Author: Vincent Fernando, CFA

America’s heartland has quietly gained some major competitive advantages over America’s crowded, expensive coasts.

Thus get ready for a heartland renaissance over the next forty years says New Geography.

It makes a lot of sense. First of all, America’s ‘fly-over’ states have substantial natural resources, which will remain extremely important in a world where developing nations are devouring more than ever and America is increasingly worried about its dependence on foreign nations.

But there’s far more ot it.

Advances in communication, ie. the internet, have removed many of the reasons for Americans to congregate in crowded industry-hub cities such as New York or Los Angeles. Sure this has been happening for awhile. It’s just that now the need for Americans to huddle together in crowded hub cities is disappearing fast.

Thus all kinds of new industries are growing, and will grow, in the heartland. You won’t be such an industry outsider anymore when you are located far from major cities either. Thus given lower living costs, more land, and less population density, there will be fewer and fewer reasons not to move. New Geography believes we’re in for an enormous structural shift in the economy as a result:

New Geography:

As huge urbanized regions become less desirable or unaffordable for many businesses and middle-class families, more and more Americans will find their best future in the wide-open spaces that, even in 2050, will still exist across the continent. The beneficiaries will include places as diverse as Fargo and Sioux Falls in the Dakotas to Des Moines, Oklahoma City, Omaha and Kansas City.

Many of these areas are now enjoying both population growth and net domestic in-migration even as the nation’s most ballyhooed “hip cool” regions like the Bay Area, Los Angeles, New York City and Chicago experience slower growth. Fargo, N.D., Sioux Falls, S.D., Des Moines and Bismarck, N.D., for example, all grew well faster than the national average throughout the past decade.

Economics undergirds this trend. Unemployment in the Great Plains has remained relatively low, even during the recession that began in 2007. For much of the decade, the biggest problem facing many businesses has been finding enough workers.

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New investment will flow back into the Heartland to tap previously difficult-to-access resources such as oil and gas, while new technologies will exploit prodigious natural sources such as wind.

We’d just take it a step further and highlight that increasing numbers of Americans won’t even need to be in the country anymore, let alone New York City, if they don’t want to be, yet still participate in a wide variety of industries. Though Kansas might still be the best option.

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Gorge Soros said at an Economist conference in London that he believes the U.K. will be in a far better position to manage its finances than the Eurozone, once upcoming U.K. elections are past.

That’s because the U.K. runs its own monetary policy, for just itself, thus has more policy flexibility.

This flexibility may be constrained by election season right now, but it seems he’s saying that once elections are done we could see a more assertive U.K. government:

City Wire:

Soros said the lack of concessions offered in a rescue package for Greece agreed this week had highlighted the lack of effective policy making in the euro area.

‘Whoever wins the election will have many more tools at their disposal,’ he said of the UK. ‘The solution offered to Greece is at best an interim step. ‘

It is a question of solvency. If you start charging very high rates as the market does in anticipation of solvency then that pushes you into insolvency.’

Read more here >

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See Also:

• Greece Shorting The Dollar In Order To Ease Its Debt Burden
• Euro Weakens Again Overnight, As Germany Emerges As The New Ugly Child Of Europe
• Um… I Take Back That Thing About The U.K. About To Explode, Actually The U.K. Is Awesome

Today’s European industrial production tells a tale of two Europes.

February 2010 industrial production rose year over year in fourteen European countries, as should be expected since right now industrial production is rising year over year across most of the world.

The world has rebounded from pretty dire straits in February 2009 after all. Total industrial production for the EU27 (27 nations) 6.5%.

A rising tide lifts all boats right? Well usually, but not always.

Some European nations haven’t caught the global rebound yet. Eight European nations saw their industrial production fall in February 2010. Greece, Bulgaria, Denmark, and Lithuania experienced -10.4%, -9.8%, -6.1%, and -4.8% year over year drops… even still today after most of the world is turning around.

Greece obviously sticks out like a sore thumb and this industrial production data shows why the nation is in such deep trouble. If the nation simply had too much debt, but could at least perform in-line with the global economy (just ride it up and down like the average nation), then things wouldn’t be too bad. Greece is a disaster because it is both heavily in debt due to unsustainable government spending AND it’s economy is horribly uncompetitive to boot. This -10.4% data point is horrendous given where the entire world is right now. Imagine what would happen to Greece if the world actually hit a new crisis. They’d be wiped out.

4-14042010-AP-EN

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New bank loans in China are already 30% of the government’s full year 7.5 trillion-yuan target, according to the latest March data. The year to date loans figure sounds large relative to the target, but it could be because loans are usually front-loaded each year. On a year over year basis, new loans have been fallen for January, February, and March, as shown below.

China Daily:

The fresh credit for the first three months is about half of the record 4.58 trillion yuan disbursed by Chinese banks a year ago, when the economy took a hard hit from the global financial crisis.

The average monthly new loans in the first quarter stood at around 860 billion yuan, compared with 444.2 billion yuan and 1.5 trillion yuan during the same periods of 2008 and 2009.

“The pace of credit growth will gradually return to normal as the record money supply from a year back would help shore up the Chinese economy effectively,” a source at the nation’s banking regulator said.

Read more here >

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Yesterday we were perplexed by the description of Greece’s 6-month and 1-year government bills sale as ‘successful’. It appeared to attract a lot of demand, but yields Greece had to pay investors were extremely high for such short-term money, for example the 1-year bill sold at 4.85% which is far higher than it was just back in mid-January.

To recap: “Yet Greece can’t fund itself entirely on short-term debt, so let’s wait and see how 10-year Greek bonds do. Because 4.85% for 1-year money still seems extremely expensive to us right now and still a bad sign for market confidence in the country’s finances… despite the surge in buying demand.”

Clearly we weren’t the only ones nonplussed by Greece’s auction yesterday since 10-year Greek bond are now deteriorating. Their yield is surging back towards the 7% mark and it appears there was a reason for the apparently ‘strong’ buying demand yesterday.

WSJ:

Analysts say the auction wasn’t necessarily a good gauge of foreign demand. Greek banks tend to be heavy bidders at such auctions, while foreign investors prefer longer-term maturities, and the 10-year bond yield climbed Tuesday to 6.86%.

Greek banks don’t count as a source of buying demand we should use as an indicator, since they essentially fall into the potential-bailout camp along with the Greek government, in the case of a crisis. They might as well pick up short-term debt at decent yields since if the Greek government is at risk of default they’ll be in deep trouble regardless, so they mind as well have picked up some decent short-term yield along the way.

Fair enough, we’ve been rightly told how short-term yields can sometimes be a more important indicator than long-term ones for Greece, but in this case, in terms of judging market confidence based on the most recent bill auction, we’ll take the deterioration in 10-year bonds as a sign that yesterday’s ‘successful’ auction wasn’t so hot.

The next big day will be May 19th, when Greece has to pay back a $8.7 billion bond that will mature.

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The vast majority of analysts these days expect some sort of yuan revaluation this year, with many thinking it could come by the end fo June.

UBS points out two reasons why a yuan revaluation would be great news for Chinese gold-buying demand:

Bloomberg:

“First and foremost gold will become cheaper in yuan terms and this should stoke additional interest in the yellow metal,” Edel Tully, London-based analyst of the bank, wrote in a report. “And if the yuan revaluation is interpreted as a signal of government confirmation that inflation is indeed a problem, this would likely boost gold’s appeal.”

Chinese gold demand doubled over the last ten years. Bulls will say that reasons such as the above are why it can double again over the next ten.

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The Baltic Dry Index (the spot index for dry bulk shipping) became famous during the commodities super-spike pre-financial crisis. It was suddenly bandied about by economists and strategists as a leading indicator for the economy ‘because it was related to commodities demand’.

We have spoken at length in the past how this was and is complete hogwash, how just by the BDI’s very nature of construction it couldn’t be a reliable indicator for the economy. We also explained why it was ridiculous for Raymond James to think it could even be an indicator for oil.

At this stage we’ve basically learned to just bite our tongue every time we see it mentioned as a reliable indicator for the world. You really have to know what’s going on behind it.

Well, you don’t need to take it from us anymore. Here — An economist put in his place, by a shipping markets specialist from M2M Management, for mentioning that he used the BDI as an indicator. Hopefully this video helps kill off the BDI-as-indicator meme because it’s been really hard to do.

Starting at 4:20:

Economist: “As an economist [sic] we often looked at the Baltic Freight to predict world trade, if you see it going up it means more trade with China and so on…”

Tim Coffin from M2M: “I doubt that the Baltic Dry Index has ever been a good leading indicator because there are too many inputs into the BDI itself…”

See his full explanation in the video below.

(Tip via our friends at Transport Trackers)

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What’s one way to know that distressed debt has become too popular a trade? There’s less and less debt qualified as ‘distressed’ because buyers have bid-down yields too low for too many issues.

Distressed Debt Investor (DDI) points out how to be classified as ‘distressed’, debt must trade a yield that is 1000 basis points above U.S. treasury yields. Thus rising treasuries and rallying distressed bonds have removed many issues from the ‘distressed’ classification.

The chart below shows how the number of issuers classified as ‘distressed’ has fallen:

DDI:

“This represents the number of issuers whose distressed bonds traded during the previous day’s market. Distressed is defined as any bond that trades at greater than 1000 basis points over the benchmark treasury.”

Now we wouldn’t be surprised to see that there were substantially less bonds trading as distressed right now versus, say February 2009. What surprised us was how much the universe continued to shrink since December of 2009, even after massive rallies for distressed debt earlier in the year.

You can see in the chart below how we went from over 200 to just 128 issuers since mid-December:

Rising U.S. treasury yields have played their part here as well, but suffice to say that for investors jumping into distressed debt funds these days they are crowding into an increasingly tight space.

(Charts via DDI, Tip via Abnormal Returns)

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U.S. Global Investors thinks Chinese property bubble fears are well overblown due to a lack of long-term historical perspective. It’s not just about where prices have come from in the last few years, but where they came from twenty years ago.

Thus while price rises may have seemed enormous recently, when put into long-term context, relative to China’s massive GDP growth over the last two decades, then the rise in property prices since 2005 doesn’t look too wild. The rise in prices has been far less than that of GDP since the late 1980’s:

U.S. Global Investors:

Prior to the early 1990s, urban dwellers in China were provided an apartment by their employers or the government, with rent set at less than 5 percent of their salary (utilities included). Starting in the early 1990s, the government began to privatize housing by selling apartments to their residents at a low price. Almost overnight it created a private home ownership rate of about 70 percent.

This policy change was also a vast redistribution of wealth from the government to the people – those apartments typically occupied prime downtown locations, and thus are worth at least the price of a new luxury apartment.

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The price of housing has roughly doubled since the late 1990s, but it’s important to remember that China’s prices have risen from a much lower base than in the developed countries (among them, Britain, Ireland and Spain) in which bubbles were created.

While admitting that property prices may have gone up too fast in signature cities such as Beijing and Shanghai, even these markets have seen their oversupply levels come down thanks to government initiatives to cool them.

Thus the message here is that China as a whole remains reasonable relative to the growth of the nation’s economy and accompanying growth of Chinese spending power. In short, if your people’s spending power doubles, then so can property prices.

It would be interesting to see the China property bears’ counter to the first chart above.

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12 out of 19 analysts believe a yuan revaluation will come by June 30th, according to a new Bloomberg survey. 17 out of 19 think it will happen by September 30th, and all of them think it will happen by year-end.

So everybody thinks a revaluation of some form is coming this year, yet they are roughly split as to how it might be accomplished.

11 out of 19 expect a widening of the yuan’s allowed trading band while the rest expect a one-off hike.

Bloomberg:

The trading band will be widened to between 0.75 percent and 3 percent either side of the central bank’s daily reference rate, from 0.5 percent now, the survey showed. The median estimate is for the yuan to strengthen 3.1 percent to 6.62 per dollar by year-end. Estimates ranged from 6.4 yuan to 6.8 yuan in the survey carried out since April 9.

The analysts are more bullish on the currency than traders in the forward market. Nine-month non-deliverable yuan contracts show traders are pricing in a 2.3 percent gain in the currency from the spot rate of 6.8252 as of 8:10 a.m. in Hong Kong.

Even traders expect a revaluation this year.

Thus it seems the question for 2010 is how China will revalue, not if. A widening of the trading band seems to most likely since not only are the analysts above expecting it but some Chinese government officials have already said this is the likely course of action as well.

An anonymous official was quoted by China Business News as saying “Research shows that a one-off yuan appreciation is not applicable but it’s possible to widen the yuan trading band, such as from current 0.5% to 1%,” and Zhang Junhua, the director of research at the People’s Bank of China, has said that inflation is now a greater risk than a double dip. A yuan revaluation would help temper inflationary expectations within the economy.

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See Also:

• Actually, China’s Trade Deficit Just Confirms The Need For A Yuan Revaluation
• China Allows Yuan To Appreciate Slightly Right After Geithner Says It’s Their Choice
• Morgan Stanley: Media Buzz Shows How U.S. Protectionism Can Get Far Worse

Here’s a quick view of where speculation is huge right now, based on data we pulled from Morgan Stanley.

Net speculative positions (as a % of open interest) are more than two standard deviations above the mean for oil and the Nasdaq, as shown below. Copper has substantial speculator activity as well.

Moreover, Morgan Stanley has done a back-test to give the most recent data perspective, and this is where it gets most interesting.

As shown below in the top section of the table, the average six-month performance for the Nasdaq under similar speculative conditions as today (with speculator open interest over 2 standard deviations, ‘>2SD’) has been a horrendous -20.7%.

Looking at the bottom section of their back-test table, the Nasdaq has never risen over the next six months (0 hit observations) after having such speculator activity as we have today. To get further and important detail on this back-test, such as the exact time period covered and the number of observations used, you’ll have to chase up Morgan Stanley.

It’s also just a back-test, it’s not gospel and the future can be far different than the past. Also note we’re not describing a specific Morgan Stanley market call right now. But we still can’t ignore how bad this looks, below. If the Nasdaq ends up doing well over the next six months, it will be a historic rally given current speculator activity:

(Via Morgan Stanley, 12 April 2010)

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PIMCO has completed an excellent Q&A with Scott Simon, the head of their mortgage and asset-backed securities team.

Mr. Simon addresses the housing outlook now that the federal reserves historic mortgage-backed security (MBS) buying program (which had been used to provide liquidity and support market prices during the crisis) has ended.

Overall, he presents a mixed outlook.

Firstly, he thinks the MBS market can hold up on its own now and doesn’t need the Fed’s buying support, and in fact hasn’t needed the Fed’s support for many months now:

PIMCO:

Simon: We are unlikely to see a significant market disruption in the Agency market stemming from the Fed’s retreat. First, the retreat had been well advertised for months before the event. Investors knew exactly when the program was going to end and how much the Fed was buying. So it’s not as if anybody woke up and was surprised by the fact that the Fed had stopped buying.

Second, private buyers are in a much better position today than they had been before the Fed started buying. The private balance sheet was seriously impaired by the financial crisis at the time the Fed stepped in with its public balance sheet. But by October 2009 or so, the private balance sheet had improved. The Fed probably could have stopped buying at that point with about $850 billion in completed purchases, but it felt compelled to reach the previously announced total of $1.25 trillion, and so the next $400 billion in MBS drove prices higher.

Yet secondly, he thinks MBS prices are looking pricey, driven up by fed buying that went on for too long, as mentioned in the excerpt above.

Q: What are your views on MBS prices today?

Simon: Agency MBS look expensive vs. 10-year Treasuries but cheaper compared to two-year swaps. We never look at mortgage bonds in isolation, but compare prices against an array of other instruments, so I avoid being too specific about labeling them as cheap or expensive. However, I’ll go so far as to say Agency MBS peaked in richness in late December or early January and finished March still priced on the richer side of fair.

Finally, and more broadly, he believes that the low-end housing market may have already bottomed, while the high-end market will bottom later this year. Thing is, he warns that “If one labels recovery as prices rising dramatically, we do not foresee that anytime soon.”

So basically, expect a rather comatose market, but one that isn’t dead and can at least remain stable with Fed support. Read the full Q&A here.

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In a continued effort to cool banks’ lending growth this year, and cool China’s property market, China’s banking regulator will require banks to present risk reports detailing their exposure to the property industry by the end of June.

The regulator will then make inspections during the third quarter and force banks to increase their provisions where ever asset (property loan value) downgrades are made.

iMarket News:

“We’ve found that banks’ risk exposure to the property market is pretty big,” China Banking Regulatory Commission director Liu Mingkang told the Boao Forum.

He said banks are required to tighten up their oversight of loans to local governments for land development projects, loans to property developers as well as mortgage lending.

“We’re requiring that banks follow up each government land auction to make sure the money from the auction goes to the right bank account,” he said.

Even if they’re just half as successful as they expect/are supposed to be in rooting out problematic lending, one can imagine that these efforts will discover some serious losses in Q3. So while many might criticize the effectiveness of such regulatory efforts, you can’t write them off completely.

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U.S. rail traffic just slipped, with year over year growth slowing. Weaker traffic in coal, grain, construction materials, vehicles, and metal products were to blame.

Journal of Commerce:

For just the largest U.S.-owned railroads, new intermodal shipments fell to 196,257 loads last week from 210,914 a week earlier and were the lowest since Feb. 13.

Rail freight traffic has maintained most of its recent strength, especially in carloads of bulk materials and equipment. Yet carloadings also slowed some for the North American majors, to 372,270 units in the April 3 week from 383,109 in the week ending March 27. The latest carloads are the lowest since Feb. 20.

Despite the sequential declines, traffic remains well ahead of last year. Total North American carloads last week were up 11.2 percent from the same week of the 2009 recession year, while intermodal was up 6 percent. But the latest intermodal volume fell behind its year-to-date growth pace, while carloads continued to increase their year-to-year gains.

Perhaps this is an example of the kind of slowing rebound we’ll see from the U.S. as we progress through Q2.

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UBS’s head of Asia-Pacific economics argues that the real global trade imbalance isn’t U.S.-China, it is U.S.-oil. As shown below, current account surpluses from fuel exporting-nations have been a far larger driver of total global trade imbalances coming from emerging markets.

China’s current account surplus (in blue) has been large in recent years, as a percentage of the global economy, but it has been dwarfed by fuel exporters (in green):

Jonathan Anderson of UBS, via Caixin:

Looking at the movements from the late 1990s through 2006, when the overall U.S. deficit worsened from 2 percent of GDP to nearly 7 percent of GDP at the trough, a full three percentage points of that adjustment came from other advanced economies and from fuel imports; only two percentage points came from China and other non-fuel emerging markets. And the recent drop in the U.S. deficit had almost nothing to do with China; again, it was oil prices and developed trade that explains the entire swing over the past 18 months.

Thus the U.S. could use a little less finger-pointing at China… and a lot less foreign oil usage… if it really wants to correct its global trade imbalance.

This is a huge argument against U.S. trade protectionism since protectionism would miss the largest cause of America’s trade deficit while only hurting U.S. export prospects by pissing off trade partners.

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Things exploded into violence yesterday in Thailand with 18 reported deaths so far and casualties well over 500. Many accuse protesters of being bribed to attend, protesting just to collect money and free food. Yet for the protesters shown in this video, it’s hard to believe given their intensity, captured by one brave person on the ground who somehow manages to maintain a sense of humor.

The clash begins at the 3:00 mark. Warning: This is graphic at the end. (See the original video here with additional commentary)

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The global manufacturing index, put together by JPMorgan, hit a new cyclical high in March which we discussed here.

This is great news for the global economy as it represents rapidly expanding manufacturing activity.

Thing is, Goldman Sachs’ wonders whether the rebound could lose some steam going forward, given that much of the recent momentum was driven by companies rebuilding their inventories from what turned out to be overly cautious levels.

Goldman (Global Markets Daily, April 6th, 2010):

Meanwhile, the momentum in the advanced economies was very strong in March as PMIs generally surprised on the upside. However, production in the advanced economies has been playing catch-up with the inventory cycle, as we continue to point out. This driver is temporary, and as mentioned above, the underlying data show that this cycle is coming closer to an end. The jump up in PMIs this month coincided with a large jump up in inventory indices, particularly in the US. As the inventory pendulum begins to swing the other way, industrial momentum may begin to slow.

Our Global Leading Indicator (GLI), released last weak, also confirms this story. While the headline measure improved, pointing to a solid industrial picture, the components generally show that momentum has been slowing. The PMIs are telling us a similar story.

Note that America’s huge Q4 GDP growth was heavily influenced by an U.S.-wide inventory re-stock from overly defensive levels. Thus the global growth slow-down Goldman forecasts will parallel that expected of the U.S..

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Many Americans feel as if workers’ compensation growth has been horrible over the last decade. Well, if you’re talking about wages alone then it has been.

But if you’re talking about total compensation, there were actually some pretty decent hikes in the amount companies paid for each employee from 2000 – 2006. Americans just didn’t feel them because soaring healthcare costs ate them up.

This implies that if healthcare cost inflation continues or, worse, intensifies due to regulatory change or just the current broken system, you can then expect that American workers’ future wage increases will remain horrendous since, any hikes to total employee compensation will continue to just funding increasingly expensive healthcare.

(Chart via Goldman Sachs, Global Themes And Risks, April 2010)

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The Pakistani stock market is on a tear… yet it must to be one of the least hyped markets in the world.

Three major Wall Street firms have progressively shuttered their local equity research businesses…

WSJ:

Citigroup’s Citibank shuttered its equity research office in Karachi, the nation’s financial capital, in March. Credit Suisse Group closed its research operations in the same city earlier this year. That follows JPMorgan Chase’s decision in late 2008 to suspend its brokerage operations, also in Karachi.

…yet nobody has cared. The Karachi 100 Index has just kept rallying and seems little concerned about the lack of Wall St. noise machines promoting it:

On a three-year chart, it looks like JP Morgan freaked-out during the crisis, and their freak-out at the end of 2008 nearly called the market bottom which came on January 23rd. The market has kept rising post the departure of Credit Suisse and Citi.

The fact that Wall St. is leaving makes us want to believe in Pakistan’s rally, despite all the country’s problems.

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As the Canadian dollar bounces around near parity with the U.S. dollar, Canadian companies are now threatened by the prospect of cheap American products and services gouging their competitiveness.

The Globe and Mail:

A leading Canadian think tank is warning Canadian firms they are putting their long-term futures in peril if they ignore the dollar’s long-term rise.

The Conference Board of Canada says Canadian firms risk losing their international competitiveness if they do nothing to counter its rise.

The U.S. dollar just weakened from 1.25 Canadian to ~1.0 in about a year. Canadian productivity gains will have a hard time keeping up.

This is an example of how it’s nearly impossible to know what is the best value for the dollar, for America. If Canadian business wants a stronger dollar right now, then is a strong dollar good for the U.S.?

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