Jamal Mecklai: Green shoots

Some US analysts are beginning to look for the positive in an otherwise gloomy outlook

The US economy shrank by 6.2 per cent in the quarter to December 2008, a lot worse than the preliminary numbers (minus 3.8 per cent), but just a bit worse than consensus expectations (minus 6 to minus 5 per cent) before the preliminary numbers were released. Interestingly, the numbers did not spook the markets too much — sure, the Dow fell below its November low hitting levels not seen since 1997, but the NASDAQ and broader equity indices, like the Russell 2000, are still above their November lows. This suggests that the market is probably very close to a bottom.

 

Indeed, there are several analysts who found comfort in the GDP revision since it showed that inventories had drawn down more than had been first announced, suggesting the recovery could begin sooner than earlier expected since businesses will start rebuilding inventories at some point. Analysts beginning to look for the positive in an otherwise gloomy outlook is another sign that sentiment may be turning.

And, indeed, if you look closely, there are a large number of green shoots sprouting up all over: 

 

 

US retail sales showed strong growth (up 1 per cent) in January after contracting every month since last June. UK retail sales have also shown strong growth in December and January. Real hourly earnings growth of still-employed US workers is very strong at 3.3 per cent in November and 4.5 per cent in December. 
 

New orders for consumer and non-defence capital goods were up in January. 
 

Used car prices hardened in January in the US on strong volumes. 
 

Applications for new mortgages and refinancings are rising. 
 

US ISM manufacturing index was up for the first time since June, the ISM services index has been up for two months. 
 

Germany’s IFO business expectations index improved for two consecutive months in January and February. US leading indicators have been up for two months with five of 10 indicators positive in January, compared to just four in December. 
 

The Baltic Dry index is up from 663 in December to 2,099, indicating a pickup in trading. While I acknowledge that numbers that are so hugely volatile may not tell us a lot, there is some anecdotal evidence of China stockpiling commodities. Oil and copper prices are up 30 per cent since December and are holding near the highs. The latest US government report shows that fuel demand in the US rose 1.9 per cent yoy — it was contracting through last year. US CPI was up in January; PPI in both December and January, suggesting that the deflationary mini-cycle may have turned. 
 

Despite the banking sector being in a funk, demand for credit is picking up across the world. $127 billion of US corporate bonds were issued in January, the most since May 2008. Three-month Libor is down to 1.2 per cent, and all spreads are down sharply (TED/ swap/investment grade/junk/bank CDS). T-bill and T-bond yields are up, as capital is chasing corporate bonds right now, indicating an incipient increase in risk appetite. 
 

The Fed’s balance sheet has already started shrinking — from a peak of $2.3 trillion, it is now around $1.9 trillion. Significantly, banks’ reserve balances with the Fed have also down from $843 billion to $687 billion, suggesting that (some) banks are no longer hoarding money. 
 

The $1 trillion TALF, which kicked in last Monday, will ease consumer and business access to loans. Tax cuts from the financial stimulus package will kick in within a few weeks and construction spending in a few months. The Treasury’s Financial Stability Plan is comprehensive and lays out a clear six-month path to recapitalise the money centre banks. The rest of the banking system seems to be handling the crisis much better than in 1988-92, certainly when comparing the number of banks being taken over by the government.

To my mind, all of these green shoots taken together point to a definitive bottoming out of the crisis, a view I have held since early January.

But, of course, it will take some time for sentiment to really turn. Right now, risk capital is tiptoeing back into the market and enjoying the corporate bond opportunity, which is extremely attractive — the spreads between Moody’s Baa borrowing costs and 10-year Treasuries are a juicy 526 basis points. Only after this opportunity is exhausted — spreads come down to, say, 250 or 300 basis points — will capital begin to move out on the risk curve and take equities higher, at which point most people will “get it”. In the current terrified environment, this could take several months; if sentiment were to pick up, it could happen in a week.

This return to more normal global conditions can only be good for India, as, in time, capital flows will resume. When this happens, the rupee, which has collapsed in the wake of the-world-is-ending sentiment, will recover smartly. Exporters should keep selling at every 25-30 paise rise, and cover hugely with options when the rupee turns back below 50, irrespective of the premiums. Importers have to bite the bullet for a while, buying on dips for the short term.