Investors who continue to short the currency in 2010 face considerable risk.
Guest Post by Oxford Analytica
The dollar/euro rate has surged from a low of around 1.25 in early 2009 to over 1.50 today, almost regaining its 2008 peak and renewing speculation that the dollar is facing sustained devaluation. While this cannot be ruled out, and the dollar faces formidable short-term pressure, there are good reasons to expect a rally over the next six to nine months. Investors who continue to short the currency in 2010 face considerable risk.
Dollar cycle. The current round of dollar weakness follows a strong rally during the peak of the financial storm, in a well-rehearsed pattern of dollar cycles:
- The rally under former President Ronald Reagan from 1980 took the dollar up by as much as 40-60% (based on a weighted index that varies according to the currency basket used) before the Plaza Accord punctured the bubble in 1985-86.
- The ’strong dollar’ rally under former Treasury Secretary Robert Rubin (the ‘Rubin rally’) of 25-30% from the late 1990s up to 2002 came amid optimism over a strong US growth outlook.
The dollar cannot be seen as a one-way bet. Indeed its latest rally took it from 1.60 dollar/euro in mid-2008 to 1.25 in early 2009.
The euro. The euro is not a driver of the dollar. On the contrary, dollar sentiment drives the euro as European bonds are the main alternative to holdings in the liquid US bond market. The euro is rising on dollar flight, moving rapidly from around 1.25 in the crisis period of early 2009 to its present rate of 1.50. Its latest surge, and the threat of rising ECB interest rates, is problematic as the EU economy is still struggling to emerge from the global recession, with world trade down some 20% from peak.
Renminbi. On a strictly balance of payments basis, a candidate for revaluation against the dollar would be the renminbi. This confronts at least two problems:
- Renminbi assets. There is no foundation for substantial foreign holdings in Chinese financial markets, so money inflows to China to sustain a renminbi rally would have nowhere to go, especially given frothy equity and property markets. Such a factor has kept the yen from becoming a more international currency.
- Policy. Any substantial revaluation in the renminbi is being blocked by China’s renewed tight control of the crawling peg. In the midst of last year’s crisis, and a sharp dollar rally, Beijing halted the renminbi’s slow appreciation against the dollar.
Now that the dollar is weakening against other units, China is enjoying a trade-weighted depreciation, prompting demands for a Chinese revaluation. These are likely to fall on deaf ears, considering the haemorrhaging in China’s export sector and the economy’s slide into deflation.
Oversold. In the short term, fear over a change in the dollar’s status and ECB talk of higher interest rates could push the dollar down and the euro higher still — perhaps to a new peak in the 1.60-1.70 dollar/euro range in late 2009 and early 2010. Yet such a trend would soon stall:
- The euro will likely have to reverse much of its gains to restart the EU economy.
- China is unlikely to seek faster renminbi appreciation. The balance of factors point to too many hazards and too few incentives in spite of unease about dollar neglect and talk of promoting alternatives to the dollar over the long run. Moreover, US policy will come under attack from Europe for dollar neglect, doing China’s job for it.
Outlook. If the US recovery picks up steam, helped by the weak dollar, while the EU economy suffers a double dip, the conditions for a new dollar rally should emerge. If global conditions look safer, led by a resurgent US economy, Japanese investors may also be back in foreign markets, weakening the yen. Tough rhetoric from the Fed may also hit the carry trade. While such a change in direction will probably have to wait until mid-2010, it could pick up considerable steam on the back of short covering in the dollar. These investors as well as those highly exposed to dollar-hedging assets such as gold would stand to lose.
Paul, Weiss has released a survey of the principal terms of selected U.S. strategic mergers announced in the wake of the credit crisis. In the twelve months ended July 31, 2009, the aggregate volume of u.s. public M&A fell 61% from the same period in 2007, to approximately $432.5 billion, with private equity activity declining 98%, to $10.7 billion. Pending transactions were tested by financing failures, underperformance and litigation, and negotiating parties were forced to reconsider transaction terms in the context of general economic uncertainty.
The study, which reviewed the top 25 strategic transactions announced in each of the 12-month periods from August 1, 2007 to July 31, 2008 and August 1, 2008 to July 31, 2009, noted the following key characteristics of the selected transactions:
Certainty was paramount. Among many of the transactions surveyed as deal makers sought to define their respective rights and obligations as specifically as possible in the face of various contingencies. The effort to achieve certainty can be seen in, among other things, the use of reverse termination fees to address the failure of a financing commitment.
Strategic transactions borrowed pages from the private equity playbook. Some of the surveyed transactions included terms that historically were more typically associated with private equity transactions, including financing outs and reverse termination fees. However, none of the surveyed transactions included “go-shop” provisions.
In large transactions, cash remained king even as credit tightened. Despite an expectation that the credit crisis would cause acquirors to favor using stock as consideration, cash-only transactions dominated the survey.
Fixed exchange ratios continued to dominate stock transactions. In transactions in which stock was all or part of the consideration, the parties almost uniformly opted for fixed, rather than floating, exchange ratios.
A small number of completed transactions resulted from a hostile approach. Only four transactions of the 50 surveyed were initially rejected by the target’s board of directors after the offers had been made public.
Tender offer activity increased. Tender offers nearly doubled as a percentage of the surveyed transactions over the two-year period of the survey.
Broken transactions were infrequent. As of July 31, 2009, all but four of the survey transactions had been completed, an impressive result considering the spate of private equity transactions terminated during the survey period.
Mergers-of-equals were absent. None of the surveyed transactions were labeled as “mergers-of-equals” by the transacting parties, and none contained all of the traditional attributes of such transactions (such as a “no-premium” offer price for the target’s shares).
The full report is available for free download here.
Looks like Lloyds Banking Group’s (LLOY) will get a shot at buying its way out of the UK Government’s bank bailout scheme, with a significant assist from the government itself. As reported previously on Research Recap, the chances of the bank being able to pull this off got a boost from Citadel analyst Joseph Dickerson’s bullish call on Lloyds more than a month ago.
But the idea was given a scare by the European Commission’s move to break up Dutch bank ING (INGA) after it received substantial government support , leading some to believe Lloyds might be required to follow suit.
Now, however, the UK Treasury has given a tentative blessing to Lloyds to test the waters for the rights issue of £13 billion or so it would need to pull this off. Even better from Lloyd’s perspective is Treasury’s indication it would take up its full allocation of new shares to maintain its 43.5% stake, adding about £6bn to the £17bn it has injected into Lloyds since January (FT Alphaville).
According to CreditSights ” Lloyds also confirmed that the APS alternative would be a combination of a rights issue (the latest speculation centres on a £13 bln deal) and the exchange of “certain capital securities” into “contingent core tier 1 and/or core tier 1 capital” (likely to be £7.5 bln according to the Financial Times). That would leave probably £4 to 5 bln of capital to be raised from other sources, such as asset disposals. Contingent capital has recently become a favourite concept of regulators, being a debt instrument that would convert to common equity under certain stress conditions, such as capital ratios falling below a defined level – not unlike a mandatory convertible note. Presumably Lloyds thinks this might be more attractive to bondholders than an exchange straight into common equity, as well as being less dilutive for shareholders.”
It will be interesting to see how such an instrument is structured to ensure it can pay a coupon if the European Commission tells Lloyds to stop paying non-mandatory coupons on its hybrids. - CreditSights
“I think the comments today provide comfort that the group will not be broken up and that any restructuring initiatives will not be particularly material to group earnings or capital,” Execution’s Dickerson said Thursday. (FinancialMirror) In reference to its talks with Brussels, the bank said: “(Lloyds) is confident that the final terms of its restructuring plan, including any required divestments of assets, will not have a material impact on the group.”
Other analysts also are upgrading the banking group. Exane BNP Paribas analyst Ian Gordon upgraded the stock to ‘neutral’ despite fears it will remain loss-making for the next year and a half. “Following the shares’ sharp underperformance since the interim results we now see the risks and rewards as evenly balanced.”
Credit Suisse also changed its view on the bank from ‘underperform’ to ‘neutral’ following its latest announcement, as well as near doubling its target price from 55p to 95p, on the assumption it will avoid entering the APS. (CityWire) It said shares were ‘far from cheap, but no longer expensive’, after its comments on Europe in particular provided some relief. However, although it has upped its price, Credit Suisse said it remained worried about the structure of the group. ‘Structurally we remain concerned by Lloyds’ liability structure and think the market is underestimating this,’ it said.
Oriel Securities analyst Mike Trippitt upgraded Lloyds to Buy from Reduce on Oct 14, with a valuation of 90p, noting “additional potential growth in net asset
value per share could drive up the valuation to over 115p per share.” Deutsche Bank’s Jason Napier raised Lloyds to Buy from Neutral Oct 15, with a target of 115p.
Morgan Stanley’s Steven Hayne upgraded Lloyds to Equal-weight from Underweight on Oct 16 with a target of 105p. “Based on recent credit healing and improving underlying property markets, we have reduced our impairment assumptions over the next few years. On this basis we believe the APS no longer provides value for money, and would view positively any effort to exit partially or totally.”
Evolution Securities initiated coverage of Lloyds on Oct 20 with a Buy rating and a 96p target price, noting that “Once the turnaround is over, LLOY should emerge as the largest distributor of banking services in the UK, and the largest mortgage bank in Europe.”
For the latest analyst comment on Lloyds, see Alacra Street Pulse.
ResearchRecap has been tracking the worrisome performance of Alt-A mortgages for some time, so it comes as little surprise that Moody’s is increasing its loss assumptions for these supposedly “close to prime” loans, along with Jumbo, Option ARM, and Subprime RMBS from 2005-2008.
Moody’s said it now expects that a trough in home prices will not be reached until the middle of 2010.
The impact of the revisions is expected to be significant for Alt-A, Option ARM, and some Jumbo pools backing securitizations from 2005-2007, with the most pronounced changes expected for the 2005 pools.
Performance has deteriorated significantly in the last six to nine months, with loss severities trending higher than Moody’s previous expectations. The impact will be less pronounced for Subprime, but still notable for the 2005 pools.
- Since the first quarter of 2009, when Moody’s last announced revised lifetime loss expectations for the major RMBS sectors, several key economic indicators and performance metrics have worsened relative to expectations. Even though the Case-Shiller index reported home price gains for three consecutive months starting in June, Moody’s believes the overhang of impending foreclosures and the continued rise in unemployment rates will impact home prices negatively in the coming months.
- Moody’s Economy.com (MEDC) now forecasts a third quarter 2010 home price trough. When Moody’s last revised RMBS loss projections the trough was projected to occur at the end of 2009. MEDC projects a total peak-to-trough decline of 38% (versus 35%), compounded by muted subsequent home price growth of less than 5% in the year following the trough. Although the magnitude of forecast peak-to-trough decline has only worsened by 3 percentage points, the extended timeline will have an adverse impact on mortgage pools and stressed borrowers will continue to default at high rates.
- Adding to borrowers’ financial pressure, unemployment is now projected to peak at over 10% in mid-2010 and to remain in the high single digits for two years following.
- Borrowers’ refinancing options are still slim, and the benefits of loan modifications have yet to be seen due to the 5-month trial period during which modified loans must be reported as delinquent. In addition, modifications of loans owned by the GSEs have outpaced modifications of loans owned by private-label securitization trusts
With the exception of reinsurance, which has a stable rating, Standard & Poor’s Ratings Services is maintaining its negative outlooks on the North American life insurance industry.
Excerpts from Industry Report Card: Outlook Remains Negative For Most North American Insurance Sectors
S&P’s outlook on the Life Insurance sector “has been negative since October 2008, when we revised it predominately as a result of the economic downturn. Since then, there have been numerous downgrades, and we expect little change in the economic conditions that led to them. Despite all the unfavorable rating actions so far, we expect that downgrades will continue to exceed upgrades during the next six months to a year, though downgrades generally will be limited to one or two notches (for example, ‘AA’ to ‘AA-’ or ‘A+’).
The outlook for the U.S. commercial lines property/casualty sector has been negative since August 2008.S&P said “We believe the reinsurance sector has undeniably demonstrated its resilience in the past 12 months.
The rating outlook for the Health Insurance sector remains negative. Generally weak economic conditions and ongoing uncertainty about the state of health care reform are key factors.
The majority of rated reinsurers emerged from 2008 with their balance sheets intact and a steely resolve to arrest the decline in underwriting margins. A relatively light catastrophe season and improved capital market conditions during the first half of 2009 have enabled most global reinsurers to post strong underwriting results and unrealized investment gains during the period. In turn, these players have displayed improved equity positions as of June 30, 2009, relative to year-end 2008. Particularly among Bermuda market reinsurers, many saw their book value grow by high single-digit to midteen percentages during the first half of 2009.”
Combined with significantly improved premium rates for property (particularly U.S. property/catastrophe) and flattening premium rates for casualty, these factors contribute to our maintenance of a stable outlook on the reinsurance sector despite the negative rating trends that currently characterize many other segments of the global insurance markets. Reinsurers’ liquidity and reserve positions also remain strong in our view.
The highest-rated reinsurer is Bermuda-based RenaissanceRe Holdings Ltd (RNR) (A/Stable/–). The company this week reported strong results for the third quarter with low catastrophe activity in the Atlantic basin and a rebound in investment values generating solid profitability. “We achieved an annualized operating return on equity of 33% and book value grew by 11%, ” CEO Neill Currie said on an Earnings conference call.
Delloitte’s Chief Economist Carl Steidtmann predicts a stronger than generally expected recovery in the US.
“A steep yield curve, compressed risk spreads, and a rising stock market are all consistent with this view,” he writes in Deloitte’s latest Global Economic Outlook. “The strength of that recovery will come from business investment, government spending, and exports to foreign consumers.”
“During the Great Depression, British economist A.C. Pigou argued that many of the government efforts to revive the economy were misdirected and were actually making matters worse. Pigou felt that the natural forces of the business cycle would bring the economy back. Falling prices would give consumers and businesses increased purchasing power while the need to rebuild inventories would add to aggregate demand.”
“We will get a real test of Pigou’s theory in the months ahead. Despite massive government spending the consensus forecast still sees sluggish growth ahead. Both consumer and business sentiment remain muted.”
If Pigou is right, we should see a much stronger than expected economic recovery over the next 12 to 18 months.
However, Steidtman also lists five reasons to worry that recovery could be short-circuited:
1: Oil prices are rising.
2: Mortgage foreclosures and bankruptcy continue to rise.
3: Bank deleveraging continues.
4: Commercial real estate delinquencies rise.
5: Inflation risk is growing.
Sees modest rise of 1.3% in 2010 as high unemployment continues to crimp consumer purchases.
Excerpts from Annual Outlook: U.S. Retail Outlook Is Stable But Consumers Are Still Pressured
Moody’s says its outlook for the U.S. retail industry remains “stable” because “we believe that sales and earnings across the industry will be fairly stable over the next 12 to 18 months, neither materially improving nor eroding over their current weak levels.” In addition, the stable outlook acknowledges the sizable portion of U.S. retail sales and earnings generated by drugstores, discounters and supermarkets — sectors that mostly sell consumables and are expected to remain solid.
We expect retail sales will rise a modest 1.3% in 2010, after an estimated 5% decline in 2009. Although this would reverse a downtrend in retail sales in place since mid-2008, it would not bring back sales to their pre-recession levels. Sales growth will pick up in 2011, upwards of 3.5%.
- High unemployment, low house prices and tight credit will cause consumers to remain focused on boosting their savings and repaying debt in the year ahead, cutting short any material improvement in sales.
- Some segments will demonstrate strength while others will demonstrate weakness. A sizable portion of the retail industry is represented by drugstores, discounters and supermarkets — segments set to perform solidly in the year ahead.
- Department stores and specialty retailers will continue to face sales and earnings pressure; however, the pace of declines in these sectors will likely moderate to a level that will not materially weaken the overall U.S. retail credit profile.
- Headed into the holidays, we believe fourth-quarter earnings will be flat to modestly better than last year — signaling that we believe the period of significant earnings declines is mostly behind us.
The IMF says the “green shoots” of recovery appear more firmly rooted in Asia than in other regions.
Asia’s growth is forecast to accelerate to 5¾ percent in 2010 from 2¾ percent in 2009, both higher than previously projected, according to the International Monetary Fund’s Regional Economic Outlook (REO) for Asia and the Pacific, This is much higher than the 11⁄4 percent growth forecast for the G-7 countires next year, but still below the 6 2⁄3 percent average recorded over the past decade.
“Not only are they (green shoots) more prevalent, but they have also appeared earlier (in April in many cases), and have progressed further. The progress made by China, in particular, is striking. Alone among major countries, its key growth indicators were expanding in August at rates that are above their long-term trend. In contrast, indicators in key Western economies, such as the United States and Germany, suggest that output was only stabilizing in August after months of severe contraction.”
Overall in Asia, policymakers consequently face two major challenges, the IMF says.”In the near term, they will need to manage a balancing act, providing support to economies until it is clear that the recovery is sufficiently robust and self-sustaining, while ensuring that it is not maintained for so long that it ignites inflationary pressures or concerns about fiscal sustainability. Striking the right balance will be difficult. But the key is clear: policymakers will need to assess the state of private demand and the extent to which it can substitute for a withdrawal of public sector demand. ”
The other major policy challenge will be to devise a way to return to sustained, rapid growth in a new global environment of softer G-7 demand.
In this “new world,” Asia’s longer-term growth prospects may be determined by its ability to recalibrate the drivers of growth to allow domestic sources to play a more dynamic role. This type of successful rebalancing will require action on a broad front. Better social safety nets will be needed to reduce private precautionary savings and continued efforts at financial sector and corporate governance reforms would also allow households to offset higher corporate saving by increasing consumption. At the same time, structural reforms could raise productivity and allow for a smooth reallocation of resources across the economy to compensate for the lower momentum from exports. Finally, Asia will need to be willing to live with smaller current account surpluses and more flexible exchange rate management.
Audit Integrity takes a look at the struggling casino and gambling industry and identifies what it believes are the weakest performers based on their corporate governance characteristics.
The casino and gambling industry has been battered by the economic downturn. Both higher-end luxury destinations, such as Las Vegas and Macau, and lower-end locations, such as Mississippi riverboats, have suffered from weaker consumer spending. There are no expectations for a recovery in the short-term, with the U.S. unemployment rate having risen to 9.8% in September, up from 7.6% in January. Casino operators are delaying or suspending development projects during this recession, in sharp contrast with continued building during other difficult economic times.
The outlook for the casino industry remains bleak, as companies face declining gaming revenues, high fixed costs, and highly-leveraged balance sheets.
Audit Integrity’s forensic analysis of accounting and corporate governance practices distinguishes between the companies of greatest and least risk via our Accounting and Governance Risk (AGR®) ratings. Companies in the bottom-ranked Very Aggressive AGR category have had consistently opaque financial reporting, weak corporate governance, and as a group are expected to have inferior performance relative to their peers over the next three months on a total return basis.
In keeping with the broader market companies with a Very Aggressive AGR rating have been outperforming companies with a more Conservative profile. Audit Integrity says” This is not an indication that our AGR signal no longer works. It is simply a function of the market responding to the pendulum having swung too far in the downward direction in 2008.”
Audit Integrity’s bottom-rated company in the US is Penn National Gaming Inc (PENN), and in Europe is Wiliam Hill, plc, (WMH) both with Very Aggressive AGR ratings.
Shares in Penn National rallied slightly to $29 after reporting a third quarter profit fall on Oct 21, but have since been declining steadily to a new low of $25 today.
The highest-rated company is Bally Technologies, Inc (BYI) with an Average AGR rating and “Strong” financials.
Analysts at Morgan Joseph reiterated their “buy” rating on Bally Technologies (BYI) on Oct 21. The target price has been raised from $47 to $57.
For latest analyst comments, see Alacra Street Pulse.
Capgemini survey also finds interest in green vehicles continues to rise.
Capgemini’s annual Cars Online study is out and it shows continuing trends towards online shopping and greater interest in green vehicles. The study surveyed more than 3,100 consumers in eight countries: Brazil, China, France, Germany, India, Russia, the UK and the US.
- Almost 90 percent of consumers today use the internet to research vehicles.
Nearly 40 percent would like to buy a car over the internet, and half would purchase parts and accessories online, the main drivers being price discounts and dissatisfaction with the dealer/retailer process.
- Reinforcing the 08/09 findings, green vehicle ownership continues its upward trend: 41 percent own a fuel-efficient or alternative-fuel vehicle, up from 36 percent the year before, and 30 percent plan to buy one. Fuel economy and environmental impact are the primary reasons.
- Customer loyalty remains vital with 68 percent of respondents likely to purchase the same make/brand again as their current vehicle, up from 61 percent last year. In addition, 63 percent would purchase from the same dealer where they bought their current car.
- The vast amount of information available on the internet is resulting in a shrinking buying cycle. Over two-thirds of respondents begin the research process two to four months in advance. Over half of respondents expect a response to an enquiry made online within four hours, and nearly three-quarters said they would look for another company if the response was too slow.
- Less than half of consumers with cars still in-warranty have their vehicles serviced at the purchasing dealership, emphasizing the importance of delivering a strong aftersales and servicing experience. Spare parts and service typically offer a profit margin up to ten times greater than that of the initial sale.
Capgemini’s recommendations for the industry:
- Eliminate the bureaucracy and inefficiency inherent in the current buying model. Consumers want a faster, easier way to buy vehicles. Improved lead management systems, dealer optimization and online buying capabilities are among the tools that can be implemented to help achieve this objective.
- Get serious about online selling. Consumer interest in buying vehicles and parts and accessories over the Internet is real. Providing a viable online option will be a key to maintaining customer loyalty in the coming years. Models may vary – ranging from services operated by individual manufacturers or dealers, to sites run entirely by third-parties such as eBay, to joint ventures between the two – but online buying will become the preferred approach for a significant group of consumers.
- Focus on the aftersales and servicing experience. Keeping in-warranty consumers coming back to the purchasing dealership for servicing is imperative, particularly at a time when vehicle sales are slow. Service and spare parts operations typically offer a profit margin up to 10 times greater than that of the initial sale. In addition, the service experience can be a factor in securing customer loyalty and driving future repurchase decisions.
- Manage your marketing mix according to each market. A one-size-fits-all marketing approach won’t work in today’s diverse automotive marketplace. Understand where to spend on the web and where to continue to invest in traditional media. And be sure to incorporate new media channels such as blogs and discussion groups into the mix. Web-based discussion groups, in particular, are growing in popularity. Consider how you, as a manufacturer or dealer, can facilitate or participate in these kinds of discussion sites.
- Communicate with consumers before they reach the showroom. By the time vehicle buyers enter a dealership they are likely to have done a considerable amount of research and reduced their list of choices to one or two vehicles. The opportunity to influence them is nearly lost. Using new types of such as a Virtual Adviser, can help automotive companies grab consumers’ attention before it is too late.
- Go green now. Consumers, automotive companies, governments, utilities and other types of businesses will increasingly focus on alternative-fuel vehicles. In the near future, “CO2” will become as important as “mpg” in vehicle buying decisions. It is becoming clear that alternative-fuel vehicles have the potential to be a market-changing force. However, the continued development of this business will require collaboration both inside and, more importantly, beyond the automotive industry.