All this and the Super Committee still to come.

You have to have a long-term plan: Among the exhibits at the Colditz museum is a row of moldy jam jars. Turns out a British officer secreted the jars under his bed and nurtured dry rot cultures for insertion into the wooden walls and joists of the castle. Once there, all he had to do was wait 25 years for the castle to come crashing down. Now if the euro designers had a slightly better plan than "there is no escape, ever" we wouldn't be spectators to one of the greatest financial disasters of our lifetime.

 

Not so dolce vita: The pressures in Italy are easily measurable. The Bund spread reached 550bp vs. 130 back in April. That's the Greek level from 2010 and represents a 12% loss in Italian bonds YTD. Not good if you have to refi your debt from around 4.5% in June to 7.3% now. Even 1-year bill auction today sold at 6.1%. It could have gone for less but the ECB is prohibited by law from intervening in the primary auction market...one of those planning oversights.

 

But Italy is a special case and not one of those sybaritic Mediterranean morality tales. It has a primary budget surplus (before interest payments), long debt maturity, low foreign liabilities and a self-funding deficit thanks to a high savings rate. Its problem is extremely low growth (GDP per capita below 2000) tied to a hopelessly uncompetitive exchange rate. Now couple this with a Bunds/OATs spread widening to 167. This is really worth looking at because for most of the decade, investors only needed a 30bp premium to hold French government paper. But now they need 146. Ouch.

The last quartet: And all this shows the paucity of thought from the EU. The austerity at any price crowd has no articulate opposition. Growth, employment, competitiveness are simply not mentioned by anyone in power. It's just cutting expenditure and fighting the inflation chimera. How does this end? 1) Someone calls the bluff and does an Iceland 2) a "core" Eurozone emerges of Germany, France, Netherlands and Austria or 3) austerity growth wins the day. If it's the last, I will be in the front row of Porcine Airlines.

 

US really better: The trade gap narrowed a lot more than expected. Exports are up 16% from last year and imports have been flat since March. You can put that down to the oil spike back then. Industrial and capital goods have done particularly well. If this keeps up, there should be a net gain of 0.3% to GDP. Not enough to offset the fiscal drag but better than most expectations. You can see some of the effects here, which measures the free fall in government vs. private job openings from this week's JOLTS:

And you can see the continuing success story of corporate profitability here in the measure of labor costs to profits where they are the lowest, well, ever. We'll spare the "share of labor in the recovery" story for another day.

Bottom Line: Keeping volatility down. Raising cash and using the trading opportunities in bonds. Trimming international especially Europe; DAX is 11% off October lows; but sentiment is very negative. This bond rally is all about the need to cover much higher margins on repos for European and Italian bonds but could have more to go.

Sources: Bloomberg, Matt Oxley, Zero Hedge, Federal Reserve Bank of St Louis, US Census Bureau, US Bureau of Economic Analysis, Bureau of Labor Statistics, Credit Suisse, Sentinel Asset Management, Inc.

 

 

 

(c) Sentinel Investments

www.sentinelinvestments.com