Which way blows the economic wind?

Anyone with substantial (and no-brainer) energy holdings likely enjoyed an outperforming half-year and Q2 compared with any main index. The scribe is sort of content to report that the holdings he manages are up 7% year to date and over 4% in the quarter (the S&P500 is down (1.4)% and up 1.2% over the same periods). "Sort of content" because: this result was less skill than, well, going with the obvious; and measuring performance over 6 months is arbitrary and hardly informative.

Nonetheless, next quarter and the full year may prove more awkward terrain: the macro-economic outlook is slowly but surely deteriorating (see the 5 point matrix below). Even energy prices cannot remain robust indefinitely within a weakening economy (unless the demand curve really has shifted outwards, and the jury will be out on that for awhile yet):

Possibly the most significant message of this matrix is that the flattening US yield curve (the June 10 year note minus 3 month Treasury bill yield is now down to 0.9 points) has begun to signal a small chance - around 8% - of a recession one year out. This is derived below from the reliable Estrella-Mishkin recession probability model.

Additionally, equities are modestly but bearishly weaker versus 6 months ago; and the ISM Purchasing Managers Index continues its decline towards the key "50" mark. A surprise drop to less than that with July 1's release (08h30 EST) would be a huge red flag (consensus is 51.5).

On the other hand, risk aversion - as measured by a widening spread between AAA rated bonds and the 10 year Treasury note - has not increased: the spread narrowed over the last 6 months and, it seems, indicates continuing risk appetite for non-sovereign paper.

Another positive is the last reading of the excellent Philadelphia Fed "Anxious Index". This shows professional economists confident of decent GDP growth 2 quarters forward. The intuitive reaction of anti-economists that this ought to be a contra-indicator does not, on the index's historical record, yet bear scrutiny.

So, bar a shock, no tipping point looks probable in the second half of 2005 although, clearly, the possibility should be kept in mind. But the US economy does have vulnerabilities: employment, sales, inventories and order data were all weaker in May (see the Chicago Fed National Activity Index for detail) and may be harbingers of the slippery slope. An unexpected piece/trend of bad data - a personal favourite being rising inflation, the chance of which is being almost entirely ignored by financial markets - could hasten any descent.

NB: The triggers shown in the matrix are consistent with calibrations that have marked the conditions for every US recession since 1962.

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Summer in the south of France and a young(ish) man's thoughts turn to...the local economy

Primarily a university town - which is how the scribe first came to spend time there over a decade ago - Montpellier now bills itself as a "technopole" despite tourism being the main support of the economy (and the reason scribe and wife just concluded a long weekend there).

The scribe's concentration not being required for the ample distractions of the seaside (or at least that's what the wife said) the beach at Carnon inspired the following thoughts instead:

* 80% or so of the region's population are squeezed into the littoral, reflecting the decline of agriculture, the rise of service industries around urban centres and the demographic trend of northern retirees seeking warmth;

* property prices are robust with an unscientific survey of apartment prices in and immediately around Montpellier showing them to be, in some cases, about 80% of London's;

* service industry is over 50% of local GDP; manufacturing is 13%; agriculture 4%; construction about 6%; and "administrative services" (code for government spending) about 25%;

* in spite of the arrival of foreign business attracted to the city by fiscal sweeteners, local unemployment at 14% is higher than the national average of 10%. It is said (though not by Adam Smith) that this persistent over-supply of educated graduates attracts firms looking for low cost labour;

* yet some evidence (other, that is, than the bald unemployment number) shows that only small numbers of the university students (25% of Montpellier's 400,000 population) end up employed by businesses attracted to the city by the various national and regional fiscal incentives on offer. IBM (the city's largest IT employer) claim, for example, to take on only 5 permanent staff from the universities per year; and

* plausibly related to high unemployment, this scribe was awoken on his first morning in the city, three floors up behind closed windows and air conditioning by the sounds of three men beating a fourth. The next morning he witnessed petty theft by a group of young men from a convenience shop. Both incidents occurred in the modern and new Parc Marianne area of the town.

It is certain the suite of fiscal incentives aimed at developing technology incubators, centres of biomed/pharma research excellence et al around Montpellier has attracted capital, including substantial foreign human capital, and had wider impact: the forerunner of the Palm Pilot was born there; the city now has a stunning blend of medieval and contemporary architecture; and infrastructure compared to the early 1990s is improved (but not perfect - the GPS mentioned in New York City notes proved essential).

Nonetheless, from some angles the economic recipe served up looks a strange brew if it was also intended to provide an outlet for all those grads pouring out of the (free, hence their hordes) Montpellier university system. The region still lags in national employment and productivity rankings; and government expenditures, including those spent on welfare, are a full 5 percentage points higher than the country's average.

Sources: National Institute for Statistics and Economic studies - France, Foreign Direct investment Magazine, Invest in Montpellier, official city website

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Timely advice of the day

Tuesday, June 28, 2005 | 0 comments »


From Dow Jones Newswire (motto: "News to profit by")


*DJ Morgan Stanley Upgrades Oil & Gas Sector To Attractive

(End) DJ Newswire
June 28, 2005 02:57ET (06:57 GMT)
Copyright (c) 2005 Dow Jones & Company, Inc.


Gee, guys, do you really think so?

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A small post dedicated to tomorrow's triple witching hour and those further ahead...

Triple what?

MoneySense Canada (byline: "for Canadians who want more") offer this definition:

"Triple witching is a term coined in the 1980s to explain the volatility associated with quarterly expirations of stock options, index options and index futures. Triple witching occurs on the third Friday in March, June, September and December."


The volatility of triple witching Fridays is due to (and confined to it based on the data below) extra volume: stock options that are exercised create large additional volume; as does the index arbitrage typically associated with the trading of big equity positions that this engenders. The data this scribe analysed showed Freaky triple witching Fridays can average close to 25% more volume than an ordinary trading day (1990-2005).

Yet the same 15 year's worth of data covering the S&P500, the Dow and the Dax does not reveal obvious differences in price variance at the aggregate level. That is, the daily points range (high minus low as a percentage of close) of all days versus triple witching days displays similar average, standard deviation, median, skew and kurtosis characteristics.

What the data does show, however, is an interesting stat for the Dax:

The pattern is more pronounced for the S&P500 (64:36); and less for the Dow (52:48).

Not a tip or trading recommendation. Only context.

Sources: Yahoo Finance; MoneySense Canada

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A subscriber asked in a comment to an earlier post what CC considered to be the implications of the French rejection of the EU Constitution.

CC's broad, simple and possibly philistinic answer is set out below:

Conclusions:

* "emerging market" investor bulls of Turkey may wish to reconsider their accession thesis. The last time Turks got into Europe was 1453 when Sultan Mehmet II was The Man. The resulting exodus of Byzantine intellect to Florence, Ferrara et al from Constantinople spurred the rise of the Renaissance (Mehmet got zero credit for this by the way) and led to an early example of euro-unification amongst the Italian city-states faced with the eastern threat;

* perceptions of insurmountable cultural differences with Turkey remain and are much greater on the ground than has been assumed on planet EU. Different groups have different reasons for holding these perceptions (when Jean-Marie Le Pen and Valerie Giscard d'Estaing agree it is rare day) but held they are.

* the French will always find any compromise involving their socio-economic model difficult to make despite (or for cynics of welfare "because of") persistent high unemployment. At last count this stood at about 10% in total and 22% for those under 25 years old;

* the EU may now look forward to either years of re-negotiation of the Constitution, or years of (fruitlessly) trying to convince citizens of the actual version's worth.

Discussion:
In France the "Non" answer to the Constitution of the debate brought together those:

* who believed France's social model would be weakened;

* that it would impose an "anglo-saxon" model favouring big business at the expense of farmers, workers and public services;

* that it threatened the country's sovereignty and identity; and

* that it would quickly let Turkey into the EU.

These were reactions to two key elements of the proposed Constitution: the EU gaining new powers from member-states over asylum and immigration policies; and the adoption of qualified majority voting.

Clearly, giving the EU new powers was going to sell badly to subscribers of the idea that the EU Council lacks legitimacy and is too distant from the populace. That these new powers included Justice policy (under which asylum and immigration fall) a bare 5 months after having agreed to accession talks with Turkey in December 2004 did not ease the task.

Indeed, the rejection of the Constitution in France arguably most reflects the opposition to Turkey joining the EU. In spite of a spirit of modernism, political secularism and a rich ethnic mix unknown in most EU nations (summed up well here), Turkey getting into the EU at all is doubtful - whatever the supposed irreversibility of the European Council decision on accession talks last December.

On this point, readers may want to cross-reference the views, for example, of the 400,000-odd French voters of Armenian descent; or the result of the Dutch referendum; or the Cypriot government (yes, an EU member) who Turkey refuse to recognise; or those EU citizens who wonder about the wisdom of extending the borders to Iraq and Syria; or EU immigrant-worriers fixated on the long-term unemployment rate of 24% in Turkey (population 68 million); etc.

On the other hand, for profit-seeking investors free of such mundane baggage, the economic case against the Turks (skint and plenty of them) does not stack up. Morgan Stanley have argued that even the poorest accession nations have historically converged with the EU average GDP per capita rate remarkably swiftly and without impacting the Union's overall growth rate.

That said, Turkey would be starting off at the unprecedented low rate of 29% of the EU 25 average. Accession brings with it EU investment (public and private) as well as aid but without these it is a reach to see quantum-leap improvements in the country's real GDP growth rate (3.4% average 2000-2003); or a reversal in the massive declines in foreign direct investment that have occurred over the last 3 years.

But it is not the economic issues that dominate. It is the cultural ones - including the racist and religious arguments - that stand foremost. In such a climate it is difficult envisaging any EU25 head of state wanting to go before his electorate in order to make Ankara's case for accession to the union. That would be a great deal like the proverbial turkeys voting for Christmas.

Sources: Eurostat (unemployment & GDP/capita data); OECD Turkey Country Statistical Profile 2005

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Tea-leaf of the day

Wednesday, June 08, 2005 | 0 comments »


A picture (below) that appeals to the Tobin's Q in this scribe. From chartoftheday.com:

Today's chart illustrates the overall trend for the Dow. Back in April, the Dow broke below its long-term uptrend (green line). More recently the Dow has retraced back up to the original trend. For the technical analyst, this type of retracement is fairly common if not expected. However, in the realm of technical analysis, the green line that was once considered support now acts as resistance. Stay tuned...

Hey, wait a moment - are fundies and techies agreeing on something?

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A rant from MD, CC's UK scribe...

If ever one wanted to blaspheme, this is one of those moments. Scottish Power - once a small company focussed on generation of hydroelectric power in the Scottish Highlands - went on a spree. The rocket scientists who work there (not many, it has to be said) latched onto the idea of buying a larger company in the US to give them "breadth, diversify their earnings and to move away from the regulated UK market" which was paying for it all. Paid top dollar and then suffered the Mother and Father of all melt downs when wholesale prices in the US collapsed.

Not content with this destruction of capital and despite things being on the (eventual) mend, they decided to flog the business last week on the grounds that they would have to spend $1bn annually (£600m in real money) for the next five years investing in the business.

Now, call me an old cynic, but the purchaser is Mid-American Energy, a company controlled by one Warren Buffet and a chap who knows a bargain when he sees one. The US has learnt from the debacle of a few years ago that you can't let the lights go out. I believe he's got a bargain and the prats (yes, that's right the prats) at Scottish Power have been stiffed. Mr Buffet doesn't get it right all of the time but he does better than most and I'm betting on him not having given the Scottish Power suckers an even break.

Still, maybe there will be a change of heart - regulatory approval will take a while as in the unregulated US some 14 authorities will have to give their nod.

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From the desk of SJ...

Malcolm Glazer appears to have completely messed up on the timing of his purchase: the UK economy is heading for a down turn; Man U are not what they were; and there must be a worry about how long present manager Alex Ferguson will stick around.

[Here follows a paragrpah of gratuitous editorial spin]

And there's still, of course, no word yet on Ricky Hatton's availability as either manager or midfield enforcer (with a concerned Roy Keane apparently pondering contesting Ricky mano a mano for both posts if necessary).

[Resumption of normal service]

Glazer has loaded-up the company with £745m of stupendous debt. Yet Manchester United's turnover is, what, £175m? Servicing the debt will cost at least £50m annually (ie over £135k per day).

You have to hand it to the former key shareholders Messrs Magnier and McManus. They've walked off, hand in hand into the sunset, with a £90m gain. Not bad by anyone's standards.

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Our resident car freak writes from Brussels

To no one's surprise (with the exception of Her Majesty's Government and the unlamented responsible Secretary of State, Ms P Hewitt) MG Rover last month finally succumbed to the weight of nose-diving sales, lack of new product and no means of raising further cash.

Though not quite in the same straits, GM announced yesterday that US sales in May were down 13%; Ford announced a similar 10% reduction (making 12 straight months of decline for old Henry's baby); and even Honda saw a drop of 14.7%.

On the other hand, the main highlight of May's US sales data was Nissan's 6.6% increase and the continuing advance of other Asian manufacturers (well, bar Honda for last month at least) at US car firm's expense: the total market share of Detroit's car makers fell over a percentage point to 57.6 percent in May from 58.7 percent a year ago.

These data are indicative, in fact, of the parlous state of most car manufacturers. Here's a quick run down on the condition of my top ten:

General Motors
Strengths: Size / Global Presence, GMAC, access to Korean product.

Weaknesses: Poor profitability, size, too many plants, too many brands, poor product (have you ever looked at a Hummer?), junk bond status, high labour costs US/Europe, failed to invest in the business, consistently over optimistic, image.

Toyota
Strengths: Size / global Presence, quality, value for money, manufacturing expertise, profitability.

Weaknesses: Dull product, from No 1 the only way is...

Ford
Strengths: Per GM, plus share of Mazda, family influence, Non-US (ie European) product is very good, potential of Jaguar, Land-Rover and Volvo.

Weaknesses: Per GM, plus share of Mazda - it continually disappoints just when all think the corner has been turned, family influence (pressure to sell out).

Daimler-Chrysler
Strengths: Size / global presence, financially sound (just)

Weaknesses: Chrysler (though getting better), "Smart" car brand, lost their quality image, Mercedes over priced, high European & US (Chrysler) cost base

VAG (VW)
Strengths: Size, perceived quality (especially Audi), strong product range Audi/VW, Skoda.

Weaknesses: Competing brands (market confusion), low profitability, Seat (underinvestment in product), Piechesreider.

Renault / Nissan
Strengths: Nissan (see sales table above), now a major player, Carlos Ghosen, implicit support of French state, profitability.

Weaknesses: Renault (quality & productivity issues), question marks over product strategy, Carlos Ghosen (should he encounter the proverbial bus).

BMW
Strengths: Image, profitability, engineering strength, Mini brand, family control.

Weaknesses: Real danger of brand dilution (eg BMW "1" series), Mr. C. Bangle (chief designer of current stupendously ugly range until promoted), mass market and high price don't mix, family control (pressure to sell...)

PSA (Peugeot Citroen)
Strengths: Family control, profitability, implicit support of French state, no US presence, strength in Africa.

Weaknesses: Ageing product, Citroen seen as cheap - struggle to gain pricing power.

Honda
Strengths: Engineering excellence, profitability but low(ish), No. 1 engine manufacturer, breadth - lawnmowers to cars to outboards.

Weaknesses: Relatively small, trying to position itself as a BMW beater, still thinks it's a sexy company (have you seen the FRV?).

Kia
Strengths: Home market support, growing fast, cheap(ish).

Weaknesses: Product - why buy when you can have Japanese?

So there you have it. Honourable mentions should go to Porsche (for convincing the market they wanted a Cayenne and for getting VW to pay for half its development) and the minnows of the UK market including Noble, Morgan, TVR, Caterham and Lotus.

Data source: The Detroit News Auto Insider

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