The Market: New Year’s Resolutions Are Made To Be Broken
I sat back and marveled at the action in the global markets on Tuesday, wondering if these non-human entities had all of a sudden turned human making New Year’s resolutions to ignore underlying fundamentals and rally 2% a day. But guess what, markets don’t drunkenly warble Auld Lang Syne in symbolic banishment of times gone. There is no Lord of the Calendar presiding over the indices, ripping the pages of 2011 from the binding, erasing the memory of an ailing global economy, resetting expectations to a level of attainability where economic indicators such as Eurozone PMI indicating a contracting economy are now a positive indicator. In fact, the only symbolic symmetry I can find is in the economic hangover rattling the brains of money managers finance ministers and newly crowned technocrats the world over.
So as January rolls around we are still faced with the same positives and negatives, each release of data driving the markets, each tick of the currency market correlated to the price of commodities and equities. But here’s THE but: I am more attracted to US equities than I was in 2011. That is my resolution for the New Year BUT unlike those who resolve to lose significant weight in 2012, my complete transformation won’t happen in one day although it should endure past the next buffet – I mean, rally.
Yesterday’s Unicredit rights offering was not a positive sign for the markets. The 27 investment banks underwriting the offering reportedly accounted for three-quarters of demand for the $9.8 billion offering, a high price to pay for a call option on future fees and one which toxifies (literary alert: new word) their balance sheets in the name of fees and, no doubt, in response to arm twisting by the ECB. Shareholders were diluted to near zero and the deal was underwater from the first tick. Can’t imagine there is much appetite for these types of deals going forward as it will swell “bad” assets at the banks involved, somewhat ironically I might add.
I still believe that we will see nationalization or partial nationalization of some banks. The reason is simple: as with Unicredit, their problem loans and refinancing needs exceed their market caps. Additionally, compliance with Basil standards has led to these banks pulling in credit lines, the most immediate response, which has stifled credit and slowed economic growth. This, of course, is why the ECB has initiated their lending program. I surmise that Draghi has had conversations with the banks taking advantage of this lending facility to participate in the new issue market.
Next week is critical as Italy and Spain come to market seeking capital from charitable buyers. European debt is actually not a bad play if you can hold it longer term because it is extremely unlikely that either country will default. However, I’m not playing and believe the price they have to pay to fund themselves will be extraordinarily high and for Italy this is only the beginning of their refunding.
All of this comes down to the fact that there is still no plan to “cure” the credit crisis in Europe, absent austerity measures that will likely not be enforced or enacted to the necessary magnitude and will only be effective in continuing to drive the EU economy into recession. It is a lose-lose situation. The loan facility has removed fears of a Lehman type moment but that is not nearly enough. We still need to see the heavy artillery from the EU in the form of stimulus. For example, Italy has had one of the slowest growing economies over the last 20 years of all OECD nations. They can’t cut their way to growth. I look at the banks continuing to park funds overnight with the ECB at record levels as insider trading: they know their market better than sell-side analysts or pundits and if they are willing to take such an imbalance in rates of return in exchange for the safety of the ECB, the problems are as bad as I imagine them to be.
But China will save us all! No they won’t; they will look out for themselves and prey on the markets as they always have. They see commodity prices declining so they will not enter the markets and be the support mechanism until they are down to their last copper penny. China is on the bad end of two phenomenon: its property bubble bursting and its primary end market’s – the Eurozone – declining economy. Their trade surplus declined from $180 billion in 2010 to $160 billion 2011, numbers that any other nation would be happy with but not the Chinese. This is positive for the US but may be a short lived victory as they dropped the value of the yuan this morning, a reversal of prior policy and a move that will undoubtedly flame already tense relations with the US. This is a strong indication that the Chinese are very, and justifiably, concerned about their economy markedly slowing despite the recent PMI release. This slowing will, of course, hit the global economy but especially Australia which is why I am short the Aussie dollar, albeit small for now. Additionally, the property market in Australia is in horrendous shape and significantly hurting their banks and populous. They have to lower rates, further pressuring the currency.
Now here is the good news as I see it and it resides squarely with the U.S. market and as a devout patriot, I couldn’t be happier. The US treasury and stock markets are the global default markets of choice. Despite 2011 4Q negative pre-announcements hitting a high previously seen during two prior recessions in 2001 and 2008, the economic data is getting better. Today’s jobless claims number continues to trend downward, which I believe is a function of a smaller sampling and companies having already cut through muscle so perhaps not an indication of a vastly improving employment picture but positive nonetheless. Corporate earnings lag the improvement in the economy as companies ultimately respond by hiring more workers. However, I do see earnings estimates continuing to decline, particularly multinationals from the combination of weaker export markets and a stronger USD. Analysts are too optimistic in their S&P estimates for 2012.
So I remain relatively lightly position in equities, short the Euro against the dollar and short the AUD. The U.S. equity markets will continue to react to the worsening situation in the EU and have a tough time rising near term. However, asset allocation to equities, which I expected to see last year and perhaps we did to an extent, will ultimately drive equities higher so I don’t mind increasing my exposure opportunistically.
My preference is in defensive, domestically focused companies including healthcare, specifically managed care, nat gas, well-positioned retail, MLPs, utilities, US telecom and strong brands such as SBUX. Some of my specific holdings are: CHK (CEO continues to pay down debt and restructure production toward liquids from nat gas as he said he would), WLP (inexpensive, buying back significant stock, defensive), NS (7.5% yld, insider buying), QCOM (market leader), GM (cheap but not in love with name), KO (yield, defensive but currency issues), EUO, short FXA. Would not mind being short LNKD, GRPN, NFLX and ZNGA. This earnings season will be marked by currency adjustments and caution about Europe so I will mostly stay away from those companies playing in those areas.
Meanwhile, with some stability returning to the political scene in the US and Romney moving to the forefront, any sense of his emerging victorious in November will finally motivate US companies to spend the massive cash hoard on their balance sheet. This is not an immediate event, however.
So there you have it. Nothing much has changed, the focus required to write 20”12” instead of 2011 really the only thing new. I get the hang of that relatively quickly, usually after writing about 5 checks and filling out a few forms. The markets however, have not changed their ways at all, renouncing their resolutions after a mere two days.
In sum, I am more positively disposed to the markets and have slightly increased exposure but want to get a better glimpse of the earnings season and the critical refunding periods for European debt before getting longer.