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Bull and Bear – an optimistic and pessimistic view of investment news. Today’s stories include: Real Street shakes off Wall Street fears: US consumer confidence, US house prices rise again, US durables hit the skies,  Mervyn King warns that normal is still a long way off, Italy hit by new derivative crisis. Companies in the news: Petrofac, Domino Printing Sciences

Bull and bear: Real Street shakes off Wall Street fears

The markets are not happy, but those sentiments are not shared by US consumers neither are they shared by purchasers of durable goods.

US consumer confidence

The US Consumer Confidence Index, produced by the Conference Board, hit a new five and a half year high in June. The index rose from 74.3 to 81.4. The last time the index was so high was in January 2008.

Bear:     But, the index only applies to data collected up to June 13, and the major stock market falls have occurred since then. Next month the index will surely fall.

Circular argument:          There is something a tad ridiculous about this. The Conference Board’s measure of US consumer confidence is watched very closely by the markets. When the index improves, stocks often rise (as indeed, they did in the US yesterday.) When stocks rise, US consumers feel more confidence, so it becomes a little self-perpetuating.

Bull:       But stock markets are not the only drivers of US consumer confidence. Jobs and house prices matter too. And the latest news on US house prices had a distinctly bullish look about it.

US house prices rise again

According to the latest Case-Shiller house price index, US house prices rose 12.1 per cent in April, which was the biggest year on year rise in seven years.

As for month on month data, April saw prices surge 2.5 per cent. Never before, never, not since Roosevelt was President, Lincoln assassinated, not even since Pocahontas and Captain Smith had a very mad affair, have US house prices seen such a large month on month rise. Okay that was a slight exaggeration, data only goes back 12 years, but the point is that April was a record in terms of month on month rises.

Some are even talking about the danger of a new bubble in the US housing market, although it is worth mentioning that US house prices to income and rent are marginally below their long term average.

US durables hit the skies

Meanwhile US durable goods orders rose 3.6 per cent in May compared to the month before, and by 7.7 per cent year on year.

That sounds like an impressive growth rate, but just to be bearish for a moment, the data was distorted by a 51 per cent jump in commercial aircraft orders, with Boeing having managed to flog 232 aircrafts in May, from 51 in April.

But strip transport orders from the equation and core orders were still up 0.7 per cent on the previous month.

The tennis score:             For some time Bull and Bear have been keeping a score comparing positive with negative news on the US economy and describing it in terms of tennis. Well, sorry, but the match is off – it has become boring in its one sidedness. Bear has gone off in a sulk.

There are still lots of cynics out there. There is no shortage of commentators who look incredulous at talk of a US recovery, but the evidence is very strong.

There are no guarantees either in life or in watching the economy, but right now, and as far as the US is concerned, the bulls really do have a reason to smile.

Mervyn King warns that normal is still a long way off

Mervyng King – outgoing governor of the Bank of England, and man who has been consistently outvoted this year in his desire to enact more QE – reckons we have got ahead of ourselves,

He was having a natter with the UK’s Treasury Select Committee and said: “I think people have rather jumped the gun thinking this means an imminent return to normal levels of interest rates. It doesn’t.” He added: “Until markets see in place policies to bring about that return to normal economic conditions, there is no prospect for sustainable recovery and without that prospect for sustainable recovery, markets understand that it will not be sensible to return interest rates to normal levels.”

He also said that so far governments have not done enough to take advantage of the opportunities afforded them by QE to set in place the conditions from a sustainable recovery.

He makes a good point. You just need to bear in mind the Fed is not talking about ending QE any time soon, rather in reducing the unprecedented $85 billion of QE per month to a level which is only slightly less unprecedented. The Fed does not expect interest rates to rise until 2015, and as for QE being reversed, the time when the Fed sells bonds seems to be a long, long way off.

The truth is that when US inflation is low, the Fed is in a position of strength, and if the US recovery wanes, it can delay its efforts to curtail QE.

But for the rest of the world we are entering a big unknown. There is this assumption that since the Fed is hinting about reducing QE, Mark Carney will be reluctant to kick off more in the UK. But why does that have to be so?

The UK economy and the US economy are not perfectly aligned, and monetary policy does not have to be identical.

What will happen to UK bond yields if the Fed does end QE, but the Bank of England reveals more? No one knows.

The big fear is that if bond yields rise, the UK government may find it increasingly hard to fund government debt. On the plus side, the Bank of England will only start upping rates if the economy improves, meaning that rising tax receipts may make it easier for the government to fund debts.

But supposing the US increases rates, while the UK economy is still in the doldrums, and despite the Bank of England’s efforts, UK market rates rise too. That’s the worst case scenario, but predicting the outcome is pure guesswork right now.

Italy hit by new derivative crisis

Someone once said that derivatives are financial weapons of mass destruction. Who was it now? Oh that’s right, some bloke called Warren Buffett. Well, some might say that the crisis of 2008, which was partially caused by derivatives based on sub-prime mortgages, proves that Mr Buffet was right.

If the inference of a story in the ‘FT’ is right, we may see more proof, this time coming from Italy.

Cast your mind back to the days before the euro was launched. We now know that bookkeeping in Greece was not entirely accurate, and that the grandees who opened the way for Greece were fooling themselves, in a way not dissimilar to Trojans opening the gates of their city to this big horse thingy made of wood.

It appears that Italy’s finances were somewhat massaged too, this time by financial weapons of mass destruction, err sorry, by derivatives.

In 1995 Italy’s budget deficit was 7.7 per cent of GDP. By 1998 it was down to 2.7 per cent, without, according to the ‘FT’, significant changes in tax revenue and public spending.

Wonderful things are derivatives – you can book future income as present income, and future spending as, well, as future spending. And that in a nut shell is what it is being alleged that Italy did.

The ‘FT’ reckons Italy may be on course to lose some 8 billion euros. Last year an article on Bloomberg (Italy Said to Pay Morgan Stanley $3.4 Billion) stated “When Morgan Stanley (MS) said in January it had cut its ‘net exposure’ to Italy by $3.4bn, it didn’t tell investors that the nation paid that entire amount to the bank to exit a bet on interest rates…The cost, equal to half the amount to be raised by Italy’s sales tax increase this year, underscores the risk of derivatives countries use to reduce borrowing costs and guard against swings in interest rates and currencies can sour and generate losses for taxpayers. Italy, with record debt of $2.5tn, has lost more than $31bn on its derivatives at current market values, according to data compiled by the Bloomberg Brief Risk newsletter from regulatory filings.” http://www.bloomberg.com/news/2012-03-16/italy-said-to-pay-morgan-stanley-3-4-billion-to-exit-derivative.html)

Companies in the news

Bull:       Petrofac. Yesterday the Share Centre’s own Helal Miah said: “We continue to recommend investors ‘buy’ Petrofac. So long as the world economy is energy hungry there will be a continuous demand for services from this type of company.” See: Petrofac continues to attract investors as order book increases http://blog.share.com/2013/06/25/petrofac-continues-to-attract-investors-as-order-book-increases/16134. This morning, Questor at the ‘Telegraph’ said it was retaining its buy rating for the firm. Looking ahead, the big challenge for the company is to win more contracts.

Bear:     At the ‘Times’, Tempus took a look at Domino Printing Sciences, which has written down the value of investment in Ten Media. Tempus said: “The shares, even after recent falls, sell on about 16 times’ earnings. Hard to justify at that level.”

 

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees


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