The US GDP Sweet Spot

When it comes to the current regime in the US, and by that I mean the the survival of the recovery resting on a foundation of zero-bound rates and asset purchases, the GDP number released last Friday was rather crucial. Of course, with economic indicators pointing to a faltering recovery, a miss was was very likely but the extent of the miss was important. And the number can be easily framed by Wall Street as the protagonist in the QE3 narrative that caught a tail-wind of late.

With the projected June end of Operation Twist, and other politically-forced fiscal headwinds coming in an election year, some form of asset purchase program was always on the cards for H2 of 2012. However, with the 2.2% GPD print and nominal GDP at 4%, the Fed now has reason to pull both of its mandate triggers. The number was weak, but not frighteningly so. I believe that the curve flattening role of Operation Twist will be a large part of the 3rd round of easing.

Friday's Goldilocks number has strengthened the resolve of equity bulls, and even saw a 100+bp move in AUDUSD despite the looming RBA cut. Here are some back-of-an-envelope macro ideas for the next few months:

US equities will continue to outperform this year
Troubled Spanish banks will use LTRO funds to form a suicide pact with the sovereign
Italian funding is a real concern
There are bargains in banking and telecommunications stocks in Europe*
China will disappoint
USDJPY will move lower still
USDRUB will head back up towards 33

*To whit, Banco Santander is trading at 0.6 to P/Book and now has a market cap of similar size to Zara. Now I am under no illusions about the turds on the SAN balance sheet, but at a yield of 10% and certainly the too big to fail category, this looks very tempting.

Let the can kicking commence.

The Chinese Rebalancing Act and the Ousting of Bo Xilai

Democracies have mechanisms for the rebalancing of power, the triumph of ideologies, and the creation and destruction of incumbents. As a citizen of a democracy, you always feel that there is an inevitability that political winds will blow in your favour eventually.

In dictatorships by committee, however; political change, the rebalancing of power, and victory over competing ideologies can only be affected by stacking the decks of officialdom in your favour and by purging your enemies. Without free media and freedom of speech, the "good" merits of of the status quo must be continually reinforced by leadership and any dissent eliminated.

Without a vigorous free press, and with a loyalist political framework broken into factions, the ground for corruption, nepotism and violence is very fertile. The purge is a very blunt weapon, even if they occur in the pragmatic sense that we have seen lately in China. Despite rumours of a coup, the ousting of Bo Xilai was carried out very methodically and euphemistically.

The purging of Bo Xilai, and effectively the hard left faction of the Communist Party is not to be underestimated, however. It represents more than the liquidation of a political rival for Xi Jinping and Hu Jintao. China is belatedly trying to rebalance its economy in favour of domestic consumption. Now, without getting into a discussion of this enormous challenge, let us pretend this is currently more than just lip-service.

Bo Xilai, as chief of the Chongqing megacity, represents the old economic guard - unchecked growth in  infrastructure investment by SOEs and LGFVs leading to extraordinary levels of debt. Chongqing managed to grow at more than double the national GDP in 2011, and its economy doubled from 2008 to 2011. Here are some details via a BofA note on the new Chongqing government:

Chongqing is reviewing its local government debt levels The new leadership of Chongqing local government has reportedly required CQ LGFVs and SOEs to report local government investment projects and BT (Build-Transfer) financing projects. There are increasing concerns with respect to the mounting debts of CQ government, esp. at county and district levels. 

The new government is reportedly considering correcting its growth model to be less aggressive and to focus more on steady growth. Fast growth based on fiscal overdraft Chongqing’s GDP growth topped in China at 16.4% YoY in 2011, and its GDP doubled in 3 years from RMB0.5tn in 2008 to RMB1.0tn. 

The rapid GDP growth was mainly driven by the infrastructure investment by LGFVs. FAI in CQ amounted to RMB760bn in 2011; majority of this can be attributed to the “8 major LGFVs”, which relied on land as collateral to borrow from banks and land appreciation for refinancing. Some data reported by various local media include: 

• In 2009, infrastructure project investment (land, bridge, water, tourism, etc) initiated by the CQ local government exceeded 520bn, vs local government budgetary income of <120bn. The gap was largely filled by LGFV loans. 
• In 2010, CQ planned to build 40mn sqm of low-rent housing, which required 100bn of investment, of which 70% is dependent on the market. 
• In 2011, fiscal income of CQ government amounted to RMB291bn, vs fiscal expenditure of 396bn. Fiscal expenditure accounted for 40% of CQ’s GDP,vs. 23% at national average.

The demise of Bo Xilai is a stark warning to other regional officials and their fiefdoms: the ship is changing course due to structural changes forced by Western deleveraging and the slowing global economy. As the Chinese economy slows, a unified political message is needed in the face of income inequality, corruption, and ill-feeling towards the political class.

Argentina and Angola oil - stereotypes in action

The oil industry has recently produced two great examples for those suffering from optimism, naivety, or amnesia. The meddlesome world of energy is something that you can throw any old cliché at and it will surely stick.

To begin with Angola, where the Goldman Sachs-backed Cobalt International Energy is very surprised that local officials are shareholders in its Angolan JV partner, Nazaki. Extensive due diligence has apparently:

“not found any credible support for [the] central allegation that Angolan government officials, and specifically the officials identified ... have any ownership in Nazaki”

I'm not sure how Cobalt failed to discover what the Financial Times and presumably at least one US investigative authority managed to find, but time will tell. Even if Cobalt are surprised, you shouldn't be - looking after the generals in Angola is sine qua non. Indeed, from the legislated Black Economic Empowerment in South Africa to "common law" corruption in other African countries, some form of private transfer payment to government or well-connected locals is expected.

And on to the second conveniently forgotten maxim - a South America country will always fall victim to a mad populist leader, ultimately wreaking havoc on the economy and, more importantly, the reputation of that country.

To whit, Argentina's nationalisation of YPF oil by the government of President Cristina Fernández has now turned into a major diplomatic incident. Spain's Repsol was until yesterday a 57% shareholder in YPF, with the stake accounting for 25% of Repsol's operating income and 33% of its total investment. Apparently the Argentine government was fed up with the pace of development of YPF's assets, despite the discovery of a 22bn barrel shale gas and oil discovery offshore at Vaca Muerta.

Argentina's failed energy policy, which sets prices far below international levels, naturally escaped any blame. If the government liberalised energy markets, and removed subsidies that swell its deficit, they might have better convinced Repsol and YPF to rebalance the 90% dividend payout ratio towards more investment. The Spanish government is rightly incensed and lawsuits through any and every jurisdiction will now surely ensue.

Still locked out of international bond markets, enquiring minds would like to now just how Argentina intends to raise the $25 billion per year that developing the Vaca Muerta field requires. As the FT's Lex said:

"Argentina can kiss goodbye being treated seriously again by investors for another generation."

Still surprised? 

Panic Buying

In the the acquisitions universe even 100 billion dollar companies aren't immune from panic buying of assets, especially in the capricious world of social networking.

Facebook's $1 billion purchase of a start-up with 13 employees, no revenue, and a 2011 valuation of $100 million seems punchy even by Silicon Valley standards. Yet, when the current go-to metric for valuations of start-ups unencumbered by revenue is people, you can see why Zuck panicked and paid a ludicrous price for Instagram. The company has over 50 million users in just under two years.

Facebook takes photo-sharing seriously, and this acquisition should leave you in no doubt that it wants to exclusively own that space. Furthermore, as GigaOm pointed out, Instagram has "cracked the code where Facebook itself has failed: viral growth via mobile".

Cue the arguments about the tech bubble 2.0 (social networking edition)...

India's Struggles

Whilst I was preternaturally focused on China - which, incidentally, is something that afflicts bulls and bears - the Indian economy fell off a cliff. The collapse in exports is quite stunning:

The RBI has been on a tightening tear to try and put the brakes on inflation, and clearly this is now showing in production. But the collapse in exports tells of aggregate demand problems and probably a wider story of a fall in competitiveness. The recent defeat of Rahul Ghandi and the Congress Party in Uttar Pradesh - India's most populous state - is a blow for desperately needed reforms in India. More populist policies lead down the bad old road to protectionism and increased domestic borrowing. 

The worrying collapse of India's GDP:

India's current account deficit is becoming structural:

Here is the RBI's tightening pattern, which has been very successful but at a cost to corporate investment. The RBI panicked last July when a big sell of of the rupee helped cause inflation to run back up to 10% by September. Sustained high rates since then have brought CPI way back down close 6% at the start of 2012.

India's CPI - possibly under control, but prices have risen in January and February leaving little room for a much-needed rate cut.