NEW$ & VIEW$ (25 MARCH 2013)

Cyprus, Spain, money flows and other Eurozone woes. Canadian slump. South Korea, Vietnam seek stimulus. Inflation watch. Yield bubble. Sentiment watch.

Cyprus Gets New Bailout

Cyprus secured a bailout from its international creditors early Monday, ending a week of financial panic that threatened to see the small island nation become the first government to leave the euro zone.

The deal lines up €10 billion ($13 billion) in financing for the government and shuts Cyprus’s second-largest bank, Cyprus Popular Bank PCL, imposing steep losses on deposits with more than €100,000, European officials said. The country’s largest bank, Bank of Cyprus PCL, will also be downsized aggressively, with large depositors there taking a hit.

Officials said the level of losses for large depositors may not be clear for several weeks, when experts from the EU and the International Monetary Fund have had time to run their calculations.

But the deal doesn’t include any losses for smaller depositors or depositors in other Cypriot banks, a proposal that derailed an initial attempt to reach a pact last week.

Spain Brings Pain to Investors

The Spanish government will impose heavy losses on investors at nationalized banks and hire external advisers to help it manage these banks’ assets.

The restructuring terms announced by the FROB will impose losses of up to 61% at Spain’s largest nationalized banks. At Bankia SA, the largest of the institutions and the only one that is publicly traded, shareholders will be nearly wiped out and junior bondholders will lose around 30% of their original investment.

The FROB also said it would reduce the value of preferred shares in other ailing banks—Catalunya Banc’s by 61%, Banco Gallego’s by 50% and NGC Banco’s by 43%—and then convert them into ordinary shares.

Nonetheless, imposing losses on investors is one of the politically difficult steps required of Spain in exchange for just over €40 billion in EU aid because most of those who made investments in the troubled lenders were small depositors.

Many of these small savers have taken to the streets to protest their expected losses in recent months, claiming they were misled into believing that that they were buying low-risk savings products, not risky bonds or shares.

Eurozone break-up edges even closer (Wolfgang Münchau)

(…) What happened last week is a fitting example of European political leaders, in a most unprofessional pursuit of narrow national interests, failing to defend the common good.

(…)  the single biggest risk ultimately stems from the eurozone’s repeated policy errors. Their effect is slow but cumulative.

Of those, the most damaging has been the policy of asymmetric adjustment through austerity. Banks in Cyprus are falling now because the Greek state and Greek banks fell earlier, and because the eurozone forced a private-sector involvement. In Italy, it was also austerity that turned a recession into a depression. That, in turn, transformed an anti-euro, anti-establishment protest movement into the single largest political party in the Italian parliament at the last elections. There is a good chance that its leader, Beppe Grillo, could end up with an absolute majority if Italy were to hold another round of elections later this year.

If austerity in the south had at least been compensated by fiscal expansion in the north, the overall fiscal stance of the eurozone would have been macroeconomically neutral. But since the north joined the austerity, the eurozone ended up with a primary fiscal surplus in a recession. In such an environment, economic adjustment simply does not take place. Without that, there can be no solution to the crisis. (…)

JPMorgan On The Inevitability Of Europe-Wide Capital Controls  Excerpts from a ZeroHedge post on a JP Morgan analysis:

(…) The obvious risk is the impact that these capital controls will have on deposits in other peripheral countries. (…) While a modest deposit tax might be acceptable to large depositors, a freeze of deposits for an un identifiable time period would likely be unacceptable to most large depositors such as corporations and institutional investors. (…)

But it is not only bank deposits that are at risk. A broader retrenchment in funding markets is possible given the confusion and inconsistency last weekend’s decision created for investors relative to previous policy decisions:

1) In the case of Cypriot banks, depositors are hit while senior bond holders are spared, so seniority is not respected.

2) Deposits of foreign branches are protected while deposits of domestic branches are hit. This is the opposite of what happened to Iceland.

3) In the case if Ireland which also had a big banking system relative to the size of its economy, only sub debt holders, accounting for a very small portion of total creditors, were hit. No depositors were hit, in either domestic or foreign branches.

4) In the case of SNS sub debt holders were wiped out and reports suggest that the Dutch government came close to imposing losses on senior bond holders and was only prevented from doing so because of unsecured intergroup loans between SNS bank and Reaal insurance that would be subjected to the same losses as senior bond holders.

But beyond the confusion and inconsistency, all these trends and the case of Cyprus in particular, are not only showing bailout fatigue on the part of creditor nations, especially in Netherlands where economic conditions have been deteriorating rapidly, but they are also pointing to a shift towards bailing in private creditors in future sovereign bailouts or bank resolutions to avoid using taxpayers’ money.(…)

In what we view as another ill-conceived and ill-timed move, the Spanish Minister of Finance & Public Administration announced this week a tax or bank levy (probably 0.2%) to be imposed on bank deposits, without details on which deposits will be affected or timing.

This is adding to the Cypriot crisis in sparking deposit outflow risks.

The FT’s Gavyn Davies is more optimistic:

(…) After all, everyone knows that Cyprus is a special case, given the size of its banking sector relative to GDP, its exposure to foreign depositors of questionable virtue and its concentration of bank lending to the collapsed Greek economy.

No other economy has that combination of disadvantages, which has made a conventional bank rescue impossible for the Cypriot government, and unacceptable to the rest of the eurozone, especially Germany. Bank depositors in Spain and Italy will presumably be aware of these unique features, and therefore more willing to view it as a special case.

That said, four of the features of the reported deal are setting unfortunate precedents for the future.

First, the way in which the bank failures have been handled shows that the eurozone is still very far removed from a workable banking union. (…)

Second, the principle of divorcing the debt of governments from that of banks (and thus breaking the “diabolical loop” which threatened to bring down Spain last year), was very rapidly thrown out of the window in Cyprus. (…) German Finance Minister Schauble even went as far as to say that in other countries small deposits are safe “only on the proviso that the states are solvent”. Does that not drive a coach and horses through the separation of banks and governments, which was one of the principle promises made by eurozone leaders at their crucial summit of June 29, 2012?

Third, there is the possibility that investors will view any haircut on large depositors not as a special tax, or a bail in of creditors, but as a capital levy on investors. (…)

Fourth, there is the fact that direct controls over the exit of capital from a eurozone member will have occurred for the first time in Cyprus. (…) Indeed, it seems to breach one of the basic principles of a single currency in the first place. (…)

Thinking smile  Mood Sours in Northern Europe  Falling confidence among companies in the euro zone’s biggest northern economies in March suggests those nations are increasingly vulnerable to the problems afflicting the bloc’s southernmost nations.

German business confidence deteriorated unexpectedly in March, as the closely watched Ifo index dropped for the first time in five months.

The business confidence index for France’s manufacturing industry hovered at 90 in March, statistics agency Insee said Friday. The index covering export order books fell to minus-40 in March from minus-34 in February, it said.

Confidence fell among manufacturers in the Netherlands in March, to an index reading of minus-4.8 from minus-3.6 the previous month, the Dutch statistics agency also said Friday.

In Belgium, business confidence fell to its lowest level since September 2009, with the Belgian National Bank’s measure at minus-15.0, down from minus-11.0 in February.

More on Germany

imageThe average reading of the IFO expectations index in
the first quarter is consistent with a 0.5% GDP rise.
The IFO signal is therefore stronger than that of the
PMI, which is currently pointing to a 0.3% GDP
increase in the first three months of the year.

Although both surveys indicate a return to economic growth in the first quarter, the concern is that the weakening of the IFO adds confirmatory support to the message form the PMI that the German economy is losing momentum again, and could see a renewed weakening of growth in the second quarter. The composite PMI has now fallen for two consecutive months, down sharply from a peak of 54.4 in January to 51.0 in March. (Markit)

More on France

imageIneichen Research & Management AG

TNT Express cuts 6 percent of jobs to face future alone

Dutch express delivery firm TNT Express said it will cut 4,000 jobs and focus on Europe after a failed $7 billion takeover by United Parcel Service.


After ending 2012 with a thud, Canadian retailers didn’t exactly ring in the New Year. Volume sales were unchanged in January, and are now down 0.9% in the past year and a hefty -2.2% annualized in the past six months. Coupled with sagging factory shipments, GDP looks to retrace only half of December’s 0.2% decline.

Even if growth picks up moderately in February and March, it will struggle to top 1% annualized for a third consecutive quarter. The Bank of Canada expected 2.3% growth in Q1. At least its view that low rates “will likely remain appropriate for a period of time” is on the money. (BMO Capital).


Storm cloud  South Korea Minister: 2013 Growth Likely Slower

South Korea’s new finance minister said the country’s economy will likely grow at a slower pace than expected this year, requiring an economic stimulus to be announced as early as next week.

The government in December forecast the domestic economy would grow 3.0% in 2013 following a 2.1% expansion in 2012.

South Korea Escalates Concern With Japan Policies on Yen

(…) Appointed by Park on March 22, Hyun said in his inaugural speech he would use “all possible measures to speed the economic recovery,” and indicated that government support would come as early as this month.

“We need to factor in the yen problem as we think about policy measures, as exports and domestic demand are two big pillars of our economy,” Hyun said on March 23. Stabilizing foreign-exchange markets should always be an important part of government policy, since currency moves can be a source of shocks, he said.

Storm cloud  Vietnam Cuts Interest Rates to Aid Growth After Inflation Slowed

The State Bank of Vietnam lowered the refinance rate to 8 percent from 9 percent and the discount rate to 6 percent from 7 percent, according to a statement on its website. It also reduced the cap on dong deposit interest rates to 7.5 percent from 8 percent. The new rates are effective March 26.

Vietnam’s central bank lowered interest rates six times last year, with the last reductions taking effect Dec. 24.


I have begun an “Inflation Watch” feature, even though world fundamentals are not conducive to an acceleration in world inflation as Moody’s points out:

Both the recent slowing pace of Chinese industrial activity and the eurozone’s seemingly chronic malaise will limit the upside for global inflation. The year-over-year percent change of Moody’s industrial metals price index shows unexpectedly strong positive correlations with both the eurozone’s composite PMI and the yearly percent change of China’s industrial production.



Nonetheless, U.S. labor costs are creeping up, along with employment.


The U.S. has strongly benefitted from imports of deflationary Asian products between 1995 and 2005. Non-fuel import prices (chart below) have been steadily rising since in spite of the lasting severe economic crisis that reduced world demand growth.


So, conditions are in place for higher inflation should U.S. employment keeps strengthening. To be monitored, given the impact inflation has on equity valuation (see the Rule of 20)


Investors are not well paid for the level of sovereign risk in the U.K. or France.

Update On Sovereign Risks

In a recent Special Report, BCA Research’s Global Fixed Income Strategy service has updated its sovereign risk analysis. According to the results, fiscal constraints due to heavy debt loads in the U.S., Japan, and the U.K. are depressing their sovereign risk scores. Meanwhile, peripheral Europe is on the mend.

Although the sovereign ranking methodology is not intended to predict spreads, the relationship between CDS spreads and our sovereign risk score highlights that the risk fundamentals in Spain, Italy, France and the U.K. are similar. However, investors are not well-compensated for the risks in the latter two countries.

Cyprus Crisis Is Credit Negative for all Euro Area Sovereigns (Moody’s)

Euro area policymakers’ handling of the Cyprus crisis to date, the increased risk tolerance apparent in their actions, and the uncertainty that a more uncompromising and less predictable approach to crisis management creates for investors’ assessment of risk, are credit negative for euro area sovereigns.

Yet: Investors embrace big eurozone bond sales  Issuance from periphery on track for best quarter since crisis began

(…) Governments on the eurozone’s stricken rim have sold €28.2bn worth of bonds so far this year, according to Dealogic, almost double the amount over the same period last year and making it the best start to a year since the first three months of 2010. (…)

The European periphery’s companies and banks have also benefited from the buoyant bond markets, and have sold €31.9bn worth of bonds so far this year, already making it the best quarter since early 2011. (…)

Junk Bond ETF Yields May Fall Below 5% Amid Scramble for Income

Yields in junk bond ETFs are threatening to fall below 5% for the first time ever as strong demand for speculative-grade corporate debt in a low-rate environment keeps pushing yields down.

FT’s Gillian Tett had a good piece March 14:  Remember lessons of 2007 in rush for junk Warnings over high yield ‘overheating’ are growing

(…) But while those tumbling yields have sparked debate, what has received less attention is the issue of maturity transformation. In previous decades, it was taken for granted that the type of people investing in high-yield debt or bank loans were mostly medium- to long-term investors, such as pension funds or life assurance groups, if not banks themselves.

But mutual funds and exchange traded funds have increasingly started gobbling up risky corporate debt on a significant scale. By late last year, assets in high-yield funds were running at about $350bn, having almost doubled in three years. And, although those flows reversed slightly in February, money is now flooding into bank loan funds.

(…) Federal Reserve figures show that funds are now buying more than two-thirds of all corporate credit debt, up from a quarter in 2007.

(…)  And if anything causes a panic among retail investors, the money that has been backing all those corporate loans and bonds could vanish overnight – revealing another maturity mismatch, and funding gap.

Now don’t get me wrong: I am not forecasting that this flight will happen. Although there were four weeks of outflows from high-yield mutual funds in February – or after Mr Stein’s speech – some $820m flooded back in the first week of March; investors are (thankfully) not exiting this sector in panic now. So far, the short-term money that has gone into the corporate debt world does not appear to be associated with too much leverage; this makes the picture notably different from the asset-backed commercial paper market or repo sector in 2007. (…)

Tett says that

Some bankers insist that this behaviour is benign, given that default rates remain low.

Pointing up  Here’s Moody’s on default rates, just as the U.S. economy seems to be doing better:

There was a similar number of rating changes for the US over the past week, 16, compared to the week prior, 18, but there is a substantial drop in the number of positive rating changes. Only four, 25%, were upgrades this week. The changes have been leaning slightly toward the down side of 50% over the past few weeks, but the 25% this past week certainly does not move toward a positive view of corporate credit quality. (…) In Europe rating change activity has increasingly moved to speculative grade industrial companies from investment grade financial companies and only two out of 10 changes were upgrades.

Confused smile  Congress weighs corporate debt tax reform
House looking at limiting interest payments’ tax deductibility

US lawmakers are considering limiting the tax deductibility of interest payments for businesses, a measure that would dramatically transform corporate finance in America by reducing the bias towards debt in the tax code.


Nike rallied 11 percent to a record after the world’s largest sporting-goods company reported a rebound in profitability. Tiffany rose 1.9 percent after posting better- than-estimated profit amid increased demand in the Asia-Pacific region.


Schwab’s Lyz Ann Sonders, always a good read, compares some market data for 2007 and 2013 concluding that

most of the better comparisons are many of the traditional stock market barometers, including earnings, valuation, technical conditions and inflation.

Then and Now: The Good

She goes on…

The news out of Cyprus was the trigger for the slight pullback the market’s experiencing as I write this report. The story will have to play out, but we don’t feel this represents the type of exogenous shock that could undermine the US stock market for any extended period of time.

Although the eurozone crisis keeps policy uncertainty elevated, US policy uncertainty has been coming down sharply of late.

Less US Policy Uncertainty…failing to point out that U.S. policy uncertainty remains far above 2007. She then lists all the items supporting the bullish case:

  • Thanks to better economic readings lately, many economists are upping first-quarter real gross domestic product (GDP) estimates; some as high as 3%.
  • “Don’t fight the Fed” (or most other global central banks).
  • Housing is firing on nearly all cylinders
  • Unemployment claims (a fellow leading indicator with the stock market) are at a five-year low.
  • Household net worth is on track to take out its prior all-time high this quarter.
  • Industrial production and retail sales have been particularly strong (primary source of higher GDP forecasts for first quarter).
  • Small business confidence is ticking up.
  • Earnings revisions turning higher.
  • Moderate, but persistent employment gains.
  • Consumer financial obligations (mortgage/credit card payments, etc.) relative to disposable personal income are near record lows.
  • The credit-card delinquency rate is at record low by wide margin.
  • Highest year-to-date stock mutual fund inflows in seven years.
  • About 90% of S&P 500 stocks are above their 200-day moving averages.

Typical of most economists, she spends precious little time on earnings and P/Es, assuming that a growing economy will automatically lift earnings. Longer term, yes. But, remember what Keynes said…


Sonders’ only reference to earnings is a statement that earnings revisions are turning higher. This is not supported by any of the earnings aggregators that I follow. S&P’s most recent update (March 21) shows Q1’13 estimates down 6 cents in the last 5 weeks (2 cents in the last week) to $25.51. Here are S&P’s charts:

image image

Factset wrote on March 22:

The estimated earnings growth rate for Q1 2013 is -0.7% this week, slightly below last week’s growth rate of -0.6%.

Sonders continues, stating that

Shorter-term, the next worry for investors is whether we’re going to see a fourth consecutive mid-year slowdown in the economy. (…)

There are some reasons to hope for a break in that cycle given many of the factors noted in the bulleted list above. But meaningful weakness the past three years didn’t rear itself until the April-May time frame (as you can see below via the Citi Economic Surprise Index comparisons), so we’ll have to wait and see.

No Sign of Weakness Yet This Year

The problem with that is her first bullet point above. The fact that most economists, including the Fed, have become more optimistic on the economy is, in itself, a reason to worry. The jury remains out for now. ISI’s weekly company surveys diffusion index has been a reliable canary in the past.


Recently, the big surprise in the U.S. has been the resiliency of consumer spending in the face of a big fiscal drag, delayed tax refunds and higher gas prices. Americans have obviously dipped into their savings (and cut restaurant outings). Just in case you want to hang your hat on a low savings rate, here’s the long term chart:




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