The American Recovery

22 March 2012

Mohamed A. El-Erian




NEWPORT BEACH – The United States has gone through an arduous period of intervention and rehabilitation since the global financial crisis in 2008 sent it to the economic equivalent of the emergency room. It moved from the intensive-care unit to the recovery room and, just recently, was discharged from the hospital. The question now is whether the US economy is ready not just to walk, but also to run and sprint. The answer will powerfully influence global economic prospects.

.
It is easy to forget how critical things were back in the fourth quarter of 2008 and the first quarter of 2009. Having suffered what economists call a “sudden stop,” many parts of the US economy were imploding or had ceased to function – to extend the medical metaphor, even the most vital organs were threatened.



Economic activity collapsed and unemployment surged. Credit stopped flowing. Banks were on the verge of bankruptcy and nationalization. International trade was disrupted. Income and wealth inequalities worsened. And a general sense of fear and uncertainty inhibited the few healthy parts of the economy from engaging in meaningful hiring, investment, and expansion.



Parlous conditions required dramatic measures. And that is what the economy got in the form of unprecedented fiscal stimulus and unthinkable policy activism on the part of the US Federal Reserve.


.
As they intervened, American policymakers consulted closely with their counterparts around the world, urging them to take supportive steps. And they did, culminating in one of the most successful periods of global policy coordination in history, involving both advanced and emerging economies.



For many, the global economic summit held in London in April 2009 marks the point when the US economy turned the corner. The change was so notable that many policymakers fell into the trap of projecting a quick rebound, especially given America’s prior history of economic dynamism and resilience, only to be humbled by what has proven to be a protracted and complex process of recovery. Even today, that process highlights the scale and scope of the economy’s structural weaknesses.



Having reduced the risk of a relapse into recession, the US economy is able now to move on its own power, though gingerly. The horrific collapse in the labor market has given way to consistent monthly employment gains, albeit less than what is needed for a full recovery. Manufacturing activity has picked up, helped by a surge in exports. The housing sector seems to be finding a tentative bottom (though housing finance remains incoherent).

.
Consumers have better access to credit. And, sensing all of this, companies are beginning to deploy the massive precautionary cash balances that they have accumulated.



With the US still by far the largest economy in the world and the anchor of the international monetary system, its well-being has huge implications everywhere. So, not surprisingly, the US recovery has helped to set a calming and constructive tone – and at a critical juncture, given that Europe is still struggling with a debt crisis on the eurozone periphery, and emerging economies are going through a cyclical slowdown.



Politics is also in play, and in a manner that significantly influences who will lead the world’s superpower after this November’s presidential and congressional elections. The economic improvements already have helped President Barack Obama’s re-election prospects, as has the continuing drama of a drawn-out, divisive, and expensive Republican primary.



The problem is that the sense of relief now can – and probably willbe taken too far. Indeed, today’s good news should not obscure some consequential structural limitations that will require prolonged therapy and caution. After all, the US economy has yet to regain its full strength, is too structurally impaired to sustain any rapid forward movement, and has not yet started to overcome the many distortive side effects of the extreme medicine that it received.



Locking in recovery implies a multi-year program of serious and coordinated reforms that fundamentally improve the way the country educates and trains its citizens, invests in infrastructure and finances other productive outlays and housing, competes in the global economy, and formulates and adheres to a rational budgetary process. Such a program will also require a recovering America to navigate several key challenges in the next few months.



For starters, the economy is not yet in a position to handle the 4-5%-of-GDPfiscal cliff” that is approaching as all of the hard political decisions that were postponed come into view at the end of this year. The prospect of a disorderly fiscal contraction needs to give way to a more rationally designed approach that avoids undermining the fragile recovery. To accomplish that, the political class must avoid the bickering that almost sent America back into recession in 2011, and that raised major questions about the quality of the country’s economic governance.



Oil prices are not helping. Having already surged on account of Iran-related geopolitical concerns, they are altering American consumers’ behavior, weakening their confidence, aggravating the country’s payments imbalances, and further reducing policymakers’ flexibility.



And then there is Europe, which is yet to overcome decisively its debt and growth problems. Like other countries, the US must continue to strengthen internal firewalls to limit its vulnerability to what is still a complex crisis across the Atlantic.



America’s full recovery is not yet guaranteed. A mix of steadfastness, caution, and good luck is needed for that to happen. And when it does, the country will be in a better position to repay its massive hospital bill.

.

Mohamed A. El-Erian is CEO and co-Chief Investment Officer of the investment company PIMCO, with approximately $1.2 trillion in assets under management. He previously managed Harvard University’s endowment, which he helped shield from the effects of the financial crisis. His book When Markets Collide was named the 2008 Financial Times/Goldman Sachs Business Book of the Year


March 22, 2012 7:55 pm

Spanish economy: Gathering gloom

Concerns are building about the country’s banks – and about its chances of avoiding a bailout



It was an eye-catching act of horseplay among politicians negotiating under pressure. At the end of yet another Brussels summit this month aimed at resolving the eurozone crisis, Luxembourg’s Jean-Claude Juncker, chair of the eurozone finance ministers, jokingly placed his hands around the throat of Luis de Guindos of Spain and pretended to strangle him.

.
In truth, the dispute about Spain’s excessive budget deficits had been resolved. The new centre-right government in Madrid had finally yielded to European demands to slash the 2012 shortfall, having already embarked on plans to liberalise the inflexible labour market, and ordered banks to set aside an extra €50bn to cover deteriorating property assets.

.

Until this week, a casual observer of financial markets would have assumed Spain had put the danger of default behind it, and that its fiscal crisis no longer threatened the integrity of the euro. Investors seemed confident about the progress of the administration of Mariano Rajoy, Popular party prime minister. As recently as Tuesday, Spain auctioned one-year Treasury bills at just over 1.4 per cent in annual interest, the lowest yield for nearly two years.


.
That confidence is already starting to evaporate. A growing chorus of economists and analysts is warning that the Spanish economy – the eurozone’s biggest after Germany, France and Italy – is in much worse shape than markets might suggest.


.
Their concerns – including a failure to “deleverage”, or cut debt, and the onset of a second recession in two years – were finally reflected in the bond market nervousness on Thursday. The country’s benchmark 10-year bond yield jumped above 5.5 per cent for the first time in two months.


.
Willem Buiter, Citigroup chief economist, told Bloomberg Radio this week that Spain was “at a greater risk than ever before” of being forced to accept a debt restructuring. This would shake the European banks that helped fund its rapid growth in the past three decades, further undermining confidence in the euro.

.
Economists say sovereign bond prices have held up until now, and thus kept yields low, only thanks to the €1tn flood of liquidity released by the European Central Bank under Mario Draghi, its president, in the form of longer-term refinancing operations. Flush with LTRO money, Spanish banks in particular have been buying more of their nation’s sovereign debt. Both Spain and Italy have been handed a lifeline by the ECB that some analysts say amounts to an informal bailout.


.
“The LTRO has given us oxygen for three years,” says Professor Luis Garicano of the London School of Economics. “It’s averted a catastrophe that was imminent as a result of the financial system being strangled.” A senior European diplomat who has followed negotiations in Brussels agrees: “Draghi has saved Spain, he’s saved the financial system.”

.
Even so, some analysts are pessimistic about Spain’s chances of avoiding a humiliating public rescue of the sort already provided by the EU and the International Monetary Fund to Greece, Ireland and Portugal.

.
One indicator of rising concern is the change in perceptions of the relative creditworthiness of Spain and Italy. This month, Spanish bond yields rose above those of Italy for the first time since last August, a sign that investors regard Spain as a greater risk.

.

To explain the increasing pessimism, economists and Spanish policy makers point to two big worries. First, the domestic economy remains in poor shape more than three years after the collapse of US investment bank Lehman Brothers – with more than one in five workers unemployed and a second deep recession under way. 

.
Mr Rajoy will therefore find it very hard to meet his promise to cut the deficit from 8.5 per cent of gross domestic product in 2011 to 5.3 per cent this year, and so reach the EU-imposed 3 per cent target in 2013.

.
Second, they think several Spanish banks, especially some of the former cajas or unlisted savings banks, still refuse to recognise the full extent of their loan losses as a result of over­exuberant property investments in the decade to 2007. In other words, although the state has taken on some of the burden of private sector debts, it may need to spend billions of euros more on rescuingzombiebanks.

.
For this reason, writes Dario Perkins of Lombard Street Research, in a pessimistic analysis of the euro crisis that predicts a Greek exit from the single currency, “in many ways, Spain looks even worse than Italy.” He sees economic growth declining this year, while unemployment risescontributing to “further sharp declines” in house prices and widespread loan defaults by businesses and households.

.
For all the talk of austerity under Mr Rajoy – he says measures to solve the country’sextremely serious problems “will not be pleasant” – and José Luis Rodríguez Zapatero, his Socialist predecessor, Spain has only recently, and only slowly, begun the process of deleveraging. According to a McKinsey Global Institute report, the total debt rose from 337 per cent of GDP in 2008 to 363 per cent in mid-2011, because of a rapid increase in public debt as Madrid tried to alleviate the effects of the crisis.


.
Prof Jesús Fernández-Villaverde of the University of Pennsylvania and the LSE’s Prof Garicano portray Mr Rajoy’s deficit reduction plans as “Mission impossible” in Nada es Gratis (“Nothing is for free”), their blog focused on Spanish economics. In 2011, the public deficit fell by only about €8bn – the proceeds of just one good bond auction, or less than 1 per cent of GDP.

.
The PP government blames Mr Zapatero for overshooting the 2011 deficit target agreed with the EU by €25bn. But Mr Rajoy, focused on winning one of the Socialists’ last fiefdoms in a regional election in Andalusia this weekend, has delayed until the end of this month the announcement of this year’s budget. It must then be approved by the national parliament, giving him seven or eight months at most to achieve the deficit target agreed in Brussels.

.
His task, say professors Fernández-Villaverde and Garicano, is even harder than it looks. As Greece has discovered, harsh austerity measures during a recession tend to deepen the downturn. In a shrinking economy, furthermore, higher tax rates do not necessarily increase tax revenues; nor do advertised spending cuts automatically result in lower revenues, as outlay on unemployment benefits and other costs rises. They reckon that to cut the deficit to the targeted 5.3 per cent this year will not therefore require tax rises and spending cuts worth €32bn, as a simple calculation would indicate, but €53bn-€64bn – “which is, frankly, impossible”.

.
To make matters worse, the austerity programmes attempted in the past two years by the Socialist and PP central governments have unveiled a picture of fiscal laxity and financial mismanagement by several of the 17 autonomous regional governments – which run hospitals and schools and therefore spend most public money – and by hundreds of municipalities.

.
Although the PP has arranged a scheme through the banks to pay off €35bn in unpaid debts to pharmaceuticals companies and other suppliers of goods and services, it is taking longer than expected to restore financial order to a highly devolved political system. “The autonomous regions and the municipalities are to Spain what Greece is to the eurozone,” says Lorenzo Bernaldo de Quirós of the Freemarket Corporate Intelligence consultancy.

.
In response to labour reforms and spending cuts at every level of government, the main trade union federations have called a general strike for March 29. But the government is unlikely to yield to the unions’ demands, since most of them require public money it can no longer afford to spend if it is to have any hope of meeting the EU’s deficit targets.

.
Business leaders and policy makers are often exasperated by periodic bouts of pessimism about Spain among international bond investors and foreign economists. History is on the side of the Spanish when they recall that the country has extricated itself from equally grave crises since the restoration of democracy in the 1970s. Spain has maintained its share of world exports in the past 12 years – among leading eurozone economies, only Germany has done better by this measure.

.
Politicians and entrepreneurs alike insist theirs is a “seriouseconomy. “The corporate base of Spain is phenomenal,” says Jorge Calvet, chairman of Gamesa, a wind turbine manufacturer and wind farm developer. “You have only to look at the power of sales, research, financial strength and internationalisation in the Ibex 35 [the index of large Madrid stocks]. That cannot be compared to other countries that are in difficulties.”

.
Joan Rosell, head of CEOE, the employers’ federation, emphasises rising exports, and identifies the most pressing economic problems as lack of confidence and lack of liquidity. Mr Rajoy’s labour reforms, he says, will help restore confidence while the ECB is providing liquidity.

.
Business leaders and politicians are now hoping they can survive the next few months without a rescue and eventually begin to see the kind of economic upturn that has recently inspired optimism in the US.

.
For some independent analysts, Spain has already been rescued in practice, avoiding the need to undergo a formal process only because, like Italy, it is “too big to fail”. A sovereign debt restructuring would be crippling for the German and French banks that financed much of Spain’s property lending in the boom years and would overwhelm the EU’s available rescue funds.



“I think Spain is de factobailed out, first by the ECB buying [sovereign] bonds in the summer, and then by the LTRO,” says Edward Hugh, a Barcelona-based economist. In return, he says, Spain must comply strictly with EU deficit reduction targets. “More and more we could see Brussels getting involved with Spain and Italy in the way that they have been involved with Greece.”


Bankrupt Jerez aims to end financial chaos


.
They file in at noon by the dozen. The jobless, the homeless, the hungry, Spaniards, Moroccans, Romanians, young and old, devouring the free lunch provided by the Daughters of Charity of Saint Vincent de Paul at the food kitchen just off the Plaza Ponce de León in the heart of old Jerez.
After more than three years of economic crisis in southern Spain, the stories they tell are familiar. Mari Carmen Riera, a 47-year-old security guard from Barcelona, has not worked since 2009 and lives on the street with her husband; Enrique López, a professional cook, aged 55, last had a job in Córdoba in 2005.

.
Jerez, famous for its eponymous sherry, is now notorious for having one of Spain’s highest unemployment rates, with one in five out of work. “I think this will be a very bad year,” says Rosario Castellón, a social worker who manages the food handouts.

.
Lack of jobs, however, is not the only problem. Jerez’s municipal finances are also in a catastrophic state, making it an egregious example of everything that went wrong with the devolution of power to autonomous regions and municipalities after the death of General Francisco Franco, the dictator, in 1975 and the restoration of democracy.


.
Residents say Jerez’s municipality lived for decades beyond its means under the ambitious Pedro Pacheco, an Andalusian nationalist who was mayor for 24 years, until 2003, after which he was in coalition with others.


Then came a collapse in municipal tax revenues when the Spanish housing bubble burst in 2007.
With just 215,000 inhabitants, Jerez municipality has debts of €980m, making it the country’s most indebted city on a per-capita basis, and can no longer pay its staff of more than 2,000 or its suppliers on time. “The bad thing is not the current situation, which is chaos,” says one senior municipal employee, who expects the town hall to finish paying his January salary in May. “It’s what is still to come.”

.
Juan Pedro Crisol, a Socialist councillor and member of the administration that lost power to the centre-right Popular party in municipal elections last May, accuses María José García-Pelayo, the PP mayor, of unfairly blaming her Socialist predecessors and of carrying out unnecessarily drastic surgery instead of curing the patient. “In nine months there’s been a total collapse of the city,” says Mr Crisol.


.
“There’s an urban bus strike, a rural transport strike. The schools are not being cleaned. Staff are not being paid.”

.
In the mayor’s office, Ms García-Pelayo dismisses such criticism, mocks the “fictitiousbudgets of the past and says she is taking the previous administration to court because it left the municipality bankrupt.

.
Municipal income up to the year 2031 was committed to paying off debts, she says. “For many years there were economic problems and instead of solving them, they just had recourse to the banks . . . It’s time to fix Europe, it’s time to fix Spain, Andalusia and Jerez.”

..
Copyright The Financial Times Limited 2012.


Gold Swerves To Avoid The Cross Of Death
.
March 22, 2012
.
Bob Kirtley
.






.Despite the turmoil in the world, gold prices appear to be range bound between $1800.00/oz and $1550.00/oz. Many are predicting a rapid move north given that the money printing machines are working overtime, debasing all currencies with the eventual outcome being the appearance of the inflation monster. Some are even looking for a black swan event to provide the ignition required to set the precious metals markets on fire. These events may already be baked into the cake; QE3 for instance, it's been coming for so long that it could now be a case of buying the rumour and selling the fact should it arrive. A black swan such as a conflict with Iran has been trailed for some time now, so again this will not be a surprise for the markets. It will undoubtedly have some effect, especially on the price of oil, but the disruption would be short-lived as preparations have been made to keep the Strait of Hormuz open and operational. And who knows, maybe common sense will prevail and a mutually satisfactory compromise can still be found.
.
                  
.
As investors, maybe we need to consider the possibility of an extended period of consolidation with not much more to look forward to than range trading and sideways movement. If this is the case, then in terms of actionable allocation of our cash, it would suggest to us that we hold onto our core positions in both the precious metals and mining stocks.

.
However, we should and have resisted the temptation to increase our exposure by making more acquisitions in the mining sector, as the risk/reward environment wasn't in our favour. We have been advocating for over a year a policy of keeping our powder dry and apart from the occasional foray into the options market. This strategy has paid off handsomely so far. Anyone who follows the HUI will know that it is back trading below the 500 level, which is where it was back in 2010, so for us to have been on the acquisition trail over this period would have been damaging to our financial health. We should also mention that many of our peers are anticipating a large move north for mining stocks and they may be correct. Again though, the essence of a good decision is timing and we are of the opinion that the time is still in front of us and not behind us. So don't panic, you have not missed anything, other than to watch household names in this sector become even more attractive as a purchase, as stock prices crumble. Indeed it is hard sitting on one's hands at times like these but as they say; patience is a virtue.



.
Taking a quick look at the chart above, we can see that gold prices have only just managed to avoid the cross of death, as the 50dma almost crossed over the 200dma in a downwards movement, but managed to swerve at the last minute and live to fight another day. Had the crossover taken place, then one would have read this event as a negative for gold. This is, of course, only one of many indicators and none of them are one hundred percent accurate. However, some traders may well have been guided by any such event, which to their way of thinking would have triggered a sell trade, thus putting even more downward pressure on gold. The technical indicators are now oversold which suggests a near term bounce.


.
For the hyper-active short term traders amongst us, this could be a trading opportunity. If it all goes pear shaped then at least you will be the proud owner of a few shares that were on your "buy list" anyway.


For now we will continue to look for absolute bargains and we will try to be patient enough to wait until whats on offer is real steal.

.

Déjà vu all over again in housing!

.
Mike Larson


Friday, March 23, 2012 at 7:30 am



In late 2009, just a few months before the 2010 spring selling season for homes got underway, the Philadelphia Housing Sector Index (HGX) started to move. The benchmark index of housing and construction-related stocks surged from around 90.55 in November to 132.53 in late April — a gain of 46 percent.


.
Investors and pundits hailed it as proof positive that the housing market was finally on the mend that blue skies and rainbows were here to stay! But what happened next? The index flopped and chopped around for a while then fell off the table. Ultimate loss through October for anyone who bought the hype? 39 percent!



In late 2010, just a few months before the 2011 spring selling season, it happened again! The HGX rallied from 94 in late November to 121 in late February — a rise of 29 percent.


.
So did THAT signal a lasting turn for the housing market’s fortunes? Erno! The index imploded 34 percent shortly thereafter.
And wouldn’t you know it? Investors are at it again!






.





They’ve been buying housing stocks, construction stocks, home improvement retailers, cabinet and faucet makers, paint companies, and more like they’re going out of style!


.
Stocks like Valspar (VAL), Sherwin-Williams (SHW), Stanley Black & Decker (SWK), A.O. Smith (AOS), Masco (MAS), Home Depot (HD) are putting even high-momentum Internet companies to shame with their recent gains!


. Me? I can’t shake the feeling it’s déjà vu all over again — and that the 2012 version of this annual rite is going to end badly too!



What the latest housing figures do —
and DON’T — show




Why is there so much optimism about these stocks and the housing market in general? I don’t know if it’s the fact it’s 80 degrees in Chicago and New York City. I don’t know if it’s just the innate optimism that prevails on Wall Street, or the happy talk from housing company executives.


But whatever it is, it sure doesn’t seem justified to me. We have undoubtedly seen some improvement from the depths of the 2007-2009 recession. Home sales, home construction activity, and builder optimism have taken a modest turn for the better.
The spike in housing-related stocks is on shaky ground.
      The spike in housing-related stocks is on shaky ground.
.


.
 But even with that slight improvement, housing starts remain a whopping 69 percent below their bubble peak! A key measure of home builder optimism is still down 61 percent. Existing home sales? They’re off 37 percent. Home prices? Down 34 percentSTILL!

.
More recently, we’ve seen mortgage rates shoot higher along with Treasury yields. That couldn’t come at a worse time, considering we’re entering the heart of the home selling season.

Is that why the National Association of Home Builders confidence index just registered 28 in March, instead of rising to 30 as expected? Hmmm.


And what about housing starts? They slumped slightly to 698,000 in February instead of rising as expected. Moreover, single-family starts plunged 9.9 percent — the biggest drop in a year!

.

“Look out below” time for housing sector?
Sure looks like it to me!
.
.
Long story short: It’s been a heck of a rally in the housing and construction sector. Some sector stocks are trading at all-time highs. Not 52-week highs, mind you. Highs they didn’t even hit during the peak of the bubble — when home prices were rising at double-digit rates and construction activity was running at the fastest rate in U.S. history!
.
.
Does that make sense to you? Because it sure doesn’t to me!
In fact, I believe the combination of that strong rally, the recent rise in interest rates, and the potential for activity to slow going forward will prove toxic to investors. If you own these stocks and have enjoyed the rally, I urge you to sell now.


.
I would also take gains off the table in other stock market sectors, something I’ve been doing in my services recently. If the recent housing strength fades, the economy will likely cool, and I don’t believe the broad market is prepared for that.

.
Until next time,
.
Mike