A long-term investment is a short-term one that went the wrong way...

Bill Blain’s Morning Porridge – March 22 2012

By Bill Blain, senior director, special situations, Newedge (as seen on TV)

T: +44 207 676 8615; Mobile: +44 777 088 1033; E: [email protected]

So where do we go from here? On one hand we’ve had a slew of the right kind of signals from the US suggesting Growth is back on the agenda. (Ok, so a few outliers like declines in housing y’day!) So is it time to sell bonds and buy equity? Or is that little warning voice at the back of your head saying… hang on.. WAIT.. Is this the real deal or just another false dawn?

One economist yesterday put out a very bearish call – Albert Edwards of SocGen saying: bond yields will move back down, equity rally will ‘dissolve into dust’, US bond sell-off is overdone, and by the end of Q4 earnings will be ‘decidedly weak’. A number of other blogs comment US earnings do seem to be peaking well ahead of the markets.

So what to do…? Take a back seat and wait for clearer vision on what lies before us.. Dang.. if you sit on the fence too long all you ever get

is a sore bottom!

This morning, its back to China as top of the worry list – a five month contraction in manufacturing has increased global recession fears, and gave Treasuries something of a bid. How might that affect prospects for next week’s Treasury auction? The sheer scale of US borrowing, the budget ceiling and all that ‘stuff’ will weigh on sentiment, while increasingly investors will be looking East to China for more on growth, property and rumours of unrest…

So what is there to look forward to?

Looking at European government bond yields over the last few days, and it frighteningly easy to buy the line Europe is normalising.

10-year Portuguese yields peaked at 15.81% in January, yet are now down to 11.87%.

Spain 10-year touched 6.63% in November, but are now a modest 5.36% - even sub 5% at times.

Italy 10-year yields are now 5%, down from 7.23% in Nov and 7.11% in Jan. What’s happened?

Outside the boost given to all bond markets by the LTROs, and the phoney-stability it’s engendered, what’s actually changed? A modest outbreak of confidence? Renewed expectations the Euro Elites can yet solve the incompatibilities at the centre of the crisis? Or has something more fundamental changed – are European economies successfully making the crisis course change? Do they deserve reassessment?

With Italy it's simple – I don’t discern anything much has actually happened except the government telling us it has. The LTROs have successfully delayed a massive debt repayment crisis – with Italian banks spanking their €260bn free cash into BTPs. A couple of recent blog postings on Zerohedge and elsewhere point out that actually the Debt/GDP ratio in Italy is probably much higher at 140+ if all the country's debt and obligations (including its ‘unfortunate’ derivatives exposures are included).

The main Italy risk remains political and that once the Monti government loses its tenuous hold over the unions, then the edifice of Italy will be exposed as wholly unreconstructed. Political smoke and mirrors can only last so long.

Meanwhile: ‘Spain has never been so close to default and Greece, Ireland and Portugal will need further bailouts..’ spake Willem Buiter, chief economist at Citibank. He reckons Spain is close to a big restructuring. At the same time Citi was revising its euro area growth forecast from down 1.2% down from 1.3% down… they raised global growth forecasts by the same amount to 2.5% up from 2.4% up.

What are the prospects for Spain? Banking crisis on the back of property loans? Soaring unemployment? Political instability down the road?  At least the Spaniards are trying – although it’s clear they won’t make stability pact budget numbers!

Yet, I can’t help but wonder if I overegg all the bad news about Europe? Yesterday I obtained a copy of a very pragmatic Portuguese MOF presentation outlining in clear terms why Portugal is doing better. (Frankly – very interesting and rational – and it convinced me!) The key points it makes are that Portugal faced enormous and apparently insurmountable difficulties, but is delivering on its promises:

i.        There is political consensus and support for its austerity programme.

ii.        The economy is stressed, but milder recession than expected, and growing exports. Structurally, it is adjusting faster than any other European country.

iii.        Fiscal targets and reform targets are being met.

iv.        Banks are more stable, transparent and regulation has succeeded.

v.        Privatisation process is well underway.

vi.        Labour market is being reformed with support for programme.

In short Portugal is transforming itself across a range of critical measures. It deserves to be congratulated. Don’t underestimate the will of European nations to adjust, struggle and through austerity endeavours reform their fractured economies.

Unfortunately, no matter how hard it tries, Portugal won’t succeed within the euro. No matter how much pain its population is prepared to take, how much it reforms the labour market, sells off the state crown jewels, improves productivity and competitiveness, Portugal is always going to be playing catch up to the developed North of Europe.

Unfortunately that remains the problem at the heart of Europe. It's not that economies aren’t adjusting – some are. It’s not that there isn’t political consensus today to achieve results – there is. It’s that there is ultimately little to adjust or restructure to. The Europe of the future will remain austerity-riven, spending-constrained and an unhappy host of struggling economies trapped in someone else’s currency. Electorates won’t take pain for ever.

When is the stretched string of European recovery going to snap? Soon… I suspect soon.

Out of time..