We are not too surprised to see a weak market today despite more positive
economic data since our sense is that this week's sell off probably reversed a
little too quickly to have fully exhausted the build-up in negative sentiment.
Attached is a short term daily VXO chart which shows that at its peak this week
the VXO only just crossed into out notional "reversal zone" between 27 - 30.
The good news is that it would not take too much further damage to the market
to accomplish this feat. We would imagine that a retest or minor violation of
this week's low would be more than sufficient and likely be followed by a more
sustained move higher in the SPX and another sharp drop in implied
volatility. This remains our favored alternative and it would take a VXO
reading above 30 to suggest that a more serious corrective move is
underway.




(See attached file: D-SPX_INDEX.gif) - D-SPX_INDEX.gif

A very strong set of data from the Chicago PMI series with the overall index
rising to 54.2 (49 expected, 46.1 in September). What is more interesting is
the fact that New Orders (red line) rose strongly to 61.4 (46.3 in September)
and that although Production data (black dotted line) also moved stongly into
expansion mode at 63.9 (47.2 in September). Meanwhile the Inventory data fell
sharply to 32.2 (38.9). Thus it appears that production is still significantly
lagging current demand, which is itself accelerating.
.
Further support for the notion that industrialists are somewhat behind the
curve comes from the Capital Equipment data (green line on bottom chart) which
fell to its 2nd lowest ever reading (note data only starts in 1998) of 76.80.
As we commented yesterday on the GDP data the inventory numbers all suggest
that a significant boost in production is required across industries simply to
meet current levels of demand. - chicagopmioct09.gif

A very strong set of data from the Chicago PMI series with the overall index
rising to 54.2 (49 expected, 46.1 in September). What is more interesting is
the fact that New Orders (red line) rose strongly to 61.4 (46.3 in September)
and that although Production data (black dotted line) also moved stongly into
expansion mode at 63.9 (47.2 in September). Meanwhile the Inventory data fell
sharply to 32.2 (38.9). Thus it appears that production is still significantly
lagging current demand, which is itself accelerating.
.
Further support for the notion that industrialists are somewhat behind the
curve comes from the Capital Equipment data (green line on bottom chart) which
fell to its 2nd lowest ever reading (note data only starts in 1998) of 76.80.
As we commented yesterday on the GDP data the inventory numbers all suggest
that a significant boost in production is required across industries simply to
meet current levels of demand.

The weekly H.4.1 report into changes of the FRB Balance sheet shows our
assumption regarding an acceleration in Bank Reserves continues to be
correct. While the overall balance sheet shrank slightly (approximately $17
bln or 0.8%) Bank Reserves grew by over $50 bln (4.96%) to $1,085 Trln. As
the attached chart shows Bank Reserve balances are now more than 50% of the
size of the FRB Balance Sheet and will almost certainly grow larger as the
FRB completes its program of MBS purchases (incidentally as of this week
the FRB now holds more MBS than Treasury securities for the first time in
its history). As we have written before the FRB is likely to face a major
issue controlling the deployment of these reserves should the type of
robust recovery we anticipate take place in 2010.


(See attached file: D-FARBCRED_Index.gif) - D-FARBCRED_Index.gif

We have been spending a great deal of time thinking about the implications
of the Inventory Cycle in recent weeks since we believe that the drawdown
in inventories not only acts as a direct drag on GDP type measures of
activity but feeds through into a host of other data measuring production,
employment and general business activity. Since we believe in the
inherently cyclical nature of the global economy the current negative
influence from inventories can be anticipated to be a powerful force for
the good over the coming quarters.
.
With this in mind it is worth considering the inventory data contained in
this morning's US GDP report. This showed that inventories dropped by -$147
Bln. over the 3rd quarter, just over 1% of GDP. This is a slight
improvement from the Q2 drawdown of -$176 Bln. but, as the attached chart
shows, we are still in highly anomalous territory. Furthermore, it should be
noted that prior inventory drawdowns of greater than 0.75% have been
short-lived affairs and were followed by sizeable swings into positive
territory as inventories were hurriedly rebuilt. Our assumption in that
inventory data will become "V" shaped and recover sharply between Q4 2009 and
Q1 2010. The importance of this process for a host of other data series (most
clearly employment) cannot be overstated.



(See attached file: D-CBINTOT_Index.gif) - D-CBINTOT_Index.gif

There are finally signs that the distortion present in the Seasonally
Adjusted Continuing Claims data are being addressed (see Speculator Extra
9/29/09 for detailed discussion). This week's data shows the NSA Continuing
Claims (black line on chart) rising by 51.4K (1.05%) to 4968K which is
actually a fairly good number given that seasonal layoffs are typically
coming into play at this time of year. Meanwhile the Seasonally Adjusted
data (red line on chart) fell by 148K (2.5%) to 5797K, its lowest number
since March. This adjustment has had the effect of narrowing the gap
between the seasonally and non-seasonally adjusted data to -829K from last
weeks near record -1080K. As the attached seasonal chart of this adjustment
(multiple colored lines) shows a more normal reading for this time of year
would be something like 400K and so this process of correction still has
significantly further to go. By our estimation "Headline" Continuing Claims
should currently be reported as being around 5,400K at the current time and
we believe that now the Department of Labor has apparently started the
process of re-aligning these 2 data series further sharp falls in the
Headline data can be anticipated in the weeks ahead.



(See attached file: D-INJCSPNS_Index.gif) - D-INJCSPNS_Index.gif -
continuingclaimsoct30.gif

The NAHB housing data had suggested that the September New Home sales would
be mediocre and this is what transpired. Total Single Family sales fell to
402K (417K in August) well below consensus estimates of 440K. Although we
would have liked to see a better number this is a volatile data series (see
blue line on attached chart) and the drop in annualized data reflects a few
hundred less homes being purchased nationally over the course of the month.
Meanwhile, even with this drop in sales total inventory continued to fall
to 251K (261K in August) and is now at the lowest level since 1982. The
number of completed homes in inventory fell to 109K, the lowest level since
September 2005 and just above the 30 year average of 103K.

What this data highlights is the growing divergence between the new and
existing home market. While the new home market is operating at level last
seen at the depths of the 1990 and 1982 housing recessions, existing homes
are being sold at a rate comparable to late 2002 on the eve of the housing
boom. As a result new home sales are back down to only 8.22% of existing
home sales, just above the record relative low point reached in January
2009. We would imagine this reflects the fact that much of the renewed
existing activity has been concentrated in foreclosure properties which
sell at substantially lower prices than equivalent new homes. The breakdown
in this relationship obviously makes the new home market to be much less
significant as an indicator for the overall economy than it would be in
more normal times. We would, however, expect to see activity in these 2
markets draw closer together later on in a recovery but perhaps not before
recording a record divergence later this year.



(See attached file: W-NHSLNFS.gif)
(See attached file: W-NHSLTOT_Index.gif) - W-NHSLNFS.gif - W-NHSLTOT_Index.gif

As the SPX continues to probe lower one of the interesting aspects of this
sell-off is that it has been accompanied by a far smaller spike in implied
volatility (as measured by the VXO index) than other corrective moves that
have occurred since the springtime. Attached is a 5 month daily chart of
the SPX Index with the VXO index that demonstrates this. As can be seen
prior sell-offs climaxed with the VXO either in the low 30's (July) or high
20's (August, September and October). These very rapid spikes in volatility
showed the high degree of nervousness present in the market, and the very
act of rapidly hedging served to protect the market from a deeper decline.
As beneficial as this was for the overall market such behavior is costly for
the individuals concerned and this reflexive tendency seems to have been
largely wrung out of the market at the current time. Thus with the SPX now just
over 40 points below its recovery high (almost 4%) the VXO is currently 24.92,
still several points below a level that would signal a definitive low in the
SPX.




(See attached file: D-SPX_INDEX.gif) - D-SPX_INDEX.gif

The September Existing Home data came in much stronger than had been
anticipated with the overall data coming in at 5.57 Mln homes (5.35
expected and 5.09 in August) and the more important Single home data rising
9.40% to 4.89 Mln. homes. This takes activity just below the lower end of
activity witnessed in the 2002-7 housing boom. We note that the annual rate
of change is now comfortably positive at 7.7% and the 3 month growth rate
at 12.9% is higher than it has been since the mid 1990's. Clearly the
expiration of tax credits for first time buyers will have accelerated the
pace of improvement in September (and we may see some pull back in later
months) but we would not underestimate the effect of much lower interest
rates and home prices as more permanent drivers behind this pick-up in
demand.
.
As would be expected this pace of sales growth is having a meaningful
affect on inventory levels. These fell from 3.30 mln to 3.00 mln (9.09%) in
September and are now only 500K above their average level since data
started in 1982. The months of inventory for sale shows a similar pattern
falling to 7.6 months compared to an average level of 6.7%. Obviously this
inventory data ignores "shadow inventory" from foreclosed or vacant homes
that have not been placed on market - but even so the pace of repair
remains impressive and in any case the only way to fix this problem is to
sell more homes. Overall this is a very strong report and it remains our
belief that current consensus substantially overestimates the ultimate
losses incurred in residential real estate over the course of this cycle.



(See attached file: M-EHSLSL_Index.gif)
(See attached file: D-EHSLHAFS_Index.gif) - M-EHSLSL_Index.gif -
D-EHSLHAFS_Index.gif

More data emerged last night regarding the powerful overspill generated by
China's monetary largesse into its surrounding economies. Taiwanese
Industrial production rose by 4.91% in September and is now actually higher
than it was 1 year ago. Indeed the current level of production has only
been bettered during the boom period of 2007- early 2008. This is
interesting since most countries have registered improvements in production
but are still sharply lower on a YoY basis.
.
Taiwanese exports also show strong signs of recovery and are now only down
3% YoY (most other countries are still 15-25% below last year's activity).
Of course Chine and Honk Kong show strong growth (up 9.44% YoY) but exports
to Japan are also now positive ((up 3.56%) and exports to the US are
recovering strongly (grew 11.28% last month and now -9.39% YoY).
.
We would draw the following conclusions from this data: Chinese stimulus is
now of regional importance, Taiwan's data suggests a degree of demand
repair is visible internationally and, (perhaps most importantly), inventory
cycles tend to turn and stimulate a strong increase in production once the
repair in demand reaches a certain level that makes it incontrovertible.
There is of course no magic number that can be applied in advance but we do
believe that the unprecedented drawdown in global inventories is very close
to reaching its turning point and this has very important ramifications for
growth rates in 2010.


(See attached file: M-TWEOTTL_Index.gif)
(See attached file: M-TWINDPI_Index.gif) - M-TWEOTTL_Index.gif -
M-TWINDPI_Index.gif

This week's H.4.1 report on changes to the FRB's balance sheet shows the
same pattern that has been established since the middle of 2009. We will
freely admit to being a little obsessed with the Excess Reserve Balances
held at the FRB (green line on lower chart) but it is our belief that this
will become one of the key issues for capital markets at some point in
2010. This week's data shows these balances growing by a massive $52.4 bln
(5.34%) to a record $1,034 Trln. We have argued that the run-off of the
various "emergency" facilities means that the FRB's rapid accumulation of
MBS securities (pink line on lower chart) would start to cause a
re-acceleration in reserves and this is precisely what is occurring at
present. The FRB bought $63 bln MBS last week and now holds $766 Bln. Our
rough estimate is that by the time the FRB has purchased its stated target
of $1.25 Trillion MBS excess reserves could be somewhere in the $1.3-1.5
Trillion range. We believe that the FRB will find it substantially more
difficult to control the deployment of these reserves than its recent
comments on developing an "exit strategy" would lead you to believe.

(See attached file: W-FARBCRED_Index.gif) - W-FARBCRED_Index.gif

The Conference Board Leading Indicator Index (LEI) grew by a greater than
expected 0.98%. Interestingly the most significant areas of improvement out
of the 10 factors was Consumer Expectations, which were measured at 73.50,
the highest reading since September 2007. This data is supplied by the
University of Michigan and is somewhat stronger than the Universities own
Consumer Sentiment survey (although respondents are asked different questions).
We would also note that the Delivery Performance Diffusion Index which rose to
58 (slower deliveries are taken to be a leading indicator of a supply chain
re-building) and this sub-index could be a useful guide as to when
manufacturers are forced to start expanding their production.
.
Looking at the overall index itself we can see a strong recovery is being
indicated. Indeed using the Conference Board's suggested 6 month annualized
change (bottom chart in green) we can see that the rate of recovery
outpaces all moves since the 1982 recession ended. Note that the ECRI
Leading Indicator Index (which we prefer) long exceeded 1982 and all prior
cycles since that data series started in the late 1960s.



(See attached file: D-LEI_TOTL_Index.gif) - D-LEI_TOTL_Index.gif

US commercial paper outstanding continues to grow rapidly with the total
rising 3.01% this week to 1366.30. Interestingly the pace of growth for
non-financial CP was even faster at 4.71% while financial CP grew 4.26%.
The ability and willingness of industrial and financial firms to access the
CP market (we note for instance that DOW commented on their re-entrance to
this market on their earnings call this morning) is a crucial part of the
recovery story in the US and total CP has now grown by exactly 300 bln
since June. With debt service costs between 20-40 bp annually it is not
hard to understand the attraction of this market from an issuers
perspective.
.
Meanwhile the Asset Backed portion of the CP market has seen no such
rebound, which is hardly surprising given its role in the rapid development
and demise of the SIV industry. As the attached chart shows asset backed CP
has shrunk from a peak of 57%of total CP in late 2006 to 35.29% today. This
is a good example of a market learning to regulate itself in the aftermath
of an expensive debacle.


(See attached file: D-FCPOTOTS_Index.gif) - D-FCPOTOTS_Index.gif

Brazil's rapid economic recovery has been well established in recent months
but it may be that its pace has been underestimated. The September
unemployment data showed a sharp drop to 7.70% from 8.10%, somewhat better
than the 8.0% consensus. This takes the unemployment rate back to exactly
where it was in September 2008. As the attached chart demonstrates peak
unemployment this cycle never got close to the level seen earlier this
decade (when Argentina's sovereign default caused Brazilian interest rates
to soar) and in fact never broke the declining trend that has been in place
since the recovery took hold in 2003.


(See attached file: M-BZUETOTN_Index.gif) - M-BZUETOTN_Index.gif

The Japanese economy has very much been a laggard in this global recovery
but there are finally some signs of improvement in industrial and trade
data. The All Industrial Activity Index rose strongly by 0.9% in August and
the July reading was revised upwards to 0.8%. This takes the rolling 6
month ma up into comfortably positive territory although not by enough to
compensate for the dramatic decline that occurred at the end of 2008.
Driving the build-up in industrial activity is a marked recovery in export
activity. These are still well down on a YoY basis but as the 6 month ma
indicates the process of repair has commenced.



(See attached file: D-JNTIAIAM.gif)
(See attached file: D-JNTBEXP_Index.gif) - D-JNTIAIAM.gif - D-JNTBEXP_Index.gif

Today's advance has finally seen the VXO index force its way down below the
20 level for the first time since early June 2008 and the level of implied
volatility is now just under one fifth of the peak reading of 103.41
recorded on October 10th, 2008, almost exactly one year ago. As many
readers will be aware 20 is typically considered the level that starts to
signify a complacent marketplace and so today's reading may appear to be
unwelcome. This is in our opinion incorrect. The average reading for the
VXO since it started being calculated in 1986 is 21.36 and the index spent
long periods of time between 1992 - 1996 and 2003 - 2007 below 20 without
signalling an imminent correction. In the current situation we believe that
the market can absorb several weeks below 20 before signalling the sort of
bullish consensus that would make us want to divest. What we would say is
that today's rapid compression of implied volatility would, if sustained,
suggest that participants are finally admitting that much of their hedging
conducted during this recovery rally has been an expensive drag on returns.
This would certainly mean that we have entered a new chapter for this rally;
it's getting later but, we trust, too late.


(See attached file: D-VXO_INDEX.gif)

Another dreary set of data from the NAHB housing survey sees the overall index
drop slightly to 18 in October (19 in September) compared to an expected small
increase to 20. The underlying sub-indexes were all dissapointing with Traffic
falling back to 14 (17 in September) and Future Sales to 27 (29). This suggests
that the remaining housing data (Permits, Starts and Sales) for the new home
market will also remain tepid when they are released later this month and it
appears that the new home market has not yet experienced the same degree of
repair in activity levels as the existing home market. While this may be true
about the overall industry, we are probably at the point in the cycle that
performance starts to diverge significantly across the industry as a whole. It
is a substantially easier time to be operating a public company with access to
the corporate credit market than a private builder with no access to
development financing. We would therefore be paying much more attention to
earnings and guidance from company management than national data at the current
time, and in general the former has improved substantially since the start of
summer.

The NY Fed put out a press release this morning describing their
experimentation on the use of reverse repurchase agreements ("repos") as a tool
for controling Bank reserves later on in this recovery (see below/attached).
While we welcome this proactive behaviour we would point out that there is a
great deal of difference between devising a practical operation (ie making sure
that the reverse repo mechanism functions smoothly and is well understood by
officials at the FRB and their banking counterparties) and being able to deploy
this mechanism on the scale required.
.
As the attached chart of bank reserves shows, we are now talking about almost
$1 Trillion with the likelihood that another $600 bln. of MBS purchases by the
FRB will take us several hundred billion higher. The idea that a reverse repo
arrangement could be rolled out on the required scale WITHOUT substantially
rocking the very asset markets that the FRB has worked so hard to repair
strikes us a fanciful. We continue to believe that at some point in 2010 this
issue will move to center stage for all concerned.

(See attached file: D-FARBRBFB_Index.gif)

+------------------------------------------------------------------------------+

New York Fed Statement on Reverse Repo Agreements (Full Text)
2009-10-19 14:00:26.572 GMT


Oct. 19 (Bloomberg) -- The following is a reformatted
version of a statement released today by the Federal Reserve
Bank of New York.

Statement Regarding Reverse Repurchase Agreements

Numerous Federal Reserve communications have indicated that
reverse repurchase agreements are a tool that could be used to
support a reduction in monetary accommodation at the appropriate
time. Over the past year, the Federal Reserve Bank of New York
has been working internally and with market participants on
operational aspects of reverse repos to ensure that this tool
will be ready when and if the Federal Open Market Committee
decides they should be used. This work is a matter of prudent
advance planning by the Federal Reserve, and no inference should
be drawn about the timing of monetary policy tightening.

Repos and reverse repos have been in the Federal Reserve’s
toolkit for years, and the Federal Reserve has conducted both as
recently as December 2008. The focus of recent work has been to
expand our existing capability to conduct reverse repos with
Primary Dealers to include “triparty” settlement.1 This has
involved working with the triparty clearing banks and Primary
Dealers to implement the necessary changes and updates. We have
recently begun testing this capability with all involved parties
and systems, and it is likely that the Federal Reserve will
engage in additional tests in the future. No actual operations
have been conducted as part of these tests.

Recent Federal Reserve communications have also raised the
possibility of expanding the set of counterparties the Desk
might employ for conducting reverse repos beyond the Primary
Dealers. The Federal Reserve continues to study this issue, and
no decisions have been made regarding the types of firms that
may be included. We will engage market participants on this
subject as appropriate going forward.

1. The Fed has conducted triparty repos with the primary dealers
since 1999.

--Washington newsroom +1-202-624-1820. Editor: Brendan Murray

It is worth noting that the SHASHR Index managed to break out and close at
3188, comfortably above its 50 day ma. There remains some resistance at
the September 17th high (3219) but with monetary policy remaining highly
stimulative it looks increasingly likely that we will see a new recovery high
recorded by the end of the 4th quarter.
.
Meanwhile the effects of this policy can clearly be seen in the closely linked
Hong Kong economy where local unemployment appears to have peaked far earlier
than in most economies. September's data came in at 5.3%, a small drop from
August's 5.4% reading. Interestingly the peak unemployment recorded this cycle
is significantly lower than the 8.6% recorded in 2003 (when the SARS scare was
at its peak) and the 6.4% recorded in the aftermath of the 1997/8 Asian crisis.
Given Hong Kong's export driven economy and the relative severity of this
crisis at a global level compared to these 2 earlier episodes this is quite
interesting data. Those looking for early signs of overheating in the global
economy should clearly have China and it's sattelite economies at the top of
their list, with commodity driven developed economies (Australia, Canada,
Norway and New Zealand) a close second.


(See attached file: M-HKUERATE_Index.gif)
(See attached file: D-SHASHR_Index.gif) - M-HKUERATE_Index.gif -
D-SHASHR_Index.gif

Retail Sales Rebound Into Xmas as Shares Show Consumer Not Dead ...

As you will see from the attached we are finally starting to see less gloomy
news stories come out of the retail sector. We would expect to see more of the
same as the holiday season comes into focus and for this realization to start
to influence a turn in the inventory cycle back towards ramping up production.
<>

Yet another data-point that suggests that the current consensus of consumer
behavior is much too negative.

Of all the major US equity sectors we probably spend the least amount of
time considering Healthcare (and no doubt many of our clients thank us for
it). However in conducting some routine chart work we were struck at how
well this sector has performed during the latter stage of this recovery
rally. This performance is all the more notable since it comes against the
backdrop of an uncertain (and potentially adverse) legislative environment
and because it has had very limited attention paid to it.

Attached is a weekly chart of the NYSE/Arca Pharmaceutical Index (DRG) from
2000-2009) with this index relative to the SPX Index on the bottom chart.
As can be seen this index peaked in absolute terms right at the start of
the 2000-2 bull market (following a 500% advance over the prior 7 years)
and in relative terms in late 2001. The story since that time has been one
of steady disappointment and in recent years many investors have
significantly cut back their allocations to this industry or simply
bypassed it altogether. This aversion is clearly shown by the red line
which tracks the number of shares outstanding in the Pharmaceutical Holders
Trust ETF (PPH). Note this instrument was launched in February 2000 a few
months before this sector peaked. As ETF usage became more accepted its
shares outstanding rose rapidly until August 2005 when they peaked at 28mm
despite the poor absolute and relative performance of this sector
and instrument. Once disillusionment set in this sector became a steady
source of capital for the following 4 years with current shares outstanding
steady at 10mm, just over one third of their peak.

This indifference is interesting because this sector has had a fairly good
crisis, holding up much better than the overall market during the post LEH
collapse and (more importantly) keeping pace with the SPX since May. As a
result the sector has held on to the bulk of its relative gains since the
powerful rally commenced which is impressive for a defensive sector. Indeed
the DRG index actually broke out to new recovery highs before the SPX
earlier this week suggesting an element of leadership is starting to reside
within it. We are always intrigued by the non-discussed developments in the
markets we track and the performance of this sector certainly makes us want
to consider it in greater detail.


(See attached file: W-DRG_Index.gif) - W-DRG_Index.gif

The October Philadelphia Index remained in strong positive territory for
October coming is at 11.50 versus 12 consensus and September's reading of
14.10. This suggests a further improvement in business conditions has occurred
over the last month. Looking at the sub-indexes we see that New Orders rose to
6.20 (3.30 in September) Shipments stayed positive but fell to 3.30 (8.20),
Inventory collapsed to -31.80 (-18.10) and Employment improved to -6.80 (see
attached chart) from -14.30 but stayed in negative territory. As with the
earlier Empire State data we see a pattern of a growing pipeline with a very
delayed response from productive activity. The Philly data appears somewhat
more lagging than the Empire State data (particularly in terms of employment)
but the remaining regional reports and the more critical National ISM data that
will be released in 2 weeks should make for interesting reading. -
philyfedempoct2009.gif - phillyfedoct2009.gif

Big overshoot for the October report with headline data coming in at 34.57 vs.
Consensus 17.25 (18.88 September). New orders 30.82 (29.84 September) Shipments
35.08 (5.24) Inventory -18.8 (-25.00) Employees 10.39 (-8.33). Note this is the
first PMI report to show positive employment data since the recovery commenced.
While we would be cautious of drawing too much from a single regional survey
(particularly with the Philly Fed due out at 10.00 this morning) this data
reflects a manufacturing cycle that has moved from simply reflecting higher New
Orders to these causing a steep rise in Shipped goods, with Inventory still
being used as a source of product. This clearly implies a growing need to boost
production, and the shift of the Employee sub Index into positive territory is
an intriguing development that should be watched for in other regional surveys
this month. - sg2009101530628.gif

The August Manufacturing Inventory Data continued to show a sharper pace of
drawdown that had been anticipated, even though a weak number had been
clearly signalled by the August ISM data 6 weeks ago. Inventory levels fell
-1.5% (consensus -1.0%) and were revised slightly lower for July (-1.1%
from -1.0%). This takes the 12 month RoC (green line) down to -12.98% and
keeps the 3 month RoC at -3.95%, an annualized pace of almost -16%. Note
that the September ISM data still indicated an inventory drawdown, although
it suggested that the pace may finally be moderating. We continue to see a
re-build of diminished inventory as an important driver of the later stage
of this recovery.


(See attached file: M-MTIB_Index.gif) - M-MTIB_Index.gif

The September Monetary and Trade statistics out of China make for their
usual fascinating reading. Monetary policy continues to be "moderately
loose" with M2 growth accelerating to 29.3% on a YoY basis, somewhat ahead
of expectations. This takes Chinese M2 more than $218 bln (about 3%) above
US M2. New loan issuance also beat expectations rising from 410.4 bln CNY
in August to 516.7 bln CNY (about $75 Bln) versus an estimate of 440 bln
CNY. What makes this data more interesting are the clear indications from
the trade data that both the Chinese domestic and export driven portions of
the economy are now recovering strongly. As the attached chart shows
Imports are now only down 3.79% on a 12 month RoC basis and in nominal
terms have more than doubled since their low point at the start of 2009.
Exports somewhat lag this performance and are still down 15% since last
September but the shape of the chart is a familiar "V" and this month's
data comfortably outstripped expectations. This suggests that the global
inventory cycle may finally be turning after a year of unprecedented
drawdown.
.
Our take on this data is that the local Chinese economy may well be growing
somewhat quicker than consensus estimates and that the liquidity fears of
late summer were clearly premature. It would therefore come as little
surprise to see the local equity market retest its 2009 highs later this
quarter as the authorities seem to be content to allow the liquidity spigot
to remain on full flow. It also implies that Chinese demand for raw
material, goods and services will remain very robust. This episode may well
(and in fact probably will) end badly but not in a timeframe that is
relevant for current investment allocations.



(See attached file: D-CNMSM2_Index.gif)
(See attached file: D-CNFREXP$_Index.gif) - D-CNMSM2_Index.gif -
D-CNFREXP_Index.gif

We have reached the point in the cycle at which the ratings agencies
assumptions are significantly more negative than what will probably occur. Note
Fitch are predicting a further fall of 10% nationally for residential house
prices from their current level over the coming 12 months. We would be very
surprised if this were to occur.

We have already commented on US bond issuance more than compensating for
declining C&I lending. This article makes a similar point about European
activity.

With the 4th quarter just under 2 weeks old our early take on changes to
investment flows is that they have become distinctly more "reflation"
oriented, with the commodity sectors and commodity related emerging markets
thus far being the greatest beneficiaries. Regular readers will know that
our current preference for allocations has shifted more to the users of
commodities (both in terms of the industrial sector and more developed
economies) but this preference is based on our own perception of relative
value and risk/reward rather than a strict prediction of where short term
performance will be maximized. Looking at the energy heavy S&P GSCI index
we can see that it has just broken out of a 4 month consolidation and
should crude oil follow by rallying above $75 (still strong resistance on
the daily chart) this index could easily move significantly higher. Above
the current level no obvious resistance comes in before 530, which is a
38.2% retracement of the 2008 collapse and our sense is that this target is
comfortably achievable during this quarter.




(See attached file: D-SPGSCI_Index.gif) - D-SPGSCI_Index.gif

While Chairman Bernanke and a number of FRB governors have started to talk
about a potential "exit strategy" it is important to realize that the FRB
is still very much in "entry mode". Regular readers will know that we have
been arguing that although the FRB's balance sheet has remained unchanged
since early 2009 its effect on US domestic liquidity has not. Perhaps the
best way to demonstrate this is to show the extent to which Reserve
Balances continue to grow even though the overall FRB balance sheet does
not. Attached is a chart showing total FRB Balance Sheet (black) with Bank
Reserve Balances held at the FRB (red), and the percentage of the latter of
the total balance sheet in green (lower chart). As can be seen these
reached a new record high of 45.24% this week, up from 40.57% at the start
of June and 34% at the start of March (when the MBS purchases commenced in
earnest). With several hundred billion left in the MBS and Treasury
facilities and commercial banks still following restrictive lending
policies this pool of currently passive (but potentially active) liquidity
could easily reach over 50% of the FRB's balance sheet in the weeks ahead.
We predict that the management of these reserves later in the recovery will
prove far more difficult than has been suggested by a number of FRB
governors.


(See attached file: D-FARBCRED_Index.gif) - D-FARBCRED_Index.gif

A well argued piece from this week's
magazine:

http://www.newyorker.com/talk/financial/2009/10/12/091012ta_talk_surowiecki

Although it is well understood that interest rates are extremely low it is
worth considering the effect that ultra low CP rates are having on
corporate cash flow. Attached is a chart showing outstanding US commercial
paper (red line, RHS) together with the cost of financing this paper using
the 30 day Top discount Rate (black line RHS). We understand that this is a
simplification, and that a portion of the CP market will pay higher rates
but since all rates have recently re-converged to their normal ranges
(roughly 20 bp) we feel that this simplification is justified. At the
current going rate of 20bp the cost of financing total CP of $1,300 bln runs at
a paltry $2.6 bln. This represents a saving of over $20 bln since early 2009
when roughly the same amount of paper was outstanding and the cost has fallen by
over $115 bln from its peak (a drop of over 98%) even though the total
amount outstanding has fallen by only 41%. Furthermore the significant new
issuance since July has come at essentially no cost to corporate cash flow.
You could not ask for a more stark example of monetary stimulus is action.


(See attached file: W-.CPCOST2_Index.gif) - W-.CPCOST2_Index.gif

We are finally seeing signs of a strong recovery in the issuance of new
commercial paper. Commercial Paper outstanding grew by $67.6 bln (5.5%)
last week to reach $1299.4 bln, its highest level since May 2009. What makes
this turnaround more impressive is the fact that the FRB's CPFF facility
has been allowed to rundown from its peak of $350 bln in January to only
$42 bln at the end of September. To gauge the true strength of recovery it
makes sense to look at the total of CP outstanding less the portion owned
by the FRB in the CPFF, and this is shown on the attached chart by the blue
line. This measure has risen from a low of $971 bln on July 31st to its
current level of $1,257, an increase of 29% in less than 3 months. It is
therefore clear that both demand for and supply of CP have both recovered
very powerfully in recent weeks while spreads to the FDTR have returned to
their pre-crisis levels.

-
As we noted last week in our chart showing new corporate debt issuance the
focus on the shrinkage of banks C&I lending really presents a misleading
picture of the ability of corporate sector to access funds for operations.
We are firm believers that funding leads activity and both the CP and
corporate debt market are suggestive of a significant ramp up in activity
in the months ahead.


(See attached file: D-FCPOTOTS_Index.gif) - D-FCPOTOTS_Index.gif

The August Wholesale Inventory data shows that the unprecedented drawdown
in wholesale inventories continued at a higher than anticipated pace
through the summer. August came in at -1.3% (versus 1.00% consensus) and
July's number was revised down to -1.6% (from -1.4%). Every category was
negative with the exception of petroleum and alcohol. Particularly strong
falls were registered in Automotive (-2.31%), Metals (-4.32%), Lumber
(-1.54%) and Hardware (-1.53%). From our perspective the extraordinary
reduction in inventory levels is creating very significant "potential"
production for the months ahead. Interestingly the September PMI data
suggested that inventories continued to shrink in most manufacturing
industries during that month, which really sets up Q4 2009 and Q1 2010 as
the most likely time periods that the acceleration in production will
become apparent.


(See attached file: M-MWINTOT_Index.gif) - M-MWINTOT_Index.gif

We are definitely seeing a more optimistic tone coming out of retail management
in recent weeks - although it still remains more downbeat than we think will be
warranted once the holiday season has run its course.

Cash Binge to End as Central Banks Jive to Exit: Mark Gilbert Oct. ...

A good commentary that highlights an issue that we are starting to put at the
forefront of our longer term concerns. At a time that most portfolios are being
carefully monitored and hedged from the perspective of credit risk their
interest rate sensitivity is not fully appreciated. We are therefore at the
polar opposite of where credit markets were in late 2006, when interest rate
sensitivity was considered vastly more important than credit risk. Although we
do not think this issue is of immediate concern we would expect it to be the
key issue for managing fixed income by the middle of 2010.
<>

New all time USD high for gold this morning - note this move is confirmed by
breaskouts in a number of non-USD currencies - shown on this chart are Gold in
USD (top black), Gold rebased by the DXY index (red line middle) and Gold in
EUR (blue). Should current gains hold we could be witnessing the start of
aother leg higher. - sg2009100650639.gif

We have been arguing for several weeks that the FRB's current policy of
purchasing CBS and (to a lesser extent) Treasury securities has become
significantly more expansionary for the US monetary system in recent weeks.
This is because these purchases can no longer be as easily offset by the
run-off in the now diminished "emergency" facilities created last fall. The
best indication that our assertion is correct is the fact that bank reserves at
the FRB are once more growing quickly reaching $924 Bln in the latest H.4.1
report. This build up of Cash is once more radically transforming the make up
of the commercial bank balance sheets as is shown by the attached chart with
looks at the holdings of Cash and Treasury Securities as a percentage of total
commercial bank balance sheets. These are now 27.44% and seem likely to force
their way above 30% in the coming weeks. Note that although we have seen higher
percentages in the past the majority of these holdings have traditionally bee
in (interest bearing) Treasury holdings rather than cash. This time Cash
represents about 40% of this total. While these funds are an inert force at
present it is our belief that the FRB will in the end struggle to control their
deployment once a recovery finally takes hold. - sg2009100437680.gif

The Monthly Non-Farm Payroll number is probably our least favorite of the major
data series but we do recognize that it is widely followed and correspondingly
influential. This on the other hand does not make it any more reliable on a
month by month basis, at the attached long term chart demonstrates. Having said
that September's data was worse than expected and coming at the end of a
generally difficult week we are not surprised to see a poor reception from the
equity and commodity markets.

This is not the same as calling it conclusive evidence of a failed recovery and
it would be typical to see today's weak number compensated for later on.
nevertheless in the meantime the bulls' resolve looks likely to be fully tested
in the coming session. - sg2009100233991.gif

The overall September ISM report came in at 52.6 vs. 54.0 consensus and
52.9 last month. While this initial reaction to the headline miss has been
unfavorable the overall report seems to be in line with a manufacturing
recovery still in its early stages, and this view is supported by the
accompanying text issued by the ISM as well as comments made on the
conference call that has just been completed.

Looking at the data in detail a reading of 52.6 keeps manufacturing on an
upward path and (according to the ISM's estimation) is consistent with real
GDP growing at 3.6% per annum. As the attached long term chart demonstrates
there is nothing alarming about a 1 month pause at the current level. The
new order sub-index dropped from 64.9 to 60.8 (red line on chart), but this
keeps orders growing strongly as does the production sub index (not shown)
which fell to 55.7 from 61.9. The greatest area of improvement was in the
inventory data (blue line, lower chart) which rose from 34.4 to 42.5. This
still suggests that inventories are being drawn down but the pace of
decline has slowed markedly. Again this is consistent with the way that
manufacturing typically works its way through a cyclical recovery. We
therefore see no cause for concern in the current report.


(See attached file: D-NAPMPMI_Index.gif) - D-NAPMPMI_Index.gif

Attached are 2 charts showing the total amount of US corporate debt issued
through Sept 30th for the last 10 years together with a second chart for High
Yield only. The 2009 data appears in white on both charts. As can be seen total
corporate issuance broke through the $1 Trillion level for the first time ever,
reaching $1,009 bln as of September 30th. The prior record level of issuance
for 3 quarters was $775 bln in 2007, and for an entire year $929 bln (also
2007). The average issuance over the last 5 years is almost exactly $600
bln.
Perhaps even more surprisingly High Yield issuance was also able to
reach a record as of September 30th. Issuance reached $143 Bln, just beating
the 2007 mark of $138 (recorded at the height of the LBO boom) and almost
double the 2008 level of $72.7
bln.
It is important to
note that these figures dwarf the substantial reduction in C&I lending by
commercial banks during 2009. The latter has dropped by $203 bln through
September 14th. This is a large number but it is only half the difference
between the average level of corporate debt issuance and the current year's
pace. It is therefore likely that the drop in C&I lending is partly demand
driven (with corporations preferring the more stable funds offered by a bond
issuance to a bank line) and in any case significantly less of a drag on
corporate activity than many suppose. - hyissuedytd93009.gif -
totalcorpissuedytd93009.gif

The "headline" seasonally adjusted continuing claims report improved to
6090K (down from 6160K) but although this drop was somewhat larger than
expected it once more obscured a far larger drop in the "raw" non seasonally
adjusted data which fell from 5223.9K down to 5054.6K. This had the effect of
widening the gap between these 2 data series to -1035K, a record disparity.
Based on the prior 9 years this gap would on average be 500.6K. We
therefore remain on course for a sizeable drop in the headline data later
on this fall.


(See attached file: sg2009100131269.gif)

(See attached file: D-INJCSPNS_Index.gif) - sg2009100131269.gif -
D-INJCSPNS_Index.gif