fk commentary 15 september 2009

8/14/2019 FK Commentary 15 September 2009

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QInvest Private Client Advisory Commentary

Fatih Karatash, Head of Private Client AdvisorySeptember 15 2009


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Markets have seen a rebound on better than expected earnings and the mirage that things are not only stabilized but also starting to improve.

Bernanke coming out today to give the all clear is just whipped cream on the market froth.

What weve seen in the numbers though, has largely been above-consensus cost savings, inventory restocking, and other onetime events.

These are all quite useless as it pertains to the market ascribing a multiple to these incremental earnings that are not repeatable in asustainable manner.

What we need to see is top line revenue growth and employment pick up, which is effectively impossible as companies continue to

dramatically reduce costs. Markets are gorging on available liquidity and getting ahead of themselves.

QInvest Private Client Advisory Commentary

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Leverage continues to be a problem in the world. We dont believe you can work through the problems stemming from the bursting of the

largest credit bubble in history with only a couple quarters of pain. Deleveraging around the world will continue, and it will come in the form of

debt paydowns, bankruptcies, and home foreclosures. The pain may not be sharp like weve seen recently, but it will take years to get to the

next secular growth phase for corporate earnings and cash flows.

China is pumping money into their economy in order to try and make up for lost exports as they wait for the US and Europe to recover, this in

itself has resulted in the fastest rise in real estate prices in China over the past few years, with lending in excess of New Zealands GDP justin the first half being extended to borrowers.


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A significant amount of this money is adding to capacity in areas operating at very low utilization rates, creating more capacity, lowering

utilization rates further. At the same time along with Bernankes triumphant proclamation, we see headlines on industrial capacity utilisation

being at the lowest ever on record in Canada, thousands of layoffs a day from Corporates worldwide and none of the positive talk from

company executives in private.

The US and Europe have quantitative easing (monetary diarrhea, see the attached Monetary Base Growth chart) programs in place as well

as other subsidy-like programs (TARP, TALF, cash for clunkers, cash for appliances) that all are focused on adding liquidity to the system but

all of which will need to be paid for one day in higher savings and lower government spending and higher taxes. For the recovery to be real, it

must come from real demand, not government programs, inducements and bailouts that will help near term, but hold back real recovery as

they take their hidden toll.

Qinvest Private Client Advisory Commentary

3

Companies will continue to focus on cost cutting to maintain profitability. This may look positive in the near-term. This will however trickle

down negatively, as cost saving has a knock on effect down the value chain, whether its squeezing another companys margins or lost jobs

and consumption. Either way, there is no clear evidence corporate earnings and cash flows will recover robustly as long as consumption

contracts, which it will so long as unemployment trends do not reverse drastically. Consumers have to continue to save. Employment drives

consumption, and the employment picture is still bad. See the graph in the chart deck, which depicts the unemployment rate including

discouraged workers who have dropped out of the labor market.

Older Americans are actually gaining jobs, even as other age groups lose them. This is because skilled, older Americans who should be

enjoying their Golden Years, are now being forced to return to the labor market due to the wealth destruction that has occurred in the value of

their homes and retirment plans which were supposed to fund their lifestyles. This event of Generations X and Y, seeing their Baby Boomer

parents and grandparents go back to work will have a profound effect on the US Consumers Psyche for years to come.


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Where are we now?

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Market decline of -52% from peak to trough, rally of more than 53% from post collapse trough

Source: Bloomberg


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Where have we seen this before?

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Market decline of -48% from peak to trough, rally of more than 44% from post collapse trough

Source: Bloomberg


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The big rally only foretold the next big fall

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Source: Bloomberg

The red box is where the prior chart fits in with the consequent years market action Yes the Great Depression


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How did we get here?

US Debt (Household, Corporate and Government) as a

percentage of GDP

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Source: Ned Davis Research, Federal Reserve


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Leverage ratios as high as 1200:1

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Poor underwriting and excessive leverage led to Equity, BBB and even AA tranches being wiped out in mortgage backed

securities. If one had a CDO with AAA ratings, made up from the BBB tranche of an MBS, it could be fully wiped out

The Commercial Real Estate market has yet to see the same kind of decimation the Housing market has seen, which it inevitably

will, unless the economy has a rapid full recovery


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Home prices and demand decoupled

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Source: US Census Bureau

Home Sales and Median House Prices decouple, as a result of speculative demand introduced from the free option given to

speculators by zero down mortgages

Exacerbated by the limited liability in the US on home mortgages, where ones liability is limited to the home the mortgage is on,

and any obligations end with the return of the key


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% of GDP

US Household Consumption

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Source: US Bureau of Economic Analysis

Household consumption was driven by easy monetisation of home price appreciation, which in turn was driven by loose

underwriting for speculators

Absent this, household saving rates will have to increase and consumption must collapse for the foreseeable future


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Savings as % of

Disposable Income

Spending as %

of GDP

US Savings Rate

12

As part of the deleveraging process, the Savings rate must increase and the Consumer Spending must decrease back to

somewhere in the middle

The current wall of liquidity injected by central banks will only soften the blow and drag it out over a longer period, not take away

the need for deleveraging

Source: US Bureau of Economic Analysis


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Defaults are bound to rise further

Defaults as % of

outstanding High

Yield Issuance

13

Source: JPM

Default rates will go much higher as growth doesnt materialise the way the market expects, at least to the 90s level if not higher


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Industrial Production Index

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This time it is much worse than prior recessions, and closer to a Depression. One must not be fooled by the 50% rally in equities

Source: US Federal Reserve and NBER


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Monetary Diarrhea

1000000

1200000

1400000

1600000

1800000

2000000

Monetary Base in Millions of $

The Monetary Base

expansion has simply been

ex losive and

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Weve witnessed an unprecedented explosion in the Monetary Base in the US

Source: US Federal Reserve

0

200000

400000

600000

800000

1/1/1959

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unprecedented. No other

words to describe it


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Unemployment is the elephant in the room

Soaring U6 Unemployment Rate this

is the real rate of unemployment

The "U-6" includes two groups of

people that the "U-3" which media

and the government tend to quote, do

not:

1. "Marginally attached workers" -

people who are not actively looking

for work, but who have indicated that

they want a job and have looked for

work (without success) sometime in

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Source: BLS

All the bailouts and stimuli are being used to repair financial balance sheets and not going towards funding

real growth and investment, while unemployment continues to rise

.

includes "discouraged workers" who

have completely given up on finding a

job because they feel that they just

won't find one.

2. People who are looking for full-time

work but have to settle on a part-time

job due to economic reasons. This

means that they want full-time work,

but can't find it.


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This document contains confidential information and is intended

solely for the recipient who is not a retail customer

This document is provided for information purposes only and

does not replace independent professional judgment

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Company registration number: 00048

For further information, please visit our website at

www.qinvest.com


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fk commentary 15 september 2009

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