Monday, December 5, 2011

Standard & Poor's confirms that it has placed all 17 eurozone nations on negative watch.

How is the FT getting quotes from S&P on this before an official release? Now a credit watch move on France would not be a surprise and maybe Austria too but Germany on the cusp of losing its AAA rating, according to S&P, would be shocking right now. With this said, if France specifically loses its AAA rating, the EFSF will have problems.

GS observations:

* A significant eurozone recession is the firm's baseline expectation now.
* A negative feedback loop in Europe could occur (similar to the U.S. in 2008-2009) unless the ECB provides a massive backstop.
* U.S. economic news continues to beat very low expectations.
* The November employment report was "better than expected" but not nearly as good as suggested in the drop in the unemployment rate - it was due to workers dropping out of the labor pool.
* U.S. growth will moderate from +2.25% in the second half of 2011 to only 1% in next year's first half, reflecting fiscal tightening and an expiration in emergency unemployment benefits (among other reasons).
* "All roads lead back to Europe these days," and the eurozone poses the greatest risk to domestic growth.
* Not much is expected out of the Fed during December's FOMC meeting (though comunication policies will be "revamped").

Much is dependent upon the ECB providing a huge backstop (which still seems unlikely).

If an important reason for buying is investors' catch-up, remember, price is what you pay, value is what you get.

The November non-manufacturing ISM declined to the lowest print 10 months.

The November non-manufacturing ISM disappointed at 52.0 vs. expectations of 54.0 and 52.9 in the prior month.

This was the lowest print in the index in 10 months. While new orders and backlogs were strong, the employment component dropped from 53 to 49.

Factory orders declined by 0.4%, in line with expectations.

S&P profits should slightly exceed $100 a share given low interest rates, quiescent inflation - at least the way it is officially counted - and restrained wage labor costs.

Overnight, China's HSBC purchasing managers index fell from 54.1 to 52.5, and China's official PMI for nonmanufacturing dropped to 49.7 from 57.7.

Bulls in the China shop see this as hastening monetary ease, which will produce a soft landing.

I am not sure why so many are so certain that preemptive monetary easing guarantees a soft landing.

We will see.

It's either risk-on or risk-off, nothing in between. But, it can increasingly be argued that a lot has been discounted in the massive de-risking (by every investor class) that has reduced the S&P 500's P/E multiple by about 3 multiples below its average over the last half century (12x vs. 15x) despite a near 70% lower yield on the 10-year U.S. note (today) and given the low inflation readings and inflationary expectations. And with interest rates near historic lows, risk premiums are now at multi-decade highs. In fact, the earnings yield of stocks less the risk-free cost of capital places stocks cheaper today statistically than at the generational low in March 2009.

Hedges, low-volatility portfolio management strategies and owning precious metals have replaced the go-go investing of the 1990s, and any sense of generating alpha through individual stock selection (given increasingly correlated assets) has been lost or given up on as ETFs traded funds grow in popularity.

But, imagine if in the eurozone:

* With its back against the wall and taking a lesson out of the U.S. playbook, Europe's tame and timid policy response to the debt contagion becomes one of shock and awe.
* The ECB massively intervenes and stabilizes sovereign debt yields.
* The eurozone's fiscal integration goes smoothly as does the implementation of a massive banking industry recapitalization, as buyers around the world appear.
* The eurozone experiences only a modest economic dip.

And, imagine if in the U.S:

* A resurgence in the popularity of Newt Gingrich (and a coalescence of the Republican Party behind its candidate) causes President Obama to become defensive about the lack of progress made during his past four-year term. The president begins to move to the political center, but it is too late, as it becomes apparent that he will likely be a one-term president.
* The U.S. stock market rejoices with the expectation of a change in the administration and likely Republican control of both the House and Senate.
* Further expanding his lead in the polls, candidate Gingrich introduces a six-point economic plan, a business-like agenda of thoughtful, intelligent and radical pro-growth fiscal policies which includes:

1. engineering a more rapid recovery in the housing markets;
2. addressing our fiscal policies (including but not restricted to setting a specific limitation on the annual gains in spending to be less than the increase in the consumer price index and mean testing entitlements, freezing entitlement payouts and gradually increasing the social security retirement age to 70 years old);
3. denting the structural unemployment problem and mismatch of available jobs to talent (through a comprehensive plan to change and upgrade our educational system);
4. a broad plan for energy self-sufficiency designed to rapidly develop all of our energy resources;
5. repatriation of overseas corporate profits tied directly to job growth earmarks; and
6. an overhaul to the U.S. tax system (which includes a flat tax and repatriation of overseas earnings only if earmarked by a commitment to job growth/hirings).

* With the outlook for top-line growth improving, contained inflation and subdued wage growth serve to sustain profit margins as 2012 S&P earnings expectations rise.
* Consumer and business confidence rebound dramatically, paving the way for pent-up demand for durable products (e.g., housing and autos) and for capital spending to be unleashed.
* M&A activity explodes in an unprecedented manner.
* With a better GDP growth outlook and rising consumer and business confidence, U.S. bond yields rise rapidly, causing a massive reallocation trade out of bonds and into stocks. Underinvested retail investors reverse their disinterest in U.S. equities and begin to reinvest in domestic stock funds, and a de-risked hedge fund community panics and exacerbates a buying stampede.