John Mauldin | July 3, 2012
Even while here in Tuscany I go on reading my email, albeit at a pace that is somewhat less maniacal than usual. I can't help myself; I find it fascinating to "surf" my emails and other sources. I get several hundred emails a day and about 40-50 that get more than a cursory notice. (I always try to read emails sent to me personally!) Today, for your Outside the Box, I am going to do something rather different. Rather than posting one or two essays, I am going to cut and paste snippets that I have found interesting in the past 24 hours.
There's no theme at all, but this will give you a sense of what I am giving at least passing thought to. While we may have been focused on Europe in my recent writings, I do try to remain aware of the broader world and markets. I still actually read research on the equity markets, and read analysis of various alternative investments and their markets. I have a number of friends who gather information, and when they send me something, even if it's somewhat lengthy, I really do try to read it. And there are so many links to follow and searches to perform. This retreat to Tuscany has made me realize that I need to focus a little less on the immediate and urgent, as fascinating as it is in today's world, and more on the deeper, importantideas.
I am going to force myself to stop at five pages, so I don't know yet how many sources there will be. My Chinese translators are anxiously awaiting this note, even though I am somewhat ahead of my US editor's day here.
I will also go deeper into what I learned this week from the lengthy and stimulating conversations here in Trequanda, and share a few impressions of Italy. The villa is getting somewhat quieter and more relaxed, as there are only a few couples (Rob Arnott and his family, among others) for the next few days; and I have promised Tiffani I will actually leave the villa this week and explore during the day, rather than just making the evening forays to dinner; so there will be even more downtime, which I am finding I need more than I thought I did. And while my partners have all told me to actually take some time off, I am sure they will be glad to see me back in the saddle, which will happen on Monday. Speaking of which, I did go to Siena yesterday to watch that horse race (Il Palio) around the town square. It has been run for over 600 years, and there is an enormous amount of ceremony and pageantry associated with it. Google it.
This morning we saw Newt Gingrich and his wife Callista off. He has been here the last week, along with Neil Howe and David Tice, who brought their daughters (daughters seem to be the general theme this season). Steven Diggle dropped by on a few occasions. Steven ran what ended up being the largest hedge fund in Asia, turning what started out as a few hundred million into more than a few billion, although he modestly says that he simply had a few very good years during the recent crisis, while everyone else lost half (or more). He closed his fund at 'the top' and now runs his own family office. But his range of knowledge and insight is quite broad. He was of particular use in explaining the nuances of Italian football during the Eurocup games.
The conversations ran far into the wee hours most nights and were picked up the following mornings. I actually find such times more relaxing and invigorating than simply 'checking out.' And having a variety of views on numerous topics and subjects from people with widely varying backgrounds has been a real delight. The only downside from the past ten days is that my must-read book list was expanded by about 30 volumes. Listening to Newt and Neil expound on Roman history, a topic about which I realized I have no more than cursory knowledge, has inspired me to try to delve from time to time into the history classics.
So with that, let's jump into my inbox and explore some more or less random notes from today's reading. Again, the only criterion is that it arrived within the last 24 hours – and I promise to stop at around five pages. My comments are italicized or [in brackets].
Your living on Italian country time analyst,
John Mauldin, Editor
Outside the Box
A Random Walk Through My Inbox
Excerpts from Kiron Sarkar, who has become a must-read source for me:
The loopy Iranian regime has threatened to close the Straits of Hormuz. Essentially, the decline in the oil price, together with the impact of sanctions, is seriously hurting the regime. In these circumstances, Iran always makes belligerent threats to force oil prices higher. Diplomatic talks look as if they have failed, though there is private session between Iran's technical experts and representatives of the major powers today, in Istanbul. The reality is that they really can't close the Straights, other than for a limited period of time. However, Brent is back up to US$98.50, good for my energy shares, but the global economy will sure appreciate a lower oil price;
Inflation continues to decline in the EZ. May producer prices declined by -0.5% MoM (-0.3% expected) or +2.3% YoY as opposed to unchanged MoM in April. Yet more data for Mr Draghi to cut interest rates by at least 25bps on Thursday and, in addition, to cut deposit rates to zero, from the current 25 bps;
What's with the Spanish – their economy minister reports that neither Holland, nor Finland can stop the ESM dispersing funds – well check your facts sir – they can (other than in an emergency, which then requires approval by an 85% majority, which is possible without Finland and Holland – though Austria and Germany's position Senior?) and, indeed will, unless Spain starts getting real. In addition, Finland is demanding collateral in exchange for allowing loans to be provided to Spanish banks, though the collateral they received in respect of aid to Greece previously, was effectively "corrupted" toilet paper.
The WSJ reports on an increasing difference of views between Mrs Merkel/Mr Schaeuble and her coalition partners the FDP. The bottom line is that both Mrs M and her finance minister are (irrespective of Mrs M "not in my lifetime" comments relating to Euro bonds recently) pushing Germany towards Euro Bonds at some time in the (not too?) distant future, if other EZ countries agree to strict fiscal targets, banking union, fiscal union and, of course, political union. Essentially, Mrs M is promising some help/aid in return for a political union – the famous "carrot and stick approach". The FDP have caught wind of this and are expressing serious concerns. The opposition SPD and the Greens are far more pro the EZ and supported Mrs M last Friday in respect of the passage of the fiscal compact and the ESM. In my view, the FDP are a spent force, though Mrs Merkel will have to think of an alternative coalition partner – difficult. [To say the least!]
And now let's hear from Dennis Gartman, who I read in the morning to find out what happened while I was sleeping. He covers nearly everything briefly, in about 8 pages. He is a machine. This is a chart he found. The details may not be entirely discernible but the point is to notice the "red" developing in the world PMI numbers. The world is visibly slowing down. This must be heeded!
And from George Friedman and Stratfor comes this note on the elections in Mexico. Mexico is a cauldron of violence on our southern border. I used to travel to Mexico a lot on quick getaways. (I can be door-to-door on the beach in five hours from Dallas.) Now I think about it twice, although I know the odds are small that there will be violence in Puerto Vallarta. is the drug violence is worrisome, though, and requires some attention, as an escalation could have serious repercussions.
No Quick Cartel Fix for Mexico's Next President
July 3, 2012 | 0627 GMT
Today, Enrique Pena Nieto is celebrating his election as Mexico's next president. But after his inauguration Dec. 1, the candidate will become the president, and Pena Nieto will come face-to-face with the real-world constraints that limit the actions of a head of state. Those strictures don't exist for a candidate on the campaign trail, but they set in resolutely after elections. Goals the candidate hoped or even promised to accomplish -- such as U.S. President Barack Obama's campaign pledge to close the detention center at Guantanamo Bay -- suddenly become far more difficult than they had appeared during the campaign.
Pena Nieto will face the same harsh realities come Dec. 1. Like his opponents in the election, he pledged to reduce the drug cartel-related violence that has wracked Mexico for years. But on the campaign trail, Pena Nieto never really articulated a coherent plan to do so. Indeed, we would offer that there is no way to reduce cartel violence quickly. Pena Nieto pledged to continue Mexico's endless process of police reform, increase federal police funding and create a new paramilitary police force, but none of these measures can make a rapid impact. It will take time to put a stop to the conflicts -- whether these be the wars between the various cartels, the war between the government and the cartels, or the war being waged by the cartels against the Mexican people.
There are hopes that the return of the Pena Nieto's Institutional Revolutionary Party (PRI) to power could usher a return to the halcyon days of the 1980s -- a time in Mexico when violence was rare as corrupt politicians became rich ensuring the flow of drugs through unchallenged corridors. But idealizing PRI-run Mexico in such a manner ignores history.
And here's a summary note from Nouriel Roubini. I am less sanguine about 2016 and French budgets than he is. ;-)
Our base case (to which we assign a probability of 45%) envisions a sharp rise in France's public-debt-to-GDP ratio to 110% by 2016, with the intensification of the eurozone (EZ) debt crisis weighing heavily on growth prospects and banking-sector recapitalization costs adding to the debt burden. France's debt will likely stabilize in 2016, so public finances will remain sustainable and a debt restructuring will likely be avoided. However, increased market scrutiny of the country's increasing public debt levels makes France among the most vulnerable to contagion of the EZ's core economies, and we expect to see a sharp rise in the sovereign's borrowing costs.
This is from my friend Barry Ritholtz of The Big Picture. I read nearly everything Barry writes, as we come from somewhat different perspectives and I find his analysis insightful and thought-provoking. Plus, his reading is even more eclectic than mine, or at least eclectic in a different way.
Hot new filing claims internal docs show rating agencies lied on MBS
If you're reasonably literate about the financial crisis, you probably know that the credit rating agencies have slipped through the carnage like a cat walking away from a knocked-over vase. With their opinions on publicly offered mortgage-backed securities protected by the First Amendment, Standard & Poor's and Moody's have won dismissals of the vast majority of MBS investor claims against them in state and federal court, despite powerful evidence from congressional investigations that they worked with underwriters to confer investment-grade ratings on securities backed by dreck. With one possible exception, the only surviving cases against rating agencies involve claims by investors in private placements, who have successfully argued that private ratings aren't protected free speech.
The near-spotless litigation record of the rating agencies means we've seen very little internal evidence, in the form of emails between rating execs, emails between the agencies and underwriters and deposition testimony from credit rating agency insiders. The only hard evidence on the agency's role in the economy's collapse came from a Senate report.
In a series of filings in federal court in Manhattan, Abu Dhabi Commercial Bank and its lawyers at Robbins Geller Rudman & Dowd disclosed thousands of pages of internal communications and deposition transcripts to back their claims that S&P and Moody's are liable for fraud and negligent misrepresentation in connection with their rating of a structured investment vehicle underwritten by Morgan Stanley. Based on a declaration by plaintiffs that accompanied the documents, a huge percentage of the newly disclosed material has never previously been seen by the public -- and a good many of the documents deal not just with the Morgan Stanley SIV but more broadly with the rating process inside S&P and Moody's at a time when the two leading agencies were swamped with mortgage-backed securities to rate.
Robbins Geller also provided a helpful Cliff Notes version of the evidence in the form of an unredacted response to the defendants' motion for summary judgment. (A redacted version was filed in February, with page upon page blacked out.) This is a hot filing. Abu Dhabi quotes deposition testimony from "S&P's most senior quantitative analyst in Europe," for instance, that says "the ratings of (the SIVs) were inappropriate because the ratings of the underlying assets were not appropriate. So it leads to the conclusion that they should not have been rated." In other snippets quoted in the filing, rating agency analysts complained about "difficulties in explaining HOW we got to these numbers since there is no science behind it" and about "(making) up haircuts that were palatable to SIV issuers."
A lead S&P analyst on the deal, according to the plaintiffs, said in an email to his boss that the default rates the agency was using for asset-backed securities were guesswork. "From looking at the numbers it is obvious that we have just stuck our preverbal (sic) finger in the air," the analyst wrote.
Morgan Stanley, according to the plaintiffs' filing, bears at least as much blame as the rating agencies: The bank allegedly wrote the Moody's report on the SIV and read the S&P report before it was released to investors. The summary judgment opposition points to evidence that Morgan Stanley pressured the rating agencies to apply methodology that didn't suit the securities and to ignore the paucity of historical data in order to grant the SIV a rating it didn't deserve. By sending a supposedly "threatening" email to an S&P higher-up when an analyst proposed granting the SIV a BBB rating, Morgan Stanley boosted the rating to an A, the plaintiffs assert. In support, they quote an email from Morgan Stanley exec Greg Drennan, who had sent the allegedly menacing email: The bank's efforts, Drennan wrote, "did get us the rating we wanted in the end."
Morgan Stanley is represented in the case by Davis Polk & Wardwell, which referred me to a representative for the bank. She sent an email statement: "We believe the allegations in this case are without merit. We have defended ourselves vigorously throughout this litigation and will continue to do so." Moody's counsel James Coster of Satterlee Stephens Burke & Burke referred me to a Moody's representative who said in an email: "The plaintiffs' brief quotes selected emails out of context to support baseless allegations that are clearly refuted by the full record. Our rating opinions in this case were, as always, fully independent and based on robust and objective analytical criteria. We are confident that the claims against Moody's are without basis and that we will ultimately prevail on the merits." [etc., etc.]
OK, I'm over five pages, but this is going rather rapidly, anyway. I could easily go to 15-20 pages. The following quick note is from the normally bullish Dan Greenhaus of BTIG, under the heading:
Uh oh. Recession Coming?
*The June reading on the ISM was much weaker than expected, falling to 49.7 from 53.5. This is the first time the index was below 50 since July 2009 when the economy was first emerging from recession
*Beneath the headline, various indices plunged with new orders falling below 50 (from above 60) while new export orders declined below 50 as well
*Interestingly, despite declines nearly across the board, the employment component held up relatively well, remaining in the upper 50s
This is not good. Not good at all. Despite the decline of manufacturing's importance to the U.S. economy, the ISM Manufacturing Index remains a premier economic indicator and a reading below 50 in June is incredibly, incredibly worrisome. We had speculated after recent employment reports (the monthly report as well as recent jobless claims releases) that the odds of a recession had meaningfully risen. While an ISM reading below 50 does not mean recession for the broader economy, it is still a terribly weak number, especially so in context of expectations (looking for 52.0).
We are not yet ready to revive our 2H recession call, something we believed was possible as recently as last September. However, as more and more weak economic numbers build on each other and indicators such as the ECRI leading index suggest weakness if not recession, investors have to begin, at a minimum, considering the possibility.