Daily Note – The Brazilians of Europe


United States: Data this week is likely to be hit further by the poor weather

Turkey: Central Bank meeting later today is in focus

Japan: The detail of GDP print suggests a push back on sales tax increase

Eurozone: “ECB hasn’t decided on negative deposit rates” Nowotny

Good morning from Sarajevo.

This is a city where the war and the terror are never far away, from the bullet holes still in the buildings, to the harrowing memorial to the one thousand seven hundred children murdered in the siege of Sarajevo, the scars of the 1992-1995 vicious war and the attempted genocide of the Muslim people of Bosnia that is still very much present.

Like many emerging post-socialist European States, today Bosnia suffers from very high levels of youth unemployment, income is falling and the political class is widely seen as siphoning off the goodies for themselves.

As a result of the war, everything is still seen through the ethnic prism. My friends here are a hotch-potch of everything: half Serb, half Muslim, with a Croat grandmother is not untypical. But my friends are the product of Yugoslavia – and those days are long gone.

However, the one bright shining star this year for Bosnia is its ethnically mixed and very brilliant football team who have qualified for the World Cup and will take their place amongst the greats in Brazil this June.  For those of us who like the beautiful game, there was no better exponent of it in Europe than the brilliant Yugoslav teams of the 1980s and early 1990s. They were known as “the Brazilians of Europe”. Had they not been ejected from the 1992 European Championship, most people believe  they would have won the competition in a canter.

Yugoslavs and now former-Yugoslavs play a different type of football. The skill levels and sophistication levels are much higher than the form of football played elsewhere, more like the Dutch of the 1970s than the dross we are fed in the Premership week in week out.

Under the eye of the great former Yugoslav player Safet “Pape” Sušić, the Bosnian team play this exciting attacking football which is based on the notion that “if you score 4, we will score 5”. It is a joy to watch, but is a rollercoaster for the fans because the brilliance attacking in front of goal can be negated by an attitude to defence which could be described as “leaky” at best. However, as a spectacle, this type of football is wonderful to watch and about as far away from the dour, defensive Italian cynicism we Irish football fans had to endure under Trappatoni.

The cavalier and reckless attitude to football, shown so beautifully by the Bosnians is not too dissimilar to the attitude of reckless investors who fail to appreciate risk. There are investors everywhere who go for the big play, the one-off position which could net a fortune, but rarely do they understand that the handmaiden of return is risk.

In today’s markets, there are some great opportunities, but they come with related risk. This evening, I fly to Turkey to examine one such country. My approach to investments there, while maybe not as dour as Trappatoni’s, will be informed by his caution rather than Bosnian style exuberance, smitten by the get-rich-quick attraction of Turkish high-yield opportunities.

In terms of watching football, the “you score 5, I score 6” approach is without  doubt the most joyous 90 minutes, but sadly these teams rarely end up top of the table.

United States: Data this week likely to be hit further by the poor weather

US equity markets have recovered most of their early-2014 losses, but the economic data in January has continued to come in significantly softer than expectations.

Investors appear to be looking through the weakness, attributing a good part of it to the severe cold weather and snow storms in January. On the whole, we agree with this interpretation. The very sharp falls in the ISM Manufacturing survey and the Manufacturing production data point to a distortion of a weather-related nature.

The fact that most other industrial surveys for January – including the Philly Fed, Chicago PMI, Markit PMI, and non-manufacturing ISM -were largely in line with expectations implies that respondents from industry are also taking account of the weather which was behind the disappointing January retail sales report.

For us, what is interesting is the contrast between the US equity market participants (who are happy to look past the poor data) and fixed income investors, who seem less keen to assume this soft patch can be easily overcome.

Consider the two charts below.

Figure 1 is the S&P 500 vs the Citi US Economic Surprise Index (which reflects positive & negative surprises in economic data when compared to consensus).

Figure 1: S&P 500 vs Citi US Economic Surprise Index

Chart 1 18 febThe S&P 500 has rallied back in the past few weeks with no material pick up in the underlying economic data. While we agree that this weather related soft patch will be made up for in coming quarters, the notion that  US corporate earnings can remain unchanged in the face of a slump in demand seems to us to be a long shot.

Now contrast the chart above with Figure 2, which is the US 5 Year note yield against the same Citi US Economic surprise index. This is behaving much more in the way you would expect – weaker data leading to lower interest rates.

Figure 2: US 5 Yr Note Yield vs Citi US Economic Surprise Index

Chart 2 18 feb

As you can see from the chart, the US bond market has seen only a marginal increase in yields in recent days contrasting starkly with their colleagues in the equity market world who seem now to be pricing in the best case scenario.

While we appreciate that fixed income markets will always be driven more by the economic data than equity markets, where sentiment and flows play a bigger role, this divergence is something we are much focused on. We remain cautious on equity markets at this point.

Back in the hard world of data, this week brings the first of the February surveys. The Empire manufacturing survey on Tuesday and,  more widely followed, the Philly Fed survey on Thursday. Consensus expects a slight softening in both surveys.

There is a risk that the cold weather in the US northeast in February will continue to muddy the waters. This could prevent us getting a clean read of the US (and global) cycle.

In the same vein, a slew of data on the housing market (Homebuilder survey, housing starts and existing home sales) could also be weaker on account of continuing adverse weather.

Turkey: Central Bank meets later today

I fly into Istanbul to a country still reeling from the emerging market crisis which has hammered its currency. Last month’s bout of intense pressure was sparked by the absence of credible action at last month’s CBRT meeting and the largely ineffective intervention in FX markets that followed.

In an emergency inter-month meeting, the CBRT hiked rates by an effective 0.225%. This has gone some way towards stemming the pressure on the TRY. Be warned, liquidity management in a solvency crisis rarely works for long.

See chart below

Figure 3: Turkish Lira vs O/N Lending Rate

Chart 3 18 feb

The Lira has now reversed most of last month’s weakness but we have reached a key point where further downside is probably dependent on further steps from the Turkish Central Bank and the more they tighten, the more the economy tanks.

I will write more extensively about Turkey from my vantage position over the Bospherous in the days ahead.

Japan: Detail of GDP suggest that the government may  postpone any sales tax increase

As we highlighted yesterday, October-December GDP growth came in far below market expectations. October-December real GDP grew 1.0% qoq annualized. This was far lower than the market consensus (+2.8%). While this marks four consecutive quarters of positive growth, momentum was much slower than the 4% recorded in the first half of 2013.

Positive contributions from consumer spending, housing investment and capex were offset by much weaker net exports.

If you look at the chart below, it shows how little traction there has been on the net export side of things. Any positive export dynamic has been more than offset with the large pickup in energy imports which are impacted by the weaker currency.

Figure 4: Japan Net Exports vs Yen

Chart 4 18 feb

The considerable delay in export volume recovery despite the weaker yen, together with the sustained rise in import volumes, is likely to be a major drag on future net export growth.

The chart above suggests we have to see Yen slump towards 110 to have a meaningful pickup in net exports. In addition, Japan’s  nuclear reactors will have to be turned back on to help slow the imported energy component. This may help those of you (myself included) who own some unloved Uranium-related assets!

Here are some highlights from the BOJ meeting overnight.

  • BOJ left its main policy program unchanged
  • Maintained its optimistic view of the economy

Extended and enlarged the two lending programs, which were set to expire at the end of March:

  • Both offer cheap loans to commercial banks
  • One of the programs aims to channel money into sectors of the economy which  BOJ officials believe have high growth potential, such as health care and tourism
  • The BOJ extended the program’s expiry by one year, and doubled its size to ¥7 trillion ($68 billion) – The fund was already near its initial ¥3.5 trillion ceiling
  • The other program rewards banks that have increased their outstanding loans, by allowing them to refinance new loans with cheap cash from the central bank
  • The BOJ, which has so far offered ¥5 trillion through this program, pushed back the expiry date of this program by one year and the BOJ added it will lend twice as much as the net increase in banks’ outstanding loans

The significance (of extending and expanding these loan programs) might not be in the detail, but proves that the BoJ is willing to amend its policy to help the economy

In a broad sense, the Bank of Japan held the course, just as economists had expected. But there was some news: The BOJ board also said it would extend, by a year, two programs that offer banks cheap loans as a way to juice overall lending and certain key sectors of the economy.

This may seem like a minor move,  but for the markets, this was huge because it showed a willingness to do more. After tipping higher for about a minute, the yen lurched downward with the dollar climbing from ¥101.98 up to ¥102.35. Stocks also went nuts, with the Nikkei Average up over 3%

Eurozone: “ECB hasn’t decided on negative deposit rates” Nowotny

Some interesting comments on an otherwise very quiet Monday came from ECB board member Nowotny. They seem to be clutching at straws t in the ECB and don’t admit that we are in a liquidity trap. Any deposit rate cut would be more to do with getting banks to start shifting the cash piles into the economy. This is ultimately what needs to happen. The fact that the ECB is still referring to inflation when deflation is the issue, indicates how out of touch it is.

Portfolio: With the US closed, there is little volatility in our positions

portfolio 18 feb


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