Credit - While My Guitar Gently Weeps

"It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so." - Mark Twain

Looking with interest at the latest surge in the US 10 year yield to 1.94% in conjunction with the "improved" employment picture in the US as well as the fall to record low level of 1986 for the Baltic Dry index to 559, we remembered one of our favorite song from the Beatles "While My Guitar Gently Weeps" recorded in 1968 for our title analogy. "While My Guitar Gently Weeps" was ranked no. 136 on Rolling Stone '​s list of "The 500 Greatest Songs of All Time", no. 7 on their list of the 100 Greatest Guitar Songs of All Time, and no. 10 on their list of The Beatles 100 Greatest Songs.

As far as the above Mark Twain quote goes, it's indeed what we know for sure when it comes to global economic growth which is of concern to us, regardless of the supposedly "deflation escape velocity" reached by the US economy and its latest Nonfarm Payroll figures. We still sit tightly in the deflationary camp for the time being and remain extremely cautious about the risk posed by the velocity in the rise of the US dollar.

The Baltic Dry Index indicative that all is not good in global economic growth - graph source Bloomberg:

"Baltic Dry Index down to levels not seen since 1986" - source Bloomberg

You might therefore be wondering why we have used such a title as an analogy. Georges Harrison's musical masterpiece had an initial incantation, which we think, resonates well with the current investment environment and global central banks meddling in asset prices:

"I look at the trouble and see that it's raging,
While my guitar gently weeps.
As I'm sitting here, doing nothing but ageing,
Still, my guitar gently weeps."

There was as well an unused line in the very beginning of his initial writing which was eventually omitted:

"The problems you sow, are the troubles you're reaping,
Still, my guitar gently weeps."

And when it comes to QE and Central Banks, an early acoustic guitar and organ demo of the famous song had a slightly different third verse which we find interesting for the sake of our analogy with our central banks "money" games:

"I look from the wings at the play you are staging,
While my guitar gently weeps.
As I'm sitting here, doing nothing but ageing,
Still, my guitar gently weeps."

In 2004, Harrison was inducted posthumously into the Rock and Roll Hall of Fame as a solo artist. "While My Guitar Gently Weeps" was played in tribute by Tom Petty, Jeff Lynne, Steve Winwood, Steve Ferrone, Marc Mann, and Dhani Harrison, and concluding with arguably one of the most  memorable guitar solo by fellow inductee Prince but we ramble again.

In this conversation we will re-assess current trends and "rotations" and "look at the trouble" to see if it is indeed "raging" while our guitar gently weeps as well as musing around the impact QE has had in Europe so far.

Synopsis:

• Lower expected returns and higher expected volatility
• "Great rotation" not from bonds to equities but, from US equities to European equities in early 2015
• European equities lift-off akin to the move seen on the Nikkei  (hedged) in 2013but with less firepower!
• Rising divergence between volatility and credit spreads in Europe

• Lower expected returns and higher expected volatility

When it comes to the outlook for returns, we agree with Nomura's latest Strategic Outlook note from the 6th of February 2015, namely that we are going to see lower expected returns and higher expected volatility. We also share their concern on the US economy. We think it is more fragile than currently assumed:

"A common view is that the US economy is in good shape – effectively immobile against a stronger USD or lower energy prices or low productivity. With most of the rest of the world (ex Brazil) loosening monetary conditions (FX and rates) another view is emerging that EM growth will recover. And the ECB’s QE announcement should, it is argued, hedge downside inflation and hence growth risks in the euro area. These views rest squarely on the assumption that the US will not and never has slowed down from above trend growth without the intervention of the Fed via tight monetary policy. In contrast we see increasing evidence that the US profit cycle is in fact maturing rapidly and that profit growth is likely to disappoint through H1. If this is the case then slower capex and employment follow – regardless of the Fed. This would constitute a major surprise to global forecasts that are more clustered than they have been since 2007.

Given the starting point for inflation this scenario would generate further upside pressure on real yields across the curve. How risk aversion would respond is critical to predicting the outcomes for returns. By contrast the bullish growth scenario would, we think, lead to a rapid repricing of Fed hikes back toward June given the stage of the US cycle. Our unpalatable strategic conclusions are that growth estimates for H2 will probably need to come down, that real yields or nominal yields are going back up under most scenarios, and that risk aversion will continue to trend higher." - source Nomura

While we have taken the proverbial "beating" on our ETF ZROZ long duration exposure losing 7% since the 30th of January, we are sticking with our position, given our lower entry level in the trade (we have also exposure to a long term macro short term trade offsetting the short term pain via ETF YCS, being short JPY for disclosing purposes...). The recent widening in US Treasuries make a good entry point for those who missed out, we indeed, expect, the data in the US, from a contrarian perspective to be weaker than previously expected, regardless of the most recent NFP.

On that specific point we would like to point out to Reorient Group's latest note on a US premature rate hike from the 8th of February 2015:

"Individual components of the employment report are at odds with other data. One of the fastest-growing components of employment, for example, was construction, with total head-counts up 5.5% year-on-year as of January. Construction spending adjusted for the construction Producer Price Index was flat year-on-year. Either the spending numbers were wrong (but unlikely because construction activity is easily counted) or the employment numbers are suspect."

 - source Reorient Group

We agree with the above, that all is not what it seems and it demands a more inquisitive mind when it comes to taking the data at "face value".

• "Great rotation not from bonds to equities but, from US equities to European equities in early 2015

From an allocation point of view, what we find of great interest has been the continued inflows into the bond sphere (59 straight weeks of inflows to Investment grade bond funds with $8.7bn) as indicated by Bank of America Merrill Lynch's Follow the Flow note from the 5th of February entitled "The Bond Capitulation":

"On Flows and Markets
Bond is Back: massive inflows to bond funds ($21bn – 7th largest weekly inflow on record – Chart 1); outflows from equity funds ($7bn).

Gold is Back: largest 3-week inflows ($3.8bn) to precious metals funds since
Aug’11 (Chart 2).

Europe is Back: 4th consecutive week of equity inflows to Europe (Chart 5); contrasts with outflows from US/EM/Japan.

EM Debt is Back (at least for a week): 1st inflows in 9 weeks to EM debt funds ($0.9bn).
Risk Resilience: best explained by ECB & Sentiment (risk has rallied since BAML Bull and Bear Index flashed "buy" on Jan 7th…US HY 1.8%, SPX 3.0%, ACWI 5.4%, WTI 5.5%, SX5E 9.1% (all $-terms).
Risk Resilience: note also significant weekly inflows to bonds and/or gold in past 15 years (i.e. moments of “fear”) have unsurprisingly proved decent entry points into stocks (Chart 4).

- source Bank of America Merrill Lynch

In relation to Bank of America Merrill Lynch and its "Great Rotation" story, it seems that, courtesy of the ECB unleashing a QE of its own, the great rotation has clearly been from US equities into European equities it seems with $4.3bn of inflows for a 4 straight week, whereas the US saw $9.9bn of outflows for a 5 straight week. European assets seems to be a large beneficiary from the ECB's promises to deliver a QE of its own as indicated once more by Bank of America Merrill Lynch's Follow the Flow note from the 6th of February 2015 entitled "Income mania":

"Biggest inflows ever into European assets
Fund flows highlight the chronic shortage of yield in Europe. Last week saw the greatest ever total inflow into European assets (chart 2). 

The reach for yield was in full effect across high-grade and high-yield credit, government bonds, money market funds, equities and commodity funds, according to EPFR. In terms of notable trends:
• Money-market inflows were the 4th highest ever.
• European equity inflows were the 6th biggest ever.
• Inflows into government bond funds were the 3rd largest ever.
• Inflows into all fixed-income funds were the 2nd biggest ever.
• High-grade credit flows were the 8th largest, since data began.
All in all, aggregate risk-on flows in to European assets were huge: almost $40bn!" - source Bank of America Merrill Lynch

At the same time and on a monthly basis, the S and P 500 saw during the month of January $28bn of outflows and equating to 15% of AUM according to Morgan Stanley. In fact, the biggest monthly outflow ever:

- graph source Bloomberg / Morgan Stanley


Also, investors continue to pile into the yield trade as the search for income runs unabated.

For instance IYR (REITS) had its largest daily inflow ever on the 2nd of February ($900 mln or 12% of AUM) according to Morgan Stanley:

- graph source Bloomberg / Morgan Stanley

We believe the great rotation story in 2015 currently playing out is indeed from US equities towards European equities for the time being and we agree with the following comments from Morgan Stanley:

• "US investors are loaded up on US risk:  50% of the entire industry ETF flows since 2009 has gone into US equities ($300 bln).
• The peak in global growth might very well have come in Q1 (US printed 5% GDP in Q3 and Q4 GDP came in 2.6% below the 3% consensus forecast).  Now we have a strong dollar and we are starting to see countries implementing policy stimulus to close the gap in growth." - source Morgan Stanley

So indeed while our guitar is gently weeping, US risk is indeed much less appealing than European risk (Grexit avoided of course...).

Therefore, when it comes to allocation to European equities it is definitely on the "menu du jour" as displayed in Louis Capital Markets Cross Asset Weekly report from the 2nd of January:

"Run Forrest!
No client meeting we have conducted has passed without a question on the relative performance of European equities compared to US equities being posed. European investors are well loaded with European equities as they suffer the classic “home bias”, well known in academic literature. US investors are similarly biased, but the letters Q and E, that recently reared their head in Europe, have broadened their investment universe and a flow of money has poured into European equities. The US ETFs that hedge the currency impact have benefited strongly from this trend as we show in the chart below.

This re-balancing has happened in a context where Wall Street has started to show some signs of weaknesses. We have recently discussed this hypothesis and it seems that US indices have lost their upward momentum (at least, in the short term).
The reversal of the profit trend could be the reason for this weakness. Or perhaps this is simply a profit taking phase, because as we all know these are a regular occurrence in equity markets.
Sarcasm aside, the fact that European equities recorded new highs in this less than favourable context is therefore heroic, because on the profit side there is absolutely nothing new. The charts below illustrate this. We can understand that the impact of the EUR/USD is positive for European companies and negative for US companies, but in the earnings forecasts of analysts there is no change. 

The 2015 EPS of the Eurostoxx50 has been revised down by 2.2% for the sole month of January. 

Although we share the consensual view that the decline of the EUR/USD will support profits of the European index later this year, this 2.2% negative revision is a reminder that on an index level the macroeconomic developments that appear obvious to many investors are not so straightforward when it matters due to its composition/structure.

By sector, the message is consistent with the “currency advantage” as consumer stocks that are quite global have done better than more domestic sectors like utilities or financials. The telecoms sector, with its very strong performance, is the exception in Europe.
However, the difference in performance between the Eurostoxx and the S&P500 since the beginning of the year is broad based and not related to a specific sector. The underperformance of US financials compared to European financials sends a key message here: this is not only a matter of exchange rates.

The herd mentality is strong on equity markets with this run against time to chase European equities that keep a potential for a catch-up if we look at prices. If we look at valuation (without discussing the impact of possible different profit cycles and different profit trend growth) the potential for a catch-up is exhausted. We have updated our table on the valuation of the MSCI EMU if we apply to it the sector composition of the US index. Here, we find a mere 2.2% discount in terms of forward PER.

Last week we started mentioning the valuation aspect of the Europe/US question. To be clear, we stress that profits have to improve significantly to think that European indices can outperform on a sustainable basis its US peers." - source Louis Capital Markets

• European equities lift-off akin to the move seen on the Nikkei  (hedged) in 2013but with less firepower!

This European lift-off in equities hedged is akin to the move seen in 2013 on the Nikkei hedged complex which provided solid performances for "wise" investors. (we admitted in 2013 that we enjoyed being long Nikkei hedged in Euro). We have repeatedly highlighted the weakness in aggregate demand in the Eurozone. We argued in the past that the growth divergence between US and Europe were due a difference in credit conditions. Unless there is a significant sustained improvement in credit conditions in Europe, we don't think Europe can deliver more stellar returns than Japan did in 2013 while our guitar gently weeps.

• Rising divergence between volatility and credit spreads in Europe

From an equity to credit perspective, one of the major impact from the ECB's QE has been the rising divergence between Eurostoxx 50 Put/Volatility versus Credit Spreads. This has been for us quite logical for Investment Grade, less so for High Yield. According to Goldman Sachs the spread between Out of the Money Put options on the Eurostoxx 50 and CDS spreads is at its highest level since 2010, and the yield that can be obtained by selling 70% put on the Eurostoxx 50 is 3 times higher than the Itraxx Main Europe CDS 5 year index (Investment Grade proxy for risk with 125 entities):

- source Goldman Sachs

Furthermore, as we indicated in our conversation relating to the growth divergence between the United States and Europe ("Growth divergence between US and Europe? It's the credit conditions stupid..."), it is all about 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 major difference can already be seen, we think from the behavior of credit versus equities as discussed by Bank of America Merrill Lynch in their Credit Derivatives Strategist note from the 6th of February entitled "Catch the basis if you can":

"Central Banks liquidity primarily provides a strong back-stop against funding risks; rather than support earnings, which usually come further down the line. When the Fed announced the first QE program, credit spreads outperformed equities.

On the flip side, the ECB QE announcement has not ignited the same response. This time around credit lagged equities.

One could argue that European credit spreads are already close to the tightest levels in years, and thus should lag post an ECB QE announcement, especially when growth outlook is coming off the lows. At the end of the day the ECB QE is meant to boost growth rather than to reduce funding/default risks, and equity markets have started pricing that.

However, we expected Crossover to follow suit on the strong reaction from equity markets, being a growth proxy in the credit market. We were expecting Main to underperform Crossover in a QE event, also reflecting the same strong growth potential the equity markets are pricing.
However, XO has lagged the risk on move tighter. We think that this was not driven by the lack of yield in credit markets – as government bond yields have continued to rally – but mainly due to the rise of geopolitical risks and the resurfacing of funding risks." - source Bank of America Merrill Lynch

End of the day, it doesn't matter that European stocks have been racing ahead of fundamentals, from a "quality" and "japanification" perspective, it is still a goldilocks period for Investment Grade credit, particularly in a shift towards a new regime of higher volatility.

On a final note we leave you with Nomura's forecast of stock of assets purchased by central banks as a % of national GDP from their Economics Insights note of the 28th of January 2015 entitled "Comparing ECB QE with BOJ, Fed and BOE programmes:

"• BOJ holdings of JGBs are expected to increase from the equivalent of around 40% of Japanese GDP at the end of 2014 to around 60% of GDP by the end of this year. This compares with “only” 14% of GDP in the case of the Fed and just over 20% of GDP for the BoE.
• ECB purchases of sovereign bonds (just over €40bn a month, allocated according to the capital key) will be equivalent to around 4% of GDP by end-2015. These will have grown to about 7.5% of GDP by end-September 2016 (or around 13% of the total stock or 17% of the targeted stock; the latter referring to the maturity parameters of a remaining maturity of 2 years and a maximum remaining maturity of 30 years at the time of purchase).
• Only the Fed has engaged in macroeconomically significant (measured as a share of GDP) purchases of assets other than Treasuries, buying the equivalent of 10% of US GDP of Agency MBS. We estimate the ECB will maintain private sector asset purchases at around €10bn a month, resulting in purchases equivalent to just 1% of GDP by the end of this year and reaching 2% of GDP by the end of September 2016.
• In conclusion, if one believes in the effectiveness of QE (we don’t), then size probably matters. In this context, there are two considerations: (i) the increase in the stock of purchases is going to be gradual, which implies it is going to take some time for the cumulated size to become meaningful, and (ii) the cumulated expected size of the programme by the end of this year will still be only a third of the size of the Fed and BoE programmes, suggesting that, if you believe in the effectiveness of QE, the ECB’s programme will need to grow much more significantly before it has a macroeconomic impact." - source Nomura

 “It's not the size of the dog in the fight, it's the size of the fight in the dog.” - Mark Twain

Stay tuned!

Greece - Cognitive Restructuring

"Economic depression cannot be cured by legislative action or executive pronouncement. Economic wounds must be healed by the action of the cells of the economic body - the producers and consumers themselves." - Herbert Hoover

Like any good cognitive behavioral therapist, we tend to watch the process rather than focus solely on the content. We have been therefore watching with interest the Greek saga and it's "Schedule Chicken" redux:

"The practice of schedule chicken often results in contagious schedules slips due to the inner team dependencies and is difficult to identify and resolve, as it is in the best interest of each team not to be the first bearer of bad news. The psychological drivers underlining the "Schedule Chicken" behavior are related to the Hawk-Dove or Snowdrift model of conflict used by players in game theory." - source Wikipedia.

It is therefore not a surprise that, given our fondness for behavioral analogies, we decided this week to use as our title analogy "Cognitive Restructuring" with the on-going Greek debt odyssey taken by its new hero, Greek Finance Minister Yanis Varoufakis to alleviate Greece's €315bn Damocles sword. 

When it comes to our title, as a tongue in cheek to debt restructuring, it refers firstly to a psychotherapeutic process of learning to identify and dispute irrational or maladaptive thoughts known as cognitive distortions, such as "all-or-nothing" thinking (splitting), magical thinking, filtering, over-generalization, magnification, and emotional reasoning, which are commonly associated with many mental health disorders according to Wikipedia. Our title is even more appropriate when one realizes that  "Cognitive Restructuring" is used to help individuals experiencing a variety of psychiatric conditions, including "depression", substance abuse disorders (debt), anxiety disorders collectively, bulimia (more debt), social phobia, borderline personality disorder, attention deficit hyperactivity disorder (ADHD), and gambling, just to name a few.

In this week's conversation, we will visit Greece issues from an historical perspective and look at solutions as well for the long term.

Synopsis:

• Greece: a story of "unfinished business"
• Redistribution without efficient taxation cannot work on the long run
• How do you deal with a Mezzogiorno country like Greece?
• Will a GREXIT solve Greeks' woes?
• Keynesian solution to counter the fall in aggregate demand even with QE will fail

• Greece: a story of "unfinished business"

The on-going Greek Tragedy and its "Cognitive Restructuring is from an historical point of view a question of "unfinished business", in the creation of a modern state. On that subject we recommend reading "The Greek State: Its Past and Future" - An interview with Anastassios Anastassiadis from March 2012:

"Greece’s budget deficit and debt started growing rapidly in the eighties. At first, devaluations of the drachma and inflation softened the blow, but they were also bad for that Greek “frugality” that I mentioned a moment ago. In the second half of the 1990s, control of public finances was only ephemeral, and was quickly set aside by the euphoria elicited by the pharaoh-like projects that were planned for the 2004 Olympics. Furthermore, upon entering the euro, the Greek economy benefited from broad access to cheap credit. Within barely twenty years, frugality had given way to consumption, leading to a heavy dependence on credit. The Greeks borrowed from their banks, which borrowed from French and German banks. Why? To buy French and German goods." - Anastassios Anastassiadis.

On the subject of Greece, we read with interest the following comment from a reader of the Economist article "What emergency liquidity assistance means":

"Syriza seems determined to generate a payments crisis in Greece.
They have pledged (this weekend) extra spending:
- rehiring over 10,000 redundant civil servants
- increased pensions for lower income pensioners
- various schemes for providing free utilities & food to low income households
They have pledged (this weekend) to cut taxes:
- tax-free threshold for income increased to €12,000 (above median wage)
They have proposed no areas for spending cuts or raising tax revenue (beyond vague notions of tackling tax avoidance; some hopes that a higher minimum wage might boost tax revenue; alongside wishful consideration of fiscal multipliers and Laffer effects).
Against that background (a Greek payments crisis seems pretty certain, irrespective of whatever credit conditions Europe offers Greece), we should also recognize that a Greek begging bowl is offensive to the many poorer countries in the eurozone (Portugal, Slovakia, Slovenia, Estonia, Latvia, Lithuania).
Note:
- Greece has a basic state pension of €400/ month (which will be €5,200/ year when Syriza reintroduce the "13th month payment"), but most Greeks receive much more than this (state pension increases based on earnings). That is far more generous than, say, Lithuania's €236/ month (flat) state pension (only 12 months - they can count). Why should Lithuania pay for Greek profligacy? Compare public sector wage levels, government transparency, court performance, corruption, etc and there are many good reasons for most eurozone countries to grudge lending Greece a cent more than they already have.
If Syriza wants to rescue this, then they are going to have to come forward:
1) with sensible cashflow (revenue, expenditure) projections, and with proposed policy adjustments (moving forward) for accommodating any surprises. There must be a high degree of confidence that Greece can function without additional borrowing, without triggering a payments crisis in the near future.
2) with a credible programme of structural reforms, e.g. disempowering the oligarchs, taxing the church, forming a land registry and progressively taxing land, reforming courts, slashing military budgets, investing in education and R&D, making it *easy & quick* to register a business online and to begin doing business (without obtrusive or protracted licensing requirements), etc.
3) with a credible pledge to (by 2016) run a small primary fiscal surplus (perhaps a 1-2% of GDP target) and some domestic mechanism (auditing, legal review, etc) for generally pursuing this target (with some flex, but without bias towards deficit)

These three points are the absolute minimum - without these three points, there can be no further credit provisions for the Greek state. Syriza must somehow be brought to recognize this - based on their remarks over the past couple of days, they seem determined to default on pensions & wages, bankrupt the banks, wipe out business and broadly destroy the Greek economy entirely."

• Redistribution without efficient taxation cannot work on the long run:

We agree with the above analysis from a reader from The Economist and we reminded ourselves what we wrote back in August 2011 in our conversation "Liquidity? The IV Greek Credit Therapy":

"One thing Greece must address is tax cheats who represents 30 billion euros, or 12 per cent of GDP, every year. Another American solution to European woes would be, for Greece, to tax its citizens on their worldwide income, similar to the US. It would be a very efficient way to stabilise its ailing banking system and deposit outflows given one third of its funds withdrawn have gone abroad for fear of a crackdown on tax evasion. By imposing Greek citizens on their worldwide income like US citizens, and with the help of Luxembourg authorities, Cyprus, Switzerland and the United Kingdom, the outflow could be stemmed and vital tax receipts could rapidly help close the gap on the very acute budget deficit, but that's another story..."

There is nothing new about the Greek situation and the errors that have been made by its creditors, French and German banks initially (before being bailed out by European taxpayers) as written by French great writer Edmond About in 1858 as reported in Vox Europe in their article of February 2012 "Greece 1858 – plus ça change":

"Loans are only granted to governments that are well established. Loans are only granted to governments that are believed to honest enough to honour their commitments, and loans are only granted to governments that lenders want to maintain in office. Nowhere in the world does the opposition lend to the government. Finally, lenders can only grant loans when they have the necessary funds themselves." - Edmond About

But the issue with Greece, when it comes to "Cognitive Restructuring" and focusing on the process rather than the content (as any good behavioral psychologist would do), is the "unfinished creation" of a proper Greek state we would argue. It was further debilitated by the introduction of the Euro .It led the government access cheap credit and mis-allocation of European subsidies, mixed with corruption of the government, who used European funds to boost public spending on a grand scale. This "mis-allocation" of "capital" (funded by European banks) led to prices rising to inappropriate levels due to the inappropriate level of salaries in the increasing cohorts of public servants hired:

"The Greek system nonetheless suffered from three serious shortcomings: finances that were generated primarily by indirect consumption taxes; haphazard enforcement, which gave some professional groups better salaries simply because of their superior negotiating powers; and, finally, the use of public-sector employment and of advantages granted on the basis of “social criteria” as a cheap way of providing social insurance." - Anastassios Anastassiadis

Of course a fiscal policy based mostly on consumption taxes and the lack of a proper land registry (even after Europe poured €100 million euros for this specific purpose) meant that as soon as "austerity" measures were put in place by the Troika, revenues collapsed and misery increased on a grand scale. 

• How do you deal with a Mezzogiorno country like Greece?

As clearly highlighted by Dr Dambisa Moyo, in her book "Dead Aid" relating to the $1 trillion in development-related aid transferred to Africa, we believe Greek Finance Minister Yanis Varoufakis is right in the need for a sort of New-Deal for Greece.

Without the mis-allocation of a large part of European subsidies, sunk into Greece, and the completion of a Greek state there would not be such a difficult debt problem in the first place. Direct investments in infrastructures which human capital benefits from as well as productive capital, is the strategy currently followed by China, for instance in Africa. This is as well a subject tackled by Dr Dambisa Moyo in her most recent book "Winner take all".

• Will a GREXIT solve Greeks' woes?

Without "Cognitive Restructuring" and dealing with the "unfinished business" of creating a proper state with efficient records and taxation, Greece's exit from the Euro with a devaluation and a return to the Drachma, will not bring an end to its misery. This is clearly shown by Dr Constantin Gurdgiev's post from the 30th of January 2012 entitled "Fake Doctors Treating Fake Disease in Greece":

"There are many 'expert' voices in the media saying Greece should exit the Euro zone in order to return to growth. This, as I commented earlier today, is a gross oversimplification of the reality.
There is simply no evidence whatsoever that Greece can grow on its own any faster or more sustainably than it did within the Euro. In fact, the evidence presented below shows that the only period during the last 30 years in which Greece was able to somewhat marginally close the gap in growth between itself and the Advanced Economies group is the period immediately following its accession to the Euro.
It is a fallacy of 'alternative expectations' to believe Greece will be enabled to grow its economy under post-euro devaluation beyond achieving a 1-2 years-long 'bounce'. Analysts who expect Greece to recover on the back of exiting the euro & devaluing are deluding themselves for two major reasons:
1.Greece has no fundamentals for growth & its debt overhang will remain, unless it defaults hard. Even with a default, removing debt overhang is not going to deliver growth to Greece beyond simple mechanical post-depression bounce, as Greece lacks all fundamentals for growth - institutional, cultural and historical.
2.However, with a hard default option, post-Euro, Greece will not be able to borrow & absent Government spending Greece has no capacity to grow. This is clearly shown in the charts below which highlight that in 23 out of the last 29 years, Greece has managed to achieve growth only with accompanying fiscal imbalances.
In summary, Greece never once had any fundamentals to grow on its own without massive subsidies either via loose monetary policy or overinflated expectations relating to the country accession to the European common structures. Greece is not about to get real growth-driving fundamentals within or outside the euro area.
 In short, all those talking about 'Greece must exit euro zone to achieve growth' are nothing more than fake doctors treating a patient who himself is faking a disease. Greece's problem is not the Euro. It's problem is Greece itself." - Dr Constantin Gurdgiev - True Economics blog

There is no good decision for Greece between Grexit or No Grexit. Regardless of the path it chooses, the lack of completion of its state is the only way to put an end to the misery of its people.

• Keynesian solution to counter the fall in aggregate demand even with QE will fail

We already touched on debt deflation in our August 2011 conversation "AAA ratings - 10 little indians...and debt deflation (why Irving Fisher is right)":

"For Keynesians, the fall in aggregate demand caused by falling private debt can be compensated by growth in public debt, a government credit bubble. It isn't working."

When it comes to Greece in particular and Europe in general we reminded ourselves of the wise words as well of our good credit friend in 2012:

"When somebody has too much debt and cannot reimburse it, how do you bail him out? Obviously by restructuring his debts, which imply losses for his creditors.
But when one lends him more money in order for him to pay back what he owes, he is not bailing him out but rather pushing him in a bigger hole! The game until now has been to "print" more money and to add more debt on the shoulders on the indebted ones, to gain some time in the hope that growth will resume and reduce de facto the weight of the existing debt burden and the additional new debt issued to support the initial debt troubles.
This is a big misunderstanding of debt dynamics and its effects on the economy. When debt becomes too big, which it is now the case in many parts of Europe, the servicing drains all the available cash flows and reduces the growth potential."

We keep reminding ourselves that credit dynamic is based on Growth. No growth or weak growth can lead to defaults and deflation. We hate sounding like a broken record but: no credit, no loan growth, no loan growth, no economic growth and no reduction of aforementioned budget deficits and debt levels.

The only way to make the marginal-utility-of-debt go positive, is to decrease the debt load back to a level where the private sector can produce more than its interest payments.

In Europe without debt mutualisation and fiscal transfers on a grand scale, deflation will not be avoided, QE or not.

From our August 2011, we indicated at the time that Irving Fisher's Forward Year Tax Receipts was indeed an interesting solution for the debt deflation situation plaguing the world (with the US in mind given the efficiency of the IRS and the fact that US citizens are taxed on their worldwide income):

"Recognizing that the federal government issues liabilities (debt) in its own currency and thus can never go bankrupt, another solution is for the federal government to become more like the corporate capital markets with debt issuance at high real interest rates and equity like issuance at even higher real rates of appreciation. The likely candidate for equity like issuance by the federal government is forward year tax receipts. A forward year tax receipt is a receipt for taxes paid in advance that are due some time in the future. Like government debt issuance, forward year tax receipts have a rate of appreciation and a duration. Unlike, government debt, the rate of return is not guaranteed. The realized rate of return is totally dependent on the owner's future income and subsequent tax liability. And so savers are rewarded with a positive real rate of return and debtors can realize an after tax cost of credit that is significantly less. For instance if the federal government sells 30 year debt with a 3% real rate of return and sells forward year tax receipts with a potential 7% real rate of return, then a debtor can realize a -4% cost of credit. At that point inflation is not required nor should it be desired." - source Debt deflation

Unfortunately, with most of the world implementing ZIRP, there will be no happy ending this time around rest assured:

"If you want to raise real GDP, you raise the real interest rate on government debt (which the federal reserve controls) and / or you lower the tax rate. This works well enough until you run a huge trade imbalance (like with China) that suppresses real interest rates or if you have a great depression type scenario where the inflation rate is severely negative (massive deflation). In the massive deflation scenario real GDP may show growth while nominal GDP would show contraction.
The way to get around both scenarios is to sell forward year tax receipts. A forward year tax receipt lowers the after tax cost of credit in the private sector while not depriving the bondholder of income (Friedman's permanent income hypothesis). This is the problem with monetary policy as it stands now. In a true great depression massive deflation type scenario even tax cuts don't have any traction because if nominal interest rates are 0, lowering the tax rate would have no effect on either money velocity or GDP." - source Debt deflation

On a final note we give you a revised Schedule Chicken" redux:

• "Wednesday February 11th – Likely t-bill auction to cover EUR 1.4bn maturity on 13th 
• Wednesday February 11th - potential emergency Eurogroup 
• Thursday February 12th – European Council of EU Leaders, Tsipras likely to meet Merkel on sidelines 
• Friday February 13th – Voting for new Greek President begins, EC Commissioner Avramopoulos most likely candidate, originating from New Democracy. Likely completed by second round on the following day requiring 151 MP majority
• Monday February 16th – Eurogroup where Greece likely to be top of agenda, conditions for extension of program to be made explicit by now 
• Wednesday February 18th-19th- - Bi-weekly ELA review Saturday February 28th – Current EFSF program expires" - source Deutsche Bank

As well as Greece debt profile as displayed in a recent CITI report:

- source CITI

"When people are taken out of their depths they lose their heads, no matter how charming a bluff they may put up." - F. Scott Fitzgerald

Stay tuned! 

Credit - Stimulant psychosis

"Every form of addiction is bad, no matter whether the narcotic be alcohol or morphine or idealism." - Carl Jung

Watching with interest our "Generous Gambler" aka Mario Draghi finally firing his "Chekhov's gun" and unleashing QE in Europe, pushing in effect more government bonds towards negative yields, we reminded ourselves, when choosing this week's analogy for our title of a specific kind of psychotic disorder called "Stimulant psychosis" that occurs in some people who use stimulant drugs:

"Stimulant psychosis commonly occurs in people who abuse stimulants, but it also occurs in some patients taking therapeutic doses of stimulant drugs under medical supervision." - source Wikipedia

While the symptoms of stimulant psychosis may vary slightly depending on the drug ingested, it generally include the symptoms of organic psychosis including hallucinations, delusions, thought disorder, and, in extreme cases, catatonia. We can already see in the MSM (Mainstream media) and in most of the comments from the European political "elite" symptoms of hallucinations, delusions and of course thought disorder of the highest order but we ramble again...

As a reminder of our conversation "Pascal's Wager" from October 2014, we pointed out the strength of the deflationary forces at play:

"In terms of the implication for Europe (as discussed in the "Coffin Corner"), the aggressiveness of the Japanese reflationary stance spells indeed more deflation for Europe, unless the ECB of course decides to engage as well in a QE of its own:
"Moving on to Europe, we are unfortunately pretty confident about our deflationary call in Europe, particularly using an analogy of tectonic plates. Europe was facing one tectonic plate, the US, now two with Japan. It spells deflation bust in Europe unless ECB steps in as well we think." - Macronomics - 27th of April 2013."

Of course in this week's conversation, we would like to review the supposed impact of what QE will bring to Europe, and we would like to point out the implications of the unleashing of the "Chekhov's gun by our "Generous Gambler" and the major difference between QE in Europe versus QE in the US, because once again the Devil is indeed in the details. 

Synopsis:

• The ECB has become the world's fastest QE gunslinger!
•  Rentiers seek and prefer deflation - European QE to benefit US Investment Grade credit investors.
• The on-going "Stimulant psychosis" experience led by our central banks deities is leading to more pronounced "Cantillon Effects" aka asset price inflation on a grand scale.
• In similar fashion to what we wrote about Japan in general and credit versus equities in particular in our April 2012 conversation "Deleveraging - Bad for equities but good for credit assets"
• The result of course is that the unquenchable hunt for yield is not only pushing investors towards the higher quality spectrum but also extending duration exposure
• When it comes to the "euthanasia of the rentier", what our central bankers deities are not realizing is that capital with ZIRP is not being deployed but merely destroyed
• We would like to re-iterate, investors shorting US Treasuries will continue to be punished!
•  European QE, the Devil is the detail and the future of the Euro lies in Germany's liability exposure

Talking about the Devil, it reminds us as well of the quote we used back in September 2014 in our conversation "Sympathy for the Devil":

"The greatest trick European central bankers ever pulled was to convince the world that default risk didn't exist" - Macronomics.

In fact in our previous conversation we indicated the following:

"Investors have indeed Sympathy for the Devil we think, as they continue to pile up with much abandon and more and more getting "carried away" in their insatiable hunt for yield. In that sense Baudelaire's 1869 poem rings eerily familiar with the current investment situation in the sense that investors have been giving our "Generous Gambler" the benefit of the doubt (OMT - and now full blown QE) and shown their sympathy and their blind beliefs in "implicit" guarantees, rather than "explicit" (such as the German Constitution as we argued in various conversations):
"If it hadn't been for the fear of humiliating myself before such a grand assembly, I would willingly have fallen at the feet of this generous gambler, to thank him for his unheard of munificence. But little by little, after I left him, incurable mistrust returned to my breast. I no longer dared to believe in such prodigious good fortune, and, as I went to bed, saying my prayers out of the remnants of imbecilic habit, I said, half-asleep: "My God! Lord, my God! Please make the devil keep his word!"
But as years have gone by in the European tragedy, we have become somewhat immunized from our great magician's spells. Many investors have indeed shown the greatest sympathy in respect to piling up on European Government Debt in the process, while banks have been shedding assets leading to outright credit contractions leading in the past two years European banks to cut their lending to businesses by about 8.5 per cent." - source Macronomics, 9th of September 2014

• The ECB has become the world's fastest QE gunslinger!

While we pointed out in our conversation "Chekhov's gun" that the BOJ and the FED had been QE fast drawers with the SNB front running aggressively the ECB as of late, as pointed out by Bank of America Merrill Lynch European Credit Strategist note from the 23rd of January entitled "QE Sera, Sera", the ECB has become the fastest gunslinger around:

"And so it begins…
The dawn of QE in Europe. Yesterday’s ECB meeting lived up to expectations, plus more. The central bank unveiled asset purchases of €60bn a month across Eurozone sovereign, agency, covered and asset-backed bonds. Banks were boosted by the TLTRO being made cheaper and thus more tempting. But the biggest victory for Draghi, in our view, was the open-ended feel that he was able to convey towards the programme.
Risk assets gave the ECB a vote of confidence by the end of the day, and understandably so – the ECB will likely now have the fastest growing balance sheet across the globe (chart 1). 

Stocks finished up yesterday, sub banks rallied and high-yield tightened. CCCs in particular were very strong, up 2-3pts, the first time in a number of months that the asset class has seen a big move.

But what of credit?

For credit investors, there was no pledge to buy corporate bonds. We had wondered whether the ECB might “tag on” corporate purchases just to make their asset gathering process easier. The dream could still live on if the ECB struggle to buy €60bn a month (note our rates team’s net Eurozone government bond issuance forecast of only €275bn this year). But for now, credit will not be bought.

Yet, there were few signs of weakness, or knee-jerk moves wider in corporate bonds yesterday. If anything, the need for income remains as intense as ever in Europe, with the backdrop of huge amounts of negative yielding government debt (chart 3), and note that the Danish Central bank lowered its deposit rate yesterday (the second cut in a week!). 

The race below zero by central banks is in full force, and so is the movement of money “up the value chain” in search of positive returns. Credit should benefit tremendously from this over time, we think.

The ECB is also becoming a prolific asset gatherer just at a time when financing needs, generally, are in decline. Sovereign funding needs have shrunk as budget deficits have reduced, bank funding needs have also dwindled amid deleveraging and the ECB’s focus on rejuvenating the loan market will mean less corporate supply over time, especially in high-yield (note SME lending rates are falling quickly now, chart 2).

 Chart 4 shows the net supply of fixed-income instruments in Europe on a yearly basis (we use sovereign debt, covered, senior banks and quasi-sovereigns), versus the net growth in the ECB’s balance sheet.

The bottom line is that the ECB is expanding its balance sheet just at a time when assets are being produced at a slower rate. As central banks exacerbate the demand/supply imbalance in asset markets, we see this as a backdrop for prices generally to rise, and by extension – credit spreads to rally." - source Bank of America Merrill Lynch

Of course we agree with the above when it comes to the value proposition of credit in Europe thanks to the on-going "japanification" process, with the slow "euthanasia of the rentier" to paraphrase Keynes from his 1936 "General Theory" book. On that subject we read with interest Andrew McKillop's January 2013 article entitled "Keynes Said: Euthanize The Rentiers, Instead We Euthanized The Economy":

"The bases of the French Revolution of 1789 had been set because even at that time, rentiers were struggling to defend the purchasing power of their interest income and at least preserve the capital value of their wealth. This put them in open conflict with the "traditional rentiers" of the monarchy, nobility, religious orders, and a few other players, who for political survival engaged in creating new and allied rentiers, giving them what French call "une rente de situation" for their personal political benefit, as well as personal financial or economic benefit. This was nothing to do with the national interest, it almost goes without saying.
Inflation is the first enemy of the rentier, but was also the friend of the state - basically the monarchy - in France throughout the 18th century. The very first "asset bubble" organized for and on behalf of the French monarchy by Scotsman John Law, before 1720, the Mississippi Company bubble, was aimed at destroying the real cost of debt owed by the monarchy and its associated nobility, to "the rentiers". Law's action, a Ponzi-type scam, had overkill effects. Some historians argue this first modern asset bubble, aimed at firstly inflating paper asset values, exchanging them against debt owed by the monarchy to rentiers, and then collapsing the bubble helped sow the seeds of the 1789 revolution through decades-long unwillingness of "the rentiers" to lend, after this asset implosion.
Rentiers seek and prefer deflation. They prefer conservative government policies of balanced budgets and deflationary conditions, even at the expense of economic growth, capital accumulation and high levels of employment. As early as 1820, this was a major theme of David Ricardo. Today, especially in Japan, it is intense daily action by the state and its central bank, seeking by all means to create inflation because "when there is inflation, the economy is still alive", and of course the cost of debt in real terms will fall.
This underlines the fatal flaw in Keynesian-type economics: high inflation, and-or extremely low or zero interest rates, "for prime borrowers", firstly needs rentiers to supply the capital to borrow. Before that, the capital has to be formed or accumulated. If both processes are unsure, uncertain, or inoperative the result can only be economic decline.
The problem today is starkly simple. Without massive money printing and issue, the dearth of capital would be so striking that the New Poverty of the world would be impossible to ignore. The global banking system, at latest since 2008, has vastly overvalued collateral or "assets", and a long-term basic trend, intensifying since 2008 of deflating balance sheets. Governments of all major OECD countries with a combined GDP of about one-half of the world's total output, through their central banks, are each day back-stopping the banks, which are insolvent institutions, flooding them with sovereign debt and fiat money, and manipulating credit markets to maintain apparent valuations.
THE NEW POVERTY OF NATIONS
Without this "window dressing", the reality is that the private sector economy is still contracting four years after the credit bubble burst. It is only concealed by the expansion of government spending and fiat money issue. Governments possibly do not understand they are in the midst of an economic collapse and will be the last to admit it, but as in previous epic struggles between the vested interests in play in a society and its economy, for example in the run-up to the French Revolution, the manipulation of credit, values, money and prices has made it impossible to accurately monitor the economy." - source  Andrew McKillop

When it comes to our contrarian take on US yields since early January 2014 we argued the following in our conversation "Supervaluationism" back in May 2014 it comes from us agreeing with Antal Fekete's take from his paper "Bonds Defy Dire Forecasts but they are not defying logic":

"The behavior of the bond market has been consistent with Keynesianism. By his compassionate phrase “euthanasia of the rentier” Keynes meant the reduction of the rate of interest, to zero if need be, as part of the official monetary policy to deprive the coupon-clipping class of its “unearned” income. Perhaps it is not a waste of time to repeat my argument why, in following Keynes’ recipe, the Fed is acting contrary to purpose. While wanting to induce inflation, it induces deflation.The main tenet of Keynesianism is that the government has the power to manipulate interest rates as it pleases, in order to keep unemployment in check. Keynes argued that the free market economy was unstable as it was open to the swings of irrational investor optimism or pessimism that would result in unpredictable and wild fluctuation of output, employment and prices. Wise politicians guided by brilliant economists − such as, first and foremost, himself  −  had to have the power “to prime the pump” (read: to pump up the money supply) as well as the power to “fine-tune” (read: to suppress) the rate of interest. They had to have these powers to induce the right amount of spending needed to put people to work, to entice entrepreneurs with ‘teaser interest rates’ to go ahead with projects they would otherwise hesitate to undertake. Above all, politicians had to have the power to unbalance the budget in order to be able to help themselves to unlimited funds to spend on public works, in case private enterprise still failed to come through with the money.However, Keynes completely ignored the constraints of finance, including the elementary fact that ex nihilo nihil fit (nothing comes from nothing). In particular, he ignored the fact that there is obstruction to suppressing the rate of interest (namely, the rising of the bond price beyond all bounds) and, likewise, there is obstruction to suppressing the bond price (namely, the rising of the rate of interest beyond all bounds). Thus, then, while Keynes was hell-bent on impounding the “unearned” interest income of the “parasitic” rentiers with his left hand, he would inadvertently grant unprecedented capital gains to them in the form of exorbitant bond price with his right." - Antal Fekete

•  Rentiers seek and prefer deflation - European QE to benefit US Investment Grade credit investors.

In our October conversation "Actus Tragicus" we disagreed with Bank of America Merrill Lynch' s credit team in their Credit Market Strategist note from the 10th of October entitled "Breaking up is so easy to do":

"We find it unlikely that the existence of big global yield differentials will accelerate inflows to US fixed income for two reasons. First, while we would indeed expect inflows in a high return environment of both high and declining US yields, with rising US interest rates – which our interest rate strategists expect – returns are much less attractive, despite the higher yields. Second, there appears to be little mean-reversion in interest rate differentials – at least between US and German interest rates." - source Bank of America Merrill Lynch

We correctly argued at the time:

"We therefore do think (and so far flows in US investment grade are validating this move) that interest rate differential will indeed accelerate inflows towards US fixed income, contrary to Bank of America Merrill Lynch's views. We do not expect a rapid rise in US interest rates but a continuation of the flattening of the US yield curve and a continuation in US 10 year and 30 year yield compression and therefore performance, meaning an extension in credit and duration exposure of investors towards US investment grade as per the "Global Credit Channel Clock" (although the releveraging of US corporates means it is getting more and more late in the credit game...)."

"When the facts change, I change my mind. What do you do, sir? - Sir John Maynard Keynes

 What is of interest is that, when the facts change, Bank of America Merrill Lynch do change their mind given that in their latest Credit Market Strategist note from the 23rd of January 2015 entitled "All but corporate bonds" they argued the following:

"US IG credit benefits from the ECB action as investors are sent our way. First, the greater than expected expansion of the ECB’s balance sheet implies that for non-official European fixed income investors the investment opportunity set shrinks. The effect is that more European investors will be forced into US IG. Second, while the absence corporate bond purchases removes the potential for a big move tighter in spreads, in the short term certain sectors in US credit could benefit as investors unwind their expressed views that the ECB would buy corporate bonds. For example an investor that wanted exposure to a certain name that had both EUR and USD bonds outstanding might have been willing to give up spread by buying the EUR bond, in order to profit more from an ECB corporate bond buying announcement. Now with that upside potential eliminated the investor may rationally swap to the generally more attractive credit spreads offered in USD tranches."

- source Bank of America Merrill Lynch

• The on-going "Stimulant psychosis" experience led by our central banks deities is leading to more pronounced "Cantillon Effects" aka asset price inflation on a grand scale.

As we posited in our conversation "Pascal's Wager":

"The only "rational" explanation coming from the impressive surge in asset prices (stocks, art, classic cars, etc.) courtesy of QEs and monetary base expansion has been to choose (B), belief that indeed, our central bankers are "Gods"."

To further illustrate the "inflationary" bias of current monetary policies on asset price bubbles coinciding with "exogenous" (central banks) monetary policy, apart from the Art market, one could simply look at the price evolution of "classic cars" clearly indicative of "pure" Cantillon Effects (detached from the capital structure). To that effect and courtesy of United Kingdom Classic Cars magazine  please find enclosed a good illustration of this "effect" on the price evolution of a Citroën DS classic car:

- source Classic Cars Magazine

• In similar fashion to what we wrote about Japan in general and credit versus equities in particular in our April 2012 conversation "Deleveraging - Bad for equities but good for credit assets":

"Financial credit may be the next big opportunity

The build-up of corporate leverage in the 2000s was confined to financials which, unlike other corporates, had escaped unscarred from the 2001 experience. However, this changed in 2008. Judging by the experience of G3 (US, EU, Japan) non-financial corporates, there should be significant deleveraging in banks going forward. Indeed, regulatory pressures are also pushing in that direction. All else being equal, this should be bullish for financial credit." - source Nomura

This is what we wrote in June 2014 in our conversation "Deus Deceptor" when it comes to the value proposition of investment grade credit we discussed as well in "Quality Street":

"The "japanification" process in the government bond space continues to support the bid for credit, with the caveat that for the investment grade class, there is no more interest rate buffer meaning investors are "obliged" to take risks outside their comfort zone (in untested areas such as CoCos - contingent convertibles financials bonds)."

• The result of course is that the unquenchable hunt for yield is not only pushing investors towards the higher quality spectrum but, also extending duration exposure:

The result of course is that the unquenchable hunt for yield is not only pushing investors towards the higher quality spectrum which is in great demand as indicated by the additional +$1.2 billion in Investment Grade inflows in the week ending on the 21st of January versus -$445 million of outflows in High Yield, but, it is also leading to duration extension as indicated by Bank of America Merrill Lynch's chart from their recent Follow the Flow note from the 23rd of January entitled "It's Europe time":

"Quality yield and some growth down the line?
Pre-ECB, the big flows were into European equities, with the expectation that monetary policy will lead to stronger growth down the line. Equity funds saw a $2.3bn inflow, the largest since June last year while the inflow into equity ETFs was the strongest since May’12.
Income remained a dominant theme: investment-grade registered its 57th straight week of inflows. Money market funds have also seen 4 straight weeks of inflows – the best streak since mid-2013 – as negative deposit rates force money “up the value chain”.
High-yield has yet to get a boost from the income theme though: the asset class saw small outflows of $445m over the last week, and has seen $2.4bn outflows YTD.
European commodity funds recorded their biggest inflow ever, with oil stabilizing and with the bid for gold in the wake of the SNB rate cut. EM debt suffered another weekly outflow, the seventh in a row."

- source Bank of America Merrill Lynch

• When it comes to the "euthanasia of the rentier", what our central bankers deities are not realizing is that capital with ZIRP is not being deployed but merely destroyed as we have argued in our conversation of November 2012, "The Omnipotence Paradox":

"Fixed Income, Floating Expenses...We are more concerned about the "Profits Cliff" or "Peak margins" effect given that companies can't figure how to make use of their cash hence the flurry of buy-backs which we greatly dislike. Indeed, the "unintended consequences" of the zero rate boundaries being tackled by our "omnipotent" central banks "deities" is that capital is no longer being deployed but destroyed (buy-backs being a good indicator of the lack of investment perspectives)"

 As illustration of the destruction of capital and the supposed recovery in the US, we would like to point to a small conversation our Macronomics fellow blogger and good cross-asset friend "Sormiou" had with a US derivatives sell-side practitioner on the micro news on the employment front:

"Sormiou": “In less than a week in the US:   SLB (-7k jobs/ 7% workforce)  / BHI (-9k, 12%) / EBAY (-4k / 7%) / AmEXpress (-4k, -8%) Oil sector of course, but not only.   We are  hearing the "wage growth / employment pick-up" consensus argument from many sell-side strategists, but on the micro front, things do not look as rosy to us, even though a few announcements do not make a trend yet... thoughts?”

Him: “First is on the macro level = Yellen (and other doves) have flagged, under-employment is still much too high.  the U6 number (USUDMAER in Bloomberg) is still 11.2% vs 8% pre-crisis.  The U6 is a measure of the unemployed and the "under" employed-those folks who want full time, but can only get part time...as well as people who have been unemployed for so long they have fallen off the headline U3 number of 5.6%.  In fact, underemployment has been a major argument for postponing rate rise by the doves.  Point here is I think you are exactly correct in digging -the U3 headline number of 5.6% is absolutely not telling the entire story! More worrying maybe is the unemployment rate dissected across demographics. Unemployment among US youth is shockingly high.

Second is on a company level as you have flagged. Much of the earnings growth over the past few years can be attributed to cost cutting rather than organic growth to operating income.  Once costs were more "in control" for some companies, they turned to M&A to help generate returns - again to increase / boost slack organic operating income growth.  This earning period I think will certainly be more interesting than the last few because there is only so long you can mask sluggish organic growth...and we are seeing it in a few names that have reported.  In general, earnings are coming in 50bps below estimates (according to FactSet numbers).  Granted, we are still early in the earning cycle so too early to call...but if M&A doesn't get you what you need via a bolt on...and organic growth is still lackluster then the only thing to do is turn to is costs again - which is what I think we are seeing (and what you have flagged).”

Could companies focusing on costs again be the reason on why US Weekly jobless claims in the US are remaining above 300K for the third straight week? This is indeed a point to closely monitor we think, going forward.

• We would like to re-iterate, investors shorting US Treasuries will continue to be punished!

We would like to re-iterate why investors shorting US Treasuries will continue to be punished because they do not understand the game being played, On that specific matter we will simply quote again Antal Fekete from our July 2014 conversation entitled "Perpetual Motion":

"Moving back to the important notion of the difference between stocks and flows we do agree with Antal Fekete's take in May 2010 in his article "Hyperinflation or Hyperdeflation" being akin to a Black Hole and the possibility of capital being destroyed thanks to ZIRP (as it is mis-allocated towards speculative endeavors) hence the risk of pushing to far the "Perpetual Motion" experience":
"Obviously, you need a theory to explain what is happening other than the QTM. I have offered such a theory. I have called it the Black Hole of Zero Interest. When the Federal Reserve (the Fed) is pushing the rate of interest down to zero (insofar as it needs pushing), wholesale destruction of capital is taking place unobtrusively but none the less effectively. Deflation is the measure of wealth in the process of self-destruction -- wealth gone for good. The Fed is pouring oil on the fire as it is trying to push long-term rates down after it has succeeded in pushing short term rates to zero. It merely makes more wealth self-destruct, and it makes the pull of the Black Hole irresistible.But why is it that the inordinate money creation by the Fed is having no lasting effect on prices? It is because the Fed can create all the money it wants, but it cannot command it to flow uphill. The new money flows downhill where the fun is: to the bond market. Bond speculators are having a field day. Their bets are on the house: if they lose, the losses will be picked up by the public purse. But why does the Fed under-write the losses of the bond speculators? What we see is a gigantic Ponzi scheme. The Treasury issues the bonds by the trillions, and promises huge risk-free profits to the bond speculators in order to induce them to buy. Most speculators believe that the Treasury is not bluffing and they buy. Some may believe that the Fed is falsecarding doubts and they sell. But every time they do they only see foregone profits. What we have here is a rare symbiotic relation between the government and the speculators." - Antal Fekete

•  European QE, the Devil is the detail and the future of the Euro lies in Germany's liability exposure

In relation to the European QE and the details of the "plan", we would like to quote our good friend and former colleague Anthony Peters, strategist at SwissInvest and regularly featured in IFR from his last post entitled  "On the ECB and mutualisation of risk":

"Yes, I did take time off the desk yesterday afternoon to listen to St Mario's press conference. I heard everything he said and but I didn't understand quite a lot of it. Going into it, I had had a long talk with Ian McBride of Mirexa Capital, a fledgling agency brokerage in the rates space and one of the most experienced people I know in London when it comes to the whys, the  hows and the wherefores of the government bond market.
He made a very strong point that, as far as he was concerned, size didn't matter. To him there was only one critical issue of concern and that was the subject of mutualisation of risk. With it, so he reckons, the Eurozone is headed for stability. Without it, it is doomed in as much as it effectively ceases to be a harmonious, homogenous area. The dream of making a United States of Europe in the image of the United States of America is dead in the water and any claim the euro might have had to be like the dollar has just gone up in a puff of smoke.
As recently as Wednesday night, the Dutch parliament had voted against mutualisation and thus, with the Germans, the Finns and the Austrians also averse, unanimity was never going to be achieved. A split vote was not an option and so there had to be a fudge. The question was, how heavily was the fudge going to be tainted with the flavour of sauerkraut? When I heard Draghi begin to explain the split in loss-sharing, I knew all was not right. Ian titled his analysis of the outcome with "Mario Swings a Big Bat, But Misses the Mutual Ball?" Please permit me to share some of his thoughts:
"Call me a cynic, but you're trying to hide the fact that you failed to force through the most important component of the QE program... namely loss sharing, liability sharing, mutualisation, or whatever you want to call it and you end up with at best 20% loss sharing only, of which only 8% is on government bonds. You hide this shortcoming in the fetching headlines that you will be buying up to €60bil/month combined Public & Private securities. And on top of that you make the program longer than some expected taking it up to at least Sept/2016, having started in Mar/2015. That is in theory €1.14trn of securities you will accumulate. Sounds big right? Then the cherry on the Smoke and Mirror Cake is that you tell everyone you will make the program conditional on achievement of your mandate for price stability. Saying that the program will go on as long as needed. Or open ended if you like."
He continues "To illustrate how big the party is in Berlin tonight... Based on what is clearly a big win on the compromise (I'd say outright victory) that Germany and its allies wrung out of Draghi. Look at some rough numbers for new German joint loss sharing exposure by the end of the Program when and if the ECB and National CBs manage to buy the total of €1.14trn by Sept/2016. Based on the Capital Key, Germany is responsible for 18% of that total or €205.2bn and of that only 8% is held by the ECB with loss sharing. So that means that the total non-Bund exposure for the BUBA is only an additional €16.4bn out of the grand total of €1.14trn bought. It'll be lots of beer and sausages all around!!"
"That tiny 8% is symbolic, but not in any way significant enough to prevent, over time, the segregation/tiering/fragmentation of the credits within the Eurozone borrowers. The Haves vs. the Have Nots. I will expect, when the dust settles and purchases begin, that the credit spreads between the strong and the weak will widen. This is not a program that is designed to float all boats equally."
"It is a divisive piece of policy that Draghi, in my mind, has lost a lot of credibility over. He and other members clearly caved in to the demands of the big bully(s) on the block. And for me, despite the big size headlines and open ended-ness of the program, it comes up short of what is needed to maintain the structural integrity of European Monetary Policy and Fiscal Unity."
So, while they were dancing on the floors of the stock exchanges and while all the high fiving was going on that St Mario and his merry men had finally come to the rescue, wrapped in open-ended QE, it could quite well be that the seeds of the final destruction of that strangest and most incongruous of constructs, the European Single Currency, were yesterday sown.
It might, of course, be that the euro softens a little bit, that inflation is imported to the tune of roughly 2%, that exports pick up enough in order to push Eurozone unemployment down from the current 11½% to 5½-6%, that construction and consumption accelerate, that fiscal revenues rise to the level at which deficits are wiped out and surpluses are achieved without legislative intervention or trimming of benefits and that pigs learn to fly. Or it might be that the whole system falters when driving down the road by hitting a whole pile of cans which had been kicked there over time." - source Anthony Peters - "On the ECB and mutualisation of risk":

This is exactly what has happened with the QE plan put forward by our"Generous Gambler" aka Mario Draghi. Back in July 2012 in our conversation "Europe - The Game of the Century" we argued the following:

"The only possible Nash equilibrium for Germany will be to defect"

While only appearing to be making material sacrifices, German Chancellor Angela Merkel has managed to keep Germany's liabilities unchanged, this is again the case with the present QE, as it was the case with the capped ESM and EFSF.

As we indicated in our conversation "Eastern promises" on the 9th of June 2012, we still believe that eventually Germany will defect in the end:

"We think the breakup of the European Union could be triggered by Germany, in similar fashion to the demise of the 15 State-Ruble zone in 1994 which was triggered by Russia, its most powerful member which could lead to a smaller European zone. It has been our thoughts which we previously expressed."

We would like to point out there is no such thing as a credit-less recovery in Europe as discussed in our conversation "In the doldrums":

"If credit growth does not return, economic recovery may prove to be difficult in the absence of sizeable real exchange rate depreciation." - Zsolt Darvas - Bruegel Policy Contribution.

"So for us, unless our  "Generous Gambler" aka Mario Draghi goes for the nuclear option, Quantitative Easing that is, and enters fully currency war to depreciate the value of the Euro, there won't be any such thing as a "credit-less" recovery in Europe and we remind ourselves from last week conversation that in the end Germany could defect and refuse QE, the only option left on the table for our poker player at the ECB:"The crux lies in the movement needed from "implicit" to "explicit" guarantees which would entail a significant increase in Germany's contingent liabilities. The delaying tactics so far played by Germany seems to validate our stance towards the potential defection of Germany at some point validating in effect the Nash equilibrium concept. We do not see it happening. The German Constitution is more than an "explicit guarantee" it is the "hardest explicit guarantee" between Germany and its citizens. It is hard coded. We have a hard time envisaging that this sacred principle could be broken for the sake of Europe."

What do we do sir? 

When the facts haven't changed, we do not change our mind.  In the European QE, there has indeed been no move towards "explicit guarantees" as it would have indeed entailed a significant increase in Germany' s contingent liabilities hence our continued negative stance on the future of the European Union.

On a final note we leave you with Bank of America Merrill Lynch's graph displaying Labor force growth vs US CPI from their Thundering Word note from the 18th of January 2015:

"Technology and demographics (Chart 3) continue to act as secular deflationary forces across the developed world. The end of QE in the US means the Fed is no longer inflating asset values. And investors are increasingly concluding that QE has ended up creating excess supply rather than excess demand. The relentless “lust for yield” continues. In Q1 it is the turn of REITs to be the asset class attracting large speculative inflows in search of Yield & Growth." - source Bank of America Merrill Lynch

"We need to ask whether, in the long term, some individuals with a history of psychosis may do better off medication." - Thomas R. Insel, American scientist

Stay tuned!