The Conference Board’s Leading Economic Index (LEI) continued to rise – the tenth consecutive rise in January 2010. Five of the ten components made positive contributions and on year-on-year basis, it rose from 6.7% in November 2009 to 8.1% in December and to a very healthy 8.7% in January 2010 – is approaching a high level by historical standing.
Having said that I note that six-month percentage change has weakened from 6.2% in December 2009 to 4.8% in January 2010 – what does all of this mean?
While the big economic picture is still looking good, the bounce will probably continue for a least another two quarters, thus supporting a continuation of the medium-term stock market rally. But thereafter the outlook isn’t so bright.
When look deeper into beneath the surface of the Leading Economic Index, the picture is becoming even more ominous, especially the contribution of the positive spread between short-term and long-term interest rates. Without it, the index would have been down 0.1% last month. There is nothing wrong with long-term rate moving higher than short-term rates, but in a post-bubble world, monetary policy has much less traction than under normal conditions. If too much debt and too many bad loans are weighing on the banking sector’s balance sheet, monetary policy becomes a rather toothless tiger.
It is very important to watch the particulars of the LEI. I think the weakening in the six-month rate of the LEI has to be treated as a first warning sign. A warning sign telling us that the economy is not on a durable growth path. A warning sign that the second half of this year may become very disappointing.
Sunday, February 28, 2010
China – Time to Get Worry
For now, the global financial markets are taking cues from three key themes. Firstly, sovereign debt problems with the saga surrounding Greece’s finances that has created tremors in the European monetary union. Secondly, China tightening credit given the massive surge of new loans in the first half of January 2010, fearing a bubble burst of its own. Thirdly, Fed’s exit strategy with its move in the discount rate last week, as part of its first active step toward reversing its emergency policies.
This, in turn, is keeping the dollar on solid footing and keeping pressure on European currencies and those currencies that are dependent upon sustained growth and demand from China – the AUD, NZD and BRL. The sentiment shift has taken place when it comes to the recovery prospects for global economies. More worrying is the bigger threat that will likely come from growing trade tensions between China and the rest of the world.
Over the last 14 years, China’s economy has grown a whopping eight-fold to US$4.9 trillion and has quickly ascended to become the world’s third largest economy, which normally among other will be reflected in a much stronger Chinese currency. Over the same period of time, Chinese currency has only strengthened 18% - a mere drop in the bucket. And that is where tensions are threatening to boll over.
On the purchasing power basis, the Chinese currency is 40-50% too cheap to US dollar. Against the Japanese yen, it is 26% undervalued, 37% against Korean Won, 50% against AUD, 27% against Rubble, 12-13% against MYR and SGD, according to IMF estimates. In a lay man explanation, it would cost 12-13% more to import identical goods from Malaysia and Singapore than it would from China.
Consequently, the G-20 has made Chinese currency policy its number one agenda under the code word ‘rebalancing’. As it becomes increasingly evident that China will not play ball on allowing its currency to appreciate to a fair value, one could expect the geopolitical tensions to rise and expect to see two forms of protectionism to follow – trade tariffs and currency devaluations against major currencies, to which the value of the Remenbi is primarily linked.
I continue to think that safety and capital preservation will re-emerge as the prime driver of capital flows around the world towards the US dollar.
This, in turn, is keeping the dollar on solid footing and keeping pressure on European currencies and those currencies that are dependent upon sustained growth and demand from China – the AUD, NZD and BRL. The sentiment shift has taken place when it comes to the recovery prospects for global economies. More worrying is the bigger threat that will likely come from growing trade tensions between China and the rest of the world.
Over the last 14 years, China’s economy has grown a whopping eight-fold to US$4.9 trillion and has quickly ascended to become the world’s third largest economy, which normally among other will be reflected in a much stronger Chinese currency. Over the same period of time, Chinese currency has only strengthened 18% - a mere drop in the bucket. And that is where tensions are threatening to boll over.
On the purchasing power basis, the Chinese currency is 40-50% too cheap to US dollar. Against the Japanese yen, it is 26% undervalued, 37% against Korean Won, 50% against AUD, 27% against Rubble, 12-13% against MYR and SGD, according to IMF estimates. In a lay man explanation, it would cost 12-13% more to import identical goods from Malaysia and Singapore than it would from China.
Consequently, the G-20 has made Chinese currency policy its number one agenda under the code word ‘rebalancing’. As it becomes increasingly evident that China will not play ball on allowing its currency to appreciate to a fair value, one could expect the geopolitical tensions to rise and expect to see two forms of protectionism to follow – trade tariffs and currency devaluations against major currencies, to which the value of the Remenbi is primarily linked.
I continue to think that safety and capital preservation will re-emerge as the prime driver of capital flows around the world towards the US dollar.
Tuesday, February 23, 2010
8 Watch Lists for 2010
When it comes to economic indicators, the list is almost endless. One economic indicator follows another, filling an entire calendar - weekly, monthly, quarterly, and annually.
On the specific day an indicator is announced, it seems to be the biggest deal going with commentators’ comment, pundits pontificate, analysts and economics analyze, predict and forecast, and financial markets around the world react - often violently. The next day brings a new batch of indicator reports. Yesterday is forgotten as the frenetic cycle plays itself out all over again.
Given this pattern, it's not surprising that the economic-indicator game seems confusing - and perhaps even pointless. In the eyes of many investors, the only thing these indicators seem to "indicate" about the economy is that it can be highly confusing and extremely difficult to predict.
Question - what do they all mean - and which indicators are truly important? Importance of these key variables depends on its relationship to the business cycle, frequency and its timing relative to overall economic activity. The timing value of various indicators can be classified in three ways. "Leading" indicators are the most important, because they tend to move ahead of the overall economy, providing investors with clues about what's coming next.
In most cases, the true predictive value of any specific indicator comes not from a single reading, but from the progression of numbers it posts over time, thereby establishing trends and making key turning points easier to recognize and act on. In singling out his favorite indicators, I place particular emphasis on trends, noting that progressive analysis of major economic conditions is the key to recognizing long-term investment opportunities. These "essential eight" are the indicators every investor needs to understand and watch if they want to be successful.
Firstly, long term growth in national productivity. Secondly, inflation rate compared to short-term interest rates. Thirdly, trends in the balance of payment and international debt levels. Fourthly, trends in the domestic budget balance and levels of public debt. Fifth, government spending as a percentage of GDP. Sixth, actual GDP growth. Seventhly, consumer sentiment and lastly, the savings rate. Simply put, the higher the savings rate, the better the outlook is for the long haul. More savings means there will be more money available for consumption and investment in the future, both of which tend to provide an overall economic boost.
Obviously, all of these indicators are subject to interpretation (that's why they're called "indicators," rather than "absolutes"). The economy can also be a very contrary creature, often defying both logic and reason. However, the more of these indicators you find showing positive (or negative) readings, the greater the odds you'll be correct when making your own personal economic and investment decisions.
On the specific day an indicator is announced, it seems to be the biggest deal going with commentators’ comment, pundits pontificate, analysts and economics analyze, predict and forecast, and financial markets around the world react - often violently. The next day brings a new batch of indicator reports. Yesterday is forgotten as the frenetic cycle plays itself out all over again.
Given this pattern, it's not surprising that the economic-indicator game seems confusing - and perhaps even pointless. In the eyes of many investors, the only thing these indicators seem to "indicate" about the economy is that it can be highly confusing and extremely difficult to predict.
Question - what do they all mean - and which indicators are truly important? Importance of these key variables depends on its relationship to the business cycle, frequency and its timing relative to overall economic activity. The timing value of various indicators can be classified in three ways. "Leading" indicators are the most important, because they tend to move ahead of the overall economy, providing investors with clues about what's coming next.
In most cases, the true predictive value of any specific indicator comes not from a single reading, but from the progression of numbers it posts over time, thereby establishing trends and making key turning points easier to recognize and act on. In singling out his favorite indicators, I place particular emphasis on trends, noting that progressive analysis of major economic conditions is the key to recognizing long-term investment opportunities. These "essential eight" are the indicators every investor needs to understand and watch if they want to be successful.
Firstly, long term growth in national productivity. Secondly, inflation rate compared to short-term interest rates. Thirdly, trends in the balance of payment and international debt levels. Fourthly, trends in the domestic budget balance and levels of public debt. Fifth, government spending as a percentage of GDP. Sixth, actual GDP growth. Seventhly, consumer sentiment and lastly, the savings rate. Simply put, the higher the savings rate, the better the outlook is for the long haul. More savings means there will be more money available for consumption and investment in the future, both of which tend to provide an overall economic boost.
Obviously, all of these indicators are subject to interpretation (that's why they're called "indicators," rather than "absolutes"). The economy can also be a very contrary creature, often defying both logic and reason. However, the more of these indicators you find showing positive (or negative) readings, the greater the odds you'll be correct when making your own personal economic and investment decisions.
Saudi’s New Friend
Saudi Arabia, the world's largest oil producer, last year shipped more oil to China than it did the United States for the first time ever. The flow of oil from Saudi Arabia to China rose to more than 1 million barrels per day (bpd) last year, just as demand in the United States fell below that level for the first time in more than two decades. The US has been moving away from fossil fuels for years, a trend that will only accelerate with the current administration.
China in December alone imported a record-high 1.2 million bpd of Saudi oil, as its economy rode the momentum of Beijing's $585 billion (2 trillion yuan) stimulus package. U.S. imports of Saudi oil, on the other hand, fell to a 22-year low of 998,000 bpd in the first 11 months of 2009, as the world's largest oil consumer clawed its way back from its worst recession in 70 years. One point to note, however, is that the US is now getting most of its oil from Canada and that overall oil consumption in China still pales in comparison to America…7.8 billion b/d to 19.5 billion b/d, even though they have more than four times the population.
On top of that, China last year supplanted the United States as the world's largest auto market with 13.6 million vehicles sold. Roughly 10.4 million light vehicles were sold in the United States in 2009 - the lowest total since 1982 and a 21% decline from 2008.
Saudi Arabia has reacted by striking new refining deals with Beijing and moving storage facilities from the Caribbean to Japan.
Saudi Arabian Oil Co. (Saudi Aramco), the world's biggest crude producer, already owns a 25% interest in a refinery in China's Fujian province, and is in talks with China Petroleum & Chemical Corp. to take a stake in a 200,000 bpd plant in Shandong.
China and Saudi Arabia aim to boost trade 50% to $60 billion by 2015, the state-owned Saudi Press Agency reported last month, citing Chinese Trade Minister Chen Deming. As global demand has been picking up in the east... Saudi Arabia has been looking east.
China in December alone imported a record-high 1.2 million bpd of Saudi oil, as its economy rode the momentum of Beijing's $585 billion (2 trillion yuan) stimulus package. U.S. imports of Saudi oil, on the other hand, fell to a 22-year low of 998,000 bpd in the first 11 months of 2009, as the world's largest oil consumer clawed its way back from its worst recession in 70 years. One point to note, however, is that the US is now getting most of its oil from Canada and that overall oil consumption in China still pales in comparison to America…7.8 billion b/d to 19.5 billion b/d, even though they have more than four times the population.
On top of that, China last year supplanted the United States as the world's largest auto market with 13.6 million vehicles sold. Roughly 10.4 million light vehicles were sold in the United States in 2009 - the lowest total since 1982 and a 21% decline from 2008.
Saudi Arabia has reacted by striking new refining deals with Beijing and moving storage facilities from the Caribbean to Japan.
Saudi Arabian Oil Co. (Saudi Aramco), the world's biggest crude producer, already owns a 25% interest in a refinery in China's Fujian province, and is in talks with China Petroleum & Chemical Corp. to take a stake in a 200,000 bpd plant in Shandong.
China and Saudi Arabia aim to boost trade 50% to $60 billion by 2015, the state-owned Saudi Press Agency reported last month, citing Chinese Trade Minister Chen Deming. As global demand has been picking up in the east... Saudi Arabia has been looking east.
Monday, February 22, 2010
Armageddon of Debt
If Wall Street’s debt crisis was traumatic, wait until you see the blow-out of Washington’s debt crisis. Never before has the US debt been financed so massively by foreign investors. Once Mexico, Spain and Argentina accumulated so much debt, they were forced to default.
In the 20th Century, a similar fate befell Germany in 1932, China in 1939, Turkey in 1978, Mexico again in 1982, Brazil and Philippines in 1983, South Africa in 1985, and latest Russia and Pakistan in 1998. Argentina kicked of the 21st century with a default in 2001.
One striking difference of these examples versus the debt crisis striking a dominant world power is that the debts of these examples represent little more than a small fraction of the total debts outstanding worldwide. Not so in our case today!
The US government and its agencies have, by far, the largest pile-up of interest bearing debts (US$15.6 trillion), the largest accumulation of unsecured obligations over US$60 trillion, the largest yearly deficit of US$1.6 trillion and the greatest indebtedness to the rest of the world of US$4.8 trillion.
In proportion, one could argue that Japan does have more debt than the US, but one should also note that nearly all of Japan’s are financed by its own citizens.
By implications, we cannot deny the possibility of sharply higher interest rates. Already, despite the weakest post-recession recovery in memory, bond prices are plunging and their rates are surging. Just a few weeks ago, the yield on 30-year Treasury bonds busted through a declining trend that had not been penetrated in more than 20 years. And just last week, it came within a hair of its highest level in over two years.
When Uncle Sam has to pay more to borrow, all of us inevitably have to pay more as well. Rates on mortgages and car loans will surge for simple reason that they are also tied at the hip of long term Treasury rates. Worse still for variable rate mortgages as the impact of surging interest rates will be even more traumatic.
The fledging recovery in housing and auto sales – the pride and joy of Washington’s bail out bridgades – will probably be toast. Institutions and individual investors holding piles of lower yielding long term bonds will get killed. All in all, we could suffer a chain reaction of defaults.
In the 20th Century, a similar fate befell Germany in 1932, China in 1939, Turkey in 1978, Mexico again in 1982, Brazil and Philippines in 1983, South Africa in 1985, and latest Russia and Pakistan in 1998. Argentina kicked of the 21st century with a default in 2001.
One striking difference of these examples versus the debt crisis striking a dominant world power is that the debts of these examples represent little more than a small fraction of the total debts outstanding worldwide. Not so in our case today!
The US government and its agencies have, by far, the largest pile-up of interest bearing debts (US$15.6 trillion), the largest accumulation of unsecured obligations over US$60 trillion, the largest yearly deficit of US$1.6 trillion and the greatest indebtedness to the rest of the world of US$4.8 trillion.
In proportion, one could argue that Japan does have more debt than the US, but one should also note that nearly all of Japan’s are financed by its own citizens.
By implications, we cannot deny the possibility of sharply higher interest rates. Already, despite the weakest post-recession recovery in memory, bond prices are plunging and their rates are surging. Just a few weeks ago, the yield on 30-year Treasury bonds busted through a declining trend that had not been penetrated in more than 20 years. And just last week, it came within a hair of its highest level in over two years.
When Uncle Sam has to pay more to borrow, all of us inevitably have to pay more as well. Rates on mortgages and car loans will surge for simple reason that they are also tied at the hip of long term Treasury rates. Worse still for variable rate mortgages as the impact of surging interest rates will be even more traumatic.
The fledging recovery in housing and auto sales – the pride and joy of Washington’s bail out bridgades – will probably be toast. Institutions and individual investors holding piles of lower yielding long term bonds will get killed. All in all, we could suffer a chain reaction of defaults.
Sunday, February 21, 2010
Euro in Question
Euro bulls are still beating their drums and the overall consensus was still advertising the pullback in the euro as an attractive buying opportunity. The median forecast of 43 economists by Bloomberg was calling for the euro to trade at 1.51 to the dollar by the end of March.
My main concern is that this type of market scrutiny surrounding sovereign debt can snowball quickly. These problems have a history of being contagious and spreading throughout the world. In that sense, the dollar doesn’t look so bad, while the euro looks increasingly vulnerable to a break up or at least a structural change of the monetary union. We may be seeing that this is a decisive moment for the future of the common currency.
With Portugal, Ireland, Italy and Spain all under the hot spotlight and the Greek situation worsening, European leaders stepped in last week in an attempt to stem the negative pressure on the Greek bond market and the euro. Nevertheless, a bail-out of a fellow EMU member country is a direct violation of rules set forth in the Stability and Growth Pact – the principle upon which the euro was built.
The Bank of International Settlements shows that European banks have $2.1 trillion exposure to sovereign debt of the weakest EMU countries and this exposure has been exacerbated by the European Central Bank’s answer to ‘extraordinary monetary policy’ – unlimited 1% funds for one year. What did those banks do with the money? They bought up sovereign debt of the weak-link EU members – backdoor quantitative easing.
Regardless of the outcome, the euro’s credibility has taken a major hit. This week, former executive board member of the European Central Bank, Otmar Issing, wrote an op-ed piece in the Financial Times, warned against a Greek bailout and further questioned the viability of the euro.
Then to add to the Eurozone’s problems, a controversy recently broke out exposing off-balance sheet funding that Greece engaged in through ‘special currency swap’ agreements with Goldman Sachs and other investment banks. These special currency swaps appear to have allowed Greece to hide debt to gain entry into the currency bloc in 2001. Now, several Eurozone countries are under investigation for their currency swap agreements.
In short, the global economic crisis has left the Eurozone with uneven economic performance. Some countries are recovering, many are not. With a one-size fits all monetary policy and currency, they lack critical tools to work their way out.
My main concern is that this type of market scrutiny surrounding sovereign debt can snowball quickly. These problems have a history of being contagious and spreading throughout the world. In that sense, the dollar doesn’t look so bad, while the euro looks increasingly vulnerable to a break up or at least a structural change of the monetary union. We may be seeing that this is a decisive moment for the future of the common currency.
With Portugal, Ireland, Italy and Spain all under the hot spotlight and the Greek situation worsening, European leaders stepped in last week in an attempt to stem the negative pressure on the Greek bond market and the euro. Nevertheless, a bail-out of a fellow EMU member country is a direct violation of rules set forth in the Stability and Growth Pact – the principle upon which the euro was built.
The Bank of International Settlements shows that European banks have $2.1 trillion exposure to sovereign debt of the weakest EMU countries and this exposure has been exacerbated by the European Central Bank’s answer to ‘extraordinary monetary policy’ – unlimited 1% funds for one year. What did those banks do with the money? They bought up sovereign debt of the weak-link EU members – backdoor quantitative easing.
Regardless of the outcome, the euro’s credibility has taken a major hit. This week, former executive board member of the European Central Bank, Otmar Issing, wrote an op-ed piece in the Financial Times, warned against a Greek bailout and further questioned the viability of the euro.
Then to add to the Eurozone’s problems, a controversy recently broke out exposing off-balance sheet funding that Greece engaged in through ‘special currency swap’ agreements with Goldman Sachs and other investment banks. These special currency swaps appear to have allowed Greece to hide debt to gain entry into the currency bloc in 2001. Now, several Eurozone countries are under investigation for their currency swap agreements.
In short, the global economic crisis has left the Eurozone with uneven economic performance. Some countries are recovering, many are not. With a one-size fits all monetary policy and currency, they lack critical tools to work their way out.
China is Taking Revenge
It was announced that China had sold $34.2 billion of Treasuries in December, effectively making Japan once again the largest holder of U.S. Treasuries. The battle between China and Japan for the title of largest holder of this dubious asset is not very interesting. What's more interesting is the question of where China is instead opting to invest. After all, $34.2 billion is a fair chunk of change, and China's overall reserves are growing and now total $2.4 trillion.
The People's Bank of China usually keeps its holdings a carefully guarded secret, much more so than for most central banks. However, we can make some inference from the holdings of China Investment Corp. (CIC), the country’s $200 billion sovereign wealth funds.
CIC got heavily involved in the U.S. financial business in 2007, buying a $3 billion stake in The Blackstone Group LP and a $5 billion stake in Morgan Stanley - in both cases, 9.9% of the outstanding common. Neither of those investments turned out particularly well - Blackstone is down about 60% from CIC's buy price while Morgan Stanley is down about 40%. More recently, CIC has turned toward natural resources, in 2009 buying 17% of Teck Resources Ltd. and 13% of Singapore-based Noble Group. Teck Resources is a major diversified mining company, while Noble is a global commodities trading/supply-chain manager with $36 billion in sales.
So which do you think the Chinese government is motivated to invest in - the staggering titans of U.S. financial services or rapidly growing commodity producers? That's without taking into consideration the fact that China has an ever-increasing thirst for commodities, because of its rapid growth, whereas it has perfectly competent banks of its own.
Let's not get carried away. The People's Bank of China is a central bank, not a sovereign wealth fund, and it couldn't invest $2.4 trillion in Teck Resources shares if it wanted to.
So given that central banks don't generally buy stocks (that's what sovereign wealth funds are for), or dabble in commodity futures, there are really only two decent alternatives into which China could sink that amount of money: gold and silver.
China already owns some gold, but not much, compared to the size of its reserves - 1,054 tons at March 2009, worth about $37 billion at today's prices. At 1.5% of its reserves, that's pathetic, though it's up 76% since 2003. On average, international central banks hold 10.2% of their reserves in gold. To get to that level, China would have to buy more than $200 billion worth - about two years' global mine output.
Silver is not is a significant part of most countries' reserves, but China is historically an exception, since in Imperial times it was on a silver standard rather a gold standard, and so retained substantial reserves. Early in the 2000s it was a major seller, selling 50 million ounces in each of 2001 and 2002, at the then-prevailing prices of below $5 an ounce. After that it stopped selling.
Then, in September 2009, the Chinese government passed a decree encouraging Chinese savers to buy silver, issuing publicity explaining that buying silver was a good deal since the gold/silver price ratio at 70-to-1 was historically very high, offering them convenient small-value ingots with which to buy it, and prohibiting the export of silver from China.
With this information, I know which way I'm betting.
The People's Bank of China usually keeps its holdings a carefully guarded secret, much more so than for most central banks. However, we can make some inference from the holdings of China Investment Corp. (CIC), the country’s $200 billion sovereign wealth funds.
CIC got heavily involved in the U.S. financial business in 2007, buying a $3 billion stake in The Blackstone Group LP and a $5 billion stake in Morgan Stanley - in both cases, 9.9% of the outstanding common. Neither of those investments turned out particularly well - Blackstone is down about 60% from CIC's buy price while Morgan Stanley is down about 40%. More recently, CIC has turned toward natural resources, in 2009 buying 17% of Teck Resources Ltd. and 13% of Singapore-based Noble Group. Teck Resources is a major diversified mining company, while Noble is a global commodities trading/supply-chain manager with $36 billion in sales.
So which do you think the Chinese government is motivated to invest in - the staggering titans of U.S. financial services or rapidly growing commodity producers? That's without taking into consideration the fact that China has an ever-increasing thirst for commodities, because of its rapid growth, whereas it has perfectly competent banks of its own.
Let's not get carried away. The People's Bank of China is a central bank, not a sovereign wealth fund, and it couldn't invest $2.4 trillion in Teck Resources shares if it wanted to.
So given that central banks don't generally buy stocks (that's what sovereign wealth funds are for), or dabble in commodity futures, there are really only two decent alternatives into which China could sink that amount of money: gold and silver.
China already owns some gold, but not much, compared to the size of its reserves - 1,054 tons at March 2009, worth about $37 billion at today's prices. At 1.5% of its reserves, that's pathetic, though it's up 76% since 2003. On average, international central banks hold 10.2% of their reserves in gold. To get to that level, China would have to buy more than $200 billion worth - about two years' global mine output.
Silver is not is a significant part of most countries' reserves, but China is historically an exception, since in Imperial times it was on a silver standard rather a gold standard, and so retained substantial reserves. Early in the 2000s it was a major seller, selling 50 million ounces in each of 2001 and 2002, at the then-prevailing prices of below $5 an ounce. After that it stopped selling.
Then, in September 2009, the Chinese government passed a decree encouraging Chinese savers to buy silver, issuing publicity explaining that buying silver was a good deal since the gold/silver price ratio at 70-to-1 was historically very high, offering them convenient small-value ingots with which to buy it, and prohibiting the export of silver from China.
With this information, I know which way I'm betting.
Monday, February 8, 2010
2010 – A Year Full of Surprises
This year is likely to be a year of surprises. Global growth will disappoint and the intrusion of governments into all matters financial, economic and even personal is a cause for uncertainty associated with policy risks. Markets hate uncertainty.
This is also a year when many countries from the US to the UK to China will experience the first moves towards policy tightening and the gradual withdrawal of financial and monetary stimulus. Moves by China to begin tightening monetary policy started, even though they are only tinkering with the problem of excess liquidity. The consequences of this tightening are not yet visible, but could well become far reaching.
What has been experienced on the ground by exporting companies has been an increase in wages because of a shortage of skilled workers. Many never returned to their factories after last year’s Chinese New Year and this sort of rate is probably indicative across many coastal exporting companies. Jiangsu province raised its monthly minimum wage by 13% to RM960. Wages for skilled workers are rising far more.
The plight of exporting companies has consequences too for the RMB. China is under pressure to revalue its currency and exporters will suffer from severe margin pressures. Beijing will resist foreign pressure to revalue its currency – the earliest would be the second half of this year. I have seen bunched up orders and across many manufacturing sector in Asia business has been boosted by the need to replenish inventory within the supplier chain.
Economic success is breeding arrogance in China and it has become far more assertive, stretching from US arms sales to Taiwan, to the dispute borders between India and China to its ‘obstreperous stance it took in the Copenhagen climate change conference last December’.
Trade will continue to be the central issue and the trend is now towards manufacturing being based close to points of final consumption rather than in some distant country or region like China and Asia. This is both a political and economic conclusion. Par of this coming revolution will surely be to bring back within American borders much of manufacturing capacity and Government has begun this process by wielding a stick, threatening to curtail many of the financial benefits and tax breaks that US companies currently enjoy from their offshore operations. The next stage will be to offer the carrot – by granting tax and other incentives for US multinationals to make that move.
By then, the competition will not be just by price, but competition by quality and design which will allow American to re-emerge as a dynamic economic power sometime by end of the 2010s.
This is also a year when many countries from the US to the UK to China will experience the first moves towards policy tightening and the gradual withdrawal of financial and monetary stimulus. Moves by China to begin tightening monetary policy started, even though they are only tinkering with the problem of excess liquidity. The consequences of this tightening are not yet visible, but could well become far reaching.
What has been experienced on the ground by exporting companies has been an increase in wages because of a shortage of skilled workers. Many never returned to their factories after last year’s Chinese New Year and this sort of rate is probably indicative across many coastal exporting companies. Jiangsu province raised its monthly minimum wage by 13% to RM960. Wages for skilled workers are rising far more.
The plight of exporting companies has consequences too for the RMB. China is under pressure to revalue its currency and exporters will suffer from severe margin pressures. Beijing will resist foreign pressure to revalue its currency – the earliest would be the second half of this year. I have seen bunched up orders and across many manufacturing sector in Asia business has been boosted by the need to replenish inventory within the supplier chain.
Economic success is breeding arrogance in China and it has become far more assertive, stretching from US arms sales to Taiwan, to the dispute borders between India and China to its ‘obstreperous stance it took in the Copenhagen climate change conference last December’.
Trade will continue to be the central issue and the trend is now towards manufacturing being based close to points of final consumption rather than in some distant country or region like China and Asia. This is both a political and economic conclusion. Par of this coming revolution will surely be to bring back within American borders much of manufacturing capacity and Government has begun this process by wielding a stick, threatening to curtail many of the financial benefits and tax breaks that US companies currently enjoy from their offshore operations. The next stage will be to offer the carrot – by granting tax and other incentives for US multinationals to make that move.
By then, the competition will not be just by price, but competition by quality and design which will allow American to re-emerge as a dynamic economic power sometime by end of the 2010s.
Friday, February 5, 2010
Shipping Reserves Course
2009 was a bad year for shipping industry with dramatic fall in shipping rates and billions of dollars in company losses. Shipping line operators bled money due to decreased trade, shipyards were flooded with order cancellations, banks tightened up lending regulations and shipping companies’ stocks plummeted.
2010 could see some shipping industry stocks to be some of the biggest movers. China’s aggressive $586 billion stimulus plan breathed new life into the shipping industry. Beijing’s recent moves to tighten monetary policy and curb lending to keep the economy from overheating have raised doubts about whether or not this growth is sustainable. But there are signs that China is ready to bring global shipping back from the brink. China needs raw materials to expand infrastructure and that will keep capesize vessels (too big to fit through canals and instead use the Cape of Good Hope or Cape Horn) busy carrying iron ore from Australia to Asia. Iron ore accounted for 27% of dry bulk trading last year.
Overseas export markets are recovering as well. The China Federation of Logistics and Purchasing said its official purchasing managers’ index rose to 55.2 in December from 54.3 a month earlier – that is the biggest increase since April 2008 and it was aided by an increase in exports.
China is also developing Shanghai to be a major centre for global shipping. The central government has already leveled an island near the city to construct a terminal in deeper waters to allow large tankers and container ships. Beijing plans to add 30 terminals able to process 15 million containers per year by 2020. And despite shipyards dealing with cancelled orders and inactivity, the country wants to overtake South Korea as the biggest shipbuilding nation.
The Baltic Dry Index, which has been a leading economic indicator since it was introduced in 1985, has climbed back to over 3,000 meaning customers are paying more than they were a year ago to ship materials across the globe. Transpacific shipping lines, mostly consisting of container ships servicing trade to and from Asia, are already reporting vessel use in the mid-to-high 90% range and expect a significant increase in volumes for 2010.
Shipping is cyclical and usually operates in three year highs and lows as shipping rates rise alongside commodity prices.
2010 could see some shipping industry stocks to be some of the biggest movers. China’s aggressive $586 billion stimulus plan breathed new life into the shipping industry. Beijing’s recent moves to tighten monetary policy and curb lending to keep the economy from overheating have raised doubts about whether or not this growth is sustainable. But there are signs that China is ready to bring global shipping back from the brink. China needs raw materials to expand infrastructure and that will keep capesize vessels (too big to fit through canals and instead use the Cape of Good Hope or Cape Horn) busy carrying iron ore from Australia to Asia. Iron ore accounted for 27% of dry bulk trading last year.
Overseas export markets are recovering as well. The China Federation of Logistics and Purchasing said its official purchasing managers’ index rose to 55.2 in December from 54.3 a month earlier – that is the biggest increase since April 2008 and it was aided by an increase in exports.
China is also developing Shanghai to be a major centre for global shipping. The central government has already leveled an island near the city to construct a terminal in deeper waters to allow large tankers and container ships. Beijing plans to add 30 terminals able to process 15 million containers per year by 2020. And despite shipyards dealing with cancelled orders and inactivity, the country wants to overtake South Korea as the biggest shipbuilding nation.
The Baltic Dry Index, which has been a leading economic indicator since it was introduced in 1985, has climbed back to over 3,000 meaning customers are paying more than they were a year ago to ship materials across the globe. Transpacific shipping lines, mostly consisting of container ships servicing trade to and from Asia, are already reporting vessel use in the mid-to-high 90% range and expect a significant increase in volumes for 2010.
Shipping is cyclical and usually operates in three year highs and lows as shipping rates rise alongside commodity prices.
Wednesday, February 3, 2010
Fate
I argue that the fate of the global equity markets is very much in the hands of bond investors. Under normal circumstances, this is the best time to be in equities but these times are not normal, so do not expect that the outstanding performance of 2009 to be repeated this year.
If international bond markets calm down again – and that may happen at least temporarily – equities can probably post further but modest gains in 2010, however, the end game is approaching. If bond investors do not revolt in 2010, they probably will in 2011, so playing the economic recovery through equities is a dangerous game.
The big challenge will be to get the timing right. These situations can run for longer than most people can imagine. Japan’s crisis has been widely predicted for almost a decade now and now the ship appears to be as steady as ever. The Dubai crisis taught us that markets are in a forgiving mode at the moment and before long, Greece could very well find some respite from its current problem. But then again, governments will find just like millions of households have found over the years that you cannot spend more than you earn in perpetuity. The enormous debt levels being created at the moment will haunt us for many years to come and we may have to wait a long time to see the PIIGS fly again.
In 2009, there have been massive flows of capital towards emerging markets and towards Asia in particular and valuations have been driven up as a result. It is hard to argue that these markets yet in bubble territory. Asian countries have effectively adopted a monetary policy which is entirely unsuitable for economies growing as fast as they do. That is how bubbles have been created in the past and why Asian equity markets should be monitored closely for signs of overheating in the months to come.
The world’s stock markets have produced brilliant returns over the past nine months. This has provoked some of the best and brightest in our industry to declare that there is a dis-connect between the economic reality and the picture painted by Wall Street.
If international bond markets calm down again – and that may happen at least temporarily – equities can probably post further but modest gains in 2010, however, the end game is approaching. If bond investors do not revolt in 2010, they probably will in 2011, so playing the economic recovery through equities is a dangerous game.
The big challenge will be to get the timing right. These situations can run for longer than most people can imagine. Japan’s crisis has been widely predicted for almost a decade now and now the ship appears to be as steady as ever. The Dubai crisis taught us that markets are in a forgiving mode at the moment and before long, Greece could very well find some respite from its current problem. But then again, governments will find just like millions of households have found over the years that you cannot spend more than you earn in perpetuity. The enormous debt levels being created at the moment will haunt us for many years to come and we may have to wait a long time to see the PIIGS fly again.
In 2009, there have been massive flows of capital towards emerging markets and towards Asia in particular and valuations have been driven up as a result. It is hard to argue that these markets yet in bubble territory. Asian countries have effectively adopted a monetary policy which is entirely unsuitable for economies growing as fast as they do. That is how bubbles have been created in the past and why Asian equity markets should be monitored closely for signs of overheating in the months to come.
The world’s stock markets have produced brilliant returns over the past nine months. This has provoked some of the best and brightest in our industry to declare that there is a dis-connect between the economic reality and the picture painted by Wall Street.
Classifying types of investors
I usually a non-stereotype person but over the years, I note that regardless of their locations and underlying businesses, investors tend to fall into one of three categories:-
Firstly, disciples of Ricardo – the law of comparative advantage as first describe by Ricardo, guarantees an optimal distribution of labour and capital between countries and thus a very good growth rate for profits. This is true as long as comparative advantages have not been fully exploited. And, of course, the one part of the world where Ricardo’s law of comparative advantages is just beginning to have an impact is, of course, emerging market. Thus, ‘Ricardian investors’ tend to be very biased today towards emerging markets.
Secondly, disciples of Schumpeter – For Shumpeterians, the source of high returns can be found in the influence of the entrepreneur/inventor and breakthroughs in technology. Such investors tend to favour knowledge-based companies and usually carry overweight position in tech stocks, healthcare stocks and other growth stocks.
Thirdly, disciples of Malthus. For such investors, commodities cannot be in short supply over time given the growth of the world’s population and of overall global incomes. Commodity prices will thus have to rise given that we are confronting a world with too many Chinese/Indians/Asians and not enough oil/copper/gold/iron-ore etc. For Malthusians, the solution is thus simple – load up the commodities or commodities producers or load up on gold and stay outright bearish of most asset classes. Most of the perma-bears as opposed to cyclical bears, I have met over the years tend to be disciples of Malthus.
In my opinion, to reach a diversified position, one can build a portfolio on Ricardo and Malthus on the assumption that rising living standards in emerging markets will lead to a structural rise in prices of many commodities. And while history does not support such a view, it still makes plenty of logical sense.
Alternatively, to capture the returns available in the ‘volume’ growth part of the capitalistic system, rather than the ‘price’ part, one can build a portfolio focused on Ricardo and Schumpeter.
Firstly, disciples of Ricardo – the law of comparative advantage as first describe by Ricardo, guarantees an optimal distribution of labour and capital between countries and thus a very good growth rate for profits. This is true as long as comparative advantages have not been fully exploited. And, of course, the one part of the world where Ricardo’s law of comparative advantages is just beginning to have an impact is, of course, emerging market. Thus, ‘Ricardian investors’ tend to be very biased today towards emerging markets.
Secondly, disciples of Schumpeter – For Shumpeterians, the source of high returns can be found in the influence of the entrepreneur/inventor and breakthroughs in technology. Such investors tend to favour knowledge-based companies and usually carry overweight position in tech stocks, healthcare stocks and other growth stocks.
Thirdly, disciples of Malthus. For such investors, commodities cannot be in short supply over time given the growth of the world’s population and of overall global incomes. Commodity prices will thus have to rise given that we are confronting a world with too many Chinese/Indians/Asians and not enough oil/copper/gold/iron-ore etc. For Malthusians, the solution is thus simple – load up the commodities or commodities producers or load up on gold and stay outright bearish of most asset classes. Most of the perma-bears as opposed to cyclical bears, I have met over the years tend to be disciples of Malthus.
In my opinion, to reach a diversified position, one can build a portfolio on Ricardo and Malthus on the assumption that rising living standards in emerging markets will lead to a structural rise in prices of many commodities. And while history does not support such a view, it still makes plenty of logical sense.
Alternatively, to capture the returns available in the ‘volume’ growth part of the capitalistic system, rather than the ‘price’ part, one can build a portfolio focused on Ricardo and Schumpeter.
Tuesday, February 2, 2010
Greece
While most still think of Greece as an isolated case, I think we should to pay more attention to what is unfolding there, just as they did for Dubai a few months ago. With time, we will see Greece as part of a much direct outcome of the global financial crisis and is becoming an important influence on valuations in many markets around the world.
There is no solution to the country’s debt issued without a deep and sustained policy effort. Given the initial conditions and the existing policy framework anchored on adherence to a fixed exchange rate via the euro, such adjustment is difficult and not sufficient. With the recent surge in borrowing costs and the disruptions in the normal functioning of government and corporate markets, we may see such spill over in Ireland, Italy, Portugal and Spain as a signal to the gradual widening in market risk spreads.
The world is still in the second and third innings of the de-leveraging process as years of excessive debt accumulation cannot be reversed in 18 months and it will take at least another 5-6 years to play out, possibly longer. We know that US sovereign debt has risen as fast as private debt has declined and the picture is similar in many other countries, providing support for the argument that all we have achieved so far is to move liabilities from private to public balance sheets, effectively burdening tomorrow’s tax payers.
At I write these lines, Greek credit default swaps – measuring the cost of insurance against a Greek sovereign default have exploded. Greece has in fact been in defaults in 105 of the last 200 years, so never say never. To bail out Greece may look manageable, but having to save all PIGGS – Portugal, Italy, Ireland and Spain would overwhelm the EU. Obviously, with low interest rates we currently enjoy, one could argue that a higher debt-to-GDP ratio could be sustained and that is essentially correct as long as interest rates remain low and should rates rise, which they almost certainly will as sovereign debt increasingly becomes junk.
Danske Bank demonstrated that in order to bring debt-to-GDP ratio to 60% by 2020, Greece, being in the most precarious position, would need to shave 4% off its budget every year and if that is going to happen, the implications on socio-political front can be depressive. Towards the end of last week, it became apparent that there might be some appetite for rescuing Greece, although few details are currently available. I am not convinced that there is a strong consensus in favour of a rescue package. Most of the positive vibes have come from Spain, whereas Germany and France have been decidedly less forthcoming. The outlook goes from murky to unbelievably grim!
There is no solution to the country’s debt issued without a deep and sustained policy effort. Given the initial conditions and the existing policy framework anchored on adherence to a fixed exchange rate via the euro, such adjustment is difficult and not sufficient. With the recent surge in borrowing costs and the disruptions in the normal functioning of government and corporate markets, we may see such spill over in Ireland, Italy, Portugal and Spain as a signal to the gradual widening in market risk spreads.
The world is still in the second and third innings of the de-leveraging process as years of excessive debt accumulation cannot be reversed in 18 months and it will take at least another 5-6 years to play out, possibly longer. We know that US sovereign debt has risen as fast as private debt has declined and the picture is similar in many other countries, providing support for the argument that all we have achieved so far is to move liabilities from private to public balance sheets, effectively burdening tomorrow’s tax payers.
At I write these lines, Greek credit default swaps – measuring the cost of insurance against a Greek sovereign default have exploded. Greece has in fact been in defaults in 105 of the last 200 years, so never say never. To bail out Greece may look manageable, but having to save all PIGGS – Portugal, Italy, Ireland and Spain would overwhelm the EU. Obviously, with low interest rates we currently enjoy, one could argue that a higher debt-to-GDP ratio could be sustained and that is essentially correct as long as interest rates remain low and should rates rise, which they almost certainly will as sovereign debt increasingly becomes junk.
Danske Bank demonstrated that in order to bring debt-to-GDP ratio to 60% by 2020, Greece, being in the most precarious position, would need to shave 4% off its budget every year and if that is going to happen, the implications on socio-political front can be depressive. Towards the end of last week, it became apparent that there might be some appetite for rescuing Greece, although few details are currently available. I am not convinced that there is a strong consensus in favour of a rescue package. Most of the positive vibes have come from Spain, whereas Germany and France have been decidedly less forthcoming. The outlook goes from murky to unbelievably grim!
Monday, February 1, 2010
The Next Contagion
Back in 1997, we witnessed a currency contagion – hatched in Thailand, spreading quickly to the rest of Southeast Asia, smacking Russia in the gut and sinking a major player in the US derivatives market.
10 years later, came the debt contagion – incubated in a sub-sector of America’s mortgage market, which soon infecting nearly all credit instruments, striking Wall Street like a sledgehammer and mortally wounding the global financial system.
Now, the next contagion is beginning at a much higher level, in the most important financial instruments on Earth – long term bonds issued by sovereign governments. It could sabotage the plans of the US Treasury, the Federal Reserve and many of their counterparts overseas.
Just 117 days ago, on October 8, Greece’s benchmark 10-yaer bond was selling for 112.295 and today is has collapsed to 92.13 respectively. And the drama of its yield surge is even more striking – from only 4.41% to 7.14% - a jump of more than 60% in less than four months.
Already, this contagion is spreading to other countries. Portugal’s 10 year government bond reached a peak on December 1, 2009 just 62 days ago. And now it has also started to plunge virtually non-stop with its biggest declines registered late last week.
British government bonds – gilts – are equally vulnerable. Sovereign bonds in Japan, Spain and other major deficit nations are also starting to get hit.
Also, one should not deny the vulnerability of US government bonds, which typically viewed as the ‘least ugly’. This helps explain why US government bonds have not been among the first targets of the contagion. But that does not protect them from becoming one of the next targets as well.
The US government suffers from the same or worse underlying disease as Greece, Portugal or any other victim of the contagion – massive and out-of-control federal deficits. America’s burden was %1.4 trillion last year and another $1.4 trillion this year. It has grossly failed underestimating the size of the deficit and its potential impact on investor confidence and the speed by which its bond prices can fall.
The consequence of this complacency is catastrophe.
10 years later, came the debt contagion – incubated in a sub-sector of America’s mortgage market, which soon infecting nearly all credit instruments, striking Wall Street like a sledgehammer and mortally wounding the global financial system.
Now, the next contagion is beginning at a much higher level, in the most important financial instruments on Earth – long term bonds issued by sovereign governments. It could sabotage the plans of the US Treasury, the Federal Reserve and many of their counterparts overseas.
Just 117 days ago, on October 8, Greece’s benchmark 10-yaer bond was selling for 112.295 and today is has collapsed to 92.13 respectively. And the drama of its yield surge is even more striking – from only 4.41% to 7.14% - a jump of more than 60% in less than four months.
Already, this contagion is spreading to other countries. Portugal’s 10 year government bond reached a peak on December 1, 2009 just 62 days ago. And now it has also started to plunge virtually non-stop with its biggest declines registered late last week.
British government bonds – gilts – are equally vulnerable. Sovereign bonds in Japan, Spain and other major deficit nations are also starting to get hit.
Also, one should not deny the vulnerability of US government bonds, which typically viewed as the ‘least ugly’. This helps explain why US government bonds have not been among the first targets of the contagion. But that does not protect them from becoming one of the next targets as well.
The US government suffers from the same or worse underlying disease as Greece, Portugal or any other victim of the contagion – massive and out-of-control federal deficits. America’s burden was %1.4 trillion last year and another $1.4 trillion this year. It has grossly failed underestimating the size of the deficit and its potential impact on investor confidence and the speed by which its bond prices can fall.
The consequence of this complacency is catastrophe.
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