Daily Note -Turkish delight? Go ask the Cypriots!

Blue MosqueSummary:

Global Equities Rally as the Turkish Central Bank lifts rates, but history argues for sceptisism.

United States: Poor Durable Goods offset by strong consumer confidence and house prices

United States: Final thoughts on today’s FOMC meeting

United Kingdom: Growth still strong

Eurozone: Mind your deposits!

Good morning

Chelsea supporters preparing for the Champions League visit to Istanbul next month will have cursed the Turkish central banks’ decision to raise rates rapidly yesterday. The way the Turkish lira was going , it would have been cheaper to fly to Turkey and see the game live than renew your Sky Sport subscription or pay your TV licence!

The Turks raised rates by 4% to stem the collapse of the currency. This stabilised things and sent the lira upwards, but history suggests that hiking interest rates rapidly in a currency crisis is about as effective as an Evertonian centre half facing a Liverpool set piece.

Although it can look like a mean, hard and decisive pillar of defence, when faced with the various moving parts that Mr Market tends to throw up, rapidly hiking rates can backfire. This is particularly the case when growth in the country is in question, has is the case in Turkey.

If you doubt this, remember  Norman Lamont in the UK when, in 1992, the UK hiked rates only to see the currency slump.And of course ,for those of us who were working in emerging markets in the good old days, we recall the reaction to the Asian Tiger currency in the weeks after macho rate rises, which crippled the domestic economies and  were followed by currency capitulation.

As a general rule in economics, if the original problem is too much debt and not enough growth, raising interest rates will make this worse not better.

Bear this in mind as we talk about emerging markets in general. Also bear in mind that most people discussing emerging markets right now with “confidence” on radio, TV or in the print, couldn’t locate one on a map.

Global Equities Rally as the Turkish Central Bank lifts rates

Global equities have rallied hard over the last 36 hours (cutting in half last week’s losses) as the concerns around China and the broader emerging markets fade, for now.

Overnight the Turkish Central Bank hiked the overnight rate by 4.25% (it had been expected to be only 2-3%). The Turkish lira strengthened. It is now up 10% from intraday low on Monday – back to levels seen two weeks ago.

As I noted above, the ability of the economy to sustain double digit rate of interest is not infinite and the credibility of high rates will depend on the growth rates. The question is whether this type of action will become a trend in emerging markets. The big one to watch is whether the South Africans raise rates to support the Rand – a bell weather emerging markets currency.

If you are stuck in emerging markets right now and don’t like the dollar return (loss) you are about to receive if you liquidate, it may be time to have a look at some of the stock markets. Hold for a while and wait for the very money that is now flowing out, to flow back in, as it will surely do.

Is there any value, anywhere?

We have maintained for a number of weeks that 2014 will be all about equity market volatility. When considering an investment you need to understand the relative strength of one market over another. We thought it worth revisiting current global developed market equity valuations (see table below)

Table 1 29 Jan

The standout buy (as we have been talking about for weeks) is China where valuations are cheap. We wait for the New Year in China (early February) before considering an investment here. When we do, it will be some comfort to us that we will be doing so at valuation levels that are historically attractive.

When markets are cheap, you can never have total confidence that you are buying the bottom – this is precisely why they are cheap because they are unloved and unwanted – but as a general rule, low single digit EPS shine like diamonds in today’s world.

Yesterday we highlighted that large cap US stocks on a multiple of 17 times are expensive. Granted, capital will always flow into US stocks particularly in a global wobble, but the question we always ask is how can US companies generate earnings when higher rates militate against share buyback and the tighter labour markets and stronger dollar squeeze profit margins?

Outside of the US, French and the Spanish markets look expensive. Broad capital inflows have benefited all Eurozone markets (equity & bonds). In a sense this has been an indiscriminate inflow, with money flooding into somewhere called “Europe”, without too much focus on earnings and multiples. Our top down macro view would be particularly bearish on the French economy for 2014. While as always we wait for a suitable catalysts, we may short these places and go long China. I head to Paris tomorrow, let me mull this trade over a Pastis or two at the weekend.

United States: Poor Durable Goods offset by strong consumer confidence and house prices

Table 2 29 jan

Headline durable goods orders fell 4.3% (vs. consensus +1.8%). There can be no disguising that that is a poor figure. Both defence orders (-21.5%), and civilian aircraft orders (-17.5%) slumped. Core capital goods orders covering nondefense goods excluding aircraft fell 1.3% (vs. consensus +0.3%), reflecting a sizable 7.8% drop in computer and electronic product orders.

Growth in November’s core capital goods orders was also revised down 1.5% to +2.6%. Durable goods tends to be a very volatile number and  will likely be revised in coming months.

The Conference Board consumer confidence rose to 80.7 in January (vs. consensus 78.0), its highest level since August 2013. Confidence is now close to post-recession highs. Both consumers’ assessment of present conditions (+3.8pt to 79.1) and their expectations about the future (+2.8pt to 81.8) have improved.

The S&P/Case-Shiller home price index rose 0.9% in November (vs. consensus +0.8%). By city, the largest house price gains were seen in Miami (+1.6%), Atlanta (+1.6%), Boston (+1.3%), Detroit (+1.3%), and San Francisco (+1.3%). All 20 cities included in the index posted a gain of at least 0.4%.

The lopsided nature of this data, is a little bit concerning. We’d prefer to see more supply (capital goods) and less demand (house price rises). However, four years into a recovery where the economy is dragged down by deleveraging, such a split would  not be so unusual.

Nothing in the data means the Fed changes its mind on “tapering” today. I would suspect, given the weakness in durable goods, there is a downside risk to the Q4 GDP release on Thursday. Current consensus is for 3.2%.

United States: Some final thoughts on today’s FOMC meeting

We will be “tweeting” the FOMC announcement this evening from 7pm. There is no press conference this month, just a statement. As we said yesterday we don’t expect any surprises. Some clients  feel a no “taper” outcome is possible. Here are the two things they highlight.

1. The weakness in employment in recent weeks in the US. With the exception of last month’s employment report, the other data suggests that the economy continues to improve. Various Fed officials have commented that the December employment data was probably distorted by weather or other statistical variance, questioning whether it is reflective of the true health of the labor market. On it own, one month’s employment figure shouldn’t be enough to stand in the way of the plan for tapering that Bernanke laid out following the December 18th FOMC meeting, when he said that he expected tapering to continue in “measured steps” in meetings to come.

2. What about the recent emerging markets stress? Some clients are indicating that given the interdependency of the global economy, the Feds might hold off “tapering” to give the emerging markets – America’s trading partners – a breather. This is a fair point and in the light of the more international leanings of Yellen and Fischer, it will be a point of discussion.

I don’t think it will change the policy. Most emerging market countries complained about QE on the way up (artificially inflating their currencies etc.). The Fed ignored these concerns on the way up, so it’s likely that it will be equally non-committal on the way down.

United Kingdom: 4Q GDP comes in as expected.

Table 3 29 Jan

According to the ONS’s preliminary estimate, UK GDP rose by +0.7%qoq (+2.8%yoy, +2.8%qoq annualised.) in Q4. This was in line with expectations. The sectorial breakdown shows solid growth in production and services. The major surprise is the weakness of construction output, which, according to the ONS, has fallen by 0.3%qoq. This is totally at odds with what we are reading in the press and hearing anecdotally.

While to some extent the weakness of construction may represent a pay-back from the strength in Q2 and Q3, it is still hard to reconcile with other indicators, such as the Construction PMI, which rose from an average of 58.3 in Q3 to 61.4 in Q4.

The UK has been the best performing of the G8 economies. Therefore, it may not be too surprising if the last few months of 2013 was the short term peak in a longer term recovery cycle. We will use any weakness in coming months to buy GBP particularly against the Euro with an entry level above 0.8450

Eurozone: Cyprus is the template according to the Germans

It got little coverage around financial markets but the Bundesbank said on Tuesday that countries about to go bankrupt should draw on the private wealth of their citizens through a one-off capital levy before asking other states for help.

This hardening of the German stance comes after the Cyprus bailout where deposit holders took a hit as part of bailing out the financial system.

Make no mistake about it. This is the Germans talking about confiscating savings.

“(A capital levy) corresponds to the principle of national responsibility, according to which tax payers are responsible for their government’s obligations before solidarity of other states is required”.

It warned that such a levy carried significant risks and its implementation would not be easy, adding it should only be considered in absolutely exceptional cases, for example to avert a looming sovereign insolvency.

The International Monetary Fund discussed the option in a report in October and said that in order to reduce debt ratios to end-2007 levels for a sample of 15 euro area countries, a tax rate of about 10 percent on households with positive net wealth would be required.

This has the potential to blow another hole in Club Med and Irish bond markets.

For details look here.

Check out the box with “one off capital levy”. The Cyprus template is there in black and white. Don’t say you weren’t warned!

Eurozone: German court verdict on OMT rescue for Southern Europe – delayed until April?

An interesting article here from the rabidly anti-Euro Ambrose Evans-Pritchard in the UK’s Daily  Telegraph. Ambrose is a great writer, but he has an agenda, so just keep this in mind. See our Punk Economics on why Brits always get Europe wrong here.

Evans Pritchard suggests that we may not get a verdict on the OMT from the German constitutional court decision until April:

“The risk is rising that the German constitutional court will severely restrict the eurozone bond rescue scheme for Italy and Spain, and may reignite the euro debt crisis by prohibiting the German Bundesbank from taking part.

The Frankfurter Rundschau newspaper reports that the verdict has been delayed until April due to the complexity of the case and “intense differences of opinion” among the eight judges.”

Referring to the European Central Bank’s back-stop plan for southern Europe, known as the OMT, he noted:

“Bank of America says there is a “relatively high” risk that the Court will rule that the OMT is illegal as designed. The Bundesbank might be prohibited from participating”.

The Verfassungsgericht (the German Court) has no jurisdiction over the ECB, but it can force German institutions to withdraw support for EU operations. Without Germany, the ECB’s rescue policies would lose all market credibility.

Bank of America said the Court is unlikely to pull the plug altogether on the OMT, but a negative ruling would greatly strengthen the position of eurosceptics in Germany and risk a fresh bond sell-off.

“Any market reaction will necessarily depend on the details. Even in an extreme scenario we would expect the ECB to calm the markets by announcing alternative tools,”.

We see the German court decision as a major risk event for the Eurozone in 2014. Talking to sources in Germany, it seems it is indeed a closer call than the market is currently pricing in. I write a regular column for the  German finance magazine www.capital.de and my sources are  well- placed .

Eurozone: Money supply 

Table 4 29 Jan

With EZ  inflation data on Friday and the ECB meeting next Thursday (6th Feb), the market  expected money supply to rise by 1.7% YoY but it came in at 1% significantly weaker than expected. This will put downside pressure on inflation and will concern the ECB. Remember with no lending, there is no growth and with no growth, there is deflation..

Portfolio: All eyes on the Federal Reserve Meeting this evening

We go into today’s Federal Reserve meeting long the USD and short US bond yields. We look to add to our fixed income position if we see 1.49%.

Portfolio 29 Jan

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The statements, opinions and analyses presented in the articles, newsletters, and other materials appearing on this website are provided as general information and for educational purposes. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this website is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. David McWilliams shall not be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.



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