Most of the sell side macro research that I have been sifting through this week is pretty constructive on the future which always makes me worry. Still, it is difficult to not agree a little bit with the point that if, indeed, the world is not ending there is still a lot of cash on the sidelines that can get sucked in on this rally.
In principle I agree with Steen Jakobsen's latest views that the upside is strongly driven by the global QE put and low holiday volumes. Hope of policy intervention as the market grinds up and beyond new highs usually is bad sign. Still, as a macro guy I should also point out following for example the latest from Simon Ward that the macro data has indeed improved. For one, investors should note that emerging economies have been slowing down to a grinding halt for 12 months and are likely already turning up from a bottom. In the US, the continuing revival in residential and commercial construction is real and starting from a low point which suggests that more upside surprises are possible here.
The problem though is that the amount of conflicting information right now is dizzying and against a backdrop of a continuing fear of the end of the workd, this creates and even more binary and frustrating world for investors. Hussman for example believes we are on the verge on a major inflection point.
We are presently in an environment that has historically been associated with the overvalued segment of late-stage bull markets. This segment of the market cycle has been frustrating for us before, and that frustration may not be over. Yet in each instance, our defensiveness was overwhelmingly vindicated. The drum-beat of investors is that “this time is different.” Simply put, I doubt that this time is different.
With that in mind, my base case remains that the scope for a choppy upward movement of the equity market is not yet exhausted and, consquently, that complacency and euphoria can get much more extreme.
The Bad Bank is Dead, Long Live the Bad Bank
Investors have only slowly been given information on the Spanish bailout which was (in)formally announced back in the beginning of July with €100 billion for the banks. By the letter of the law, Spain has not yet requested for aid and despite the ECB's verbal intervention outright ECB financing of Spanish deficit spending will require full Troika programmes.
So far then, it is difficult to know whether to laugh or cry at the news that Economy Minister Luis de Guindos and the government has apparently decided to create a new bank just months after the other bad bank (Bankia) went belly up.
Spain will put its bank rescue fund in charge of the bad assets separated out from the nation’s struggling lenders that are receiving a European bailout. The FROB fund will be the main shareholder in a so-called bad bank, according to a proposal that will be approved by the Cabinet on Aug. 24, Economy Minister Luis de Guindos told the Efe news agency in an interview today.All the banks receiving loans from European rescue funds will have to transfer their non-performing assets to the bad bank, he said. The comments were confirmed by a Spanish official, who asked not be identified, citing government policy.
You seriously cannot make this up, but the only difference now is that it will be easier to add the liabilities to the Spanish sovereign since, sooner or later, the FROB itself will have to be bailed out. Of course, Spain may ask for an official bailout long before that and then the transformation will be complete. Losses in the Spanish construction and RMBS industry will have migrated from one consolidated bad bank balance sheet to another, on to the sovereign and finally into the heart of the Eurosystem.
This process has been clear for a long time what hasn't has been the speed and twists and turns for us to get there. Speaking of twists and turns, the news coming out of Germany (apart from a rapidly slowing economy) is also mixed with Merkel apparently fighting other members of the government on whether to cut Greece some slack all the while that Der Spiegel apparently is reporting that the ECB is going to cap yields in the periphery.
Until action proves otherwise, the base case remains that the ECB will refrain from strong intervention until memorandums of understandings have been signed, but Spain and Italy are big fish compared to Greece. Their respective governments know that they could bring the euro down and inflict mortal damage to Germany. It is difficult to see exactly what the position of Germany is here, but one is certain , Germany (and all other so-called safe havens) have benefitted from the ongoing euro crisis charade in that it has been significantly cheaper for them to borrow. Italy and Spain could merely be seen as asking Germany to pay for this privilege.
Ultimately though the market will call Italy and Spain on their bluff and the onus will be on the ECB to do just enough to keep the boat afloat, but not so much as to be seen caving in to guerilla tactics. This is already an incredibly difficult minefield for the ECB to maneouevre and it won't get easier as the recession intensifies. The end result is that losses will increasingly be mutualised and this may, in the end, make it more palpatable for the ECB to engage in outright monitisation.