My Diary 682 --- The Roadmap of European Debt Crisis; The Threat

My Diary 682 --- The Roadmap of European Debt Crisis; The Threat of AAA Rating Cut; The Solutions for Chinese Debts; The Impact on Asia and Policy Options

Monday, July 04, 2011

“The Threat of Debt: Deal or Death” --- I would like to devote this diary piece to the topics of debt, as many of us should have fresh memories of the “near death” experience over the past few years or even the past few weeks, if not exaggerated. Indeed, it was never seen in the economic history that the world has so many countries had so much combined Government and Financial (G+F) Debt. Many countries have defaulted through history with much lower debt. It is only been the last 10-15 years where financial debt/GDP has generally been in Double Digits (%) across the globe and now many countries are in Triple Digits on this ratio across the broad 'financial' sector. Taking BIS numbers for reference, G+F Debt/GDP in the Peripheral 5 was 214% and was 200% in Spain and 210% in Italy. It is possible that these numbers are just way too high and it is only a matter of time before the “ultimate default” happens. No-one has a template for such an environment but we do know that severe problems have occurred at lower debt levels through history. I believe this is one of the reasons that, over the weekend, the Basel Committee agreed to make 30 of the world's largest and systemically important banks to hold as much as 250bps more capital than the 7% core Tier-1 capital required. 

Before we moving into detailed analysis over debt issues in Europe, United States and China, let us review the asset markets’ performance over the week. Global equities closed a very strong week with MXWO +5.36%, US +5.6%, EU +4.1%, Japan +2.47% and EMs +3.68%. In particular, this week’s surge in US stocks has been accompanied by a drop in implied volatility, with VIX dropped to 15.87%, -24.79% wow. Elsewhere, UST yields closed a bit higher with 2yr +8bp to 0.47% and 10yr +25bp to 3.18%. Spot gold price closed 1.2% lower to USD1485/oz from USD1554.6/oz on 22Jun2011. Moreover, it was a risk-relief week for European sovereign spread with Greece, Ireland and Portugal credit shrinking by -64bp, -55bp and -64bp to close at 1330bp, 858bp and 790bp, respectively. Currency space, EUR strengthened 2.38% to 1.4526USD and JPY softened 0.5% to 80.83USD. 

That said, time flies, and another half year ticks over. Looking back, 1H11 was very much a story of two contrasting Qs largely dictated by the macro backdrop whether it be issues surrounding the continued funding problems facing European Sovereigns and Banks or the general health of the economy. However, the week saw pessimism has become tiresome, so optimism is gaining a foothold. But is the optimism justified? Indeed, there are various facts support a new attitude. Growth in EM economies is robust, and recovery looks to be on a self-sustaining path in the countries that were at the centre of the 2007–09 crises. Yet the remaining challenges are enormous – towering debt, global imbalances, extremely low interest rates, unfinished regulatory reform, and financial statistics still too weak to illuminate emerging national and international stresses. With respect to the US economy, the past week also marks the end of the Fed's QE2 program which began in November last year. So USD600bn and 8 months later, the economy continues to grow at a sub-par pace (1.9%), UNE rate remains high (9.1%) and inflationary expectations (briefly boosted by QE2) seem to be declining (-0.37% 5yr BE) again. Meanwhile, Bernanke seems to have lost enthusiasm for QE, suggesting another round is unlikely even though FOMC is concerned about disappointing economy performance. On the other hand, SP500 is +25% since Jackson hole, WTI, Gold and CRB index are 19%, 22%, and 28% during the same period. One of the unintended consequences of QE2 was to boost food and fuel commodity prices – forcing central banks of EM economies to tighten monetary policies. Looking back, this 2-year recovery cycle seems to be behaving significantly differently from most seen through observable history since 1921 --- the economic data has generally been much weaker than normal, but with asset prices generally higher. In fact, this is the weakest of the 17 nominal US GDP recoveries in the 90 years history, but it's the 2nd strongest rise in commodity prices seen in the 23 recoveries since 1900. This large dichotomy most likely reflects the fact that to get a small recovery we've needed to throw so much liquidity at the system that much of it has leaked into financial assets. My conclusion is that policy makers are walking on a thin-balance and the chance of policy errors is very high.

The Roadmap of European Debt Crisis

The good news is that investors don't have to wake up to a Midsummer's nightmare this morning. Over the weekend, EMU countries approved its share of a EUR12bn (USD17.4bn) aid payment for Greece and pledged to complete work in the coming weeks on a second rescue package for the cash-strapped nation to prevent a default. Finance ministers agreed to disburse EUR8.7bn loans under last year’s EUR110bn bailout by July 15, rewarding Greek PM Papandreou for pushing an extra austerity plan through parliament. The IMF is due to provide the rest of the July aid installment (EUR3.3bn), the fifth under the 2010 package. The spotlight now turns to a second bailout to which banks and insurers plan to contribute following German demands for taxpayer relief. Euro-area governments and investors will provide 70% of new aid that may total as much as EUR85bn, with the IMF offering the rest.

Moreover, Chinese Premier Wen Jiabao said on Saturday he was "still confident" that Europe can overcome the debt crisis and said China would remain a long-term investor in Europe's debt market. I also saw some headlines around the private sector rollover. According to BBG, French banks would reinvest about 70% of Greek sovereign debt maturing from mid 2011 to mid 2014. Of this 50% of the redemptions would go into 30yr Greek securities and the remaining 20% invested in a fund made of "very-high quality" securities that would back the 30yr bonds. The “Die Welt am Sonntag” reported that the German Government wants the country's major financial institutions to extend the maturities on Greek bonds by up to five years as part of the private sector involvement. Former Bundesbank chief Axel Weber said that Europe needs to consider guaranteeing all Greece's outstanding debt because Athens's only viable alternative is a messy default that would be more costly and risk sparking broader financial turmoil. The further details leaked out through the past week is the new 30yr Greek bonds could carry EIB or EFSF guarantee, in an obvious concession to those who had been calling for some sort of security, and were seen as carrying an AAA credit rating (somewhat optimistically) with a 5.5% coupon plus an annual surcharge of up to 2.5%. The proposed coupon is around 600bps below where 30yr Greece is currently trading.  Such a very long maturity loan with a low interest rate is essentially a fiscal transfer to Greece.

What is now critical is the prompt and effective implementation of the decisions of Greek parliament. In May, EU warned that Greece had slipped off its course to narrow its budget deficit to 7.4% GDP this year from 10.5% of GDP in 2010, saying this year’s shortfall would be 9.5%. The nation’s debt will rise to 158% of GDP this year from 143% in 2010, according to EU forecasts. Even if Greece meets its budgetary objectives, privatizes a significant number of assets and achieves some rollover of maturing market debt, the pace at which Greek market debt is being replaced by official liabilities will continue to be very rapid. The new package is likely to show that the stock of Greek sovereign liabilities in the form of official loans at the end of 2014 will be around EUR155bn, which would be significantly higher than the projection of EUR75bn in the original package (excluding ECB’s holdings of Greek debt). The actual outturn could be different depending on the extent to which Greece fails to meet the deficit and privatization objectives and on the extent that private sector participation in the rollovers falls short of expectations. With Greece shut out of financial markets, the rest of the region will likely fill in most of any financing gap that emerges.

If Greece is unable to reaccess capital markets at that time, the process of socialization will continue until there is virtually no Greek market debt left at the end of the decade. The only thing that can slow down this process of socialization is an aggressive maturity extension of market debt with a high participation of private-sector investors. At the moment there is little appetite for this due to concerns about financial stability. This was made clear by the decision of the European Council last week that private sector involvement in the new Greek package will be in the form of “informal and voluntary rollovers of existing debt at maturity”. It is still unclear exactly what this will look like. Also striking was the decision last week to drop the preferred creditor status of ESM loans, at least for Greece, Ireland and Portugal when they transition from the EFSF to the ESM.

In short, Europe is trying to draw a line under a debt crisis that Greece sparked more than a year ago and that threatens the 12- year-old monetary union. Ireland and Portugal sought emergency aid totaling EUR146bn after the initial bailout of Greece in May2010 and investors remain concerned about the vulnerability of some bigger euro nations including Spain. Such a concern has also been raised by IMF last week. The IMF said that whilst Spain had responded vigorously to its economic problems over the past year it did describe the labor market as 'dysfunctional'. The IMF said that the repair of the economy is incomplete and risks are considerable saying that in the short term investor fears about European sovereign risk could be increasing Spain's borrowing cost. In addition, the contagion risks remain to be closely watched, although lessened a bit after Greece new bailout package approval. ECB President Trichet lately said that the link between the Euro zone peripheral debt problems and the Euro zone banks "is the most serious threat to financial stability in the European Union. In other news Fitch's updated its review of US MMF' exposure to European banks, which highlights the contagion risk among global financial markets. The agency noted that the exposures to European financial institutions remain significant at roughly 50% of total MMF assets at the end of May 2011 (stable over the last 3 months). German bank exposure decreased from 8.2% to 6.3% of MMF assets while French bank exposure increased to 14.8% from 13.3%.

Lastly but not least, one development that could significantly deepen the Euro area sovereign crisis is a bank run in the periphery. Over the past 15 months, deposits have flowed out of the Greek and Irish banking systems, but there has not been an actual bank run. In each of these economies, the level of private nonfinancial domestic deposits is now nearly 20% lower than at the start of last year. Banks have replaced this funding with borrowing from the ECB: currently the ECB is funding around 20% of the Greek and Irish banking sectors’ balance sheets. A significant increase in deposit outflows would start to create more serious problems if banks ran out of collateral that they could use in borrowing from the central bank. Initially,there could be a relaxation of collateral requirements, as takes place when banks borrow through their local central bank’s ELA. But, at some point, a dramatic deposit outflow would trigger a broader policy response. Some commentators think that increased deposit outflows would be the trigger for default. In contrast, market would expect a policy response that increased the amount of socialization: some kind of area wide guarantee for banking or sovereign liabilities in the affected country.

There is an important lesson we can derive from the latest sovereign crisis in EMU. In fact, in terms of EMU, one could say the MU part – that is, monetary union – has worked. The problem is with the E part of EMU. The reason one size does not fit all when it comes to interest rates is that the Euro area has such a varied group of countries within its membership. It is not an optimal currency area. Its economies are too different. This is in part because the entry convergence criteria were relaxed by politicians. This is very evident now, in terms of the economic gulf between the core and the periphery. One lesson from history is that if the Euro were to survive, it would need to become a political union. Or, failing that, it might have been able to get away with a central, well funded, and fully accountable Treasury. This explains the possible way out of Greece’s current problems.

The Threat of AAA Rating Cut

IMF said last week global markets will suffer if the US Congress fails to approve an increase in USD14.3trn debt ceiling and cautioned about the risk of a downgrade in the country’s credit rating. In the same statement on the annual report, IMF said that risks to US include housing market weakness and the European debt crisis…“these risks would also have significant global repercussions, given the central role of US Treasury bonds in world financial markets”. The IMF endorsed the Fed’s current monetary policy stance…“with subdued inflation prospects and ample resource underutilization, the extraordinary monetary policy accommodation will likely remain appropriate for quite some time…” the IMF said “…going forward, the Fed should remain vigilant to the risk of an unmooring of long-term inflation expectations, and respond decisively should the risk materialize in either direction” .

On the other note, S&P have been on the wires stating it's position on the US that if USD30bn of bills maturing on August 4th are not honored, then a "selective default" rating would apply to the US. Moody's have already stated that they would cut the US rating to Aa range on a ceiling related default. Given the potential “fly-to-safe” needs of USD, Fed extended for one year the existing USD swap facilities with the ECB, SNB, BoE and BoC, all of which were scheduled to expire on August 1st of this year. The facility with BoJ will expire as scheduled at the end of next month. All of the swap lines are of unlimited size, except the one with the BoC, which is capped at USD30bn. In the past, we saw that the hurdle to extending these facilities is fairly low, as it is within the FOMC's traditional powers, and so should not be seen as a major signal but rather just a precautionary renewal of a back-stop facility. In fact, the existing swap lines have not been tapped since early March.

Another factor to consider is that an end to QE2 will halt the expansion in the Fed’s balance sheet. Although it is still a low probability event at the moment, additional QE by the Fed cannot be completely ruled out, especially if US growth fails to rebound in 2H11. Question is -- would US start QE 3?  I think that at this stage the possibility is near zero. While investors are clearly speculating about this, the political and economic hurdles for this are quite high, and much higher than last year. One key difference between this year and last year is that inflation is now much higher. On the basis of the Fed's own forecasts, core inflation may be reaching into the central bank's implicit target band of 1.7-2% yoy in the 4Q, whereas last year analysts perceived a risk of the US sliding into deflation. The only conceivable scenario whereby the Fed would initiate QE3 over the coming year is if the US government was to suddenly cut its budget deficit sharply for political reasons.

The Solutions for Chinese Debts

Last week, China's State Audit Bureau released a report that total local government loans is RMB10.7trn, about 79% (Rmb8.46trn) is bank loans. LGFV is RMB4.97bn, about 20% (RMB1trn) is not guaranteed by local government. Of the outstanding local govt and LGFV debt, the repayment schedule is: 2011 (24.5%), 2012 (17.2%), 2013 (11.4%), 2014 (9.3%), 2015 (7.5%), 2016 and after (30.2%). However, I do think this RMB10.7trn only revealed a big portion of total public debt picture, but not all of them. According to SCB, the estimated public debt in China at year-end 2010 was around RMB28trn, some 71% of GDP. This includes official central government debt, policy bank debt, estimates of local government and LGIV debt, Ministry of Railway debt, and the carried costs of the last round of bank restructuring. This number used the recent NAO estimates as baseline for local government debt, then made adjustments. The NAO, CBRC and PBoC estimates of local government debt differ in scale and definition. The NAO has reportedly taken a strict definition of LGIV debt, including only formal liabilities entered into by local governments for their own infrastructure-building platforms. Its estimate is RMB4.97trn, while the CBRC and PBoC appear to have taken a broader view, including informal guarantees on LGIV debt offered by local governments. The CBRC estimate is RMB9trn, the PBoC has implied up to RMB14trn.

Moreover, last week also saw reports of LGIVs in Yunnan province and Shanghai telling their banks that they can only repay the interest, rather than capital, on their loans signal the beginning of a wave of difficulties, I believe. If we assume that the LGIV loans are mostly bullets, and 3-5 years in term, so the pressure for repaying principal has not yet hit. But it will begin in 2012-13. The interest burden of around 6% on local government/LGIV debt is much higher than the 2% that the MoF is currently paying on outstanding central government debt. If assuming that local governments and their vehicles have total debt of RMB14trn, and that all of it is bank debt, then the interest due this year will be around RMB880bn (USD134bn). This is a tremendous amount of money, equivalent to 21% of local government tax revenues in 2010.

In fact, market concerns of NPLs from LGFV started last April following a Fitch report. However, such concerns seem overdone. Chinese banks are under instructions to stop extending credit to LGFVs, so it is no longer easy to take out new loans to repay old loans. At some point, the legacy will have to be recognized. And if that were not bad enough, local governments have strict instructions to start 10mn units of social housing this year – which I beleive mostly relies on commercial bank loans and land sales. It is the LGFVs that seem to be expected to bear this additional burden. So how will this game end? In the past two years, the CBRC has been encouraging the banks to define and ring-fence LGFV loans, ensure they have a proper legal claim to pledged collateral, and to categorize LGIVs into three types according to their ability to cover interest. In 1Q11, the regulator required banks to introduce differentiated capital risk-weightings (RW) for different levels of LGIV loan-interest coverage. For example, a LGFV paying all of its interest gets a 100% RW while one with zero coverage gets a 300% RW. In that sense, the potential exposure of NPL from LGFV to listed banks will be about RMB300-350b (8bn overdue, 240bn with improper registration, and 75bn with overstated collateral). Listed banks have set aside RMB100bn capital (for LGFV bad debts) and Rmb170bn loans provisions for all bad loans. So the amount to hit listed banks' P/L will be Rmb350b - Rmb270b = Rmb80b loss to split over 3 to 4 years (assume Tier-1 CAR not affected).

But investors have to keep an important thing in mind that, unlike the European countries and US, China’s long-term debt outlook is not so bad. Using a conservative assumption of 10% nominal GDP growth over 2011-15, and assuming total nominal debt remains stable, China’s debt ratio should fall to 45% of GDP by 2015. Other positives include the fact that total government budget revenues are running at 24% of GDP, and rising as a proportion of GDP. This number excludes off-budget and other revenues (including land-lease sales) that the government receives – add those in and one finds a government with revenue streams of some 30-35% of GDP, which is pretty good for a developing economy. And then there is the ‘other side’ of the government balance sheet – the government’s industrial assets and land holdings, which are large and valuable. The value, however, is even harder to calculate than the liability side of its balance sheet, given the lack of relevant information. Such assets would be hard to liquidate in a crisis, but given that they have considerable scale, they should ultimately be very useful over the medium term.

The Impact on Asia and Policy Options

After two years of improving data, the recent deterioration of macro figures globally has been significant enough to make investors worrying about “double-dip”. Over the month, I saw global ERR fell as analysts downgraded earnings forecasts, Global Industrial Confidence fell on weaker sentiment in US, UK, Italy and France. Also, global Credit Spreads widened, global Consumer Confidence fell marginally, and Global UNE indicator deteriorated. However, I think the world economy is slowing but not collapsing. Significant challenges will keep monetary policy loose in the West. This will reinforce the need for Asian central banks to be vigilant on inflation, particularly if asset prices are fuelled by the return of hot money flows.

Across Asia, there are signs that the current round of consumer price inflation is abating. But monetary policy needs to remain tight, or even be tightened further. The next three to six months will be critical. More macro-prudential measures and other policy tools are required to contain leverage and the risk of asset bubbles. Investors looking for a quick policy reversal are likely to be disappointed, and markets could turn more volatile in anticipation of policy changes. In China, more tightening is expected, but I believe a hard landing can be avoided. Similarly, India has few options but to tighten further given stubbornly high inflation. While headline inflation has fallen recently in Indonesia, core inflation is still trending up and more tightening is needed, especially if fuel subsidies are cut. The Bank of Korea may stay on hold after the latest hike, but we believe it can only delay, not stop, the current hiking cycle.

That said, we need to estimate the potential impact of an EU debt crisis to Asian economies. Within the region, I expect Asian economies with high export-to-GDP ratios – such as Singapore, Hong Kong, Taiwan and Thailand – to suffer the worst hits to their headline growth rates if the European debt situation deteriorates into a Europe-led recession. This is because they have shown the highest growth volatility over the global economic cycle. The good news is that Asian governments have sufficient policy tools, both fiscal and monetary, to protect themselves from a much weaker global growth environment. In 2008-09, Asian governments channeled 2-4% of GDP to stimulate local lending, economic activity and jobs. Meanwhile, interest rates were reduced to protect borrowers and investment. Moreover, Asia could see USD240bn in lending cuts by European banks, mainly in China, Korea and Singapore. In addition, foreign investors’ heavy positioning, especially in local government bond markets, could trigger significant capital outflows if risk sentiment deteriorates further.

Furthermore, the coming week will see the release of June inflation data from Korea, Thailand and Indonesia. Headline inflation is expected to ease in all three countries, but the uptrend in core inflation remains intact. This reflects that while food and energy inflation is moderating, underlying domestic demand remains firm. The policy implications are clear. Central banks in Asia still need to keep monetary policy tight. Thailand has repeatedly warned that its core inflation target (0.5-3.0%) will be breached in Q3 and Q4-2011. Meanwhile, Indonesia may be cautious in raising its benchmark BI rate, as it has been keen to use the Indonesian rupiah (IDR) exchange rate to contain imported inflation. Most central banks in the region have spoken of the economic and financial threat from a potential European debt crisis, and they are expected to react accordingly. However, until there is a material deterioration in the European situation with visible repercussions for economic activity in Asia, central banks are likely to push ahead with gradual tightening.

More important in halting consumer price inflation are demand-side measures taken by Asian authorities, including monetary tightening, currency appreciation and fiscal restraints. Since Vietnam announced the first post-global crisis policy rate hike in December 2009, key Asian central banks have raised their policy rates by 50-700bps, accompanied by reserve ratio increases and outright loan quotas. Over the past six months, Asian currencies – with the exception of the VND, THB and HKD – have appreciated by 1.0-6.5% against USD. Other measures have pushed some indicators, including RRR in China and RMBUSD, to record or cyclical highs. Yet it is premature to say that their peaks have been reached and no more tightening is needed. In real terms, all Asian policy rates are still in negative territory – except those of China, Indonesia and Taiwan, which are marginally positive. There is a limit to how much authorities can use monetary and exchange rate tools to manage the current round of inflation. Higher interest rates and stronger currencies could attract more capital inflows and defeat the very purpose of monetary tightening, especially for economies with open capital accounts. In response, some governments have imposed restrictions on capital inflows, including withholding and capital gains taxes in Korea and Thailand,

More importantly, historically, asset-price inflation is more difficult to combat and presents a bigger risk to system stability than consumer price inflation, as evident in the latest global financial crisis and earlier asset bubbles in Japan and Asia. Policy makers have a reasonable understanding of the relationship between various monetary tools and consumer prices, but the connection between monetary policy and asset prices is much less obvious. Demand for assets is more sensitive to leverage than demand for consumer goods, but supply of assets is less responsive to stimulus. Easy credit is a key driver of most property booms, but housing and land policies take years to adjust housing supply.This supply-demand asymmetry in asset markets allows the build-up of much bigger imbalances and calls for the use of policy tools beyond normal liquidity management. This is a more complicated task, requiring close co-ordination between different authorities, including tax, housing, land, customs, immigration, planning and finance.

In HK and Singapore, where the risk of property price bubbles is fuelled by open capital accounts and the lack of effective monetary policy tools, the fight against asset-price inflation is more challenging. On top of traditional macro-prudential measures like loan-to-value and debt-to-income ratios, the authorities have resorted to a wide range of measures – tax measures, adjustments to land and housing policies, and changes in immigration regulations – to restrain property prices. While there is clear pressure for these governments to offer (or be perceived as offering) quick fixes, they must also avoid unnecessarily undermining long-term policies and principles. In the coming months, with monetary policy tightening cycles moving into an advanced stage but complementary policies and macro-prudential measures yet to arrest asset-price inflation, confusion about policy direction may increase, and market sentiment may swing more widely. This could fuel market volatility, requiring a firmer hand.

2H11 Market Outlook

The political economy is key for 2H11. Governments in the Euro region might be forced to move with the view of the majority rather than the market. This is evident from civil unrest in Greece over the proposed fiscal roadmap. The Portuguese austerity plan has led to protests by the trade unions. Protesters in Spain, unhappy with government’s economic policies have defied government ban on political protests. Policy making is severely constrained in such an environment.

Currently I am less bearish due to two data points; cheaper oil  and recent A-share market strength. But the risk reward balance is still unfavorable, given:

1)     The cuts in government spending are yet to hit the US economy as Washington and individual states tackle their record budget deficits

2)     A far greater concern regarding the outlook for consumer spending is the labor market in US. The May payroll report was a disappointment. If that weakness continues, then the view that the slowdown in growth is temporary would have to be shelved.

3)     Portugal and Ireland could fall into similar difficulties like Greece. If the long bond yields remain well above 6% (2010 average), concerns of a funding crisis would inevitably start to grow.

4)     Earnings D/G revisions are yet to occur. Both 2011 and 2012 EPS are still 10% higher today than Feb 2010 while conditions have deteriorated compared to then – lower ISM, slower growth, higher inflation. Market performance typically lags earnings revisions. FY2 Revisions ratio has just become negative at the end of May.

5)     Bulls would argue earnings downward revisions are already priced. PEs have de-rated by 5% and 4% for 2011 and 2012 respectively since the start of the year. I would be concerned if this is pricing in all the macro headwinds. 2008 PE de-rated by 21% between Jan and Aug 2008 as economic conditions worsened before the Lehman event.

6)     YTD net outflows at USD9bn are 11% of the net inflows in 2010. The flows turned negative since 3rd of week of May after USD14bn inflows in April. We fear a peak in outflows is yet to come. Net outflows between Jan and Aug 2008 were USD26bn.

7)     Stagflation is a concern in the US. The term stagflation was coined in 1965 by Iain Macleod, Shadow Chancellor of the Exchequer, when UK inflation was 4% and real GDP growth was 2%. US inflation (PCE) is rising at 4.6% (QoQ annual rate) while real GDP growth in 1Q11 was 1.8%. The US economy is suffering from inflation imported from EM via higher commodity prices. This is compressing household compensation and end demand. If oil prices increase to USD130/bbl, a US double dip scenario should not be ruled out.

8)     The Chinese property market is a bubble in our view. Property companies are accelerating construction starts when sales are disappointing. The Chinese government measures to control demand for property appear to be working.

To Sum up, EM market valuations are within 1-STDEV of their LT- averages. In my own viewd, large cap stocks with good fundamentals are not cheap. The cyclical sectors offer value but have the highest earnings risk. I think investors could wait for a better entry point in 3Q11. The most bullish scenario for the year is a meaningful decline in energy and commodity prices. This is more likely with the IEA release of 60mn barrels of oil.

Good night, my dear friends!