rmr q1 2013
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Global macroTRANSCRIPT
Feature
The great manipulation continues. The most important variable for
savers, producers, and investors to allocate capital and risk
continues to be manipulated in a fashion that is arguably
unprecedented and dangerous.
The current political regimes do not trust the markets. It is fair to
say that the distrust is mutual.
More and more investors want real assets. They want out. They
want something outside of the whole financial system where the
authorities are becoming more and more repressive. Trust has been
lost. Sadly, not all investors have the flexibility to take their funds
and park them outside of the financial system; they’re stuck.
Bonds are expensive. If an asset class is priced cheaply and
something goes wrong, the asset class gets even cheaper and
potentially becomes an opportunity for value and distressed
investors and bottom fishers. If an asset class is priced expensively
and something goes wrong, hell breaks loose.
Macro update
Global economy remains at an inflection point.
The average PMI are below 50 and stabilising. So the economic
trend, on average, is towards slight contraction and slow
deterioration of economic circumstances. This would be more or
less consistent with a falling average GDP growth rate and falling
average industrial production. All the monetary easing and fiscal
stimuli have stabilised the whole situation. Economically it’s not
great, but it’s not a global depression either.
Risk update
Risk is on. Risk seeking behaviour remains elevated, currently in the
4th highest percentile since 1997.
The easing of sovereign credit spreads is partially a function of
Draghi and partly a function of regulatory-induced short covering.
Risk management research
Repressionomics
18 January 2013 Alexander Ineichen CFA, CAIA, FRM +41 41 511 2497 [email protected] www.ineichen-rm.com “My true adversary does not have a name, a face, or a party. He never puts forward his candidacy but nevertheless he governs. My true adversary is the world of finance.” —Francois Hollande, Financial Times, 22 January 2012
Ineichen Research & Management (“IR&M”) is an independent research firm focusing on investment themes related to absolute returns and risk management.
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Repressionomics
On a personal note .............................................................................................. 3
Whatever it takes moments ............................................................................ 3
Murphy’s Law .................................................................................................. 4
We do not trust you......................................................................................... 7
Dogma in investment management .............................................................. 12
The ALM time bomb and the reality kick ...................................................... 15
Macro update .................................................................................................... 20
Summary ........................................................................................................ 20
Global economy: at inflection point .............................................................. 21
United States: improving ............................................................................... 29
Europe: at inflection point ............................................................................. 35
Germany: improving ...................................................................................... 37
France: declining ............................................................................................ 39
Italy: at inflection point ................................................................................. 41
Spain: improving ............................................................................................ 42
Netherlands: declining ................................................................................... 43
UK: declining .................................................................................................. 44
Switzerland: improving .................................................................................. 46
Japan: declining ............................................................................................. 47
China: improving ............................................................................................ 49
Risk update ........................................................................................................ 53
Summary ........................................................................................................ 53
Publications ....................................................................................................... 59
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On a personal note
“We must re-establish the primacy of
politics over the markets.”
—Angela Merkel1
“Make no mistake: We have
instruments of torture in the cellar,
and we’re going to show them, if
necessary.”
— Jean-Claude Juncker2
Whatever it takes moments
The great manipulation continues. Investment banks are being punished for
manipulating Libor by a couple of basis points; while central banks are being
lauded for manipulating the whole yield curve by a couple of percentage points.
The most important variable for savers, producers, and investors to allocate capital
and risk continues to be manipulated. Figure 1 shows some “whatever it takes”
moments in recent financial history. Where would interest rates be when left to
the market? Higher, most likely.
Figure 1: Whatever it takes moments
Source: IR&M, Bloomberg
One result of the great manipulation is that buy-and-hope strategies have worked
very well. Reflation has resulted in all boats rising. Figure 2 shows performance
since QE1 was announced in November 2008.
1 Firefighting, The Economist, 14 July 2011
2 Interview in Handelsblatt, 1 March 2010.
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Figure 2: Performance of a selection of indices/instruments (25 Nov 2008 to 11 Jan 2013)
Source: IR&M, Bloomberg
Risk management came at a cost and was a drag on performance.
Murphy’s Law
Mark Boleat, Chairman of The City of London, said in relation to the summer
Olympics in London:
Everything that could have gone wrong, didn’t.1
This quote is obviously a witty reference to Murphy’s Law:
Anything that can possibly go wrong, does.
In relation to the current financial landscape, here referred to as Repressionomics,
there is potentially a third variation:2
Anything that can possibly go wrong, will eventually but it may take a while.
In the inaugural report of this risk management research effort I made fun of
forecasting. The reason for the ridicule is due mainly to an unfortunate lack of
foresight on my part of course. Secondarily, the track record of forecasting is not
great. The latest analysis I came across was from Big Picture Barry Ritholtz. He did
a back of the envelope analysis of “Ten stocks to last the decade” from Fortune in
August 2000.3 The portfolio managed to lose 74.31% to 19 December 2012, with
two high profile bankruptcies (Nortel and Enron). Top pick was Nokia that fell
roughly 95%. Thirdly, an investment process that relies on forecasting cannot be
robust; I would argue, by definition.
How does Murphy’s Law or the modified Murphy’s Law above apply to the current
market environment of Repressionomics? It has to do with bonds. Here some
related facts:
1 AIMA’s Annual Conference, Guildhall, London, 20 September 2012
2 There are actually many more variations. See http://www.murphys-laws.com/murphy/murphy-laws.html
3 “Buy-and-Forget Portfolio: 10 Stocks To Last The Decade,” Big Picture 20 December 2012
“I've gone into hundreds of fortune-
teller's parlors, and have been told
thousands of things, but nobody
ever told me I was a policewoman
getting ready to arrest her.”
—New York City detective
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Bonds are widely perceived as less risky than equities, mainly due to academia
saying so. The argument is that bonds have, generalising a bit, lower volatility
than equities. Since volatility is the metric for risk chosen by modern portfolio
theory, bonds are less risky.
Regulators like bonds, as do national and supra-national accounting
committees. They need to go with the scholarly consensus; what else?
Retiring—and equity market crash doubly-shell-shocked—baby boomers have
been switching from equities into bonds for some time now. Japanese
investors have small allocations to their local stock market; it simply has been
going down for too long.
Last of all, and most importantly, allocations by institutional investors are high,
not low. Many bond markets in developed economies had a really really good
30-year run, hence the high allocation.
Newsletter writer Dennis Gartman from the Gartman Letter likes to refer to
something that has risen a lot as having moved “from the lower left hand corner
to the upper right”. Bonds are a good example, as Figure 3 shows. Bonds, quite
literally, have been going from the lower left hand corner to the upper right hand
corner in the graph. This is true in nominal as well as real terms. The Barclays US
Aggregate has compounded at a rate of 8.5% per year since 1980 which
compares to 3.4% for official US consumer price inflation.
Figure 3: Bonds (inception – 11th January 2013)
Source: IR&M, Bloomberg
With institutional bond allocations historically so high, the one thing that should
not happen is a strong rise in yields. The relevance to modified Murphy’s Law is
that it will eventually happen, it just might take a while. The “when” is the trillion
dollar question. Figure 4 shows yield curves of a selection of industrialised
economies compared to their own 10-year history as well as inflation. (CPI is
negative in Japan and Switzerland and therefore does not show in the graph.)
“A random market movement
causing the average investor to
mistake himself for a financial
genius.”
—Alternative definition of a bull market
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Figure 4: Yield curves
1.85
3.04
1.57
2.362.03
3.27
0.75
2.00
0.68
1.21
0
1
2
3
4
5
6
7
3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y
Yie
ld,
%
10Y Range
18/01/13
03/01/13
31/12/12
30/12/11
Inflation
USD EUR GBP JPY CHF
Source: IR&M, Bloomberg
Note: Numbers in graph stand for 10-year and 30-year yields. Short end of CHF yield curve “disappears” because yields
are negative.
Yield curves are low and have been reasonably stable over the past two years. The
US yield curve is negative up to a maturity of ten years, assuming official consumer
price inflation of 1.8% has any meaning. Shadow Government Statistics claims
inflation to be around 5% using pre-1990 methodology and around 10% using
pre-1980 methodology.1 The practical relevance is of course that the larger the
difference between inflation and nominal yields, the more extreme and quicker is
the saver expropriated. (At a real rate of -8% it takes a bit more than eight years
to half ones wealth in real terms.) The EUR and GBP yield curves are nearly fully
under water, i.e., real yields are negative for nearly all maturities. Negative real
yields are probably the most elegant, politically pragmatic way to reduce debt.
Interest rates are essentially the price for money, for risk capital. We know that
prices fluctuate. They rarely only go in one direction forever. Trees don’t grow to
the sky; even Apple shares are not excluded from gravity. It’s how these things
work. We just do not know when.
1 shadowstats.com
“There are two ways to conquer and
enslave a nation. One is by the
sword. The other is by debt.”
—John Adams (1735-1826), Founding
Father and second US President
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We do not trust you
Do we know what will be the catalyst for higher yields? Not really. Does it matter?
Yes it does. However, debating on the catalyst is speculative. One idea is that
yields will rise when trust is lost. But hasn’t that happened already? Europe is a
comedy. In Italy a comedian might become the next prime minister and France
inaugurated one last May while the infantile gyrations between the two political
squabblers in relation to the fiscal cliff was even embarrassing to me, and I’m a
non-American and an eight hour flight away from DC. So dwindling trust in our
leaders cannot help us time the eventual rise in yields. Note that we are now in a
sovereign crisis. A couple of years ago it was a banks crisis. The problems have
moved on. The pin that pricked the bubble in the banking crisis was a collapse of
trust. When banks didn’t trust each other, the game was over. Now, when
sovereigns stop trusting each other, the game is over. Asmussen’s “we do not
trust you,” therefore is quite a statement. Whether it is the clownish behaviour in
Washington and the political comedy unfolding in Paris which is the underlying
reason why the Bundesbankers in Frankfurt want their gold back, I don’t know. It
is certainly an indication that trust is not rising.
Another aspect on trust that is related to Repressionomics is the short selling bans.
Credit spreads on sovereigns in peripheral Europe have narrowed considerably. See
Figure 5. Having been as wide as 600 bps, Spanish 5-year CDS is now around 240
bps, Italy is down from 570 bps to 220 bps. Ireland now trades below 200 bps.
Now at least part of this performance can be put down to Draghi’s “it will be
enough – whatever it takes” speech in July 2012. And after the speech, Draghi
eventually followed this up in September with the announcement of the Outright
Monetary Transactions (OMT) programme in which the ECB would buy short dated
government bonds of Eurozone members where bond spreads reflected too high a
breakup premium (but with some conditionality attached in return). So is the
improvement in credit sentiment a reflection of conviction in the European
authorities to “save” peripheral bond markets? Not really.
Figure 5: Sovereign CDS spreads of PIIGSF (Jan 2006 – 11 Jan 2013)
Source: IR&M, Bloomberg
1 “Currency Union Teetering, 'Mr. Euro' Is Forced to Act,” Wall Street Journal Online, 26 September 2010
2 “Debt crisis: Mario Draghi pledges to do 'whatever it takes' to save euro,” The Telegraph, 26 July 2012
“Because we do not trust you.”
—Joerg Asmussen, the debuty
German finance minister’s response to
the question “Why don’t you let us
handle this?” to a senior commission
official trying to persuade Mr.
Asmussen to let Brussels run the
stabilization fund1
“Within our mandate, the ECB is
ready to do whatever it takes to
preserve the euro. And believe me,
it will be enough.”
—Mario Draghi2
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The other dynamic in H2 2012 might have been just as powerful; namely the
realisation amongst hedge funds and other asset managers that the EU regulation
on short selling and sovereign credit default swaps, published in April, might well
force them to close out short positions in the troubled sovereigns. The regulation
states that uncovered (“naked”) sovereign CDS shorts on European Union (not just
Eurozone) nations will not be permitted, and must be closed out by 1st November
2012. This is of course just a further, more aggressive stage in Repressionomics.
Short selling bans are the equivalent of banning gold in earlier times. “Naked”
broadly means not hedging an underlying government bond exposure – it covers
bearish trades on government creditworthiness. The short can be closed out by
either using an opposing CDS contract, or by buying underlying government
bonds to the same value. Whilst there was an exemption for positions initiated in a
period before the regulation was published, any short positions put on since then
have to be closed out, whether this is a single name CDS or even an index which
includes an EU member (for example the iTraxx Sovx CEEMEA index, a CDS index
consisting of 15 sovereigns from Central and Eastern Europe, Middle East and
Africa, includes Poland, and so a naked short position in the index would be
banned). The regulation is global in its reach and so should forbid even, for
example, a Singaporean bank dealing with a US insurance company out of an
office in Chile.1
Liquidity in the EU sovereign CDS market has collapsed. Since sovereign debt
instruments include short-term bills with a maturity of just one month when first
issued, market-making is often unfeasible over the entire term of such
instruments. Some market participants worry that the sovereign CDS market could
die off altogether due to these constraints and a host of other regulatory
pressures. There is a risk that market participants may find other ways to hedge
their exposures or express bearish views on EU sovereign risk, including shorting
government bonds – which the regulation does not forbid – or finding single-
name proxy CDSs. It’s a bit like prohibition or prostitution; the market will find a
way to respond to the repression. Since the ban on short selling, there has been a
sharp uptick in the number of investors using exchange traded futures that are
more lightly regulated. Open interest in Eurex listed Italian BTP futures for example
have almost doubled since the announcement of the ban.
The bottom line is that the current political regime doesn’t trust the markets. It is
fair to say that the distrust is mutual.
One could of course argue that trust has evaporated a long time ago. It must be
something else that causes real yields to fall further or nominal yields to rise;
financing a war perhaps, or a balance-of-payments crisis in the emerging markets,
or anything else. Figure 6 shows the underwater perspective of UK bonds since
1700. Judging by Figure 6, war can be ruled out too. After all, Britain has been at
war for most of its recent history (and I haven’t even included all conflicts where
military force was used). That’s what super powers—as well as former super
powers—do; it’s the norm. Pax Romana was defended by force; as was Pax
Mongolica and Pax Britannica; and now Pax Americana is secured by force.2 (If
1 http://www.bondvigilantes.com
2 Otherwise the USD$700bn+ per year spent on defence could be spent on social security; granting redistributive
payments to 99% of the population instead of just 50% which is the current estimate. Personally, I am actually quite
grateful of growing up and living in the Pax Americana; the alternatives are so much less attractive. The older I get, the
Short selling bans, forbidding the
holding of gold, nationalising
private pensions, etc. are forms of
repression
The market will find a way
“The past may not repeat itself, but
it sure does rhyme.”
—Mark Twain (1835-1910), American
author and humourist
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there is ever a Pax Helvetica, then they will use force too.) The US military currently
has troops in more than 150 countries; barbarians at the gate everywhere.1 History
does indeed rhyme sometimes.
Figure 6: UK bonds under water in real terms (Jun 1700 – Dec 2012)
Source: IR&M, Global Financial Data, Bloomberg, inflation from 1750-1800 from Twigger (1999)2, war dates from wikipedia.
Note: Zero inflation was assumed for 1700-1749
As a very rough estimate, Great Britain spent 71% of its time at war since
1700. It’s the norm, peace the exception.
Bonds can spend a long time under water; in the UK and elsewhere of course.
At the moment it seems that the regulators don’t know this, while the asset
liability benchmark hugging community doesn’t care. Their incentive to care is
being repressed. More on that later.
Figure 7 shows the underwater perspective of a proxy for US Treasuries as well as
US equities.
more I seem to side with Margaret Thatcher: “During my lifetime most of the problems the world has faced have come, in
one fashion or other, from mainland Europe, and the solutions from outside it.” Thatcher, Margaret (2002) “Statecraft—
Strategies for a changing world,” New York: Harper Collins, p. 320. Thankfully, my native place, Switzerland, is not in
Europe.
1 Note that Osama Bin Laden is perceived and named a terrorist by the people who live within Pax Americana; similarly as
George Washington was to the people living within the Pax Britannica. The perspective matters greatly. (And winning, of
course.) Note that the word “terrorism”—emotionally charged with different definitions in circulation—is younger than
George Washington, another word was used for massacres inflicted by non-governmental forces.
2 Twigger, Robert (1999) “Inflation: the Value of the Pound 1750-1998,” Research Paper 99/20, House of Commons
Library, 23 February.
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Figure 7: US equities and bonds under water in real terms (Jan 1900 – Dec 2012)
Source: IR&M, Global Financial Data, Bloomberg, war dates from wikipedia
When risk for an asset class is defined as “potential years under water in real
terms”, i.e., the longevity of capital compounding negatively, bonds are more
risky than equities. The drawdowns in equities are more violent and the
recovery more swift, both contributing to a higher standard deviation of
returns, i.e., volatility. Bond/credit cycles are longer than equity/business cycles.
What is most important is that the 48-year episode in Figure 7 is outside of the
living memory of the contemporary investor or regulator.
The United States was at (hot) war in 81% of the time since 1900 when the
cold war and some minor conflicts are ignored. War is the rule, not the
exception. History is a constant struggle between freedom and repression. Pax
Americana and its allies, with differing contributions, have fought for the
former and against the latter. Perhaps it’s one of the ironies of history that
Western civilisation is now becoming repressive on its own citizens and those
who were formerly repressive are opening up. It seems that Russia and China
are done with social experiments whereas the United States have just began.
Ms Merkel—an Ossi—knows. She has seen with her own eyes and knows that
it doesn’t work. Mr Obama hasn’t and doesn’t.
The idea that wars are more likely in a fiat money system is difficult to defend
when examining the chart. When you want to go to war, you go to war.
Nevertheless, the financing of the armament is probably easier in a fiat money
system. (In a non-fiat monetary system you would need to tax the rich heavily
or use financial repression and force investors to buy government bonds and
ban short selling of those bonds or you would need an influential orator, a
demagogue, a yes-we-can-kind-of-guy in charge.)
Yields can rise for a long time. This means of course that bonds can
compound negatively (nominally as well as in real terms) for a long time.
A further aspect is related to correlation. Both equities and bonds can both
compound negatively simultaneously for a long time. Both equities and bonds
are valued on the basis of discounting future cash flows to today. When
1 Merkel hints at need to cap social spending, Financial Times, 17 December 2012
“Man seems to insist on ignoring the lessons available from history.” —Norman Borlaug (1914 - 2009), American agronomist and the father of the Green Revolution
“We witnessed in the GDR and in
the entire socialist system that an
economy which was no longer
competitive was denying people
prosperity and ultimately leading to
great instability.”
—Angela Merkel1
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nominal yields rise, the present value of those cash flows falls. The period of
disinflation and falling interest rates was good for both. The opposite,
whatever that might be, is not. It is not surprising, therefore, that more and
more investors want real assets. They want out. They want something outside
of the whole financial system where the authorities are becoming more and
more repressive. Trust has been lost. Sadly, not all investors have the flexibility
to take their funds and park them outside of the financial system; they’re
stuck.
When examining bonds in Figure 7, it is not necessarily obvious that the past 25+
years are in any way representative for the long term. It seems the past two or
three decades seem actually rather an exception than the rule. The Maestro,
pictured, was inaugurated in 1987. When thinking about bonds and correlation
between equities and bonds, it is possible that the past 25+ years were one single
regime with certain characteristics. It essentially was a credit bubble causing asset
price hyperinflation. Whatever it’s called, if this idea has any merit then, of course,
a different regime may have entirely different characteristics. For mean-variance
optimisation, or any other optimisation, to be intelligent, the regime should not
switch. Currently, diversification is perceived as a good idea.1 It is possible that a
regime awaits us, where no government bonds of sovereigns in the industrialised
economies is the course of action of the wise investor. This would be quite the
opposite of the risk parity idea in which one essentially levers up on bonds because
volatility is so much lower than equities.
Figure 8 shows what Keynes meant, what Keynesians did, and what seem the
current and unintended consequences. The third regime/graph is arguably
different from the previous/second one.
Figure 8: What Keynes meant, what Keynesians did, and the mess it caused
Source: First two graphs are from Protégé Partners, third is IR&M
Keynes idea was about counter-cyclical fiscal stimulus, i.e. boosting aggregate
demand by expanding debt to weather the trough of the business cycle and
correspondingly shrinking demand by retiring debt during the ensuing boom.2
However, this latter point was sort of ignored. As the Economist put it:
The state’s growth has been encouraged by the right as well as the left, by
favour-seeking companies as well as public-sector unions, by voters as well as
1 The idea of diversification goes back a long way and is indeed a good idea. See Diversification? What diversification? for
some additional colour on the topic.
2 From Protégé Partners 4Q 2009 quarterly letter
Mon
ey
Time
Save
Borrow
Borrowing
Business Cycle
What Keynes Meant
Mon
ey
Time
Borrow
Borrowing
Business Cycle Borrow
Borrow
What “Keynesians” Did
Mon
ey
Time
Borrowing
Business Cycle
Monetising debt
Unintended consequences
Monetising debt
Monetising debt
“None of us can have as much as
we want of all the things we want.”
—Oliver Wendell Holmes (1809-1894),
American writer
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bureaucrats. Indeed, given the pressures for ever larger government, many
reformers feel they will have to work hard just to
keep it at its present size.1
Alan Greenspan on the topic of fiat money, gold,
welfare state, and the government’s involvement;
before working for the government:
In the absence of the gold standard, there is no
way to protect savings from confiscation through
inflation. There is no safe store of value. If there
were, the government would have to make its
holding illegal, as was done in the case of gold. …
The financial policy of the welfare state requires
that there be no way for the owners of wealth to
protect themselves.
This is the shabby secret of the welfare statists'
tirades against gold. Deficit spending is simply a
scheme for the confiscation of wealth.2
I’m not a believer in the gold standard. However, I believe in Repressionomics, i.e.,
that failed authorities go after the saver’s money. (I also believe that sometimes
there is great wisdom and truth in cartoons.) And what better place to get the
money where it currently resides: institutional investors, namely pension funds and
insurers. These institutions are the safekeeper of the forced savings of the
populace. They hold large allocations of government bonds. They have to.
Interestingly, in many cases, they also want to.
Dogma in investment management
At one level, dogma, beliefs, faith, and uncertainty are related. On another level a
discussion of dogma, beliefs, faith, and uncertainty could become emotionally
charged as someone’s strongly held beliefs are complete and utter nonsense to
someone else. To some historians dogma is the number one cause for Homo
sapiens killing one another. 500 years ago it was Catholics against Protestants (in
some places they still do) and today its Shiites and Sunnis.3 George Bush went on
record saying that “God told me to invade Iraq.” This is one example of differing
perceptions. Imagine he had said: “A creature on Alpha Centauri has told me
through my hair blower to invade Iraq.” Everyone would have thought he is mad.
However, by adapting a common belief system, only parts of the world population
thought he was mad. For some people, those in the second and third row in Table
1, the two aforementioned statements are nearly identical.
1 The Economist, A special report on the future of the state, Taming Leviathan, 19 March 2011
2 Gold and Economic Freedom, The Objectivist, 1966, reprinted in Ayn Rand’s Capitalism: The Unknown Ideal, 1967.
3 These things seem to oscillate. In 500 years it might be Catholics and Protestants again. When Europeans were
chopping each other’s heads off because they couldn’t agree which old book was more important, the area we today call
the Middle East made great advances in the natural as well as social sciences as well as philosophy and medicine. For
the time being it’s the other way around.
History suggests that when
authorities fail, the 99% lose
Montaigne's axiom:
"Nothing is so firmly believed as
that which least is known."
—Michel de Montaigne (1533-1592),
French author, philosopher, and
statesman
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Table 1: Belief in a supreme being by country
Source: Harris Organization Inc.
Caveat lector: The topic of belief and dogma are tricky, especially when combined
with ridicule. However, the topic of belief and dogma is central to this publication
as will become apparent below. Ridicule1, humour2, cynicism3 are all forms of
honesty, the search for the truth; essentially the opposite of political correctness.
Political correctness is dishonest by definition. Research is defined as seeking the
truth and ought to be honest and therefore must be political incorrect by
definition. Occasional and potential offensiveness is not the purpose but an
unfortunate side effect.
I believe the following pieces of wit and wisdom have merit and, in one form or
another, apply to the topic of dogma in finance. If some of these remarks are
offensive, it’s not the messenger’s fault. Personally, I find the way in which they
apply to finance and the current political environment shocking. It goes without
saying that these quotes were taken out of context; Leonardo da Vinci wasn’t
thinking of asset-liability benchmarking when he said the below. I must assume,
therefore, that the applicability of these references lie in the eye of the beholder.
"Believe those who are seeking the truth; doubt those who find it."
—Andre Gide (1869 – 1951), French author and winner of the Nobel Prize in
literature in 1947
Well, that one was just a bit of self-promotion; bad taste, so to speak. The
following are more applicable.
“The greatest deception men suffer is from their own opinions.”
—Leonardo da Vinci (1452-1519), Renaissance Man
“It is not disbelief that is dangerous to our society; it is belief.”
—George Bernard Shaw (1856-1950), Irish dramatist, critic, political activist
and co-founder of the London School of Economics
1 “All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being
self-evident.”—Arthur Schopenhauer
2 “Not a shred of evidence exists in favor of the idea that life is serious.”—Brendan Gill (1914-1997), American writer (The
New Yorker); “It is my belief, you cannot deal with the most serious things in the world unless you understand the most
amusing.”—Winston Churchill
3 “The power of accurate observation is commonly called cynicism by those who have not got it.”—George Bernard Shaw
4 Breakfast with Dave, Gluskin Sheff, 9 February 2012
% France Germany Great Britain Spain Italy United States
Believer in any form of God or any type
of supreme being27 41 35 48 62 73
Agnostic (one who is sceptical about
the existence of God but not an atheist)32 25 35 30 20 14
Atheist (one who denies the existence
of God)32 20 17 11 7 4
Would prefer not to say 6 10 6 8 8 6
Not sure 4 4 7 3 3 3
“The two pillars of ‘political
correctness’ are: a) wilful
ignorance, b) a steadfast refusal to
face the truth.”
—George MacDonald (1824-1905),
Scottish author
“In the arena of wealth
management, there is no room for
dogma.”
—David Rosenberg4
“Bad taste is simply saying the
truth before it should be said.”
—Mel Brooks
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“The fact that an opinion has been widely held is no evidence
whatever that it is not utterly absurd.”
—Bertrand Russell (1872-1970)
Rephrased: Just because everyone matches their assets to their liabilities doesn’t
necessarily mean it’s a good idea.
“The most common of all follies is to believe passionately in the
palpably not true. It is the chief occupation of mankind.”
—Henry Louis “H. L.” Mencken (1880 - 1956), American journalist, essayist,
magazine editor, satirist, and critic of American life and culture
“The death of dogma is the birth of reason.”
—Immanuel Kant (1724-1804)
"There can't be a practical reason for believing what isn't true. I rule it
out as impossible. Either the thing is true or it isn't. If it is true, you
should believe it, and if it isn't, you shouldn't. And if you can't find out
whether it is true or whether it isn't, you should suspend judgement."
—Bertrand Russell on the question whether there is a practical reason for
having a religious belief1
This essentially means: If you cannot be sure that a 90% bond allocation is really in
the best interest of your “liabilities”, diversify.
“At least two-thirds of our miseries spring from human stupidity,
human malice and those great motivators and justifiers of malice and
stupidity: idealism, dogmatism and proselytizing zeal on behalf of
religious or political ideas.”
—Aldous Huxley (1894 - 1963), English writer
At one level, one would have assumed everyone to be on the same page with
respect to the effects (not side effects, effects) of a 75% marginal tax rate. One
obviously would have erred.
“The difficulty lies, not in the new ideas, but in escaping the old ones,
which ramify, for those brought up as most of us have been, into every
corner of our minds.”
—John Maynard Keynes2
The idea that bonds are less risky than equities is a strongly held belief; it’s dogma.
Asset liability management (ALM), i.e., the idea that long-term bonds are a perfect
match for long-term liabilities, is widely regarded as the pinnacle of investment
wisdom. It might not. Not, if history rhymes.
1 “50 renowned academics speaking about god,” by Jonathan Pararajasingham, bigpicture.com.
2 Preface of The General Theory of Employment Interest and Money (1935), Paraphrased variant: “The difficulty lies not
so much in developing new ideas as in escaping from old ones.”
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The ALM time bomb and the reality kick
There is an element of déja vu. It seems I have seen this show before. Let me
explain. The period of disinflation of the 1980s and mainly the 1990s together
with some other factors gave rise to the cult of equities. By the late 1990s, I was in
derivatives research specialising in equity indices and the “adds and delets” trade.
Additions and deletions (“adds and delets” for short) were then a market
inefficiency. There are two bullet points related to dogma and belief systems that I
believe are worth mentioning and are relevant to today.
The rise of the equity cult among non-English-speaking institutional investors
was slow. The slowest invested last. I remember speaking at a conference in
Oslo around 2002, when the Ericsson-heavy OMX had already more than
halved. The Swedish finance minister was a fellow speaker and talked about
the pension reform that took place in the 1990s and was implemented quite
literally around the peak of equities. The reforms allowed some of the AP
funds larger allocations to equities, essentially to take more risk. The dogma
prior and at the peak was that “equities are for the long-run” and that they
outperform bonds in the long run. As long-term investor, one could therefore
have a large equity allocation because one could sit through large drawdowns.
In other words, some Swedish pension funds bought at the peak—literally.
The Swedish finance minister took it with humour. His vantage point was one
of hindsight. What else can one do other than grin? Other investors started
increasing their equity allocations too around the late 1990s. Many German
institutional investors, for example, started to move away from their traditional
bond-heavy portfolios and piled into equities. The whole nation was
infatuated with the “Neuer Markt” and business TV. It was a crazy time.
History rhymed a couple of years later with hedge funds. Pioneers invested in
the 1990s, early adopters in 2000-2002 while late comers made their first
allocation to fund of hedge funds close to the peak around 2007. So when we
hear more and more institutional investors claim that ALM is the pinnacle of
institutional investor’s wisdom; it somehow has a déja vu ring to it.
One aspect of the “adds and delete” trade which I still find fascinating is that
many long-only managers I have visited at that time just didn’t care. Hedge
funds and traders from investment banks were all over this. The reason why
they were all over it was because it was an investment opportunity, a
profitable market inefficiency. The inefficiency—just to recap—was that large
index funds and so-called active managers who were running money on a
tracking error constraint of 1-2% to their benchmarks were forced buyers of
the stocks that went into an index and forced sellers of the stocks that went
out. Their action was predictable; hence the profit potential. The reason they
were “forced” was because their risk management department overruled any
other discretionary decision-making. The fascinating thing is that the long-only
managers didn’t care. I’ve seen this with my own eyes; it’s not from a book or
paper. The funds were managing relative risk (tracking risk) and that was the
end of it. If this behaviour lost money, it didn’t matter, no one cared. It was
the peak of the tracking error or relative returns paradigm in equities:
complete indifference to losing money. The careful reader knows what is
1 Charmingly portrayed in Woody Allen’s Midnight in Paris.
“This is the lesson that history
teaches: repetition.”
—Gertrude Stein (1874-1946),
American writer1
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coming: the same applies today with ALM and the benchmarking of bond
allocations to match liability benchmarks.
The two or three cardinal rules to investing could be:
“Diversification should be the cornerstone of any investment
program.”
—Sir John Templeton
“The first rule of investment is don’t lose. And the second rule of
investment is don’t forget the first rule. And that’s all the rules there
are.”
—Warren Buffett quoting Benjamin Graham1
George Soros referred to Buffett’s first rule as “cardinal” in November 2008:
“During the current financial crisis, many hedge fund managers forgot
the cardinal rule of hedge fund investing which is to protect investor
capital during down markets.”
—George Soros2
The diversification idea is based on the premise that we don’t know the future. If
we knew that wind farms would yield the best 10-year point return, there would
be no need for caring about risk or diversification. Diversification is for those who
know what they don’t know. All other investors either don’t know what they
don’t know or caught some dogma bug from which the only cure is substantial
losses. “Learning by doing” is an important adage in risk management and
experience a cruel and expensive teacher.
My fascination with ALM and liability benchmarking and the subsequent high
bond allocations is that it is out of synch with the two “rules” mentioned above.
Diversification: There are institutional investors who are not diversified.
The belief is that they don’t need to. The belief is that
bonds, long-term bonds in particular, are the perfect
match for their liabilities.
Capital preservation: There is an indifference to potential losses. When interest
rates rise and bonds fall, the liabilities will fall too. So all is
well. So the risk management department, therefore, is
managing tracking risk, like in equities 10+ years ago.
There is a reality kick out there.
Figure 9 shows the S&P 500 Index with the peak of the relative returns and
tracking risk paradigm circled. When equities were falling, the absolute returns
revolution kicked in. History could rhyme once again.
1 It is unclear whether original quote is from Ben Graham. Buffett in “The Forbes Four Hundred Billionaires, October 27,
1986: “Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.”
2 Statement of George Soros before the U.S. House of Representative Committee on Oversight and Government Reform,
13 November 2008
"There are three kinds of men. The
one that learns by reading. The few
who learn by observation. The rest
of them have to pee on the electric
fence for themselves."
—Will Rogers
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Figure 9: S&P 500 Index
Source: IR&M, Bloomberg, book publishing dates from amazon.com
At the peak perceptions are different than at the trough. Calling an institutional
equity mandate with a tracking error constraint of 1-2% “active” was perfectly
normal. Absolute returns weren’t even a thought among many long-only asset
managers and their clientele. However, this started to change as share prices
started to fall. The assumed indifference to absolute losses slowly but steadily
turned out to be ill-advised. It is this reality kick that put hedge funds on the
agenda of many institutional investors.
Related to ALM, this reality kick has not yet materialised. The reason is that the
ALM crowd has actually done rather well lately. So when they argue that they are
indifferent to absolute losses it actually makes perfect sense to them. After all,
when interest rates rise—assuming they will ever rise again—and bonds fall, so do
liabilities. Assets and liabilities are in synch. Risk is defined as tracking risk, i.e., risk
is perceived as the assets moving out of synch with their liabilities. This is of course
the same as the tracking risk dogma in equities twelve years ago. There is the
perception that there is no need for diversification or capital preservation. Being
indifferent to absolute losses is like hearing voices of world peace from Alpha
Centauri through our hair blowers: it’s insane to some, but not to everyone.
An additional aspect not yet mentioned is related to committee-based investment
decision making. Most institutional investment committees are comprised of
individuals with different backgrounds. Not all of them are familiar with finance
and economics in general and the history of stock and bond markets in particular.
Those with knowledge dominate the investment process, especially when all goes
well. Those with less knowledge have nothing much to add other than agree and
nod approvingly with the bellwether. Any criticism is easily put down by referring
to favourable past performance. However, when equities started to tank the
“You can avoid reality, but you
cannot avoid the consequences of
avoiding reality.”
—Ayn Rand (1905-1982), Russian-
American novelist and philosopher
“Men, it has been well said, think in
herds; it will be seen that they go
mad in herds while they recover
their senses slowly and one by
one.”
—Charles MacKay (1812-1888),
Scottish author
“A fool with a tool is still a fool.”
—Saying
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investment committee dynamics started to change. Suddenly the equities-
outperform-bonds-in-the-long-term mantra had a different feel to it. The equity-
defending bellwethers in the committee had their wings clipped. The laypeople in
the committee started to question the logic of having such a high allocation to
equities. Doubting equities was nearly impossible when they were rising, but was
made easier when falling. Was tracking risk really all that mattered? Real absolute
losses changed the game. Discussing the equity risk premium puzzle with the
academics in the investment committee over a glass of claret was a thing of the
past. Things turned less friendly when faced with losses. Suddenly underfunding
and fund solvency were agenda items. The investment committee dynamics were
different when share prices were free-falling than when they were rising irrational
exuberantly. It was like pre-battle theorising versus the reality of the battle field.
The practical relevance is that history rhymes. This time it is not an infatuation with
equities but with long-term bonds including government bonds. The regulator and
accounting ruling boards are partly to blame. Next to politics and central banking,
they play a role in Repressionomics. It is they who apply current dogma in finance
unquestioned and set the guidelines. The ALM phenomenon is essentially, or
partly, a function of the general legal and regulatory framework; hence the
perception of rationality on part of the asset liability benchmarker. The relative
return risk manager behaves rationally from the perspective of his vantage point
and assessment of the framework in which he operates.
Bottom line: Anything that can possibly go wrong, will eventually but it may take a
while.
One aspect beyond the scope of this report is an ethical one: Rational decision
making under uncertainty and asset allocation is one thing. Another is whether the
Prudent Person Rule supports financing political scoundrels, supports the
participation of what is clearly identifiable as a pyramid scheme, supports
unprecedented maladministration, misgovernment, and mismanagement of public
funds. I don’t have an answer, just doubt.
***
One aspect of something rising heavily is that it becomes overpriced as everyone
and his dog has already chipped in. That is what crowd psychology (and cheap and
available financing) does to pricing.3 Figure 10 shows pricing of equities, bonds
and cash for the US as a proxy for the industrialised economies. Valuation is based
on a high-low comparison. Equities valuation is based on the trailing earnings yield
(reverse of the PE ratio), bonds on the 10-year Treasury yield and cash on the Fed’s
fund rate. The first six groups of bars shows the valuation metric in January of the
decade while the bars on the right show the most recent valuation. The higher the
yield, the cheaper the asset class.
1 Nassim Nicholas Taleb (2012) “Antifragile – Things That Gain from Disorder,” New York: Random House, p. 15.
2 The Sun, 4 October 2012
3 Throughout my career I have occasionally been asked what my favourite books related to finance were, so I have been
maintaining a top ten list for many years. “The Crowd” by Gustave Le Bon was first place on that list for most of the time.
However, over the past couple of years it has been “The Lessons of History” by Ariel and Will Durant. The Crowd is
runner-up; for what it’s worth.
“People that are really very weird
can get into sensitive positions and
have a tremendous impact on
history.”
—Dan Quayle
“Modernity has replaced ethics with
legalese, and the law can be gamed
with a good lawyer.”
—Nassim Taleb1
The United States has 5% of the
world’s population, 25% of its
incarcerated people, and almost
50% of the world’s lawyers.
—Conrad Black2
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Figure 10: Valuation (January 1960 – 14 January 2013)
Source: IR&M, Bloomberg
Equities are neither historically cheap nor expensive. Demographics favour
bonds, not equities, as flows over the past couple of years have indicated. If
institutional investors for whatever reason need to reduce bonds, equities are
most likely to benefit.
Cash is expensive and not king. In Repressionomics it’s a wasting asset. Cash
and low duration fixed income instruments compound negatively in real terms.
However, there is a difference between an economic area that is fragile and
one that is antifragile. A system that is fragile breaks when under stress while
a system that is antifragile, benefits; at least up to a point.1 Italy is fragile
because of its debt levels, misadministration and corruption. Switzerland is
antifragile, it benefits from disorder in the Eurozone; up to a point at least. I
like to explain these things with Wriston’s Law of Capital. However, Taleb’s
new word creation is original and works well too.
Bonds are expensive. I do not know what will prick the bubble, neither does
anyone else. But something is for sure: If an asset class is priced cheaply and
something goes wrong, the asset class gets even cheaper and potentially
becomes an opportunity for value and distressed investors and bottom fishers.
If an asset class is priced expensively and something goes wrong, hell breaks
loose.
1 See Nassim Nicholas Taleb (2012) “Antifragile – Things That Gain from Disorder,” New York: Random House.
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Macro update “There is actually a much tighter relationship
now between the stock market and the
central bank balance sheet – via the P/E
multiple – than there is between the stock
market and corporate earnings. Somehow,
this chapter on the importance of central
bank money printing was missing in the
Graham % Dodd classic on Security Analysis
when it was first published in 1934.”
— David Rosenberg1
Summary
Global economy remains at an inflection point.
Both business and consumer sentiment are reasonably stable.
Monetary policy remains easy; cash remains hoarded, volatility remains low,
uncertainty remains high.
Table 2 shows a summary of what we believe are the economic trends and surprises. A brief comment as well as some technical
information on the stock market has been added. Changes since our last update are circled.
Table 2: Summary
Remarks
Surprises**
Percentile Change*** Direction* Average Above 50D 200D 50D>
18 Jan 13 (2006-) (3 Jan 13) (10-day) (100-day) average? 200D?
Global 48 1.1 Rising Falling No Positive At inflection point Rising Rising Yes
US 97 0.9 Rising Rising Yes Positive Improving. Rising Rising Yes
Europe 44 1.0 Rising Rising Yes Positive At inflection point. Rising Rising Yes
Germany 47 4.5 Rising Rising Yes Positive Improving Rising Rising Yes
France 28 -0.7 Rising Falling No Negative Declining. Rising Rising Yes
Italy 27 -1.7 Rising Falling No Positive At inflection point. Rising Rising Yes
UK 56 -6.2 Falling Falling No Positive New: Declining (from inflection point) Rising Rising Yes
Switzerland 47 0.3 Rising Rising Yes Negative Improving. Rising Rising Yes
Japan 26 -0.7 Rising Falling No Positive Declining. Rising Rising Yes
China 24 4.3 Falling Rising Yes Positive Improving. Rising Falling No
Fundamentals Technicals
IR&M Models Moving averages
Source: IR&M
Notes: * Direction: average last ten days versus previous ten-day average; ** Surprises are from Citigroup except Germany, France , and Italy (which are our own). *** Change
in percentile points relative to date shown in brackets.
The relationship between red changes and green changes is 3:3, i.e., on
average not much has changed.
1 Breakfast with Dave, Gluskin Sheff, 11 January 2013, emphasis in the original.
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Global economy: at inflection point
GDP growth rates: falling
Table 3 shows year-on-year GDP (seasonally adjusted in most cases) for a range of economies. We have colour-coded the data to
show highs (green) and lows (red), synchronisation of the data, and past and current trend. The average is equally weighted.
Table 3: Global real GDP, SAAR (seasonally adjusted annual rate)
06 12 09 12 12 12
1.7 1.3 1.4 Average
2.1 2.6 n.a. US
7.6 7.4 7.9 China
1.0 0.9 n.a. Germany
-0.5 -0.6 n.a. Eurozone
3.9 0.5 n.a. Japan
-0.3 0.1 n.a. UK
0.1 0.0 n.a. France
-2.3 -2.4 n.a. Italy
-1.4 -1.6 n.a. Spain
0.5 0.9 n.a. Brazil
2.2 1.0 1.1 Canada
n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.5.5 5.3 n.a. India
4.0 2.9 n.a. Russia
3.8 3.1 n.a. Australia
2.3 1.5 n.a. South Korea
-0.1 1.0 n.a. Taiwan
1.2 1.3 n.a. Hong Kong
2.5 0.3 1.1 Singapore
0.3 1.4 n.a. Switzerland
Mar 1999 to Mar 2012
Source: IR&M, Bloomberg. Notes: Not seasonally adjusted: Japan, South Korea, Singapore, and Switzerland. Original data: US: Bureau of Economic Analysis; China: National
Bureau of Statistics; Germany: Federal Statistical Office; Japan: Economic and Social Institute; UK: Office for National Statistics; France: INSEE; Italy: ISTAT; Spain: Eurostat;
Brazil: IBGE; Canada: STCA; India: Central Statistical Organisation; Russia: Federal Service of State Statistics; Australia: Bureau of Statistics; South Korea: Bank of Korea;
Taiwan: Directorate General of Budget Accounting & Statistics; Hong Kong: Census & Statistics Department; Switzerland: State Secretariat for Economic Affairs.
Average GDP peaked in Q2 2010 and has fallen more or less gradually ever
since. First indications including recent PMIs suggest that the growth rate
might have stopped falling, i.e., has stabilised in low but positive territory.
China Q4 2012 were reported at 2.0% where 2.2% were expected. It seems
that everything that is “not negative” is good news.
QoQ for Q4 in Singapore was higher and above expectations. However, Q3
was revised downwards.
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Industrial production: contracting but not free-falling
Table 4 shows year-on-year industrial production. The average is equally weighted. Industrial production is generally perceived as
a lagging indicator. In the case of a figure not available, the previous one is used to calculate the latest average. Chart 1 shows
Taiwan trade (exports minus imports) as a proxy for global economic activity.
Table 4: Industrial production
Oct Nov Dec
-0.9 -0.8 n.a. Average
2.0 2.9 2.3 US
9.6 10.1 10.3 China
-3.3 -3.7 n.a. Eurozone
-4.5 -5.5 n.a. Japan
-3.0 -2.9 n.a. Germany
-3.4 -3.6 n.a. France
-3.0 -2.4 n.a. UK
-1.7 0.7 n.a. Netherlands
-4.3 -4.3 n.a. Sweden
-6.1 -7.6 n.a. I taly
-3.1 -7.2 n.a. Spain
-0.8 2.9 n.a. South Korea
8.3 -0.1 n.a. India
n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.-5.1 3.1 n.a. Singapore
4.8 5.9 n.a. Taiwan
Jul 2007 to Sep 2012
Source: IR&M, Bloomberg.
Notes: Based on yoy industrial production. Industrial production is generally perceived as a lagging indicator. The average is equal weighted. In the case of a figure not
available, the previous one is used to calculate the latest average.
US December 2012 was lower but in line with expectations, China was stable
and in line.
November 2012 figures for EC, Italy, the UK, Spain, and Sweden were all
lower and below expectations. Germany was flat but disappointing. France
and the Netherlands were higher on MoM basis and better than expected.
Chart 1: Taiwan trade
35
40
45
50
55
60
65
70
-150
-100
-50
0
50
100
150
200
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Glo
ba
l PM
I
Ta
iwa
n tr
ad
e b
ala
nce
Negative surprises in G10 (Citi, since 2003) Taiwan trade balance (lhs) Global PMI (JPM, rhs)
Contracting
Source: IR&M, Bloomberg.
December 2012 trade balance was higher and much better than expected.
Exports were +9% while +4.5% was expected.
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PMI: below 50 but stable
Table 5 shows a selection of global Purchasing Manager Indices (PMI) for the manufacturing sector. These are diffusion indices
and therefore oscillate between 0 and 100. A reading above 50 is associated with an expanding industrial activity whereas a
reading below 50 signifies contracting activity.
Table 5: PMI
Aug Sep Oct Nov Dec
48 47 47 47.8 47.9 Average
48 49 49 49.6 50.2 Global PMI (JPM)
50 52 52 49.5 50.7 US: ISM
53 50 50 50.4 51.6 US: Chicago
49 50 50 50.6 50.6 China
48 48 47 46.5 45.0 Japan
45 46 45 46.2 46.1 Eurozone
45 47 46 46.8 46.0 Germany
50 48 47 49.2 51.4 UK
46 43 44 44.5 44.6 France
44 46 46 45.1 46.7 Italy
47 44 46 48.5 49.5 Switzerland
45 45 43 43.2 44.6 Sweden
49 50 50 52.2 51.1 Brazil
45 44 45 44.3 44.3 Australia
48 49 50 48.8 n.a. New Zealand
51 48 47 49.5 47.4 South Africa
49 49 48 48.8 48.6 Singapore
Jan 2008 to Jul 2012
Source: IR&M, Bloomberg. Original data: Global: JP Morgan; US: Institute for Supply Management; Chicago: Kingsbury International; China: China Federation of Logistics and
Purchasing (CFLP); Japan: Markit/Nomura; Eurozone, Germany, UK, France, Italy, New Zealand: Markit; Switzerland: Credit Suisse; Sweden: Swedbank Markets; Brazil: NTC
Economics; Australia: Australian Industry Group; New Zealand: Bank of New Zealand; South Africa: Kagiso Securities; Singapore Institute of Purchasing and Materials
Management.
Average PMI peaked in February 2011, had fallen to 49 in October and
November of 2011, and had risen to a lower peak in February 2012. The
average PMI has fallen below 50 in April 2012 and has remained below 50
ever since. The Average PMI is like “hanging in there,” “muddling through” to
use a John Mauldin term.
Europe, especially the Eurozone, continues to contract. The PMIs of the
Eurozone have been below 50, i.e., the economies are contracting, since
August 2011.
The UK’s rise to 51.4 was a bit of a surprise.
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PMI Services: below 50 but stable
Table 6 shows a selection of global Purchasing Manager Indices (PMI) for the services (non-manufacturing) sector. These are
diffusion indices and therefore oscillate between 0 and 100. A reading above 50 is associated with an expanding activity
whereas a reading below 50 signifies contracting activity.
Table 6: Non-manufacturing PMI
Aug Sep Oct Nov Dec
49 49 49 49.3 49.8 Average
52 54 52 54.8 54.8 Gl. Services PMI
54 55 54 54.7 56.1 US: Non-Man
56 54 56 55.6 56.1 China
47 46 46 46.7 47.8 Eurozone
48 50 48 49.7 52.0 Germany
54 52 51 50.2 48.9 UK
49 45 45 45.8 45.2 France
44 45 46 44.6 45.6 I taly
51 47 50 46.3 49.1 Sweden
42 42 43 47.1 43.2 Australia
48 53 50 52.5 53.5 Brazil
Jan 2008 to Jul 2012
Source: IR&M, Bloomberg. Original data: See previous table.
The services PMI are reasonably consistent with the manufacturing PMI, i.e.
peaking some while ago, falling and then stabilising below 50. Note that our
average is below 50 while the composite by JPM is above 50. The reason is
that we equal weight while JPM GDP-weights the PMI indicators.
In 2008/2009 the Eurozone services PMI was below 50 for 15 months.
Currently, the services PMI has been below 50 for 16 months, ignoring one
brief spike to 50.4 in January 2012.
Italy has been below 50 since June 2011 but is off the lows from April 2012.
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Business sentiment: rising
Table 7 shows a selection of business and economic sentiment and expectations indicators for the past five years. Some are more
leading than others. We show all figures in percentiles. The period high is set to 100 and is shown green. The period low is,
therefore, set to 0 and is red. The colour coding allows getting a feel for the trend on a reasonably high frequency basis. There is
an update nearly every day.
Table 7: Business sentiment
Sep Oct Nov Dec Jan
53.1 51.7 50.4 54.4 54.5 Average
40 41 45 40 40 US: Empire State
54 58 41 59 45 US: Philadelphia Fed
67 51 74 68 n.a. US: Richmond Fed
71 74 69 80 n.a. US: Dallas Fed
69 69 52 56 n.a. US: AIM
66 68 36 39 n.a. US: NFIB
23 24 28 31 42 EZ: Sentix
38 36 39 42 n.a. EZ: Economic
47 42 50 51 n.a. EZ: Business
32 32 30 n.a. n.a. China
38 43 40 58 n.a. Germany: ZEW Exp.
55 50 55 58 n.a. Germany: IFO Climate
46 46 52 60 n.a. Germany: IFO Exp.
55 65 72 65 n.a. UK (EC)
59 65 65 68 n.a. UK (Lloyds)
49 37 44 46 n.a. France
43 41 43 43 n.a. I taly
36 40 40 48 n.a. Switzerland
54 47 33 41 n.a. Sweden
50 45 46 50 n.a. Belgium
75 70 70 97 n.a. Japan (ESRI)
79 74 72 74 n.a. Japan: Small biz
52 47 44 39 44 South Korea
61 59 43 n.a. n.a. Australia
69 70 78 75 n.a. New Zealand
Feb 2008 to Aug 2012
Source: IR&M, Bloomberg. Original: US: NY Fed, Philadelphia Fed, Richmond Fed, Dallas Fed, AIM (Associated Industries of Massachusetts), NFIB (Small Business Optimism
Index), Eurozone (EZ): Sentix Behavioral Indices, EC (Economic Sentiment Indicator and Business Climate Indicator); China: National Bureau of Statistics, Germany: ZEW
(Expectation of Economic Growth), IFO (Business Climate and Business Expectations); UK: EC, Lloyds TSB; France: INSEE; Italy: ISEA; Switzerland: ZEW/Credit Suisse,
Sweden: National Institute of Economics, Japan: ESRI, Japan Finance Corp for Small Business; South Korea: BoK; Australia: National Australia Bank; New Zealand: National
Bank of New Zealand. Note: The table sows percentiles. 100 (green) marks high for period shown, 0 (red) is the low. The average is equally weighted.
Philly came in shockingly bad, massively below expectations. Analysts literally
got the sign wrong (5.6 instead of -5.8). Dec estimate revised downwards.
Empire State was unchanged but materially below expectations.
Japan (ESRI) made a huge jump, much better than expected.
Indications for the Eurozone were “less bad” than expected.
US NFIB (small companies) was slightly higher and slightly better than
expected. This despite survey being conducted when fiscal cliff not resolved
yet.
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Repressionomics January 2013
Ineichen Research and Management Page 26
Consumer sentiment: falling
Table 8 shows a selection of consumer sentiment indicators for the past five years. We show all figures in percentiles. The period
high is set to 100 and is shown green. The period low is set to 0 and is red.
Table 8: Consumer sentiment
Sep Oct Nov Dec Jan
39.9 42.0 42.4 37.8 38.1 Average
50 55 53 46 n.a. US: Conf Board
55 66 66 42 n.a. US: Michigen
25 26 22 24 n.a. Eurozone
23 54 49 n.a. n.a. China
59 61 61 57 54 Germany
56 54 53 52 n.a. Japan
30 24 46 27 n.a. UK: GfK
57 84 74 74 n.a. UK: Lloyds TSB
22 19 19 26 n.a. France
3 3 0 3 n.a. Italy
28 31 26 20 n.a. Spain
19 14 5 2 n.a. Netherlands
23 35 32 n.a. n.a. Switzerland
50 41 33 24 n.a. Sweden
45 35 48 37 n.a. Denmark
31 32 36 15 n.a. Ireland
13 10 16 19 n.a. Greece
80 79 74 70 n.a. Brazil
56 55 53 55 n.a. Canada
43 45 56 47 48 Australia57 54 62 64 71 New Zealand
50 47 50 50 n.a. South Korea
Feb 2008 to Aug 2012
Source: IR&M, Bloomberg. Original: US: Conference Board and University of Michigan Survey Research Center; Eurozone, France, Spain, Greece: European Commission;
China: National Bureau of Statistics of China; Germany: GfK (for the month ahead); Japan: Economic and Social Research Institute (ESRI); UK: GfK and Nationwide; Italy:
ISAE; Netherlands: Dutch Statistics Office; Switzerland: UBS; Sweden: National Institute of Economic Research; Ireland: IIB Bank; Brazil: Fundacao Getulio Vargas; Canada:
OECD; Australia: Westpac Banking Corporation; New Zealand: ANZ Bank; South Korea: Bank of Korea, since July 2008. Note: The table sows percentiles. 100 (green) marks
high for period shown, 0 (red) is the low. The average is equally weighted.
The average consumer sentiment has been falling to October 2011, has risen
to May 2012 and has been more or less stable ever since. However, consumer
sentiment in the US, arguably the most important consumer on the planet, has
been rising and hit a 5-year high in the case of the University of Michigan
consumer sentiment index last autumn. December estimates were lower and
below expectations, with November estimates revised downwards in the case
of the Conference Board Consumer Sentiment Index, as already mentioned in
the last update.
December estimates for Japan and UK were unchanged.
Consumer sentiment rose slightly in Greece but fell sharply in Ireland and
slightly in Spain, since our last update.
Consumer sentiment estimates for January in Australia and especially New
Zealand have risen.
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Repressionomics January 2013
Ineichen Research and Management Page 27
Summary PMI, business and consumer sentiment: stable
Chart 2 below shows a summary of the average PMI (Table 5), average business sentiment
(Table 7) and consumer sentiment (Table 8).
Chart 2: Summary
0
15
30
45
60
75
90
30
35
40
45
50
55
60
2007 2008 2009 2010 2011 2012 2013
Bu
sin
es
s s
en
tim
ent a
nd
co
nsu
me
r c
on
fid
ence
(p
erc
en
tile
s)
PM
I
PMI Business sentiment Consumer confidence
Source: IR&M, Bloomberg
The average PMI are below 50 and stabilising. So the economic trend, on
average, is towards slight contraction and slow deterioration of economic
circumstances. This would be more or less consistent with a falling average
GDP growth rate and falling average industrial production. All the monetary
easing and fiscal stimuli have stabilised the whole situation. Economically it’s
not great, but it’s not a global depression either.
Business and consumer sentiment is reasonably stable. The former ticked up a
bit while the latter ticked down a bit in December. Both these “ticks” were
less than one standard deviation moves though.
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Repressionomics January 2013
Ineichen Research and Management Page 28
Economic trend vs global equity market
Chart 3 shows a model that was designed to give an indication of the economic trend nearly every day. The idea behind the
model is that these indicators are not random but trend. Models such as these allow us to decide whether the global economy is
expanding or things economic are deteriorating. The moving average is the trend. We then combine the trend with expectations.
The shaded areas show periods where reality is “coming in” worse than economists and strategists are expecting, i.e., the
economic data is below consensus.
Note here that these graphs (there are more below) do not in any way predict the future. Whether these variables turn
tomorrow or keep falling for years to come, we do not know. The idea is simply to pick up the trend and its derivative, the
surprises. We believe that being hedged when the trend is down and surprises are negative prevents experiencing long periods
of negative compounding. Also, it seems to us, negative tail events do not normally happen out of the blue. They occur when
things economic are not well and the red line in the graph below is declining.
Chart 3: IR&M global economic model vs FTSE World Index
40
55
70
85
100
115
130
145
150
200
250
300
350
400
450
500
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M G
lob
al M
od
el (
1.1
.20
06
= 1
00
)
FT
SE
Wo
rld
Ind
ex
Negative Surprises in G10 (Citi) FTSE World (lhs) IR&M Global Model (rhs) 100-day MAV
Source: IR&M, Bloomberg. Note: Surprises are based on Citigroup Expectations indices. IR&M Global Model is based on 22 indicators, was designed to give a data point
nearly every day, and remains work in progress.
In our last quarter report from October 2012 the 100-day moving average
(MAV) had just turned upwards. Now it just turned downwards. So the trend
is not as clear cut as one would hope. Surprises have been positive since
September on a G-10 basis.
When we do not know what to say or the trend is unclear we tend to call this
“at inflection point,” which might or might not be very helpful.
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Repressionomics January 2013
Ineichen Research and Management Page 29
United States: improving
Economic trend vs US stock market
Chart 4 shows a model based on economic variables relevant to the economy in the United States.
Chart 4: IR&M US economic model vs S&P 500
10
20
30
40
50
60
70
80
90
100
110
600
700
800
900
1000
1100
1200
1300
1400
1500
1600
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M U
S M
od
el (
1.1
.20
06
= 1
00
)
S&
P 5
00
Negative surprises in US (Citi) SPX (lhs) IR&M US Model (rhs) 100-day MAV
Source: IR&M, Bloomberg. Note: Surprises are based on Citigroup Expectations indices. IR&M US Model is based on 26 indicators, was designed to give a data point nearly
every day, and remains work in progress.
The US continues to roar ahead, at least according to his model. The crony
capitalism of the previous administration, the socialism of the current, the
fiscal cliff parody, California’s bankruptcy, food stamps for everyone, deficit
ceiling, tax complexity, falling productivity, etc. is just not very important at the
moment.
Surprises have been positive since 6th September; the same day where our
model was at its intermittent low.
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Repressionomics January 2013
Ineichen Research and Management Page 30
Monetary policy stance
Chart 5 shows monthly non-farm payrolls and the Fed fund rate. Note that non-farm payrolls are subject to vast revisions many
months after data release.
Chart 5: Fed fund rate with non-farm payrolls
0
1
2
3
4
5
6
7
8
-1000
-800
-600
-400
-200
0
200
400
600
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Fe
d fu
nd
ra
te, %
No
n-f
arm
pa
yro
lls, k
Non-farm payrolls, lhs Fed fund rate, rhs
Source: IR&M, Bloomberg
Non-farm payrolls have been low (or “not high”) but reasonably stable.
Fed tightening seems a non-issue at the moment. The last time the Fed started
tightening was when non-farm payrolls were above 200,000 (red line) for
three consecutive months.
Fed said it would probably hold the federal funds rate near zero at least until
unemployment < 6.5% or inflation > 2.5% (FOMC 12 December 2012).
However, there have been voices to stop easing earlier.
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Repressionomics January 2013
Ineichen Research and Management Page 31
Business outlook: disappointing
The Philadelphia Fed Business Outlook (Philly) falling below -20 is perceived as a near guarantee for a recession.
Chart 6: Philadelphia Fed Business Outlook
-80
-60
-40
-20
0
20
40
60
80
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Ph
ilad
elp
hia
Fe
d B
us
ine
ss O
utl
oo
k
Source: IR&M, Bloomberg. Note: Shaded area show official US recessions.
As mentioned earlier, the Philly disappointed last Thursday where analysts
were expecting +5.6 and -5.8 was reported for January. Furthermore,
December estimates were revised downward from 8.1 to 4.6. Revisions
downwards are of course a small negative.
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Repressionomics January 2013
Ineichen Research and Management Page 32
Economic outlook: red flag
Coincident-lagging indicator ratio is derived by dividing the coincident index by the lagging index and is generally perceived as
being an early indicator for a recession.
Chart 7: Coincident-lagging indicator ratio
0.80
0.85
0.90
0.95
1.00
1.05
1.10
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Co
inc
ide
nt -
lag
gin
g in
dic
ato
r ra
tio
US recessions Coincident Composite Index/Lagging Composite Index (Conference Board)
Perceived recession indicator
Source: IR&M, Bloomberg
This ratio is a red flag as the ratio is below what is perceived as a recession
indicator.
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Repressionomics January 2013
Ineichen Research and Management Page 33
High frequency economic indicators: stable
Table 9 shows eleven economic, high-frequency variables that are related to the business cycle in one way or another. The first
line shows the average of the percentiles since 2007 of these indicators. The idea behind this table is to get a near real-time
reading of the direction in which the economy is heading. Chart 8 graphs the average percentile compared to the S&P 500.
Table 9: High frequency indicators
Sep Oct Nov Dec Jan
High Low Median W35 W36 W37 W38 W39 W40 W41 W42 W43 W44 W45 W46 W47 W48 W49 W50 W51 W1 W2 Last Economic proxy
77 9 61 57 59 57 58 59 59 59 59 59 58 57 59 62 62 62 63 63 63 63 63 Average percentile
98 -141 10 15 20 21 6 44 49 53 55 57 61 48 47 43 51 51 55 48 34 11 5 US Surprise Index
291 -15 183 142 162 149 140 148 140 147 145 143 135 134 142 137 138 147 150 145 164 162 160 US Yield curve (10-2Y)
2 -54 -43 -47 -42 -41 -40 -37 -39 -35 -35 -35 -34 -33 -34 -33 -34 -35 -32 -32 -32 -34 -36 Bloomberg Cons Comfort
1.16 0.57 0.93 1.00 1.02 1.01 1.00 1.00 0.99 1.00 1.00 1.02 1.01 1.01 1.01 1.01 1.01 1.00 1.03 1.03 1.04 1.04 1.05 Cons Discret vs. Staples
0.84 -4.02 -0.23 -0.56 -0.49 -0.45 -0.47 -0.49 -0.49 -0.38 -0.24 -0.06 0.13 0.35 0.47 0.48 0.43 0.37 0.34 0.33 0.34 0.36 0.35 Aruoba Diebold Scotti
667 282 389 367 385 385 363 369 342 392 372 363 361 451 416 395 371 344 362 363 367 372 335 US Jobless claims
5.5 -2.5 2.7 3.7 3.4 2.1 2.9 2.4 2.8 2.7 2.9 2.7 1.4 1.8 2.5 4.0 3.2 2.5 3.5 3.2 2.7 4.0 3.3 US chain store sales, YoY
638 316 484 523 527 524 531 527 518 516 502 498 505 507 507 515 519 524 530 530 530 532 534 CRB RIND
463 127 340 365 383 379 376 378 370 364 355 348 345 345 353 363 366 368 357 359 369 365 367 Copper
81 -70 11 -2.0 1.0 5.3 5.5 5.2 6.4 0.4 -0.7 -4.8 -4.9 -3.6 -1.9 -1.8 0.4 1.6 3.1 5.2 6.7 7.3 9.5 JoC-ECRI Industrial Price
1022 237 428 380 377 375 375 374 371 371 367 365 363 362 361 359 358 356 353 353 351 351 350 Container Ship Index
2007-
Source: IR&M, Bloomberg. Notes: US Surprise Index is from Citigroup. Bloomberg Consumer Comfort was previously from ABC News. Consumer Discretionary underperforms
Consumer Staples during economic slowdown. The Aruoba Diebold Scotti Business Conditions Index (ADS BCI Index) is designed to track real business conditions at high
frequency and is a daily index, published with a one week lag. CRB RIND is the Commodity Research Bureau/Reuters US Spot Raw Industrials Index consisting of raw
industrial components with pre-cyclical characteristics. The prices of index constituents are not as much distorted through aggressive trading activity.
This table worked very well during 2011 as the average percentile trended
nicely. However, the average is currently abnormally stable.
Surprises are positive but have been in decline over the past two weeks.
Chart 8: Average percentile from high frequency indicators (Table 9) vs. S&P 500
600
700
800
900
1000
1100
1200
1300
1400
1500
10
20
30
40
50
60
70
80
90
100
2009 2010 2011 2012 2013
S&
P 5
00
Av
era
ge
pe
rce
nti
le
Average percentile (lhs) S&P 500 Index (rhs)
Source: IR&M, Bloomberg.
The trend seems up-ish. The gap between the two lines is probably best
explained by intervention; it’s all a bit artificial. As we like to say: the stimuli
would even make Lance Armstrong blush.
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Repressionomics January 2013
Ineichen Research and Management Page 34
Economic health check: stable, sort of
Table 10 shows three-month moving averages for four central bank balance sheets and eleven economic indicators related to the
business cycle. The table was designed for two reasons. First, during a trend this table allows us to tick a box every now and then
with respect to the current trend. This should heighten conviction that the trend is the trend and nothing materially has
changed. Second, the table should allow us to observe the trend reversal early.
Table 10: Economic health check
2011
2012
2013
Year
O N D J F M A M J J A S O N D J Month
38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 1 2 Last Week
Central Bank Balance Sheets (three-months moving average)
Rising Fed
Falling ECB
Rising BOJ
Rising BOE
Selection of US economic variables (three-months moving average)
4 # Positives
Falling Surprises
Falling PPI
Rising Steel production
Falling ISM PMI
Rising Architects Billing
Falling Consumer Confidence
Rising Nonfarm Payrolls
Falling Jobless Claims
Falling Hiring intentions
Falling CEO Confidence
Falling Restaurant Performance
Positive trend Negative trend
Source: IR&M, Bloomberg
Notes: Surprises from Citigroup, Consumer Confidence and Help Wanted Ads from Conference Board, CEO Confidence from Chief Executive Magazine, US Initial Jobless
Claims and US Employees on Nonfarm Payrolls from Department of Labor Statistics,
When looking at three-month averages as in the table, surprises and consumer
confidence are now falling. The glass is either half full or half empty, a mixed
bag of indications, sort of.
Chart 9: Jobless claims by year
300
350
400
450
500
550
600
650
700
1 5 10 15 20 25 30 35 40 45 50
Init
ial c
laim
s (4
-we
ek
mo
vin
g a
ve
rag
e)
Weeks
2007
2008
2009
2010
2011
2012
2013
Source: IR&M, Bloomberg
The labour market seems to be improving, as is the real estate market. The
two are related.
The more the 2013 jobless claims
line resembles the 2008 line, the
higher is the probability of a
recession
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Repressionomics January 2013
Ineichen Research and Management Page 35
Europe: at inflection point
Economic trend vs stock market
Chart 10 shows a model based on economic variables relevant to the economy in Europe.
Chart 10: IR&M Europe economic model vs STOXX Europe 600
20
40
60
80
100
120
140
150
200
250
300
350
400
450
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M E
uro
pe
Mo
del
(1.
1.20
06 =
100
)
ST
OX
X E
uro
pe
600
Negative surprises in Eurozone (Citi) SXXP (lhs)
Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices for the Eurozone. IR&M Europe Model is based on 26 indicators, was designed to
give a data point nearly every day, and remains work in progress.
Europe is certainly contracting economically. However, there are some
positives. Draghi’s “whatever it takes” attitude is working at the moment.
There are the occasional economic “positives” from places such as Italy (Monti
reforms) and France and Spain (improved productivity). Some deep-rooted
problems are not solved though. The Euro has not all of a sudden become the
pinnacle of monetary policy wisdom. It’s still a problem. Banks, unlike in the
US, have not yet been recapitalised.
Surprises have been mainly negative since April 2012. However, surprises have
turned positive on 7th January 2013.
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Repressionomics January 2013
Ineichen Research and Management Page 36
Chart 11: Euro STOXX 50 and EC Composite PMI
30
35
40
45
50
55
60
65
1500
2000
2500
3000
3500
4000
4500
5000
2005 2006 2007 2008 2009 2010 2011 2012 2013
PM
I
Eu
ro S
TO
XX
50
Euro STOXX 50 (lhs) EC Composite PMI (rhs)
Source: IR&M, Bloomberg.
The composite PMI for the Eurozone has been below 50 since September
2011, part from a brief LTRO-induced holiday at 50.4 in December 2011. It
has been stable over the past couple of months though. Readers with very
good eyesight might even spot an uptick in the Composite PMI.
Chart 12 shows two widely followed economic sentiment indicators for France and Belgium.
The latter is often referred to as a proxy for Europe.
Chart 12: Business sentiment in France and Belgium
-35
-20
-5
10
60
70
80
90
100
110
120
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Be
lgiu
m B
us
ine
ss
Co
nfi
de
nc
e
Fra
nc
e B
us
ines
s S
en
tim
ent
Bank of France Business Sentiment Indicator (lhs) Belgium General Index Business Confidence (rhs)
Averages since 1990: France = 100Belgium = -5.6
Source: IR&M, Bloomberg
The trend is down, the situation cyclically un-bullish.
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Repressionomics January 2013
Ineichen Research and Management Page 37
Germany: improving
Economic trend vs stock market
Chart 13 shows a model based on economic variables relevant to the economy in Germany.
Chart 13: IR&M Germany economic model vs DAX
50
70
90
110
130
150
3000
4000
5000
6000
7000
8000
9000
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M G
erm
an
y M
od
el (
1.1
.20
06
= 1
00
)
DA
X
Negative surprises in Germany (IR&M) DAX (lhs) IR&M Germany Model (rhs) 100-day MAV
Source: IR&M, Bloomberg. Notes: IR&M Germany Model is based on 16 indicators, was designed to give a data point nearly every day, and remains work in progress.
Cyclical economic variables and sentiment indicators (our model) on average
point upwards. Surprises have been positive since mid-December.
German labour costs are rising at the fastest pace in a decade according to
Bloomberg, eroding most of the progress made under Gerhard Schroeder,
which ECB board member Joerg Asmussen has warned could return Germany
to the “Sick Man of Europe”, although Germany’s EUR17bn trade surplus
hardly points to a loss of competitiveness as yet. Asmussen also criticised
German education which he says leaves German workers with skill shortages
against what they will need to compete going forward; “Germany is seriously
lagging behind in science and mathematics education,” an area that they used
to dominate and that allowed them their engineering prowess.
Chart 14 shows the last and current business cycle based on IFO (Institut für Wirtschaftsforschung) climate indices. The horizontal
axis shows current business climate whereas the vertical axis shows business climate expectations for the next six months. All is
well in the upper right quadrant where current conditions as well as expectations are high. Then things economic start slowing
down and the path goes from the upper right hand quadrant to the lower left hand quadrant. Once the nadir is reached, the
path is from the lower left to the upper right again. Then the whole circle starts anew. The practical risk management relevance
is that one ought to be hedged on the way from the upper right hand corner to the lower left hand corner. It is in those periods
where the DAX experiences its losses. Chart 15 shows the DAX with PMI.
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Repressionomics January 2013
Ineichen Research and Management Page 38
Chart 14: IFO Pan Germany Business Conditions and Expectations
70
75
80
85
90
95
100
105
110
115
80 85 90 95 100 105 110 115 120
Ex
pe
cta
tio
ns
(IF
O)
Current Business Conditions (IFO)
Recovery
Recession
Boom
Slowdown
02-2011
12-2008
11-2009
10-2011
02-2009
06-2012
12-2012(latest)
Source: IR&M, Bloomberg
The trend was clearly negative for many months, moving from the upper right
towards the lower left. The DAX was one of the greatest performers in 2012
anyway. The latest two indications were positive, i.e., towards the upper right.
The cyclical DAX was anticipating this, accompanied by Draghi-induced risk-on
euphoria.
Chart 15: DAX and PMI
30
35
40
45
50
55
60
65
2000
3000
4000
5000
6000
7000
8000
9000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
PM
I
DA
X
DAX (lhs) PMI (rhs)
Source: IR&M, Bloomberg
German PMI has fallen below 50 in March 2012 and has bottomed at 43 in
July of that year. Unlike the DAX, the PMI has not mushroomed.
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Repressionomics January 2013
Ineichen Research and Management Page 39
France: declining
Economic trend vs stock market
Chart 16 shows a model based on economic variables relevant to the economy in France.
Chart 16: IR&M France economic model vs CAC 40
50
60
70
80
90
100
110
120
130
2500
3000
3500
4000
4500
5000
5500
6000
6500
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M F
ran
ce
Mo
de
l (1
.1.2
006
= 1
00
)
CA
C 4
0
Negative surprises in France (IR&M) CAC 40 (lhs) IR&M France Model (rhs) 100-day MAV
Source: IR&M, Bloomberg. Notes: IR&M France Model is based on 15 indicators, was designed to give a data point nearly every day, and remains work in progress.
Swopping ones French passport for a Russian one is not noble. But then,
neither is punishing success. The trend remains down.
Chart 17: INSEE Manufacturing Sentiment and General Production Expectations
-80
-70
-60
-50
-40
-30
-20
-10
0
10
20
30
60 70 80 90 100 110 120
Ge
ne
ral P
rod
uc
tio
n E
xp
ec
tati
on
s (I
NS
EE
)
Manufacturing Sentiment (INSEE)
Recovery
Recession
Boom
Slowdown
03-2011
03-2009
12-2012(latest)
Source: IR&M, Bloomberg
This chart looks similar to the German equivalent: a long downtrend which
recently has been interrupted by two upticks for the better.
Chart 17 is analogous to Chart 14.
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Repressionomics January 2013
Ineichen Research and Management Page 40
Chart 18 compares the CAC 40 Index with the manufacturing PMI.
Chart 18: CAC 40 and PMI
30
35
40
45
50
55
60
1500
2000
2500
3000
3500
4000
4500
5000
5500
6000
6500
7000
7500
2006 2007 2008 2009 2010 2011 2012 2013
PM
I
CA
C 4
0
CAC 40 (lhs) PMI (rhs)
Source: IR&M, Bloomberg
If we were chartists we probably would be quite excited about the
“breakout”. But since we’re not, we’re not.
R
Repressionomics January 2013
Ineichen Research and Management Page 41
Italy: at inflection point
Economic trend vs stock market
Chart 19 shows a model based on economic variables relevant to the economy in Italy. Chart 20 shows consumer sentiment.
Chart 19: IR&M Italy economic model vs FTSE MIB
50
60
70
80
90
100
110
120
10000
15000
20000
25000
30000
35000
40000
45000
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M It
aly
Mo
de
l (1
.1.2
00
6 =
10
0)
FT
SE
MIB
Negative surprises in Italy (IR&M) MIB (lhs) IR&M Italy Model (rhs) 100-day MAV
Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices for the Eurozone. IR&M Italy Model is based on 13 indicators, was designed to give a
data point nearly every day, and remains work in progress.
Industrial production for November published on 14th January was lower and
below expectations. Industrial orders and sales published on 18th January was
negative and lower than October. Consumer sentiment remains depressed.
Chart 20: Italian consumer sentiment and FTSE MIB
85
90
95
100
105
110
115
120
125
10000
15000
20000
25000
30000
35000
40000
45000
50000
1996 1998 2000 2002 2004 2006 2008 2010 2012
Ita
lian
Co
ns
um
er
Co
nfi
den
ce
FT
SE
MIB
FTSE MIB (lhs) Italy: Consumer confidence (rhs)
Source: IR&M, Bloomberg
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Repressionomics January 2013
Ineichen Research and Management Page 42
Spain: improving
Economic trend vs stock market
Chart 21 shows a model based on economic variables relevant to the economy in Spain.
Chart 21: IR&M Spain economic model vs IBEX
40
45
50
55
60
65
70
75
80
85
90
95
100
105
110
115
4000
5000
6000
7000
8000
9000
10000
11000
12000
13000
14000
15000
16000
17000
18000
19000
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M S
pa
in M
od
el (
1.1
.20
06
= 1
00
)
IBE
X
Negative surprises in Eurozone (Citi) IBEX (lhs) IR&M Spain Model (rhs) 100-day MAV
Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices for the Eurozone. IR&M Spain Model is based on 14 indicators, was designed to give
a data point nearly every day, and remains work in progress.
Spain has been improving cyclically. However, the main issues are structurally,
debt related.
Mariano Rajoy has called on Germany and other creditor countries in the
Eurozone to do more to stimulate growth, arguing that a switch to a more
expansionary policy would boost economic recovery across the single currency
area. “What is clear is that you cannot ask Spain to adopt expansionary
policies at this time. But those countries that can, should," he told the FT.
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Netherlands: declining
Economic trend vs stock market
Chart 22 shows a model based on economic variables relevant to the economy in Spain.
Chart 22: IR&M Netherlands economic model vs AEX
40
50
60
70
80
90
100
110
120
130
150
200
250
300
350
400
450
500
550
600
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M N
eth
erl
ad
ns
Mo
del
(1.1
.20
06
= 1
00
)
AE
X
Negative surprises in the NL (IR&M) AEX (lhs) IR&M Netherlands Model (rhs) 100-day MAV
Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices. IR&M Netherlands Model is based on 16 indicators, was designed to give a data
point nearly every day, and remains work in progress.
The trend is downwards but potentially bottoming out. Industrial production
for November reported on 11th January was positive and better than expected.
Consumer sentiment remains low though.
Chart 23: FTSE World vs Dutch consumer confidence
-50
-40
-30
-20
-10
0
10
20
100
150
200
250
300
350
400
450
500
2005 2006 2007 2008 2009 2010 2011 2012 2013
Du
tch
Co
ns
um
er C
on
fid
en
ce
FT
SE
Wo
rld
FTSE World (lhs) Netherlands: Consumer confidence (rhs)
Source: IR&M, Bloomberg.
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Repressionomics January 2013
Ineichen Research and Management Page 44
UK: declining
Economic trend vs stock market
Chart 24 shows a model based on economic variables relevant to the economy in the UK.
Chart 24: IR&M UK economic model vs FTSE 100
50
60
70
80
90
100
110
120
3500
4000
4500
5000
5500
6000
6500
7000
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M U
K M
od
el (
1.1
.20
06
= 1
00
)
FT
SE
10
0
Negative surprises in UK (Citi) FTSE 100 (lhs) IR&M UK model (rhs) 100-day MAV
Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices for the UK. IR&M UK Model is based on 19 indicators, was designed to give a data
point nearly every day, and remains work in progress.
There seems to be a divergence between economic variables (trending
downwards when measured by an average) and the stock market. Surprises
have been positive since early September.
Bank of England Governor Mervyn King said “The economy is operating well
below full capacity, the banking system is in a stretched position and we are
clearly struggling to find instruments to ensure an economic recovery.” He
warned that “A weak recovery and people searching for yield in ways that
suggest that risk isn’t fully priced in, is a disturbing position.” As to Europe he
said “The actions of the ECB have been successful in calming markets and in
buying time. What it can’t do, because no central bank can do this, is to
resolve the underlying real challenges. And in that sense, banking union is
certainly not a magic answer.” He was also negative about the British banks
saying that “We do think there is a shortfall of capital in the system. It’s a big
number.”1
1 Andy Lees, AML Macro, 16 January 2013
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Chart 25: FTSE 100 vs PMI
30
35
40
45
50
55
60
65
70
3000
3500
4000
4500
5000
5500
6000
6500
7000
2006 2007 2008 2009 2010 2011 2012 2013
PM
I
FT
SE
10
0
PMI<50 and falling FTSE 100 (lhs) PMI (rhs)
Source: IR&M, Bloomberg.
The manufacturing PMI jumped above 50 for December. However, services
and construction PMI (not shown here) remain below 50, both disappointing
relative to expectations for December.
Chart 26: UK GDP vs Lloyds TSB Business Barometer
-80
-60
-40
-20
0
20
40
60
-8
-6
-4
-2
0
2
4
6
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Llo
yd
s T
SB
Bu
sin
es
s B
aro
me
ter
UK
GD
P
UK GDP (lhs) Lloyds TSB Business Barometer (rhs)
Source: IR&M, Bloomberg.
One (erratic) business barometer has been trending upwards though.
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Repressionomics January 2013
Ineichen Research and Management Page 46
Switzerland: improving
Economic trend vs stock market
Chart 27 shows a model based on economic variables relevant to the economy in Switzerland.
Chart 27: IR&M Switzerland economic model vs SMI
20
40
60
80
100
120
140
160
3000
4000
5000
6000
7000
8000
9000
10000
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M S
wit
zerl
an
d M
od
el (
1.1
.20
06
= 1
00
)
SM
I
Negative surprises in Switzerland (Citi) SMI (lhs) IR&M Switzerland Model (rhs) 100-day MAV
Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices for Switzerland. IR&M Switzerland Model is based on 16 indicators, was designed to
give a data point nearly every day, and remains work in progress.
The trend is favourable, the currency not strengthening. However, surprises
have been negative since 24th September with only very brief interruptions.
At the time of writing it seems as if the Swiss central bank is teaching some
investors a lesson, namely those who thought that the EUR1.2 peg cannot
hold. It can. A central bank with its own currency can always weaken its
currency. The CHF weakened from EUR1.21 to EUR1.25 which is given the low
volatility since the peg was announced a rather substantial 7-day fall. The
adage “don’t fight the Fed” is very old. Since July 2012 everyone knows that it
also applies to the ECB. Now everyone knows that it also applies to the SNB.
Learning by doing.
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Repressionomics January 2013
Ineichen Research and Management Page 47
Japan: declining
Economic trend vs stock market
Chart 28 shows a model based on economic variables relevant to the economy in Japan. Chart 29 compares the Nikkei 225 with
the interestingly named Japan New Composite Index of Business Cycle Indicators Leading Index.
Chart 28: IR&M Japan economic model vs Nikkei 225
0
15
30
45
60
75
90
105
6000
8000
10000
12000
14000
16000
18000
20000
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M J
ap
an
Mo
de
l (1
.1.2
006
= 1
00
)
Nik
ke
i 22
5
Negative surprises in Japan (Citi) Nikkei 225 (lhs) IR&M Japan Model (rhs) 100-day MAV
Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices. IR&M Japan Model is based on 23 indicators, was designed to give a data point
every day, and remains work in progress.
The trend is down. Surprises have been negative for a long while with only
brief interruptions. However, the game has changed in December with Abe
being elected. The new administration is pro more stimuli, pro defence
spending, pro inflation, and, most importantly, pro a weaker JPY. The Nikkei
has risen on the basis of all of these “pros”. It will of course be interesting to
see if the incoming administration can deliver.
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Ineichen Research and Management Page 48
Chart 29: Nikkei 225 vs Leading indicator
70
75
80
85
90
95
100
105
110
0
5000
10000
15000
20000
25000
30000
35000
40000
1980 1985 1990 1995 2000 2005 2010
Le
ad
ing
Ind
icat
or
Nik
ke
i 22
5
Two consecutive quarters with negative growth Nikkei 225 (lhs) Leading Indicator (rhs)
Source: IR&M, Bloomberg
Note: LEI (Leading Economic Indicator): Japan New Composite Index of Business Cycle Indicators Leading Index, issued
by Economic and Social Research Institute Japan (ESRI).
The leading indicator is off its high from March this year. The trend is arguably
not up.
Chart 30: Economic current conditions vs expectations
10
15
20
25
30
35
40
45
50
55
60
10 15 20 25 30 35 40 45 50 55 60
Ec
on
om
ic E
xp
ec
tati
on
s (E
SR
I)
Economic Current Conditions (ESRI)
Recovery
Recession
"Boom"
Slowdown
12-2008
03-2011(Tohoku)
12-2012 (latest)03-2006
Average since 2000
Ave
rage
sin
ce 2
000
Source: IR&M, Bloomberg
Note: the chart shows all combinations since 2000 with the most recent movement highlighted.
One survey published on 11th January showed a large uptick for the better.
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Repressionomics January 2013
Ineichen Research and Management Page 49
China: improving
Economic trend vs stock market
Chart 31 shows a model based on economic variables relevant to the economy in China.
Chart 31: IR&M China economic model vs Shanghai Composite
60
70
80
90
100
110
120
600
1600
2600
3600
4600
5600
6600
2006 2007 2008 2009 2010 2011 2012 2013
IR&
M C
hin
a M
od
el (
1.1
.20
06
=1
00
)
Sh
an
gh
ai C
om
po
site
Negative surprises in China (Citi) Shanghai Composite (lhs) Model 100-day MAV
Source: IR&M, Bloomberg. Notes: Surprises are based on Citigroup Expectations indices. IR&M China Model is based on 19 indicators, includes a daily read of relative
performance between property stocks and a market index, was designed to give a data point every day, and remains work in progress. Note that we had issues with data on
China in the past.
The economic trend is up. Unlike with our German model, the economic and
sentiment variables were leading the stock market, not lagging. Surprises have
been positive since early November with only a brief interruption earlier this
month due to CPI and PPI rising unexpectedly.
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Repressionomics January 2013
Ineichen Research and Management Page 50
Economic health check: no current red flags from electricity and freight traffic
Thanks to WikiLeaks we know what politburo member Li Keqiang thinks are important and incorruptible measures for China’s
economic speed. Given China’s high level of perceived corruption, it makes sense to look for incorruptible proxies. Li Keqiang is
the First-ranking Vice-Premier and deputy Party secretary of the State Council of the People's Republic of China, the seventh
ranked member of the Politburo Standing Committee, the People's Republic of China's de facto highest decision-making body.
Most official statistics are “for reference only” he once confide—smiling, apparently—to the US ambassador. The three variables
he looks at are electricity consumption, rail cargo volume, and bank lending. We look at electricity and rail cargo volume as a
form of economic health check. Note that some researchers suggest that electricity data is corrupted too.
Chart 32: Electricity
0
50
100
150
200
250
300
350
400
450
1 2 3 4 5 6 7 8 9 10 11 12
Ele
ctr
icit
y, b
n k
wh
Month
2005
2006
2007
2008
2009
2010
2011
2012Falling electricity is the warning
sign to look out for.
Source: IR&M, Bloomberg
Electricity has been picking up and was higher than 2011 throughout most of
2012.
Chart 33: Freight traffic volume
100,000
120,000
140,000
160,000
180,000
200,000
220,000
240,000
260,000
280,000
1 2 3 4 5 6 7 8 9 10 11 12
Ch
ina
Fre
igh
t Tra
ffic
Vo
lum
es
Ra
ilwa
ys
Month
2005
2006
2007
2008
2009
2010
2011
2012Falling freight traffic is the
warning sign to look out for.
Source: IR&M, Bloomberg
Freight traffic volume triggered a red flat in summer last year. The November
figure was the same as in the year before.
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Repressionomics January 2013
Ineichen Research and Management Page 51
Inflation: rising
The spectre of inflation is not only an issue for China. One could argue inflation in China, or any negative surprises out of China,
economic or geopolitical, are akin to a sword of Damocles bumbling over the global economy. The following graph shows CPI
with agricultural wholesale prices. The reason inflation is important from a risk assessment standpoint is that food inflation
spiralling out of control would not only bear the risk of economic weakness but also heighten the risk of intra-national tensions.
Chart 34: China CPI
-10
-5
0
5
10
15
20
25
-4
-2
0
2
4
6
8
10
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Ag
ric
ult
ura
l wh
ole
sa
le p
ric
es
CP
I
China CPI YoY (lhs) China agricultural wholesale prices YoY (rhs)
Source: IR&M, Bloomberg
It was a question of time until rising food prices would filter through to higher
CPI prints. This occurred on 11th January and sent the stock market down by
1.8%.
On one hand higher inflation is good news. Mainly because the alternative,
deflation, is worse. Generally it is perceived as bad news though as it increases
the probability of the People’s Bank of China to start tightening via the RRR
(required reserve ratio). The central bank is still in easing mode despite not
having lowered the RRR for a while.
Chart 35: PBoC 1Y lending rate and RRR
5
10
15
20
25
4
5
6
7
8
2005 2006 2007 2008 2009 2010 2011 2012 2013
RR
R (
%)
1Y
Le
nd
ing
ra
te (%
)
China 1Y lending rate (lhs) Required Reserve Ratio (RRR) for Major Banks (rhs)
Source: IR&M, Bloomberg
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Repressionomics January 2013
Ineichen Research and Management Page 52
Chart 36: China Real Estate Climate
94
96
98
100
102
104
106
108
0
1000
2000
3000
4000
5000
6000
7000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Ch
ina
Re
al E
sta
te C
lima
te
Sh
an
gh
ei C
om
po
site
Shanghai Composite (lhs) China Real Estate Climate (rhs)
Source: IR&M, Bloomberg
Real estate sentiment could have bottomed.
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Repressionomics January 2013
Ineichen Research and Management Page 53
Risk update
“The simplistic view says that because the
world is uncertain today, we shouldn't
venture forth. But I think it's much wiser to
say that despite the uncertainty, we
shouldn't automatically settle for assets
believed to be entirely safe - especially since
(a) flight of capital to their seeming safety
has rendered their promised returns low and
(b) that safety can prove to be illusory.
Instead we should attempt to take control of
our fate and strive for reasonable returns
with the risks handled responsibly.”
—Howard Marks1
Summary
Risk is on. Risk seeking behaviour remains elevated, currently in the 4th highest
percentile since 1997.
The easing of sovereign credit spreads is partially a function of Draghi and
partly a function of regulatory-induced short covering.
Yield curves: reasonably stable
Chart 37: Yield curves
1.85
3.04
1.57
2.362.03
3.27
0.75
2.00
0.68
1.21
0
1
2
3
4
5
6
7
3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y 3M 6M 2Y 5Y 10Y 30Y
Yie
ld,
%
10Y Range
18/01/13
03/01/13
31/12/12
30/12/11
Inflation
USD EUR GBP JPY CHF
Source: IR&M, Bloomberg
Note: Numbers in graph stand for 10-year and 30-year yields. Short end of CHF yield curve “disappears” because yields
are negative.
Yield curves remain low and positively sloped. The EUR has risen a bit but is
entirely below inflation.
1 “On Uncertain Ground,” Memo to Oaktree Clients, 11 September 2012.
Chart 37 shows five nominal yield
curves compared to history and
inflation.
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Repressionomics January 2013
Ineichen Research and Management Page 54
Central bank balance sheets: contracting a bit
Chart 38 shows the sum of four central bank balance sheets.
Chart 38: Total assets central banks
3,000
3,500
4,000
4,500
5,000
5,500
6,000
6,500
7,000
7,500
8,000
8,500
9,000
9,500
2007 2008 2009 2010 2011 2012 2013
US
Db
n
Total assets central banks (Fed, ECB, BoJ, BoE)
Source: IR&M, Bloomberg
The trend is unmistakably from the lower left to the upper right. This is a
“helping hand” rather than an invisible one. The cost to society from this
“help” is yet unknown.
Since our last update from 3rd January the total balance sheets have
contracted a bit from $8.70tr to $8.65tr.
Chart 39: Target rates
0
1
2
3
4
5
6
7
8
9
10
1990 1995 2000 2005 2010
Ta
rge
t ra
te (<
10
%)
US, EU, and UK easing US EU UK Japan China
Source: IR&M, Bloomberg
Central banks, including China, are easing. Money was, is, and remains cheap.
And is hoarded; velocity remains low.
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Repressionomics January 2013
Ineichen Research and Management Page 55
Financial risk monitor: risk is on
Table 11 is a risk monitor. The idea is to show heightened risk or stress very early on. We update this frequently in our on-screen
updates.
Table 11: Financial risk monitor
2011 2012 2013
Market Risk proxy High Low Median 06 07 08 09 10 11 12 01 02 03 04 05 06 07 08 09 10 11 12 03-01 Last
Composite St. Louis Fed Stress 5.8 -1.3 -0.1 -0.1 -0.1 0.7 0.9 0.6 0.8 0.6 0.3 0.1 0.0 0.0 0.2 0.2 0.1 -0.1 -0.3 -0.3 -0.3 -0.3 -0.3 -0.5
BB Financial Conditions 1.3 -12.7 0.1 0.5 0.0 -0.9 -1.8 -1.0 -1.0 -1.0 -0.5 -0.1 0.1 0.0 -0.7 -0.1 0.0 0.1 0.5 0.6 0.7 0.6 0.9 1.0
Citi Macro Risk 0.99 0.0 0.39 0.40 0.68 0.90 0.97 0.82 0.85 0.79 0.59 0.47 0.36 0.35 0.72 0.36 0.32 0.24 0.12 0.15 0.18 0.24 0.07 0.11
Liquidity LIBOR 1M OIS Spread 338 1 9 8 8 13 15 16 18 22 17 13 12 10 8 8 11 10 7 5 6 6 7 7
Euro Libor-OIS Spread 196 -2 28 20 35 64 81 81 98 97 77 63 42 39 39 42 33 21 13 11 13 12 12 11
Euro Basis Swap Spread -3 -300 -36 -28 -46 -80 -105 -92 -131 -114 -72 -67 -51 -45 -50 -54 -42 -32 -26 -25 -25 -21 -19 -17
Credit TED Spread 464 9 32 24 16 32 35 44 53 57 49 41 40 37 40 38 35 35 27 20 23 27 24 23
EmMa Spread 1037 111 273 239 256 336 462 376 418 425 398 338 314 330 413 378 346 319 295 269 267 252 231 240
CDX.NA.IG 279 29 98 91 96 115 144 121 128 120 101 94 91 95 123 112 107 102 99 101 99 94 86 88
iTraxx 5Y Europe 217 20 98 106 117 153 202 162 185 173 143 129 125 140 180 166 160 149 136 129 123 117 103 103
iTraxx 5Y E. Crossover 1150 150 428 395 438 646 839 660 757 755 620 568 613 650 719 662 633 592 568 524 497 482 418 419
Sovereign iTraxx 5Y E. Sovereign 386 47 178 217 270 293 339 304 327 357 338 343 269 275 326 282 256 230 148 107 105 111 102 99
(5Y CDS) Greece 5047 5 56 1952 1722 2261 3536 >4000 essentially default
Ireland 1192 5 223 769 790 769 700 694 711 726 621 603 572 566 726 553 512 441 319 173 179 220 209 180
Portugal 1527 4 41 745 924 918 1110 970 1060 1093 1484 1175 1076 961 1185 805 834 662 515 503 498 449 401 382
Spain 641 3 40 270 363 358 382 340 408 394 376 368 437 476 599 531 534 518 387 305 284 295 273 253
Italy 592 6 43 171 310 361 470 445 487 503 416 381 397 445 563 488 485 466 356 274 244 278 257 226
Belgium 406 2 22 143 199 230 260 269 304 316 245 238 233 252 282 240 177 160 128 75 76 83 81 75
France 250 2 23 80 122 154 187 176 200 222 181 176 169 193 219 189 161 140 114 68 80 91 89 85
Rates BBOX (swaption volat.) 138 68 90 98 98 93 94 96 97 94 86 91 89 86 82 80 80 81 78 78 77 77 77 76
Bonds MOVE (bond volat.) 265 51 92 89 88 98 101 107 100 91 72 76 79 63 74 73 70 69 61 71 52 59 64 57
Equities VIX (equity volat.) 81 10 18 17 25 32 43 30 28 23 19 18 16 17 24 17 19 17 16 18 16 18 15 14
Skew Index (CBOE) 142 106 119 122 121 120 115 121 117 116 122 125 125 120 119 119 114 121 126 119 117 121 118 121
FX VXY (G7 FX volat.) 24 6 10 11 12 12 14 12 13 12 11 10 10 9 11 10 9 9 8 8 8 8 8 9
10-year*
Source: IR&M, Bloomberg
Note: *10-year period or since data is available.
Risk is on and this table is turning greener and greener.
One of the few upticks in risk worth mentioning is in emerging markets.
Emerging markets could be the pin that pricks the yield bubble in the
developed economies. However, the rise was modest.
As mentioned elsewhere, the easing of sovereign credit spreads is partially a
function of Draghi and partly a function of regulatory-induced short covering.
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Repressionomics January 2013
Ineichen Research and Management Page 56
Macro and geopolitical uncertainty
Chart 40 combines the Citigroup Macro risk index with the Citigroup G10 Economic Surprise
Index. All is well when these indices are rising, surprises rising above the zero line.
Chart 40: Macro risk and financial conditions
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0-120
-100
-80
-60
-40
-20
0
20
40
60
80
2007 2008 2009 2010 2011 2012 2013
Cit
i M
ac
ro R
isk
Ind
ex
Cit
igro
up
Ec
on
om
ic S
urp
ris
e In
dex
-G
10
Citi Economic Surprise Index (G10, lhs) Citi Macro Risk Index (reversed scale, rhs)
Positive surprises
Negative surprises Risk aversion
Risk seeking
Source: IR&M, Bloomberg
Risk seeking behaviour remains elevated, currently in the 4th highest percentile
since 1997. Economic surprises continue to fall.
Table 12 shows the IR&M conflict monitor that we update quarterly. It’s a yellow-to-red flag
approach to a selection of geopolitical as well as currency (war) conflict zones.
Table 12: IR&M conflict monitor
Source: IR&M
We made no changes to this table.
The Middle East and the Eurozone remain in turmoil. Draghi’s magic is most
likely temporary as the underlying structural problems have not been solved.
Some shooting between India and Pakistan, two nuclear nations, was
disturbing but not yet alarming. The political rumblings in the South China Sea
continue.
Geopolitical Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Currency/trade trouble Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
North Korea vs RoW China vs US
Iran vs US/RoW Brazil vs West
India vs China South Korea vs West
India vs Pakistan Euro
Russia vs Japan
Middle East
South China Sea
Alert levels:
2011 20112012 2012
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Ineichen Research and Management Page 57
Fear gauge: low and falling
Chart 41 shows the most prominent risk/fear gauge, the legendary VIX.
Chart 41: VIX
0
20
40
60
80
100
120
140
160
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
VIX
VIX
1987 crash
Gulf war Asian crisis
Russian default
9/11
Enron/Worldcom
Iraq war
Subprime crisis
Lehman
EUR debtcrisis
Tohoku
EUR debt crisis
Source: IR&M, Bloomberg
VIX ticked up a bit at the end of the year but remains very low.
Chart 42: VIX by calendar year
0
10
20
30
40
50
60
70
80
90
1 25 50 75 100 125 150 175 200 225 250
VIX
Trading days
2008
2009
2010
2011
2012
2013
All-time low of 9.31% on 22 Dec 1993
Lowest percentile (10.7% ) since Jan 1986
Source: IR&M, Bloomberg
The VIX started 2013 on a low note, falling from 18% to 13.5%. The average
for 2012 was 17.8% which compares to 24.1%, 22.5%, and 31.5% for
2011, 2010, and 2009.
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Repressionomics January 2013
Ineichen Research and Management Page 58
Gold as a hedge against fiat money fear
Gold, rightly or wrongly, is perceived as a hedge against funny money, sometimes also referred to as fiat money.
Chart 43: Gold in real USD terms
0
500
1000
1500
2000
2500
3000
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Go
ld, a
dju
ste
d b
y U
S C
PI
Nixon takes USD off
the gold standard
US devalues USD
to 38 $/oz
Most major countries
adopt floating exchange rate system
US devalues USD
to 42.22 $/oz
Gold hits 850 $/oz
due to high inflation, high oil prices,Soviet intervention in
Afghanistan, impact of Iranian Revolution, etc.
Black
Wednesday
Brown's Bottom: HM
Treasury (Goldfinger Brown) decides to sell and eventually
sells 60% of UK gold reserves between July 1999 and March
2002 averaging 275 $/oz
Greenspan on Brown's
Bottom: “Gold still represents the ultimate form of payment in the
world . . . Germany in 1944 could buy materials during the war only with gold. Fiat
money paper in extremis is accepted by nobody. Gold is always accepted.”
"Washington Agreement" to limit gold
sales by 15 European central banks
Spike in run-up
of Irak invasion
2 Jan 08: Gold
breaks 850
China announces it
has raised gold reserves by three-quarters since 2003
Unrest in Middle
East starts
18 Aug 11:
Gold breaks1800
5 Sep 11: Gold
breaks 1900
26 Jul 12: Draghi put
Source: IR&M, Bloomberg
Gold responded to further announced money printing by rising. However, the
gains were modest.
The first column of Chart 44 shows the percentage of time where real 10-year Treasury
yields were below 1%. The second column shows the nominal return for the whole period
whereas the third column shows the nominal return adjusted for inflation.
Chart 44: Gold vs 10-year real USD yields
Decade
Percentage
of months where
real 10Y USD
Yield below 1%
Period
nominal return
of Gold
Period
real return
of Gold
1970s 50% 1356% 627%
1980s 11% -22% -53%
1990s 0% -28% -46%
2000s 25% 281% 196%
2010s 62% 55% 45%
Source: IR&M, Bloomberg
The first column will go higher and higher. It is not entirely unreasonably to
think that the second and third columns will go higher and higher too; even if
the theory behind the relationship is a bit shaky.
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Repressionomics January 2013
Ineichen Research and Management Page 59
Publications
Risk management research (subscription based)
Far from over 3 January 2013
Wriston’s Law of Capital still at work 19 December 2012
A very long process 5 December 2012
In search of a real fix – obviously 22 November 2012
Socialising losses 7 November 2012
No risk (Q4 2012 report) 26 October 2012
No panacea 12 October 2012
No knowledge, no experience 1 October 2012
QE infinity 18 September 2012
Draghi put kicks in 7 September 2012
Enormously ineffective 27 August 2012
They want your money 16 August 2012
Whatever it takes 6 August 2012
No money 20 July 2012
Wriston’s Law of Capital (Q3 2012 report) 10 July 2012
Pompous meddling continues 2 July 2012
Empty monetary bag of tricks 22 June 2012
Helping hand rather than an invisible one 15 June 2012
Fed recommends to hedge too 8 June 2012
Waiting for the next fix 1 June 2012
Hopium running low 25 May 2012
Euro area tearing itself apart 18 May 2012
PMIs make for horrid reading 7 May 2012
Just in the middle of the river 2 May 2012
Risky fragility 19 April 2012
What makes bears blush (Q2 2012 report) 11 April 2012
Conditionally well but subject to revision 4 April 2012
Not yet out of the woods 22 March 2012
Eerily unchanged 15 March 2012
Ltroveneous double liquidity whammy 2 March 2012
Bullish middle-game: an intermezzo? 17 February 2012
Shooting the economic lights out 3 February 2012
Confidence rally 27 January 2012
Relatively difficult (Q1 2012 report) 16 January 2012
Global economy stabilises a bit 22 December 2011
Santa put 8 December 2011
Europe in the tails 28 November 2011
Gap between US and Europe opening 16 November 2011
October looks like a short sigh of relief 3 November 2011
On can kicking and bouncing dead cats 25 October 2011
Kicked can cause dead cat to bounce 16 October 2011
Beware of lights at the end of tunnel 7 October 2011
Europe doubling down (inaugural report, available on www.ineichen-rm.com) 3 October 2011
Europe is levering up, ie, doubling down 30 September 2011
Summer of 2008 revisited 23 September 2011
Depression rather than recession 16 September 2011
Déjà vu 9 September 2011
Global economy arguably in recession 2 September 2011
Risk levels in Europe have risen strongly 26 August 2011
US recession a sure thing 19 August 2011
PIIGSF? 12 August 2011
Early indications continue to deteriorate 5 August 2011
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Repressionomics January 2013
Ineichen Research and Management Page 60
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