In order to underline the point we made earlier regarding the indifference
of the current FRB to very strong industrial data we have created the
attached chart which compares the Chicago PMI index (red) to the direction
of the FDTR (black). The latter is expressed as the trailing 12 month
change of the rate calculated as a PERCENTAGE of the rate 12 months ago
(hence the outsized leap in 2004-6 when the FDTR started from 1%) but in
any case it is the location of the black line in positive or negative
territory that really is the key.

As can be seen we have never seen Chicago PMI data anywhere close to the
current reading of 68.6 combined with an FOMC on hold, never mind the fact
that the FDTR itself is a mere 25bp and additional easing via QE2 has also
been enacted. There are two key points to take from this; firstly never
have monetary conditions been as conducive to industrial activity at this
point in the cycle, leaving scope for further re-acceleration going
forwards. Secondly, one of the risks embedded in the current environment
is that the FOMC belatedly wakes up and senses that the strength in
industrial activity warrants a re-appraisal of monetary policy (note that
the FOMC would no doubt call this a "success"). Current LIBOR futures
estimate that the FDTR will be approximately 75bp in December 2011 and
just over 1.75% in December 2012 and this strikes us as being too low to
realistically price in the possibility of a far shorter life-span for the
current super-accommodative policy. - M-FDTR_Index.gif -

Equity Funds See First Weekly Inflow Since April, ICI Data Show

Finally some signs that US retail investors are tip-toeing back into the US
equity market but note that Non-US equity funds still received over 10 times
the level of flows.

 

US Pending Home Sales for Existing Homes continued to recover from their
tax-credit hangover in November with the index rising to 92.2, slightly
ahead of consensus. As the attached chart shows this puts ending sales at
the top end of the range with contained data between the end of the 2007
collapse and the start of tax credits in 2009. Thus another of the causes
of the summer "data-panic" has been fully repaired and shown to be an
overreaction to a large drop in activity that should have been foreseen as
reversible (as we argued at the time).

Although Pending Sales are still far below the peak activity of the
housing boom the report shows a reasonably healthy level of activity that
is in line with the pace of sales in the late 1990's housing market. This
strikes us as sufficient to cross the existing home market off the list of
potential disasters going forwards. House prices may fluctuate or even
drift moderately lower in some markets and the foreclosure backlog will
take many quarters to fully clear but the repair process is underway and
we have probably reached the point in the story at which the housing data
contributes more upside than downside surprises (this is even more true of
the very depressed New Home market). - M-USPHTOTL_Index.gif -

We have become used to strong PMI data in recent months but even so the
December Chicago PMI report stands out as a remarkably good report. The overall
index (black) rose to 68.6, the highest reading since July 1988. New Orders
(red) rose to 73.6 and Production (blue) to 74.0, for both these series this
was the strongest reading since October 2004. Inventory data (green) shows an
acceleration in rebuilds crossing the 60 level for the first time since 2006
while Employment (pink) at 60.2 is at its best reading since the summer of
2005. As historically minded readers will be aware all the above time periods
came in the middle of FRB TIGHTENING CYCLES, a far cry from the current FOMC's
perma-hold at 0.25% and introduction of QE2 two months ago. The scope for a
re-appraisal of monetary policy some time in 2011 should not be underestimated
at the current time. - chicagopmi.gif

We have been arguing for the last few months that the weekly Initial Claims
data was probably the key metric to watch at this point in the cycle and more
justification for this argument was provided this morning with the surprising
drop in claims to 388K, the lowest reading since July 4th 2008 and well below
consensus expectations of 415K. Much of this shortfall can be ascribed to much
better than normal seasonal factors. Late December typically sees significant
industrial and construction related lay-offs but at the present time the
industrial sector is rushing to rebuild inventories with a depleted workforce
while construction has been in deep-freeze for so long that there is no need to
shut down sites for the winter months since they were never opened in the
spring and summer in the first place. This does not make the improvement any
less real, it just explains why it was predictable if one thought carefully
about where we are in the current cycle.

In any case today's data takes the 4 week ma (our preferred metric for this
volatile data) down to 414K, the lowest reading since July 25 2008. As the
attached chart shows the familiar "second stage" of the improvement in Claims
data is now clearly visible on the chart and this tends to be the point at
which the more closely watched non-farm payroll data starts to accelerate
higher. The data is too unreliable for us to say anything definitive about
December's number but at some point in Q1 2010 a meaningful improvement in
payroll data should become apparent. - 4weekinitialclaimsdec242010.gif

Yet another example of MPMP being applied by an emerging market Central Bank.
As we have stated before these are starting to concentrate in efforts to
discourage foreign inflows and attempts to cool local real estate markets.
Indonesia's new rules target the former.

In what is turning out to be a very quiet end to the year for the US
equity market one trend that bears consideration is the continued
outperformance of the energy sector. Although the SPX and XOI index have
nearly identical 2010 total returns (15.12% vs. 15.18% respectively) this
disguises the radical difference between the first and second halves of
the year. From January through June 30th the XOI index lost -15.95%, or
-9.30% more than the SPX (the ongoing BP spill was a major factor behind this
decline).

This has been more than made up over the last few months with the energy
sector's performance being particularly strong in the 4th quarter during which
the XOI has gained 16.95% (5.93% more than the SPX). This out-performance has
been a major contributor to the overall index's performance. Given the very
small gains by healthcare, utilities and large financial companies the index
would have been overly reliant on technology, materials and consumer sectors
without the help of energy and it is doubtful that it would have been able
to break above the key 1220 level that marked April's high.

One other interesting thing to note is how much better the holder of a
basket of energy stocks has done than a "buy and hold" investor in crude
oil itself. As the second chart shows although the price of the current CL
future for crude oil has gained in line with the XOI index (note the chart
excludes dividends for the latter which would have taken its gain up to
15.12%, just above crude) these gains were largely frittered away by the
cost of rolling the monthly contracts. The JPM Crude Total Return Index
for instance is only up 4.27% (this actually beat the USO ETF which lost
-0.91%) which will have come as a nasty surprise to anyone who allocated to
the crude as a commodity rather than the equity of energy producing
companies. - D-XOI_Index.gif - D-XOI_Index.gif -

The refusal of consumer confidence polls to reflect any improvement in
consumer's psyche is starting to become one of the true anomalies of this
cycle. We are used to this data being a lagging and contrary indicator (it
tends to peak just after economic activity has started a long decline and to
trough a couple of months after a recovery) but once a trend is established the
data tends to move fairly rapidly up or down the scale according to the
direction of economic activity.

This time although all data (including metrics that measure consumer activity)
suggests that things are markedly better at the end of 2010 than they were in
the middle of 2009 the consumer confidence reports do not reflect any admission
of this by the polled population. Particularly striking is the "Present
Situation" index produced by the Conference Board (blue line on attached
chart). This shows absolutely no improvement taking place over the last two
years which is very different from the experience of other deep recessions such
as the mid-1970's or early 1980's (both of which included severe unemployment
cycles). We are at a loss to explain this phenomena other than attributing it
to the prolonged exposure that many of the prophets of doom have received on
the nations airwaves and print media (perhaps the Nobel Prize for Economics
should come with a requirement that the winner only opines on the specific
arcana that the prize was awarded for; this alone would probably add several
points onto the confidence metrics)

Fortunately this remains a sociological oddity and has had no discernible
impact upon the actual recovery in consumer spending. We would imagine that at
some point in the recovery sentiment will suddenly surge higher but
paradoxically this may well usher in a much more difficult time in asset
markets since it would probably reflect a big change in retail investor
allocations in favor of domestic equities. - confboardccdec10.gif

A double dose of macro-prudential monetary policy (MPMP) from Taiwan last night
as significant curbs on currency derivatives were announced (aimed at reducing
foreign inflows into local asset markets) and future curbs on local Real Estate
lending were rumored to be on the cards (see attached). We would expect to see
many more examples in the weeks ahead.

Very interesting how poorly this collection of "name-brand" funds have done.
Note that although the story talks about the failure of "Big Stocks" to
participate in the rally when you read the story it becomes clear that it is a
reliance on "safer" names that has really hurt performance (plus in certain
cases a large cash position). Plenty of large stocks have done very well in
2010 even though it is true that after the ferocious 4th quarter rally the
small cap RTY has outperformed the SPX by a comfortable margin. One of the open
questions for 2011 is the degree to which large funds re-allocate to chase
winning sectors and stocks or continue to chase value.

Brazil Said to See Credit Curbs Same as Rate Increase (Update1)

As we have been arguing for several weeks one of the great problems with
Central Banks going down the path of "macro-prudential" monetary policy (MPMP)
is judging the level of tightness in effect. Even when tracking "hard" numbers
such as interest rates and money supply this was more of an art than a science
but the difficulties are multiplied when one attempts to translate a specific
MPMP tightening measure such as the increase in bank reserves into a more
orthodox increase in interest rates. As the attached story makes clear Central
Banks (or at least the Bank of Brazil) are attempting to issue a guide as to
how to translate MPMP into more orthodox interest tightening. Of course this in
no way guarantees that the bank's calibration of equivalent interest rates is
in any way correct, but no doubt if it is said with enough authority and often
enough it will become received wisdom.

We remain of the view that MPMP will prove to be another unhappy chapter in the
fault ridden annals of central banking.

 

November's data confirmed that the US New Home market remains at a record
low level of activity. Headline sales increased to 290K, just below
consensus estimates of 300K but this gain was entirely due to seasonal
factors with NSA single month sales falling to 21K homes. Even so the
inventory of homes for sale continues to fall hitting 197K, the lowest
level since March 1968. We would expect to see sales bounce around between
275K-350K for the remainder of winter but await the spring selling season
with some interest. - D-NHSLNFS.gif -

US Initial Unemployment Claims data continues to point downwards with this
week's report coming in at 420K in line with expectations. This caused the
4 week ma (attached) to tick upwards slightly to 426K due to the very low
reading from November 19th leaving the data set but more importantly
confirms that the breakdown below the key 450K level can be treated as
definitive. All things being equal this improvement in claims data should
already be worth 80 to 100K in the monthly non-farm payroll data although
the different methodologies used to construct the two series means that in
practice little short term linkage may be apparent. Looking forwards into
2011 it is our hope that Claims can continue to force their way downwards
with 400K being a realistic target for the middle of Q1 and 375K being
possible by the start of Q2. Such an improvement would be welcomed but
most observers but would start to raise serious questions regarding the
current extremely stimulative monetary policy. Of course the prevailing
high rate of unemployment (it would take several quarters of sub-350K
claims to return the unemployment rate to normal) would continue to offer
a degree of justification for loose policy but not for the sort of
depression mandate that the FRB has currently implemented. -
D-INJCJC4_Index.gif -

Edmunds.com tends to give a reliable snapshot of US car sales three quarters of
the way through the month. Their December report shows that car sales have
continued to accelerate through the end of 2010 with current sales running at
an annualized pace of 12.34mm units, up from 12.21 units in November 2010 and
11.5mm units for 2010 as a whole (see attached for details).

Bulgari Gold Succumbs to Ceramics With Jewelry Hostage to Bubble

An interesting article that describes the extent to which gold's utility as the
base for jewelery has been largely superseded by its new found status as a
financial asset. To complicate matters demand for gold as jewelry (as the
article makes clear) is inversely related to price while as a financial asset
it becomes more attractive to investors as its price increases. Eventually of
course the soaring market cap of a financial asset (be it real estate, art
equities or commodities) grows to the point that it overwhelms the ability of
new capital commitments to propel prices higher. In the case of gold the
destruction of traditional demand from jewelry manufacture leaves the metal
ever more dependent on financial flows. In the short to medium term this need
not have an effect on price but typically when an asset becomes priced well
above the maxiumum level that its traditional use can be contemplated the
longer term prognosis for price is quite poor.

 

Existing Home Sales were reported at an annual pace of 4.68mm, just below
consensus estimates of 4.75mm. Single Family sales (which we prefer to
concentrate on) rose to 4.15mm putting them back to where they were in
March 2009 before the distortion of the tax credit program took effect.
Our assumption would be that sales should be able to settle into a range
between 4.00 to 4.50mm during 2011 and we would not pay too much attention
to this data unless these extremes were violated. With new delinquency
rates finally moderating as employment recovers this would allow the
inventory of existing homes to fall steadily in the months ahead. Any
prolonged move above 4.50mm would suggest that an "upside surprise" for
the housing market is underway. This is certainly a possibility given the
affordability of the housing stock but not a current requirement as far as
the overall economic recovery is concerned. - D-EHSLSL_Index.gif -

Anyone looking for signs of overheating in Asian emerging markets could do
worse than monitor the soaring price of Singapore's "Certificate of
Entitlement" that confer the right to own an automobile in that congested
island.

These are set at a bi-monthly auction and include various categories of cars
based on engine size and type of vehicle (the licenses are transferable and so
maintain a financial value rather like a taxi medallion in NY City or the
old NYSE seat licenses). Attached are is a chart of the price of category
E licenses which represent the "open" category. These have soared higher
over the last 12 months rising $58,213 SGD (just under $45K USD) to
$76,102, an increase of over 350%. Even though the numbers of licenses
issued has been reduced over this period from just under 600 per auction
to 300 this hardly explains the increase over the last few months and
particularly the explosion higher in recent weeks. Although we would
hesitate to make any sweeping conclusions from this somewhat arcane
statistic anecdotal evidence continues to mount that large portions of the
emerging market complex have monetary conditions that are far too loose
for underlying economic conditions. - D-SPOPQPE_Index.gif -

As would be expected the rapid back up of treasury yields has coincided
with a collapse in the MBA Refinance Index. We have explained many times
the dialectical nature of the relationship between yields and refinancings
and the attached chart shows the well established nature of prior booms
giving way to far quieter levels of activity. What should not be lost,
however, is the fact that the multi-month spike in activity has resulted
in permanent savings (approximately 90% of dollar volume was in fixed
loans this summer, and almost 95% in terms of the number of loans) for
those homeowners who participated in the boom and therefore its
stimulative effect on future household expenditure will remain in effect
going forwards.

Looking ahead although we doubt that there will be another spike in
refinance activity for several quarters the 30 year mortgage rate remains
historically low at 5.02% (green line, lower chart). This is quite low
enough to keep the cost of debt service at an extremely affordable level
for the average US home and remains a significant stimulant for future
existing and new home sales. - D-MBAVREFI_Index.gif -

We have consistently argued against the concept of a "New Normal" and, after a
difficult summer, opinion has started to swing forcibly against this belief.
Allocations on the other hand remain skewed towards a much more conservative
weighting than has historically been normal and even though changes are finally
being made the opportunity cost of under (or not) participating in equity
market over the last 21 months is hard to justify no matter what difficulties
remain in the US and global economy.

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

S&P 500 Gaining 43% Beats Pimco New Normal Return: Chart of Day
2010-12-22 05:00:15.0 GMT


By Nikolaj Gammeltoft and Inyoung Hwang
Dec. 22 (Bloomberg) -- The Standard & Poor’s 500 Index has
rallied 43 percent since Pacific Investment Management Co.
predicted a “new normal” of below-average returns. That’s
twice the increase for the bond manager’s flagship fund.
Pimco, based in Newport Beach, California, first told
clients in May 2009 that rising government deficits and
regulation would reduce gains in equities and bonds. The CHART
OF THE DAY shows the benchmark gauge for U.S. stocks beating
Pimco’s $250 billion Total Return Fund, which has climbed about
20 percent since the report.
Corporate earnings that exceeded analyst estimates helped
boost the S&P 500 13 percent this year, giving the index an
annualized advance of 27 percent since the “New Normal”
report, compared with 12 percent for Pimco, data compiled by
Bloomberg show. Mohamed El-Erian, Pimco’s chief executive
officer, said in an e-mail on Dec. 1 that the forecast has a 55
percent to 60 percent chance of coming true.
“It was a classic case of when strategists finally got
their heads around the economic trends to coin fancy terms like
new normal and the frugal future, it was already over,” said
Doug Ramsey, Leuthold Group LLC’s director of research in
Minneapolis. “It was time to go the other way.”
While the S&P 500 has lost 4.6 percent on an annualized
basis since the last bull market ended on Oct. 9, 2007, Pimco’s
Total Return Fund, which invests at least 65 percent of its
assets in investment-grade fixed income securities, has returned
9.7 percent to investors during the same period.
Treasuries returned 81 percent between 1999 and 2009 when
the S&P 500 dropped 9.1 percent, including dividends, for its
first loss over the course of a decade, according to data
compiled by Bank of America Corp.’s Merrill Lynch and Bloomberg.

For Related News and Information:
Developed Markets View: DMMV <GO>
World stock indexes: WEI <GO>
Most-active U.S. stocks: MOST US <GO>
U.S. stock market map: IMAP US <GO>
Top stories on stocks: TOP STK <GO>
Stories on U.S. stocks: NI USS <GO>
Equity screening: EQS <GO>

--With assistance from Brendan Moynihan in Chicago and Rita
Nazareth in Sao Paulo. Editors: Chris Nagi, Michael Regan

To contact the reporters on this story:
Nikolaj Gammeltoft in New York at +1-212-617-1061 or
[email protected];
Inyoung Hwang in New York at +1-212-617-6289 or
[email protected].

To contact the editor responsible for this story:
Nick Baker at +1-212-617-5919 or [email protected].
- cod dec 22 2010.tif

Since the SPX index has today finally managed to recover its entire "post
Lehman" loss it makes sense to look at some of the internals of this powerful
recovery. Attached is a chart which compares the price of the SPX index
(red) to its Cumulative Advance - Decline line (black). As can be seen
today's price breakout has been matched by a new all time high in the
number of Cumulative Net Advances (the data starts in 2002) and a new
relative high between the 2 lines (indicating that breadth continues to
accelerate higher faster than price). This suggests that the recent
advance has been participated in by a large number of the smaller issues
in the SPX rather than dominated by a smaller number of the larger names
(interestingly the opposite is true of the NDX index). This makes sense
since the leading groups this year have included transportation, retail
and automobiles (all of which are generally on the small side of large cap)
while the laggards have been the ultra-large cap dominated
Pharma/Biotech and Diversified Financials sectors together with Utilities.

Interestingly this shift actually commenced during the 2008/9 collapse
when large Diversified Financial stocks contributed an outsized share of
the total decline in the overall index. As such we would describe this
phenomenon as more than a simple indication that the internals of the
current rally have been healthy but also another sign that leadership
within the US equity market has shifted decisively over the last two
years. - W-TRADCADS_Index.gif -

We continue to monitor monetary conditions in key emerging markets and
this morning's surge in India's LIBOR equivalent (the NSE Interbank 3
month Offer Rate or NSER) caught our attention. This rose 25bp to 9.06%, the
highest level since December 2008. As a result the cost of short term
money has risen 160 bp since the start of the 4th quarter, which is 21.6%
of the rate in place on October 1st (7.46%). Looking at the attached chart
we would appear to have passed through the level of rates that would
represent a healthy normalization of conditions and are rapidly closing in
on the psychologically important 10% level above which money would
certainly be considered to be "tight".

Of course the relationship between the tightness of money and local equity
market performance is complex. Interest rates tend to move in the same
direction as equity market and economic performance before reaching a
sufficient extreme to cause conditions to reverse. The January 2008 peak
in the SENSEX (which was briefly surpassed last month) was actually made
between the 2007 and 2008 peaks in interest rates which indicates the
folly in using the latter as a real time indication of equity market
performance. On the other hand a very rapid tightening in rates is
unlikely to be helpful to an equity market already troubled by a sizeable
scandal in its local real estate and infrastructure sectors (both of which
are highly interest rate sensitive themselves) and should the NSER
continue to barrel higher through the end of the year we would see this as
a significant hurdle for the equity market going forwards. -
W-NSERO3M_Index.gif -

In what has been a generally quiet session one group that has caught our
eye has been the US Homebuilders which appear to be picking up some useful
flows at the tail end of a largely disappointing year. The S&P
Supercomposite 1500 Homebuilder Index (S15HOME) Index has risen 3.51%
today to a new 6 month high of 253.82. Today's move takes the index back
through its 200 day ma (which has had a fair degree of technical
significance since the middle of 2009) and also back into positive territory
for 2009 (compared to a 13.3% increase for the S&P 1500 as a whole).
Interestingly there does not seem to be any obvious news catalyst for today's
move leading us to believe that some new long investors are building positions
in anticipation of better housing statistics being announced in 2011.

This would make sense from our perspective given that current activity in
new home sales and housing starts remain at 40 year lows having seemingly
de-coupled from a generally stronger US economy. At their current
depressed levels home building stocks represent a reasonable "call option"
on recovery for those with the patience to ride out the long waiting game.
Of course we argued along the same lines 12 months ago and proved to have
mistimed the recovery substantially. Nevertheless the longer that activity
remains depressed the greater the likelihood of expansion going forwards
and the greater the indifference of market participants to the possibility
of this occurrence. Today's breakout therefore bears watching since it may
represent the first signs of this sector re-coupling with other
economically sensitive sectors. - D-S15HOME_Index.gif -

Although the performance of the US and emerging market equity markets has
been broadly similar in 2010 (the SPX is up 13.74% including dividends
while the MSCI Emerging Market index has risen 15.25%) the underlying
monetary conditions have started to diverge meaningfully across a number
of key markets. Our concern would be that this leads to a much greater
range of performance return going forwards, and one that will favor those
markets where money remains loose (such as the US) against those where
money has become considerably tighter. Tracking tightness this cycle is
likely to be made considerably more difficult by the widespread embrace of
"macro-prudential monetary policy" (we suspect given Wall Street's
laziness this will soon be shortened to MPMP) which eschews the simple use
of interest rates in favor of directly targeted measures. This means that
although economy-wide indicators will have to be followed it will be the
performance of the particular industries that are in the cross hairs of
Central Banks that will give the most accurate guide to future policy
shift.

One example worth following is Israel where the local real estate market
has begun to receive special attention from the local central bank (mostly
in the form of more stringent lending standards being required for
mortgages). As can be seen on the attached chart this shift in policy has
been accompanied by a very sharp slowdown in monetary growth with annual
M1 growth slowing from over 58% last November to just 1.55% one year later.
This stringency is yet to have an effect on either the local equity market
(the TA-100 index is up 13.38% YTD) or the overheated real estate market
(although transactional volumes have apparently dropped in recent weeks)
but assuming the BOI continues to mop up the excess liquidity created in
2009 one or other of these markets may have a more difficult time going
forwards. - M-ISMSL_Index.gif -

The reasons behind last Friday's announced increase of Chinese bank reserve
requirements became even more obvious later that evening with the publication
of November's CPI data. This was significantly higher than had been expected at
5.1% (consensus was 4.7% and only 3 out of 29 estimates were for 5.1% or
higher) and will increase the sense that local authorities have been running an
inappropriately loose monetary policy. Perhaps most troubling is the fact that
the acceleration of inflation over the last 12 months is 450bp (red line) which
is close to a record for annual change and suggests that further increases can
be expected in the immediate future. Interestingly Rural inflation is running
somewhat higher than Urban at 5.6%, with Food being a major input and
increasing 11.7%.

Meanwhile other metrics of economic activity continue to show a very rapid pace
of growth with Retail Sales up 18.7%, Industrial Production 13.3% and Fixed
Asset Investment 24.9%. The first 2 of these were in line with consensus but
Fixed Asset Investment is once more showing signs of re-acceleration from its
already lopsided level. The much famed ability of the Chinese authorities to
solve the riddle of business cycle management therefore seems to have been
overplayed. The current situation looks little different to other inflationary
bursts that have accompanied the final portions of numerous other cycles across
the globe in recent decades and presumably will elicit further policy response
before either running out of control or being tamed at the expense of a sharp
slowdown in growth.

With hikes in interest rates running counter to the wish to dampen appreciation
of the local CNY currency the temptation to introduce further
"macro-prudential" measures must be overwhelming at the current time. -
chinacpinov2010.gif

The treasury curve continues to unwind its highly unnatural contortion
that was caused by the massive inrush of capital during the run-up to QE2.
As we had expected this has resulted in sharp increases in yields in the
intermediate portion of the curve while the long bond remains fairly
stable between 4.00 and 4.50%. As a result the 30 to 10 year spread has
now collapsed from its peak of 160 bp to the current level of 1.13% with
its speed of decline being even faster than its hasty ascent. This sort of
disorderly reversal suggests that there is an element of stress present in
the treasury market (as does the very poor performance of many treasury
funds in recent sessions).
.
Unfortunately for those caught in the cross-hairs we would expect this
process to continue until this spread gets back to at least 100 bp (which
prior to 2010 represented the maximum divergence between 30 and 10 year
yields) but the possibility of a considerable overshoot down to as low as
75bp cannot be ruled out. If the 30 year bond were to stay below 4.50%
this would imply a 10 year note around 3.75% which would be right at the
top of our anticipated range of 3.25% to 3.75%. A higher 30 year bond
yield would allow the 10 year to move up accordingly and we would not rule
out a brief overshoot closer to 4.00% if things were to accelerate from
here.

On a separate note I would like to inform readers that I will be on the
road next week in Brazil visiting clients. While I will endeavor to write
on any major developments publication will be less frequent and timely
that when we are working from our office. - D-USGG30_Index.gif -

Last night saw both the publication of China's November monetary data and
the announcement that bank reserve requirements will be raised yet again
to 18.5%. Looking at the data first we see that M2 continues to force its
way higher, growing 1.5% in November and 19.4% over the past 12 months.
The 3 month RoC is growing at an annualized rate of 13.8% which suggests
that growth has moderated in recent months but we would caution that China
has typically seen its money supply surge at the starts of each year and
so no conclusions can really be drawn until the January data is published
in 2 months time. Loan growth also remains well above consensus at 564 Bln
CNY (consensus was 500 Bln) which matches the trailing 6 month ma and
would be consistent with mid-teen M2 growth going forwards.
.
Given the failure of China's authorities to cool lending the decision to
raise requirement once more to 18.5% can be readily understood. This is
not the same as saying it is a good idea. Our concern remains that
creative tightening, or "macro-prudential" central banking is creating
significant uncertainty as to the effect of new policy on economic
activity. Ultimately there will be a level at which reserve requirements
and other restrictions on lending (predominately targeting real estate)
start to prove to be unpleasantly potent and cause serious disruption in
local asset markets. The trouble is that highly speculative markets do not
readily repair themselves once they have started to collapse (the NDX for
instance continued to fall from 2500 in January 2001 to 804 in October
2002 while the FRB cut the FDTR from 6.50% to 1.75%). If the Chinese
authorities are indeed seriously in their intent to control monetary
growth and local asset markets then it is only a matter of time until they
are "successful". If on the other hand they simply serve to make "lip
service" then monetary growth will remain well above GDP growth and supply
sufficient liquidity to allow asset markets to continue their giddy ride
higher. Neither alternative strike us as representing the backdrop to an
attractive investment opportunity although the latter would at least allow
for "trading gains" while the band plays on. - W-CHRRDEP_Index.gif -
D-CNMSM2_Index.gif -

The October Wholesale Inventory data confirmed other earlier surveys of
industrial activity (most notably ISM data) in showing a continued surge
of both inventory rebuild and sales. Wholesale inventories jumped 1.9% in
October (more than double consensus estimates of 0.8%) while September's
data was revised higher to 2.1% from 1.5%. This takes inventories back to
where they were in January 2009 near the start of the massive drawdown.
Sales data was also very strong, rising 2.2% the best month since March
2010. This kept the inventory sales ratio at 1.18 which is still on the
low side historically. As can be seen on the multi-industry chart, the rebuild
in inventory/sales ratios is visible across industries. We would note that
apparel (green) has recovered the fastest (no doubt in part because it is
relatively easy to source additional product) while automobiles have moved
the least (very strong sales and relatively high barriers to increasing
production over the short term). Although today's data has been largely
priced in to the industrial sector's equity prices it underlines that the
4th quarter surge is rooted in strong fundamental data. - D-MWINTOT_Index.gif -
D-MTISAPPA_Index.gif -

The San Francisco FRB publishes a monthly tech pulse index which measures
economic activity in technology (employment, production, investment,
shipments and consumption being the metrics measured). November's data was
released yesterday afternoon and as can bee seen on the attached chart the
index has risen to 111.60, the highest reading since February 2001. As
would be expected there is a close correlation between the Tech Pulse
index and the direction of the NDX index. With the latter now challenging
its 2007 high (which conveniently was made on October 31st and therefore
is accurately shown on the attached monthly chart) it is very interesting
to note that the Tech Pulse index was only at 99.65 at that time and
subsequently peaked at 104.92 in December 2007. The breakout of this metric
above its 2007 peak supports our belief that the NDX index will follow suit in
the weeks ahead and acts as a reminder that the crisis of 2008 was economic and
not industrial in nature. - D-PULSNOMI_Index.gif -

As we describe in this morning's "Weekly Speculator" there has been a
considerable divergence recently of performance across the spectrum of
emerging markets. This is in marked contrast to the first 11 months of
2010 (and indeed most of 2009) when correlations of returns were extremely
close across geographical markets and suggests that investors are becoming
increasingly selective within this asset class. Consider for instance the
performance of Korea's KOSPI index and India's SENSEX (see attached). As
can be seen these markets moved in lock step until late September at which
point India became the clear favorite amongst major emerging markets and
started to outperform. We noted in late October a large number of Hedge
Fund and Mutual Fund commentaries that advised playing India as a "benign
bubble" as part of the basket of trades designed to benefit from the FRB's
introduction QE2. The SENSEX duly peaked at a new all time high on
November 5th (helped also by the local Diwali holiday which is a
traditional time to purchase equities) but since this time has been
dragged sharply lower by a growing corruption scandal regarding the
awarding of infrastructure projects. To our eyes the SENSEX now looks
quite vulnerable and has risen to the top of our global "watch list" for
weakness going forwards. By contrast the KOSPI was not singled out for
capital flows in the run-up to QE2 and we have seen few specific
recommendations of this market even though its YTD performance (up 18%) is
starting to outstrip other major markets. As can be seen the KOSPI has
managed to record a new recovery high in recent days even though the
overall EM complex has been quite weak. This has caused the relative
performance of the KOSPI versus the SENSEX to break out of its 2010 range.
Korea is of course much more sensitive to the strength of developed economies
than most emerging markets which is precisely why we favor it and others who
are more concerned about the state of the US, Europe and Japan do not.
With year end approaching it may be that Korea's popularity amongst EM
investors is about to increase considerably. - D-KOSPI_Index.gif -

The combination of a massive spikes in volume together with massive inflows
typically makes for toppy asset markets. This certainly would seem to be an apt
description of the EM debt arena which is suffering a very poor second half to
the 4th quarter.

We note that this morning Iceland's Central Bank lowered its base rate to
4.5% which is the lowest rate on record since our data begins in 1999.
The implications of Iceland's rapid recovery should not be lost since it
is in stark contrast to the state of affairs in Ireland and Greece
following their "rescue" by the ECB and IMF. From our perspective the
possibility of default either on sovereign credit or bank bond obligations
must be increased by the realization that restructuring may allow a
recovery to take place far faster than the "extend and pretend" policies
currently being followed. Without the existence of the Icelandic example
it would be possible to maintain the pretense that "there is no
alternative" but there is a very real alternative of organized restructuring
and it is must be looking more attractive by the day to the population of those
countries struggling under their current debt load. - D-ICBRANN_Index.gif -

Evidence continues to roll in suggesting that the global industrial sector is
experiencing a very strong recovery. The UK may largely be thought of as a
"post industrial" economy but it does still have a large industrial sector that
is globally integrated and a strong history of measuring its activity making it
a useful source of data. We were therefore interested to see the very large
improvement in the monthly CBI Order Book index which was reported this
morning. December's print of -3 compares to November's -15 reading and
consensus estimates of -13 and is the best reading since June 2008 (+1). As the
attached chart shows this index has improved by +39 over the last 12 months
which is close to a record and reveals the speed with which industrial activity
has mended itself over the last 18 months. There is little to suggest that this
is about to change in the immediate future and positive readings for this index
should be expected sometime in Q1 2011. - cbiordersdec2010.gif

We make no apologies for picking up where we left off last night since the
middle of the treasury curve represents by far the most interesting asset
market on our screens at the moment. Yields have continued to force their way
higher with the 5 year note up 9bp and the 10 year 7.6bp. Interestingly the 30
year bond yield has hardly budged causing the 30/10 year spread to collapse
down to 118bp, over 40bp lower than its remarkable record of 160bp recorded on
November 10th (see attached). We would expect this spread to fall back to a
more normal level of around 100bp quite quickly and would hold out the
possibility of something of an overshoot down to 75bp. This would allow the 10
year note yield to move up another 25-50 bp even if the ultra-long 30 year bond
yield stayed around the current level.
.
The potential for a significant uptick in yields is even more striking in
the 5 year note since the 5-10 year spread is itself at near record
levels. Even after its remarkable 84% increase since November 4th the 5
year note yield remains abnormally low at 1.84% (see attached) and still
implies a prolonged failure to recover by the US economy which runs contrary to
most data points that have been released since mid summer. Yields could easily
increase another 50-75 bp and still be considered to be at "normal recession"
levels.

Such an outcome would be quite problematic for a number of investors who poured
into this arena in the run up to QE2. Indeed we note that the total returns of
many bond funds and indexes have dropped sharply over the last month and are
now well below that of the SPX. If the current trend of stable to higher
equities and sharply rising yields was to remain in place through the end of
the year the final relative returns of US equities and fixed income
would be strongly skewed in favor of the former. The potential for a very
sizeable re-allocation of investment capital back towards the equity
market should therefore not be underestimated at the current time. -
W-USGG5YR_Index.gif - D-.30-10SP_Index.gif -

We continue to track the steady backing up of US treasury yields following
their low-point at the time QE2 was announced. As the attached chart shows the
10 year note has consolidated its breakout above the 3.00% and followed this by
breaking above its 200 day ma this morning to reach 3.12% (see attached candle
chart). We would describe this as a moderate technical achievement since the
200 day has only been of limited significance in recent months but more
importantly the yield would appear to have room to run with little resistance
between here and the 3.25% - 3.35% range and MACD indicating a powerful amount
of positive momentum is in place.

This would have important ramifications for the key "middle" of the curve (3 to
7 years) which has absorbed the bulk of the damage thus far. As the attached
chart of the change in the US yield curve since QE2 (white line on blue
background) shows, the greatest increase in yield has taken place in this
portion of the curve. The 5 year note for instance has risen 60 bp, which is a
60% increase over the ludicrous 1.01% yield recorded a month ago. Moreover even
after this spurt higher the 5 to 10 year spread (red line) remains at near
record territory meaning that any further increase in the 10 year yield should
be at least matched by the 5 year note. The last 30 days have already been a
difficult time for a number of closed and open ended fixed income managers and
we would be alert for further losses if yields do continue to force their way
higher. - D-USGG10_Index.gif - W-USYC5Y10_Index.gif - yieldcurvepostqe2.gif

The spot price of silver forced its way above the $30 level for the first
time since early 1980 this morning. Attached is a logarithmic chart of
silver going back to 1960 and as can be seen the acceleration of the last
few months compares to that seen in the early 1970's and the run-up to the
explosion higher in early 1980. We have not quite reached the velocity
seen in in the final blow-off rally caused by the Hunt's cornering of the
market but what we are currently witnessing represents a close second in
terms of the power of the speculative wave behind it. It therefore seems
pointless to talk about "value" or an index-linked price, which would
theoretically argue for a much higher peak in 2010 than the $49.45 that
was briefly experienced in 1980 (note the attached chart only shows the
monthly closing price). Silver is worth whatever those pouring money into
it are prepared to pay for as long as they are prepared to pay it (or can
afford to do so) and those who have chosen to fight its progress on the
short side have been taught a painful lesson along the way.

November was another very strong month for car sales in Brazil with total
sales coming in at 328K, a 30.5% increase from November 2009 and a new
record for what is traditionally a fairly sluggish month for car sales.
The trailing 12 month ma increased to 285K, also a new record. Today's
data is typical of the extremely buoyant data surrounding Brazil's
domestic consumption and underlines the need for tighter monetary
conditions going forwards. We may therefore have reached the point of the
economic cycle in which "good news is bad news" for the local equity
market since it will be seen as requiring harsher steps by the local
central bank.

Another sign of the rapid turnaround in consensus. Media coverage of the market
has become notably more pro-bull in recent weeks (see for instance the muted
reaction to last Friday's payroll shortfall). To an extent we would view this
as a long overdue re-alignment of commentary to match the performance of the
market and underlying economy. The attached article does a decent job of
holding some of the more alarmist commentators accountable for their comments
last summer but its publication also signals that the attraction of the US
equity market is less controversial than it was three months ago and that risks
have increased accordingly.

Google Said to Buy New York Building for $1.8 Billion (Update1)

A very significant transaction and although Google is undoubtedly a cash rich
buyer arguably in search of a trophy (albeit a decidedly eclectic one) there is
no reason to believe that they have paid an unrealistic price for the property.

 

In the latest Weekly Speculator we suggested that crude oil may finally be
ready to break out of its multi-month trading range and we note that the
last few days have seen strong inflows (which we assume are heavily
influenced by new allocations to the commodity index products) take crude
up to a new 2 year high at $88.80. If Crude manages to close at this level
it will be its best weekly close since October 2008. We would refrain from
getting too excited until crude puts some distance between it's price and
the breakout level ($90 would be a reasonable target) and would also want
to see crude's strength extend beyond the window of monthly allocations.
Nevertheless the early indications are that crude is heading higher and since
breakouts from prolonged ranges can often be quite powerful it should be
watched closely. - D-CL1_Comdty.gif -

At first glance October's Factory Order data would appear to be surprisingly
weak at -0.9% but the entire decline is accounted for by a large revision to
September's already strong data which was increased from +2.1% to 3.0%. As with
so much official data it is the TREND which matters and not the single data
point and the attached chart uses a 12 month ma and ROC to demonstrate the
(obvious) fact that US Manufacturing continues to improve rapidly with orders
currently growing 8.9% over the last year. Since we already have November's ISM
report "in the bag" it is fair to assume that this improvement has carried on
another month, no matter what the November Census Bureau data shows to have
happened one month from now. - usfactoryorders.gif

This morning saw another good report from the ISM Non-Manufacturing Index
with the overall index rising to 55 and strong readings in Business
activity (57) and New Orders (57.7) and an improvement in employment to
52.7. We do not hold this data series in anything like the regard of the
Manufacturing Index but we are still happy to see a well balanced metric
indicate an acceleration of growth in the US service sector. -
D-NAPMNMI_Index.gif -

As we have argued many times, trying to derive meaning out of a single
Non-Farm Payroll report is absolutely pointless given the volatile and
erratic nature of this data. This month's poor report of +39K additions
(compared to consensus estimates of 160K) comes in the face of numerous other
employment metrics that would suggest a far more robust rate of
improvement is taking hold. Given the high degree of visibility from other
data sources we would be particularly sceptical of data showing Retail
employment falling -28K and Manufacturing by -13K since the news from
these sectors suggests something very different is occurring. Nevertheless it
should be understood that this type of error is inherent in a large and
bureaucratic survey and the problem is more with the usage of this data than
its construction.

The only answer from our perspective is to use a sensible moving average
and wait for the inevitable revisions and overshoots to indicate the true
pace of change over the course of the cycle. We default to the 12 month
moving average but one could argue that 6 months would be sufficient to
smooth out the data. As the attached chart shows, even after today's data
the 12 month ma has moved higher to 90K, a level equivalent to Q1 2004.
The best use of today's data will be to judge the underlying strength of
both the US Treasury and equity markets. We are particularly interested in
the former since a failure to rally on this data would indicate that the
problems in this market are somewhat deeper than most people realize. -
M-NFP_PCH_Index.gif -

Brazil Raises Bank Reserve Requirements on Deposits (Update2)

Our thesis remains that unconventional monetary loosening in developed
countries (QE2 being the prime example) will be matched by equally "creative"
tightening measures in emerging markets. Today saw another prime example with
Brazil announcing a steep rise in reserve requirements to 20% for time deposits
(from 15%) and 12% for cash deposits (from 8%). Most importantly we note the
following comment from Central bank President Meirelles:

"It would be prudent to not dissociate these MACRO-PRUDENTIAL MEASURES from
conventional monetary policy actions. They are complementary
channels used in different situations."

We noted earlier today a sizeable improvement in US Pending Home Sales for
October. Driving this improvement has been a surge in the affordability of
housing, which in turn has been driven by a combination of stagnant
home-prices (following a steep fall in 2006-8) lower treasury interest rates
and very tight mortgage spreads (readers may recall that we highlighted
the very unusual move of the Fannie Mae 30 year fixed mortgage rate below
the 30 year Treasury yield a few weeks ago). Today's publication of the NAR
Home Affordability Index shows the effect of these changes, with the index
surging to a new all time high of 184.2 in October. Even though we
ourselves would expect to see treasury yields back up (and mortgage rates
with them) this should still maintain the affordability of housing within
this historically high range. With employment data also improving along
with the personal income of those employed it is increasingly unlikely
that we will see a further leg down of national home prices going forwards
or a collapse in transactional volume. - D-AFFDCMOM_Index.gif -

The roughly six month "home sale hangover" caused by the expiration of tax
credits would seem to finally be behind us as October saw US Pending Home
Sales surge by a record 10.4% to 89.3. Although the 6 month ma continued
to decline to a new record low of 80.78 we would expect this more reliable
indicator to turn higher going forwards and for sales to settle in the
range between 82.5 and 92.5 which contained the data prior to the
introduction and expiration of tax credits artificially boosting and
depressing sales. This would suggest that existing home sales (red line)
will move back up to around 5mm units which is approximately where they
were in the early 2000's. Although this is far from boom conditions it
would represent a reasonably healthy market and sufficient activity to
steadily clear the large pipeline of inventory that remains on the market
and trapped in the foreclosure process over the next few quarters without
requiring a further leg down in home prices. - D-USPHTOTL_Index.gif -

With the world's attention very much on the FRB and ECB it has gone
largely unnoticed that the BOJ has been quietly turning on its own
monetary spigot in recent months. Last night's release of the November
monetary base data showed an increase of 0.37% in what is historically a
fairly weak month. This takes the 12 month RoC up to 7.57%. close to its
crisis peak of 8.22% recorded in April 2009. Of course this is still only
a fraction of the monetary growth seen in any other major country but it
should be noted that Japan suffered a strictly INDUSTRIAL crisis in
2008/9, with its large financial firms left largely unscathed (itself a
reflection of the fact that they have been globally irrelevant for over 15
years). We would also note that the Japanese equity market held up much
better than most during the recent bout of turbulence and would credit
some of this resilience to an improvement in local liquidity levels. A
continued boost to the monetary base that took annual growth to double
figures would probably be accompanied by a more robust performance by one
of the world's most forgotten markets. - M-JNMBMOB_Index.gif -

The headline Initial Jobless Claims data was reported at 436K, slightly
higher than the consensus estimate of 424K and a rise of 26K from last
week's (revised) total of 410K. Claims data at this time of year is
particularly volatile due to large seasonal adjustments and so attention
should really be limited to the more reliable 4 week ma (see attached)
which continues to show good downward progress falling to 431K, the lowest
reading since August 2008. This therefore represents a significant
improvement in Claims data since the last non-farm payroll report was
issued. In an ideal world this would give us some insight into tomorrow's
data but although it raises the odds of a favorable report (consensus is
for a rise of 155K) the erratic nature of this data on a month-by-month
basis in no way guarantees this will occur. - D-INJCJC4_Index.gif -

We were remiss in not publishing a note on the MBA Refi index yesterday
but since the very large drop in activity hardly received any attention we
will address it today. As can be seen on the chart the index fell 21.59%
to 2974.40, the lowest reading since early June. This clearly marks the
end of the 2010 refi-boom which, as we had pointed out before, had already
run on considerably longer than many of its predecessors. This is
important since it signals a substantial reduction in demand for
intermediate treasuries from duration hedging of MBS portfolios. As would
be expected this drop off in refinancings has coincided with a rapid move
higher by the middle of the treasury curve. We explained at length last summer
how refinancing cycles and treasury curves reinforce the magnitude of each
others moves in both directions. The astonishing drop in the 5 year treasury
note yield to 1.01% on November 4th strikes us as the "sweet spot" for
over-specualtion and we are therefore hardly surprised to see yields back up to
1.69% just over 4 weeks later. - D-MBAVREFI_Index.gif -

Our view on the Federal Reserve's Beige book is that while its value as a
forecasting tool is highly questionable since it forms the basis for
discussions at the regular FOMC meetings it is worth monitoring for insight
into the FRB's appreciation of the state of the economy (this should never be
confused with the actual state of the economy).

We were particularly interested in looking at today's publication
(http://www.federalreserve.gov/fomc/beigebook/2010/20101201/default.htm) since
it is the first to be issued following the decision to embark on QE2 and comes
after a series of postive macro data points from the FRB's own internal
statistics. As would be expected this is reflected in a much better tone to the
report with 10 out of 12 Districts reporting broadly positive trends in
economic conditions (Philadelphia and St Louis were merely "mixed") and 5
Districts reporting a "somewhat stronger pace of economic activity" (New York,
Richmond, Minneapolis, Chicago and KAnsas City). Notably absent is any mention
of the phrase "double dip" or the "widespread signs of deceleration" that were
reported in September's edition.

November's ISM Manufacturing report was another solid report that came in just
above to expectations at 56.6. Although this represents a small drop from
October's reading of 56.9 since because this is a diffusion index Manufacturing
continues to grow quite rapidly. New Orders (red) at 56.6 shows another strong
month at the key "front line" of wholesale demand while Production also grew
strongly at 55. Both these numbers are somewhat lower than October's extremely
high readings but this drop off this should be expected to occur. The real
upside surprise was in Inventory which at 56.7 is the strongest reading since
July 1984. This confirms our thesis that the unusually deep and long-lived
inventory drawdown in 2008/9 is now translating into a very powerful commitment
to rebuild depleted inventories. Interestingly Customer Inventories (not shown)
remain slightly negative at 45.5. Finally employment (pink) posted another
excellent reading at 57.5 indicating that Manufacturers continue to seek to
hire additional workers. The only caution that we would issue is that today's
data is no longer a surprise with consensus finally starting to embrace the
idea of a sustainable recovery in US Manufacturing. We still think that the
overall economic consensus underestimates the scope for recovery but this is
clearly less true than it was 60 days ago. - ismmanufactnov10.gif

More positive payroll data was supplied by the November ADP Employment
Change report which estimated payrolls increased by 93K, well above the
consensus estimate of 70K. Furthermore the October data was revised much
higher to 82K from the original reading of 43K. This takes the 6 month ma
up to 51.5K, which is broadly comparable with its level in Q4 2003. Given
the rapid pace of repair to this data (October 2010 is 242K above its
level 12 months ago) we would hope to see continued strong gains in the
months ahead. Readers should however recognize that this data is volatile
and subject to large revision. The dangers of a negative monthly "data
shock" are therefore also increasing as consensus estimates for employment
are starting to be adjusted significantly higher. Today's data is also of
little use for forecasting Friday's more important Non-Farm payroll report
since both use different methodologies to create rough and volatile
estimates. As a result although over the course of a cyle the twwo indicators
follow each other reasonably closely but in any single month they can diverge
markedly.
.
Meanwhile the Challenger Job Cut report showed a small uptick in announced
firings in November after month's of very low reports. This takes the 6
month ma up to just below 40K, a figure quite low enough to allow for
substantial payroll gain in the overall economy. - D-ADP_CHNG_Index.gif -
D-CHALTOTL_Index.gif -