The Recession is "Over"

According to the RBA's forecasts as of May:

The central bank predicts that the negative economic growth recorded in the December quarter will be repeated in the March and June quarters, with the economy shrinking by a total of 1.25 per cent before beginning to pick up from the middle of this year.

According to Merrill Lynch, it is now over:

"The recession is over" Merrill declared in a report Tuesday authored by Michael Hartnett, chief global equity strategist.

The brokerage’s famed horned mascot is snorting again: "We are bullish on global equities," Hartnett says in the report.

According to news articles quoting US Treasury Secretary Timothy Geithner, it will be over in a matter of months. Of course, he never actually says anything solid, he simply alludes:

"We have a powerful set of policies coming on stream," he said. "We have a very good chance of seeing the US economy and the global economy get back to the point where [they are] growing again over the next few quarters."

According to Dennis Kneale, it has been over since the start of this quarter.


The market has certainly reacted accordingly. That is to say, the stock market reacted, the futures market's message is plainly unchanged. I'm unaware of a history of successful predictions from any of these sources, and quite aware of a lack of success, so I'll add my own prediction to the pot:

The global economy will be out of "green shoots" in a matter of months - that is, the hope of an imminent recovery will melt away to be replaced by fear and then panic.

Futures spreads

I've been a bit out of things lately, a little dismayed at getting done by this rally. It appears that my experience is insufficient for predicting the timing of the future, so for this I turn to a source vastly better at making timing predictions - the futures market.

As I explained earlier, the futures market is chained to the stock market because it will be forced to match upon expiry of the contract, and so it never seems to drift more than about 35 points apart. From this I'll define a scale from -50 to 50, where -50 is "The End of the World approaches" and 50 is "Everlasting World Peace any time now".

The September spread is -35, or "Oh my god didn't there used to be an economy", the December spread is -30, or "Well, looks like the economy is still here... maybe we really have bottomed" and the March spread is slightly different because betting on it is less liquid - but it's between -36 and -60, which places it somewhere between "The economy is no more" and "The world is no more". I really hope it's the former.

Rates and Ratings

The outlook for UK credit rating was cut to negative by S&P.
There's talk of something similar coming down the line for the US by the head of a major investment company that specialises in bonds.

Meanwhile, US 10 year treasury interest rates went up 0.21% overnight, from 3.16% to 3.37%, continuing a recent run up from a bit over 2%. This is the rate that the US pays to borrow money. This is particularly significant, since most other debt is seen in the light of "is x% less safe than US government debt". This is directly and immediately impacting Australian government debt, which has gone from below 4.4% to 5.2% in the last month, with an expected translation from there into all long-term debt rates in Australia.

What this really means is that anyone refinancing debt now will have a much harder time, whether it be a personal loan, home loan, or large corporate loan, and they'll have to pay a higher rate. A number of on-edge companies will be pushed over really soon should this trend continue, and a number of on-edge individuals will find themselves in foreclosure/bankruptcy proceedings.

Australia swirls

Business Speculator has a nice article on the direction of the Australia:

The forward estimates period will produce government debt of at least $200 billion with no further fiscal stimulus or infrastructure spending.

With a conclusion that is exceedingly negative on Australia's outlook:

As a result the Australian dollar will fall. At 70 US cents it looks fundamentally overvalued.

Australia is in recession

Apparently Australia is in recession, and has been since the start of the year. And here I was thinking Australia was strong...

In real news, major US banks have been making profits - but by less than the markup on their own debt. This is a piece of accounting genius: Suppose company XYZ sells $15 Billion of debt due in 5 years for a total of $10 Billion. Next, the market realises that there's a real risk that XYZ will not last 5 years and the debt is going to be paid only partially and only through bankruptcy proceedings, so the debt falls in value to $7.5 Billion. XYZ records a profit of $2.5 Billion because the present value of their outstanding debt has fallen.

In theory, XYZ could buy its debt back for $7.5 Billion - but there were any way it could do this, the market would not have discounted the debt quite so harshly. This windfall profit comes with the catch that it is guaranteed to go away over time - firstly, if the health of the company improves, an equal amount of loss is incurred, and secondly, as the debt matures the present value approaches the face value, making an equal amount of loss.

And on the dangerous side, let's take a look at CDS rates. Rio Tinto is currently around 7.25%, while Macquarie Bank managed to hit 12.65% at the market bottom. Loosely speaking,
CDS rate = Risk of bankruptcy per year * Expected recovery on debt after bankruptcy
At a recovery rate of 2/3rds (probably low for Rio, high for Macq Bank unless they're telling the truth), this gives a market expectation of over a 20% chance on Rio bankruptcy this year and briefly rated almost 40% on Macquarie Bank.

Disclosure: Currently short Macquarie Bank and Rio Tinto in a variety of ways.

Futures spreads

One thing that is fantastic about derivatives is the ability to bet on just about any aspect of the future, so long as there is someone willing to bet against you. The end result of this is that you can get odds on many things, and a consensus bias on many more.

On the way down, the futures spread on the ASX 200 index (both March and June) were around 1% below the index, indicating a consensus of "falling". At the bottom it flipped around, with a spread of 0.5% above the market (June only - March had expired), indicating a consensus of rising, something I bet against to my great detriment. In the last week, the June contract has slipped to between 0.1-0.2% above the market, indicating an expectation of a very mildly upward drifting market until June, however the September contract is trading 1% below the index. After September, the bets get less precise, but imply no recovery even through to June 2010.

To complicate this further, there is an activity called arbitrage. A big player could make bets against all stocks now and buy futures for a guaranteed profit, which will move the market down and the futures up. I believe this results in around 1% being the maximum possible difference between futures and the market while the market is open - otherwise financial institutions with nifty maths and powerful programs will step in and take free money.

In summary, the futures market is predicting a massive market fall between June and September. Bet against it at your own risk.

Earnings & Bankruptcy

Wells Fargo pre-announced that it was going to have massively successful earnings - of course, they're not real. The timing was a surprise. Goldman Sachs had good earnings, which were meant to come out in the morning but came out the evening before - again a surprise impact on the market - but then they flipped into capital raising mode before the market knew what hit it. Good earnings, but still need more money somehow. JP Morgan's earnings were decent, and were also released on time. None of this should really be a surprise given the previous posts here.

At the same time, we have the US's largest commercial real estate bankruptcy - GGP. It appears that the company was worth $18 Billion at the peak in April 2007. The CEO mantains they were fine, simply couldn't roll over debt, and stories appear to indicate how this is positive for Commercial Real Estate because of the opportunity to acquire assets at firesale prices. This is true, if the large CRE companies are cashed up and the economy is poised for recovery...