Caisse Getting Ready for the Next Big Move? (Natural Resources)

Thursday, September 30th, 2010

Frederic Tomesco of Bloomberg reports, Caisse Pension Fund May Borrow More After C$8 Billion Program, Sabia Says:

The Caisse de Depot et Placement du Quebec, Canada’s biggest pension fund manager, isn’t ruling out selling more bonds after completing an C$8 billion ($7.8 billion) borrowing program three months ago, Chief Executive Officer Michael Sabia said.

The Caisse in June sold 750 million euros ($1 billion) in 3.5 percent bonds maturing in 2020 through its CDP Financial unit, the last step in a seven-month plan to replace short-term borrowings with longer-term debt. As of June 30, the Montreal- based Caisse, which manages Quebec’s public pension plan, had net assets of C$135.8 billion.

“We did the C$8 billion that we set out to do,” Sabia said Sept. 28 in an interview at Caisse headquarters in Montreal. “We dealt with the most pressing problem. Whether or not down the road at some point we decide to do something else, that’s possible. I won’t necessarily rule that out.”

The latest transactions mean that about 74 percent of the Caisse’s sources of financing have maturities of more than two years, while 78 percent of its assets are investments such as real estate that the firm will hold for more than two years, Sabia said. Before the refinancing, only 20 percent of the borrowings were due in two years or more, while 80 percent of the assets were long-term, he said.

“We had this really big mismatch between sources and uses of funds,” Sabia said. “That exposed us to a huge amount of refinancing risk. One of the things that this organization learned in 2008 was that we can’t always count on refinancing.”

Record Loss

During the global financial crisis that followed Lehman Brothers Holdings Inc.’s bankruptcy, the Caisse sold equities, closed out futures contracts and reduced its foreign-exchange hedging amid a fall in the Canadian dollar. It eventually reported a record loss of C$39.8 billion, or 25 percent, for 2008, including C$6.1 billion in hedging-related losses.

After posting a 10 percent gain last year, the Caisse reported a 2.3 percent return in the first six months of 2010, led by its infrastructure and private-equity units.

Sabia, 57, said he expects the refinancing to allow the Caisse to seize investment opportunities more quickly than in the past.

“We live in a period of exaggerated response and disconnection between fundamentals and short-term market reactions,” he said. “It takes very little to move markets. In this environment, what really matters is institutional agility.

You need to be able to react to events and to do it quickly.”

Sabia, the former CEO of Canadian telecommunications company BCE Inc., joined the Caisse in March 2009.

Mr. Sabia is right, the Caisse being a mature fund needs to reduce refinancing risk and be as opportunistic as possible while minimizing risk, which is very difficult when you’re managing billions.

Tags: Bloomberg Reports, Brazil, Caisse De Depot, Caisse De Depot Et Placement Du Quebec, Canadian Dollar, Canadian Market, Chief Executive Officer, China, Commodities, energy, Futures Contracts, Global Financial Crisis, Lehman Brothers, Lehman Brothers Holdings, Lehman Brothers Holdings Inc, Maturities, Michael Sabia, Mismatch, Montreal Quebec, Move Commodities, Natural Gas, Natural Resources, Net Assets, oil, Pension Fund Manager, Pension Plan, Public Pension, Quebec Canada, Term Borrowings, Term Debt
Posted in Brazil, Canadian Market, China, Energy & Natural Resources, Infrastructure, Markets, Oil and Gas | Comments Off

The U.S. Oil Glut

Thursday, September 30th, 2010

This note is a guest contribution by Bespoke Investment Group.

Although US oil inventories declined by 475K barrels in the latest week, the decline was less than the forecasted decline of 700K barrels.  As shown in the charts below, oil inventories in the US are currently right near their highest levels of the year relative to the historical average (bottom chart).  Since oil stockpiles peaked earlier in the year, inventories have declined by 2% (blue line top chart).  In the average year, however, oil stockpiles are down 6% from their seasonal high for the year (red line top chart).

Copyright (c) Bespoke Investment Group

Tags: Bespoke Investment Group, Bottom Chart, Decline, oil, Oil Glut, Oil Inventories, Oil Stockpiles, Red Line
Posted in Energy & Natural Resources, Markets, Oil and Gas | Comments Off

China: A World-Class Act (Mobius)

Thursday, September 30th, 2010

This article is a guest contribution by Mark Mobius, Vice-chairman, Franklin Templeton Investments.

I attended a Franklin Templeton client conference in Vietnam in August and had the opportunity to meet a special guest speaker for the event, Li Cunxin, the author of the book Mao’s Last Dancer. Li grew up in China during the Cultural Revolution where he and his family had to endure poverty and hardships, getting by with having dried yams for each meal. He was lucky to be selected from thousands of children to join Mao’s wife’s ballet group.  Again he had to undergo tough training but emerged as a lead dancer, and then with phenomenal success as a principal dancer on the world stage. Now he lives in Australia with his Australian wife and children.  Since retiring from dancing, he has become a stock broker and an international motivational speaker.

Li’s success is reflective of China’s rise as an economic heavyweight. The country recently became the world’s second largest economy and is projected to overtake the U.S. as the largest economy in the world as early as 2030, if current growth trends continue.[1]

I have been living in Hong Kong since the 1960s and, like Li, have witnessed the tremendous changes in the daily lives of people in China. Today, millions of Chinese have refrigerators, washing machines, mobile phones and other electronic appliances in their households – unheard of during the years of the Cultural Revolution. And the nation of bicycle-riders has turned into one of fervent car owners, with more than 1.2 million cars sold in China every month, surpassing U.S. domestic car sales.[2]

I continue to believe the investment prospects and long-term outlook for China are excellent for a number of reasons. In my opinion, the reason for China’s economic success is really because of the Chinese people: (1) Chinese leadership is intelligent, resourceful and enlightened, with an interest in maintaining growth with a better standard of living for all Chinese; (2) that leadership has the organizational skills and policies capable of ensuring that China continues to achieve the highest GDP growth of any major country in the world; (3) China has the financial resources to undertake this gargantuan task with the world’s largest store of foreign reserves; (4) China has one of the healthiest banking systems in the world, where most individuals have little borrowings; and (5) investments in infrastructure continue to boom, contributing to future competitiveness.

As China celebrates the founding of the People’s Republic of China (PRC) on October 1, investors continue to be concerned about overheating in select sectors, greater inflationary pressures and a widening wealth gap in the country. I do not believe the Chinese real estate market is in dangerous bubble territory, for a number of reasons I discussed in an earlier blog. In summary, the Chinese property market is deep and varied, average household leverage is substantially lower than that in the U.S., and the government has been quick to act to prevent bubbles. In terms of inflation, while consumer price inflation continues to rise, producer price inflation has begun to subside, declining from a year-to-date high of 7.1% year-over-year in May to 4.3% year-over-year in August.[3] The recent move to increase the flexibility of the renminbi, allowing for a slight appreciation, is another tool that the central bank can use to control inflation.

The widening wealth gap is a common social problem in various countries and is not unique to China. For example, based on the GINI Coefficient which measures income equality, China is on par with the U.S.[4] The Chinese government has been trying to spread the economic benefits to the non-coastal regions by developing inland cities and investing in infrastructure.

There will always be challenges on the path to prosperity, but nothing seems insurmountable to the Chinese people, who are determined that their country regain its past glory and its place on the world stage.

[2] Source: China Association of Automobile Manufacturers, as of Jun 30, 2010.

[3] Source: China Economic Information Net, as of Aug 31, 2010.

[4] Source: GINI Coefficient World CIA Report, CIA World Factbook, July 2009.

Copyright (c) Franklin Templeton Investments

Tags: Bicycle Riders, Car Owners, China, China Today, Chinese Leadership, Class Act, Commodities, Cultural Revolution, Domestic Car, Economic Success, Electronic Appliances, Franklin Templeton Investments, Growth Trends, International Motivational Speaker, Investment Prospects, Mark Mobius, Million Cars, Phenomenal Success, Principal Dancer, Stock Broker, Term Outlook, Yams
Posted in China, Infrastructure, Markets, Outlook | Comments Off

Kim Shannon – Outlook for Canadian Banks

Thursday, September 30th, 2010

Kim Shannon – The Outlook for Canadian Banks

Kim Shannon, portfolio manager and founder of Sionna Investment Managers, which manages mutual funds for Brandes Investment Partners, discusses her outlook and views on the Canadian bank sector with Dan Richards, of ClientInsights.ca

Dan Richards: Kim, can we start today by talking about Canadian Banks. Can we begin by talking about how Canadian banks have performed over the last little while.

Kim Shannon: They’ve had quite a volatile ride. We’ve had them be quite challenged in ’08, and then have a pretty phoenomenal recovery, and a couple of the banks are back at the highs that they were in 2007, and back in 2007 we had blue skies as far as the eyes could see for banking.

We don’t have that future forecast today.

DR: The end of June, looking at the public data on the funds you manage, you had about a 10%-age weighting in Canadian banks, and that’s just over half of the weight of banks in the index. Can you talk about the rationale for that.

KS: We think that the Canadian banks are expensive today. They have shown up incredibly well in our model for most of the last 25 years, but recently, they are not showing up well in the models, so intrinsically they are not inexpensively any longer, like they have been in the past.

And that’s largely the reason we are underweight. Our concern is that they’ll be dead money for investors, basically earning you a dividend yield at best, and our job is to create wealth for investors.

DR: And could you elaborate when you “they show up in your model, as attractive in the past, not as attractive today?”

KS: Our model identifies which stocks are truly cheap in the universe, and traditionally banks have been inexpensive relative to the other opportunities, that of stocks in the universe. Today, they are not showing up in the universe of 140 cheapest stocks, which means that they’re expensive relative to their traditional earnings power. On top of that we’re concerned that the earnings power is likely to be subpar what we’ve seen in the last decade.

DR: Now, the one bank that you do own that’s roughly at the index weight would be Bank of Nova Scotia. So it sounds like in an environment where you’re not crazy about banks, that’s one bank that you don’t mind. Can you talk a little about that?

KS: Well, that one shows up as relatively less expensive than the rest overall. But, its also an incredibly well managed bank, and its always had a better than average efficiency ratios, its had an incredibly strong culture that survived new CEOs coming and going into the role. For a future focus, we really like the fact that they’re international in nature, and they actually have true potential for real growth because they are embedded in emerging markets that are under-banked. The rest of the banks in Canada are primarily located in Canada, with some entities mostly in the United States, and those are very mature banking environments, and so any growth they can enjoy means they’re having to steal it from a competitor.

DR: Kim, final question. Over the last little while, we’ve seen some earnings disappointments by some Canadian banks. Do you want to comment on that?

KS: We’ve been talking to investors for quite some time about what we believe to be ongoing pressures on Return on Equity and earnings and so we’re not surprised that there’s been a stumble here because that fits in with our analysis that it will be very hard to enjoy the strong earnings that we saw for the middle part of this past decade in banking.

DR: Kim, thank you very much.

[CSSBUTTON target="http://www.clientinsights.ca" color="23238E" textcolor="ffffff"]Access many more Dan Richards’ interviews at ClientInsights.ca[/CSSBUTTON]

Tags: Autoload, Blue Skies, Brandes Investment Partners, Canadian Banks, Canadian Market, Dead Money, Dividend Yield, Flv Player, Investment Managers, Investors, Job, Models, Mutual Funds, Outlook, Portfolio Manager, Rationale, Shannon, Stocks, True Loop, Universe, Universe Today
Posted in Canadian Market, Markets, Outlook | Comments Off

The Myopic Bond Market

Thursday, September 30th, 2010

It is axiomatic that investors in government bonds expect to earn a return in excess of inflation. Why invest in a bond if it does not increase the purchasing power of one’s capital? Hence, the current yield to maturity of a bond includes an expected real return element and a component for expected inflation. Since 1926, long-term U.S. government bonds have had an annualized return of 5.6% comprised of a real return of 2.6% and an inflation component of 3.0%.

As yields plunge ever lower, the bond market appears to be anticipating a protracted period of low inflation. Fears of outright deflation have escalated as the economic recovery slows swelling the burgeoning legion of bond purchasers and further depressing yields. In turn, lower yields reinforce the notion that future inflation rates will themselves be lower. This self-reinforcing cycle, however, begs the question – how successful has the bond market been in forecasting future inflation rates?

The answer is “not very”. As illustrated in the following graph, long-term government yields (in red) have almost consistently misestimated the subsequent long-term inflation rate (in green). During the late 1920′s and the mid-1970′s to 1990, the bond market chronically overestimated future inflation. This is evidenced by the fact that long-term bond yields were substantially in excess of the following 20-year inflation.

Conversely, from the early 1930′s until the early 1970′s, the bond market nearly always under-estimated subsequent inflation. In general, long-term bond yields were below the subsequent long-term inflation rate. Overall, the correlation between long-term bond yields and the subsequent long-term inflation was a negligible 0.20.

Mid-term bond yields also did a poor job of anticipating future inflation. The following graph illustrates how intermediate-term government yields (in red) failed to anticipate the subsequent five-year inflation rate (in green). As can be seen, intermediate-term bond yields tended to be either too high relative to the subsequent realized inflation rates (as occurred in the late 1920′s and the late 1970′s through to mid-2000′s) or too low (as occurred in the late 1930′s and 1940′s and the 1970′s).

The correlation between intermediate-term bond yields and the subsequent five-year inflation rate was a weak 0.27.

The bond market does a poor job of estimating future inflation rates over the mid to long-term. Hence, investors should have little comfort that today’s low yields properly anticipate future inflation over longer time frames or properly compensate them for the risk of potentially higher inflation further down the road.

In fact, historically, low bond yields have not provided investors with sufficient reward for the risk of unexpected higher inflation. This is illustrated in the following graph which compares the monthly long-term bond yields from January 1926 to September 1990 to the annualized real (i.e. inflation adjusted) return actually earned in long-term bonds over the subsequent twenty years.

Low long-term government bond yields such as the 3.4% yield today have typically resulted in either low or negative real returns for long-term bondholders. The only exception was the mid-1920′s when bond investors benefited from falling prices in the late 1920′s and early 1930′s as well as wartime price controls. Very low intermediate-term bond yields such as the 1.3% yield today have also resulted in either low or negative real returns over the subsequent five years (see Appendix I).

At today’s low yields, government bond investors are banking on a future of protracted low inflation or even outright deflation. They need to understand that, like Mr. Magoo, the bond market really doesn’t see clearly at a distance. Hence, although low inflation is the likely scenario over the several years, beyond that, the bond market has limited insight into mid to long-term inflation.

And the market is akin to Mr. Magoo in another respect. With yields so low today, it will also be prone to some nasty accidents in the future.

September 30, 2010

www.tacitacapital.com

Appendix I

Source: Data from Morningstar Ibbotson covering the period January 1926 to September 2005; calculations by Tacita Capital. 60-month real return is the actual annualized inflation-adjusted return on intermediate-term bonds compared to the bond yield in month one.

Tacita Capital Inc. (“Tacita”) is a private, independent family office and investment counselling firm that specializes in providing integrated wealth advisory and portfolio management services to families of affluence. We understand the challenges of affluence and apply the leading research and best practices of top financial academics and industry practitioners in assisting our clients to reach their goals.

Tacita research has been prepared without regard to the individual financial circumstances and objectives of persons who receive it and is not intended to replace individually tailored investment advice. The asset classes/securities/instruments/strategies discussed may not be suitable for all investors and certain investors may not be eligible to purchase or participate in some or all of them. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Tacita recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial advisor.

Tacita research is prepared for informational purposes. Neither the information nor any opinion expressed constitutes a solicitation by Tacita for the purchase or sale of any securities or financial products. This research is not intended to provide tax, legal, or accounting advice and readers are advised to seek out qualified professionals that provide advice on these issues for their individual circumstances.

Tacita research is based on public information. Tacita makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete.  We have no obligation to inform any parties when opinions, estimates or information in Tacita research changes.

All investments involve risk including loss of principal. The value of and income from investments may vary because of changes in interest rates or foreign exchange rates, securities prices or market indexes, operational or financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in securities transactions.  Past performance is not necessarily a guide to future performance.  Estimates of future performance are based on assumptions that may not be realized. Management fees and expenses are associated with investing.

Tags: Annualized Return, Bond Market, Bond Yields, Correlation, Current Yield, Deflation, Early 1970, Economic Recovery, Graph, Inflation Component, Inflation Fears, Inflation Rate, Inflation Rates, Notion, Poor Job, Purchasing Power, Term Bond, Term Inflation, U S Government Bonds, Yield To Maturity
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Tracking Performance of Base Metals

Thursday, September 30th, 2010

Base metal prices took a big hit from the financial crisis but many of the metals are now seeing their shine return. Since late 2008, copper has experienced the strongest rebound (up 137 percent through mid-September) followed by nickel and lead.

The outperformance is simply a factor of supply and demand. Stimulus from China, the U.S. and other countries helped demand outstrip supply as mines have struggled to raise output.

China has been the key driver of higher copper prices during the upswing, but could provide a headwind for the next several months. The country consumes nearly half of global supply but is currently destocking its copper supply which weakens overall demand for copper in the marketplace. This is one reason we’ve seen copper prices rise only 7.5 percent, lagging behind tin and nickel prices.

However, it’s likely to be only a temporary lag. Copper’s industrial flexibility makes copper one of the most important metals as the global economy continues.

The market hasn’t been as kind to aluminum in the past but the metal was up 42 percent from very depressed levels through mid-September. Macquarie says the aluminum market has been in a surplus and the industry is carrying historically high levels of inventory.

Those high inventory levels looked to be gobbled up by a combination of physical and investment demand. According to Deutsche Bank, roughly 75 percent of the aluminum inventory that sits on the London Metal Exchange is spoken for through financial/investment demand. With short-term interest rates around the globe predicted to remain near zero for an extended period of time, interest in the metal as an investment should remain robust.

Physical demand for aluminum is expected to grow by 40 percent this year, with 40 percent of that coming from China. If the Chinese government is successful in transforming the country into a consumer-led economy, aluminum could be a big beneficiary because of its use in automobiles, electricity and other consumer goods.

Tags: Base Metals, China, Chinese Government, Copper Prices, Depressed Levels, Deutsche Bank, Financial Investment, Global Economy, Global Supply, Headwind, Inventory Levels, Investment Demand, London Metal Exchange, London Metals Exchange, Macquarie, Nickel Prices, Outperformance, S Industrial, Stimulus, Term Interest, Time Interest, Upswing
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Doug Kass: “There is an Inevitability of a Bull Market”

Wednesday, September 29th, 2010

Transcript

KERNEN: Doug, I wanted to talk to you earlier about this and your call that could be the trade of the decade.

And that’s the short bonds in which, I think what gets interesting in times like this is that for how many years have we decided that rates have nowhere to go but up?

And I remember at the beginning of this year, everyone said over four percent, everyone, every economist.

KASS: I did not.

KERNEN: Maybe you didn’t.

KASS: In my surprise list, I said the ten-year yield will go under three percent.

KERNEN: Well, you also said that Democrats would pick up seats in the House and the Senate.

KASS: Right.

KERNEN: So you said some other interesting things, too, that — and you’ve come to that. You said you were dead wrong about that.

KASS: Yes, yes.

KERNEN: OK. But on the bond call, if you had started the year saying we’re going up above — people have tried to stay short bonds longer than their finances have allowed them to stay short. And now we’re staring at the ad we have, ka ching, ka ching, ka ching with the.

QUICK: Central banks.

KERNEN: Yes, the central banks all across the world turning them in and gold at $1,300 and a slow economy, yet industrial commodities all went up. It’s staring you in the face to the point of where it almost sounds too obvious to work.

But it’s like rates have nowhere to go but up, right? Right?

KASS: But (ph) to argue (ph).

(CROSSTALK)

KERNEN: How come it’s such a hard trade (ph) to make?

KASS: The reason it’s hard is because short rates are anchored as zero for the time being, but the.

KERNEN: Artificially?

KASS: Artificially. There’s a possibility — a zero interest rate policy. But there is a possibility that QE II fails just like QE I failed and the administration will be forced into some sort of transformative jobs program.

More fiscal stimulation at the expense of monetary and that will provide growth.

KERNEN: And that would be the end of the bond market.

KASS: That would be the end of the bond market. I guarantee you.

KERNEN: So — OK. So we print more money. That wouldn’t work. And that would make us print even more money is what you’re saying kind of?

KASS: We’d have a focused transformative jobs program much like Mr. Augustine talked about.

KERNEN: Which would also be expensive.

KASS: Yes.

KERNEN: And it’s expensive around the globe right now for everybody.

KASS: Right, right.

KERNEN: .just like the ad has.

All right, Doug, thank you.

QUICK: Thanks for coming in, Doug.

KASS: Thank you.

KERNEN: You haven’t had any sea breezes yet today, right? That’s just the name of your.

KASS (ph): .you know it is a drink.

KERNEN: Right.

KASS: I do know. I also live on Seabreeze Avenue in Palm Beach, Florida.

KERNEN: OK, that makes sense and all right, it doesn’t mean it’s — OK, thank you.

KASS: Thanks for having me.

END

Tags: Bond Market, Bonds, Central Banks, Commodities, Crosstalk, Decade, Democrats, Doug Kass, Economist, Gold, Industrial Commodities, Inevitability, Interest Rate Policy, Interesting Things, Ka Ching, Qe Ii, Senate, Slow Economy, Staring You In The Face, Surprise, Zero Interest
Posted in Bonds, Gold, Markets | Comments Off

Hedge Fund Titan David Tepper Weighs in on Economy, Markets, and his Strategy

Wednesday, September 29th, 2010

Transcript

(BEGIN VIDEOTAPE)

KERNEN: My entire body has chills right now because of this guy that I’m going to introduce right now.
And I’m going to explain how hard it is to get this — remember when Howard Hughes, no one had ever seen him, and that guy met him in the desert and they didn’t even know who he was?

QUINTANILLA: Melvin.

KERNEN: Melvin, Melvin.

QUINTANILLA: Melvin and Howard.

KERNEN: This guy, no one has ever seen — let me introduce our special guest for the next half hour, raked in a record of $7.5 billion for his fund last year by investing in financials returning an eye-popping 132 percent for himself and investors.

Joining us in a rare exclusive interview, hedge fund heavy weight, David Tepper, President and founder of $12.4 billion Appaloosa Management who I’ve talked — David, thank you for coming in.

TEPPER: You’re welcome, Joe.

KERNEN: Talked about you a lot because the Short Hills Mall is the only thing people know about Short Hills. And you, instead of being in the, you know, the canyons of New York City, you’ve managed this money out at — overlooking a parking lot near the Short Hills Mall.
And talked about you a lot. I’ve run into you but didn’t know who you were. You’re kind of like Carlos, the Jackal — no one has ever seen.

TEPPER: Actually seen him.

KERNEN: this man before. So it’s like.

QUINTANILLA: What was said to you to get you to come here?

KERNEN: Yes.

TEPPER: What was said to me?

QUINTANILLA: Yes.

KERNEN: Yes.

TEPPER: You know, actually, I listened to Joe who said I was mysterious, elusive — at least this type of stuff. So I said, you know, why not come on?

KERNEN: So far, it worked good. All right.

TEPPER: Although I’m a little concerned when you say you have chills when you see me. I’m not going to the mess (ph).
(CROSSTALK)

KERNEN: Oh, no, no, no. It’s only in the nicest way.

TEPPER: All right. We can talk. I mean, that’s okay. I mean, if.

Tags: Appaloosa, Canyons, Carlos The Jackal, Chills, China, Crosstalk, David Tepper, Desert, Economy, ETF, ETFs, Half Hour, Heavy Weight, Howard Hughes, Investing, Investors, Joe Kernen, Melvin And Howard, New York City, Parking Lot, Short Hills Mall, Titan, Videotape
Posted in China, ETFs, Gold, Markets | Comments Off

Is China’s Yuan Intervention Coming To An End?

Wednesday, September 29th, 2010

This article is a guest contribution by James Pressler, Northern Trust.

Currency intervention is a funny thing, particularly in Asia. Plenty of emerging economies maintain some quiet government presence in the markets with rarely a mention, while Japan’s sudden defense of the yen was accepted after the initial surprise wore off. Then there is China – an overt currency market presence that gets plenty of press, mounds of criticism, yet rarely changes. With the next round of challenges to the yuan fast-approaching, might Beijing’s yuan policy be due for a change?

The most recent shift in China’s forex policy came in mid-June, not surprisingly just days before policymakers headed to an international summit where the yuan exchange rate threatened to dominate conversation and shame Beijing’s leadership. Those 11th-hour reforms resulted in a six-cent appreciation of the yuan and dampened enthusiasm for anti-China rhetoric, but just as soon as currency talk shifted away from the yuan, the appreciation came to a halt. In August, the currency even weakened, losing four of those six hard-earned cents, and inspiring Washington to come back from its summer recess with more talk of legislative retaliation. Indeed, the yuan appreciated by twelve cents over the next month. In all likelihood this was not a coincidence.

The current policy environment in Washington, however, suggests that another ‘spontaneous’ appreciation of the yuan may not mollify legislators. After all, mid-term elections are approaching and US legislators (read: Democrats) are looking to score as many points as possible before the November vote. The House is currently debating legislation that would brand China as a “currency manipulator,” and its passage (it currently carries strong bipartisan support) would be the first step toward retaliatory sanctions through the World Trade Organization (WTO). Even though the proposed bill would likely not pass through the Senate until at least November and not be reconciled and signed into law until the next Congress is sworn in, it would begin a possibly irreversible process that could force China into addressing some significant imbalances. And if there is one thing Beijing does not respond well to, it is being pushed around by foreign interests.

Within China, policymakers are already fretting about a real estate bubble that is growing more menacing by the day, confidence figures that are less than assuring, and an export industry ill-prepared to face the challenge of a stronger currency. The last thing it wants to endure is punitive tariffs by the US (with the blessing of the WTO) issued against any industry seen as adversely affected by the artificially low exchange rate. Beijing’s arguments against the “currency manipulator” label are fairly simple. First, it insists that the US is using such legislation to remedy a trade imbalance of its own making, and China should not be punished for the excesses of the US. Second, Beijing notes that a 20% appreciation of the yuan (the consensus estimate of the yuan’s undervaluation) would trigger a wave of bankruptcies and massive job losses. And then it points to the last few rounds of reforms, insisting it has already addressed the issue.

Through this approach, Beijing is showing its friendlier side, allowing the yuan to appreciate and making plenty of statements through the state media about how further undefined reforms are being implemented. It is likely to keep this up even if the US House passes the bill on to the Senate, waiting for mid-term elections to play out and see what kind of Washington it will face. A victory by those more willing to pursue the “currency manipulator” brand could likely result in a change of tone in Beijing, with public statements shifting toward the downsides of a trade war, possible retaliation and a less-receptive environment for US companies looking to invest in China. It is unlikely that the Chinese government will launch a pre-emptive strike to a possible trade war, but it will make very clear that any actions taken – regardless of the WTO’s blessing – will come at a hefty price.

Tags: Bipartisan Support, China, Currency Intervention, Currency Manipulator, Currency Market, Emerging Economies, Funny Thing, Government Presence, Initial Surprise, International Summit, James Pressler, Market Presence, Mid Term Elections, Northern Trust, Policy Environment, Retaliatory Sanctions, Summer Recess, World Trade Organization, World Trade Organization Wto, Yuan Exchange Rate
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Bob Doll: Second Round of Quantitative Easing is Likely

Wednesday, September 29th, 2010

This article is a guest contribution by Bob Doll, Chief Equity Strategist for Fundamental Equities, BlackRock Investments, LLC

September 27, 2010

Last week marked the fourth consecutive week in which stock markets posted gains, with the Dow Jones Industrial Average climbing 2.4% to 10,860, the S&P 500 Index advancing 2.1% to 1,149 and the Nasdaq Composite rising 2.8% to 2,381. With these gains, the S&P is now up around 3% for the year, while the Dow is up 4% and the Nasdaq 5%.Investors are questioning whether the improved tone of equity markets in recent weeks is merely a reflection of stocks moving to the upper end of their trading range or if this trend is a reflection of real underlying changes. Certainly, the macro backdrop does seem improved when compared to one month ago. Economic data has moved from “bad” to “less bad” (if not to “good”), and the rhetoric from Washington, DC has recently focused on some pro-business and tax policies. Optimism is growing that with the upcoming midterm elections, investors may be seeing some more equity-friendly policies in the works. From our perspective, we are leaning more toward the positive side of the market debate and remain optimistic that the economy will avoid a double-dip recession, meaning that stocks should be able to continue to grind higher.

In perhaps the most notable headline last week, the National Bureau of Economic Research told us (rather belatedly) that the recession ended in June of 2009. The “Great Recession” marked the longest reported recession since the Great Depression, and over the 18 months of its existence, it resulted in an annualized decline in gross domestic product of 2.8% and a loss of 7 million jobs.

In other economic news, the Federal Reserve commented last week that it remains committed to doing what it can in terms of using its balance sheet to reflate the economy. Mirroring recent statements from the Bank of England and the Bank of Japan, the Fed made it clear that low growth levels are not acceptable, nor are deflation risks, and that the central bank stands ready to begin the next phase of quantitative easing. In its statement, the Fed admitted that it believes inflation levels are too low, limiting its ability to promote stable prices. This was a significant statement, as until now the Fed was more focused on the slow pace of growth and high unemployment. These concerns obviously still remain, but by explicitly adding deflation risks to the list of problems, the Fed has made it clear that additional policy action is needed.

Although the downside risks to the economy seem to have eased over the past month, there is little reason to expect high growth rates to resume soon, suggesting that the Fed’s work is not finished. The world’s developed economies seem to have settled into a period of positive but weak growth marked by high unemployment and high deficits. In this environment, the Federal Reserve is under pressure to help the economy break out of this phase. The prospects for additional quantitative easing measures have already prompted a decline in the value of the dollar and the lowering of private-sector borrowing costs.

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