Saturday, 19 February 2011

Macro Level Trends – 3 Speed Global Economy – The American Rebound ...via “Liquidity & Linkages”?

It is no secret that much of the dynamic within western capital markets over the last 3 years has been largely macro-driven.

The financial flee of 2007/8 was partially stemmed by massive government stimulus packages across the US and Europe, with thereafter investment managers necessarily more attuned to long 'macro-plays' in EM regions and commodities, and contra short-plays in western currencies and sovereign-bonds, all the while stock-picking those companies best positioned to ride the recession, ranging from low-risk utilities to Asia-exposed luxury goods houses.

The necessary national re-capitalisation of western banking allowed those in-house investment-banking arms to help themselves, their own required contraction of proprietary trading desks and other front & back office activities creating leaner entities which could in turn better benefit from extracting the global value to be had, which in turn boosted the banks liquidity levels so helping to meet new capital reserve expectations and so increasing confidence of stability.

Of course for the US in particular, the Quantitative Easing packages have assisted the process, Wall Street metaphorically indebted to Washington whilst it is literally indebted to the world, China especially so. The massive first and secondary rounds of QE created concerns for much of the world's other governments and central banks, since it's hyper-Keynesian stance flies directly in the face of the conservative 'economic consolidation' stances the UK and European administrations have elected to pursue, the southern European nations begrudging participants in this very necessary action. The prime US vs European differentiator is concern about QE-linked re-bound inflation or indeed the stagflation paradox of rising prices within an economically stagnant environment.

Thus popular perception garnered from economic text-books' theorums is that via QE the USA believes it can 'spend' its way out of the deep recession. Whilst part of rational, allowing for the provision of 'social stability' spending through welfare benefits and the like, the fact that large stretches of old industrial (unionised) America are irrevocably lost to foreign shores or less labour constrained 'new domestic' manufacturers (eg BMW, Hyundai), plus the increasingly marginalised US export-base (of capital goods, aircraft, defence equipment, cars and service-support) means that the idea of 'spending its way' out of recession has had its detractors.

So could there be another rationale for the massive QE programmes, beyond the dollar devaluation advantages which help to explain the willingness to bare the massive and increasing weight of national debt-servicing?

[NB as FT Video highlights, projections show debt-servicing levels to rise well above average in 2012/13, hitting the 2% average in 2012 with $330bn annual interest, and 4% GDP and $900bn in annual interest payments by 2020. The GDP ratio % level is not concerning but the total amount is more worrying given the real eventual drag on the ability for national and state spending].

US debt-servicing of this magnitude has of course been a prime underlying concern for capital markets when not thence diverted by European sovereign-debt woes, its superseded by the recent social unrest in the Arab world. The US debt focus has returned as international funds partially move-out of China and other 'macro-China' related EM countries as concerns about either the regional over-heating or the quelling of a possible bubble grow. That has meant returning to western safe-havens with the German 'pfandbrief' (ie covered corporate [inc bank] bonds) popular in Europe, but the T-Bill remains the most visible instrument.

Whilst US 'growth' and 'value' stocks have enjoyed renewed favour, the notional safety of Treasury Bonds has buoyed. Through the crisis US Bonds became increasingly unpopular and even saw the historical inversion of the short vs long-term yield relationship which still exists today as investors continue to worried about the long-term possibility of Federal bankruptcy – an end-point scenario created by a domino-effect of inter-state bankruptcies.

[NB This 'inversion' seen in the 30 year Bond yield demands have recently seen a rise, edging to 5% compared to the 2-year Bond yield demands at near 1%, and so previously poor sales of the 3-year Bill given its lowly returns]

However, like Einstein's theory, within the economic universe all things are relative, and recently that 'black-hole' worry appears to have eased – even though its fundamentals still presently remain . As a consequence, the recent 10-year Bill offering worth $24bn on 11.02.2011 (via the usual Fed auction) saw a dramatic 70% take-up and so the spread drop as institutional investors dropped their coupon return expectations, preferring to merely park their monies. This then either infers that they are concerned about fewer near-term investment opportunities, or simply wish to offset the slight EM slowdown.

Though the markets react to near-term economic reasoning and crowd behavior, the broader US position begs a very pertinent question:

“What is the ultimate ambition of the Federal Reserve & Washington?”

The obvious answer is “to get America back on its economic feet again”. But how exactly? Even with good news stories such as 'junk-bond' default yields narrowing, the picture still looks grim given that the impetus of federal and state level spending is heavily curtailed by having to meet budget cuts thus cannot inject monies into society, and the fact that the still large & fragile unemployment figures are paralleled by necessary static-wage or deflationary-wage in the corporate world. A devalued dollar and exports will assist to a point, but without sufficient domestic activity in what is still by far the world's largest economy, the economic motor will only hiccup and lurch, a smooth running depending upon the right fuel, mixed in the right proportion, injected into the system at the right temperature – more easily done in combustion engines than national economies.

Yet the technological inference is wholly intended, since the US must recapture its once lead grid-position in the global technology race, and whilst it maintains its grasp on Defence, IT and Software – now at critical intersects within the worldwide web – with additionally Pharma, it must regain its abilities in the other physically related eco-tech realms: ranging from all vehicle types to housing and commercial construction, and from 'new-age' consumer goods to internal-use and exportable capital goods.

It is within this context that investment-auto-motives believes that Washington's true ambition is to buy-back its once global technological lead, using the 'printed money' from QE and Wall Street to do so.

[NB. In this manner it will re-run its own play-book from the beginning of the 20th century, an example being the acquisition of the then German technological lead in electrical capital goods and consumer goods manufacture.

The 1890s saw the consolidation of the German electrical sector under the 3 big names of AEG, Siemens and Halske-Schuckert. The 2 latter merged whilst AEG was became the General Electric Co, which in turn purchased S-H-S assets, so relieving the technology gap the US had in the face of its burgeoning immigration and urban growth].

Today's contextual position is presently very different to the USA's in the 1900s, yet the need to re-grow its R&D and manufacturing base in physically tangible high-value 'eco-goods' (of all types) is very much a concern. An like any time-constrained, competitively pressured CEO seeking to climb the value-ladder for his/her own company, the default position to 'Acquire' as opposed to the growth pains endured via 'Organic Expansion' has been noted for its efficacy time and time again.

Having created the 'Liquidity' for international acquisition, the next task is to create the 'Linkages'.

As has been well argued by financial journalists, the need to consolidate the world's capital market exchanges has been a pressing challenge since the emergence of alternative platforms (OTC and other exchanges such as the lamented 'dark pools'). The wave of possible imminent exchange consolidation began with the SGX (Singapore) - ASX (Australia) tie-up, which in turn prompted the idea for a LSE (UK) - TMX Canada venture, this possibility pushing the recently announced NYSE Euronext - Deutsche Bourse relationship. This in turn setting-off rumour that a consortium of smaller exchanges comprising of the NASDAQ OMX Group / CME Group / Inter-Continental Exchange Group (ICE) all combine to bid for NYSE Euronext (and or) Deutsche Borse. And lastly (for now at least) the respectively US and European entities of BATS and Chi-X combine to potentially create the largest cash-equities trading platform, even though they have no 'clearing house'.

Thus today we see a rash of potential consolidations take place that vie to gain the trading volumes expected from the release of the QE $ liquidity created and much of which is still stored within the heightened capital reserves of bank balance sheets, on the books of US corporations and within the cash-shells created by private equity and hedge funds.

Thus whilst the Liquidity waits, the Linkages are being created along the lines of greatest capital markets' rationality; all in the face of the US eco-tech acquisition potential which has already shown aspects of its intention.

Previous web-blog posts serve as prime examples of the activity seemingly underway. Previously we saw Navistar's JV with the UK's Modec; possibly limited to a JV due to constrained corporate funding at the time prohibiting a full acquisition.

More recently for readers n the last few posts, we saw BorgWarner strategically purchase Sweden's Haldex Traction Systems for a relatively small sum. (investment-auto-motives would not be surprised to see BorgWarner separately list the Traction Systems division whilst holding onto a major share so as to feed the US – Swedish NASDAQ OMG Group with a purportedly eco-tech participant).

But it is the last post pertaining to the decision by the UK's Williams GP Holdings to list on the Deutsche Bourse which perhaps provides the best example which soundly supports the presented hypothesis of 'Liquidity & Linkages'.

The UK based Williams GP Holdings (at first glance) represents a leading light in the eco-engineering of vehicles, given that its F1 targeted engineering conduces a need for lightweight construction materials and increasingly sophisticated 'hybridised' combustion engines. (The less sophisticated American race series comprising of of Indy 'open wheelers' & NASCAR 'pseudo-sedans'' do not have such a technological nor IPR reach as F1).

In short and very simplistically, F1construction and propulsion techniques holds the eventual regulatory formula for superseding generations of passenger cars, trucks and specialist vehicles. And just as Navistar sought Modec's propulsion systems, so a plethora of US industry players will need to seek-out and purchase other similarly parallel technologies which form part of their own technology roadmap. This done so via friendly or potentially hostile M&A.

This to play-out from 2012 onward, once this round cross-border Exchange tie-ups are resolved.

This is all to the good of the much needed American rebound, which sees an initially underpinning of co-listed companies on Wall St and other global exchanges, as a consequence the rising valuations of which in turn nurtures investment spending and internal demand for educationally attuned employees. Thus the American rebound appears to be liquidity-driven, the QE monies used to capture international tech advances and IPR.

In the face of this prevalent scenario, the question the rest of the world must ask – Northern Europe, Japan and S.Korea in particular – is: “what must we do in the face of this liquidity-charged challenge?”

The balancing act of combining economic and industrial policies which both serve the 'greater good' of globalisation, whilst simultaneously protecting any domestic industrial strategic advantage which serves the national economy, has never been greater.

Ironically, it may be exactly this that pushes China to become more 'international' in its financial and regulatory dealings as it possibly seeks to replicate the American stance in wooing other nations' technology.

Given Germany's tech-lead, and as obvious target for 'tech-fishing', this then sets the future context for its DAX 30 participants and those operating below the that 'radar'. Within the auto-sector then the likes of Daimler, BMW, VW, BASF (for plastics and bonding chemicals) with also critically Continental (which absorbed Siemens Auto and assisted GM's Volt programme).

Whilst Merkel and her cabinet try and maintain some kind of European macro-economic order via her 'head-girl' role in the ESF programme, Berlin will not be unaware of the eventual industrial dynamics that could unfold. Although somewhat ironic, the Churchillian quote that “those who fail to learn the lessons of history are doomed” may be ringing about the hall of the Riechstag.

America's second coming could about to begin given the buoyancy on Wall St. Washington proffering an alternative Churchill quote: “history will be kind to me, for I intend to write it”.

1912 was a watershed year in the US – European dynamic.

2012 could see history repeating itself, this time the “Liquidity & Linkages” pertaining to the bigger picture of the whole advanced world.