24 March 2011

Global Strategy
Alternative view
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Global Strategy Weekly
And the award for extreme optimism in the face of reality goes to……
Some 18 months on from the end of the recession the US housing sector remains in a dire state and, if anything, is getting worse! Meanwhile, in Europe, the debate is no longer whether, but when, rates should be raised to head off a non-existent inflation threat.
Albert Edwards (44) 20 7762 5890 albert.edwards@sgcib.com

Much has been written about Japan in the wake of recent tragic events and I do not feel I can usefully add to that. The only thing I would note is that those who believe that the US bond market will hit a brick wall when QE2 ends will feel even more confident in their belief as Japan’s rebuilding programme soaks up domestic savings and leaves a reduced surplus to be recycled abroad.
 

Global asset allocation
% Equities Bonds Cash
Index Index neutral SG Weight

30-80 20-50 0-30

60 35 5

35 50 15

Although a bond bear myself on a long-term perspective, my years of observation lead me to believe that excess supply is never quite as critical a determinant for bond yields as many suppose. Obviously, there is an extreme where a supply/demand imbalance can cause a noticeable move in prices, but, without that binding constraint, economic fundamentals seem to explain yields just fine. Just as UK gilt yields did not spike upwards as QE ended last year, I do not see US treasury yields spiking higher on the end of QE2 and/or the reduced flow of funds from Japan.

Source: SG Cross Asset Research

 I don’t normally write about monthly data releases but I want to make an exception this week regarding February’s shock 16.9% mom decline in US new home sales. With sales languishing at a record low, I had to laugh when I read the Reuters story. The phrase that made me chuckle was “despite the surprise plunge in sales, economists do not believe a new downturn is underway” Are they nuts?! We are plunging to new all time lows for many housing indicators (see chart below) and we are not in a new downturn? I know this industry has a consistent bias towards optimism about which one gets rather blasé, but this really does deserve some sort of special award. I’m going to think of a name.

I seem to remember being assured 12 months ago that US housing was recovering…..
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building permits

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Global Strategy Team

Albert Edwards (44) 20 7762 5890 albert.edwards@sgcib.com Dylan Grice (44) 20 7762 5872 dylan.grice@sgcib.com

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New home sales
0 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 0

Source: Datastream

Macro

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Please see important disclaimer and disclosures at the end of the document

50 headline 4.50 5.00 4. but clearly they haven’t (see chart above).50 3. sometimes I can’t even see the glass at all.00 0.50 2.00 2. an old school friend who. with the vast bulk of personal wealth tied up in housing. decided it would be a jolly good idea to smash a beer glass in my face. Why do I have this awful problem? I really should have brought the subject up with my therapist when I had some sessions a few years back. I had a drink last night with Stuart. it is difficult to be anything other than bearish about the US consumer while this continues. What about UK inflation? UK CPI inflation 5.00 1.50 2010 Source: Datastream 2 24 March 2011 . my work life would be so much easier! Hey. is just hitting 50. I did emerge from the evening minus a front tooth.00 2.50 ex energy.00 3.Global Strategy Weekly Some of my readers might suspect the real truth is that I am actually jealous of the ability of my fellow scribblers to see the good in everything. all bearish and that. Crikey! There I go again. US house prices 000'S 280 240 260 220 240 220 FHFA house price index (rhscale) 200 180 200 160 180 140 160 median new home prices 140 120 120 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 100 Source: Datastream So I’d like to say house prices in the US have bottomed.00 4. Maybe that’s why I get suspicious whenever I see a glass half-full.50 4. whose name I didn’t quite catch. And despite the best efforts of ‘helicopter’ Ben.50 5.00 5. alch and tobac 2006 2007 2008 2009 headline x VAT 0. London. but there really wasn’t time with all the other things we had to get through. As we rambled through stories about the good old days. I might have the answer. he reminded me of the time in 1976 when we were having a beer in The Orange Tree pub in Richmond. A gentleman. Despite no lasting damage to my handsome visage.00 3.00 1.50 3. If only I could see that glass as half-full.50 1.50 1. But now at last.50 2. rather than half-empty. like me. Let me try being optimistic about something. The increasing rate of mortgage resets is raising the rate of foreclosure and inventory overhang and driving prices ever lower. food.

in my view.00 2.Global Strategy Weekly Seemingly runaway UK inflation is firmly in the news.00 3.00 2002 2003 2004 2005 2006 2007 2008 2009 2010 -1. I side with the school of thought that says the BoE should do nothing.00 3.50 2.50 1. The official leading indicator is very weak indeed and the OECD measure. after recovering slightly has turned down again. just at exactly the wrong time (see chart below). the trigger-happy ECB was the only major central bank to increase interest rates.50 -0. further rounds of deflationary scares and a lot more money printing. though.50 4. Also. The Bank of England held off raising rates in the middle of 2008 when inflation was much higher than now.50 -1. Eurozone CPI inflation and repo rate 4. US and Eurozone in the not too distant future.00 1. In the near term.00 0.50 core CPI 0 0 -0.50 3. that will only come after further recessions.00 2. The FT reports that a survey of institutional clients cites a Chinese hard landing as the most underpriced risk in the market – link.50 0. the likelihood of a Chinese hard landing remains very high indeed. By contrast.50 4.00 Source: Datastream Once QE2 ends in June we will find out how much it has contributed to the recent commodity price surge. And although I acknowledge that the ultimate destination will be considerably higher double-digit inflation 510 years from now.00 repo 4. I side with the belief that virtually all of the components of rapidly rising inflation are outside the bank’s control and to drive up unemployment to restrain a non-existent wage price spiral is sheer lunacy. After yet another leap upwards in headline inflation. Chinese leading indicators 106 OECD (rhscale) 104 105 102 104 103 100 102 official National Bureau 101 100 98 96 99 94 98 97 2006 2007 2008 2009 2010 92 Source: Datastream 24 March 2011 3 . many commentators believe that the Bank of England is losing credibility in the markets and that they need to act soon to raise interest rates.00 1.50 2.50 headline CPI 3.50 1. This author at least expects to see negative headline inflation in the UK.

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