MacDonald, Scott June 0611
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Transcript of MacDonald, Scott June 0611
Where Do We Go From Here?
A Mid-2011 Outlook On Markets
S c o t t B . M a c D o n a l d , P h . D .
S e n i o r M a n a g i n g D i r e c t o r
H e a d o f C r e d i t a n d E c o n o m i c R e s e a r c h
J u n e 2 0 1 1
A L A D D I N C A P I TA L H O L D I N G S L L C
6 Landmark Square, Stamford, CT 06901 – Phone: (203) 487-6700 | Fax: (203) 487-6720
The Perceptional Lens
2
Aladdin is in the fixed income business, largely focused on U.S. assets.
Comments narrowed to U.S. markets with focus on fixed income, mainly IG corporates.
The U.S. is a relative safe harbor for investors in 2011.
2012 carries greater risk on a number of fronts, including the possibility of a slowing economy.
To understate, the investment environment remains challenging due to a backdrop of structural changes in the global economy, ongoing deleveraging in advanced economies, a heightened period of political instability, and investor caution.
What Do We Expect By Year-End?
3
Equity markets are likely to end the year up (with a fair amount of range trading).
There will be a rotation of sector leaders.
Fixed income bonds will end the year marginally tighter, both IG and HY.
The most challenging sectors will remain sovereigns and financials, while industrials, consumer, and tech will outperform.
The current softness in the U.S. economy is likely to moderate if it is indeed caused by exogenous factors:
Global supply chain and weather volatility.
Elevated oil prices will remain a drag on growth.
If the global economy recovers at a stronger pace than expected, investors will be drawn into equities over fixed income.
The Most Likely Scenario:
How Do We Get To This Scenario?
4
U.S. economic recovery continues, though there are questions as to the pace and sustainability going into 2012.
If U.S. economic indicators remain “soft”, QEIII (or something similar) looms (2012, after all, is an election year).
Corporate profitability and balance sheet strength have been robust though new investment has been slow. If “soft patch” continues, profit margins will decline, but remain in positive territory.
Growing economy, fundamentals and technical factors will allow defaults to remain low in 2011- early 2012.
Black swans (i.e. a Greek default) are contained in the short term and not allowed to go systematic (or so it is hoped). U.S. investors are not currently pricing in a Greek credit event.
Real GDP and Related Measures (% change from Preceding Period)
* Source: Bureau of Economic Analysis (Q1 2011 is a Seasonally Adjusted Annual Rate)
Growth is coming from consumer durables and business fixed investment in equipment and software.
2008 2009 2010 Q1 2011
GDP 0.0 -2.6 2.9 1.8
PCE -0.3 -1.2 1.7 2.7
Gross Private Domestic Investment -9.5 -22.6 17.1 8.5
Fixed Investment -6.4 -18.3 3.9 0.7
Nonresidential 0.3 -17.1 5.7 1.8
Structures 5.9 -20.4 -13.7 - 21.7
Equipment and Software -2.4 -15.3 15.3 11.6
Residential -24.0 -22.9 -3.0 -4.1
Government Consumption 2.8 1.6 1.0 -5.2
Excess Capacity means structures may continue to
decline
Technology Leapfrogging
spurring corporate spending on S&E
Housing will remain tepid
Market Implication: Equipment and Software are leading growth
U.S. Forecast: The U.S. Recovery Continues
5
100% depreciation for 2011 CapEx, a new tech cycle and pent up demand will keep this sector strong in 2011, but it is a only 10.5% of GDP
Sources: Census Bureau/Haver Analytics
Mfrs' Shipments: Nondefense Capital Goods ex AircraftSA, Mil.$
Mfrs' Shipments: Nondefense Capital Goods ex Aircraft% Change - Year to Year SA, Mil.$
1009080706Sources: Census Bureau /Haver Analytics
67500
65000
62500
60000
57500
55000
52500
15.0
7.5
0.0
-7.5
-15.0
-22.5
Manufacturer Shipments: Non-defense Capital Goods ex Aircraft (Mil. $, LHS) Manufacturer Shipments: Non-defense Capital Goods ex Aircraft (change YoY, RHS)
Market Implication: Capital goods sector will benefit, especially cash rich companies with low leverage.
U.S. Forecast: The U.S. Recovery Continues
6
Corporate Cash Balance Sheets Q1 2011
7
U.S. Companies Cash Balances (Q1 2011)
Sector Market Cap
(US $ bn) Cash on Hand
(US $ bn) % of
Market Cap
GAP Clothing Retailer 10.92 2.42 22.0
International Paper Paper & Paper Products 13.81 2.05 15.0
John Deere Industrial Goods 35.05 3.52 10.0
Intel Corp. Technology 119.88 11.95 9.0
Archer Daniels Midland Consumer Goods 19.75 1.62 8.2
Honeywell International Aerospace/Defense Products 45.84 3.61 7.8
AT&T Telecom 18.45 1.39 7.5
IBM Technology 203.47 13.25 6.5
Caterpillar, Inc. Industrial Goods 65.44 3.65 5.6
Wal-Mart Stores Discount, Variety Stores 191.59 9.40 4.9
Sources: Bloomberg, Company reports
U.S. Financials Have Stabilized
8
2 4 11
3 4 0 0
3
25
140
157
39
0
20
40
60
80
100
120
140
160
180
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Jan-Apr
2011
Total Bank Failures
U.S. Financials – 2011
A quiet return to profits, but restructuring continues and lending is not coming back anytime soon. Questions exist over impact of a deeper housing decline.
Source: FDIC
*As of May 27, 2011.
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
U.S. Speculative-Grade 12-Month Trailing Default Rates - Actual (Red) and Forecasts:
Baseline (Yellow), Optimistic (Black), Pessimistic (Grey)
In April 2011 the trailing 12-month global default rate stood at 2.3%.
The April 2011 U.S. speculative-grade high yield default rate was at 2.6%. This rate is projected to decline to 1.6% by December 2011.
Source: April Default Report, Moody’s Investor Services, May 5th, 2011
Apr ‘11 12-mo Trailing Default Rate: 2.6%
Moody’s April 2011 Default Report
9
But What About The Current Slowdown?
10
Q1 GDP was lower than hoped at 1.8%.
Why?
Lower government contribution to growth.
A normalization in consumer consumption from Q4 2010.
Poor weather.
Japan’s earthquake/tsunami interrupted global supply chains.
Q2 GDP expectations shaped by more of the same.
Q3 and Q4 likely to benefit from falling energy prices, low interest rates and a return to growth in Japan.
There are enough positive factors to keep the economy moving, but not enough to launch a broader and deeper recovery.
Structural problems are being treated like a can and kicked down the road. The road is now uphill.
U.S. Markets Have Held Up Relatively Well
11
VIX: Volatility Index
Source: Bloomberg
Expectation of continued loose monetary policy has helped contain volatility while there is a discounting of European sovereign risk.
0
5
10
15
20
25
30
35
40
45
50
55
60
65
70
75
80
85
90
Contained Volatility in U.S. Credit Markets
12
0
50
100
150
200
250
300
350
400
450
500
550
600
1990 1992 1995 1998 2000 2003 2006 2009 2011
bps
Source: Barclays Capital Live
End of
USSR
Mexico Debt Rescue
Asian Crisis
Tech Bubble Burst
US
Recession US Bank Crisis /
First Gulf War US Economic Recovery
US Economic
Slowdown
US Economic Recovery
Fed Raises
Rates 6 Times
9/11
Enron / Worldcom
Scandals (224bps)
US Invasion of Iraq
Auto Blow-Up
US Housing
Bubble
Global
De-Leveraging
Begins
Russian Default (69bps)
Updated as of April 12, 2011
The Great Recession
GM Files for
Chapter 11
Federal Reserve
Issued Stress
Tests Results
European
Sovereigns
Barclays Capital U.S. Credit Index (OAS)
New issues have been strong and most of it priced to sell.
Remaining risks contain market upside and could make the current market correction a bear market.
13
The risk to the U.S. economy is that it slows further than expected: housing double-dip, lower spending, continued exogenous shocks.
Government policy becomes more interventionist.
With a growing budget deficit and nascent inflation, Financial Repression could be used to keep rates artificially low.
U.S. Federal and municipal debt levels will hinder growth and equity market performance if not addressed.
Events around the world – Japan, the Middle East, and Europe – derail U.S/global recovery.
Risks to Resilience
An Extended Season of Black Swans and Warning Signs
14
2010
April-May: Greek tremors / EU/IMF agreement on May 2.
September: Mozambique food riots mark return of food-inflation related problems.
November: Ireland goes to EU/IMF.
2011
January: Tunisia’s Jasmine Revolution (president Ben Ali ousted Jan. 14th). Riots occur in Yemen, Bahrain, Oman.
February: Egypt’s Mubarak Resigns (February 11th). Riots begin in Libya and turn into civil war.
March: Earthquake hits Japan (March 11th). Tsunami/Nuclear problems follow. Saudi intervention into Bahrain. Jasmine Revolution spreads to Syria.
April: Oil at $110 a barrel. Portugal goes to IMF/EU for help.
May: S&P changes outlook of U.S. sovereign AAA from stable to negative. Commodities sell-off. Greek 2yr bond hits 25%.
The U.S. Credit Landscape – The Most Likely Scenario
15
Corporate sector is profitable. Q1 2011 earnings were strong. Q2 likely to show marginal profitability decline.
Although cautious, U.S. corporates have a large cash reserve to sustain them if economic “soft patch” continues. Cash is also being used to raise dividends and finance stock repurchases and strategic M&A.
Weaknesses in bank lending indicates U.S. corporate bond market will remain open. Also will force infrastructure funding needs to nonbank sources.
Shadow banking system is an increasing source of debt financing as banks remain constrained by bad legacy loans and heavy regulation.
Demand for alternative credit products will remain strong.
Significant investor cash keeps investment grade spreads and high yield spreads relatively tight.
16
Savings Deposits, including Money Market Deposit Accounts (SA, bn USD, log scale)
Source: Federal Reserve Board/Haver Analytics
Investor Concerns Keep a Lot of Cash on the Sidelines
Money Stock: Savings Deposits, including MMDAs
SA, Bil.$
1009080706050403020100Source: Federal Reserve Board /Haver Analytics
6000
5250
4500
3750
3000
2250
1500
6000
5250
4500
3750
3000
2250
1500
Conclusion
17
Investor dilemma is risk-trade v. safety.
Cash is safe, but very low returns.
Low interest rate environment to continue through 2011.
Bank lending remains anemic (both in the U.S. and Europe).
Uncertain global factors add to the risk factor and are not going away.
U.S. equity and credit markets offer a relative safe harbor from volatility and uncertainty in other regions – for 2011.
Indicators point in multitude directions for 2012, leaving the investment environment lacking clarity.
Dr. SCOTT MACDONALD, Senior Managing Director, Head of Credit and Economic Research
Dr. MacDonald has an extensive background in credit and economics, having worked at the U.S. Comptroller of the
Currency, Credit Suisse, and Donaldson, Lufkin and Jenrette. His experience covers banks, commodity companies,
energy, sovereigns, and emerging markets. From 1995 through 1999 he was consistently rated as one of the top fixed
income analysts by Institutional Investor. Dr. MacDonald is widely published on international economic and
financial issues with sixteen books to his credit. He received his Ph.D. in Political Science from the University of
Connecticut, an MA in Asian Studies from the University of London’s Oriental and African Studies Department, and
a BA in Political Science (with Honors) and History from Trinity College.
Biography
Disclaimer
This document was prepared by Aladdin Capital Management LLC (Aladdin Capital), and reflects the current opinion of the contributor. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This document is for informational purposes only and does not constitute a solicitation or an offer to buy or sell any investment security, nor provide investment advice. Neither Aladdin Capital nor any officer or employee of Aladdin Capital or any affiliate thereof accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents. No part of this document may be reproduced in any manner without the permission of Aladdin Capital.