Weekly Review - Sept 8.12

India

McDonald has announced it will launch a Vegetarian Outlet in India sometime June 2013.  This will be the first vegetarian restaurant in the world!  A few other fast food restaurants are fleeing into India in attempt to capture a consumer base of 1.2Billion people.  Can you say "McDonaldization" I mean globalization. 

India released its trade balance on Monday.  Economist forecasted a deficit of -8.8Billion however their estimates were wrong.  Actual number was -15.5Billion!  I think they(economist) need to update their model.  This means Imports outgrew exports by 15.5Billion dollars.  This re-affirms our belief that India is in the process of industrialization and has a lot of growth potential. 

Europe
The dreaded Troika stepped back into Greece this week to impose more restriction.  Austerity is a dirty nine letter word for many Greeks.  The public force (police and military) successfully opposed cuts to their pay checks.  This means the ministry of Finance will look into other areas to cut…. PENSIONS are next! With unemployment almost at Spanish levels of 25% a cut to pensions will be devastating.  Old age pensioners are the bread winners for large number of unemployed.  Hundreds of retirees took to the street their signs and protested this week.





On a Euro wide level,  Purchasing Manufacturing Index (PMI) was less than 50 indicating again another contraction in the economy.  Managers are still bearish.  Here are more gloomy numbers to show that Europe is in a big mess. 
*Retail Sales (MoM) : Down -0.2%
*GDP(QoQ) : -0.2%

USA
Much attention to Congressional speeches this week adverted attention away from the real problem.  Unemployment is still above 8% and wont seem to go down no matter how much stimulus and tax breaks are given.  Plain and Simple, business aren’t hiring new workers.   Unemployment rate came out this week, it still remains above 8% at 8.1%(not seasonally adjusted).   Also, manufacturing index came out showing that levels are below 50 which shows a bearish outlook in business. 

Canada
As expected, interest rate remained unchanged on Wednesday.  Bank of Canada kept rates at 1%.  Furthermore, Purchasing Manufacturing Index is well above 50 at 62.5.
Canadians are doing well!  Carney stated "As long as demand for commodities are strong Canada will do well"  In other words "Expensive oil = happy Canada."

Fiscal Cliff and Superman

The Cliff

What's all this Fiscal Cliff talk? The fiscal cliff is a mix of expiring tax cuts (Bush tax cuts, Alternative Minimum Tax inflation patch and the payroll tax cut) and spending cuts (the “sequestration.” which chops 10 percent from defense and 8 percent from all discretionary spending; Medicare doctor payments; and extended unemployment benefits).  All these cuts are set to expire by year end and are likely to pose a big threat if not resolved.  

Last week the Congressional Budget Office (CBO) stated that the American economy is headed for a full out recession if all tax increases and spending cuts occur.

"The deficit will shrink [by] almost $500 billion ... Such fiscal tightening will lead to economic conditions in 2013 that will probably be considered a recession, with real GDP declining by 0.5 percent between the fourth quarter of 2012 and the fourth quarter of 2013 and the unemployment rate rising to about 9 percent in the second half of calendar year 2013"

Simply put, if Congress doesn't get their act together Americans should expect a loss of "2 million" jobs and a "recession".   That's right folks, a recession.  A loss of $500 billion is equivalent to 4% GDP.  Current GDP is 1.5%.  Therefore, in a 100% scenario (worst case)  we can expect GDP to be -2.5% (1.5%-4%).

Gridlock

I expect Congress to act similarly to last year debt ceiling crisis where republicans and democrats acted like children and after much political brinkmanship and a rating downgrade by Standards and Poor's, Congress finally came to their senses. 
Although a full blown scenario where all tax cuts and spending expire seems very unlikely.  Given Congress's track record it is also unlikely to assume they will extend all tax and spending cuts.  This leaves one to assume that half the cuts will be extended and the fiscal drag on GDP will be about 2%.

Scenario	GDP
No Fiscal Cliff (not likely)	1.5%
Full Fiscal Cliff (not likely)	-2.5%
50% of cliff (most likely)	-0.5%

 

It gets worse! ...... The clifflet

Here's the real threat. Even if the Bush tax cuts are extended and the sequester delayed, a huge amount of fiscal drag remains in place. They include the expiration of the payroll tax cut, the expiration of extended unemployment insurance benefits and an imposition of a new 3.8% Medicare investment tax on the wealthy.  The IMF reckons fiscal policy will tighten more in America next year than in Spain, Italy or Portugal. Though smaller than the full fiscal cliff, the fiscal clifflet still poses a significant headwind to the economy.

Bernanke to the Rescue!

Paying close attention to the minutes released by the Feds and reading between the lines, one can see  there's a very high probability that we see some sort of quantitative easing come Sept 12.   According to PIMCO's Bill Gross QE3 is 80% probable. 
Passages from the minutes: 

Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.

The data has been improving slightly, but nothing impressive and sustainable to withstand a large fiscal drag.  Expect the Feds to keep interest rate depressed throughout 2014 and inject liquidity through some sort of Treasury/MBS purchase program.

As a Canadian, why should you be concerned about Fiscal Cliff?
Contact us to learn how you can hedge your portfolio and profit for what's about to come.

                  

      Herman Venegas

Will California go Bankrupt?

 

Once again, California, the home of Hollywood and entertainment has filed for Bankruptcy for the third time in a month. Is this a rare occurrence or do we expect to see more of this coming our way?
Let’s investigate!

Stockton, CA

Population: 291,707
Median household income: $45,730

Prior to the housing collapse of 2008 this city was Booming.  The city had spent over $190Million on a new Harbour, City Hall, Stadium and Parking Garages. In early 2007 average home sales totaled 7,000 on a quarterly basis with a median price of $340,000 per unit. Unemployment was low with the majority of employment in the construction industry and public works.  

What happened after 2008?

Quarterly average home sales dropped by 1,500 and the same house that was selling at $340,000 is now  selling at $110,000 (68% drop in value…ouch!).  In addition, with less houses being built, the construction industry took a big hit.  Unemployment is now at its highest, 20.1% which is 10% above the California State average.  Furthermore, as Stockton panicked to pay its debt, it almost cut public wages by 43%, police force and fire by 25% and 30%.  Anyone paying close attention to this city could see this coming a mile away!  The city had no other options.  It has a looming pension obligation and health benefits totaling $400Million.   

20% of the city unemployed combined with a 68% drop in housing value, filing for bankruptcy was the only option left.  

Mammoth Lakes, CA

Population: 7,392
Median Household Income: $51,929

Mammoth Lakes, California is a small resort town up in the Sierra Nevada Mountains.  Its largest creditor, "Mammoth Lakes Land Acquisition" has been involved in an ongoing court case battle since 2006.  Unfortunately, the city lost the case (breach of contract) and was forced to make full payment of $43 million by June 30, 2012.  This city has an annual operating budget of only $2.8Million which makes it feasibly impossible to pay off "Mammoth Lakes Land Acquisition" unless each citizen was willing to cough up an additional $6,000 in taxes. 

 

San Bernardino, CA

Population: 209,924
Median household income: 35,978

This city was also hit hard by the 2008 housing turmoil. It displayed a high degree of foreclosures and a rapid decline in the housing market.  Since 2007, home prices have declined from $300,000 to $100,000.   In addition, unemployment rose to 16.% with the majority of labour employed in construction. 

 

The city calculates that public safety spending now accounts for 73% of the general fund budget.  Also, the city imposed a 10% pay cut to public workers but the firefighter union successfully revoked it.  In addition to failed negotiation attempts with union, its pension cost are soaring and have  doubled since 2006.  Pensions are set to reach $25Million.   

With little cash on hand (approximately $120Million for this fiscal year) San Bernardino was not able to meet its contractual agreements and filed.   

 

Stockton and San Bernardino both displayed the following symptom

      Excessive public spending

Rapid foreclosure rates with the largest share of employees in the construction industry

Unemployment above 15% (well above the national average of 8.2%)

        Strong Unions with high pension cost

It’s clear to see these two states have a high degree of sensitivity to the housing sector.  Most economists like to call this “elasticity” With the average price of a house costing approximately $300,000, the municipal government was able to generate a substantial amount of revenue off property taxes.  Furthermore, the majority of labour was in the construction industry causing a surge in unemployment which ultimately had spillovers into other areas. 

To answer the question "do we expect to see more of this coming our way?"
Municipalities that exhibit the above symptoms are at risk of bankruptcy.  Areas which were hardest hit by the housing market and have yet to recover (home prices are still falling in most cities) are areas to look out for.  One piece of advice, stay away from municipal bonds if they display these symptoms. 

Herman Venegas