Virgin Post

So this is my first post - having thought about blogging before - that being before the technology was readily available - it never came off, but now I feel the time has come!

The inspiration has really come from my friend Steen Jakobsen (http://steenjakobsen.blogspot.com/)

Anyway, as most of what I will have to say will have something to do with financial markets, I might as well get on to it:

It's a bit refreshing to see that some degree of sanity has returned, albeit still in a small way as the market is waking up to the fact that bear markets do not end one day with a bull market starting the next! It's a long and protracted process.

The 'green shoots' are, as David Blanchflower writes in The Telegraph today, only visible to the colour blind - it's all sentiment based. Stock market goes up a bit i.e. the world is no longer ending tomorrow, so consumer and business confidence indicators bounce from their lows, so the stock market goes up a bit further and so on. We've had three months of this self-fulfilling prophecy and finally it looks like it's over.

In my opinion the (US) economy will not rebound before the housing market bottoms and unemployment stops rising. It does not look like either is just about to happen as foreclosures are still rising at record levels after the moratorium lapsed and there is a massive number of ARMs to re-set for the rest of this year and 2010, which again will lead to more foreclosures.

The US needs to create about 150,000 jobs per month to stop the unemployment rate rising, so even after the much better than expected job losses in May there still is a gap of almost 500,000 jobs a month to stop the unemployment rate going up. This gap is not going to be closed anytime soon.

But even if the housing market bottomed and unemployment stopped rising would the US consumer be in a position to (or even want to) start spending like a drunken sailor again? After having had no visible savings rate in the US for years (it was all accumulated in the stock and housing markets) it is now 5% there's little wage growth and zero bargaining power due to the unemployment rate, you have to presume that the only rational behaviour for the consumer is to maintain the higher savings rate and prioritise paying down debts. not putting money, saved or borrowed 'to work' in the stock market, as the pundits on CNBC and Bloomberg TV are always banging on about?

The time when you would (and could) max out your credit card to buy stocks and expect to make more in the stock market than the 15% rate on the credit card are surely gone?

With the consumer being 70% of the US economy and a frightening 20% of the global economy and in effect being in a precarious financial situation with frugality, rather than frivolity, on his mind, where is the growth going to come from???????

China, I hear you say - yes China is investing heavily in infrastructure and expanding their capacity to produce goods for the American and European consumer - this is after reports of tens of thousands of factories having been closed in China and the western consumers having slashed spending, in favour of saving?

Wages in China, according to Paul Mason's report on BBC's Newsnight program last night, have fallen 20% from last year (from 5,000 to 4,000 RMB/month) in China for workers coming to the urban areas from the country side. This kind of wage destruction is clearly deflationary - western workers should be quite happy that they haven't been subjected to that - yet!

Which leads me to the next mis-conception in the market that inflation is coming and it's going to be high. It may come, but it will take a long time....Yesterday I watched JP Morgan Private Bank's chief strategist being shot down by Steve Liesman on CNBC after referring to the 7% increase in inflation in 1951, after 1950 being the last year inflation was more negative y/y than the last 12 months, as he forgot to mention that un-employment was 3.4% in 1951 - as opposed to 9.4% now. We are simply not in a situation where wage inflation anywhere, is going to be a problem anytime soon.

Capacity utilization is at the lowest level since records began (1967) just to mention another indicator.

So what now? The Fed is very unlikely to increase rates any time soon - and not before 2011 according to Pimco's Paul McCulley - so the front-end of the US curve has plenty of value, not least since Friday before last's massive sell-off, while a lot of that has come back since then, but red Dec eurodollar futures are trading at 97.61 so implying 3m libor to fix at 2.39% in December 2010 against a current fixing of 0.65% and a fed funds target of 0-0.25%. While this trade is not without risks a lot of the weak longs have probably been stopped out after a on day move of more than 50 bp's.

Equities are going to re-test their lows sometime in Q3/Q4; the lows may hold - or the markets could make new lows. In the last bear market the recession ended in November 2001, the equity market bottomed in October 2002 and tested that low again in March 2003. This is clearly a much worse situation so to expect the market to continue to go up from here without a re-test (of the lows) is in my view naive at best and plain stupid at worst!

I will be back with my views on how to fix part of the US twin deficits, while saving the planet!