US small business never recovered from the last recession

US small business optimism continues to improve gradually, but still remains at recessionary levels. One of the big problems for small businesses remains the uncertainty in future economic conditions. 23% of survey respondents say they have no clue what to expect from the economy going forward. That's the highest level of uncertainty since the Jimmy Carter administration (see video below). And as discussed earlier (see post), uncertainty can materially inhibit economic growth.

Credit conditions don't seem to be a problem in part due to the lack of demand. With uncertainty at such high levels, the last thing a number of small businesses want to do is increase debt levels.

Weak sales are the number one single issue cited in the survey, but regulation and taxes are still a major concern for US small business - which of course contributes to more uncertainty.

DB: - Together, government requirements and taxes are cited by 39% of small businesses as their biggest problem among the eight remaining components. While this is down from 42% in September, it is clearly an elevated reading that likely needs to fall substantially further for small business confidence to ultimately trend higher.

Source: DB

Just to put things in perspective, small businesses represent half the private GDP and half the private workforce in the US (see video below). That explains in part the anemic economic growth in the US over the last several years.

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Recovering from the 2011 shock is proving difficult for hedge funds

Some may find this a bit surprising. The magnitude of losses experienced by hedge funds on average during the height of the Eurozone crisis in 2011 was as large as the losses the industry witnessed during the financial crisis in 2008.

"CORE" = The Dow Jones Credit Suisse Core Hedge Fund Index; "TR" = total return (source: CS/DJ)

But unlike the performance after the financial crisis, the industry has been unable to shake the 2011 losses. Since the 2011 shock, hedge funds have been trending sideways for over a year now. Managers continue to find it extremely difficult to position themselves in response to the Eurozone madness. Many became short the various risk markets (or went into cash) this past summer and got hurt by Draghi's action in late July (see discussion).

Numerous funds got involved in sovereign CDS - long protection - and took losses as CDS tightened (see discussion). Being short going into QE3 did not help either. Also a number of equity funds got hurt by a sharp sell-off in technology recently. The declines in commodities and emerging markets earlier in the year caused some funds to underperform as well.

The groups that did well have been some of the more specialized managers such as the Nile Pan Africa Fund (up 35% YTD) or DAFNA Lifescience (up 49%). But with yields at historical lows and macro risks still lurking, generating consistent returns (after high fees) has became extraordinarily tough for the industry as a whole.

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No Greek Deal, but did Germany Blink?

Guest post by Marc Chandler (www.marctomarket.com)

Everyone is talking about European finance ministers failing to reach an agreement on Greek funding.  There is another meeting scheduled for Monday.  It is clear that a Greek exit, which many observers had thought was inevitable six months ago, is not in the cards. 

Instead, what is being debated is how to fund Greece, which we continue to note is not really about aiding Greece as much as ensuring the country's ability to service its debt, which is primarily in official hands.  Still that does not stop some officials from proposing to give the private sector another haircut through the buy back of government bonds at a 50 cents or so on the euro.  Anticipation of some buy back may be helping to drive Greek bonds higher today.

However, perhaps the most important take away from the failed talks was that it appears to have spurred a tactical shift by Germany.  Shortly after talks ended, Germany indicated that it is open to providing new financing for the euro zone's EFSF lending capacity and accept lower interest rates on existing loans.  It seems more determined than it has been in making sure that the Athens' program remains intact.  The new funds would ostensibly be used by buy back Greek bonds.

To be sure though, increasing the EFSF lending capacity does not necessarily cost German a single cent.  Despite cries from some quarters about German  reluctance to give more funds to Greece, the fact of the matter is that the EFSF works on the basis of guarantees, not money from the creditor nations.  The EFSF funds are raised by the sale of bonds to investors, not by transfers from German tax payers.

While there may be opposition to new guarantees, most recognize it is preferable to the alternative that the IMF is pushing for which is an official sector haircut.

The media continues to report that a key remaining hurdle is debt sustainability.  The issue is whether Greece should have another two years, to 2022 to bring its debt/GDP ratio down to 120%.  That is what the European finance minister seem to favor.  The IMF insists on 2020.

These numbers are arbitrary.  Why is 120% debt to GDP sustainable, but not 125%?  Moreover, the debt/GDP ratio is just as much about the denominator as the numerator.  The IMF has done a spectacularly poor job in forecasting Greek GDP.  Given the margin of error, there is, statistically speaking, no real difference between the IMF and European finance ministers positions.  To be filed under "the hubris of small differences". 

Germany's tactical shift underscores another point we have made.  Some observers have argued that Germany should consider leaving the monetary union.   There is no sign that this is being considered and quite to the contrary, Germany is willing to make some concessions to ensure that monetary union is sustained.     Simply put, EMU is in Germany's interest.  Leaving EMU would cost Germany.  The hard won competitive gains of German producers would be quickly eroded by competitive devaluations.  It would leave Germany isolated, which is abhors and it would be blamed for wrecking Europe...again. 

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Natural gas up nearly 100% from April lows

The US natural gas in storage is finally showing a more seasonal pattern, with the first sign of declines due to seasonal demand increases. This rise in demand was helped by low temperatures in the Northeast that followed Hurricane Sandy. Nuclear power plant outages have also provided support, as gas-fired plants have been used to offset the loss of nuclear generation.

Weekly changes of gas in storage (source: Econoday)

With better demand fundamentals - especially after the hot summer that burned off some excess supply via increased power usage (see discussion) - natural gas continues to rally. Henry Hub spot price is now about 100% above the lows reached in April.

Natural gas spot price $/mmbtu (source: Barchart)

In the long run, a number of pipeline projects should reduce excess supplies from the Marcellus Shale area, lowering regional price differentials and providing some stability to the business.

EIA: - As production in the Northeast United States has grown, particularly from the Marcellus, insufficient infrastructure has led to excess supply and depressed prices in some areas. Several major pipeline expansions and new projects are planned in the coming years to help further ease constraints in moving gas out of the Marcellus Shale region.

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Citi ends its decade-long ill-fated love affair with hedge funds

Guest post by TheDealer


Some years ago Citigroup built a massive internal hedge fund platform called Tribeca. It was managed by Tanya Beder who became famous in advising Orange County on its derivatives fiasco in the 90s. She tried to turn Tribeca into an $20bn institutional hedge fund supermarket. This was a massively expensive undertaking that lasted for about 3-4 years and met with limited success.

Citi later bought Old Lane (Pandit's fund - that wasn't too successful on its own in terms of performance) for $800mm. As is typical of these large banks, it decided to build up Old Lane and shut down/replace Tribeca. Out with the old and in with the new. Then in 2008, when Pandit got promoted, Old Lane triggered the so-called key-man clause. This allowed Old Lane investors to withdraw their money immediately - as they promptly did. Citi followed by shutting down Old Lane as well. The firm later tried to rebuild the business once again under the name of Citi Capital Advisors.

Now, years later, Citi has a $6bn hedge fund platform which consists of Tribeca, Old Lane, and other pieces (including people and technology) of hedge fund ventures and acquisitions the firm undertook (more money was spent along the way to keep the funds going). The bulk of the platform consists of fixed income funds including mortgages, credit, (part of the AUM are some CLO assets - a low margin business) etc. - all involving heavy infrastructure expenditures.

Citi has about $2.5bn-$3bn invested in these funds, which of course puts the bank at odds with the Volcker Rule. So the firm recently decided to simply give the hedge fund platform to the managers - effectively for free - and spin them out into a separate firm. Of course Citi will have to pull its money out before the Volcker Rule comes into effect in 2014, forcing the new fund to replace the assets via an institutional fund raise. That's a difficult undertaking in this environment - even for Citi.

The spin-out marks a sad ending to a decade-long effort in Citi's history, as it spent an enormous amount of money trying to build, buy, raise a large hedge fund platform. With the spin-out, the bank will have little to show for after a decade of efforts. It's a great example of value destruction in a business that Citi as well as a number of other large banks never fully mastered.


See this Institutional Investor write-up from 2009 for some Citi hedge fund nostalgia.

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US Manufacturing stabilizing; margins may be at risk

US Manufacturing PMI (flash) is showing some stabilization, although manufacturing expansion remains slow.

MarketWatch: - Markit said its preliminary flash manufacturing purchasing managers index, which is based on around 85% of usual monthly replies, rose to 52.4 in November from 51.0 in October to indicate a moderate manufacturing expansion overall. Output, new orders and employment each accelerated and stayed above the 50 level indicating growth.

There is one troubling sign however. Manufacturing input prices seem to be rising faster than the output prices. The table below shows the full breakdown of the index.

Source: Markit

This may indicate that manufacturers don't have the pricing power to fully compensate themselves for rising costs.

Markit: - The sharpest rise in input costs for eight months was indicated by November PMI data. Greater demand for raw materials such as metals and limited supplies for some goods due to unseasonably bad weather had both contributed to higher input prices in the latest survey period.

The relative moves of the two indicators will be important to watch going forward because this could be a sign of declining manufacturing margins.

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Shifting expectations of the Fed's first rate hike

Discussions on the first tightening move by the Fed are taking place once again, as investors become a bit more optimistic about the US economy. The tightening action timing was brought into spotlight by the latest speech by Bernanke. The Chairman did not discuss further QE in 2013, which was somewhat unexpected (and disappointing to some).

WSJ: - Interest-rate futures nudged forward monetary tightening expectations Tuesday after remarks from the head of the Federal Reserve didn't offer hints of more Treasurys buying next year.

With a current Treasury buying and selling program due to end this year, bond investors have increasingly expected the Fed to announce it will continue the purchasing-end of those efforts in 2013. Though he maintained that the labor market is still far from healthy, Fed Chairman Ben Bernanke didn't tip his hand on future stimulus measures in a speech Tuesday, causing some disappointment.

The thinly traded July 2015 Fed Funds futures contract reflected a 50% chance for a 0.25 percentage point policy-rate increase at the mid-2015 Fed meeting. That's up from 44% late Monday. As the Fed has stated, it doesn't intend to lift its policy rate from near-zero through at least mid-2015.

Odds for an early-2015 rate move rose to 12% from 8%.

The October survey of primary dealers was showing 41% of Wall Street economists expecting action by mid 2015.  Rate futures are now pointing to a 50% probability.

Question for primary dealers: "Of the possible outcomes below, please indicate the percent chance you attach to the timing of the first federal funds target rate increase." (source NY Fed)

In fact the Fed Funds futures two years out (October 2015) are implying 50bp for the overnight rate.

Fed funds futures implied overnight rate (source: CME)

It is not surprising that market participants are beginning to talk about the end of zero rate policy from the Fed. The spike in housing construction has been quite sharp (see earlier forecasts) and some are beginning to think this could lead to a more robust growth going forward.

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Catalonia's independence is a pipe dream

Independence fervor in Spain's region of Catalonia is growing. Driven by severe austerity measures, the population believes that by breaking away from Spain, things will somehow get better. Catalonia's election will be taking place this Sunday.

Reuters: - Spain's wealthy but financially troubled region of Catalonia chooses a new government on Sunday in an election that could trigger a constitutional crisis over a resurgent Catalan breakaway movement.

Opinion polls show most Catalans will vote for pro-independence parties, either from the left or right, handing their leader a mandate to hold a referendum on succession, despite strong resistance from the Spanish government.

This desire for independence is a fairly new phenomenon in Catalonia. Being the wealthier region, Catalonia's citizens think that they are being asked to bear disproportionate burden of the nation's high taxes.

Reuters: - Like the Basque Country, which also borders France, Catalonia has its own language and sees itself as different from the rest of Spain.

Catalonia's busy Mediterranean ports, car factories, chemical plants and banks account for a fifth of Spain's economy. Until recently the region of 7.5 million people was content to push for greater self-governance - such as collecting and spending its own taxes - without seeking independence.

But Spain's recession, with 25 percent unemployment and drastic public spending cuts, has sharpened a Catalan perception that they are taxed unfairly.

The opinion has shifted drastically toward independence recently.

Catalonia's independence poll (Source: CS)

There are of course incredible obstacles to Catalonia's independence. Here are some of them:

1. Spain's constitution prohibits a referendum on independence. That means the best the region can do is hold a non-binding unofficial referendum.

2. The Eurozone is unlikely to accept Catalonia as a separate state, given it has a difficult enough time dealing with a number of highly indebted nations. The issue of maintaining the euro in the Spanish region may become untenable. And that, at least in the short term, could destroy the region's commerce.

3. Given that the region is a fifth of Spain's economy, the separation could spell disaster for Spain's plans to pull itself out of its economic and fiscal mess. In fact Spain would become one of the poorest states in the Eurozone. The nation will do whatever it takes to "preserve the union".

GDP per capita (Source: CS)

4. The biggest issue of course is Catalonia's debt. In spite of being the wealthiest region it is also the most indebted (22% of region's GDP). It certainly has no ability to roll its debt in the public markets without Spain's regional bailout fund (see discussion). And Spain's central government will threaten to pull the plug on this support should Catalonia move toward independence.

Catalonia stands a somewhat better chance of obtaining more autonomy over its finances - which may be good enough for its citizens. But a full independence will remain a pipe dream.

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