The January housing data has very poor overall and the Existing Sales Data
continued this trend by coming in at 5.05mm units compared to a consensus
estimate of 5.50mm and December's number of 5.44mm. Obviously this is weak
data and it suggests that the Existing Home market is still suffering from
a post-stimulus hangover (the stimulus is still in place but clearly the bulk
of its effects are in the rear-view mirror) rather in the same way that "Cash
for Clunkers" forced auto sales beyond a sustainable level and then saw them
fall back sharply. Importantly after a couple of months auto sales then
recovered and continue to do so, and our expectation is that something similar
will occur with existing home sales. In the meantime we would use a reasonable
moving average (the attached chart uses 6 months) to judge the sustainable
demand for existing homes and for Single Family Homes this is currently 4.93mm,
500K more than January's data and 767K less than the November 2009 peak.
This is roughly equivalent to the level of demand in 2002-3, in other words
a very healthy but not booming housing market (at least as far as volume
is concerned). Inventory levels were also stable over the last month with
total inventory falling from 3.283mm units to 3.265mm unties and Sing
Family inventory increasing slightly to 2.80mm from 2.76mm.
.
Of course what really matters is how this data performs in the coming
months. The housing data is very seasonally weighted with January sales
typically being only 50-60% of those seen in the peak closing season of May
- August. A poor January therefore is far less important than similar data
later in the year. In the meantime we would expect to see yet more
Congressional pressure to "fix the problem" when simply showing a little
patience is almost certainly all that is required.


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

Another good set of numbers from the Chicago PMI which offers some
encouragement for Monday's more important National ISM report. The overall
index increased moderately to 62.6%, indicating the greatest monthly
improvement since April 2005 (right on the even of the mythical 2005 "soft
patch"). The sub-indexes continue to show the familiar pattern of stronger New
Orders running ahead of increased Production. The New Order index moderated to
62.2 (from 66.4) but this is still a very positive monthly change. Production
flattened to 65.2 (from 66.6), again indicating an acceleration in
manufacturing, but this was insufficient to keep Inventories from falling with
the index hitting 42.4 (from 48.7) and suggesting that drawdown is still a real
factor. This is obviously very encouraging in terms of future production
requirements. Employment stayed positive at 53.0 (from 59.8) but only
moderately so. This is in line with the February Initial Claims data that
suggests that industrialists have not yet started to hire significant numbers
of workers. Nevertheless, if new orders continue to push their way forwards it
is only a matter of time before this occurs and the longer industrialists wait
the faster the pace of re-hiring is likely to be. - chicagopmifeb10.gif

We continue to see significantly better Industrial data coming out of
Japan. This is important since for all the obsession regarding China, Japan
is still a slightly larger economy and it seems that the world's investors
and commentators have simply assumed that Japan is no longer a significant
economic influence in the global economy. As ever, we would point out that
it is things that people are NOT talking about that have the greatest
potential to surprise asset markets (in this case pleasantly) and therefore
we are continuing to monitor Japanese data quite closely.
.
Last night saw two important releases, firstly Housing Starts which came in
at 862K vs, a consensus of 830K. As the attached chart shows Japanese
Housing starts have been growing rapidly after collapsing in 2008 and early
2009. Although the 12 month RoC is still negative at -9.82% the 3 month RoC
shows an annualized growth of over 50% and starts should be able to easily
get back to the 1 - 1.25mm unit level in the coming months. It is worth
noting that even at these historically depressed level Japan's housing
starts still dwarf those in the US (see second chart) despite a far smaller
population (this has only happened during the early 1980's US housing
collapse and during the great Japanese property bubble of the late 1980's -
early 1990's) and this is an accurate gauge of the remarkable lack of US
residential construction currently taking place, something that we do not
expect to continue for much longer.
.
Other encouraging data was supplied by Industrial Production which rose by
2.5% in January compared to consensus estimates of 1.0%. This takes the 12
month RoC up to 19.8% while the 3 month RoC is growing at an annualized
25%. Production is still 16.5% below the February 2008 peak but at current
growth rates this could be fully repaired by late summer. As we state above
Japan merits rather more attention than it is currently receiving.


(See attached file: M-JNHSAN_Index.gif)
(See attached file: D-NHSPSTOT_Index.gif)
(See attached file: M-JNIP_Index.gif) - M-JNHSAN_Index.gif -
D-NHSPSTOT_Index.gif - M-JNIP_Index.gif

There is no doubt that February has seen moderately disappointing data from
both Continuing and Initial Claims but the real question is the
significance of this data. It should be recognized from the attached chart
that Initial Claims in particular are quite "noisy" over the short term,
particularly during winter time when seasonal factors are at their
greatest. We would hesitate to conclude that the pace of firing has started
to increase once more unless claims were to stabilize around 500K for
several more weeks (we do not expect this to occur). What the data probably
does reveal is that we have not yet reached the point at which
Industrialists are prepared to re-hire large amounts of workers. This is
precisely why we have argued that New Order metrics really are the key to
understanding the progress of this cycle since they represent a gauge of
pressure that is building on industrialists to re-hire.
.
Of course we would not expect the equity market to have the patience to
wait this out. Today's data will put pressure on a market that in any case
probably still needs to probe support a little longer before this
corrective phase is completed. For the SPX below 1093 support can be found
at 1076 and 1056 and we will probably test at least the middle of these
levels in the sessions ahead.

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

As we had expected, sterling continues to be conspicuous by its weakness
with the GBP falling to a new 9 month low this morning of 1.5273.
Interestingly this is an exact 50% retracement of the entire 2009 recovery
rally from 1.3503 on January 23rd to 1.7043 on August 5th. Although this
level can be expected to offer some support negative momentum has built to
the point that it will probably be overwhelmed. This would point the GBP
down to the big round number at 1.50 or should that fail the 61.8%
retracement level at 1.4855. It is worth noting that unlike last week the
Gilt market is fairly well bid at present, with the 10 year yield falling
back to 4.04% after peaking last week at 4.30%. This suggests that the
current pressure on sterling is probably coming more from speculative
currency flows than investment capital fleeing its government debt market,
which is probably the lesser of two evils. Of course this could change if
sterling were to suffer more abrupt losses and this situation still needs
to be monitored closely in the days ahead.


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

Following a poor NAHB Homebuilder Sentiment report last week we had expected
weak New Home Sales data. This was delivered this morning with a sharp drop in
sales from 348K in December to 309K in January, missing consensus estimates of
354K by a wide margin. This level of activity is notable for marking not
just a new cycle low point but also a new record low for sales in the 45
year history of this data series. However, as dramatic as this may seem, it is
important to realize that we are dealing with seasonally adjusted annualized
data, and January is typically one of the quietest months on record. Total non
seasonally adjusted sales were 22K for the month and so it can be seen that
a few hundred sales in either direction has a dramatic effect on sales
growth or shrinkage at the current level of activity and seasonality. This
"data-shock" therefore needs to be treated with some caution.
.
Having said that this it is still poor data and it increases the pressure
on the upcoming Spring selling season to show a meaningful up-tick in
demand. It does not (in our view) decrease the likelihood of this
occurring. What is more encouraging is that today's data clashes with the
reports coming from a number of public builders (see for instance TOL this
morning) which are suggesting that although activity remains subdued
conditions have improved significantly since last winter. Perhaps the
answer to this anomaly is the fact that the larger public homebuilders have
been able to weather the storm more effectively than smaller private
builders and are therefore able to respond to the little demand that is
currently out there. In any case the next 3 months of data are likely to
hold the key to this industry for 2010.


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

In following the global Inventory Cycle no metric is more important than
New Orders. Therefore this morning's release of December Eurozone
Manufacturing New Orders is an encouraging report since the headline index
comfortably beat consensus of -1.0% by actually rising 0.8%. This very much
keeps the steady recovery from last winter's nadir intact and at 93.5 the
index is almost 13% higher than it was last March. Of course it is also
still 27% below its peak value of 127.4 recorded in June 2007 but this
shortfall should really be seen as an encouraging sign as to how much future
improvement in this metric can be anticipated in the month's ahead.
.
Looking at the data in more detail there were significant geographical
dispersions (France saw the greatest surge amongst large countries up
17.13% for the month while Germany posted a moderately negative -1.8%) and
also across Manufacturing sectors, with the Capital Goods area producing
the greatest gains up 7% for the month. As ever we note these points
without making too much of them across a single month. The bigger picture
is more significant, Eurozone Manufacturing New Orders appear to have grown
more than was anticipated in December, a fact that is largely bourne out by
corporate announcements made during Q1 2010. This (and other measures of
New Orders) remains one of the key metrics to watch at the current time since
if they continue to indicate growing demand they are increasingly likely to
force Industrial Production to move to a significantly higher plane of activity.


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

The Conference Board February Consumer Confidence Index showed a sizeable
decline from 56.5 last month to 46. This compares with a consensus reading of
55. Unsurprisingly the immediate response by the equity market has been to take
this data badly (and we can only wait to see what some of the more bearish
commentators will make of it) but at this point in the cycle Consumer Sentiment
indexes has virtually no predictive capability and are merely reflections of
the news flow and market action that were prevalent at the time of the poll.
.
Given that most of February has been dominated by poor equity markets, mediocre
employment data, rampant bipartisanship and concerns about sovereign credit, a
down-tick in the index really comes as no surprise but we should resist the
urge to extrapolate from this reading and interpret it as having relevance for
consumer activity in the weeks ahead.
.
Looking at the data more closely we can see that the real down-shift in
sentiment has taken place in Consumer's view of Future Conditions (blue line on
first chart). Of course Consumers are particularly bad forecasters (though no
worse than many Central Banks) and this downshift therefore does not concern
us. The real key to this data remains the employment data. The fact that
payrolls have recovered to the point that they are stable has had very little
effect on Consumer Sentiment (see chart 2) with both the Jobs Plentiful and
Jobs Hard to Get indexes still indicating near record levels of concern by
consumers. Historically such readings have been followed by significant
employment growth (and then much better sentiment readings). We expect the
story to play out the same way this time but until that point is reached weak
sentiment readings will be a definite (short term) risk for market performance.
In line with our current view the post-data sell off (which may extend down to
support at 1070 over the next couple of sessions) represents a buying
opportunity for our favored sectors. - consumerconffeb10.gif -
confidenceemploymefeb10.gif

We continue to monitor the rapid build-up of liquid assets on Commercial
Bank balance sheets and note that the percent of Cash and Treasuries has
now reached a new 16 year high at 31.46% and is close to breaching the
record 32.14% recorded in September 1993. Of course this cycle is somewhat
different since almost half of these holdings are Cash ($1375.4 Bln as of
February 10th) whereas in prior cycles the vast majority were Treasury
holdings. To place the size of the Cash holdings in perspective we have
included a chart that compares them to US M2. At the current level they
represent 16.21% of M2, comfortably the largest percentage on record.
.
From our perspective these charts continues to highlight the very serious
difficulties the FRB is likely to encounter when it tries to prevent the
Cash holdings being re-deployed either into risk assets or expanded lending
activity. We also note that the potential cost of the proposed IOER is also
increasing at the same rate as the build-up of Cash in the form of Excess
Reserves. With several weeks of FRB MBS purchases ahead of us the final
level of these Reserves seems likely to be even higher than their current
astronomical level further compounding these difficulties.


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


(See attached file: D-ALCBCASH_Index.gif) - M-.BANKCASH_Index.gif -
D-ALCBCASH_Index.gif

The initial market reaction to the FRB's move last night is perhaps more
visible in currency rather than interest rate markets but given that the USD is
already almost 3 months into its recovery this should perhaps be of little
surprise. Of all the major currencies the most significant move has taken
place against the GBP. Writing a few weeks ago, we highlighted the GBP as a
potential victim of "sovereign flight" and while we would not yet
categorize this sell off as representing something of that magnitude the
technical damage to both the local Gilt market and currency is starting to
mount. Since we wrote the GBP has broken its 200 day ma and left this
indicator far behind, its 50 and 200 day ma's have completed a "dead
cross" and diverged considerably while today's sell off has taken the GBP
down below support established in early February. A move down to test round
number support at $1.50 seems to be a reasonable target over the remainder
of the quarter. Meanwhile the local Gilt market shows similar duress with the
benchmark 10 year note breaking out through the key 4.60% level this morning to
4.16%. This is the highest yield seen since November 2008 and does represent
something of a sea-change in the willingness of participants to hold longer
term UK sovereign credit. Both the GBP and Gilt market are worth watching
quite closely in the days ahead.



(See attached file: D-GUKG10_Index.gif)
(See attached file: D-GBP_Curncy.gif) - D-GUKG10_Index.gif - D-GBP_Curncy.gif

Up until August 10th 2007 the vast majority of market participants had
never heard of the "Discount Rate" and if they had they never thought it to
be a policy tool of interest. That all changed on that Friday morning when
the FRB suddenly announced that the Discount Rate was to be lowered by 50
bp to 5.75% but that the FDTR would be kept at 5.25%. Although this attempt
to mollify the markets was a completely inadequate measure (we described it
at the time as like trying to feed a hungry lion a veggie-burger) it also
marked the turning point in the FRB's understanding of the interest rate
cycle from one of stasis or tightening (it should be remembered that
Richmond Fed Governor Lackey had voted for an FDTR hike in the summer) to
one of loosening and then emergency measures that were utterly unforeseen
in the summer of 2007.
.
Although we do not expect the coming interest tightening cycle to be
anything like as historic it is still extremely significant that it has
undoubtedly begun. Once more the move to fiddle with the Discount Rate is
largely symbolic. As the Attached chart shows total Discount Rate
borrowings are approximately $87 Bln at present meaning that a 25 bp hike
will cost the borrowers about $217 Mln per annum. There is also currently
no sense within the FRB that the FDTR will need to be raised soon or that
the new IOER (Interest On Excess Reserves) will make the transition from
acronym to active program. And yet this is very reminiscent of August 2007
when the FRB totally underestimate the strength of cyclical forces that
were gathering rapidly. In fact it was arguably the capital markets that
forced the FRB to belatedly recognize the seriousness of the issues it was
facing. This time around the FRB seems to be blind to the implications of
the fact that economic data keeps on beating expectations even as the
latter are consistently ratcheted forwards. The data has now reached the
point that any further improvement (particularly in employment metrics)
would make "recovery denial" uncomfortable. We would expect to see
consensus within the FRB over monetary start to fracture under such
circumstances and for the market to increasingly take its lead from the
more hawkish members of the committee. As we have stated before at a time
that global portfolios are positioned to deal with the problems and
opportunities of a Credit Cycle we appear to have commenced an Interest
Rate Cycle, again this is the precise opposite of the state of affairs on
the morning of August 10th 2007, and once more a move in the Discount Rate
is a clarion call to transition portfolios before market disruption occurs.


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

Up until August 10th 2007 the vast majority of market participants had
never heard of the "Discount Rate" and if they had heard of it they never
thought it to be a policy tool of interest. That all changed on that Friday
morning when the FRB suddenly announced that the Discount Rate was to be
lowered by 50 bp to 5.75% but that the FDTR would be kept at 5.25%. Although
this attempt to mollify the markets was a completely inadequate measure (we
described it at the time as like trying to feed a hungry lion a veggie-burger)
it also marked the turning point in the FRB's understanding of the interest rate
cycle from one of stasis or tightening (it should be remembered that
Richmond Fed Governor Lackey had voted for an FDTR hike in the summer) to
one requiring loosening and then emergency measures that were utterly unforeseen
in the summer of 2007.
.
Although we do not expect the coming interest tightening cycle to be
anything like as historic it is still extremely significant that it has
undoubtedly begun. Once more the move to fiddle with the Discount Rate is
largely symbolic. As the Attached chart shows total Discount Rate
borrowings are approximately $87 Bln at present meaning that a 25 bp hike
will cost the borrowers about $217 Bln per annum. There is also currently
no sense within the FRB that the FDTR will need to be raised soon or that
the new IOER (Interest On Excess Reserves) will make the transition from
acronym to active program. And yet this is very reminiscent of August 2007
when the FRB totally underestimated the strength of cyclical forces that
were gathering rapidly. In fact it was arguably the capital markets that
forced the FRB to belatedly recognize the seriousness of the issues it was
facing. This time around the FRB seems to be blind to the implications of
the fact that economic data keeps on beating expectations even as the
latter are consistently ratcheted forwards. The data has now reached the
point that any further improvement (particularly in employment metrics)
would make "recovery denial" uncomfortable. We would expect to see
consensus within the FRB over monetary start to fracture under such
circumstances and for the market to increasingly take its lead from the
more hawkish members of the committee. As we have stated before, at a time
that global portfolios are positioned to deal with the problems and
opportunities of a Credit Cycle we appear to have commenced an Interest
Rate Cycle, again this is the precise opposite of the state of affairs on
the morning of August 10th 2007, and once more a move in the Discount Rate
is a clarion call to transition portfolios before market disruption occurs.


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

We are currently paying close attention to the 30 year bond yield which is
toying with key resistance at the 4.75% level. The highest closing yield
since the 2008 collapse was 4.76% on June 10th 2009 and over the last 2
years 4.79% on June 16th 2008 meaning that this is potentially a crucial
level to be aware of. Should the long bond go on to establish a higher
range this would be one of the first signs of "bond fatigue" in the face of
a continuous stream of positive economic data. As we have written before,
the greatest danger to fixed income this year is not credit (which should
continue to improve) but a significantly higher base yield in Treasuries
pushing all nominal yields higher even if credit spreads continue to stay
tight.
.
The 30 year bond seems likeliest to be a leading indicator of this change
(the short end of the curve is too tied to FRB expectations to move ahead
of a general change in sentiment regarding the recovery - see Speculator
Extra "Zone of Indifference" for a longer discussion) but it is highly
likely to drag the benchmark 10 year note yield higher in its wake. As the
attached chart shows the spread between these 2 yields is at the wide end
of its historic range at 96 bp and we doubt whether it would widen more
than another 10-15 bp at most. Should the 30 year bond yield breakout we
would expect to see the 10 year note yield move up to test key resistance
at the 4.00% level.


(See attached file: D-USGG30_Index.gif) - D-USGG30_Index.gif

The February Philly Fed report underlines the growing strength in the US
Industrial economy. The overall index (black) came in slightly stronger than
expect at 17.60 but the really encouraging data was contained in New Orders
(red) which soared to a new recovery high of 22.70. The fact that New Orders
may be accelerating is a very exciting prospect since it means that Production
will have to be significantly increased even to keep current depleted Inventory
levels steady. With regards to the Inventory index (blue) this moved into
positive territory at 3.20 but this hardly represents evidence of a significant
re-build. Employment (green) continues to show signs of gradual improvement
with the index moving up to 7.40. But as we write above if New Orders start to
move up to a new higher level this will start to put pressure on even the most
stubborn of Industrialists to make a rapid adjustment to activity levels. -
phillyfedfeb10.gif

The January PPI data continues to suggest that Producer Prices are
recovering somewhat faster than most people anticipated. PPI grew by 1.4%
in January, taking the index up to 179.8, approximately 2% below its all
time high of 183.4 recorded in July 2008. The 12 month RoC is now 5.02%
(note this is somewhat higher than the official YoY number of 4.6%) while
the 3 month RoC of 3.12% would annualize at over 12%. Although PPI is still
only recovering ground lost during the 2008 collapse the power of this
trend would seem likely to push the index up into record territory by the
end of Q2. This increase in PPI is important since PPI typically leads CPI
by 12-18 months. The fact that this trend has been in place for over 6
months suggests that we could be seeing some signs of CPI accelerating
beyond the FRB's comfort zone by mid summer. As we have stated before
choosing an appropriate monetary policy is likely to get considerably more
complex in the months ahead.


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

Our initial reading of these unusually long minutes (there were a large number
of procedural issues discussed that we have not had time to analyze) confirms
our belief that there is an extremely muddled and unrealistic range of opinions
regarding an "exit policy". The fact that we use the word "range" is
significant since the differences of opinions amongst the various FRB Governors
seem likely to become wider and more public as this process gathers momentum.
Indeed it is our belief that one of the (unintended) consequences of Chairman
Bernanke's difficult re-election is that his standing has been somewhat
diminished, certainly from the height of the crisis when he personally enacted
a vast amount of emergency policy with the bare minimum of internal or external
discussion.
.
With regards to the the current minutes this confusion can perhaps best be seen
in the discussion regarding the appropriate interest rate tools for the FRB to
utilize. We note that the idea of paying interest on Excess Reserve Balances
has now been anointed with an acronym - IOER. This is a telling indication that
it is about to be adopted as a formal policy tool, even more so than Bernanke's
remarks to Congress that we commented on last week. There was (of course) no
discussion about the possible complication of the FRB paying billions of USD to
the Commercial Banks. There is also no agreement on the desirability of
shrinking Reserves in advance of paying interest, or (more importantly) the
fact that there is no simple policy which would allow this to occur.
.
Our take therefore remains unchanged. The FRB is compounding its lack of
appreciation of the recovery's power by pursuing a needlessly complex monetary
policy. At some point in 2010 this is likely to become of direct relevance to
asset markets and the process of realization is likely to be a painful one. We
will continue to follow these developments closely in the weeks ahead.

January's Industrial Production and Capacity Utilization data continues to
show a steady "V" shaped recovery is underway. Industrial Production was
reported to have risen by 0.9%, somewhat higher than consensus of 0.7% and
the strongest reading since August 2009. In addition the December data was
revised slightly higher to 0.7% from 0.6%. Capacity Utilization also moved
higher to 72.6% (in line with consensus) which is the highest level since
December 2008. It should be recognized that this improvement in production
data has taken place without actually starting a rebuild in inventories.
The idea that this data will simply flat line later this year therefore
makes no sense to us and while Capacity Utilization would still probably
have to rise another 5% or so to get the FRB's attention the current pace
of repair this could easily occur by the start of Q3 2010.


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

Our favored metric for housing starts is the Single Family Building Permit
data and this series confirmed the small improvement in activity that was
registered in December. Permits were measured at 507K annualized, a small
uptick from December's 505K and the highest reading since activity
collapsed from 529K in September 2008 down to 470K in October 2008. This
takes the 12 month RoC up to 48.25% and although this figure is largely a
reflection of the total seizure that gripped the industry 12 months ago it
should also be recognized that all prior turns in the home-building cycle
have been accompanied by similar surge in the 12 month RoC.
.
Looking ahead everything depends on the Spring selling season. There is no
doubt that any increase in New Home Sales would put tremendous pressure on
depleted industries. Given the level of capital repair that the public
homebuilders have accomplished we would judge them to be able to significantly
ramp up home-building activity should they see clear evidence that
end-demand is improving. As with other inventory rebuilds there is
typically a lag between a boost to New Orders and Production (the ISM data
took approximately 2 months to respond last year) but this would still
suggest that the home-building sector could make a significant positive
contribution to the US economy by the summer time. Such an event is not
allowed for in any consensus estimate of the economy.


(See attached file: D-NHSPA1_Index.gif) - D-NHSPA1_Index.gif

The February NAHB Sentiment Index shows a moderate degree of improvement in
Homebuilder Sentiment with the overall Index rising to 17 from 15 last month.
This was slightly better than the consensus reading of 16 but this clearly
represents mere "noise" in the data and the Index remains mired in the
ultra-low sub-20 range that has contained all readings since December 2006
(green
box).
.
The real key is what transpires once the Spring 2010 selling season gets
underway in the coming weeks. This month's data covers the relatively
insignificant late-Winter sales period but the March and April releases are a
different matter and we really need to see this index force its way up into the
mid to high 20's during the next couple of months if it is to signal that a
significant recovery in the homebuilding industry is underway. In the meantime
all the evidence suggests that homebuilders have fully adjusted to the current
level of activity, indeed the degree of adjustment may prove to be so large
that any sustained increase in sales activity creates some discomfort in a
capacity constrained industry. - nahbfeb10.gif

The signs are mounting that we have seen a sufficient downshift in sentiment to
bring this corrective phase to a close. We would still be alert for a retest of
support but any weakness should be used as an entry point for our favored
sectors.

It is somewhat ironic that as Chairman Bernanke has started to make
increasingly detailed public pronouncements regarding the "Exit Policies"
of the FRB the data still suggests that the current policy continues to
create an ever-growing pool of passive capital at the heart of the
Commercial Banks. As we have written before it seems highly likely that
controlling the willingness of Commercial Banks to deploy their Cash
Reserves and Treasury holdings will be a major (and we judge unmanageable)
task as this recovery gathers steam. The notion that the FRB will simply
pay interest on excess reserves in order to prevent their rapid deployment
seems particularly problematic once one realizes that on $1 Trillion (the
current Reserves are somewhat larger at $1.154 Trillion) will involve the
FRB paying the Commercial Banks $10 bln per annum (there has been
absolutely no public recognition of this fact either by the FRB, Congress
or the financial media). Equally the notion that "reverse repos" can simply
be used to drain a few hundred billion of reserves is silent as to the
effect on the underlying yields of the instruments being used in this
mechanism (wether Treasuries or MBS securities). In the meantime the size
of the problem continue to grow larger, and as this week's data shows the
total of Cash and Treasuries has now crossed the 30% mark of total
Commercial Bank assets for the first time since the summer of 1994.




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

When the December 2009 Empire State Manufacturing report came in very light we
made the point that this erratic data series needs to be smoothed by a
reasonable moving average (we use 6 months, the red line on attached chart) if
it is going to be sensible interpreted. Today's report at 24.91 is comfortably
ahead of consensus (18) and takes the 6 month ma up to 19.64, its highest level
since November 2007. in terms of the sub-indexes we note that New Orders remain
positive at 8.78, but that this is a lower pace of change than we have seen in
recent months (to an extent this is simply a reflection of a higher level of
overall activity). Prices paid remain very high at 31.94 while prices received
recovered to 4.17. The latter is an important gauge of manufacturer's margins.
The Inventory recovered to 0.00, indicating that the drawdown paused for a
month but still not signalling any inventory rebuild. The Employee Index rose
to 5.56 while the Work Week Index rose to 8.33, indicating that Manufacturer's
continue to try and eke productivity gains out of a much diminished workforce.
In sum this is a positive report that supports our current notion that a strong
Industrial recovery is underway in the US. - empirefeb10.gif

The Census Bureau data for overall US Manufacturing and Trade Inventory and
Sales shows the same pattern of growing Sales and lagging Inventories that
we saw in the Wholesale data that was released earlier this week. Today's
data shows that overall sales (red line) increased by 0.9% in December
taking the 12 month RoC (pink) up into positive territory at 4.7%. Given
the strong trend of increasing sales that has been established this 12
month RoC looks likely to accelerate significantly in the coming months.
While some production increase occurred it was not enough to stabilize
Inventories which shrank -0.2% in December. This did have the effect of
reducing the 12 month drawdown (green line) to -9.73% but this is a long
way from representing any sort of Inventory rebuild. We will therefore
repeat ourselves and state that far greater increases in the level of
production seem likely to be required in the coming months than consensus
estimates.


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

The University of Michigan Consumer Sentiment Index came in slightly lighter
than expected at 73.7. However, given that this survey would have been
conducted against the backdrop of a weak equity market this shortfall is hardly
surprising and is in no way significant. As can be seen a fluctuation like this
is simply noise during a recovery. Looking ahead we would expect to see this
index force its way through the key 80 level (green line) once substantially
better employment data is released. In the meantime, as can be seen by today's
Advance Retail Sales, mediocre sentiment is no impediment to recovery. -
univmichiganfeb10.gif

Advance Retail Sales came in a little stronger than expected at 0.5% (0.3%
consensus) keeping the clear trend of recovery that has been in place since
early 2009 intact. This data takes the 12 month RoC to 4.02% while the 3
month RoC suggests a considerable acceleration may be underway since it is
moving at an annualized rate of approximately 9%. It should also be noted that
this recovery in sales has taken place in advance of any growth in US
payrolls. The scope for further gains in the months ahead should therefore
not be underestimated.


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

No sooner had the Chinese markets closed for the week long Lunar New Year
holiday than the monetary authorities announced another 50 bp rise reserve
requirement for large and small banks. This move cannot be characterized as a
total surprise and the fact that the local equity market will be closed for a
week will probably dampen its impact on other markets. In our view this really
sets the pattern for 2010 both within China and outside and we expect to see a
large number of incremental tightening measures enacted globally over the coming
months. Although individually each of these measures feels fairly
inconsequential in aggregate their impact upon the global availability and
price of liquidity is likely to be significant. The question, as ever, is when
do capital markets take this into account a re-price accordingly?
.
Our sense is that the current bout of turbulence has probably recalibrated
valuations sufficiently to take into account the current round of global
tightening and we would not be surprised to see a general rally in the
commodity and emerging market complex develop that may even take some (but not
all) markets back up to their 2010 highs. Our concern, however, is that the
strength of the US recovery in particular is being grossly underestimated
at present and that we are reaching the point in the cycle where a string of
very positive data releases is going to forcibly change a good portion of
opinion both within the market and the FRB. The notion that US monetary policy
could be tightened in 2010 would be a very significant influence on the
Central Banks in countries who are struggling to balance their monetary
policy between local economies that show signs of overheating and globally
depressed short term rates and allow a far more aggressive stance to be
followed.. If we are correct and a rally does unfold it will therefore mark a
vital opportunity to re-balance a portfolio away from those asset classes most
likely to be impaired by a global tightening of monetary conditions.


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

As we argued in this morning's Weekly Speculator following the Technology
sector's relative performance should give us a key indication as to the end of
the current bout of weakness (see attached chart). This is because Technology
both suffered from the "over-owned" condition that led it to be included in the
wave of liquidation that has taken place over the last couple of weeks and has
also been the centre of a large amount of very positive earnings releases that
should encourage "bottom up" investors to buy selective issues on weakness. At
a certain point the latter (positive) pressures should overwhelm the former
(negative) ones, and relative out-performance versus the overall market will be
a good indication this is taking place. With this in mind today's performance
is note-worthy with the NDX up 0.78% while the SPX is up only 0.32%. We would
not yet call this definitive but it is clearly a step in the right direction. -
sg2010021141463.gif

We continue to follow Australia as a useful leading indicator of monetary
pressures that we believe will be felt globally over the course of 2010. As
we have argued before, Australian monetary conditions (and specifically
local short term rates) seem far too loose (low) for the state of their
local economy. Last night's release of January employment data certainly
supports our case since it showed 52K new hires, the highest level since
September 2004 and a far stronger showing than consensus estimates of 15K.
.
The problem for the RBA (which by all accounts is one of the more
sophisticated of the global central banks) is that its Cash Target rate of
3.75% may be historically low for Australia but is relatively high against
the near zero rates prevailing in other developed economies. This creates
an understandable unwillingness to go out on a limb and risk and raise
rates in case this attracts even more speculative capital from other lower
interest rate environments. This impasse seems likely to be solved later
this year by a belated realization that global growth is accelerating well
beyond consensus estimates, leading to a general rise in global short term
interest rates (including the FDTR). Between now and then central banks in
countries such as Australia and Norway will be caught between a risk of
overheating and raising rates to the point that local capital markets are
disrupted. It is unfortunate to note that in a typical cycle both these
events may occur sequentially.


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

It had been well signalled in advance that China's January Monetary data
would show a strong expansion and this was bourne out by last night's data.
M2 grew by a significant 3.12% for the month taking its 3 month RoC back up
to 6.64% (an annualized rate of approximately 29%) while the 12 month RoC
drifted down to 26%. The main cause of this expansion was a surge of New
Loans which reached 1390 Bln CNY, the highest level since June 2009. While
this infusion of liquidity will help keep the party going for a little
longer we do not see January's data as representative of future activity.
Indeed all anecdotal evidence suggests that the bulk of lending activity
took place at the start of the month prior to a series of public
pronouncement on the need for lenders to show restraint.
.
In any case we have argued that liquidity cannot be understood in nominal
terms but needs to be compared to the size of asset markets, and our proxy
for this is New Loans as a percentage of the local equity market. This
shows January's injection as 6.27% of market cap. Although this is the
strongest number for several months it is well below the levels seen a year
ago, a reflection of how much faster asset prices have grown than liquidity
over that period of time, while the 6 month ma improved to 3.21%, well
below its 10 year average. Our view remains that Chinese monetary policy
will continue to tighten over the course of 2010 and that while the current
episode of monetary concern is probably drawing to a close (particularly
since local markets will shut for the Lunar New Year at the end of the
week) we would expect to see a more serious reprise later on this year.


(See attached file: D-CNMSM2_Index.gif)
(See attached file: M-.CHBOOM_Index.gif) - D-CNMSM2_Index.gif -
M-.CHBOOM_Index.gif

We note that the immediate reaction to Bernanke's testimony is a lot of
excitement regarding his comments about the Discount window. Having read the
speech in total it is clear that these comments merely represent Bernanke's
belief that credit markets have normalized (hard to argue with this) and the
raising of the Discount Window spread back up to a more normal level (100 bp
above FDTR) is no different to the other retractions of 2008's series of
emergency measures. In any case the usage of the discount window has shrunk
dramatically in recent months (see attached) form a peak of 438 bln on October
15th 2008 to $89 bln last week. An extra 75 bp on this sum ($670 man annually)
is absolutely negligible in terms of US monetary conditions. We do of course
have several issues with the FRB's stated "exit plan" but we will address these
more thoroughly when time allows. - sg2010021036837.gif

An interesting story (we apologize to non-Bloomberg users who cannot see that
chart) that reiterates a point that we have been emphasizing. A change in
leadership has started to take place in global equity markets, which (as is
nearly always the case) runs contrary to the composition of the vast majority
of global portfolios. As more investors become cognizant of this shift in
relative performance the re-allocation of portfolios only serves to make this
distinction more pronounced. An increase in public acknowledgement of this
issue is therefore an important marker in the process.

China's January Trade data continues to portray a vigorous recovery in both
the domestic and export driven economies that is in danger of overheating.
Exports were recorded at $109.48 bln, up 21% from January 2009's level
($90.45 bln) and only just below January 2008's record of $109.64 bln). As
with December's data this suggests that China's export driven economy has
recovered to the point that it can be considered to be out of danger, and
it is notable that this has occurred at a fairly early stage of the global
inventory rebuild, meaning that a significantly stronger performance can be
expected to unfold in the months ahead. If this will be something of a
relief to the local authorities the surge in Imports must be sounding an
alarm. These surged to a new January record of $95.31 bln (prior peak was
$90.17 bln in January 2008) up 85.5% from their level a year ago at the
depth of the slowdown. Even allowing for January 2009's depressed level,
and the fact that an earlier than usual Chinese New Year has boosted
domestic consumption, this January this is still a figure that suggests
rampant domestic acceleration. The effect of the disparity in growth rates
can be seen in the overall trade surplus which at $14.17 bln is down by
almost $25 bln from its level a year ago and is the lowest January reading
since 2006. Our conclusion remains that the Chinese authorities have every
incentive to create substantially tighter monetary conditions in the months
ahead.


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

The Census Bureau's Wholesale Inventory and Sales report continues to
suggest that Sales are improving at a faster rate than Industrial
Production. In fact, according to this data, Sales (red line on chart 1)
increased by 0.8% in December while Inventories (black line) shrank by the
same percentage. This has had the effect of taking the Inventory/Sales
ratio all the way down to 1.12, close to the record low of 1.1 recorded in
June 2008. We have included 2 additional charts this month that look at
actual Inventory numbers (indexed against 2003 levels) and the
Inventory/Sales ratio for a number of the specific industries included in
this report. Looking at this data we would note that Apparel (dark green on
both charts) inventory continues to decline very sharply (a sign that
retailers kept a very tight control of stock going into the holiday selling
season) and is at a record low Inventory/Sales ratio (data starts in
1992). Durable goods on the other hand (blue) continue to see Inventories
shrink without having reached a similar point in the Inventory/Sales ratio
(the same can be said of Automobiles (red) and Machinery (light green)).
Interestingly the one area of rapid Inventory rebuild has been Computers
but sales have almost entirely compensated for this such that the
Inventory/Sales ratio remains very low at 0.6311.
.
The pattern of this data mimics that of the ISM Manufacturing survey (which
has the advantage of being one month further ahead). Stronger sales have
boosted productive activity but not yet to the level that an inventory
rebuild has commenced. The importance of this fact for the current economy
is hard to overstate. The "artificial" inventory boost that many expect to
expire imminently is highly likely to remain in place for a number of
quarters to come and the scope of this recovery continues to be
underestimated.


(See attached file: D-MWINTOT_Index.gif)
(See attached file: D-MWINTOT_Index1.gif)
(See attached file: D-MTISAPPA_Index.gif) - D-MWINTOT_Index.gif -
D-MWINTOT_Index1.gif - D-MTISAPPA_Index.gif

Looking at the very rapid recovery in the US equity market on Friday
afternoon, the relatively healthy aftermath in yesterday's session (we
held the majority of Friday afternoon's gains) and Monday night's action in
the Far East and Europe it is tempting to conclude that this correction has
run its course. This is certainly a possibility, we fulfilled a number of
our requirements (most notably a VXO reading at or close to 30) and a
number of key indexes traded at or close to key support levels, but our
sense is that this correction is yet to fulfill its requirement in terms of
time. Corrections must be understood to represent a psychological
adjustment of participants from overconfidence at their commencement to
undue concern at their depths. While price changes are the efficient
mechanism for causing this mood change it does take time for the mass of
participants to make their adjustments and we doubt whether 3 weeks is long
enough.
.
Indeed, if we look once more at the experience of the great 1974-76
recovery rally we can see that the correction that started on July 15th
1975 took a full two months to reach its ultimate low (although the bulk of
losses were recorded in the first 5 weeks), and also required a number of
tests of support before the market was able to find its footing. This
unpleasant episode was enough to dampen enthusiasm for a number of weeks
before a powerful year end rally unfolded and the SPX made a new recovery
high on January 12th 1976. We continue to view this period as a useful
template for 2010, meaning that the current correction probably has a few
weeks to go and will see the SPX retest and probably break last Friday's
low (1,040) before it has run its course. Having said this, for a number of
domestically focussed sectors and companies we have probably already
reached the point at which positions can be built with the longer term in
mind. Our tactics would be to use stronger sessions to sell commodity
related and emerging market equities, and weaker session to build holdings
in our favored sectors. This is likely to be a far more achievable and
productive goal than "picking the bottom".


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

As we wrote earlier this afternoon a VXO reading near 30 would signal
sufficient capitulation for a rebound and this condition has been fulfilled
(see chart attached). We may yet see some more turbulence and a retest but we
are seeing the first clear signs in several days that the market is trying to
put a defendable bottom in place.


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

One of the least commented facets of the current sell off is how well the
US small cap sector has performed given that it is a high-beta sector.
Attached is a chart of the RTY Index together with its relative performance
to the SPX Index (green line on bottom). Although the index (like all
others) has broken down this week its overall decline is somewhat less than
would typically be expected in a market decline of this magnitude. This can
be seen on the relative performance line, which has hardly declined since
the sell off started in mid-January. Note that in prior sell-offs
(February, July and October 2009 are shown on the chart) the relative line
dropped far more significantly during the declining period. We always give
credence to stronger than expected performance in a downturn and this chart
suggests that "small" may be the way to go once this decline is exhausted.
Interestingly this would support the notion of a US recovery that broadens
and deepens in scope. It typically takes longer for smaller companies to feel
the benefits of a recovery but once they do their operating leverage to improved
conditions tends to be significantly higher than their larger brethren.



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

As the SPX probes gently lower this session our sense is that the market
needs to exhibit a little more evidence of panic before we would feel
comfortable saying that this corrective phase is over. In this regard we
would view a reading of the VXO at or close to 30 as an appropriate signal.
Looking at the price chart of the SPX this would be likely to take the
index to within touching distance of the 1016 "opening gap" (blue dotted
line) that has been our "worst case" target for this correction for the
last 2 weeks. Having said this, the final phase of this sell-off may be
quite brief and narrow in focus. For investors with the willingness to buy
a little early (and risk some short term pain as a result) there are
already a large number of domestic stocks and sectors that look attractive
at current prices. However, we would continue to avoid the commodity and
emerging market complex and use any bounces as selling opportunities since
there remains significant potential downside in these areas.


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

Taking our eyes away from the continuing correction and today's employment
report we were interested to see last night's release of the Japanese
Leading Indicator Index. Regular readers will know that we like long-term trend
following types of data since, if used with patience, they often predict good
entry and exit points across cycles. December's data came in at 94,
considerably higher than November's 91 (revised up from 90.7) and ahead of the
93.5 consensus. As the attached chart shows, having reached the current level
the index is likely to continue moving higher for the next few months.
.
Historically, a rise of this index through the mid 90's has always been
accompanied by a sizeable rally in the local equity market (which has had
several cyclical bull phases during its 20 year bear market) and we would
expect this time to be no different. Indeed Japan is one of the few countries
where monetary conditions are actually still loosening (at least as measured by
the Monetary Base) while the stronger USD will make life easier for exporters
that compete with Chinese counterparts. Our sense is that this sell off will
represent an attractive medium term buying opportunity for the Japanese equity
market.

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

January's Non-Farm Payroll report is even more chaotic than normal but
although the headline number at -20K may seem a little disappointing
(consensus was for +15K) and last month's number was revised sharply lower
to -150K (from -85K) there are some quite positive indications in the
report. Perhaps most interestingly we would note that the manufacturing
sector moved back into positive territory (see attached chart) with 11K
jobs being provided. While this number itself it not significant there is
every reason to believe that sizeable re-hiring by Industrialists will be
required in order to reverse the inventory drawdown, therefore unlike the
last two recoveries in which Manufacturing job growth was a non factor
(indeed it was a non-factor throughout the 2003-8 expansion) the next 12-18
months may see a sizeable increase in employment in this sector. We would
expect to see the 6 month ma (red line) advance to somewhere in the 50-100K
range over the next couple of quarters.
.
The other point we would make is that the Unemployment Rate appears to have
decisively turned and that in prior cycles this has ALWAYS continued to
move downwards quite rapidly for multiple quarters once a turn is achieved
(see attached chart). We are of course aware that this is basically a
statistical construct that may bear little direct relevance to a reliable
measure of the proportion of people unemployed, but this was also the case
in prior cycles and does not negate the fact that this indicator has great
significance in tracking employment trends. It is also a key driver of investor
sentiment. We continue to believe that employment will be a source of major
upside surprise in early 2010 and this data supports our thesis.
.
Shorter term the slightly weaker than expected data may cause the USD to
pause for breath. If this occurs this would take some of the intense pressure
off the commodity and emerging market complex, at least in the immediate term.
We would still be inclined to use any bounce to lighten positions in these
areas.


(See attached file: D-USMMMNCH_Index.gif)
(See attached file: D-USURTOT_Index.gif) - D-USMMMNCH_Index.gif -
D-USURTOT_Index.gif

As we had expected the SPX has now definitively broken support at 1070 and
therefore is now targeting either of the two lower "gap openings" (blue
arrows on chart) at 1040 and 1016. Note that the VXO has moved into the
25-30 zone as support has given way, indicating that volatility pricing is
in line with market conditions. Our assumption in that the VXO will peak
around the 30 level at the time the market puts in a sustainable low (which
looks likely to occur sometime in the next couple of sessions). Although we
have been quite negative from a technical perspective for a couple of weeks
we should reiterate that during the sell-off a large amount of significant and
positive economic data has been released together with a host of excellent
earnings. This is therefore very much a "liquidity shock" that we are
encountering rather than a precursor of worse economic times and for the right
sectors the eventual low will be an excellent buying opportunity.


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

The IBOV Index is rapidly moving in for a test of key support at 64,500. If
that level is breached this would point the way for a fall down to the 200
day ma (green, currently 58,843 which is just under 10% below the current
market level. Note that 60,000 (where the market bounced violently in late
November) would also provide some support on the way down, while 55,000
would probably provide enough support to halt a breach of the 200 day ma.
Note that the BRL also seems likely to breakout through 1.90 in which case
it would be targeting a move to at least 2.00. This means that total losses
to USD investors could potentially total 15% +/- from this point on, in
addition to the 13.25% lost already on a YTD basis.


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

Today's report of Q4 non-farm productivity came in slightly light at 6.2%
while the Q3 number was revised down to 7.2%. However, given the high
margin of error in this data series we are not too concerned about the
exact level of productivity gains provided they are reported as being well
north of 5% per quarter. The key to this cycle in our opinion is the
Manufacturing Sector, which has seen a far greater contraction in labor
force than in the prior 2 recessions and is now facing the need to rebuild
a historic inventory drawdown. As the attached chart shows this has already
taken productivity into unseen territory (even after the Q3 revision) and
the 4 quarter ma is approaching record territory (both the 2 and 3 quarter
measures have already done so). Given that new orders (according to the ISM
data and numerous comments on this quarter's earnings calls) continue to
grow and inventory levels are now simply being balanced a future increase
in production is highly likely to require significant hiring of labor.
Again we suggest that the experience of the 1992-4 and 2002-4 shallow
employment recoveries are not valid comparisons to this cycle. In neither
case were inventories slashed and employment losses were relatively
contained, removing the need for a radical re-appraisal of employment
needs. The conditions today could hardly be more different and while we
have no clue what tomorrow's non-farm payroll report will announce (we
never do) our strong feeling is that it is only a matter of time before a
sizeable "data-shock" is going to be delivered.


(See attached file: D-PRODMOP%_Index.gif) - D-PRODMOP_Index.gif

A sudden slowdown of IPO activity and a failure of deals to price within their
original ranges is a reliable sign of a market on its last legs (provided prior
activity has been frenetic). Our assumption would be that the IPO window in
China is about to slam shut (think Nasdaq August 2000).

The non-Manufacturing ISM data came in slightly weaker than anticipated at
50.5. However we would not make too much of this slippage and in any case this
data series has a fraction of the predictive value of the ISM Manufacturing
data. See attached file for official ISM text on the data.

http://www.mineweb.com/mineweb/view/mineweb/en/page34?oid=97140&sn=Detail&pid=92
730
An interesting article
that shows the rampant retail popularity for gold in 2009. We view this demand
as being a "lower quality" equivalent to the surge in open positions in Large
Speculators futures and shares outstanding in global precious metal ETFs (the
27.6 million ozs sold by the mint is about 7.5% of the amount controlled by the
GLD ETF) . Everything points to gold being a super-crowded trade at the current
time that requires ever increasing inflows to keep it going.

Gold May Repeat Early Rally, Citigroup Says: Technical Analysis ...

An interesting study although they fail to mention that these "month start"
rallies are a reflection of massive speculative flows into the precious metals
(and also the fact that a number of large HF's now offer "gold series" shares
to their clients, again making the metal sensitive to the start of each month
to the extent that these HF's are themselves attracting inflows). Nevertheless
they make the correct point - the key for gold is what happens after the first
2 or 3 sessions of this month. As a general rule prices that start to be overly
influenced by the starts of months are heavily speculated in (for obvious
reasons). This clearly is the case with gold.
<>

We are always very sensitive to groups showing relative strength during a
corrective move and so we have been monitoring the performance of the
homebuilders quite closely in recent days. Their better than average
performance in recent sessions (see relative to SPX line in green) is
largely a function of the prior disgust shown to them by the investing
public. Since this has very much been a "populist" decline where the
sectors that attracted the most money in Q4 typically declined the most it
made sense that the homebuilders losses were quite muted. In recent days
however, a smattering of positive news (most clearly DHI's earnings release
this morning) has seen prices rise strongly across the group. At the time
of writing the index is challenging important resistance at 280. Resistance
here can be expected to be strong but if the group can close above this
level the chart would indicate that a move to test the September high at
307.13 is on the cards.



(See attached file: D-S15HOME_Index.gif) - D-S15HOME_Index.gif

This report shows the first chinks of light in the lending cycle. No large
banks reported tightening between October 2009 and January 2010. 52 (out of 55)
reported the same standards while 3 "Eased Somewhat", the largest number since
May 2007. Clearly given the robust repair to economic activity that has been
reported in recent weeks we would expect to see more loosening going forward.
However, it should be understood that bank lending cycles tend to be very
tightly correlated in time with the FRB rate cycle. Banks typically want to
start lending at precisely the time the FRB wants to dampen activity (see 1994
for a textbook example). As with so many other things this cycle it appears to
be deja vu all over again.

We are on record as predicting that Q1 2010 will mark the point at which
the US employment cycle turns positive and further support for this
viewpoint comes today from the Conference Board Online Employment Index
(see chart and link to today's release). This rose very strongly by 381K
openings to 4023.50K, a rise of 10.48% from December. This surge in
advertising obviously suggests that employers are starting to actively seek
to re-hire workers. Unfortunately due to the relative youth of this data
series (and indeed the entire online-jobs market) we do not have comparable
data for prior violent employment cycles. Nevertheless this surge in
activity suggests that something is stirring within employment and that
this will be reflected in more traditional employment measures going
forward.

http://www.conference-board.org/economics/helpwantedOnline.cfm

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

This morning's release of ISM data is an unambiguously positive report. The
overall index came in at 58.4, significantly stronger than consensus at 55.5.
As the attached chart shows we continue to see the same process of stronger New
Orders (red) with the index rising to 65.9, the strongest reading since April
2004 (67.1) forcing Production (blue line) higher to 66.2, the highest reading
since April 2004 (66.6) while Inventories are yet to be rebuilt with the index
hitting 46.50 suggesting that a moderate drawdown is still in effect. Perhaps
most importantly Employment data has turned comfortably positive at 53.3
(highest since April 2006), and can be expected to rise strongly as
Manufacturers are forced to actually rebuild depleted Inventories. It is also
worth noting that much of the data is comparable to that seen in April 2004.
That month marked precisely the time at which the market and the FRB belatedly
realized quite how strong the recovery was (following the release on the March
non-farm payroll data on April 2, 2004). A very rapid back-up of short term
yields ensued with the FRB finally raising rates in June of that year. Today's
data therefore strongly supports our thesis that the FRB and the vast majority
of commentators and participants are significantly underestimating the need for
higher short term rates at the current time. We doubt that this state of
affairs will last too much longer should more data of this quality be released
in the coming weeks. - ismfebruary2010.gif

Back in the dark days of 2008 we spent a great deal of time familiarizing
our readers with the collapse of 1974 and subsequent powerful recovery over
the next 2 years since this seemed to offer some good historical parallels
to the crisis that was then at its height. Following last week's abrupt
decline in the US (and global) equity markets we were reminded that
something similar occurred in the latter portion of the 1974-6 recovery
rally. Upon checking this data we were intrigued by the close match in
terms of time between the climactic low and mini-correction that took the
index almost 15% lower in July 1975 and the sell-off that commenced in mid
January. Attached is a chart that overlays the SPX for the 1972-1977 period
(black) with the performance between 2007-Present day (red). Interestingly our
lowest target for the current sell off is the opening gap at 1016, which
would be close to a 12% sell-off from the recent recovery high, putting
this mini-correction in the same range as that experienced 35 years ago. It
is therefore interesting to note that in 1975 the market strongly rebounded
from 82.09 and ultimately topped at 107.83 (a gain of 30%) 14 months later,
in current terms this would target a level of around 1300 for the SPX's
ultimate recovery high. As ever we would caution against putting too much
faith in exact historical parallels. particularly in terms of exact
percentage moves. What is more helpful is to be reminded that recoveries
from crises tend to be fractious affairs, with negativity overwhelming
brief bouts of optimism on numerous occasions. Eventually the weight of
economic evidence supporting a recovery and higher equity prices wins out,
typically just before monetary conditions tighten to the point that it is
time to take a far more defensive stance. The likelihood of this pattern
playing out in 2010 seems quite high in our opinion.

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

In our recent Speculator Extra on Chinese monetary conditions we
highlighted Australia as one the obvious economies to be negatively
impacted. Compounding the China effect is the growing evidence of
overheating within the Australian economy which is forcing the RBA to start
its own tightening cycle. Last night saw the release of the Q4 2009 House
Price Index which rose 5.2% compared to consensus 3.5%. This represents an
annualized rate of 22.4% in an index which is already 40% higher than its
2003/4 reading (see black line of first chart). As a result since 2002
Australian home prices have outpaced the US FHFA Index by over 40% (see
blue line on lower chart). Note that the FHFA Housing index has only fallen
by 8.6% from its peak, unlike indexes such as Case Shiller which are
sensitive to foreclosure markets and have fallen far more significantly. By
any definition Australia is experiencing a "super-hot" housing market that
should tip the balance of central bank action in favor of significant
additional tightening. In this regard it should be noted that the current
RBA Target rate (red line) is a mere 3.75% although it is expected to be
raised in tonight's meeting.
.
Looking at the local equity market and currency it would seem that we have
reached the point in the cycle in which "good" economic news is "bad" news
for the market. The S&P ASX 200 Index declined by 6.18% in January (over 7%
in USD terms) and after Monday's session is bearing down on key support at
4500. With this index largely dominated by financial and commodity related
issues it can be expected to perform quite poorly should the RBA shift to a
more aggressive policy stance. With regards to the AUD although in theory
higher interest rates are helpful for a currency this is rarely how things
play out, with the reversal of international investment flows from local
asset markets overwhelming any "carry" based investors. As a result we
would be avoiding Australian exposure at the current time.


(See attached file: D-AUEHPI_Index.gif)
(See attached file: D-AS51_Index.gif) - D-AUEHPI_Index.gif - D-AS51_Index.gif