I have been reading a lot about the growing concern over US$1 trillion dollar deficits. Latest, the Stanford professor John Taylor, creator of the famous Taylor rule, argued in a rather alarming op-ed in the Financial Times this week that the risk posed by this debt is systematic and could do more damage to the economy than the recent financial crisis.
From the projected US$1.2 trillion by the Congressional Budget Office in 2019, income tax revenue are expected to be about $2 trillion, so a permanent 60% across the board tax increase would be required to balance the book.
Clearly to any sound mind, this will not and should not happen. The next question is how else can debt service payments be bought down as a share of GDP? Inflation will do that!
To bring the debt-to-GDP ratio down to the same level at the end of 2008 would take a doubling of prices. That 100% increase would make nominal GDP as high and thus cut the debt-to-GDP ratio in half, back to 41% from 82%. I know the math sounds complicated, and in a lay-man terms, I am arguing for a 10% inflation rate for 10 years period in time.
Issue is that we may see return of great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years and a successively higher inflation rate after each recession. While a large tax increase would keep the economy from crisis and collapse, it is not without very serious consequences. It will put a serious crimp in economic growth.
Is Obama give lip service in cutting the deficit in half? I am seeing that this is a very dangerous path and one that bond market seems to be concerned about, as interest rates are rising, even on mortgages that the Federal Reserve is buying in massive quantities in its effort to hold down rates and stimulate the housing market.
Home prices are still free-fall and they are down almost 19% yoy and 32% from their 2006 highs and if we get back to the long-term price growth trend, we could see another average 10% drop, and as prices tend to overshoot on the upside and the downside, in some markets, they could fall even further. While house sales are still quite depressed, what are selling are homes in foreclosure as buyers perceive that there are bargains and they are right! However, on the negative side, the supply of homes available for sale is again rising as more and more foreclosures come onto the market!
Sunday, May 31, 2009
Monday, May 25, 2009
Green Shoots?
Green shoots are springing everywhere and the stock market has managed to claw its way higher since early March. I am not too sure if this green shoots can just as easily turn into wilting weeks again this summer?
Over the past 9 weeks, the market rally, as correctly predicted as early as January 2009, is leaving many investors frustrated and bewildered. I see this just another bear market bounce and I wonder what on earth investors are thinking even though some recent data has improved but it is still too early to be optimistic as the cold and hard facts present themselves.
10 of America’s largest banks are coming up short and must raise at least US$75bn in capital they desperately need to survive. Mind you that this number is derived after the government did everything possible it could to lower the bar to allow more banks to step over the stress test hurdle. So far, more than 500 US banks have already received nearly US$200bn in government hand-outs.
The back-to-back GDP declines of -6% annually for 1Q2009 and 4Q2008 are not only the worst in decades, but they are also worse than the worst-case scenario used in government stress tests, which forecasts a -3.3% annual GDP decline this year.
The decline in US home prices still alarming, down nearly a third from their peak in 2006 and even worse, a record 5.4 mn Americans are delinquent on their mortgage loans or already in foreclosure. One in five homeowners is already under water. 20 mn Americans nationwide now owe more on their mortgage loans than their homes are worth, which doesn’t inspire much confidence, I believe.
So, anyone who still thinks the worst is over and the recent green shoots will lead to sustainable recovery soon, may want to think again. Don’t let Wall Street pundits brain wash you that they are reacting to the much anticipated ‘V-shaped’ recovery patterns.
I firmly think that the current rally is consistent with the historical pattern of the long-term secular bear markets of the past and it is what I anticipate for this one as well.
Market is now trading at normalized P/E of 15.6x – certainly not cheap and at the end of previous secular bear markets in the 1940s, 1970s and early1980s, the normalized P/E ratio frequently fell below 10 and sometimes even lower.
So, don’t ignore the lessons of the past!
Over the past 9 weeks, the market rally, as correctly predicted as early as January 2009, is leaving many investors frustrated and bewildered. I see this just another bear market bounce and I wonder what on earth investors are thinking even though some recent data has improved but it is still too early to be optimistic as the cold and hard facts present themselves.
10 of America’s largest banks are coming up short and must raise at least US$75bn in capital they desperately need to survive. Mind you that this number is derived after the government did everything possible it could to lower the bar to allow more banks to step over the stress test hurdle. So far, more than 500 US banks have already received nearly US$200bn in government hand-outs.
The back-to-back GDP declines of -6% annually for 1Q2009 and 4Q2008 are not only the worst in decades, but they are also worse than the worst-case scenario used in government stress tests, which forecasts a -3.3% annual GDP decline this year.
The decline in US home prices still alarming, down nearly a third from their peak in 2006 and even worse, a record 5.4 mn Americans are delinquent on their mortgage loans or already in foreclosure. One in five homeowners is already under water. 20 mn Americans nationwide now owe more on their mortgage loans than their homes are worth, which doesn’t inspire much confidence, I believe.
So, anyone who still thinks the worst is over and the recent green shoots will lead to sustainable recovery soon, may want to think again. Don’t let Wall Street pundits brain wash you that they are reacting to the much anticipated ‘V-shaped’ recovery patterns.
I firmly think that the current rally is consistent with the historical pattern of the long-term secular bear markets of the past and it is what I anticipate for this one as well.
Market is now trading at normalized P/E of 15.6x – certainly not cheap and at the end of previous secular bear markets in the 1940s, 1970s and early1980s, the normalized P/E ratio frequently fell below 10 and sometimes even lower.
So, don’t ignore the lessons of the past!
Sunday, May 24, 2009
Who is Robert Prechter?
I don’t know him and have not seen in person before, but I have been following his works over the last 12 years. Robert has been in forecasting business in the last 30 years and has run an investment company based on the Elliot Wave Theory, propounded in 1948 by Ralph Nelson Elliot.
In 1981-82, in the bear market days with Dow of around 800 at that time, he predicted that the US stock market was about to enter a huge uptrend, which might last as long as 20 years and for which 3,000 on the Dow was only the first stage. It was considered bullish, which would have been 15% above the index’s all-time peak set in 1972.
But Robert was right!
He was again right in 1987, when he forecasted the sharp bull run of that year would end but that pull back would be only a temporary problem before the market went on to greater things.
In the late 1990s, Robert turned bearish, explaining that the ‘fifth wave’ of an Elliot Wave cycle, and therefore the bull market was coming to an end. He was a few years early but by following his advice after about 1998 you would have avoided a decade in which your money made an all-in return of approximately zero.
He even managed to call this year’s March bottom, expecting a substantial bear market rally at around 6,300 on the Dow. However, he expects the market to resume its downtrend trend shortly, ending with a decline similar to the 86% in real terms of 1929-32 as we are in a long Elliot Wave downswing – and that would take Dow down to around 2,000 level.
Personally, I would not go that far, but the downward macroeconomic momentum looks bigger than in either 1974 or 1982 bear markets that bought real-term drops of slightly more than 50% from previous highs. I see similarity to the British crisis of 1972/75, which caused a drop of 72% from the high, or the Japanese crisis after 1990, which bought a drop of 70% within three years and led to a long-term bear market that has left that market in its current doldrums, about 80% below its peak. If that being translated to Dow, it will be around 4,400 and at that point, it would about as cheap as after the 1987 crash, though still not as cheap as it was in 1982, before the great bull market began.
In 1981-82, in the bear market days with Dow of around 800 at that time, he predicted that the US stock market was about to enter a huge uptrend, which might last as long as 20 years and for which 3,000 on the Dow was only the first stage. It was considered bullish, which would have been 15% above the index’s all-time peak set in 1972.
But Robert was right!
He was again right in 1987, when he forecasted the sharp bull run of that year would end but that pull back would be only a temporary problem before the market went on to greater things.
In the late 1990s, Robert turned bearish, explaining that the ‘fifth wave’ of an Elliot Wave cycle, and therefore the bull market was coming to an end. He was a few years early but by following his advice after about 1998 you would have avoided a decade in which your money made an all-in return of approximately zero.
He even managed to call this year’s March bottom, expecting a substantial bear market rally at around 6,300 on the Dow. However, he expects the market to resume its downtrend trend shortly, ending with a decline similar to the 86% in real terms of 1929-32 as we are in a long Elliot Wave downswing – and that would take Dow down to around 2,000 level.
Personally, I would not go that far, but the downward macroeconomic momentum looks bigger than in either 1974 or 1982 bear markets that bought real-term drops of slightly more than 50% from previous highs. I see similarity to the British crisis of 1972/75, which caused a drop of 72% from the high, or the Japanese crisis after 1990, which bought a drop of 70% within three years and led to a long-term bear market that has left that market in its current doldrums, about 80% below its peak. If that being translated to Dow, it will be around 4,400 and at that point, it would about as cheap as after the 1987 crash, though still not as cheap as it was in 1982, before the great bull market began.
Wednesday, May 20, 2009
US – Deeper Budgetary Hole
April is usually a windfall month for the Federal Treasury, with big budget surpluses the norm as money floods in. However, for the first time since 1983 the Treasury ran a deficit in April. It racked up $20.9 billion in red ink - worse than the Congressional Budget Office had forecast. This was a huge shift from a year earlier, when Treasury recorded a surplus of $159.3 billion.
In short, Uncle Sam spent money he didn't have! And, you don't need a Ph.D. in economics to know that's a recipe for disaster.
The budget deficit for the current fiscal year is now running at $802.3 billion. That compares to $153.5 billion this time last year. The administration was just forced to raise its 2009 budget deficit estimate to $1.84 trillion, up 5 percent from the outlook it shared just two months earlier. And the 2010 deficit estimate jumped 7.4 percent to $1.26 trillion. This means we're running a deficit equal to a whopping 12.9 percent of the U.S. economy ... the highest in 64 years!
I keep harping on these budget points because I'm convinced they have longer-term implications for the economy and interest rates. Investors may already be starting to rebel, in fact. The latest $14-billion auction of 30-year bonds bombed. Bidding was relatively weak and the Treasury had to offer much higher-than-expected interest rates to get buyers to step up to the plate. The government will have to sell $2.4 trillion in new bills, notes and bonds in fiscal 2009, according to UBS.
It causes interest rates to be higher than they otherwise would be, which may induce the American people to save more and foreigners to move funds into the United States. Capital-intensive industries may contract in the United States but expand wherever capital continues to be formed. American wage rates may fall while some foreign rates continue to rise. When foreign investors finally conclude that they have enough dollar liquidity and enough investments in the United States, the dollar must fall.
Hopefully some semblance of budgeting sanity will return to Washington ... before it's too late! You have a Congress that’s lost its fear of deficits, so it’s still going to be hard to turn the deficit around once the economy and tax receipts have recovered. Everyone is so interested calling the turn in the economy that they are missing the actual developments. It tells me a systemic risk event is coming simply from the projected federal deficit alone.
In short, Uncle Sam spent money he didn't have! And, you don't need a Ph.D. in economics to know that's a recipe for disaster.
The budget deficit for the current fiscal year is now running at $802.3 billion. That compares to $153.5 billion this time last year. The administration was just forced to raise its 2009 budget deficit estimate to $1.84 trillion, up 5 percent from the outlook it shared just two months earlier. And the 2010 deficit estimate jumped 7.4 percent to $1.26 trillion. This means we're running a deficit equal to a whopping 12.9 percent of the U.S. economy ... the highest in 64 years!
I keep harping on these budget points because I'm convinced they have longer-term implications for the economy and interest rates. Investors may already be starting to rebel, in fact. The latest $14-billion auction of 30-year bonds bombed. Bidding was relatively weak and the Treasury had to offer much higher-than-expected interest rates to get buyers to step up to the plate. The government will have to sell $2.4 trillion in new bills, notes and bonds in fiscal 2009, according to UBS.
It causes interest rates to be higher than they otherwise would be, which may induce the American people to save more and foreigners to move funds into the United States. Capital-intensive industries may contract in the United States but expand wherever capital continues to be formed. American wage rates may fall while some foreign rates continue to rise. When foreign investors finally conclude that they have enough dollar liquidity and enough investments in the United States, the dollar must fall.
Hopefully some semblance of budgeting sanity will return to Washington ... before it's too late! You have a Congress that’s lost its fear of deficits, so it’s still going to be hard to turn the deficit around once the economy and tax receipts have recovered. Everyone is so interested calling the turn in the economy that they are missing the actual developments. It tells me a systemic risk event is coming simply from the projected federal deficit alone.
Tuesday, May 19, 2009
China Field Visit 3 – When Will the Music Stop?
I could sense optimism among Chinese. I was told last year was the worst but a big thank to strong stimulus injection by the government, pessimism turned optimism by a click of finger. China's loan growth reached a 55-month high in December 2008 and China's commitment to a loose monetary policy will likely generate as much as 8 trillion yuan (US$1.17 trillion) in new loans this year - well above the 5 trillion yuan target.
Though the expanded credit could help turn around declining economic growth, some analysts are seeing potential pitfalls on the horizon. The surge in loans together with expected strong growth in investment by the government and businesses will challenge the country's ability to combat asset bubbles and industrial overcapacity. It will also put greater pressure on the long-term credit quality of the commercial banks.
China will maintain a relaxed monetary policy and ensure sufficient liquidity in the banking system to sustain economic growth, the People's Bank of China said. The central bank won't tighten in the second quarter or even in the third. That means credit growth can hit 7 trillion to 8 trillion yuan this year.
Having said that there are signs that loans growth may ease – credit extended by China's banks in April have dropped to above 600 billion yuan (about 87.85 billion U.S. dollars) after staying at above 1 trillion yuan for three straight months. Short-term loan balances contracted for the first time since November 2008 and that could be due to write-offs or banks are not rolling over some of the shorter term working capital loans. This, I believe, that 1Q09’s strong growth was not sustainable.
Chinese regulators are investigating some of the nation's largest banks to see whether the recent boom in lending has included illegal loans for stock speculation. The Shanghai Composite is one of the best performing indexes in the world so far in 2009, with gains of nearly 40% under its belt. China Banking Commission Regulatory Commission Vice Chairman Jiang Dingzhi told the state-run Shanghai Securities Journal there were concerns about the surge in lending and that the regulator was ready to issue warnings.
Though the expanded credit could help turn around declining economic growth, some analysts are seeing potential pitfalls on the horizon. The surge in loans together with expected strong growth in investment by the government and businesses will challenge the country's ability to combat asset bubbles and industrial overcapacity. It will also put greater pressure on the long-term credit quality of the commercial banks.
China will maintain a relaxed monetary policy and ensure sufficient liquidity in the banking system to sustain economic growth, the People's Bank of China said. The central bank won't tighten in the second quarter or even in the third. That means credit growth can hit 7 trillion to 8 trillion yuan this year.
Having said that there are signs that loans growth may ease – credit extended by China's banks in April have dropped to above 600 billion yuan (about 87.85 billion U.S. dollars) after staying at above 1 trillion yuan for three straight months. Short-term loan balances contracted for the first time since November 2008 and that could be due to write-offs or banks are not rolling over some of the shorter term working capital loans. This, I believe, that 1Q09’s strong growth was not sustainable.
Chinese regulators are investigating some of the nation's largest banks to see whether the recent boom in lending has included illegal loans for stock speculation. The Shanghai Composite is one of the best performing indexes in the world so far in 2009, with gains of nearly 40% under its belt. China Banking Commission Regulatory Commission Vice Chairman Jiang Dingzhi told the state-run Shanghai Securities Journal there were concerns about the surge in lending and that the regulator was ready to issue warnings.
Monday, May 18, 2009
China Field Visit 2 – Property Prices
Kwang-tung or broadly interpreted as the Broad East, is the province Western traders visited it as early as sixteen hundred years ago, and for centuries it was the only point of contact between China and other countries.
From my first visit point from Nan-hai, Zhong-san, Hua-du and Kwang-chow, I see no apparent sign of slow-down in property development in this province. I am not too sure if this is a sign of over-heating either even though the prices have climbed to a level that far exceeded local earnings power. Majority are still earning less than RMB1,500 with a wage floor of RMB790, a law rarely observed. Prices are “still not affordable for ordinary people,” four government agencies said in a joint statement. “The key to revitalizing the real-estate market is to set reasonable prices,” the housing ministry, finance ministry, central bank and the National Development and Reform Commission said.
My conversation with couple of people in Zhong-san in particular, reveals that Kwang-tung’s property market rebounded in the first quarter with expanding transaction volumes. Developers are taking the opportunity to raise prices, yet higher prices yet to dampen demand. I was told that residential property sales are strong, though the commercial market remained weak, with sales of office property down.
I wonder who are the buyers? In the early 2008 bubbling property market, authorities conveyed to potential house buyers that they would be wise to hold off. Now the government is telling them it's not just okay to buy, it would be a great time to buy and the banks will be happy to lend to you. A series of supportive measures, combined with aggressive interest rate cuts and accelerated price reductions from October have begun to lure some Chinese homebuyers from the sidelines, bringing higher transaction volumes in the recent months.
Cities like Shanghai, Guangzhou, Shenzhen, and Beijing are awash again in a sea of cranes and high-rise building construction. While the correction in the Chinese real estate market may not be over, numerous fundamental issues will create one of the most lucrative investment opportunities that we have seen in recent times. The Chinese government has already fired the first salvo with a $585 billion infrastructure stimulus package, equal to 20% of total GDP in 2008.
Also to note that Chinese banks do not have the exposure to sub-prime loans and toxic debt that other markets have. In fact, the exact opposite is true as Chinese banks typically demand a 30% down payment for residential property and up to 50% for commercial property.
The demand for housing in China far outstrips supply with an estimated shortfall of 6.8 million units. This stands in stark contrast to the U.S., where 20 million homes stand empty. I see opportunity if we skewed the investment strategy to be more heavily weighted toward multifamily, mid-tier residential developments as opposed to commercial.
From my first visit point from Nan-hai, Zhong-san, Hua-du and Kwang-chow, I see no apparent sign of slow-down in property development in this province. I am not too sure if this is a sign of over-heating either even though the prices have climbed to a level that far exceeded local earnings power. Majority are still earning less than RMB1,500 with a wage floor of RMB790, a law rarely observed. Prices are “still not affordable for ordinary people,” four government agencies said in a joint statement. “The key to revitalizing the real-estate market is to set reasonable prices,” the housing ministry, finance ministry, central bank and the National Development and Reform Commission said.
My conversation with couple of people in Zhong-san in particular, reveals that Kwang-tung’s property market rebounded in the first quarter with expanding transaction volumes. Developers are taking the opportunity to raise prices, yet higher prices yet to dampen demand. I was told that residential property sales are strong, though the commercial market remained weak, with sales of office property down.
I wonder who are the buyers? In the early 2008 bubbling property market, authorities conveyed to potential house buyers that they would be wise to hold off. Now the government is telling them it's not just okay to buy, it would be a great time to buy and the banks will be happy to lend to you. A series of supportive measures, combined with aggressive interest rate cuts and accelerated price reductions from October have begun to lure some Chinese homebuyers from the sidelines, bringing higher transaction volumes in the recent months.
Cities like Shanghai, Guangzhou, Shenzhen, and Beijing are awash again in a sea of cranes and high-rise building construction. While the correction in the Chinese real estate market may not be over, numerous fundamental issues will create one of the most lucrative investment opportunities that we have seen in recent times. The Chinese government has already fired the first salvo with a $585 billion infrastructure stimulus package, equal to 20% of total GDP in 2008.
Also to note that Chinese banks do not have the exposure to sub-prime loans and toxic debt that other markets have. In fact, the exact opposite is true as Chinese banks typically demand a 30% down payment for residential property and up to 50% for commercial property.
The demand for housing in China far outstrips supply with an estimated shortfall of 6.8 million units. This stands in stark contrast to the U.S., where 20 million homes stand empty. I see opportunity if we skewed the investment strategy to be more heavily weighted toward multifamily, mid-tier residential developments as opposed to commercial.
Sunday, May 17, 2009
China Field Visit 1 – An Overview
I was at Kwang-tung province, China and visited more than 15 factories and entertainment centres. One common message that I gathered is that the worst is over and business orders are picking up. Prices of hotels, foods and entertainments are rising – largely attributable to government spending.
Focus has largely shifted to local markets. Exports in April down 22.6% compared to -17.1% in the month before, so the expected inventory shift isn’t lifting China yet. However, fixed asset investment (FAI) is super-strong. A friend of mine in Zhong-san told me that he is super-bullish and is preparing for its seventh factory opening in the next couple of months. FAI of 30.5% year-to-date is actually 34% in April – the strongest since early 2004. This is decoupling: exports collapse but domestic demand actually accelerates on the back of strong government spending and more than 30% rise in loan growth.
My conversation with some retailers, however, reveals that retail sales are growing fast, but top-line growth has been at the expense of margins – bottom-line growth for retailers can be a very different story. It is no surprise to me when I reading local papers. In one conversation with a local graduate, I was told that finding job for new entrants like him is tough and there are too many people. Yu Yondding of the China Academy of Social Sciences says the Chinese economy must grow between 8 to 9% annually to absorb the 24 million new workers who enter the labor force each year. Of the 5.5 million university graduates this year, 800,000 have yet to find work, according to Xinhua, the state news service. The labor market in China is getting increasingly competitive, with more job hunters than vacancies.
Beijing takes next step in boosting domestic spending. The plan to allow non-deposit taking companies with at least $12bn in asset to issue consumer loans moves a step closer to implementation. With other on-going reforms in the banking sector and the relatively low penetration rate of China’s consumer credit business, I think the economic and commercial potential for this channel of credit expansion is huge.
Focus has largely shifted to local markets. Exports in April down 22.6% compared to -17.1% in the month before, so the expected inventory shift isn’t lifting China yet. However, fixed asset investment (FAI) is super-strong. A friend of mine in Zhong-san told me that he is super-bullish and is preparing for its seventh factory opening in the next couple of months. FAI of 30.5% year-to-date is actually 34% in April – the strongest since early 2004. This is decoupling: exports collapse but domestic demand actually accelerates on the back of strong government spending and more than 30% rise in loan growth.
My conversation with some retailers, however, reveals that retail sales are growing fast, but top-line growth has been at the expense of margins – bottom-line growth for retailers can be a very different story. It is no surprise to me when I reading local papers. In one conversation with a local graduate, I was told that finding job for new entrants like him is tough and there are too many people. Yu Yondding of the China Academy of Social Sciences says the Chinese economy must grow between 8 to 9% annually to absorb the 24 million new workers who enter the labor force each year. Of the 5.5 million university graduates this year, 800,000 have yet to find work, according to Xinhua, the state news service. The labor market in China is getting increasingly competitive, with more job hunters than vacancies.
Beijing takes next step in boosting domestic spending. The plan to allow non-deposit taking companies with at least $12bn in asset to issue consumer loans moves a step closer to implementation. With other on-going reforms in the banking sector and the relatively low penetration rate of China’s consumer credit business, I think the economic and commercial potential for this channel of credit expansion is huge.
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