if the credit bell has arguably rung three times which would mean an acceleration in global economic growth led by the US economy, we noticed recently a significant rebound in the Baltic Dry Index - source Bloomberg:

Why the rebound? As we have argued in our conversation "The link between consumer spending, housing, credit and shipping":
"The relationship between container shipping and consumer spending, traffic is indeed driven by consumer spending".

We also indicated:
"The on-going "green shoots" in US housing, the impact on the Containership industry led by consumer spending and consumer confidence is very significant"

Given consumer confidence in the US climbed to 83.1 in October according to the preliminary University of Michigan report (a 5 year high), improved sentiment and personal finances, could lead to a sustained level of optimism which could help jumpstart spending which accounts for 70% of the US economy. If the improving housing market leads to a rise in consumer spending, the GDP could surprise to the upside we think.

As far as containerized traffic is concerned as represented by the Baltic Dry Index, a change in consumer spending would have a direct impact on global traffic volume and economic growth. Looking at the Asia-Originated Containerized freight, on the 21st of September, it was up by 25%, although below May levels according to Bloomberg:

While Asia to Europe lanes worsen with volumes continuing to decline, trans-Pacific and Intra-Asia volumes are improving.

Whereas the US consumer confidence seems to be rising, falling European Confidence is hurting Air Travel Demand as indicated by Bloomberg:

"Demand for air travel in Europe will fall as business and consumer confidence is shaken by the sovereign debt crisis. The summer improvement in confidence has given way to weakness as debt problems in Spain, Italy, Ireland and Greece return to the forefront. The Bear Case is that uncertainty will lead consumers and businesses to pull back discretionary spending on air travel." - source Bloomberg.

One of the most important indicator we think in relation to our Credit Chadburn and the growth divergence between the US and Europe is the evolution of the Loans-to-Deposit ratio progress as displayed by Morgan Stanley in their recent report entitled - Tracking Deleveraging - from the 19th of October:

Another important point for the US chadburn, we think, comes from Citi's US Credit Strategy note from the 10th of October indicating the following:
"Bond vs. dividend yields: Back in ’07 the average HG non-financial bond was yielding 6.2%, while stocks for the same issuers offered a dividend yield of 1.9% (difference of 4.3%). The difference is now a negative 0.2% (2.7% vs. 2.9%), even before adjusting for factors such as high dollar prices. At some point the marginal dollar should flow from credit into equities, and it’s hard to see why we are not fairly close now."

In relation to US credit in general and US HY in particular, Goldman Sachs in their recent note from the 17th of October entitled - Assessing the interplay of macro surprises and spread products made some very interesting points:
"Macro surprises matter for spread products but in different ways.
We investigate the impact of macro surprises on the corporate bond and Agency MBS markets. 
We find that for both investment grade corporate bonds and Agency MBS, it is total returns (or equivalently yields) that respond to macro surprises. 
For high yield bonds, it is the spreads that respond to macro surprises. 
This difference reflects a trade-off between the ‘rates effect’, where positive surprises cause a back-up in rates, and the ‘spread effect’, where positive surprises lower the default premium. 
For investment grade bonds and Agency MBS, the ‘rates effect’ largely dominates the ‘spread effect’, while for high yield bonds the two effects cancel out. 
The impact is broader and larger since the global financial crisis Focusing on the post-global financial crisis (GFC) sample period, we document that the impact of macro surprises on both the corporate bond and Agency MBS markets has become larger and broader. 
Recent spread rally driven by declining premia, not better data.
Looking at the recent spread rally, we find that both high yield bonds and Agency MBS have outperformed the macro data, confirming our view that the rally has been driven mostly by risk premia compression as opposed to a better macro picture. 
The relationship with macro surprises is reasonably robust for both corporate bond spreads and MBS yields: CCC and B spreads are negatively related to the surprises, while the inverse pattern prevails for CMM yields. 
The intuition conveyed is simple: positive surprises lift growth expectations and thus cause the default risk premium to compress and Treasury yields to back up. The result is tighter corporate bond spreads and wider MBS yields.

Three key findings: Not all macro indicators are created equal (unsurprisingly). 
-For both the credit and mortgage markets, labour market indicators (non-farm payrolls, initial claims, the ADP employment report and the unemployment rate) tend to have the strongest impact. Survey data (such as the ISM – both manufacturing and nonmanufacturing – and Philly Fed) and hard data (such as retail sales and durable goods) also appear to have a significant impact on daily moves in credit spreads and total returns, as well as on CMM yields. 
-In spread terms, only high yield is sensitive to macro surprises. Moreover, the response of high yield spreads to macro surprises is monotonic in ratings: the lower the rating, the stronger the response. By contrast, investment grade credit spreads are virtually unresponsive to macro surprises for both financials and non-financials. 
-Lastly, CMM yields respond to macro surprises in a way that is almost identical to 10-year Treasury yields. This is consistent with the notion that agency MBS and 10-year Treasury securities are close substitutes of each other."

On a final  note, falling bond yields and the Fed's purchases of MBS (mortgage-backed securities) will erode further US banks profitability in the next few quarters according to David A. George, a Robert W. Baird and Co. analyst as indicated by Bloomberg Chart of the Day:

"As the CHART OF THE DAY illustrates, banks’ net interest margins have generally contracted for more than two years. The chart, based on data compiled by the Federal Deposit Insurance Corp., shows the gaps in percentage points between the average interest earned on loans and investments and the average rate paid to depositors. JPMorgan Chase and Co.’s third-quarter results showed the average yield on its securities holdings fell 18 basis points from the second quarter, George wrote on the 15th of October in a report. At Wells Fargo and Co., the drop was steeper: 27 basis points. Each basis point equals 0.01 percentage point. “Unfortunately, this headwind should accelerate” in the fourth quarter, the St. Louis-based analyst wrote. Refinancing rates for home loans have dropped as the Fed begins purchasing $40 billion of mortgage-backed bonds a month. The decline has resulted in faster payoffs on the mortgages underlying the securities, he wrote. Profits may also suffer as banks shift toward loans from securities and compete more intensely to draw borrowers, George wrote. He added that lenders may retain more of their mortgages, which would reduce fee income from selling the loans. Net interest margins peaked in 2010’s first quarter and narrowed in eight of the next nine quarters. Margins at banks with more than $10 billion in assets have dwindled more than the average for all federally insured institutions, as the chart shows." - source Bloomberg

Provided the fiscal cliff is avoided, we think the growth divergence between the USA and Europe will continue to grow and the chadburn on USS USA might indeed move on "Full Ahead" whereas for USS Europe (NCC-1792), we think it is on "Dead Slow Ahead", it is indeed in the credit prices...

"A sailing ship is no democracy; you don't caucus a crew as to where you'll go anymore than you inquire when they'd like to shorten sail." -   Sterling Hayden, American actor.

Stay tuned!

Yogurts, European Consumer Confidence and Consumption

"Consumption may be regarded as negative production."
Alfred Marshall - Economist

Looking at European company Danone's profitability warning leading to a drop in the share price in conjunction with a dismal German investor confidence Zew index (ZEW institute reported that its monthly confidence index dropped by 27.7 points to a level of -16.9 points — its strongest decline since October 1998) has made us reflexionate around Yogurts, European Confidence level and Consumption.

Danone share price taking a beating - source Bloomberg:

As reported by Dermot Doherty in Bloomberg, Danone, the world's biggest yogurt maker cut its profitability forecast as Spanish consumers switch to less expensive products and raw-material costs rise, sending the shares down the most in three years - Danone Cuts Profitability Goal on Southern Europe, Costs:

"Danone is losing market share in dairy in Spain, where about one in four people are unemployed, and will take measures such as cutting costs and introducing new products to react. That will reduce profitability in southern Europe, Chief Financial Officer Pierre-Andre Terisse said today.

“The competitive environment in Spain is a lot tougher, so they’re having to invest more in promotion and pricing,” said Martin Dolan, head of equity research at Espirito Santo in London. “This is very Danone-specific rather than sector wide because of milk raw-material costs, and Danone’s exposure to Spain is far greater at about 8 percent than for other big food companies.”

Danone also indicated in relation to consumer spending in the same article:

"The French yogurt maker in April said it expected consumer spending to remain “under pressure” this year in western Europe. European companies are wrestling with the fallout from a drop in consumer spending as the sovereign debt crisis rocks the region’s economies. Carrefour SA, the biggest European retailer, last week said it would withdraw from Greece and carmaker Fiat SpA said it would cut investment in the region by 500 million euros ($630 million)."

In similar fashion to the trend in shipping with shipping giant Maersk is in fact shifting its business away from Europe (Shipping is a leading deflationary indicator) while Airlines are benefiting from growth outside Europe where traffic to the Americas have been the biggest beneficiary (Air Traffic is a leading deflationary indicator), Danone said sales growth target of 5-7% was unchanged; with robust performance in Asia, Americas, Africa, Middle-East, CIS offsetting pressure in Western Europe.

Leading us to an interesting exercise, plotting Danone share price against the gauge for consumer sentiment which last came at minus 19.3 (from minus 19.9) at the end of May 2012: Danone share price versus European Consumer Confidence since 2006 - source Bloomberg:

At the end of May Consumer Confidence in Europe fell to a two and half year low, following the previous inconclusive Greek elections, Spanish woes and fears of a euro break up.
Yogurts matter as an indicator? One has to wonder...

As austerity bites consumer spending and with Italy and Spain in recession, companies have been forced to lower cost to protect earnings so far. End of May the ECB also indicated that loans to households and companies in the euro zone grew at the slowest pace in two years as the on-going crisis curbed demand for credit.

We already discussed the difference between the growth differential between the USA and Europe (Growth divergence between US and Europe? It's the credit conditions stupid...), which continue to improve in the USA for now as indicated by my friends at Rcube Global Macro Research:
"The private sector credit growth (one of the most reliable Fed Fund leading indicator) has spiked(15% yoy).
The % of US commercial banks reporting stronger commercial & industrial loan demand is back to 2004 levels."

"As a result, US commercial banks will adjust balance sheets to the rising demand for loans, buying fewer Treasuries in the process. Their stock of government securities has risen from less than 10% of total assets in Q4 2009, to 15% today. While the incentive to do so was large over the last 4 years (extremely steep yield curve, falling inflation, broken credit channel), it is less so today. Their pace of purchase has already slowed from 25% YoY in Q3 2009 to less than 10% today, and should weaken further."
- source Rcube Global Macro Research - 18th of June 2012

As far as European Staples are concerned, according to a recent study by Morgan Stanley, impact of private consumption in Europe could be very significant in "European divorce" scenario playing out  - "European Consumer Testing Defensiveness – Downside Case Priced In?" - 14th of June 2012:
"Better prepared for an even worse scenario? In a “European divorce” scenario, the impact on private consumption in Europe could be worse than in 2009 due to the reduced scope for fiscal and monetary policy and higher unemployment. On the positive side, the Consumer Staples sector could see less of a relative de-rating because a) financial leverage is lower, b)inventory levels are generally at more manageable levels, c) commodity inflation is lower, and d) many companies have also expanded their lower-price point offerings. The relative re-rating has also been more measured this time, as the PE premium (60%) has not yet reached the peak from Nov 2009 (80%)."

It isn't only Danone facing similar exposure to weakening consumption levels in Western Europe with a slowdown in consumption levels in peripheral countries such as Spain. Heineken, L'Oreal, Reckitt and others are also exposed to similar trends as indicated by Morgan Stanley in their recent note:

"Within the region, Southern Europe only accounts for less than 10% of group sales on average across the sector. Imperial Tobacco is the most exposed to the region (Spain accounts for around 2/3 of its sales in Southern Western Europe). It is followed by Diageo and Heineken with more than 15% of group sales in the region (mostly Ireland and Spain for Diageo, and mainly Spain and Italy for Heineken). In Food, Danone has the largest exposure to Southern Europe, as Spain (~14% of group EBIT) is its most profitable market." - source Morgan Stanley - "European Consumer Testing Defensiveness – Downside Case Priced In?" - 14th of June 2012

No surprise Morgan Stanley's conclusion:
"Mix is Key
Our Bear case analysis illustrates the importance of having diversified portfolios and geographic exposures. Geographic mix (which we define as higher-margin regions growing faster than the group average and vice versa for lower-margin regions) plays a crucial role in determining the magnitude of downside risk in our Bear case scenarios."

In regards to European Consumption trends, CreditSights in their recent Euro Consumer Takeaways from the 18th of June made the following interesting points:
"-Italy: Confidence has fallen to its lowest level ever as of May; minus 38.6. Spending had already fallen by 2.4% in the 12 months to the first quarter, which is as large as the fall in the 2009 recession. Consumer spending can only fall so far before households fall back on subsistence levels, and prolonged declines in spending are rare. As such they believe that full-year spending decline will be less negative than the 2.4% fall in the year to the first quarter, but we are still expecting to be at least 1% lower over 2012 as a whole in real terms.
-Households debts in France, Germany and Italy are much lower versus national income; compared to the UK (96% down from 103% of GDP in 2009); respectively 55%, 60% and 45% of those country’s annual GDP. Household debt-to-GDP for the Eurozone as a whole is 65%. But while households in France, Germany and Italy are less encumbered by debts and do not, therefore, have to divert income to servicing that debt, low interest rates should still act as some motivation to bring forward spending by borrowing. They believe that is especially the case of borrowing costs are barely any more than households expect their salaries to grow by.
-Consumer borrowing costs , adjusted for wages, in Germany are roughly in line with the crisis low in 2007 at 2%. However, at 4% in France and 6% in Italy, the interest rates on unsecured debts are well above the lowest rates they reached in the 2000s. Additionally, these lower real borrowing costs have not obviously generated greater increases in household debts.

Wealth holdings – the “housing” conundrum:
"In the UK most peoples’ primary provisioning for retirement is their house, that tends to mean that changes in house prices are closely associated with changes in spending. Therefore the stabilisation in UK house prices is good in that falls are not actively undermining spending any more, but in their view it will be a long time before rampant house price appreciation once again drives a boom in consumer spending.
In Germany and France, house prices have, since 2009, been growing strongly. Prices were not over-inflated by a bubble in mortgage lending in the pre-recession years. And to some extent that growth may feed through to a greater willingness to spend in those countries. But their UK contemporaries and so while booming prices in Germany may provide some inclination to spend less, they believe that more consistent income growth and falling unemployment (leading to greater job security and consumer confidence) will be more important drivers of any increases in household spending.
In contrast to France and Germany, Italian house prices have been falling for some time. And falling incomes, tax-induced increases in prices, rising unemployment and worries about the government’s fiscal position are all likely to ensure that spending by Italian households remain depressed with or without the additional impact of house price declines."

UK wise:
"The government’s attempt to tighten its belts at the same time as the private sector is also cutting spending will not only be self-defeating for the government’s fiscal position but is prolonging the period that it takes UK consumers to reduces their debts and feel confident once again about the outlook for their incomes. They expect UK household spending to be centered around the 0% range this year."

With consumer confidence and investor confidence in the doldrums, in conjunction with struggling Southern Europe no wonder yogurts are taking a beating...

"The shelf life of the average trade book is somewhere between milk and yogurt."
Calvin Trillin

Stay tuned!