Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 10 September 2012 at 12:23 GMT

The fifth wave

Chief Economist & CIO / Saxo Bank

I’m just back from travelling in Sweden, the US and China. This weekend I spoke at a major investor conference in Shanghai and I left with a very negative outlook for China and a more positive one for the US – but most importantly I was shocked at the much higher prices I saw during my travels.

The key change since my last round of musings is the following:

  • Inflation is rising – I was shocked to see the extent of price hikes in both the US and China. I am of course only comparing hotels, restaurants and basic services, but I can say this: They are up about 15-30 percent across the board. This is either due to more pricing power, rising input costs or the micro-economy adjusting to the endless printing of money.
  • Relative to consensus, the US is better and China is worse. There is a quiet optimism which I like in the US and in China, we are nearing “panic” levels. Based on my dicsussions with business people attending the Shanghai conference it was very clear that "the Chinese" see the need for changes to the Chinese business model. “Reshoring” is the buzzword in the Chinese press – more on this below.
  • There is a major yield chase at the moment similar to 2007/08 (also an election period, by the way)
  • Finally, we in the financial sector are far too entrenched in the negatives of the world – too much macro talk (policy, especially central banks) and too little micro.

Allocation and changes

Overall macro themes
Extend-and-Pretend continues – now in the phase of Maximum Intervention but it’s the wrong medicine at the wrong time.

  • Elections are the main drivers of policies
  • “Reshoring” is the buzzword in Asia. Increasingly companies are moving back to the US and Europe, and in particular US companies feel confident with lower natural gas prices (due to the US shale gas bonanza) which leads to cheaper production costs for chemicals, and electricity-heavy industries.
  • The low in interest rates is here and now, even if the economic nadir may not come until Q1-Q2 of next year. There is major divergence in rates (yields at new lows, but relative prices not following). Economically, the like-for-like comparison will mean slow momentum going forward – we see both US and Europe hitting a low around now, before slowly coming back (as we now have maximum austerity, and low financing costs as we are still in a period of maximum intervention)
  • Too much Macro, too little Micro. S&P 500 companies have seen a return-on-equity of >20 percent! Micro rules. A macro policy of “do nothing” should be the norm, but policy makers are desperate to do even more even as the money-printing press is already working overtime. Let technologies like 3D-graphics, shale gas, and genome mapping provide forward economic momentum rather than deficit spending and money printing, which are failing us.
  • Greece is still the main EU risk – it will default inside the next two quarters.

Event risks from here

  • The European Stability Mechansim will be approved on Wednesday by the German Constitutional court, but more importantly, I believe the court will not allow a “narrow” Budget Committee to rule on EU questions, which will make every single one of the 600 members of Bundestag accountable. Rather than enhancing it, this could shift the consensus away from  a commitment to the Euro.
  • Greece is done – and so is Spain, but policy makers will try to buy more time. Merkel now talks of our “Meeting of the Cardinals” in December, trying to change the EU Treaty. One problem: time is running out!
  • Fiscal cliff:  +/- 1 per cent of GDP equates to about 5 to 7 dollars of earnings on the S&P, ergo, about 75-110 S&P points if forward multiples remain in the current area. The cliff will be smaller than if no action were to be taken. I expect a political compromise will be found that costs 0.5-1.0  percent of GDP.


Equity: We are in a final fifth wave move that has been driven by the lack of alternatives in a zero interest rate environment. The market performs well during cheap quantitative easing (QE) talk from the Federal Reserve. The Fed moving to extend its pledge to not tighten until through 2015 will mark the zenith in this rally in equities as both relative value and forward looking PE’s are stretched. We also believe China leads rather than lags.

S&P 500 large cap index

S&P 500 12m forward PE

S&P 500 weekly

Interest rates: May have hit a bottom for now based on rising gasoline prices, agriculture, benchmark prices (my travel indicates that like-for-like hotel, restaurants, and services are up 15-30 percent over the last six months).

30-year T-Bond yield

Commodities: Infinite printing is here and will be confirmed this week – Gold may have a look at 1800+

We are in the fifth wave of all major macro benchmarks: the stock market (high), yields (low), economics (low), intervention (high), hope (high) and politics (low). This will lead into an ABC correction phase for valuation.

We also firmly believe that the period we could and should compare with is the 1970s: High energy prices, big government, expansive fiscal policies and a more or less clueless political establishment.

Below you can see the US GDP and the relevant S&P performance – the 1970s grew by 3.2 percent annualised while the S&P fell by 1.6 percent, but this was the major companies. We believe that 2013 and onwards will be about reshoring and the micro-economy, and that the best growth and performance will come from small and medium-sized enterprises (SME) - from USD 500 million to 2 billion in market cap. They are more innovative, agile and will be increasingly more competitive due to the quick scalability of technology and as they are eventually able to access risk capital.

US real GDP trend growth

We are looking for the low in yields now, for the low in economic data during Q4 2012 to Q1 2013 and a 25/35 percent correction before we start anew after Greece has left the EU, and a Meeting of the Cardinals which will redefine the Treaty of Europe and the EU. The “positive” changes will not come from macro, but from the micro economy which will and is already performing.

 Finally, here are my two notes “from the road” in the US:


MedievalAstrology MedievalAstrology
Great article. thank you ! I like the part that we should look more at micro. However, I still can`t believe in the infinite printing part, although everyone expects it.
Tadeusz Browarek Tadeusz Browarek
Money printing is an immanent characteristics of free democracy where politicians are being elected for certain time period. The candidates must promise to be elected, then they try to keep (partly) their promises with money printing.

The Catholic Pope is being elected for their lifetime or own wish time by limited circle of electors nominated by his predecessor. Therefore he does not have to seek support with voters. The same applies to Russian Tsars. Both do not have budget deficits, debts and economic crisis.

Rarely there are politicians with a vision far beyond their service term. They become part of history. We call them "homme d'état" (statesman). They do not promise anything – they act.
William Willis William Willis
Well said.
goldfinger goldfinger
Yes, I agree great piece and very well thought out. I think I may be a little older than you Steen, and I was in the equity markets through the late 60's and 70's. There was nothing pleasant about 1972 to 1974 and beyond. I cannot recollect any growth although memory might fail me. Infact, the UK had a three day week enforced due to Heath failing to take on the miners properly and interest rates rose to 15%. Inflation was about 24%, or am I having a bad dream...
goldfinger goldfinger
Apologies for an afterthought. You are looking to the micro and sme's to save the day, if left alone! I agree with being left alone and less gov't interferance is all important. As an sme we are drowning in petty bureaucracy. But, and it is a big but, banks are not lending. It doesn't matter how innovative, if you can't get the shekels........
seemore seemore
Very well said Tadeusz.


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