We continue to follow Turkey closely since we believe it may represent an
important leading indicator of a potential longer term deterioration in
the emerging market complex. Earlier today the June trade data was
released which at -$10.2 bln managed to surpass even the dismal consensus
estimate of a -$9.5 bln. This takes the trailing 12 month ma down to
-$8.077 bln, per month, or a total of $96.92 bln over the last year. Note
that this data was released prior to the sharp decline in the TRY, which
will increase the cost of imports and decrease the value of exports over
the short term, further putting pressure on the patience of investors. It
should be recalled that the initial deterioration in Trade data at the
start of the year was treated as an aberration by most observers, but as
the months have rolled by their has been a growing realization that
Turkey's economy is overheating to a degree that can be considered to be
alarming.

It is important to understand that this economic mismanagement stems from
a political imperative, namely to keep the economy strong while
negotiations take place over a vital rewriting of the country's secular
constitution take place over the summer. We were therefore interested to
see that the country's chief of staff resigned suddenly this evening
(Turkish time), as did the chiefs of the army, navy and air force. This is the
first time a co-ordinated resignation of this manner has happened. Coming
on top of troubling economic data this sign of growing political
instability can only put further pressure on Turkey's asset markets. -
D-TUTBEX_Index.gif -

July's Chicago PMI report came in at 58.8, slightly less than consensus
expectations of 60. Given the beating that participants' psyche has just taken
from the GDP report any further miss from economic data is unwelcome, but this
is in fact a fairly solid report that is consistent with decent growth in the
industrial sector.

The overall index is still very much in expansion territory and although the
very quick burst seen a few months ago has clearly moderated this is hardly
surprising. New Orders (red) also remained strongly positive at 59.4 while
Productions (blue) was somewhat stronger at 64.3. Inventory rebuild (olive) was
modest at 53.2. The only disappointing report came in the form of Employment
(pink) which although still positive at 51.5 was somewhat lower than recent
reports. We now await the much more important national ISM report which is due
to be released on Monday.

- chicagopmijul11.gif

It is one of the unfortunate truths about top down analysis that the more
encompassing a piece of data the less useful it tends to be for gaining an
understanding of a cycle and making actual investment decisions. This of
course runs counter to the general consideration of data in both the media
and mainstream research, but while a large headline piece of data such as
today's GDP report will drive market allocations over the short term it
will have surprisingly little relevance after its initial shock has worn
off and will be even less use for assessing the actual level of activity
within the US corporate sector.

Consider for instance the Personal Consumption portion of the GDP report
which accounts for approximately 70% of the total reported figure. One
would imagine that this figure would be a helpful guide to the health of
the US retail sector which gains all of its sales from this portion of the
economy. Interestingly a comparison of the personal consumption data to
the performance of US retail stocks shows only an approximate relationship
exists between these measures. There have been periods of very strong
personal consumption data combined with weak retail performance
(1992-1996) and period such as the last 24 months which have seen well
below trend personal consumption data combined with a very strong
performance by the retail sector, both in terms of share price performance
and actual sales. The same would be true of other portions of the report
which in general is a significantly overrated set of data so far as
forecasting is concerned.

This is not the same as saying that it is irrelevant. Today's poor report
will act to further depress investor sentiment towards the US economy and could
not be worse timed coming in the middle of the fractious debt ceiling
debate. We are not surprised that the market's initial response has been
to sell off hard with the SPX testing important support at the 200 day ma
which thus far has held. No doubt these figures will now find their way
into a myriad of models and lead to a moderation of already tepid
forecasts of US growth. Should this extend towards the cutting of year end
estimates for the equity market by a number of prominent firms we would
be relieved, since this would suggest somewhat nearer to the end of this
corrective phase. From our perspective this report gives no reason for
patient investors to avoid equities whose recent earnings withstand a
rigorous bottom up analysis and fortunately this includes a significant
portion of the US equity market. - D-GDPCTOT_Index.gif -

US Pending Home Sales remained steady in June, the seasonally adjusted
index rising 2.4% to 90.9 (2001 Sales = 100). This was a little better
than consensus, which was for fall of -2.0%. Given the volatile history of this
data series this is clearly only a marginal "positive beat" but June is
historically the strongest month for Pending Sales and that does add a
little importance to this release. In any case the 6 month ma remained
virtually unchanged at 88.8 and so today's data continues the run of
housing related releases that suggest that we are bumping along the bottom
of the current cycle. If hopes of a 2011 housing recovery have largely
been dashed, it is equally true that fears of a further leg downwards for
the housing market seem equally unrealistic. This is a more positive
situation than most observers realize since over time the absorption of
distressed units, which is taking place even at current sales volume, will
shift the odds in favor of the bulls even if this process now looks likely to
take somewhat more time than we had originally hoped. - D-USPHTOTL_Index.gif -

This week's Initial Jobless Claims data offered the first suggestion that
the abrupt deterioration in this metric may finally have run its course.
Total Claims fell 24K to 398K, the best reading since April 1st and
comfortably below consensus estimates of 415K. This took the 4 week ma
down to 413.8K, its lowest reading since April 29th. As the attached chart
shows, this metric has recorded a considerable improvement in recent weeks
since topping out at 440.3K on May 13th, and it is starting to look as if
the surge in Claims may prove to be less permanent than many fear. It is
in fact fairly normal for this data to deteriorate abruptly during a long
trend of improving data (we highlight three other instances from each of
the last three cycles) only to force its way lower after an interval of
several months. Whether this is because of a true change in the pace of
hirings and firings or an aberration in the estimation of Claims from a
limited sample size is open to question, although we favor the latter. One
additional positive factor in today's data was the fact that "raw"
non-seasonally adjusted data improved very strongly to 366K, a drop of
104K. As the attached chart shows this takes the current Claims data back
below the rolling 5 year ma of NSA Initial Claims, and suggests that the
BLS may actually have been a little conservative in releasing its headline
number. - D-INJCJC4_Index.gif -

Brazil's increasingly fractious fight against currency speculation took
another turn this morning with the announcement that a 1% tax on
derivative transactions on short USD positions. Given that today's measure
allows the tax to be raised up to a maximum of 25% it would appear that
the marketplace is being effectively "warned" to curb its behavior ahead
of a far more restrictive level of taxation being introduced. In writing
this we are reminded of the unfortunate "pea shooter/bazooka" analogy
employed by Henry Paulson early in the sub-prime crisis (we joked later on
that this military build-up ended with employment of the "loose cannon")
since in our experience once extreme measures are considered there is a
natural momentum towards their implementation. All that can be said at the
moment is that speculative flows (which are increasingly directed towards
Brazilian corporate and sovereign credit) have driven the BRL to its highest
level since the collapse of the currency at the start of the century. Although
the BRL has weakened by 1.81% today it is hard to see this current move in
itself bringing this process to a close. We would therefore expect to see
a series of "Derivative Tax" increases implemented.

What today's announcement does do, however, is indicate an ever broadening
of macro-prudential measures designed to cool the Brazilian economy
without causing a collapse in either activity or local asset values. Each
time a new measure is introduced it increases the complexity of the task
facing the local monetary authorities, and increases the likelihood that
measures will ultimately overshoot their intended consequences by some
margin. To some extent this can already be seen to be true of the local
equity market which is one of the worst performing global markets so far
this year. As the attached chart shows, the IBOV has recorded a series of
new 2011 lows in recent weeks and is currently down 15.5% YTD (10.39% in
USD terms). Although some headlines have pointed to the fact that the
index is now 20% below its 2010 high (and thus in a "bear market") it
remains above key support at the May 2010 low that would really need to
break in order for this to qualify as such in our eyes. So far Brazil has
proved to be a "momentum trap" for investors who chased the market higher
during the second half of 2010, but this poor performance is yet to lead
to any large-scale reallocation of capital away from this equity market.
Historically the surest way to weaken a currency has been to break the back
of the local equity market. Although this surely cannot be the intended
"solution" sought by the local authorities it is a risk that they are taking at
the current time. - D-BRL_Curncy.gif - D-IBOV_Index.gif

It has been a busy morning in Brazil with the monthly loan data being
released and a new macro-prudential measure aimed at controlling
investment inflows (this will be discussed in a separate note). Looking at
the loan data we can see that credit growth in Brazil continues to remain
brisk with the annual growth rate remaining steady at 20.8%, far in excess
of nominal GDP growth. Housing credit continues to be the notable outlier,
growing at 3.76% last month and 50% over the last 12 months. Housing
credit has now reached 15.8% of total Private Sector loans, over twice the
2007 low point of 7.45% (see chart). Although the penetration of mortgage
credit can still be considered to be unusually low in Brazil a very
rapid expansion of this nature is almost certainly leading to some
deterioration of underwriting standards. Certainly the Bank of Brazil can
take no comfort in today's data which shows very little response by credit
markets to their multiple tightening moves. We continue to expect further
initiatives which are increasingly likely to involve non-interest rate
moves (more on this in a separate note to follow).

Meanwhile the monthly delinquency report suggests that the sudden
deterioration in non-performing loans registered last month was not an
aberration. Total loans 90+ days due remained at 6.40%, causing the 6
month ma (our favored metric) to continue to track higher at 6.067%.
Further evidence that loan conditions are deteriorating came in the form
of Santander bank's earning statement, which highlighted an unexpected
increase in Brazilian bad loans as a cause of a profit shortfall from
their local subsidiary. We continue to believe that there is considerable
scope for further deterioration of credit performance in the months ahead. -
D-BZLNPTOT_Index.gif - D-BRCDDEFT_Index.gif - D-.BZHOUS_Index.gif -

US New Home sales for June were reported in line with expectations, with
total sales of 312K close to the consensus reading of 320K, while last
month's number was revised down slightly to 315K. This continues the
string of extremely low activity reports seen since April 2010 and
suggests no improvement in the New Home market has taken place in 2011.
The non-seasonally adjusted sales came in at 29K, unchanged from last
month. Since June normally sees a marked drop off in sales this is
perhaps a sign that the seasonal patterns of this industry have become
much less influential at current depressed volumes and if this is the case
the headline data may show some improvement later in the summer. Even so
the improvement would be modest, should the current month's sales be
replicated over one year this would still only take the annual rate up to
348K, under half of the average historic sales rate. Once more the only
positive data in the report was inventories, which fell to a new all time
low of 164K homes or 6.3 months of sales. Of this only 60K homes are
completed, a sign of how lean this industry has become in recent months. -
D-NHSLNFS.gif - D-HSMNTOT_Index.gif -

In a move that surprised the market the RBI chose to increase its
benchmark REPO Cutoff yield by 50 bp to 8.00%, rather than the 25bp hike
that had been universally expected. In doing so the RBI sent a clear
message to the market that it intends to combat inflationary pressures
with an increasingly aggressive monetary policy. The accompanying
statement made it clear that the departing RBI Chairman views controlling
inflation as the primary aim at the present time, and chose to comment on
the "large fiscal deficit" that needs to be counterbalanced by a more
restrictive monetary policy. Unsurprisingly this news led to a decline in
the local SENSEX, which dropped 1.86% to 18,518. This still keeps the index
within its current trading range and we doubt whether the immediate
response of the equity market will be to break-down further. What is more
important is the medium term implications of today's move. Portions of the
Indian economy were already showing signs of strain following the increase
in local interest rates that has taken place over the last 15 months. An
acceleration in the pace of increases therefore raises the stakes somewhat
and it is now possible to imagine a REPO yield close to the 2008 maximum
of 9.00% by the end of 2011. Our view remains that tightening cycles such
as this typically run their course until clear signs of disruption start
to emerge. Today's announcement raises the odds that India will follow
this familiar course. - W-INRPYLD_Index.gif -

We have followed Turkey closely over the last 9 months since it was our
belief that the highly unusual mix of monetary and fiscal policy was
likely to fray the confidence of market participants and lead to an exit
of investment capital. It would seem that last week's meeting of the
central bank was something of a break-point for many investors, with not
only rates being kept on hold but the possibility of a reduction in rates
being considered later in the year. Comments that the Turkish lira would
be used as a lever of adjustment for the local economy did not fall on
deaf ears either, and the reaction of the FX market has been swift and
punishing. As the attached charts show, the TRY has now broken through the
1.70 level and at the time of writing is 1.7244. This level is still
approximately 2.5% below the maximum rate reached in the 2006 mini-blow up
(which was caused by massive FX speculation being forcibly unwound without
any fundamental catalyst) and approximately 6% below the rate reached at
the peak of the Lehman crisis. However, the USD rate does not show the
scale of destruction against other major currencies. In Turkey's case the
EUR is a much more important relationship and here we can see that the
TRY/EUR rate has forced its way to a new record low in recent days, with
the 2008 extreme reading of 0.425 being easily surpassed this morning. The
important "round number" at 0.40 now looms into view.

This weakness has apparently caused some alarm within the central bank,
since this morning came the announcement of limited currency intervention
($30mm) together with the easing of the reserve requirement for banks
holding foreign exchange. Neither policy strikes us as sufficient to turn
this tide and we would expect the TRY to have a hard task regaining its
lost ground, particularly if the perception of heightened currency risk
leads to a liquidation of local equities and bonds by foreign investors. A more
important question is whether the disruption in Turkey marks something of a
turning point for EM overall, or if it will remain isolated as a "special case"
at the margins of investors' concerns. - D-TRY_Curncy.gif - D-TRYEUR_Curncy.gif
-

In what, despite the headlines, has been a generally quiet end to the US
trading week it is worth noting that the NDX index has managed to push up
to a new 10 year high this morning, reaching 2424.41 at the time of
writing. Since there have been multiple attempts by the NDX index to push
and hold above 2420 since last February we would not yet call the current
break-out decisive, but at the very least it shows that this portion of
the US equity market is currently acting as leadership for the first time
in several months. Of particular interest is the fact that the recent
advance has taken place "issue by issue" following generally strong
earnings by most large technology concerns. In most cases investors have
waited for results to be announced prior to chasing prices higher,
suggesting that earnings have beaten market expectations comfortably
(simply beating sell-side consensus earnings does not guarantee this will
be the case). This is precisely the sort of "bottom up" buying force that
is required to overcome the heavy macro headwinds that have becalmed most
of the global equity market in recent months and is far more likely to
lead to sustained gains than a knee-jerk response to the latest
pronouncement from Washington or Europe. We will be watching this index
closely next week to see if this proves to be a decisive breakout or
simply another minor gain to be followed by further consolidation. -
D-NDX_Index.gif -

Despite clear signs of an overheating economy Turkey's central bank
elected to keep interest rates on hold at 6.25% and even suggested that
rates could be lowered if"problems in the developed economies deepen". Although
this decision was anticipated it would appear that the central banks comments
have started to fray at the nerves of investors who are currently only too
mindful of how prior cycles of excess have ended in countries a few hundred
miles to the west.

Our own view is been that Turkey's government and central bank have been
pursuing a "neo-Peronist" experiment for several years, with easy monetary
and fiscal conditions leading to a boom that helped burnish the competence
of an increasingly authoritarian regime (we would describe the governing
party as being "Islamo-Democrats" much in the way that Peron led a
"Christian Democratic" party in Argentina). It would seem that others are
beginning to appreciate this viewpoint with the continued promise of easy
monetary policy and fiscal largesse starting to unnerve the marketplace.
This is of vital importance since the enthusiasm of foreign investors has
been a key factor in allowing this process to continue as long as it has,
with a 9.8% current account deficit being funded by powerful inflows into
Turkish debt and equities.

This makes the Turkish lira unusually vulnerable to any reduction in
foreign flows, and it is little surprise to see it weaken to a new 2011
low of 1.678 this morning. Other bouts of RTY weakness in 2006 and 2008
have taken the currency to the 1.75 - 1.80 range and this would seem to be
a reasonable target for the current move. One significant difference is
that the current weakness is far more attributable to specific issues
within the Turkish economy, making the loss of value in the TRY much less
likely to be reversed quickly once a period of crisis has passed. The
local equity market also remains under pressure, with the XU100 index
trading down as low as 59,434 this morning before bouncing to 60,675 at
the time of writing (down 1.59% on the day). As can be seen on the
attached weekly chart the area around 60,000 represents important long
term support for this index and a failure to hold would leave investors
groping for support some 10-15% lower. - W-XU100_Index.gif -

The Existing Home Sales report makes for interesting reason since although
the overall headline number shows little improvement there is some sign of
potential shift in some of the secondary data. Overall Sales were
estimated at 4.77mm units, just below last month's report of 4.81mm and
below consensus of 4.90mm. We would not make too much of either miss since
they are well within the error rate of this data. Single Family sales came
in at 4.24mm (identical to last month) causing the 12 month ma to tick
down to 4.28mm units (see chart). This keeps the pace of existing home sales at
the same level as was seen during the late 1990's. Condo sales were somewhat
worse, falling 40K from an annual pace of 570K to 530K. This takes the
share of condo sales down to 11.11%, the lowest reading since May 2009
but even though condo-sales were trimmed, the inventory of unsold condos
fell very sharply to 452K units, and this inventory has now dropped by
21.66% over the last 12 months. We would caution that this metric is very
volatile, but its seasonal pattern does not normally cause a sharp
drawdown of inventory in the early summer (unlike the December/January
months when there is a dearth of new listings). We would therefore watch
this number quite closely going forwards. Finally the average and median
selling prices of new single family homes and condos all were sharply
higher. This time the seasonal influence is clearly in favor of the data,
with prices typically peaking in June or July (we have no idea why but this
pattern occurs but this trend is clearly visible in the data). Even so the
sharp rise in prices remains statistically notable, with the average selling
price for a Single Family home in June 2011 reaching 237.3K, the highest
reading since August 2008. None of this amounts to clear evidence of
recovery, but equally the data runs against any notion that the US housing
market faces a "double dip" or has deteriorated substantially in recent
months. - D-EHSLSL_Index.gif - M-EHSLAP_Index.gif - M-ECSLHAFS_Index.gif -

June's Housing Start and Building permit data echoed yesterday's NAHB
survey in that while it still historically dreadful data, it is at least a
little better than consensus and shows that the New Home industry has
arguably finally stabilized. Total Starts were estimated at 629K, beating
consensus estimates of 575K and 80K higher than May's pace of 549K
(revised lower from 560K). The bulk of this improvement was caused by the
multi-family starts popping by 40K and activity in this area continues to
run ahead of single family construction (see chart).

Our favored metric is Single Family Permits. These were virtually
unchanged at 407K, still well below their 36 month ma of 442K which would
be the minimum improvement needed to signal a meaningful recovery is
underway. On the other hand given the ravages of the last 5 years the
creation of stability is an achievement of some note and we continue to
see the very depressed level of the New Home industry as a "wild card"
that is more likely to help rather than hinder the US recovery going
forwards. - D-NHSPA1_Index.gif - D-NHSPSTOT_Index.gif

Home-builder sentiment remains awful but at least July's data showed a modicum
of improvement over recent months. The overall index rose 2 points from 13 to
15, as did Present Sales. These are both extremely low readings that still
suggest a moribund New Home market. Significantly better data was reported in
Future Sales which recovered to 22 from its slump last month at 15. Traffic
remained unchanged at 12, suggesting that a qualitative improvement in
potential buyers may have taken place. Nothing in today's reports suggests that
either New Home Start or Sales data for June will shock to the upside, but at
least it does suggest that things have stopped getting worse for this troubled
industry. - nahbsentimentjuly11.gif

We continue to track the growing divergence in Euro-zone yields and there are
now 4 distinct groups of nations within this increasingly fractious monetary
union.

Greece, Ireland and Portugal all trade at yields that show a clear risk of
imminent default (17.1%, 13.5% and 11.9% respectively) but are not where the
really troublesome move in recent yields has occurred. This is in the next tier
of nations which currently includes Spain (red) and Italy (black), now 6.3 and
6.0% respectively. Both countries therefore now have long term interest rates
at post-Euro records, although both yields are still well below the nominal
rates and spreads seen when they operated as stand-alone nations (see chart).
Belgium (4.35%) appears to be the country at most danger of being pulled into
this group of troubled debt markets.

Below this group can be found nations such as France (blue) that while thus far
untroubled by the recent dislocation have not seen their bond market attract
"flight to safety" capital. This should certainly be seen as RELATIVE weakness
given that other nations, most notably Germany (green) and the US (not shown)
have seen long term yields forced lower in recent weeks. As can be seen on the
attached chart the post-Euro relationship between Germany and France has
completely broken down in recent weeks, with the spread widening to a very
considerable 70bp. Again this is well below the maximum divergence seen prior
to the Euro but it is another sign that the 11 year suspension of disbelief
drew to a decisive close last spring-time. Even if this current episode can
somehow be contained by the up-coming summit the idea that German and French
log term bond risk is equivalent will be a hard sell in today's jaded markets.
- germanfrancespreadjuly18.gif - euroyieldsjuly18.gif

July's University of Michigan Consumer Confidence Index showed a sharp drop in
sentiment with the index falling to 63.8, the lowest reading since March 2009.
As we have explained before, this in no way indicates a change in the expected
behavior of consumers, or their aggregate expenditure, but it does show a
somewhat surprising degree of reaction to what has been a mere failure of data
to meet consensus rather than the deep recessionary figures being released back
in March 2009.

Of course from our perspective this is a bullish sign. Consumer Confidence
follows developments in economic data and political events (we would imagine
that the debt ceiling debate has been a considerable influence on this month's
data) but has little predictive capability and July's collapse in confidence is
an overreaction that is likely to be reversed before the summer's end. To the
extent that a sharp move in confidence influences investment decisions (and we
believe there is a linkage), today's data suggests that retail investors may
have taken some action to lighten up on US equity holdings. This would
certainly tally with the ICI fund flow data which has remained in negative
territory. This again would be a medium term positive for the domestic equity
market. - conssentjuly11.gif

We have commented on the continued flows out of US Domestic Equity Mutual funds
a number of times over the last 18 months and the attached Bloomberg
Businessweek article

(see also link to chart of data:
http://images.businessweek.com/cms/2011-07-14/mf_fundflows30__01__popup.jpg )

is a good summary of the massive shift in investment allocation over the course
of the last decade. While the article muses whether this represents a permanent
shift if investor choice (And investment opportunity) we would argue that it is
an extreme position typical of the end of a long period of obvious
outperformance (by bonds, non-US equities and commodities). In fact one of the
most positive arguments one can make about the durability of the post 2009 bull
market is that it has come in the face of continued liquidation by retail
investors, and that any re-allocation back towards the domestic US market would
represent a meaningful change in the balance between buyers and sellers.

We are taking this opportunity to point out the remarkably placid reaction
of the long term treasury market to the flurry of headlines relating to
QE? (our latest contribution to the ever growing nomenclature of this
messy period) and the US Federal Debt Ceiling.

Looking at the case of the debt ceiling first we would make the point that
however unpleasant it is watching the US Congress and Senate "debate" this
issue and whatever the uncertainty surrounding the eventual outcome, the
fact that this process is required under US law is one of the great
STRENGTHS of the US funding system. There is something surreal about
ratings agencies issuing high-minded threats to downgrade the US debt
rating based on a failure to extend the ceiling higher, when those same
agencies would be silent on this issue if the Treasury simply had the
ability to issue debt this summer. Clearly it would be preferable to have
a deal thrashed out by the deadline, and for this deal to include some
much needed fiscal rectitude, but from a bondholders perspective even a
messy stand-off is preferable to simply allowing government spending to
increase without public debate and legislative constraint. This would be true
even at the cost of delaying an interest payment, since this process is
ultimately beneficial to the ultimate credit-worthiness (as opposed to
artificial rating) of the country's treasuries.

As to QE? we frankly wonder what all the fuss is about. Firstly the
importance of QE2 (both its necessity and ultimate effect) have been
grossly overstated. As we (and some others) have pointed out since the
start of 2011 the entire increase in FRB Treasury holdings has been
accounted for by an identical increase in Commercial Bank Reserves held at
the FRB and the matching entry of cash on commercial bank balance sheets
(see attached chart). With Reserves now $1.6 Trln (over 10% of GDP) and
Cash and Treasury holdings now 39.8% of Commercial bank Balance sheets it
is hard to argue that there is any point in pushing more sums down this
path. As to QE2's actual effects on the US economy, we believe these were
extremely limited, with the sizeable improvement in US macro data largely
being a quirk of (mis)calculation of official data over the summer and
possibly some pent-up capital spending being released by the simultaneous
mid-term election and extension of Bush-era tax credits.

As to today's economy, we remain much more sanguine than most observers. We
see no realistic risk of a "double dip" and expect to see confirmation
that most domestically focused US corporations continued to generate
strong earnings in Q2. The need for another bout of QE is therefore
grossly overstated and we are pleased to see that Chairman Bernanke has
taken a couple of steps back from suggesting this was required during his
testimony to the House this morning.

Regarding the long end of the curve this seems likely to remain well bid
until the current concern over economic performance has subsided. Should
sentiment start to become more constructive we would expect to see a
sell-off in treasuries similar to that of last fall and winter, but it is
hard to see a 10 year note yield above 3.75% being sustained until a new
tightening cycle is entered into by the FRB. - D-USGG30_Index.gif - qe2.gif

The attached Bloomberg © Chart of the Day column echoes a point we have made
many times in recent quarters regarding the robust performance of US consumer
stocks. It is interesting to note that this sector is slowly transforming
itself from a pariah to its more traditional place as a core holding of a
balanced portfolio, a process that should benefit equity values over the coming
months as greater capital allocations are directed to this area of the market
(chart attached for non-Bloomberg users).

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

Consumer-Stock Rally Defies More Joblessness: Chart of the Day
2011-07-13 04:01:00.2 GMT


By David Wilson
July 13 (Bloomberg) -- Apparel retailers, restaurants and
other companies most closely tied to consumers’ discretionary
spending have risen to record highs in the U.S. stock market
this month even though unemployment is climbing.
As the CHART OF THE DAY illustrates, the performance is at
odds with historical precedent. The chart compares the Standard
& Poor’s 500 Consumer Discretionary Index with the jobless rate
every month since June 1992, when unemployment peaked after the
1990-91 recession. The equity index climbed to a record on July
7, the day before the U.S. Labor Department said unemployment
rose for the third straight month to 9.2 percent.
This seeming contradiction reflects a gap between “Haves”
and “Have-Nots” in the American economy, Edward Yardeni,
president and chief investment strategist at Yardeni Research
Inc., wrote yesterday in a report.
“The Haves have jobs and are spending money,” Yardeni
wrote. Their outlays are reflected in consumer-discretionary
companies’ revenue and earnings as well as their share prices,
the report said.
“The Have-Nots are struggling,” Yardeni said. “Many have
lost their jobs in previously booming industries that have gone
bust.” He singled out construction as well as state and local
governments, which have cut workers to close budget deficits.
Spending cuts by lower-income consumers have hurt Wal-Mart
Stores Inc., the world’s largest retailer. Sales at U.S. stores
open at least a year have fallen for the past eight quarters.
Wal-Mart’s shares have risen less than 0.1 percent this
year. Target Corp., the country’s second-largest discount chain,
has declined 15 percent. Both are trailing the S&P 500 consumer-
discretionary index, which has gained about 8 percent.

For Related News and Information:
Unemployment rates: ALLX USUR <GO>
Economy top stories: TOP ECO <GO>
U.S. stock strategy: TNI USS STRATEGY <GO>
Stock-market top stories: TOP STK <GO>
Charts, graphs home page: CHART <GO>

--Editors: Nick Baker, Stephen Kleege

To contact the reporter on this story:
David Wilson in New York at +1-212-617-2248 or
[email protected]

To contact the editor responsible for this story:
Nick Baker at +1-212-617-5919 or
[email protected]

- codjul132011.gif

The attached story is illustrative of the rapid change in the cost of operating
a business (as opposed to the official CPI) across 214 global major cities. As
such it represents a useful (albeit rough) contrary indicator of medium to long
term investment opportunities. We are particularly interested in rapid changes
in status and setting aside Luanda, we note that Rio de Janeiro and Sao Paulo
jumped to 12th (from 29th) and 10th (from 21st) respectively. This indicates a
very rapid change in the cost of doing business, which is makes sense given our
growing concerns about the stability of the current Brazilian expansion.
Meanwhile the opposite can be said about the US, which no longer has a
representative in the top 10. New York now languishes at number 32, down from
27th last year which is an accurate reflection of the undervaluation of the USD
relative to other currencies, and tallying with our belief that the US equity
market has started a period of substantial outperformance.

We are generally sceptical about the quality of national economic data (it
simply is too hard a task to be achieved with any useful degree of
accuracy) but we employ an extra level of doubt when it comes to China
simply because the data tends to be so unsurprising. There is a complete
absence of the sort of month-to-month volatility that we see elsewhere
over the course of a cycle, particularly over the last 18 months when
China's growth has been metronomically (and hence suspiciously)
predictable.

June proved to be no exception with Q2 GDP estimated at 9.6% (just above
9.3% consensus). The monthly industrial reports showed Industrial Production
growing by a higher than consensus 15.1%, while retail sales were steady
at 16.8%. More problematically Fixed Assets Investment remains very high
at 25.6%. Given that China's monetary data continues to point to powerful
credit issuance (see yesterday's note) June's economic data comes as
little surprise but it is interesting to note that all three categories
are now at or above the rate of M2 growth, indicating a degree of
tightness in monetary conditions exists even at an absolute level that would
seem to epitomize largesse.

Our conclusions from the above are that we would not look for Chinese
government data to provide any clue in advance of a slowdown within the
Chinese economy (should one occur). At best it will be allowed to reflect
a deterioration in conditions once these have become obvious to all
concerned. On the other hand these statistics are important not only
because they help from a global consensus on economic growth both within
and outside of China, (and hence influence investment capital allocation)
but also because they are relied upon by central bankers when setting
monetary policy. Most clearly this applies to the PBOC, who many assume
are at or near the end of the current tightening cycle. The data released
over the last couple of days must bring this assumption into question and
we continue to expect additional steps taken over the course of the
summer. Finally over the last few weeks we have noted an increasing number
of comments regarding China heading for a "soft landing" or avoiding a
"hard landing". As many of you will know, we regard this as by far the most
dangerous metaphor employed during an economic cycle. We have not yet
reached the crescendo of recession-denial that typically precedes an
abrupt slowdown but we are clearly heading in that direction. -
D-CNRSACMY_Index.gif -

One of the more ironic aspects of the Euro crisis is that as investors flee the
foolish trades of the last decade a new folly in emerging market corporate debt
seems to be in the process of building. As the attached article shows, this
extends even to areas where underlying corporate performance is problematic.
Although it is possible that bonds issued by corporations doing business with
Chinese municipalities (who are themselves overstretched) would be bailed out,
this scarcely explains why it is worth the risk of placing capital in such a
trade. Over time credit markets tend to teach the importance of discipline
rather well, and we expect another lesson to be delivered in the months ahead.

China's money supply and loan data shows little evidence of slowing down
with June's M2 growth rate rising slightly to 15.86% per annum and the
shorter term 3 month RoC roughly equivalent at 2.99%. New loans issued
totaled 633.9 bln CNY, an increase of over 12% from May and slightly ahead
of consensus estimates of 622.4 bln CNY. This takes the 6 month ma up to
697 bln, still well above the level seen prior to the 2009 loosening of
monetary policy. Interestingly this data contrasts with some private
sector loan surveys that had indicated that the majority of borrowers
reported a tightening of standards over the last quarter. It may be that
both sets of data are correct, with lenders concentrating lending to a
smaller group of more credit-worthy borrowers (at least by current
metrics) while keeping the aggregate level of loans at their elevated
levels.

In any case June's data hardly suggests that the PBOC can rest on its
laurels, rather the frustration within this body that loan growth remains
unimpaired this far into the tightening cycle is likely to be growing
rapidly. We continue to expect further tightening moves in the form of
both interest rates and macro-prudential measures in the weeks ahead. -
D-CNMSM2_Index.gif -

We try not to state the obvious in our daily commentary and so we refrained
from simply pointing out that Italy had become "Spanish" over the weekend, with
its bond yields now far above the stable Eurozone rate. The importance of this
is considerable, given the size of Italy's outstanding debt and the fact that
much of this is held by non-Italian institutions, but enough has been written
elsewhere for us to simply repeat our advice given at the start of this crisis,
namely that it would be a long drawn out affair whose solution would be framed
far more by a political "solution" than a practical economic one.

Meanwhile it is interesting to consider that Italy, France and Spain have
shared a common (albeit often competitive) history for much of the last 2000
years. This clearly extended into the post-war econo-political project that
culminated in the launch of the Euro in 1999. However, prior to the Euro's
launch, Italy was treated as beeing much closer to Spain than France. Indeed
despite the fact that Italy was one of the founding 6 nations of the European
Union (or the Common Market as it was known) it was very much the ugly
step-child of the union with bond-holders demanding a substantial yield premium
to compensate for the political instability and tendency of the Lira to
depreciate rapidly from time to time.

For instance, in early 1995 (at the height of the Mexican Peso crisis) Italy's
10 year yield reached 13.6%, above Spain's 10 year yield of 12.5% and far
higher than France's 8.3% peak (see chart). It was only in the run-up to the
Euro's launch that this substantial yield gap was breached with the great
"convergence trade" causing all yields to fall close to 4% at the EUR's launch
in early 1999. Thus the great historical aberation was the period from 1999 -
2009 when Italy and Spain were both considered "French". As the ongoing
"Bunga-Bunga" has shown, it is hard to argue that Italy did much to earn this
reduction in risk-premium in terms of improving its internal government and its
internal fincances speak for themselves.

The fact that Italy and Spain were treated equivalently pre-Euro is important
since it suggests that the breakdown that we have seen in the last few days may
be extremely hard to reverse no matter what schemes the ECB and Euro-zone
governments concoct. Rather it looks to be a classic case of markets forcing
price upon a regulated market, albeit after a decade of succesful suspension of
disbelief. - italyfrancespain.gif

May's Wholesale Inventory data continued to point towards a steady
re-build of inventories with the Census Bureau estimating they grew by
1.8% and revising April's growth up from 0.8% to 1.1%. This keeps the
annual pace of growth above 15% and takes the total inventory level up to
$456.3 bln, just surpassing the prior all time high of $456 bln recorded
in August 2008. Sales were estimated to have fallen slightly by -0.2% but
this was in part due to a +0.3% revision to April's data. Total sales have
grown by 14.4% (blue line on chart) over the last 12 months and there is
no sign of this pace diminishing. With total sales within 1% of their 2008
high we would expect to see a record level of activity recorded this
summer. This growth in sales has kept the Inventory/Sales level at a very
moderate 1.16, allowing for further acceleration in the production of
wholesale goods later this cycle. - M-MWSLTOT_Index.gif -

Even by its historically erratic nature June's non-farm payroll report was
surprisingly soft. Total additions to non farm payroll were 18K while the
private sector was estimated as adding 57K. This compares to estimates of 105K
and 132K respectively. To make matters worse May's weak data was revised
downwards with total gains trimmed to 25K (from 54K) and private sector
gains to 73K (from 83K). The final blow came from the separate Household
Survey where the estimated Employed Population was slashed by -445K,
causing the unemployment rate to rise to 9.2%.

This data flies in the face of the vast majority of private sector employment
measures that suggested that June was a fairly decent month for employment.
Moreover the fact that the data was awful across the entire survey may
paradoxically be a good sign. We have found that the BLS suffers from "group
think" from time to time, creating significant upward and downward shifts in
its data (they are at least fair minded in their adjustments over time) and the
universally poor quality of this month's report is suggestive of such an
occurrence.

In any case the last two months of employment data has led to a flattening
of our own trend gauge, which is the 12 month ma of private sector gains
(thick line on chart). At its current reading of 142K this measure still
remains in the middle of a "jobless" and "strong employment" environment. In
other words things are not as good as we had hoped but not as bad as most
people fear. This will not erase the negative effect this report will have on
market sentiment, at least on a short term basis. Our thinking already was that
the SPX would probably have to re-test Friday's break-out from 1320, this
release only increases the odds that this will occur. - M-NFP_PCH_Index.gif -

This story helps explain the strength of last Friday's move in the US equity
market, and a portion of its follow through into this week's trading. The
forced unwind of a large negatively positioned book (the story does not
actually state this but it is implied by the timing of the liquidation) in the
thin holiday markets would presumably have a significant effect on the index
and also draw in other traders who became aware of the buying activity (while
not necessarily knowing its source or cause). We had already marked the gap
between Thursday's close and Friday's opening (just above 1320) as an obvious
re-test target for the SPX and this story increases the odds that this will
occur.

An interesting article that drives home the point that tightening monetary
conditions are starting to have very real effects on loan yields in the Indian
real estate market. Needless to say rates of 15-20% require excellent property
markets in order for a development to be profitable and most anecdotal evidence
suggests that India's major luxury residential markets are faltering (according
to one estimate Mumbai home registrations dropped 30% YoY in June). Our
experience with most distress cycles is that it is the loans made in the last
12-18 months that cause the vast majority of the credit losses, and the news
that India's banks continue to accelerate real estate credit issuance this late
into the cycle suggests that there will be a heavy future price to pay.

We note that a combination of good retail sales data from a number of key
chains and better employment data has been sufficient to propel the S&P
500 Retail Index to a new all time high of 555.47 this morning. This is a
significant achievement given that the overall SPX index is still some
distance below its 2011 high (and more than 200 points below its 2007 all
time high) and once more reminds us that an overstatement of consumer
duress that has be a persistent accompaniment to this 2 year old recovery.

It is also interesting to note the much more resilient performance by the
retail sector during the recent "Soft Patch" scare compared to the beating
it took during last years "Double Dip" panic. As can be seen on the
attached chart, last year's decline was far more brutal in both absolute
and relative terms, and the retail index lagged the SPX index in forcing
its way to a new recovery high by several weeks as investors ignored
decent sales numbers and worried about a future slowdown that never
emerged.

This time around investors have remained much more focussed on actual
sales data (in part because management itself has been more positive about
the sustainability of current business levels) and have been more
reluctant to dump holdings simply because macroeconomic data has been
disappointing. We see this improvement in performance as part of the shift
in power between "top down" and "bottom up" flows that we describe in this
morning's Weekly Speculator, with actual corporate data now starting to
become significantly more influential in determining investor decisions. -
D-RELX_Index.gif -

Each month we find ourselves making the same comments regarding national
payroll data, namely that despite its overarching influence on
macro-sentiment it is simply too erratic to be trusted on a month-by-month
basis. This is equally true of the private sector ADP report and the BLS's
official data (although the latter is ultimately the senior data that
everyone slavishly follows). On the other hand using a longer term moving
average (we favor 6 months) does give a rough guide as to how an
employment cycle is progressing, although the corresponding reduction in
volatility makes for far less dramatic headlines.

This month's ADP report shows the wisdom of this methodology, since the
data swung back violently from May's suspiciously poor +36K to a far more
robust +157K. This is very close to the 6 month ma of 162K that we would
use as a sensible estimate of the underlying pace of payroll gains. We
have no idea what caused last month's drop but a casual glance of the
chart shows that fluctuations of this order are hardly uncommon in this
data series, Our assumption would be that some of the very strong readings
seen in early 2011 may have overstated payroll gains with a resulting
adjustment taking place in May. We are much more resistant to the idea
that ACTUAL EMPLOYMENT down-shifted suddenly in May and then
re-accelerated in June since there is no obvious cause for such a shift to
have taken place. Even if tomorrow's BLS data fails to reflect a similar
improvement (these two series use different methodologies and so can diverge
considerably over the short term) there is now good reason to doubt the weak
May reports.

In terms of the current cycle, a monthly pace of approximately 160K
represents solid but unspectacular employment growth that is roughly the
same pace as was seen in Q2 2004, which was sufficient at that time to
allow the FRB to start raising the FDTR from 1.00% to 1.25%. It should
also be sufficient to keep the positive trends in consumer activity intact
and for the existing home market to remain stable through the summer
months, both key factors behind our own patience with the current US
economic cycle. - D-ADP_CHNG_Index.gif -

The ISM Non-Manufacturing survey for June was just below expectations
(53.7) at 53.3, suggesting that the US service sector continues to grow at
a moderate but steady pace. Regular readers will know that we place much
less importance on this survey than the earlier-released Manufacturing
version, but it is still a useful second tier data-point. Given that the
main reason for the drop in the index from May's 54.6 was a sharp drop in
the Prices Paid index, which fell from 69.6 to 60.9 there is little to be
concerned about in this release. New Orders moderated slightly to 53.6
(from 56.8) but remain in positive territory and in general we would avoid
parsing the various sub-indexes too closely since we do not see them as
adding much insight into the workings of the service sector (it is not
clear for instance what exactly that the term "Inventory" represents in many
service industries).

One exception we would make is the Employment sub index (blue line on
chart) which rose slightly to 54.1, the highest reading since February. It
is notable that both the ISM Manufacturing and Non-Manufacturing surveys
have failed to reflect the deterioration in official employment metrics
that has been seen over the last few weeks. Given the huge disparities in
methodology this in itself does not suggest that Friday's June payroll
release will be stronger than expectations but it does at least open up
the question as to the veracity of the weakness of recent official
employment reports which have been known to fluctuate widely in the past. -
D-NAPMNMI_Index.gif -

Our analysis of China's May data for monetary growth and economic activity
suggested that further monetary tightening would be forthcoming and this
morning the PBOC announced an increase in the 12 month lending rate of
25bp to 6.56%, effective tomorrow. It should be noted that this
announcement came at 6.30 am (NY time), after the close of the Chinese and
most Asian equity markets. At 6.56% the China lending rate is still
roughly halfway along the tightening path followed between 2004 and 2008
(see attached chart) but it should be realized that the Chinese economy
has become much more reliant on credit use in recent years and therefore
can be expected to be more interest rate sensitive. It is impossible to
know the precise level at which monetary tightening will take effect, but
this is perhaps the wrong question to ask. Our argument is that central
banks always continue tightening until clear signs of a slowdown are in
evidence (even though they may halt a couple of times along the way as
data fluctuates). Unfortunately once growth rates are disrupted a period
of some distress generally follows, with sharp downward adjustments to
asset prices in markets where leverage has been a factor. We do not buy into
the argument that the PBOC posesses some mysterious wisdom that will
prevent it following the path of other central banks.

We would also stress that even after today's interest rate hike this has
been a very unorthodox tightening cycle (increasing the risk of a mistake
in our opinion). Macro-Prudential monetary policy (MPMP) has dominated the
PBOC's actions, with the reserve requirement being the primary policy
tool. As can be seen on the attached chart back in 2007 the reserve
requirement was roughly 5.5% higher than the 12 month lending rate. Prior
to today's hike the spread had widened to 15.19% (it will fall to 14.94%
tomorrow). We do not think that today's announcement represents any change
in policy direction and believe that futher tightening moves will come
from a combination of interest rates and MPMP. - W-CHLR12M_Index.gif -
W-CHRRDEP_Index.gif -

Although we do not ascribe much importance to the US Factory Orders data
(mostly because it comes out over one month after the more useful ISM
Manufacturing report for any given time period) May's report is
interesting because it underlines our point that despite the wide, short
term fluctuations in data, this has been a very steady US recovery for the
manufacturing sector over the longer term. For instance May's data shows
an increase of 0.8% in total factory orders, a substantial improvement in
April's -0.9% decline (revised higher from -1.2%). Although this means that the
data missed official consensus of 1.0%, this is more than made up for by the
revision to April's data.

While is is technically possible that orders did decline in April and then
recover in May we doubt whether this truly happened. It is far more likely
that the fluctuation in data is simply a reflection of sample error or
"noise". This point is driven home by the smooth advance of the longer
term 12 month ma (red) and the very tight range of the 12 month RoC (blue
lower chart). The latter has fluctuated around the 12% level for several
quarters, which probably represents a good rough estimate of the pace of
recovery of factory orders. It should be noted that these are still
roughly 90% of their peak level, meaning that orders are on track to break
into new ground sometime in Q1 2012. - M-TMNOTOT_Index.gif -

June's ISM report goes some way to defusing concerns that the US Manufacturing
sector is slowing down with the headline index of 55.3 beating consensus ( and
May's reading of 53.5. Although this index is now somewhat lower than the very
high levels reached in Q1 it should be remembered that we are dealing with
diffusion data, meaning that Manufacturing has continued to make progress month
after month and the ISM index indicates that this improvement is sustainable
for the foreseeable future.

In terms of the sub-indexes we note that Prices Paid (not shown) fell sharply
to 68 (76.5 in May), which suggests that some of the recent drop in commodity
prices is starting to reduce input cost pressures. New Orders (red) grew
modestly at 51.6, perhaps the only disappointing data point in the report while
Production (blue) was somewhat more buoyant at 54.5. Not surprisingly this led
to some Inventory growth (olive) with the index moving back into positive
territory at 54.1. Finally Employment (pink) remained very strong at 59.9,
which clashes somewhat with recent official metrics that have suggested a
moderation in manufacturers's hiring.

Since we never took the "soft patch" thesis seriously we are unsurprised by
today's data, but we still welcome it as a timely emotional balm for those
starting to fret that something amiss with the US recovery. - ismjune11.gif