Volatile day 9-Aug-2011

Roubini on mother of all carry trades

From FT Mother of all carry trades faces an inevitable bust:

So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.

But one day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.

Why will these carry trades unravel? First, the dollar cannot fall to zero and at some point it will stabilise; when that happens the cost of borrowing in dollars will suddenly become zero, rather than highly negative, and the riskiness of a reversal of dollar movements would induce many to cover their shorts. Second, the Fed cannot suppress volatility forever – its $1,800bn purchase plan will be over by next spring. Third, if US growth surprises on the upside in the third and fourth quarters, markets may start to expect a Fed tightening to come sooner, not later. Fourth, there could be a flight from risk prompted by fear of a double dip recession or geopolitical risks, such as a military confrontation between the US/Israel and Iran. As in 2008, when such a rise in risk aversion was associated with a sharp appreciation of the dollar, as investors sought the safety of US Treasuries, this renewed risk aversion would trigger a dollar rally at a time when huge short dollar positions will have to be closed.

Market commentary from Art Cashin

GR reports Q3 2009 results

Here is the market action before and after the pre-market October 22 results. The results were mixed. From MSN money Goodrich cuts 2009 sales outlook:

Goodrich lowered its 2009 sales outlook, to $6.7 billion, compared with a forecast of $6.9 billion in July. The company said its estimate includes unfavorable sales impacts of about $154 million related to foreign currency exchange rate fluctuations and lower sales of about $125 million related to the formation of a joint venture.

The Charlotte company said it still expects to post a profit of $4.60 to $4.75 per share for 2009.

Analysts surveyed by Thomson Reuters, on average, expect a 2009 profit of $4.58 per share on $6.82 billion in sales.

For 2010, Goodrich said it expects to post a profit of between $4.15 and $4.40 per share on sales of about $7 billion. The company said 2010 should be a year of "modest recovery which should allow us to grow our commercial aftermarket sales." It expects the recovery will take hold toward the middle of next year. Its shares gained $1.81, or 3.3 percent, to $56.46 in morning trading.

Analysts, on average, expect a 2010 profit of $4.59 per share on $6.89 billion in sales.

Goodrich also said its third-quarter profit fell 14 percent, as the weak economy continued to depress sales.

From the Economist Denial or acceptance:

At their most panicky investors shunned all but the safest and most liquid assets: American Treasuries were a favoured comfort blanket. That demand for safe assets prompted a rally in the dollar in the months after the collapse of Lehman Brothers last September.

Headache for countries with floating exchange rates has prompted three responses: direct measures to stop currencies rising; attempts to talk them down; or acceptance of a weak dollar as a fact of life.

Brazil has gone for the direct approach. Foreign capital has flooded in, attracted by the healthy prospects for economic growth and high short-term interest rates. That has pushed up local stock prices, as well as the real, Brazil’s currency. To stem the tide, the government this week reintroduced a tax on foreign purchases of equities and bonds.

Others have resorted to talking their currencies down. In a statement released after its monetary-policy meeting on October 20th, Canada’s central bank said the strength of the Canadian dollar would more than offset all the good news on the economy in the past three months.

Other euro-zone countries are less rattled. “A strong euro reflects the strength of the European economy,” shrugged Walter Bos, the Dutch finance minister. Germany, Europe’s export powerhouse, feels that its firms can just about live with a euro worth $1.50. Its exporters still flourished when the euro last surged to that level, because demand from Asia and the Middle East for its specialist capital goods proved insensitive to price. France, however, struggled. Other euro-area countries such as Greece, Ireland, Italy and Spain have at least benefited from the recent revival of risk appetite through lower premiums on their debt.

Ghosn's electric car gamble

From the Economist Mr Ghosn bets the company:

Mr Ghosn believes that by 2020 purely electric, zero-emission vehicles will take 10% of the global car market. What is more, he wants such vehicles to account for 20% of Renault-Nissan’s sales by then.

In urbanised western Europe, 80% of journeys are below 60km, and 20% of cars in Europe—about 20m vehicles—never go any further. Battery technology is undergoing a revolution, with more than 20 big companies worldwide competing to produce smaller, tougher and more powerful batteries. One reason for Renault’s leasing model is to allow vehicle owners to upgrade their batteries as and when the technology improves.

Renault’s commitment and attention to every detail is impressive, but Mr Ghosn’s bet depends on three things working in his favour that he cannot control: the eager co-operation of governments; a rising oil price; and the willingness of drivers to change their habits. It is the last of these that is hardest to predict.

Dollar weakness - long TBT?

From the Economist Down with the dollar:

The recession, which reduced America’s imports as consumers tightened their belts, has improved its trade imbalance, shrinking its current-account deficit. But ironically this has been accompanied by renewed weakness for the dollar.

The simplest explanation for the currency’s decline is based on risk aversion. On the days when risky assets fall, the dollar tends to go up. When risky assets rise, the dollar falls. The dollar has fallen fairly steadily since March, a period which has seen stockmarkets enjoy a phenomenal rally. Domestic American investors may be driving the relationship, repatriating funds in 2008 when they were nervous about the state of financial markets and sending the money abroad again this summer because of a perception that the global economy is reviving.

But although risk aversion may be a factor, describing the dollar as a “safe haven” seems dubious. Indeed, the weakness of American fundamentals has revived the longstanding bearish case against the currency. Some cite the American budget deficit, expected to be 13.5% of GDP this year.

But if foreign investors are so concerned, why is the dollar’s decline not accompanied by a sharp rise in bond yields? One reason may be that the Federal Reserve has been buying so much of the year’s debt issuance, as part of its quantitative easing programme. That has helped to keep yields down.

A simple dynamic may be at work: supply and demand. Last year the market was short of dollars because investors needed the American currency to meet their liquidity needs. This year QE is creating a surplus of dollars (and pounds) and is thus driving both currencies down.

The use of QE also creates a problem for central banks as they contemplate their exit strategies. An early abandonment of the approach could cause bond yields to rise sharply, unless there is an unexpectedly dramatic improvement in the fiscal position. But continuing QE could cause further currency weakness.

It is hard to see what the American authorities could do to bolster their currency even if they wanted to. Low yields offer little support to the dollar.

A country heavily in debt to foreigners, with a government deficit it is making little headway at controlling, is creating vast amounts of additional currency. Yet it is allowed to get away with very low interest rates. Eventually such an arrangement must surely break down.

Cloud computing: Battle of the clouds

From the Economist Battle of the clouds:

The idea is that computing will increasingly be delivered as a service, over the internet, from vast warehouses of shared machines. Documents, e-mails and other data will be stored online, or “in the cloud”, making them accessible from any PC or mobile device. Many things work this way already, from e-mail and photo albums to calendars and shared documents.

This represents a big shift. If you store more and more things online, and access more and more software through an ordinary web browser, it suddenly matters much less what sort of computer you have, and what kind of software it is running.

By switching to cloud-based e-mail, accounting and customer-tracking systems, firms can reduce complexity and maintenance costs, because everything runs inside a web browser. Providers of cloud services, meanwhile, can benefit from economies of scale. Why should every company or university set up and maintain its own mail server, when Google or Microsoft can do it more efficiently? Companies are already happy to rely on utilities to provide electrical power, after all. Cloud computing will do the same for computing power.

The ability to summon computing capacity from the cloud when needed will also give the software industry a shot in the arm. During the dotcom boom, the first thing a start-up had to do was raise the money to buy a room full of servers. If a website experienced a sudden surge in popularity, more servers were needed to meet demand. Today a capacity can be rented as needed, allowing cloud services to scale up smoothly. This lowers barriers to entry and promotes innovation and competition.

From the Economist Clash of the clouds:

Windows 7 is not just a sizeable step for Microsoft. It is also likely to mark the end of one era in information technology and the start of another. Much of computing will no longer be done on personal computers in homes and offices, but in the “cloud”: huge data centres housing vast storage systems and hundreds of thousands of servers, the powerful machines that dish up data over the internet. Web-based e-mail, social networking and online games are all examples of what are increasingly called cloud services, and are accessible through browsers, smart-phones or other “client” devices.

The rise of cloud computing is not just shifting Microsoft’s centre of gravity. It is changing the nature of competition within the computer industry. Technological developments have hitherto pushed computing power away from central hubs: first from mainframes to minicomputers, and then to PCs. Now a combination of ever cheaper and more powerful processors, and ever faster and more ubiquitous networks, is pushing power back to the centre in some respects, and even further away in others. The cloud’s data centres are, in effect, outsize public mainframes. At the same time, the PC is being pushed aside by a host of smaller, often wireless devices, such as smart-phones, netbooks (small laptops) and, perhaps soon, tablets (touch-screen computers the size of books).

Apple is also secretive about the way it conducts its internal R&D. Mr Jobs clearly calls most of the shots. But insiders say that there is a system of teams that pitch projects to him.

EnerNOC: an interesting business model

From the Economist Wiser wires:

For applications that run on smart grids, it is still early days. EnerNOC gives a hint of things to come. The speciality of this American firm, whose share price has more than quadrupled in the past 12 months despite the crisis, is demand response. It promises utilities to supply them if they need additional power and is paid as if it were keeping physical plants ready. In fact it has agreements with many firms, which it pays for the privilege of being allowed to shut down their non-essential gear if need be, thus freeing up capacity. As of June 2,400 customers, from steel plants to grocery stores, had signed up. They represent 3,150MW, the output of about 30 peak-power plants. But EnerNOC also wants to use the equipment it has installed and the data it collects to offer something called “continuous commissioning”: making sure that big buildings, for instance, do not start to waste energy.

Smart grid developments

From the Economist Wiser wires:

A global movement is afoot to make grids “smart”. This means adding all kinds of information technology, such as sensors, digital meters and a communications network akin to the internet, to the dumb wires.

Governments have earmarked parts of their stimulus packages for smart grids. Utilities have started to spend serious money. In recent years American venture capitalists have put more than $1 billion into smart-grid start-ups, even if investment this year has not matched the heights of 2008. Two of these start-ups, GridPoint and Silver Spring Networks, raised $220m and $170m respectively.

Outages cost the American economy $150 billion a year.

A more resilient grid, however, is the less important half of the story. Just as the original grid facilitated the industrial innovations of the 20th century, the smart grid should support the green advances of the 21st.

More intelligence in the grid would also help integrate renewable sources of electricity, such as solar panels or wind turbines. As things stand, the trouble is that their output, being hostage to the weather, is highly variable. A standard grid becomes hard to manage if too many of them are connected to it; supply and demand on electricity-transmission systems must always be in balance. A smart grid could turn on appliances should, for instance, the wind blow more strongly.

Within the smart-grid market, there are three different strata of technologies, known as “stacks”.

The first stack is called “advanced metering infrastructure”, or AMI. It is at the heart of every smart grid and is the most vibrant part of the market so far, which is good news for makers of smart meters, such as General Electric, Itron, based in Washington state, and Landis+Gyr, from Switzerland. Their products are rather like smart-phones: they have a powerful chip and a display, and are connected to a communications network. More than 76m will have been installed worldwide by the end of this year, forecasts ABI Research, a market-research firm. By 2013 the number will rise to 155m.

The main task of a metering system is to get information reliably into and out of meters—for example, how much power is being used, when and at what price. The best approach is to use wireless mesh networks, in which data are handed from one meter to the next.

Such networks, which automatically reconfigure themselves when new meters are added, are at the core of the wares sold by Silver Spring Networks and Trilliant Networks, both based in Silicon Valley. Yet as well as providing the communications infrastructure of a smart grid, they also want to offer its software foundation. So far Silver Spring is the more successful of the two, having several American utilities on its customer list, PG&E among them. But Cisco is likely to enter this market, probably through acquisition.

The other two technology stacks of a smart grid are more straightforward, but no less promising. One is all the technology a utility needs to manage the usage data, combine it with other information and set rates depending on demand. The leading start-up in this area is eMeter, from Silicon Valley, but Oracle, a database giant, offers similar software. IBM helps utilities connect their disparate systems, build applications for smart grids and analyse the huge amount of data they produce.

The third stack is the “home area network” (HAN)—industry-speak for all the smart-grid technology in the home, behind the meter. There is general agreement that it will include things such as wireless displays that show the household’s power consumption at that instant, thermostats that are connected to the meter and smart appliances that can be switched on and off remotely. The big question is how all these devices will be connected and controlled. Will the HAN be dedicated to regulating electricity consumptions, for instance, or will it also control home security or stream music through the rooms?

Given the infantry of start-ups and the artillery of corporate giants, you might think it cannot be long before smart grids are widely deployed, at least in the rich world. Alas, things are more complicated, for three main reasons. The first of these is that the technology is not ready yet. Granted, most of it exists in some form (with the notable exception of ways to store energy efficiently when demand is low). But many products are not widely available or still need honing. Smart grids are also said to be vulnerable to cyber criminals. At a recent conference, a security consultant showed how a large number of meters could be hacked and shut down.

What is more, many standards have yet to emerge and the technology is still in flux. Understandably, utilities are hesitant to make big bets on products that could soon be obsolete.

That does not mean that smart grids will never be widespread. But just like other new technologies, they will first go through what Gartner, a market-research firm, calls the “hype cycle”. After a peak of inflated expectations, there comes a “trough of disillusionment” before the technology reaches the “slope of enlightenment”. And perhaps more than with other technologies, how steep this slope turns out to be will largely depend on what people, from politicians to business leaders to consumers, make of it.