Emerging Markets Radar (May 14, 2012)

Sunday, May 13th, 2012

Emerg­ing Mar­kets Radar (May 14, 2012)

Strengths

• China’s April Con­sumer Price Index (CPI) was 3.4 per­cent, 0.2 per­cent lower than March but equal to mar­ket con­sen­sus. This is below the gov­ern­ment tar­get of 5 per­cent, leav­ing room for fur­ther mon­e­tary eas­ing if needed.
• Pas­sen­ger vehi­cle sales in April were up 13 per­cent to 1.28 mil­lion units, the China Asso­ci­a­tion of Auto­mo­bile Man­u­fac­tur­ers said Wednes­day. Sales were fore­cast to increase 11.3 percent.
• Indonesia’s real GPD rose 6.3 per­cent for the first quar­ter, in-line with mar­ket expec­ta­tions. In spite of a slow­down from the pre­vi­ous quarter’s GDP growth of 6.5 per­cent, the mar­ket was sat­is­fied with the out­come con­sid­er­ing the head­winds faced by the economies elsewhere.
• Stan­dard & Poor’s sta­ble out­look on Turkey’s long term rat­ing is sup­ported by the agency’s view of the country’s gen­er­ally effec­tive pol­i­cy­mak­ing and insti­tu­tions, its mod­er­ate and declin­ing pub­lic debt bur­den, and its mon­e­tary pol­icy flex­i­bil­ity, said S&P ana­lyst Eileen Zhang.
• Sep­a­rately, Sam Zell spoke at the annual CFA con­fer­ence in Chicago.  He men­tioned that one of his key the­ses in emerg­ing mar­kets is to invest in a coun­try 3 to 4 years before it attains invest­ment grade, because the process keeps pol­icy mak­ers hon­est in the run up to the upgrade.

Weak­nesses

• Russ­ian elec­tric­ity dis­tri­b­u­tion com­pa­nies were denied tran­si­tion to Reg­u­lated Asset Base (RAB) pric­ing by the Fed­eral Tar­iff Ser­vice, throw­ing util­ity sec­tor reform into dis­ar­ray.  The East­ern Euro­pean Fund has no expo­sure to Russ­ian utilities.
• Tai­wan exports dis­ap­pointed again in April, falling at a faster pace of 6.4 per­cent vs. 3.2 per­cent in March, partly due to hol­i­days in China. China’s April trade num­ber was also weak. China’s exports were up 4.9 per­cent vs. the esti­mate of 8.5 per­cent, while imports were up 0.3 per­cent vs. the esti­mate of 10.9 percent.
• China just released April eco­nomic data. April indus­trial pro­duc­tion was up 9.3 per­cent year-over-year, vs. the esti­mate of 12.2 per­cent; retail sales were up 14.1 per­cent, vs. the esti­mated 15.1 per­cent; new loans were RMB681.8 bil­lion, vs. the esti­mate of 780 bil­lion; M2 money sup­ply grew 12.8 per­cent vs. the esti­mate of 13.3 per­cent; and fixed asset invest­ment was up 20.2 per­cent year-to-date, vs. the esti­mated 20.5 per­cent. Due to the weak eco­nomic num­bers, the mar­ket spec­u­la­tion this morn­ing was that the People’s Bank of China (PBOC) will cut the bank reserve ratio tonight.
• The bank of Korea main­tained its bench­mark rate at 3.25 per­cent for the 11th suc­ces­sive month as expected, while Indone­sia also kept its bench­mark rate at 5.75 per­cent, but raised the cen­tral bank rate and term deposits to absorb exces­sive liquidity.
• Else­where in Asia, Malaysia’s indus­trial pro­duc­tion gained only 0.6 per­cent in March, vs. the esti­mated 3.3 per­cent; Philip­pine export unex­pect­edly dropped 1.2 per­cent in March.
• China’s home sales trans­ac­tion value fell 16 per­cent in April from the pre­vi­ous month as the gov­ern­ment reit­er­ated it will keep curbs on the prop­erty market.

Oppor­tu­ni­ties

• A sig­nif­i­cant por­tion of global equity returns comes from the local mar­ket cur­ren­cies effect.  The chart below from BCA Research plots coun­try equity val­u­a­tion along the hor­i­zon­tal axis and pro­pri­etary “cur­rency val­u­a­tion” along the ver­ti­cal axis.  From that per­spec­tive, China, Tai­wan, and Emerg­ing Europe mar­kets look under­val­ued, while Indone­sia, South Korea, and Latin Amer­ica look overvalued.

• In April, China’s power pro­duc­tion growth was less than 1 per­cent, one of the low­est monthly num­bers. If the past is any guid­ance, the Chi­nese equity mar­ket will rally fol­low­ing a dis­mal monthly power generation.

Threats

• One of Russ­ian Pres­i­dent Vladimir Putin’s first acts in his new/old job was to sign a direc­tive for the gov­ern­ment to imple­ment afford­able and com­fort­able hous­ing. Among the tasks set to be achieved by 2018, the gov­ern­ment must bring down the spread between aver­age mort­gage rates and infla­tion to a max­i­mum of 2.2 per­cent.  If imple­mented as such, net inter­est mar­gins at the banks would come under pressure.
• Weaker-than-expected April eco­nomic num­bers strongly sug­gest the People’s Bank of China needs to cut rates or bank reserve ratio to pro­vide liq­uid­ity to the economy.

Tags: Asset Base, Automobile Manufacturers, China Association, China China, Consumer Price Index, Debt Burden, Electricity Distribution Companies, GDP Growth, Gpd, Headwinds, Holidays In China, Index Cpi, Investment Grade, Market Consensus, Market Expectations, Sam Zell, Sector Reform, Stable Outlook, Target, Utility Sector
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Big GDP Miss: 2.2% Vs Expectations Of 2.5%, Composition Even Uglier

Friday, April 27th, 2012

So much for the +3.0% GDP whis­per num­ber. Instead of print­ing at the expected num­ber of +2.5%, the first pre­lim­i­nary GDP data point (two more revi­sions pend­ing) came out at 2.2%, a big dis­ap­point­ment for a quar­ter which had a sub­stan­tial boost from the weather. And while of the 2.2%, Per­sonal Con­sump­tion came in strong — as expected, as it was pre­cisely the fac­tor most impacted by pulling in demand for­ward cour­tesy of "April in Feb­ru­ary", 0.59% of the 2.2% was an increase in inven­to­ries, some­thing which was not sup­posed to hap­pen as it means that the qual­ity of the eco­nomic growth in Q1 was far worse than expected. Cement­ing the ugly com­po­si­tion of Q1 GDP was fixed invest­ment which added just a pal­try 0.18% — this is the num­ber which is crit­i­cal for ongo­ing cash­flow gen­er­a­tion and unfor­tu­nately, the very low print means that growth out­look for Q2 is now even worse than before and we expect econ­o­mists will promptly trim their already bear­ish pre­dic­tions for Q2 GDP. Finally, gov­ern­ment "con­sump­tion" sub­tracted just 0.6% from the total num­ber, a decrease from the 0.84% in Q4, which means that once again the gov­ern­ment is start­ing to become less of a detrac­tor to growth — a dag­ger in the heart to any­one who claims there is "qual­ity" in GDP growth. And the num­ber you have all been wait­ing for: At March 31, US Debt/GDP was 100.8%.

Full break­down by category:

Tags: Composition, Dagger, Detractor, Disappointment, Economic Growth, Economists, GDP, Gdp Data, GDP Growth, Government Consumption, Growth Outlook, Heart, Inventories, Personal Consumption, Q2 Gdp, Q4, Revisions, Ugly, Weather, Whisper Number
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The Day Austerity Died (Tchir)

Tuesday, April 24th, 2012

by Peter Tchir, TF Mar­ket Advisors

Aus­ter­ity is dead! Long live Spending!

Futures are up, Ital­ian and Span­ish bonds are up, CDS spreads on them are at least 10 bps tighter, and MAIN is 3 bps tighter on the day (though I have this feel­ing I bet­ter type fast as we are start­ing to fade off the best levels).

Lots of lit­tle things seem to be con­tribut­ing to the strength, TXU earn­ings, no eco­nomic data, auc­tions that raised the required money, etc., but there does also seem to be a belief that Ger­many finally “gets it”. That Ger­many is finally going to relent on their demands for austerity.

The first ques­tion is “what is defined as aus­ter­ity?” Pro­grams that are pro­vid­ing money today, that is quickly re-circulated into the econ­omy because it is pay­ing for peo­ple to live should not be cut – that is bad aus­ter­ity. Rais­ing taxes in gen­eral is prob­a­bly bad aus­ter­ity, but what about actu­ally col­lect­ing taxes on all those who have avoided pay­ing what they owe? Plans to reduce long term ben­e­fits must go for­ward, min­i­mal cur­rent cost to the econ­omy, but nec­es­sary for any long term solu­tion. So while “aus­ter­ity” hasn’t worked, it is not all bad, and some forms need to be main­tained to have any hope that the sit­u­a­tion can be turned around in the future.

The sec­ond, and more impor­tant ques­tion, is “why does any sane per­son think spend­ing for growth will work?” Just pause for 1 moment. How were these mas­sive deficits built up? Was all the spend­ing friv­o­lous? I don’t think so. A lot of spend­ing was meant to tar­get growth in cer­tain areas. It is just very dif­fi­cult to achieve. If spend­ing to get growth was so easy in a global econ­omy, the U.S., the cur­rent king of spend­ing, would have Chi­nese like GDP growth. It is not that easy to spend your way to growth. I’m sure at some level, Solyn­dra received money because there was a real belief some­where that it was a good invest­ment for growth. GM might be used as an exam­ple, but I’m not con­vinced that the gov­ern­ment spend­ing did any­thing more than pri­vate cap­i­tal would have done in the wake of a real bank­ruptcy. The excite­ment over “spend­ing for growth” is almost mind-boggling, because it basi­cally goes against a decade of his­tory show­ing the inabil­ity of gov­ern­ments to spend and achieve real growth. But, there is one part that does make sense, at least from a Wall Street perspective.

So the final ques­tion is, “who will finance all that spend­ing?” Ahhh, the real rea­son Wall Street is enthu­si­as­tic about spend­ing for growth. The only way a spend­ing for growth cam­paign can begin, is with another mas­sive round of bal­ance sheet expan­sion by cen­tral banks. That has been great for banks and wall street, while less clear what it has done for the econ­omy, or any­one with­out a sig­nif­i­cant por­tion of their wealth in stocks. If Spain announced a big new spend­ing cam­paign, would any­one really believe it would work? What would they do? Build more homes to get con­struc­tion going? How would that help when an unpopped real estate bub­ble is part of the prob­lem (actu­ally the bub­ble has burst, it just hasn’t been rec­og­nized on banks’ and cajas’ bal­ance sheets). Would investors who aren’t excited about lend­ing 5 year money at 4.75% sud­denly line up to buy all this debt think­ing the new spend­ing ini­tia­tives (which increase debt in the short term) will really work? I don’t think so. Buy­ing new debt in an envi­ron­ment where coun­tries feel free to spend and run deficits because aus­ter­ity doesn’t work, will only frighten pri­vate cap­i­tal. So the cen­tral banks of the world will have to step up again and pro­vide the fund­ing. I don’t think that is a good thing, but can see why some do, and can really see why some of those push­ing the most for a return to debt issuance and spend­ing and cen­tral bank inter­ven­tion would want it – because they ben­e­fit, not because it will work.

The real­ity is that spend­ing won’t solve any­thing. It will grow debt faster than the spend­ing can improve the econ­omy. Stop­ping longer term aus­ter­ity pro­grams will make the future debt to GDP ratios look even more hor­rific. There will ulti­mately need to restruc­tur­ing on a mas­sive scale.

It is no co-incidence that more and more sov­er­eign debt is being funded by insti­tu­tions in that coun­try. It is specif­i­cally to make leav­ing the Euro eas­ier. An Ital­ian pen­sion plan for exam­ple has both its assets and its lia­bil­i­ties in Italy. A con­ver­sion back to Lire is man­age­able in a sit­u­a­tion like that. Yes, the pen­sion plan’s rede­nom­i­nated Ital­ian Lire bonds may trade down because of the deval­u­a­tion, but their pen­sion oblig­a­tions would also be rede­nom­i­nated at the same time, off­set­ting a lot, if not all of the pain. The same is true in the bank­ing sec­tor. Cor­po­ra­tions won’t have that lux­ury as many are global, but it may explain why Ital­ian and Span­ish com­pa­nies have been busy issu­ing debt. So return­ing to tra­di­tional cur­ren­cies has the least impact on the coun­try and the Euro­zone if the debt is largely held inter­nally. That is the direc­tion the coun­tries and the ECB have been mov­ing, so don’t ignore this as a more likely real solution.

Debt restruc­tur­ing in terms of coupon reduc­tion, notional reduc­tion, and matu­rity exten­sion are all real pos­si­bil­i­ties too. If coun­tries learned any­thing from Greece, it is that by wait­ing too long, and accept­ing more Troika money than the pri­vate sec­tor wrote-off, the prob­lem doesn’t go away. Restruc­tur­ing early and harshly is far bet­ter than wait­ing and doing it in bits and pieces, and it has to affect ALL cred­i­tors. One rea­son that the ECB hasn’t resumed its SMP just yet is that coun­tries aren’t sure how much they want to owe the ECB. The ECB has proven itself to be an unhelp­ful part­ner in restruc­tur­ing. Watch what the ECB does (or doesn’t do) and ask your­self why.

So “Aus­ter­ity Now” may be over, but killing some­thing that didn’t work, isn’t the same as solv­ing the prob­lem. Going back to the norm that caused the prob­lem in the first place, hardly seems like a solu­tion either. Cur­rency rever­sion and/or debt restruc­tur­ing will be the ulti­mate end-game.

We get a del­uge of hous­ing data out this morn­ing. I expect it to dis­ap­point, but at this stage I’m not sure another hous­ing dis­ap­point­ment does any­thing for the mar­ket. It would merely con­firm what is becom­ing a con­sen­sus view – that the actual weather actu­ally played a role in mak­ing the win­ter num­bers look bet­ter than they might oth­er­wise have been.

Good luck with the rest of the day, though I sus­pect that once Europe goes home we will do noth­ing but watch every move in AAPL like we did yes­ter­day after­noon. In the mean­time I hope I can get the Don Maclean Amer­i­can Pie song out of my head on “the day aus­ter­ity died”….

Copy­right © TF Mar­ket Advisors

Tags: Auctions, Austerity Programs, Belief That, Bonds, Bps, Current, Earnings, Economic Data, Futures, GDP, GDP Growth, Global Economy, Gm, Long Term Solution, Money, Nbsp, Sane Person, Taxes, Tf, Txu
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The Good Life Comes at a Cost (Bill Mann)

Monday, April 23rd, 2012

There are plenty of ways to get ahead. The first is so basic I'm almost embar­rassed to say it: spend less than you earn. – Paul Clitheroe

I am draft­ing this let­ter from a park in Paris. It is early on a Wednes­day after­noon, and the park is full of fam­i­lies. Nearby, men gather to play boule, have a smoke, and enjoy a drink with friends. It is glo­ri­ous. It's a scene that is repeated through­out France and West­ern Europe (OK, replace the boules with some­thing else depend­ing on your coun­try). It’s much less com­mon in the United States. It is exceed­ingly rare in Asia.

Accord­ing to a Credit Suisse study, in 1980 Europe accounted for as much as 35% of global GDP growth per year. This year it will be 12%. Yes, some of this is due to the advent of eco­nomic devel­op­ment in coun­tries like South Korea, Brazil, and China, but the share of world GDP attrib­ut­able to the U.S. has held much more sta­ble. And keep in mind that at the same time, the debt lev­els of many Euro­pean coun­tries have soared, as has unem­ploy­ment. This debt has pur­chased lots of things, but it has not been suf­fi­cient to keep Europe up to speed with the rest of the world in eco­nomic devel­op­ment. And gen­er­ally speak­ing, debt must even­tu­ally be repaid, a process that removes eco­nomic cap­i­tal from a sys­tem. That process is cur­rently under­way. In France in 2011, more than 10,000 busi­nesses declared bank­ruptcy, while fewer than 600 were formed.

All your bras are belong to us

It’s not get­ting bet­ter, either. France has long been asso­ci­ated with sophis­ti­cated lin­gerie, but news that a bra fac­tory in Yssingeaux, a small town in south-central France, will close in favor of out­sourc­ing pro­duc­tion to Tunisia has made women’s under­wear both a sym­bol of every­thing wrong with the French econ­omy and a touch point of the ongo­ing French elec­tion cam­paign. As one jour­nal­ist put it bluntly: If France can no longer make bras and lace knick­ers, what can it make?

None of this is to dis­miss the attrac­tive­ness of the Euro­pean way of life. Let's face it — if liv­ing is in itself a pur­suit, then the Euro­peans are bet­ter at it than any­one. (Take a deep breath, Cal­i­for­ni­ans — it's not even close.) Their cities are pleas­ant, their infra­struc­tures mighty, their social struc­tures extremely robust, their vivre full of joie. If I could fig­ure out how to live in Europe but work in Amer­ica, I'd do it. In a heartbeat.

But trav­el­ing back and forth between Europe, Asia, and the U.S. (which I’ve had the plea­sure to do, all in the past month), I find the spec­trum of the striv­ing nature of Asian com­mer­cial activ­ity to the lan­guid atti­tude Euro­peans have toward hard work to be noth­ing short of amaz­ing. Greece offers state employ­ees a thir­teenth month of pay. Paid mater­nity leave in Swe­den can be as much as two years. A full work week in France is 36 hours.

Mean­while in Korea, chil­dren attend intense cram schools, both after class and on week­ends, prepar­ing to take the stan­dard­ized tests that deter­mine how pres­ti­gious a col­lege they can attend. Chi­nese work­ers endure long hours doing, in some cases, back­break­ing work. Best of all, in coun­try after coun­try in Asia, sys­tems are being put into place to help bring eco­nomic devel­op­ment to a wide por­tion of the pop­u­lace. In Europe, they're sim­ply try­ing to min­i­mize fail­ure. A noble pur­suit, indeed, but not par­tic­u­larly effec­tive as a strat­egy to remain competitive.

The end of the story here is that the rapid growth of Asia and the stag­na­tion of Europe seem to me to be out­comes of broader pol­icy. It is not a sure thing that a soci­ety pred­i­cated on hard work will out­per­form one that has per­fected the art of leisure, but that's prob­a­bly the best way to bet.

So where is Amer­ica in all of this?

Both in Asia and in Europe I heard the same thing (which makes it so strange that I heard the oppo­site when I was in North Dakota): Amer­ica is viewed by much of the world as hav­ing a nearly absurd amount of cre­ative spirit, some­thing that nei­ther Europe nor Asia have been able to match.

And if you think about this, just focus­ing on three vec­tors — enter­tain­ment, tech­nol­ogy, and brands — evi­dence sug­gests this is true. Amer­ica has 5% of the world's pop­u­la­tion, but an entre­pre­neur­ial capac­ity that is many times higher. In the past I've argued that Amer­i­can schools are much more effec­tive than sta­tis­tics would sug­gest, so I won't rehash that here. But suf­fice it to say that America's edu­ca­tional sys­tem does a really good job of edu­cat­ing high achiev­ers. Now no politi­cian could ever say such a thing with­out being accused of ignor­ing the needs of all Amer­i­can chil­dren. But the world is not look­ing to South Korea — the coun­try with the high­est aver­age scores in math and sci­ence apti­tude tests – for the next great cre­ators of eco­nomic wealth; it’s look­ing to Amer­ica. Abil­ity at the mean to per­form well on a stan­dard­ized test and encour­age­ment of entre­pre­neur­ial cre­ativ­ity are two very dif­fer­ent edu­ca­tional pur­suits. The score­board sug­gests we do the lat­ter very, very well.
Over the past month the mar­ket has con­tin­ued to soar higher as eco­nomic growth in the U.S. and a reduc­tion of fears in Europe have con­vinced many investors that the water is indeed OK for risk assets. Where these peo­ple were sev­eral months ago when the stock mar­kets were much weaker is beyond me, but there you go. The prob­lem, of course, is that the absence of fear of risk is far dif­fer­ent than the absence of risk. Euro­pean politi­cians seem to believe that things are improv­ing (and they are), and that they have done all that they can (they have not) to solve the myr­iad prob­lems Europe faces. In the last week of March, we began to see some of the results of Euro­pean com­pla­cency as the Span­ish government's bond auc­tion went absolutely hor­ri­bly, send­ing mar­kets back into a tailspin.

Lest you won­der if we've seen this pat­tern before, rest assured that we have. Politi­cians have very lit­tle capac­ity to solve prob­lems before they become crises, for the sim­ple fact that they tend to not act with great courage until all other avenues have been exhausted. This isn't a slap at politi­cians (not a direct one, at least), but a recog­ni­tion that no politi­cian has ever got­ten credit for avert­ing a cri­sis that is unseen by the gen­eral pop­u­lace, and even then there are entrenched inter­ests in main­tain­ing the sta­tus quo as the plane flies into the ground. It's a sim­ple bedrock prin­ci­ple of the "eco­nom­ics of pol­i­tics." So while Europe remains in a state of rel­a­tive calm, lit­tle will get done.

So why do we have money in Europe?

If we see so lit­tle vital­ity from Europe, why do we invest there? First of all, the fact that Europe has been in cri­sis is obvi­ous, which means that investors every­where — includ­ing in Europe — have been look­ing for other places to put their money. When this hap­pens, investors tend not to dif­fer­en­ti­ate between the great and the not-great. And sec­ond, even if Europe were toast (which it isn't), that doesn't mean that every com­pany in Europe is equally hosed. Many of the world’s great brands are Euro­pean, and many of them gen­er­ate much, if not most of their rev­enues in other mar­kets around the world. I was shocked by the low level of GDP growth that Europe accounts for, because Europe accounts for so much mind­share every­where in the world.

Last month we met with man­agers from sev­eral Chi­nese sports apparel com­pa­nies, and left the meet­ings think­ing, "Adi­das is going to crush these guys." (As an aside, meet­ing with com­peti­tors of one of our port­fo­lio com­pa­nies is often more infor­ma­tive than meet­ing with the com­pany itself.) Euro­pean com­pa­nies have not for­got­ten how to make money, and Euro­pean man­agers have not for­got­ten how to run these com­pa­nies well. This is mean­ing­ful, and as long as the world's investors view Europe as a bas­ket case, we believe there will be oppor­tu­nity for those who focus on indi­vid­ual com­pa­nies rather than on broad-based markets.

Con­sider, for exam­ple, Ital­ian leather goods maker Tod’s SpA, which hap­pens to not only be our largest hold­ing in the Epic Voy­age Fund, but also our best-performing hold­ing dur­ing the month. Although the Ital­ian mar­ket con­tin­ues to get (right­fully) shel­lacked, Tod’s con­tin­ues to out­per­form sales expec­ta­tions in emerg­ing mar­kets and throw off cash at a mag­ni­tude that should be the envy of most other Ital­ian and/or lux­ury con­sumer goods companies.

Monthly Results
It was a good month for domes­tic stocks and a weak one inter­na­tion­ally. Our funds fol­lowed those results, with excel­lent returns domes­ti­cally (Great Amer­ica Fund), decent results glob­ally (Inde­pen­dence Fund), and flat results inter­na­tion­ally (Epic Voy­age Fund). All three funds out­per­formed their bench­marks by vary­ing degrees, revers­ing results from Feb­ru­ary when all three underperformed.

For the month, the Inde­pen­dence Fund gained 1.38% vs. 1.34% for the bench­mark MSCI World. Lit­tle changed in the port­fo­lio, and some of the usual sus­pects in our Top 11 hold­ings were among the biggest con­trib­u­tors to a good month, such as Yum! Brands (on gen­eral enthu­si­asm for the con­sumer sec­tor) and a big come­back from Well­Point on spec­u­la­tion that the Supreme Court would over­turn the Patient Pro­tec­tion and Afford­able Care Act. Recent addi­tion Cru­cial­tec joined Posco in hav­ing a poor month, largely on the back of weak­ness in the Korean mar­ket. As we’ve noted in the past, South Korea is the largest com­po­nent of the MSCI Emerg­ing Mar­ket Index. As such, when the­matic investors “reduce expo­sure” to emerg­ing mar­kets, com­pa­nies in the Korean mar­ket tend to be hit dis­pro­por­tion­ately hard. Add in the prospect of a North Korean mis­sile test, and you have the mak­ings of a tough mar­ket environment.

The Great Amer­ica Fund increased in value by 2.44% vs. a 2.24% per­for­mance for its bench­mark. Lit­tle changed in the port­fo­lio. We liked what we owned, though by the end of the month, given the increase in prices across the mar­ket, it was becom­ing harder to find things we were espe­cially inter­ested in adding.

Despite tur­bu­lence in inter­na­tional mar­kets, it was a fairly quiet month for the Epic Voy­age Fund, which was a dead flat 0.00% in March ver­sus a 1.36% decline for its bench­mark, the Rus­sell Global ex-US. Our only trans­ac­tion of note was to sell our shares of Cana­dian yoga apparel maker Lul­ule­mon. You may remem­ber that when we talked about Lul­ule­mon dur­ing our Jan­u­ary share­holder con­fer­ence call (and com­pared it to craft beer), it was already quite an expen­sive stock. And while we endeavor to be long-term own­ers of great busi­nesses, it’s also true that our stocks are on sale every day — and we believe we received a price that more than com­pen­sated us for the value of Lululemon’s brand and grow­ing store fran­chise. We would love to own this com­pany again at the right price, but we think that the shares are cur­rently val­ued for absolutely extra­or­di­nary future results.

As always, the entire port­fo­lio team joins me in thank­ing you for entrust­ing your money with us.

Fool­ish best,

Bill Mann

Tags: Bill Mann, Boules, Central France, Credit Suisse, Debt Levels, Economic Capital, Election Campaign, European Countries, French Economy, French Election, GDP Growth, Global Gdp, Knickers, Park In Paris, Paul Clitheroe, Sophisticated Lingerie, South Korea, Wednesday Afternoon, Western Europe, World Gdp
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The Fed's Next Move

Sunday, April 22nd, 2012

April 20, 2012

The Fed's Next Move?

"If every­thing seems under con­trol, you're not going fast enough"—Mario Andretti.  If you're an investor, you might hope that pol­icy mak­ers in the devel­oped world would heed the wis­dom of Mario Andretti. After a burst of con­fi­dence in the first quar­ter, when things appeared to be run­ning smoothly, the mar­kets have re-focused on the chal­lenge of try­ing to reduce gov­ern­ment debt in the absence of eco­nomic growth. Here in the U.S., the next oppor­tu­nity bond investors will get to observe shifts in pol­icy will be the Fed­eral Reserve's next meet­ing on April 24-25th. The Fed may feel rea­son­ably con­fi­dent that they're "in con­trol," but it seems less likely to us that they'll feel we're going "fast enough."

• We don't expect any change in pol­icy at the Fed's April 24-25th meet­ing. But the mar­ket will be scru­ti­niz­ing the Fed's eco­nomic pro­jec­tions for hints about fur­ther quan­ti­ta­tive eas­ing, the end of Oper­a­tion Twist and the length of the Fed's com­mit­ment to low inter­est rates. At the Jan­u­ary FOMC meet­ing, the com­mit­tee made the his­toric deci­sion to pub­lish fore­casts on rates and eco­nomic mea­sures from the 17 com­mit­tee mem­bers, along with the "cen­tral ten­dency" (i.e. where the bulk of the pro­jec­tions reside.) It's the range that we'll be watch­ing most closely for signs of shift­ing expectations.
• Pro­jec­tions for GDP growth are likely to indi­cate a mod­er­ate, but not excep­tional, growth rate. The range is likely to remain in the 2.5% to 3.0% range, in our view. Based on the Jan­u­ary pro­jec­tions, the range of fore­casts for GDP wasn't very wide, though there was a wider range of views on infla­tion and unem­ploy­ment. Pos­i­tive growth is encour­ag­ing, of course, but the pace of growth remains sub-par com­pared to a more robust recovery.
• The unem­ploy­ment rate has already fallen to the low end of the Fed's range, based on the Jan­u­ary pro­jec­tions. There­fore, it seems rea­son­able to antic­i­pate that range will be low­ered from the 8.2% to 8.5% pro­jec­tions pub­lished in Jan­u­ary. FOMC mem­bers appear to dis­agree on the rea­sons for the recent path of unem­ploy­ment. Fed Chair­man Ben Bernanke and the more "dovish" Fed mem­bers (mean­ing, they favor lower rates and more accom­moda­tive mon­e­tary pol­icy) sug­gest that the drop in unem­ploy­ment is largely due to dis­cour­aged work­ers drop­ping out of the labor force. In con­trast, some more "hawk­ish" mem­bers (those who tend to lean toward a tighter mon­e­tary bias) believe that unem­ploy­ment is high due to a struc­tural mis­match of skills with job open­ings. It's no sur­prise to report that the Bernanke "dovish" camp is still dri­ving policy.
• On infla­tion, the views also diverge between the hawks and doves. The Jan­u­ary Fed report showed a wide dis­per­sion of pro­jec­tions for the defla­tor for per­sonal con­sump­tion expen­di­tures (PCE, one of the Fed's pre­ferred infla­tion mea­sures) between 1.3% and 2.8% for 2012. The cen­tral ten­dency nar­rowed to 1.4% to 1.8%, but clearly this is where there is some dis­agree­ment on the out­look. The more dovish Bernanke camp, expect­ing lower infla­tion, will hold sway here (in our view) as well, until data show­ing higher prices dri­ven by increased lend­ing and/or wage growth clearly changes.
• We don't expect that the Fed will hint at or announce fur­ther quan­ti­ta­tive eas­ing. GDP appears to be grow­ing at 2% to 2.5% rate or higher, unem­ploy­ment is falling and core infla­tion is hold­ing near the 2% level. Lend­ing growth is improv­ing, point­ing to a more sta­ble bank­ing sec­tor and ade­quate liq­uid­ity in the finan­cial sys­tem. Returns from each round of eas­ing appear to be dimin­ish­ing. How­ever, we also expect that Bernanke will leave the pos­si­bil­ity of QE3 (i.e. a third round of bond buy­ing from the Fed designed to help keep inter­est rates low) on the table. He has con­sis­tently said that the Fed is pre­pared to do more if eco­nomic con­di­tions war­rant it.
• What would war­rant more action by the Fed? We're encour­aged by stronger signs from the U.S. econ­omy, as well as efforts to sta­bi­lize the Euro­pean credit cri­sis. But two risks we worry about are the upcom­ing fis­cal tight­en­ing that may hap­pen in 2012—the so-called "fis­cal cliff"—as well as a wors­en­ing of the Euro­pean debt crisis.

1. On fis­cal stim­u­lus. Bush-era tax cuts are set to expire, auto­matic spend­ing cuts are set to trig­ger and stim­u­lus pro­grams are wind­ing down. Cuts to stim­u­lus alone even with an exten­sion of tax cuts will likely be a drag on the U.S. econ­omy in the short-term. The effect of this is esti­mated to be in the vicin­ity of 3% of GDP by many economists.
2. On Europe. If Euro­pean sov­er­eign debt prob­lems threaten to spread over to the U.S. bank­ing sec­tor and affect U.S. growth, the Fed may be pushed to respond with some form of mon­e­tary stimulus.

• Bot­tom line. While we don't expect an offi­cial pol­icy change at the upcom­ing FOMC meet­ing, the release of a new set of eco­nomic expec­ta­tions, if they vary greatly from the last pro­jec­tions in Jan­u­ary, could be a mar­ket mov­ing event. For bond investors, there's noth­ing to indi­cate to us that the tilt won't remain toward accom­moda­tive rate pol­icy until 2013 and beyond until there's rate of change in growth speeds up.

Cen­tral Ten­dency of Fed Forecasts—January 2012

Source: Fed­eral Reserve, Jan­u­ary 25, 2012.  Num­bers in the table are year-over-year per­cent­age change for real GDP, PCE infla­tion, and core inflation.

Moody's Down­grade of GE

While it may not have been a major news event to most mar­ket watch­ers, Moody's down­graded the debt rat­ings for Gen­eral Elec­tric Com­pany (GE) to Aa3 along with the rat­ing on its wholly-owned finan­cial sub­sidiary, GE Cap­i­tal Cor­po­ra­tion (GECC), to A1. GE was once one of the seem­ingly 'untouch­able' Aaa/AAA-rated indus­trial cor­po­ra­tions, so the changes aren't insignif­i­cant. In Moody's view, GE still has "many AAA-like credit char­ac­ter­is­tics." But their view also reflects the "height­ened risk pro­file inher­ent to finance com­pa­nies like GECC," they say, a sig­nif­i­cant part of GE's oper­a­tions. The broader take­away to us is not so much a com­ment on GE specif­i­cally. We are not mak­ing a company-specific com­ment or invest­ment rec­om­men­da­tion. It's more about the inher­ent sen­si­tiv­ity of lend­ing and finan­cial com­pa­nies to smoothly func­tion­ing finan­cial mar­kets as well as access to money when they need it.

• The credit cri­sis con­tin­ues to reveal the risks in mar­ket funded finan­cial insti­tu­tions, a risk that rat­ing agen­cies and mar­kets strive to under­stand. Moody’s indi­cated that the GE down­grade was a reflec­tion of risk stem­ming from its finan­cial arm, GECC. While the down­grade isn’t good news for investors, it’s not a major sur­prise. On March 19, Moody’s revised its global rat­ing method­ol­ogy for finan­cial insti­tu­tions and warned that oth­ers may be down­graded as well, some, poten­tially, by sev­eral rat­ing notches. Their views, they say, reflect ongo­ing mar­ket and struc­tural devel­op­ments as well as insights gained from the recent global credit cri­sis and 2007–2009 recession.
• "Dur­ing the credit cri­sis, [credit] mar­kets were unre­li­able for even the strongest issuers." While over­sight has improved, the sen­si­tiv­ity of banks and finan­cial firms to mar­ket con­di­tions is still a fun­da­men­tal part of the busi­ness model of finance firms. Finan­cial insti­tu­tions, includ­ing GECC, involve risks asso­ci­ated with a "high reliance on con­fi­dence sen­si­tive fund­ing," even though, in Moody's view, GECC is "one of the strongest finance com­pa­nies in the world." Even with its fun­da­men­tal strengths, and con­nec­tion to Gen­eral Elec­tric, GECC still "relies on the cap­i­tal mar­kets" to fund its portfolios.
• For investors, be care­ful about credit qual­ity and too much expo­sure to a sin­gle sec­tor or secu­rity. Most banks and finan­cial insti­tu­tions have taken steps to build cap­i­tal and strengthen reserves. Reg­u­la­tory scrutiny, includ­ing Dodd-Frank and the Volker rule, are seek­ing to put rules in place to man­age and limit risk. Other banks con­tinue to deal with legacy issues from the finan­cial cri­sis. Still, this is an area to be wary of lower-rated issuers and invest­ing based on higher yields only.
• We divide cor­po­rates broadly into finan­cial insti­tu­tions, indus­tri­als and util­i­ties. We're not com­mit­ted to the notion that investors should strictly bench­mark their expo­sure to indi­vid­ual bond sec­tors, such as cor­po­rate bonds, to an index or snap­shot of the mar­ket. But it's help­ful to under­stand the com­po­si­tion of mar­kets as a whole as a reminder to spread out invest­ments in a way that pro­vides diver­si­fi­ca­tion and lim­its expo­sure to any sin­gle sec­tor alone.  The table below shows this mar­ket bal­ance, over time, using the widely-followed Bar­clays US Cor­po­rate Bond index.

Com­po­si­tion of the U.S. investment-grade cor­po­rate mar­ket by sector

Source: Bar­clays U.S. Cor­po­rate Bond Index, daily data as of April 17, 2012.

Finan­cials includ­ing banks cur­rently account for roughly 35% of the U.S. investment-grade cor­po­rate mar­ket, a level that’s fallen from nearly 50% prior to the 2008 credit cri­sis. Indus­tri­als, includ­ing con­glom­er­ates like GE and a wide range of other non-financial issuers exclud­ing util­i­ties, now accounts for 54%.

• Yields should be higher, in our view, com­pared to similarly-rated indus­tri­als and util­i­ties. This is mar­ket pric­ing in com­pen­sa­tion for rat­ings volatil­ity, the poten­tial for future changes in reg­u­la­tory pol­icy and method­ol­ogy from the rat­ing agen­cies as well as fun­da­men­tally lever­aged, market-reliant busi­ness mod­els. The chart below shows these yield spread over time. Cur­rently, it looks to us that investors are gen­er­ally being com­pen­sated, rel­a­tive to the risks, if they can stom­ach some price volatil­ity and diver­sify ade­quately against risk in any sin­gle issuer. Whether you are receiv­ing ade­quate com­pen­sa­tion for your needs should be an indi­vid­ual deci­sion, depend­ing on your risk tol­er­ance and the role in the rest of your portfolio.

Yield Spread of the U.S. investment-grade cor­po­rate mar­ket by sector

Source: Bar­clays U.S. Cor­po­rate Bond Index, daily data as of April 17, 2012.  Option-adjusted spread (OAS) is the basis point spread rel­a­tive to Trea­suries, net of the cost of any embed­ded options.

The Grow­ing Divide in Muni Bonds

The direst pre­dic­tions about muni defaults haven't mate­ri­al­ized. The rev­enue pic­ture for state and, to a lesser degree, local gov­ern­ments, is sta­bi­liz­ing in our view. Still, munic­i­pal gov­ern­ments are caught in the bind of ris­ing social ser­vice needs and employ­ment costs and the "age of austerity"—the fun­da­men­tal need, as well as the polit­i­cal tide, of lim­ited rev­enue and tax­ing abil­ity. We think that we're well into a process of diver­gence in credit qual­ity in state and local gov­ern­ment muni bonds—that is, the divi­sion between the vast, silent major­ity that are man­ag­ing chal­lenges and the vocal minor­ity who are not. It's our view that defaults in state and local gov­ern­ment bonds will remain iso­lated events. But issuers have become less homoge­nous, less inter­change­able with each other with­out inves­ti­ga­tion or credit analysis.

• We think the top pri­or­ity for munic­i­pal gov­ern­ments will be man­ag­ing mul­ti­ple stake­hold­ers and oblig­a­tions. This is gen­er­ally the case for the wide range of 50,000+ state and local munic­i­pal bod­ies, whether they're active bond issuers or not. That's the real­ity of a tight rev­enue cli­mate and a tough bal­ance of employ­ment and health­care costs, ser­vice oblig­a­tions, and other oblig­a­tions like employee pen­sions that have been promised and funded. This is a much tougher task when resources are lim­ited. It's not a sur­prise to see debate and head­lines focused on these issues. This will be a chal­lenge for the next decade or more, in our view. We'll likely see more idio­syn­cratic cases of these pres­sures lead­ing to dis­tress. For the most part, we expect that that the impact to bond­hold­ers will remain iso­lated, but not zero.
• Stock­ton, Cal­i­for­nia and oth­ers are case stud­ies. What hap­pens, exactly, when a munic­i­pal­ity reaches the end of its rope and needs help? We're find­ing out, with the widely-publicized exam­ples of Vallejo, CA, Jef­fer­son County, Alabama and now Stock­ton, CA. As we said, there will be excep­tions. And other issuers will watch the cases to see if they're "suc­cess­ful." Note: Vallejo, CA is one exam­ple that has been widely cited as an exam­ple of the enor­mous expense, and lim­ited ben­e­fit, of a munic­i­pal bank­ruptcy fil­ing. The city was able to nego­ti­ate very few con­ces­sions with stake­hold­ers includ­ing unions. And indi­vid­ual bondholders—not the pri­mary source of most of Vallejo’s problems—were largely unaffected.
• Pay close atten­tion to the bonds you buy, and own. There's more and more infor­ma­tion avail­able every day to help with this, thanks to ongo­ing reforms from munic­i­pal secu­rity gov­ern­ing bod­ies such as the Munic­i­pal Secu­ri­ties Rule­mak­ing Board (MSRB). The MSRB's web­site, EMMA, has links to cur­rent munic­i­pal bond dis­clo­sures. But the con­sis­tency and qual­ity of the dis­clo­sures is being watched closely by the MSRB and other rule-making author­i­ties. Even with cur­rent dis­clo­sure, investors must also have some sense of how to use the infor­ma­tion they receive. This is still a chal­lenge, given the com­plex­ity and idio­syn­crasies of munic­i­pal credit analysis.
• Few munic­i­pal­i­ties will broad­cast in plain Eng­lish pend­ing credit stress. Unlike cor­po­ra­tions, munic­i­pal­i­ties aren't profit-seeking orga­ni­za­tions. And they don't have quar­terly report­ing require­ments, their bud­get processes can be opaque and they don't have pub­licly traded equity as a mea­sure of cur­rent and future suc­cess. (The flip-side to this, we'd note, is that you’d have to work hard to find a way for a munic­i­pal gov­ern­ment to shut-down and dis­ap­pear. This is not the case with cor­po­ra­tions where liq­ui­da­tions hap­pen reg­u­larly.) As a result, you won’t hear much in plain Eng­lish about credit risk unless you're well-trained in read­ing between the lines and find­ing the fine line between ordi­nary busi­ness and signs of real stress.
• Out­sourc­ing credit analy­sis using funds and pro­fes­sional man­agers is still a good option, for many. Pro­fes­sional man­agers, whether for funds or man­aged accounts, can help look for prob­lems, but also pro­vide the vari­ety of indi­vid­ual muni issuers to diver­sify against idio­syn­cratic, issuer-specific risk. We don't expect that we'll see a wide­spread shift in defaults, as we’ve said pre­vi­ously. But credit analy­sis and active mon­i­tor­ing may be increas­ingly impor­tant in the “next phase” for the his­tor­i­cally sta­ble, but strained, uni­verse of state and local gov­ern­ment bonds.

Diver­si­fi­ca­tion and Bond Benchmarks

What's a good bench­mark to build a bond port­fo­lio around, and is it ade­quate as a start­ing point in the cur­rent mar­ket for most investors? The Bar­clays U.S. Aggre­gate Bond Index is a commonly-used tax­able bond index. Over time, it has become heav­ily skewed toward gov­ern­ment bonds, with very low yields and lim­ited expo­sure to other sec­tors. Does this pro­vide enough diver­si­fi­ca­tion for most investors focused on a broader range of invest­ments as well as income now?

• The Bar­clays U.S. Aggre­gate Bond Index is now dom­i­nated by Trea­suries and government-backed secu­ri­ties. Since the finan­cial cri­sis, a con­cern we have is that the index has a greater pro­por­tion in gov­ern­ment bonds, includ­ing agency-backed secu­ri­ties, many of them mort­gage bonds from Gin­nie Mae as well as Fan­nie Mae and Fred­die Mac. Both Fan­nie and Fred­die mort­gage bonds, a multi-trillion dol­lar part of the U.S. tax­able bond mar­ket, are cur­rently sup­ported by the U.S. gov­ern­ment. Only about 20% of the index rep­re­sents cor­po­rate bonds. Note: This index does not include tax-exempt muni bonds. Many investors could con­sider using highly-rated munis, in our view, as the foun­da­tion for a core bond port­fo­lio in tax­able accounts.
• The index is now more con­cen­trated in one issuer—the Fed­eral government—and has been deliv­er­ing a lower yield than many clients may want for an income-oriented port­fo­lio. It will be no sur­prise to most fixed income investors, but the yields on gov­ern­ment bonds remain low, with the yield for the Aggre­gate Bond Index 2.1% as of April 16, 2012. The aver­age matu­rity of bonds in the index has also become slightly longer, cur­rently at 7 years. This may be longer, with lower yield, than many investors will be com­fort­able with, even in their core hold­ings.  Keep in mind that the Aggre­gate Bond index does not incur man­age­ment fees, costs and expenses and can­not be invested in directly.
• One strat­egy is to diver­sify into other sec­tors of the bond mar­ket, sub­ject to need and risk tol­er­ance. We con­tinue to favor credit (i.e. investment-grade cor­po­rate bonds) in the cur­rent cli­mate, for up to 30% or so of a core bond port­fo­lio, as well as cer­tain types of munic­i­pal bonds in tax­able accounts. In the cur­rent cli­mate, a core port­fo­lio may ben­e­fit from "tilts" in credit away from an 80% expo­sure to Trea­suries and government-related mort­gage bonds. The key point to us, as always, is diver­si­fi­ca­tion and not push­ing the bound­aries here too far. A "core and explore" strat­egy, start­ing with bonds with low credit risk, sup­ported by expo­sure to intermediate-term cor­po­rate and muni bonds using lad­ders, still makes sense to us for most income-oriented investors in the cur­rent climate.
• We also con­tinue to believe that investors can also "expand the core" using mutual funds or exchange-traded funds to build a diver­si­fied bond port­fo­lio. For exam­ples of port­fo­lios using funds, clients can log-on to Schwab.com and go to Prod­ucts, then Port­fo­lio Solu­tions, and then look for the Schwab Port­fo­liosTM link. They'll find an online tool they can use to view a pre-set list of mutual funds allo­cated accord­ing to the risk pro­file they select.  Con­sider using the list as a start­ing point, boost­ing diver­si­fi­ca­tion using other funds—such as credit-specific exchange-traded funds (ETFs) or multi-sector and world bond funds—to expand your portfolio.

For addi­tional help or a look at the mix of matu­ri­ties and credit in your port­fo­lio, talk with your finan­cial con­sul­tant or a Schwab Fixed Income Spe­cial­ist at 800–626-4600.

Please visit www.schwab.com/onbonds for more fixed income per­spec­tive from the Schwab Cen­ter for Finan­cial Research. If you have ques­tions or con­cerns about the issues raised in this pub­li­ca­tion, please speak to your Schwab representative.

Impor­tant Disclosures

Tags: April 24, Bond Investors, Bond Markets, Bond Portfolio, Central Tendency, Committee Members, Diversified Bond, Economic Growth, Economic Measures, Economic Projections, Federal Reserve, Fixed Income, Fomc Meeting, GDP Growth, Government Debt, Low Interest Rates, Mario Andretti, municipal bond market, Schwab, Strategist
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Emerging Markets Radar (April 23, 2012)

Sunday, April 22nd, 2012

Emerg­ing Mar­kets Radar (April 23, 2012)

Strengths

• The People’s Bank of China (PBOC) is ready to use reserve required ratio (RRR) cuts and open mar­ket oper­a­tions (OMOs) to boost liq­uid­ity where nec­es­sary, Xin­hua News reported.
• China will widen the yuan trad­ing band to 1 per­cent as of April 16, PBOC said in a state­ment. The new move even­tu­ally will pave the way for RMB inter­na­tion­al­iza­tion and an open cap­i­tal market.
• China has cut RRRs for some county-level lenders by 100 basis points.
• Recently China started exper­i­ment­ing in Wen­zhou with legit­imiz­ing pri­vate cap­i­tal for bank lend­ing. This type of lend­ing has been banned since the Com­mu­nist party started rul­ing the coun­try. The move should have sig­nif­i­cant impact for long-term social and eco­nomic devel­op­ment in China, which tends to thrive in a freer environment.
• Brazil’s cen­tral bank cut its bench­mark rate by 75 basis points to 9 per­cent from 9.75 per­cent this week. This pos­i­tively impacts money sup­ply, but weak­ens the Brazil­ian real and may cause money to flow out of the country.
• India also cut its bench­mark rate by 50 basis points to 8 per­cent to help boost growth after infla­tion sta­bi­lized and first-quarter GDP growth sig­nif­i­cantly slowed.

Weak­nesses

• China Inter­na­tional Cap­i­tal Corp. reported that the big four banks in China lost Rmb 1 tril­lion of deposits in early April, which may renew con­cerns over a lack of new loans this month.
• For­eign direct invest­ments in China dropped for a fifth-straight month in March. Inbound invest­ment fell 6 per­cent from a year ear­lier to $11.76 bil­lion after a 0.9 per­cent drop the month before.
• The Philip­pines cen­tral bank main­tained its bench­mark rate at 4 per­cent, halt­ing after two con­sec­u­tive cuts.
• Singapore’s non-oil domes­tic exports fell 4.3 per­cent in March as ship­ments of elec­tron­ics and petro­chem­i­cals eased, while the mar­ket expected a gain of 7.1 percent.
• Chi­nese pre­mier Wen Jiabao indi­cated from a State Coun­cil meet­ing that China remains firm on its prop­erty curbs despite slow­ing eco­nomic growth (China power use rose only 7 per­cent in March, the low­est for a long time) and will strictly reg­u­late local gov­ern­ment financ­ing vehi­cles (LGFV). In truth, the hous­ing mar­ket may become health­ier if devel­op­ers can come to real­ity by low­er­ing prices and clear­ing up inventories.

Oppor­tu­nity

• The pop­u­la­tion in China is increas­ingly using mobile inter­net as smart­phone pen­e­tra­tion rises. The chart below by Mor­gan Stan­ley shows the num­ber of mobile inter­net users is reach­ing 400 mil­lion, and the firm says this will ben­e­fit social net­work and search engine providers such as Sina, Ten­cent, and Baidu.

Threat

• China’s econ­omy is still see­ing down­ward pres­sure and the sec­ond quar­ter may mark a “lower point” for growth before it slowly accel­er­ates in the sec­ond half, said Zhu Bao­liang, chief econ­o­mist at the State Infor­ma­tion Center’s fore­cast depart­ment in China.

Tags: 100 Basis Points, Bank Of China, Benchmark Rate, China International, Chinese Premier Wen Jiabao, Consecutive Cuts, Country India, Domestic Exports, Economic Development In China, Foreign Direct Investments, GDP Growth, Inbound Investment, Open Market Operations, Pboc, Philippines Central, Premier Wen Jiabao, Private Capital, Quarter Gdp, Wenzhou, Xinhua News
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Jeremy Grantham: How to "Survive Betting Against Bull Market Irrationality"

Thursday, April 19th, 2012

Ridicu­lous as our mar­ket volatil­ity might seem to an intel­li­gent Mar­t­ian, it is our real­ity and every­one loves to trot out the “quote” attrib­uted to Keynes (but never doc­u­mented): “The mar­ket can stay irra­tional longer than the investor can stay sol­vent.” For us agents, he might bet­ter have said “The mar­ket can stay irra­tional longer than the client can stay patient.”

— Jeremy Grantham

Here with­out fur­ther com­ment is an open­ing excerpt from Grantham's lat­est let­ter. You can read/download the whole let­ter in the slid­edeck below.

Jeremy Grantham — Let­ter to Investors Q1 2012

My Sister’s Pen­sion Assets and Agency Prob­lems
(The Ten­sion between Pro­tect­ing Your Job or Your Clients’ Money)

The cen­tral truth of the invest­ment busi­ness is that invest­ment behav­ior is dri­ven by career risk. In the pro­fes­sional invest­ment busi­ness we are all agents, man­ag­ing other peo­ples’ money. The prime direc­tive, as Keynes¹ knew so well, is first and last to keep your job. To do this, he explained that you must never, ever be wrong on your own. To pre­vent this calamity, pro­fes­sional investors pay ruth­less atten­tion to what other investors in gen­eral are doing. The great major­ity “go with the flow,” either com­pletely or par­tially. This cre­ates herd­ing, or momen­tum, which dri­ves prices far above or far below fair price. There are many other inef­fi­cien­cies in mar­ket pric­ing, but this is by far the largest. It explains the dis­crep­ancy between a remark­ably volatile stock mar­ket and a remark­ably sta­ble GDP growth, together with an equally sta­ble growth in “fair value” for the stock mar­ket. This dif­fer­ence is mas­sive – two-thirds of the time annual GDP growth and annual change in the fair value of the mar­ket is within plus or minus a tiny 1% of its long-term trend as shown in Exhibit 1. The market’s actual price – brought to us by the work­ings of wild and wooly indi­vid­u­als – is within plus or minus 19% two-thirds of the time. Thus, the mar­ket moves 19 times more than is jus­ti­fied by the under­ly­ing engines!

This incred­i­ble demon­stra­tion of the behav­ioral dom­i­nat­ing the ratio­nal and the “effi­cient” was first noticed by Robert Shiller over 20 years ago and was coun­tered by some of the most tor­tured logic that the ratio­nal expec­ta­tions crowd could offer, which is a very high hur­dle indeed. Shiller’s “fair value” for this pur­pose used clair­voy­ance. He “knew” the future flight path of all future div­i­dends, from each start­ing posi­tion of 1917, 1961, and all the way for­ward. The result­ing the­o­ret­i­cal value was always sta­ble (it barely twitched even in the Great Depres­sion), but this data was widely ignored as irrel­e­vant. And ignor­ing it may be the cor­rect response on the part of most mar­ket play­ers, for ignor­ing the volatile up-and-down mar­ket moves and attempt­ing to focus on the slower burn­ing long-term real­ity is sim­ply too dan­ger­ous in career terms. Miss­ing a big move, how­ever unjus­ti­fied it may be by fun­da­men­tals, is to take a very high risk of being fired. Career risk and the result­ing herd­ing it cre­ates are likely to always dom­i­nate invest­ing. The short term will always be exag­ger­ated, and the fact that a corporation’s future value stretches far into the future will be ignored. As GMO’s Ben Inker has written,2 two-thirds of all cor­po­rate value lies out beyond 20 years. Yet the mar­ket often trades as if all value lies within the next 5 years, and some­times 5 months.

Ridicu­lous as our mar­ket volatil­ity might seem to an intel­li­gent Mar­t­ian, it is our real­ity and every­one loves to trot out the “quote” attrib­uted to Keynes (but never doc­u­mented): “The mar­ket can stay irra­tional longer than the investor can stay sol­vent.” For us agents, he might bet­ter have said “The mar­ket can stay irra­tional longer than the client can stay patient.” Over the years, our esti­mate of “stan­dard client patience time,” to coin a phrase, has been 3.0 years in nor­mal con­di­tions. Patience can be up to a year shorter than that in extreme cases where rela­tion­ships and the tim­ing of their start-ups have proven to be unfor­tu­nate. For exam­ple, 2.5 years of bad per­for­mance after 5 good ones is usu­ally tol­er­a­ble, but 2.5 bad years from start-up, even though your pre­vi­ous 5 good years are well-known but helped some­one else, is absolutely not the same thing! With good luck on start­ing time, good per­sonal rela­tion­ships, and decent rel­a­tive per­for­mance, a client’s patience can be a year longer than 3.0 years, or even 2 years longer in excep­tional cases. I like to say that good client man­age­ment is about earn­ing your firm an incre­men­tal year of patience. The extra year is very impor­tant with any invest­ment prod­uct, but in asset allo­ca­tion, where mis­takes are obvi­ous, it is absolutely huge and usu­ally enough.

What Keynes def­i­nitely did say in the famous chap­ter 12 of his Gen­eral The­ory is that “the long-term investor, he who most pro­motes the pub­lic inter­est … will in prac­tice come in for the most crit­i­cism when­ever invest­ment funds are man­aged by com­mit­tees or boards.” He, the long-term investor, will be per­ceived as “eccen­tric, uncon­ven­tional and rash in the eyes of aver­age opin­ion … and if in the short run he is unsuc­cess­ful, which is very likely, he will not receive much mercy.” (Empha­sis added.) Review­ing our expe­ri­ences of being early in sev­eral extreme out­ly­ing events makes Keynes’s actual quote look painfully accu­rate in that “mercy” some­times was as lim­ited as it was at a bad day at the Col­i­seum, with a sea of thumbs down. But his attri­bu­tion, in con­trast, has proven too severe: we appear to have survived.

Jglet­ter All 4–12

Tags: Calamity, Central Truth, Clairvoyance, Discrepancy, Flight Path, GDP, GDP Growth, Inefficiencies, Investment Behavior, Investment Business, Investment Outlook, Irrationality, Jeremy Grantham, Keynes, Market Volatility, Martian, Pension Assets, Prime Directive, Professional Investment, Professional Investors, Rational Expectations, Robert Shiller, Stable Growth, Term Trend, Volatile Stock Market
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The Economy and Bond Market Radar (April 16, 2012)

Sunday, April 15th, 2012

The Econ­omy and Bond Mar­ket Radar (April 16, 2012)

Trea­suries ral­lied this week, send­ing yields sharply lower. The non­farm pay­rolls report that was released on Good Fri­day dis­ap­pointed and with neg­a­tive rum­blings out of Europe, it was a “risk off” week. China reported first quar­ter GDP growth below expec­ta­tions, which increases the like­li­hood of addi­tional pol­icy accom­mo­da­tion from the Chi­nese author­i­ties in the near future.

Strengths

• Nat­ural gas fell below $2 this week, pro­vid­ing con­sumers with some relief to higher gaso­line prices.
• Sev­eral infla­tion data points were released this week and were over­all in line with expec­ta­tions. This is gen­er­ally sup­port­ive of the exist­ing Fed­eral Reserve policies.
• Whole­sale inven­to­ries rose 0.9 per­cent in Feb­ru­ary, indi­cat­ing con­tin­ued restock­ing that should boost first quar­ter GDP in the U.S.

Weak­nesses

• March non­farm pay­rolls grew a mod­est 120,000, well below mar­ket expectations.

• Weekly ini­tial job­less claims jumped to 380,000 this week, the high­est read­ing since January.

• Spain remains in the spot­light as yields spike higher and investors remain ner­vous about long-term solu­tions for the country’s finan­cial woes.

Oppor­tu­nity

• The weak Chi­nese GDP num­ber implies that the cur­rent global eas­ing poli­cies are likely to remain in place for the fore­see­able future.

Threat

• Ris­ing oil and gaso­line prices, com­bined with liq­uid­ity impli­ca­tions of global eas­ing led by Europe, may raise the prospect of higher infla­tion going forward.

Tags: Bond Market, Chinese Authorities, Federal Reserve, Financial Woes, Gasoline Prices, GDP, GDP Growth, Good Friday, Inflation Data, Initial Jobless Claims, liquidity, Long Term Solutions, Market Expectations, Market Radar, Nonfarm Payrolls, Quarter Gdp, Reserve Policies, Rumblings, Treasuries, Wholesale Inventories
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Gary Shilling Still Looking for a Recession in 2012 Part I

Wednesday, April 11th, 2012

Gary Shilling has been more dour than most on the under­ly­ing econ­omy the past 3–4 years, and that could be argued was a rel­a­tively good call.  Despite never before seen lev­els of fed­eral gov­ern­ment and cen­tral bank inter­ven­tion, the econ­omy con­tin­ues to limp along at what I call a "meh" pace.  Nor­mal recov­er­ies sans mas­sive inter­ven­tion should have had some sus­tained peri­ods of 4–5%+ type GDP growth; we're happy with 2–3% nowa­days.  Gary's long U.S. Trea­suries call has been against the grain, and mostly right the past few years, and he's had quite a few other pre­scient calls as well.  Shilling posted 2 arti­cles on Bloomberg, stat­ing the case for a reces­sion in 2012 – which is now again an out­lier view.  We'll look at part 1 today, and look at part 2 which focuses on the labor mar­ket tomorrow.

Here are some of his views as he looks at the main pil­lars of the economy:

• For sev­eral months, I’ve been fore­cast­ing a reces­sion in the U.S. this year, argu­ing that weak­ened con­sumer spend­ing – the key to the eco­nomic out­look — would tip the econ­omy back into a down­turn.  But what about recent pos­i­tive data and markets? Do they affect my forecast?
• Con­sumers Are the Linch­pin: The U.S. econ­omy is being fueled these days by strong con­sumer spend­ing, which increased in Feb­ru­ary by 0.8 per­cent, its best show­ing in seven months, after ris­ing 0.4 per­cent in Jan­u­ary. Retail sales rose 1.1 per­cent in Feb­ru­ary — the fastest pace in five months — while same-store sales advanced 4.7 per­cent. These num­bers cor­re­late with recent gains in con­sumer con­fi­dence and sentiment.
• I don’t see this pace con­tin­u­ing. Personal-income growth con­tin­ues to be weak — up just 0.2 per­cent in Feb­ru­ary — mean­ing this recent exu­ber­ant con­sumer spend­ing is being fueled largely by increased debt and tap­ping of savings.
• At the same time, pay per employee is ris­ing slowly and con­tin­ues to fall in real terms. So increased job growth remains the key to any increases in real house­hold after-tax income, which declined in Feb­ru­ary for a sec­ond straight month and gained a mere 0.3 per­cent, com­pared with Feb­ru­ary 2011.
• Spend­ing, Sav­ing and Debt: The sup­port that con­sumer spend­ing has received from less sav­ing and more debt appears tem­po­rary. House­hold debt – includ­ing mortgages,student loans, and auto and credit-card loans — has fallen rel­a­tive to dis­pos­able per­sonal income, though. In my analy­sis, this is largely because of write-offs of trou­bled mort­gages. Nev­er­the­less, revolv­ing con­sumer credit, mostly on credit cards, is no longer being liquidated.
• Non-revolving con­sumer credit con­tin­ues to rise in response to grow­ing sales of vehi­cles — most of which are financed — and in stu­dent loans, as the poor job mar­ket keeps stu­dents in school or sends them back. Tuition increases encour­age more bor­row­ing, while inter­est costs on past-due loans mount.  [Mar 8, 2012: What Drove Yesterday's Surge in Con­sumer Credit? Mas­sive Upswing in Fed­eral Stu­dent Loans]
• It would seem, then, that con­trary to my stead­fast belief that con­sumers are being forced to save more and reduce debt to rebuild net worth, they have been doing the oppo­site lately.
• Con­sumer Retrench­ment: The data so far aren’t con­clu­sive, but evi­dence of U.S. con­sumer retrench­ment is emerg­ing. Con­sumer con­fi­dence has moved up recently but remains far below the lev­els of early 2007 before the col­lapse in sub­prime mort­gages set off the Great Recession. Real per­sonal con­sump­tion expen­di­tures growth has been volatile in recent months and falling on a year-on-year basis. Voluntary depar­tures from jobs, another mea­sure of con­fi­dence, may be decreasing. And con­sumer spend­ing will no doubt have a big slide if my fore­cast of another 20 per­cent drop in house prices pans out. (Mark's note: that seems aggressive!)
• Hous­ing activ­ity remains depressed, with the only signs of life com­ing from the mul­ti­fam­ily com­po­nent, which is being dri­ven by the appetite for rental apart­ments as home­own­er­ship declines.
• What Oil Threat?: Recently, there has been great con­cern about $4 per gal­lon gaso­line and whether, as in 2008, those high prices will act as a tax on con­sumer incomes and force dras­tic cut­backs in other pur­chases.  These con­cerns are overblown. Amer­i­can con­sumers have reacted to ris­ing gaso­line prices as you would expect in tough times: by con­sum­ing less. Demand (DOEDMGAS) in the mid-February to mid– March four-week period was down 7.8 per­cent from a year ear­lier, mainly due to more effi­cient vehicles.
• As a result, the recent surge in gaso­line prices has had a rel­a­tively small impact on con­sumer pur­chas­ing power. The $14.8 bil­lion increase from Octo­ber 2011 to March 2012, com­pared with the year-earlier period, amounts to about 0.3 per­cent of con­sumer spending.

Con­clu­sion:

• Con­sumer spend­ing is the only major source of strength in the U.S. econ­omy this year. State and local-government spend­ing remains depressed because of deficit woes and under­funded pen­sion plans. Housing suf­fers from excess inven­to­ries and may face a fur­ther 20 per­cent drop in prices. Excess capac­ity restrains cap­i­tal spending. Recent inven­tory build­ing appears involuntary. So con­sumer retrench­ment will tip the bal­ance toward a mod­er­ate and over­due recession.

Tags: Bloomberg, Central Bank Intervention, Consumer Confidence, Downturn, Economic Outlook, Federal Government, Five Months, Gary Shilling, GDP, GDP Growth, Market Tomorrow, Massive Intervention, Personal Income Growth, Pillars, Recession, Retail Sales, Sentiment, Seven Months, Tapping, Treasuries
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Betting on the Race to the Bottom (Krasting)

Monday, April 9th, 2012

Cour­tesy of Bruce Krast­ing

On Mon­day and Tues­day the market’s atten­tion will be on the USA and the neg­a­tive eco­nomic impli­ca­tions of the Non­farm pay­roll (NFP) miss. Mar­ket eyes will also be focused on the bond mar­kets in Italy and Spain. As of last Thurs­day, Europe seemed to be on the verge of another “acci­dent.” The EURCHF closed the week a frac­tion above the 1.20 peg to the Euro. The Swiss National Bank will likely be forced to show its mus­cle. While the peg will not break, news of the attack will rile the FX markets.

If this sce­nario plays out, the Yen should ben­e­fit against the dol­lar and the Euro. If the Yen crosses get cheap, I think it will be a good oppor­tu­nity to short the Yen. As bad as Euroland appears, and as shaky as the USA looks, Japan looks like it might end up win­ning the race to the bottom.

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There are two very big issues that Japan is con­fronting; energy and taxes. Both of these issues will come to a head over the next sixty days. I don’t see a soft landing.

Four­teen months ago Japan had 54 oper­at­ing nukes. Today it has one. By the end of May, it will have none.

The Japan­ese press is dis­cussing options such restart­ing the nukes, but many peo­ple want to shut them all down:

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There are two sig­nif­i­cant con­se­quences of the shut­downs: (A) soar­ing imports of expen­sive hydro­car­bons (LNG, oil and coal), and (B) this sum­mer, there will be as much as a 12% short­fall in elec­tric­ity to to cool homes and run factories.

The shut­down of the nukes has already led to a major turn­around of Japan’s exter­nal trade posi­tion. In 2011 Japan reported its first annual trade deficit in over 30 years. The short­fall came to Y2.5T ($32B). In 2012 that num­ber could be as large as $100B.

The short­age of “juice” this sum­mer will cause cut backs in sup­ply to big indus­try. As a result, indus­trial pro­duc­tion will fall. Depend­ing on the sever­ity of the sum­mer slump, Japan could face neg­a­tive GDP growth for the full year. This will trans­late into more red ink in the national bud­get (already 10+% of GDP). More debt will have to be issued to cover the gap. Japan’s already insane Debt to GDP (230%) has nowhere to go but up.

Japan is lead­ing the world into trou­ble as far as demo­graph­ics go. The Social Secu­rity and med­ical costs of its aging pop­u­la­tion are explod­ing. Unlike in the USA, most of the Japan­ese lead­ers have acknowl­edged that the country's posi­tion is un-sustainable. Not a day goes by with­out it being the sub­ject of an arti­cle in the press. On March 31, the Noda gov­ern­ment for­mally pro­posed dou­bling the con­sump­tion tax from 5% to 10% in a des­per­ate effort to shore up the government’s empty cof­fers. The pro­posal for new taxes will be debated in the Japan­ese Diet in April. A final vote is antic­i­pated in June.

I doubt this crit­i­cal leg­is­la­tion will pass. The pro­posal has oppo­si­tion from many polit­i­cal direc­tions. It has fierce oppo­nents within Mr. Noda's own party, the Demo­c­ra­tic Party of Japan, but the real oppo­si­tion will come from the Lib­eral Demo­c­ra­tic Party (LDP).

Japan’s pol­i­tics are not unlike that of the USA. The oppo­si­tion par­ties will do any­thing to under­mine the efforts of those in power. My read­ing is that the LDP would sup­port a tax increase as a philo­soph­i­cal mat­ter, but it will oppose Noda’s leg­is­la­tion with the objec­tive of bring­ing down the government.

It’s a good bet that the LDP will suc­ceed, and the Noda gov­ern­ment will be forced to call for new national elec­tions. That would be a "worst case” out­come. As of today, polls show that there is sub­stan­tial oppo­si­tion to the new tax. Fail­ure to pass new taxes would put Japan on a debt tra­jec­tory point­ing to infinity.

Polit­i­cal insta­bil­ity in Japan is becom­ing a real issue. The coun­try has had six Prime Min­is­ters in six years. Another reces­sion may kick in this sum­mer. The trade deficit will be at lev­els never seen before. ($500m USDYEN must be bought every trad­ing day to fund the deficit.) The fail­ure of the coun­try to pass new taxes will force down­grades of the pub­lic sec­tor debt. Japan will be on track to exceed 300% Debt to GDP.
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I like USDYEN on the long side at 81 and under. EURYEN is hard to call, and for the time being is a “stay-away”. If the EURYEN cross would some­how get down to around 100, I think it would be“safe” to get long.

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Tags: 32b, Bond Markets, Economic Implications, Eurchf, Fx Markets, GDP Growth, Hydrocarbons, Japanese Press, Last Thursday, Major Turnaround, Nonfarm Payroll, Peg, Race To The Bottom, Shortfall, Shutdowns, Summer Slump, Swiss National Bank, Trade Deficit, Verge, Winning The Race
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The Dating Game: Michael Pettis Challenges The Economist to a Bet on China

Friday, March 30th, 2012

The Econ­o­mist says "China’s GDP, mea­sured in nom­i­nal dol­lars, will be the world’s largest by 2018". Michael Pet­tis at China Finan­cial Mar­kets dis­agrees and says I would like to make a bet with The Econ­o­mist.

I recently read in The Guardian an arti­cle by enthu­si­as­tic ori­en­tal­ist Mar­tin Jacques in which he says that The Econ­o­mist has just pre­dicted that China’s GDP, mea­sured in nom­i­nal dol­lars, will be the world’s largest by 2018. Ear­lier esti­mates, he says had China becom­ing the largest econ­omy in the world by 2027.

I have always been a lit­tle skep­ti­cal about the 2027 claim ... given how much we would have to assume about the sus­tain­abil­ity of Chi­nese growth, about the like­li­hood of cur­rent GDP num­bers not hav­ing been vastly inflated by an over-investment boom, and about the unsta­ble range of polit­i­cal out­comes. It seemed to me to be a pre­dic­tion about as valu­able as the world-beating pre­dic­tions about the USSR in the 1960s or Japan in the 1980s.

Still, this 2018 pre­dic­tion deserves I think more than a lit­tle ques­tion­ing — it requires that nom­i­nal Chi­nese GDP growth in dol­lars out­pace nom­i­nal US GDP growth by 12% a year.

So I am won­der­ing whether we could set up a friendly bet — not for too large stakes. I would like to bet that by the end of 2018 China will not be the largest econ­omy in the world.

If I win, per­haps The Econ­o­mist could invite a very cool under­ground Chi­nese band of my choice to per­form at their next big con­fer­ence, whereas if I lose I could buy four-year sub­scrip­tions (stu­dent rates, please) to a group of Peking Uni­ver­sity fresh­men. Every­body would end up feel­ing pretty pleased with them­selves no mat­ter who wins, right? So?

The Dat­ing Game

Inquir­ing minds are look­ing at an inter­ac­tive chart on The Econ­o­mist in an arti­cle called The Dat­ing Game.

AMERICA'S GDP is still roughly twice as big as China’s (using mar­ket exchange rates). To pre­dict when the gap might be closed, The Econ­o­mist has updated its inter­ac­tive chart below with the lat­est GDP num­bers. This allows you to plug in your own assump­tions about real GDP growth in China and Amer­ica, infla­tion rates and the yuan’s exchange rate against the dol­lar. Over the past ten years, real GDP growth aver­aged 10.5% a year in China and 1.6% in Amer­ica; infla­tion (as mea­sured by the GDP defla­tor) aver­aged 4.3% and 2.2% respec­tively. Since Bei­jing scrapped its dol­lar peg in 2005, the yuan has risen by an annual aver­age of just over 4%. Our best guess for the next decade is that annual GDP growth aver­ages 7.75% in China and 2.5% in Amer­ica, infla­tion rates aver­age 4% and 1.5%, and the yuan appre­ci­ates by 3% a year. Plug in these num­bers and China will over­take Amer­ica in 2018. Alter­na­tively, if China’s real growth rate slows to an aver­age of only 5%, then (leav­ing the other assump­tions unchanged) it would not become num­ber one until 2021. What do you think?

Snap­shot of The Econ­o­mist Base­line Assumptions

The inter­ac­tive graph is too large for my blog, but the above screen snap­shot shows The Econ­o­mist base­line assump­tions. To play around with the num­bers, click on the above link.

I share a view­point with Pet­tis that The Econ­o­mist is way too gen­er­ous in their esti­mate of real GDP growth for China.

Pet­tis thinks China will aver­age 3% growth and I already posted I found that num­ber rea­son­able. As far as Yuan appre­ci­a­tion is con­cerned, I am not at all con­vinced the Yuan is under­val­ued at all, yet I plugged in a nom­i­nal 2% annual appreciation.

Assum­ing a "Real GDP growth" of 3% and Infla­tion at 4% yields a chart that looks like this.

Snap­shot of Mish Base­line Assumptions

Even still, I won­der if the year 2030 is still far too opti­mistic from the stand­point of China.

I strongly believe peak oil and energy con­sump­tion is going to put a seri­ous damper on Chi­nese growth, and that is on top a nec­es­sary and very painful shift away from an entirely unsus­tain­able growth model based on exports, hous­ing, and fixed investment.

I share Pet­tis' view regard­ing "inflated GDP num­bers, an over-investment boom, and the unsta­ble range of polit­i­cal out­comes" adding my own energy con­cerns and yuan val­u­a­tion con­cerns on top of it all.

Thoughts on Chi­nese Growth

• March 23, 2012: Excel­lent Doc­u­ment on Decou­pling and Global Sup­ply Chains by ECRI; Why BRIC, and U.S. Decou­pling Won't Happen
• Feb­ru­ary 29, 2012: World Bank Warns of Eco­nomic Cri­sis in China; Only 3% Growth for Decade Says Michael Pettis
• Sep­tem­ber 21, 2011: Mis­lead­ing Indi­ca­tors — China's Growth Won't Last; Chanos on Chi­nese Prop­erty Bub­ble and Growth
• August 22, 2011: Michael Pet­tis on Long-Term Out­look for China, Europe, and the World; 12 Global Predictions

I find the argu­ments by Pet­tis, the ECRI, and Chanos com­pelling. Add to that the restraint of peak oil cou­pled with poten­tial polit­i­cal insta­bil­ity and the proper con­clu­sion is that long-term Chi­nese growth of 7.5% is Fan­ta­sy­land material.

Mike "Mish" Shed­lock
http://globaleconomicanalysis.blogspot.com

Tags: Bet, China Economy, China Gdp, Chinese Growth, Dating Game, Economist, Financial Markets, Game America, Gap, GDP, GDP Growth, Inquiring Minds, Interactive Chart, Investment Boom, Market Exchange Rates, Michael Pettis, Orientalist, Peking University, Political Outcomes, University Freshmen
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Fed Policy: Bernanke Is Warming Up His Helicopter

Wednesday, March 28th, 2012

This arti­cle orig­i­nally appeared in the Daily Cap­i­tal­ist.

Econ­o­mists cling to sta­tis­ti­cal data like bar­na­cles in order to have some kind of anchor to explain what is going on in the world. They will try to cram the square data peg into the round holes of eco­nomic "laws" rather than aban­don them when they are obvi­ously wrong. Which is not a very sat­is­fac­tory way to explain things. You might begin to think the data you mea­sure is just coin­ci­den­tally cor­rel­a­tive for the period mea­sured if it falls apart at some point. Instead of try­ing to stretch the data into what you think it should be, then maybe you might think that you've got it all wrong.

Chair­man Ben Bernanke is not let­ting a data incon­sis­tency get in the way of his prior con­clu­sions about unem­ploy­ment. In his speech today, he says that he's not sure why we have such high rates of unem­ploy­ment, some may be just cycli­cal, some may be struc­tural, but what­ever it is the Fed will be avail­able to print money to "sup­port demand and for the recov­ery." Some­how QE1 and QE2 were not enough.

In his speech Bernanke tries to explain why Okun's law (a cor­re­la­tion between GDP and employment/unemployment) is still valid yet doesn't explain the cur­rent situation. Perhaps GDP "growth" Bernanke sees is really a fig­ment of money steroids, some­thing the Fed has unleashed, and that unem­ploy­ment is still high because of long-term capital/savings destruc­tion caused by QE and ZIRP.

If you look at the rate of employ­ment to the work­ing pop­u­la­tion, you might won­der why it crashed so dis­pro­por­tion­ately to past cycles:

The blue line is the ratio of employ­ment to pop­u­la­tion; the red line shows pop­u­la­tion growth. The pop­u­la­tion is still grow­ing but the ratio fell off a cliff. The ratio of employed to pop­u­la­tion is back to 1977 lev­els. This is not some­thing Chair­man Bernanke wishes to hear or believe. He would rather adhere to the out­dated ideas of the main­stream rather than ques­tion the dogma.

This is apro­pos of a con­fer­ence spon­sored by the Fed last Fri­day on, among other topics, the effi­cacy of quan­ti­ta­tive eas­ing. The con­clu­sion com­ing from a Fed con­fer­ence should be pretty obvi­ous: QE is suc­cess­ful. The paper pre­sented by econ­o­mist Mark Gertler of NYU, a close col­lab­o­ra­tor with the for­mer Pro­fes­sor Bernanke, con­cludes that QE works and he has an econo­met­ric model to prove it. What he does is look at what he con­sid­ers to be the proper data and con­cludes that there is cause and effect and then he builds a math­e­mat­i­cal model around this and believes it works. If his inter­pre­ta­tion of the data is incor­rect then the model is incorrect.

Here is a por­tion, out of con­text, of Gertler's model:

Etcetera. You would have to be an econo­me­tri­cian to under­stand this. But it is just a way to dis­guise false ide­ol­ogy by cloak­ing it in math­e­mat­i­cal for­mula. See Hayek and Mises on this topic. Because the for­mula "works" doesn't mean it is right. Believe what you want to believe.

I think this is mostly an ad hoc ergo propter hoc (A hap­pened and then B hap­pened, thus A caused B) kind of analy­sis and that his con­clu­sions are based on incor­rect the­ory and fail to explain any­thing. But it doesn't mat­ter if he's right or wrong for our pur­poses because Bernanke and most of the peo­ple at the Fed believe it. We can thus be assured that the Fed will unleash another round of QE when the econ­omy stag­nates (as I have fore­cast that it will).

It mat­ters if he's right or wrong for our pur­poses as investors though, because QE dis­torts the entire econ­omy, gives an illu­sion of growth, destroys cap­i­tal, causes more unem­ploy­ment, and leaves the econ­omy struc­turally impaired for a con­sid­er­able time. One of the nasty lit­tle side-effects of QE that is most rec­og­niz­able to investors and con­sumers is price infla­tion. It is prob­a­bly higher than it is reported but it would grow much higher with more money print­ing. It destroys your wealth. It is pos­si­ble, as we found out in the 1970s that you can have eco­nomic stag­na­tion and high infla­tion at the same time.

What we are see­ing now in the data is an effect from QE1 and QE2 and Oper­a­tion Twist. It can­not last and it won't because you can't cre­ate wealth out of thin air as they are attempt­ing to do.

Bernanke's speech is another exam­ple of Mr. Bernanke's admis­sion that he does not under­stand the fun­da­men­tals under­ly­ing our eco­nomic prob­lems. Oth­er­wise Fed poli­cies he unleashed would have cured the prob­lem long ago.

Just last Thurs­day in an econ class at George Wash­ing­ton Uni­ver­sity he said the Fed's low-interest-rate poli­cies in the early 2000s didn't cause the hous­ing boom and bust:

"There's no con­sen­sus on this," Mr. Bernanke told a class of col­lege stu­dents at George Wash­ing­ton Uni­ver­sity. "But the evi­dence I've seen sug­gests that mon­e­tary pol­icy did not play an impor­tant role in rais­ing house prices dur­ing the upswing."

The hous­ing boom-bust must have been caused by "irra­tional exu­ber­ance" which was Alan Greenspan's "ani­mal spir­its" Key­ne­sian expla­na­tion for the Dot­com bub­ble. Greenspan has also denied that he caused the hous­ing bubble.

What can one say about this? There is actu­ally very good evi­dence that the Fed's easy money pol­icy was the foun­tain­head of the bub­ble. But read­ers of the Daily Cap­i­tal­ist are well aware of that.

These speeches are fur­ther con­fir­ma­tions of dis­as­trous Fed mon­e­tary poli­cies that won't end until the Fed raises inter­est rates and stops print­ing money. I'm bet­ting on stag­na­tion, more QE, and higher price inflation.

Tags: Barnacles, Ben Bernanke, Correlation, Correlative, Data Inconsistency, Dogma, Economic Laws, Economists, Employment Unemployment, Fed Policy, Figment, GDP Growth, Long Term Capital, Outdated Ideas, Population Growth, Qe, Red Line, Statistical Data, Steroids, Zirp
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The Emerging Market Growth Story Continues (ING)

Tuesday, March 20th, 2012

by Dou­glas Coté, ING

We have dis­cussed the pos­si­bil­ity, and risk, of a hard land­ing in China (growth slow­ing to less than 7%), but what has been going on in some of the other BRIC’s like India and Brazil? Right now India is in the midst of bud­get nego­ti­a­tions which would reign in its gross fis­cal deficit to 5.9% of GDP (total debt is around 50% of GDP). India’s GDP growth is expected to sub­side to 6.9% after two solid years of greater than 8% growth. A global slow­down as well as high oil prices have con­tributed to the decrease. How­ever, Indian finan­cial offi­cials expect a return to 9% plus growth in the future. Mean­while Brazil has just over­taken the U.K. to become the sixth largest econ­omy in the world. Brazil grew 2.7% in 2011 com­pared to U.K.’s mea­ger .8%. And with sub­stan­tial oil and gas reserves fuel­ing their exports, Brazil has their eye on num­ber 5. You can find some key sta­tis­tics about India and Brazil as well as other emerg­ing mar­kets on page 33 of the Global Per­spec­tives book.

Click on images below for PDF

Copy­right © ING Invest­ment Management

Tags: Brazil, BRIC, Budget Negotiations, Economy, Emerging Market, Emerging Markets, Financial Officials, Fiscal Deficit, Gas Reserves, GDP, GDP Growth, Global Perspectives, Global Slowdown, India, Ing, Ing Investment Management, Key Statistics, Midst, Nbsp, Oil and Gas, Oil Prices, risk
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ECRI: Why Our Recession Call Stands

Friday, March 16th, 2012

Why Our Reces­sion Call Stands

Tags: Coincident Index, Concoction, Consumer Spending, Current State, Downturn, Economic Data, Economic Growth, Economic Indicators, Ecri, Employment Income, GDP Growth, Gold Standard, Lakshman, Personal Income, Q3, Recession, Recessions, Straight Answer, Three Quarters, Usci
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Goldman's Jan Hatzius: 3 Reasons to Expect Fed to Still Ease in April or June

Friday, March 16th, 2012

Based on some of the "action" and com­men­tary in the past few days, it appears many believe the Fed is poten­tially step­ping away from the mon­e­tary eas­ing parade based on com­ments from the last FOMC meet­ing.  I don't believe that, nor does Goldman's top econ­o­mist hon­cho, Jan Hatzius.

“It has def­i­nitely become a closer call, but we still expect another asset pur­chase pro­gram that involves pur­chases of both mortgage-backed secu­ri­ties and Trea­surys,” he said.

Below he out­lines the 3 rea­sons he expects the Fed to announce an eas­ing in April or June, I par­tic­u­lar want to high­light the last one  i.e. no con­tin­ued eas­ing = tightening! since the mar­ket has priced in fur­ther easing.

Also note Hatz­ius high­lights the poten­tial impact of warmer weather (which many have noted) and sea­sonal adjust­ment dis­tor­tions.  If you have not read the piece from Decem­ber on this, it is impor­tant to note - it gets very lit­tle play in the finan­cial media but we've seen spikes up in eco­nomic activ­ity in Q4's and Q1's and down in Q2's and Q3's (which lead to more mon­e­tary eas­ing!).  Hence the gov­ern­ment eco­nomic data, if it fol­lows the pat­tern of the past few years should begin to weaken in April-June if for noth­ing else than the dis­tor­tions 2008–2009 have had on tra­di­tional sea­sonal adjustments.

On to Hatzius:

1. The improve­ment might not last.

With real GDP growth track­ing just 2% in the first quar­ter and signs that at least some of the recent strength is prob­a­bly due to the unusual warm weather and per­haps some sea­sonal adjust­ment dis­tor­tions, ques­tion marks still sur­round the true pace of activ­ity growth. In addi­tion, there are still sev­eral actual or poten­tial “head­winds” for growth, includ­ing a reduced boost from inven­tory accu­mu­la­tion, the recent increase in oil and gaso­line prices, con­tin­ued risks from the cri­sis in Europe, and the specter of fis­cal retrench­ment after the pres­i­den­tial election.

2. Even if the improve­ment does last, faster growth would be desir­able to push down the unem­ploy­ment rate more quickly.

Fed offi­cials believe that the level of eco­nomic activ­ity and employ­ment is still far below poten­tial. This means a large num­ber of indi­vid­u­als are invol­un­tar­ily unem­ployed, which not only causes hard­ship in the near term but may also trans­late into higher struc­tural unem­ploy­ment in the long term…This cre­ates an incen­tive to find poli­cies that speed up the return to full employment.

3. Not eas­ing might be equiv­a­lent to tightening.

At a min­i­mum, the bond mar­ket cur­rently dis­counts some prob­a­bil­ity of QE3. This has kept finan­cial con­di­tions eas­ier than they oth­er­wise would have been, which has pre­sum­ably sup­ported eco­nomic activ­ity. A deci­sion not to rat­ify expec­ta­tions of QE3 could there­fore result in a tight­en­ing of finan­cial con­di­tions.

Tags: Asset Purchase, Distortions, Economic Activity, Economic Data, Fiscal Retrenchment, Fomc, Gasoline Prices, GDP Growth, Goldman, Headwinds, Presidential Election, Q4, Question Marks, Real Gdp, Seasonal Adjustment, Seasonal Adjustments, Specter, Spikes, Treasurys, Warm Weather
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Emerging Markets Radar (March 12, 2012)

Sunday, March 11th, 2012

Emerg­ing Mar­kets Radar (March 12, 2012)

Strengths

• The Global Emerg­ing Mar­kets Fund (GEMFX) has ben­e­fited from a bias toward small-caps in 2012. On a rel­a­tive basis, the fund has ben­e­fited from choos­ing stocks that pay more than twice the div­i­dend yield of the Rus­sell 2000 Index and those com­pa­nies which have a low price-to-earnings ratio.
• China’s Feb­ru­ary Con­sumer Price Index (CPI) was up 3.2 per­cent in Feb­ru­ary, lower than the esti­mate of 3.5 per­cent and below January’s 4.5 per­cent fig­ure. With infla­tion expec­ta­tions tamed, the mar­ket expects the People’s Bank of China (PBOC) to fur­ther cut the reserve require­ment ratio (RRR).
• China’s fixed asset invest­ment (FAI) growth came in stronger than expected at 21.5 per­cent year-over-year dur­ing the first two months of 2012, up from 18 per­cent in Decem­ber. Inter­est­ingly, res­i­den­tial FAI rose 27 per­cent, the same pace as last year. This indi­cates that the hous­ing mar­ket may not col­lapse as many wor­ried last year.
• New bank deposits rebounded strongly in Feb­ru­ary to Rmb 1.6 tril­lion, enabling Chi­nese banks to lend more in March. In addi­tion, M2 money sup­ply growth was near expec­ta­tions, right at 13 percent.
• Philip­pine CPI rose 2 per­cent in Feb­ru­ary. This is well below the 3.2 per­cent increase that was forecasted.

Weak­nesses

• China’s retail sales and indus­trial pro­duc­tion growth came in weaker than expected. Retail sales rose 14.7 per­cent, down from 17.1 per­cent in 2011. Indus­trial pro­duc­tion rose 11.4 per­cent, slow­ing by 1.4 per­cent­age points from Decem­ber. These data points indi­cate that China had prob­a­bly over tight­ened its mon­e­tary and indus­trial poli­cies and needs to loosen up these poli­cies dur­ing the first half of the year.
• China has low­ered the country’s GDP growth tar­get to 7.5 per­cent this year, 50 basis points lower than in the past eight years. Many believe Chi­nese pol­i­cy­mak­ers will try to slow down the country’s eco­nomic growth by curb­ing hous­ing mar­ket growth and post­pon­ing some infra­struc­ture growth. How­ever, China has con­sis­tently beaten its own GDP tar­get every year over the last decade and the coun­try will still encour­age growth in con­sump­tion and indus­trial enhancement.
• Malaysia’s exports grew 0.4 per­cent in Jan­u­ary, the slow­est pace in 15 months.
• After a good run, Turk­ish indus­trial pro­duc­tion fal­tered in Jan­u­ary. Indus­trial pro­duc­tion was up by 1.5 per­cent year-over-year in Jan­u­ary, weaker than the mar­ket expec­ta­tions. Turkey’s Pur­chas­ing Manager’s Index (PMI) also dete­ri­o­rated in Feb­ru­ary as a result of poor weather conditions.

Oppor­tu­ni­ties

• Droughts from Mex­ico to Argentina are shrink­ing corn stock­piles to a five-year low. This raises the prospect of a bull mar­ket in the U.S., as farm­ers are expect­ing to see the biggest crop ever.
• Corn demand in China, the biggest con­sumer after the U.S., may decline after Pre­mier Wen Jiabao low­ered the annual growth tar­get to 7.5 per­cent. Prices fell 16 per­cent in the last four months of 2011 as the U.S. Depart­ment of Agri­cul­ture (USDA) pre­dicted Brazil and Argentina would pro­duce their biggest crops ever. The two coun­tries cur­rently account for almost 10 per­cent of global corn sup­ply. While prices may keep ris­ing for now, ana­lysts antic­i­pate declines by the end of the year as U.S. grow­ers har­vest the most acres planted since 1944.
• This chart shows China’s infla­tion has come down notably since July 2011. Food prices, the largest con­trib­u­tor to the rise in infla­tion last year, have come down since the fourth quar­ter after the sup­ply chain and logis­tics were improved. The mar­ket expects the PBOC to cut RRR again in order to sup­port eco­nomic growth and liq­uid­ity in the economy.

Threats

• While invest­ment flows pour into most of the largest emerg­ing mar­kets, for­eign investors are sell­ing South African equi­ties at the fastest pace in four years over grow­ing con­cern that pol­icy mak­ers will seek a larger share of the nation’s min­ing prof­its. Inter­na­tional investors sold $933 mil­lion of South African equi­ties in the first two months of this year and are on track for the biggest first-quarter out­flow since 2008.
• A study com­mis­sioned by Pres­i­dent Jacob Zuma’s rul­ing African National Con­gress party pro­posed increas­ing taxes on the min­ing indus­try last month. In addi­tion, the party’s youth wing has lob­bied for a gov­ern­ment takeover of gold and plat­inum mines to boost employ­ment in Africa’s biggest economy.
• China’s Feb­ru­ary retail sales rose 14.7 per­cent, below the expec­ta­tions of pol­i­cy­mak­ers. In order to reach the stated con­sump­tion growth tar­get near or above 18 per­cent, Chi­nese pol­i­cy­mak­ers need to loosen the country’s mon­e­tary pol­icy or begin a fis­cal sub­sidy, such as a new home appli­ance incentive.

Tags: Agriculture, Asset Investment, Bank Deposits, Bank Of China, Chinese Banks, Consumer Price Index, Dividend Yield, emerging markets fund, GDP Growth, Gemfx, Growth Target, Index Cpi, Industrial Policies, Inflation Expectations, Infras, Money Supply Growth, Pboc, Price To Earnings Ratio, Relative Basis, Russell 2000 Index, Small Caps
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Hugh Hendry (Eclectica) Discusses Hyperdeflation, Europe, China, and Japan

Thursday, February 23rd, 2012

With the masses scream­ing their lungs of about hyper­in­fla­tion, some­thing that is highly unlikely at best, Hugh Hendry of Eclec­tica Talks About Hyper­de­fla­tion, why China might have a hard land­ing, and var­i­ous off-the-beaten tracks Japan plays.

Here is clip from a Barron's interview.

Barron's: Where do you find your­self out­side the exist­ing belief sys­tem today?

Hendry: In 2009, I made a YouTube video of the empty sky­scrap­ers in Wuhan, China. Gold­man Sachs and oth­ers artic­u­late a very rea­son­able and com­pelling argu­ment of being invested in China. With the evi­dence of my own eyes, I con­cluded that China had a very robust sys­tem of cre­at­ing gross-domestic-product growth, but for­sak­ing the cre­ation of wealth.

When Amer­ica was hav­ing its China moment in the 19th cen­tury, it occurred against the back­drop of a gold stan­dard, a hard-money régime, with a pub­lic sec­tor that was minus­cule ver­sus the over­all size of the econ­omy. As an entre­pre­neur, if your project failed to gen­er­ate a sus­tain­able level of cash flow, you failed.

If you talk about a hard land­ing in China, you talk about GDP growth of 5%, not minus 5% or minus 15%. The Chi­nese gov­ern­ment prints money. It can build super­fast rail­ways and over­build air­ports, because the rest of the econ­omy can sub­si­dize it. China's swollen pub­lic sec­tor is direct­ing asset allo­ca­tion, rather than pur­su­ing profit max­i­miza­tion. They see [their sys­tem] as a suc­cess. But it cre­ates a bub­ble, which can prove quite damaging.

Barron's: You've already had a hard landing—in the Chi­nese stock mar­ket.

Hendry: I should add some­thing else that is contentious—U.S. quan­ti­ta­tive eas­ing [that even­tu­ally sent more money flow­ing to China], pro­moted because Amer­ica had two sharp reces­sions and pur­sued ortho­dox poli­cies, and had very lit­tle to show in the cre­ation of jobs.

The pol­icy was very suc­cess­ful. China now has infla­tion. Min­i­mum wages have grown 20% annu­ally for the past three years. This has encour­aged the Chi­nese to tighten mon­e­tary pol­icy. When you have bub­bles and you tighten, bad things hap­pen. China's stock and prop­erty mar­kets are weak, a side-effect of quan­ti­ta­tive eas­ing. We may now have the prick­ing of the Chi­nese bub­ble. A year or two down the line, it could have enor­mous reper­cus­sions for the global economy.

Barron's: How does one play it?

Hendry: The world is very fear­ful of hyper­in­fla­tion. Pen­sion schemes have a pre­pon­der­ance of real assets, from forestry to gold to TIPS [Trea­sury inflation-protected secu­ri­ties], because they are very fear­ful. The road to hyper­in­fla­tion is via hyper­de­fla­tion. That is why it's prov­ing so dif­fi­cult for hedge funds to make money. How does the ratio­nal mind that antic­i­pates hyper­in­fla­tion own 10-year gov­ern­ment Trea­suries yield­ing less than 2%? It can't. That's why peo­ple are strug­gling. To lay the seeds of hyper­in­fla­tion, you need really, really bad things to hap­pen. I thought the U.S. hous­ing mar­ket hav­ing a mas­sive crash would be hyper­de­fla­tion­ary. But then my Chi­nese friends pumped $1 tril­lion of credit into their $5 tril­lion econ­omy, and cre­ated a global recov­ery, which has just come to an end. I'm spec­u­lat­ing that hyper­de­fla­tion hap­pens before hyper­in­fla­tion. What's the worst that could hap­pen? But the sum of all my fears would be China hav­ing a real hard land­ing of minus 5% or minus 10% GDP growth. If we had that—and Europe—the Fed would be print­ing $20 tril­lion, and I would have gold at $5,000. You can have a mod­est amount of gold, but you can't have all your assets in real assets, in case we get that hyper­de­fla­tion event.

Barron's: So how do you make money?

Hendry: Would you believe that the AIG strat­egy of sell­ing too much credit pro­tec­tion in risky assets like mortgage-backed secu­ri­ties is alive and boom­ing today in Japan? It doesn't con­cern mort­gages. It is credit-default swaps on indi­vid­ual Japan­ese corporations.

Barron's: Do you seri­ously believe Japan­ese cor­po­ra­tions are going to fail?

Hendry: Clearly, they can and do go bust. I'm buy­ing the CDS on investment-grade Japan­ese cor­po­ra­tions because of the over­pric­ing anom­aly. Japan had a bust 20 years ago, and yet today the bank­ing stocks, rel­a­tive to [Japan­ese bourse] Topix, are mak­ing fresh lows.

If I'm a Japan­ese bank and I lend money to a new busi­ness, I get 1% on 10-year paper. Then the bank gets a call from me, and I'm will­ing to pay 50 basis points for five-year pro­tec­tion on this same com­pany. So sud­denly, the yield has gone from 1% to 1½%. Com­pare that to five-year Japan­ese gov­ern­ment bonds, yield­ing 30 basis points. The bank thinks: This is a great trade! Japan­ese steel com­pa­nies are investment-grade and won't go bank­rupt. So, the bank gets this huge yen yield, and thinks it is not tak­ing any risk. You'd bet­ter believe it will sell way too much of that good thing.

One of my part­ners told me about Japan­ese steel: Here is a coun­try with no energy, no iron ore or coal, yet it's the largest exporter of steel in the world, exports half its out­put. To put that in con­text, China man­u­fac­tures 700 mil­lion tons of steel and exports per­haps 30 mil­lion. Japan pro­duces 110 mil­lion tons and exports 40 mil­lion. As long as Asia is strong, they are fine. But if Asia hic­cups or reverses, plant-utilization rates go from very high to very, very low very quickly.

Then we dis­cov­ered that War­ren Buf­fett owned shares of South Korea's Posco [5490.S. Korea], and that Korea was the biggest importer of Japan­ese steel, but Posco and Hyundai [5380.S. Korea] are build­ing huge, inte­grated steel plants. They have a sur­plus of steel capac­ity and—guess what?—they're export­ing to Japan, because the yen is so strong.

Ini­tially, I wanted to buy a three-year, out-of-the-money put on Nip­pon Steel. My bro­ker said, "I've been in a 20-year bear mar­ket; my boss will kill me." Then I thought, being long credit pro­tec­tion is being long volatil­ity. I redi­aled his credit coun­ter­part. I said: "I'm think­ing of pur­chas­ing up to a bil­lion yen of five-year credit-default swaps in Nip­pon Steel." The first thing he said was, "Would you con­sider 10 bil­lion?" So one part of the bank is banned from sell­ing volatil­ity, and the other part is hav­ing a party. I bought reams of the stuff.

Barron's: We've barely dis­cussed Europe.

Hendry: We are partly play­ing it through Japan. If events kick off again in Europe, the cor­re­la­tion across all [global] asset classes will go to one. So the steel CDS is 130 basis points, while to insure against default by the French gov­ern­ment, I'd be pay­ing the same amount. Which is riskier? A very lever­aged steel com­pany that can't tax you? Or a gov­ern­ment that can? Our bear­ish bets are largely out­side Europe. As for Greece, the end game will be the Greeks reject­ing aus­ter­ity. The euro is noth­ing but a gold stan­dard lack­ing flex­i­bil­ity, and all the onus is on pri­vate cit­i­zens to take the pain. Even­tu­ally, a Greek politi­cian will say, 'Vote for me, and I'll get us out of this system.'

I cer­tainly agree with that last com­ment above.

I as I have said and repeated Even­tu­ally, Will Come a Time When ....

Even­tu­ally, there will come a time when a pop­ulist office-seeker will stand before the vot­ers, hold up a copy of the EU treaty and (cor­rectly) declare all the "bail out" debt foisted on their coun­try to be null and void. That per­son will be elected.

The Barron's inter­view is well worth a read in entirety.

Mike "Mish" Shed­lock
http://globaleconomicanalysis.blogspot.com

Tags: Asset Allocation, Belief System, Chinese Government, Chinese Stock Market, Eclectica, GDP Growth, Gold Standard, Goldman Sachs, Hard Money, Hugh Hendry, Hyperinflation, Minimum Wages, Own Eyes, Profit Maximization, Recessions, Robust System, Skyscrapers, Sustainable Level, Wuhan China, Youtube Video
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Hugh Hendry's Interview with Barron's

Thursday, February 23rd, 2012

For those in the Hugh Hendry fan club we have an arti­cle from last week's Barron's where the hedge fund man­ager espouses his long held view that China will have a hard land­ing, along with the prospects of hyper­in­fla­tion, and thoughts on Japan among other things.  As always it is more enter­tain­ing to see video of the acer­bic Hendry than have to read it, but it is what it is.

Some snip­pets:

Where do you find your­self out­side the exist­ing belief sys­tem today?

In 2009, I made a YouTube video of the empty sky­scrap­ers in Wuhan, China. Gold­man Sachs and oth­ers artic­u­late a very rea­son­able and com­pelling argu­ment of being invested in China. With the evi­dence of my own eyes, I con­cluded that China had a very robust sys­tem of cre­at­ing gross-domestic-product growth, but for­sak­ing the cre­ation of wealth.

When Amer­ica was hav­ing its China moment in the 19th cen­tury, it occurred against the back­drop of a gold stan­dard, a hard-money régime, with a pub­lic sec­tor that was minus­cule ver­sus the over­all size of the econ­omy. As an entre­pre­neur, if your project failed to gen­er­ate a sus­tain­able level of cash flow, you failed.

China's great oppor­tu­nity is tak­ing place within the U.S. fiat sys­tem, and so the con­se­quences are per­haps less stark than in 19th-century Amer­ica, which had stops and starts and many depres­sions, though with an over­ar­ch­ing pros­per­ity. China has not had that volatility.

If you talk about a hard land­ing in China, you talk about GDP growth of 5%, not minus 5% or minus 15%. The Chi­nese gov­ern­ment prints money. It can build super­fast rail­ways and over­build air­ports, because the rest of the econ­omy can sub­si­dize it. China's swollen pub­lic sec­tor is direct­ing asset allo­ca­tion, rather than pur­su­ing profit max­i­miza­tion. They see [their sys­tem] as a suc­cess. But it cre­ates a bub­ble, which can prove quite damaging.

You've already had a hard landing—in the Chi­nese stock market.

I should add some­thing else that is contentious—U.S. quan­ti­ta­tive eas­ing [that even­tu­ally sent more money flow­ing to China], pro­moted because Amer­ica had two sharp reces­sions and pur­sued ortho­dox poli­cies, and had very lit­tle to show in the cre­ation of jobs.

How does one play it?

The world is very fear­ful of hyper­in­fla­tion. Pen­sion schemes have a pre­pon­der­ance of real assets, from forestry to gold to TIPS [Trea­sury inflation-protected secu­ri­ties], because they are very fear­ful. The road to hyper­in­fla­tion is via hyper­de­fla­tion. That is why it's prov­ing so dif­fi­cult for hedge funds to make money. How does the ratio­nal mind that antic­i­pates hyper­in­fla­tion own 10-year gov­ern­ment Trea­suries yield­ing less than 2%? It can't. That's why peo­ple are strug­gling. To lay the seeds of hyper­in­fla­tion, you need really, really bad things to hap­pen. I thought the U.S. hous­ing mar­ket hav­ing a mas­sive crash would be hyper­de­fla­tion­ary. But then my Chi­nese friends pumped $1 tril­lion of credit into their $5 tril­lion econ­omy, and cre­ated a global recov­ery, which has just come to an end. I'm spec­u­lat­ing that hyper­de­fla­tion hap­pens before hyper­in­fla­tion. What's the worst that could hap­pen? But the sum of all my fears would be China hav­ing a real hard land­ing of minus 5% or minus 10% GDP growth. If we had that—and Europe—the Fed would be print­ing $20 tril­lion, and I would have gold at $5,000. You can have a mod­est amount of gold, but you can't have all your assets in real assets, in case we get that hyper­de­fla­tion event.

The pol­icy was very suc­cess­ful. China now has infla­tion. Min­i­mum wages have grown 20% annu­ally for the past three years. This has encour­aged the Chi­nese to tighten mon­e­tary pol­icy. When you have bub­bles and you tighten, bad things hap­pen. China's stock and prop­erty mar­kets are weak, a side-effect of quan­ti­ta­tive eas­ing. We may now have the prick­ing of the Chi­nese bub­ble. A year or two down the line, it could have enor­mous reper­cus­sions for the global economy.

What else do you own?

In the next 12 months, we'll see fur­ther patho­log­i­cal swings in investor sen­ti­ment. Despite my reser­va­tions, I'm mod­estly long equity-market futures, some non­in­dus­trial com­modi­ties, and some bull­ish fixed-income posi­tions. We are very bull­ish agri­cul­tural com­modi­ties and agri­cul­tural equi­ties, and hold a global bas­ket of businesses—with inter­ests rang­ing from fer­til­izer to farm equipment.

Dis­clo­sure Notice

Any secu­ri­ties men­tioned on this page are not held by the author in his per­sonal port­fo­lio. Secu­ri­ties men­tioned may or may not be held by the author in the mutual fund he man­ages, the Pal­adin Long Short Fund (PALFX). For a list of the afore­men­tioned fund's hold­ings at the end of the prior quar­ter, visit the Pal­adin Funds web­site at http://www.paladinfunds.com/holdings/blog

Tags: 19th Century America, Acerbic, agricultural, Asset Allocation, Belief System, Chinese Government, Chinese Stock Market, Depressions, GDP Growth, Gold Standard, Goldman Sachs, Hard Money, Hedge Fund Manager, Hugh Hendry, Hyperinflation, Own Eyes, Profit Maximization, Robust System, Sustainable Level, Wuhan China, Youtube Video
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Lacy Hunt: Face The Music, Road Back To Prosperity Is Through Shared Sacrifice, Not Government Stimulus

Friday, February 17th, 2012

John Mauldin posted an extra­or­di­nary inter­view by Kate Welling of Dr. Lacy Hunt, the chief econ­o­mist of Hois­ing­ton Invest­ment Management.

Dr. Lacy Hunt cor­rectly iden­ti­fies frac­tional reserve lend­ing as the cul­prit behind the mas­sive rise in debt. Hunt also explains why gov­ern­ment spend­ing can­not help, why Europe is in worse shape than the US, why a US reces­sion is com­ing, and why Ben Bernanke is an excep­tion­ally poor stu­dent of the great depression.

The entire PDF is a lengthy 29 pages, but well worth a read in entirety.

Here are some per­ti­nent snips from "Face the Music".

Face The Music
Road Back To Pros­per­ity Is Through Shared Sac­ri­fice, Says Lacy Hunt.

Kate: Happy New Year, Lacy. And thanks for send­ing all those charts to back­ground me for our con­ver­sa­tion. I have to say the first one stopped me — show­ing debt as a per­cent­age of U.S.

Lacy: If you con­fine your analy­sis to post-war period, you only have one major debt-dominated cycle and that’s the one we’re cur­rently in — and have been in for a num­ber of years. But if you go back far enough, you have three more. You have the 1820s and 1830s. You have 1860s and 1870s and then you have 1920s and their after­math. Some­times it’s essen­tial to take your analy­sis back as far as you pos­si­bly can.

Kate: Doesn’t your sec­ond chart, on the veloc­ity of money [below], show how none other than Mil­ton Fried­man was mis­led into think­ing that it was a con­stant because he only looked at post-war data?

Lacy: That’s cor­rect and, in fact, I was mis­led along with him because I was also doing analy­sis based on the post-war data. Friedman’s period of esti­ma­tion was basi­cally from the 1950s to the 1980s. Well, if you look at the veloc­ity of money in that time period, it’s not a con­stant, but it’s very sta­ble around 1.675. So if you tracked money sup­ply growth then, you were going to be able to get to GDP growth very well. Not on an indi­vid­ual quar­terly basis, but even the indi­vid­ual quar­terly vari­a­tions were not that great. Until veloc­ity broke out of that range after we dereg­u­lated the bank­ing sys­tem. Now, veloc­ity is break­ing below the long-term aver­age and it’s behav­ing exactly like Irv­ing Fisher said, not like Fried­man said, absolutely.

Kate: What a per­fect exam­ple of the dif­fer­ence your frame of ref­er­ence can make.

Lacy: Keynes and Fried­man both felt that The Great Depres­sion was due to an insuf­fi­ciency of aggre­gate demand and so the way you con­tained a Great Depres­sion was by your response to the insuf­fi­ciency of aggre­gate demand. For Keynes, that was by hav­ing the fed­eral gov­ern­ment bor­row more money and spend it when the pri­vate sec­tor wouldn’t. And for Fried­man, that was for the Fed­eral Reserve to do more to stim­u­late the money sup­ply so that the pri­vate sec­tor would lend more money. Fisher, on the other hand, is say­ing some­thing entirely dif­fer­ent. He’s say­ing that the insuf­fi­ciency of aggre­gate demand is a symp­tom of exces­sive indebt­ed­ness and what you have to do to con­tain a major debt depres­sion event — such as the after­math of 1873, the after­math of 1929, the after­math of 2008 — is you have to pre­vent it ahead of time. You have to pre­vent the buildup of debt.

Kate:  And that your goose is cooked if you don’t you cut off the credit bub­ble before it over­whelms the economy?

Lacy: Yes, and Bernanke is think­ing that the solu­tion is in the response to the insuf­fi­ciency of aggre­gate demand. That was Friedman’s thought. That was Keynes’ thought and most of the eco­nom­ics pro­fes­sion has tra­di­tion­ally thought the same way. They were look­ing at it through the wrong lens. Fisher advo­cated 100% money because he wanted the lend­ing and depos­i­tory func­tions of the banks sep­a­rated so we couldn’t have another event like the 1920s.

Kate: You’re say­ing that Fisher argued against frac­tional reserve banking?

Tags: 1820s, 1920s, Ben Bernanke, Chief Economist, Culprit, Face The Music, GDP Growth, government spending, Great Depression, Happy New Year, Indi, Investment Management, John Mauldin, Massive Rise, Milton Friedman, Money Supply Growth, Music Road, Recession, Snips, Stimulus, Velocity Of Money, War Period
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David Rosenberg — "Let's Get Real — Risks Are Looming Big Time"

Wednesday, February 15th, 2012

Ear­lier, you heard it from Jeff Gund­lach, whom one can not accuse (at least not yet) of sleep­ing on his lau­rels and/or being a bro­ken watch, who told his lis­ten­ers to "reduce risk right now" espe­cially in the fren­zied momo stocks. Now, it is David Rosenberg's turn who tries to refute the pre­sid­ing tran­si­tory dogma that 'things are ok" and that a Greek default will be con­tained (no, it won't be, and if nobody remem­bers what hap­pened in 2008, here is a reminder of every­thing one needs to know ahead of the "con­trolled", what­ever that is, Greek default). Alas, it will be to no avail, as one of the dom­i­nant fea­tures of the lem­ming herd is that it will gladly believe the grand­est of delu­sions well past the ledge. On the other hand, they don't call it the pain trade for nothing.

From Gluskin Sheff

LET'S GET REAL

We are con­stantly being told how much bet­ter the econ­omy is doing. It's incred­i­ble what the Jan­u­ary employ­ment report did to people's per­cep­tions of the macro land­scape. It's as if we were just trans­ported to the men­tal­ity that pre­vailed this time last year. Below we chart out the YoY trend in core capex orders on a quar­terly basis ... the pace has slowed now for six quar­ters in a row.

The peak was 20.8% in the sec­ond quar­ter of 2010, but then again, that com­par­i­son was skewed by com­ing off the depressed 2009 base. In Q4 of last year, the trend mod­er­ated to 7.3% from 9.5% in Q3, to actu­ally stand at its low­est level since the end of 2009. Food for thought.

Maybe the econ­omy seems to be doing bet­ter because we have all adjusted our expec­ta­tions so rad­i­cally after being dis­ap­pointed for so long — I mean — take 2011 as an exam­ple. A year that would nor­mally see 5% real GDP growth for this stage of the cycle came in at a woe­ful 1.7%. This, despite a $3 tril­lion Fed bal­ance sheet (triple its nor­mal size), zero per­cent pol­icy rates now for three years and now going on year num­ber four of $1 trillion-plus fis­cal deficits. Based on all this stim­u­lus, if this were a nor­mal post-recession recov­ery, GDP growth would be 8% right now, not sub-2!!

RISKS LOOMING BIG TIME

I remain amazed at how the con­sen­sus eco­nom­ics com­mu­nity is so cer­tain the U.S. econ­omy has sud­denly hit escape veloc­ity ... again! The econ­omy is on major duty life-support and yet the reces­sion, we are told, ended nearly three years ago. And the best the econ­omy can do is a trail­ing GDP trend of 1.7%. Go fig­ure. Hous­ing has bot­tomed, we are also told. No kid­ding? From a real GDP stand­point, res­i­den­tial con­struc­tion has actu­ally con­tributed to head­line growth for three quar­ters in a row, and over­all growth was still tepid.

In any event, in terms of peak con­tri­bu­tion, it's prob­a­bly over. And yet econ­o­mists talk about this as if it's new and not already priced into the mar­ket. Of course auto sales are doing fine and this is a heck of a model year—this is an area where an argu­ment can be made that there is some pent-up demand. But what is inter­est­ing is that miles dri­ven are down nearly 1% on a YoY basis — buy more cars, drive them less. But autos are just 10% of total con­sumer spend­ing on goods and the improv­ing trend here masks a seri­ous decel­er­a­tion in ser­vice expen­di­tures, which rep­re­sent the bulk of house­hold outlays.

One wild card is gaso­line prices which are on a ris­ing trend. Four bucks by May looks real­is­tic and that alone would siphon around $70 bil­lion from con­sumer pock­et­books right into the gas tank. Cap­i­tal spend­ing growth is fol­low­ing the pace of cor­po­rate prof­its on a down­ward trend to boot. The boost from inven­tory accu­mu­la­tion is behind us. Gov­ern­ments are bent on aus­ter­ity — that remains a sec­u­lar theme. The biggest hur­dle ahead: the hit to the econ­omy from a widen­ing trade deficit. The num­bers out for Decem­ber we saw on Fri­day were the thin edge of the wedge — that widen­ing occurred for dif­fer­ent rea­sons (inventory-induced import boom). Wait until the Euro­pean reces­sion and Asian slow­down hits the export sector.

Tags: Avail, Balance Sheet, Big Time, Broken Watch, David Rosenberg, Dogma, Dominant Features, Employment Report, Fiscal Deficits, GDP Growth, Gundlach, Laurels, Mentality, Perceptions, Q3, Q4, Quarterly Basis, Real Gdp, Size Zero, Trillion
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