Archive for May, 2012

The Eurozone Crisis: 4 Developments to Watch (Koesterich)


Thursday, May 31st, 2012

 

by Russ Koesterich, Chief Investment Strategist, iShares

With the future of Greece and the eurozone still so uncertain, many investors are asking how they might predict what the most likely outcome is.

While I don’t have a crystal ball, in addition to paying attention to eight pivotal eurozone events happening from now until July, I’m also watching for four critical developments in the run-up to the second Greece election on June 17. Here’s my watch list:

1.)    Greek poll numbers. A market friendly development would be the New Democracy Party, Greek’s center right party, rising in the polls. This would signal that Greece is likely to accept the terms of the bailout package and remain in the euro. But if we continue to see advances by Syriza, the far left party that wants to repudiate the bailout package, the risk of a Greece showdown with the rest of Europe goes up.

2.)    Greek banking system outflow. Further outflows will likely force the European Central Bank to provide more emergency assistance to prevent a collapse of the Greek banks and would signal a worsening crisis.

3.)    Recapitalization of Spanish banks. Spain needs to recapitalize its banking system, which is likely to cost at least 50 billion euros. The sooner we receive some clarity on how Spain plans to do this, the better for markets and the eurozone.

4.)    Germany’s position on mutualizing European debt (i.e. Eurobonds). Chancellor Merkel has long been in strict opposition to Eurobonds, but she is coming under increasing pressure to accept the idea. In fact, recent comments from her suggest that she may be softening her position. Any development in this direction would signal a growing eurozone consensus toward how to resolve the crisis, a positive for markets.

To be sure, how these developments will actually play out is hard to predict, but what is certain is that there’s little likelihood of an imminent solution in Europe and markets are likely to remain volatile as a result. As such, I continue to advocate that investors assume a modestly more defensive posture in equity portfolios. In addition to the other defensive options I’ve mentioned recently, here are two other positions to consider:

1.)    Underweight India. Given India’s slowing growth, stubbornly high inflation, large current account deficit and chronically high budget deficit, I’d remain cautious on the market and use it to balance overweights to China and Taiwan — a position that has worked well since I started advocating it last February.

2.)    Overweight Global Telecom. I continue to believe that this sector’s low beta (a measure of the tendency of securities to move with the market at large) and relatively high yield (around 5.5%) should provide some cushion during market volatility and sell-offs. In fact, while the iShares S&P Global Telecommunications Sector Index Fund (NYSEARCA: IXP) is down since its May high, it’s down less than the broader global stock market.

 

 

Source: Bloomberg

The author is long IXP

 

Past performance does not guarantee future results.

 

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country and narrowly focused investments may be subject to higher volatility.

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Axel Merk: U.S. Dollar and Euro – Review and Outlook


Thursday, May 31st, 2012

 

U.S. Dollar and Euro – Review and Outlook

by Axel Merk, Merk Funds

May 30, 2012

The analysis below is based on our letter to shareholders in the annual report of the Merk Funds*.

The 12-month period ended March 31, 2012 (the “Period”) could be described as one of contrasting halves. The first half of the Period was marked by increased pessimism and concern regarding Europe, particularly the periphery nations. In contrast, market sentiment was more optimistic through the second six-months of the Period, and markets exhibited significant strength. During the first six-months ending September 30, 2011, the market – as measured by the S&P 500 Index – returned -13.78%, while the market returned 25.89% during the second six-months ending March 31, 3012.

News emanating from Europe dominated market gyrations for the majority of the Period. Specifically, the periphery nation sovereign debt crisis and concerns surrounding its global contagion effects – particularly on countries previously considered immune to the fallout, like China – held the market’s attention. Concerns appeared more acute through the first half of the Period, where we witnessed heightened levels of market volatility and general selling of perceived risky assets. The VIX index – widely followed as a bellwether for market volatility – reached a high of 48 in August 2011, as concerns mounted regarding the Greek debt situation and focus shifted to the larger European countries, particularly Italy and Spain, where political upheaval only muddied the waters. Policy makers on this side of the Atlantic compounded the problem, with Washington leaving the decision to raise the U.S. Government’s debt ceiling to the last minute causing further market distress.

During the second half of the Period, the market appeared to ascribe a more optimistic assessment to the European situation and the global economy. Particularly in the U.S., we saw the release of many economic data points that beat consensus expectations, including notable improvements to the unemployment rate. European policy makers also appeared to alleviate the market’s concerns regarding Italy and Spain, where austerity measures were finally agreed to and put in place, while much needed clarity was provided surrounding the Greek situation when bondholders agreed to participate in a debt swap. At the same time, we witnessed a number of central banks following much easier policies through the second half of the Period. The U.S. Federal Reserve (Fed) became evermore dovish in its rhetoric regarding easing measures and extended the calendar date that low rates are anticipated to be kept in effect, moving it out to the end of 2014 from mid-2013 previously. The Bank of England expanded its quantitative easing program by £50 billion pounds and the Bank of Japan also increased its expansionary asset purchases by ¥10 trillion and concurrently set an inflation target. Additionally, the ECB expanded its balance sheet via two long-term refinancing operations (LTRO’s), together totaling over €1 trillion. All of which helped alleviate market concerns and underpinned significant strength in equity markets, as indicated above, and a substantial reduction in the VIX index, which fell to a low below 14 in March of 2012.

Going forward, we consider that central banks around the world are likely to err on the side of further monetary policy easing. Our analysis finds that the composition of voting members on the Fed’s Federal Open Market Committee (FOMC) is more dovish in 2012 compared to 2011 and is set to become even more dovish in 20131. We therefore consider it very likely that rates will be kept low for an extended period of time in the U.S. and, should economic fundamentals deteriorate, further easing policies may be put in place. Elsewhere, the Bank of Japan appears committed to generating inflation via easing policies, while the Bank of England appears to be more concerned about deflation despite the existence of what we deem to be elevated inflationary pressures (as measured by the consumer price index). We consider it likely that the Bank of England announces further stimulus measures should economic growth in the United Kingdom disappoint. At the same time, there is renewed pressure on the ECB to purchase periphery nation debt to stave off further fiscal deterioration in the region. While ECB President Draghi appears committed to provide the banking system with unlimited levels of liquidity (through the two three-year LTRO facilities), pressure is mounting to intervene directly through the Securities Market Program (SMP) and buy the likes of Spanish debt. Notwithstanding, the ECB is likely to do everything in its power to stop the financial industry from collapsing, which may mean further liquidity provisions, such as the LTRO’s already seen.

All of which should serve to underpin those currencies most correlated with the outlook for economic growth and of countries set to benefit from increases in the price of commodities and precious metals. We believe as central banks continue to follow expansionary, inflationary policies, that those assets exhibiting the greatest monetary sensitivity should benefit – such as commodities, natural resources and precious metals. As such, we favor the currencies of commodity producing nations, such as Australia, Canada and New Zealand. In particular, we do not consider that China will experience too severe a slowdown in economic growth – the recent announcement to expand the trading band of its currency should be seen as a signal that policy makers there believe the risks to the economy have satisfactorily abated. We think Australia and New Zealand are well situated to benefit from ongoing Asian economic strength, while both countries’ fiscal positions are in stark contrast to the U.S. and Europe, for all the right reasons. Canada, too, should benefit from ongoing commodity price appreciation, and is well placed should the U.S. economy continue to pick up steam ahead of consensus forecasts.

In Asia, we continue to favor the currencies of nations who are producing more value-added goods and services while concurrently focusing on the development of the domestic economy as a source of long-term sustainable economic growth. China in particular checks these boxes. We consider building inflationary pressures brought about by increases in global commodities and a tightly managed currency, may ultimately force the Chinese into allowing the currency to float more freely2. While there have been recent hiccups regarding China’s upcoming leadership transition, the ultimate goal of the Communist Party remains intact: to maintain social stability, so as to remain in power. We believe there are several aspects to this notion, none the least being the support of strong, sustainable economic growth and the containment of inflationary pressures. Regarding the latter: should inflation get out of hand, the risk of social upheaval may become elevated. China’s close management of the dissemination of any news discussing the “Arab Spring” uprisings is indicative of the strength of its resolve in maintaining social stability. One of the contributing factors causing the “Arab Spring” was runaway inflation.

In China and other Asian nations, allowing the respective currencies to float more freely may act as a natural valve in alleviating the inflationary pressures being experienced. Moreover, we consider China and countries such as Malaysia, Singapore, South Korea and Taiwan to have the pricing power to allow their currencies to appreciate. These countries now produce relatively higher value-add goods and services compared to other Asian nations; therefore we believe they have the ability to pass on price pressures to the end consumer – Western consumers. With a concurrent focus on the development of their domestic economies, we believe Asian nations will eventually be less reliant on exports to the West, with a renewed focus on domestic demand, as well as demand within Asia, as a source of future growth. The result may be stronger Asian currencies over the medium to long-term, while western nations may experience increases in import prices going forward.

Regarding the U.S. dollar, we consider the more dovish FOMC voting member composition to be a negative for the currency, as it will likely lead to more expansionary policies relative to global central bank counterparts. In our view, the aforementioned debt ceiling debacle is just one increment in the ongoing marginal deterioration of the U.S.’s safe haven status; concurrent degradation to the long-term sustainability of the U.S.’s fiscal situation may ultimately erode confidence that the U.S. will honor its future obligations. Importantly, we do not doubt these obligations will be fulfilled, but the manner in which they are likely to be fulfilled gives us grave cause for concern. In our assessment, future obligations are unlikely to be met through much needed austerity measures, either from spending cuts or revenue increases, as neither side of the political aisle has shown a willingness to comprehensively and satisfactorily address the issues. Rather, future obligations are likely to be met through the path of least resistance: inflation. Said another way, devaluation of the currency.

We continue to believe the currency asset class may provide investors with the opportunity to access enhanced risk-adjusted returns and valuable diversification benefits. We are excited about the outlook for the asset class and believe many investment opportunities continue to exist in the space.

Please make sure to sign up to our newsletter to be informed as we discuss global dynamics and their impact on currencies. Please also register for our upcoming Webinar on June 13 where we will discuss the investment strategy and objectives of the Merk Absolute Return Currency Fund. We manage the Merk Funds, including the Merk Hard Currency Fund. To learn more about the Funds, please visit www.merkfunds.com.

Axel Merk

Manager of the Merk Hard Currency Fund, Asian Currency Fund, Absolute Return Currency Fund, and Currency Enhanced U.S. Equity Fund, www.merkfunds.com

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What Record Low 10-year Rates Tell Us About the Toxic Effects of Permanent Zero


Thursday, May 31st, 2012

 
by Edward Harrison, Credit Writedowns

On Twitter the latest buzz is about the US ten-year government bond hitting a record low of 1.6713%. Some are amazed that the world of ‘financial repression’ where long-term yields are lower than consumer price inflation can go on and on without a hiccup. Well don’t be. Long-term interest rates are a series of future short-term rates. If the central bank is telling you that zero rates are practically permanent i.e. permanent zero, wouldn’t you expect the term structure to eventually flatten? That’s what has happened, folks – just as in Japan.

So what does this mean for you and me? Well, first of all, what’s your savings account statement saying? Is it telling you you can spend a lot more because you are flush with interest income or is it telling you you better save more if you expect to retire without having to live on cat food? Here’s another question: does this bode well for consumption or ill? Clearly, it bodes ill via the interest income channel but it could bode well if you and I leverage up a bit as debt service costs are down. And that is the point of low rates, by the way.

The Fed is squeezing interest rates down to levels where you see private portfolio preference shifts, a euphemism for the risk seeking return mentality that arises from artificially low real fixed income returns and that forces up risk assets. But this can only go one for so long.

See, eventually there will be another recession and the question should be what happens to all those toxic assets on bank balance sheets. What happens if new loans go sour too? If you recall, US FDIC-insured institutions recorded $35 billion in Q1 2012 accounting gains. But the quality of those accounting gains was dubious. Here’s the key line to note:

Lower provisions for loan losses and higher noninterest income were responsible for most of the year-over-year improvement in earnings.

That means FDIC insured institutions are under-provisioning and earning money through non-lending channels. These institutions are taxpayer guaranteed by the FDIC because they take deposits and lend that money in support of economic activity. Yet, what the FDIC is telling you is that institutions are not earning money through the traditional interest income channel which is the source of their FDIC guarantee. And that’s as you should expect in a permanent zero environment.

After all, that’s what regulatory forbearance is all about, by the way. The S&L crisis is a prime example:

So what happened in the S&L crisis is that in the early 1980s American banks got slammed by Volcker’s high interest rates. Lending long and borrowing short meant that they were losing money as short rates skyrocketed. What’s more is that the S&L model was busted by money market funds which competed with the S&L’s low cost deposit funding base. The fix was what is known as regulatory forbearance, which is a fancy way of saying regulators looked the other way as insolvent banks continued to operate as if they were solvent.The thinking here was that giving the banks a bit of time to “earn” their way back into solvency would keep the 1980-1982 crisis from becoming another Great Depression. There was no Great Depression in 1982. But S&L executives ended up loading up on risky high yield assets, knowing that it was a heads-I-win tails-you-lose situation since their banks were already insolvent. Many like Charles Keating turned to fraud and looting, what criminologist and law professor Bill Black calls control fraud.

So, what we should expect going into the next downturn is an environment in which banks have much less net interest margin as the yield curve is as flat as a pancake due to permanent zero. As the downturn takes form, risk assets will be selling off and loans will be souring such that the sources of accounting gains today will turn to sources of accounting losses. And then the worry again will be about bank solvency. When I see record low yields in the United States, that’s what I am seeing.

About Edward Harrison

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

Copyright © http://www.creditwritedowns.com

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Canada: Untangling Pipeline Projects to Realize Energy Export Potential


Thursday, May 31st, 2012

 

Canada: Untangling Pipeline Projects to Realize Energy Export Potential

by Thomas White

May 25, 2012

For a country richly endowed in natural resources, and with growing energy production, Canada has been facing a perplexing problem in recent years. While its producers are supplying oil and gas to U.S. refineries at prices below the international market, Canadian refineries on the east coast are paying higher international prices for the oil they import. It may seem odd that a major energy producer like Canada imports oil at all. But for Canada, it’s unavoidable. Truth be told, the Maple Leaf lacks the necessary infrastructure to transport oil from its domestic fields in the central part of the country to markets on the east coast.

With more than 175 billion barrels of proven deposits, in oil and oil equivalents, Canada has the third largest energy reserves in the world. Most of the reserves are in the Alberta province, which has traditionally shipped most of its oil exports to the Midwest U.S. Oil output in Alberta has steadily increased in recent years, the result of large investments to extract crude from oil sands. At the same time, oil and gas output in American Midwestern states such as North Dakota has also gone up substantially as improvements in fracking technology have allowed for increased energy production from shale deposits. This has led to a supply glut to refineries in the area, with average prices realized by oil producers dropping. For instance, when the West Texas Intermediate (WTI) crude oil benchmark was trading well above $100 a barrel, Canadian oil fetched an average of $75 a barrel in the U.S. By some estimates, Canadian oil producers who export 1.55 million barrels of oil and equivalents a day to the U.S. Midwestern states lose nearly $15 billion annually because of this price differential.

Until recently, Canadian oil producers were banking on the expansion of a major pipeline project that would eventually stretch from Alberta all the way to the Gulf Coast of Texas, where prices are set by the WTI benchmark. The first phase of this project, completed in 2010, currently brings Canadian oil to the U.S. Midwest. The second leg of the pipeline connects to Cushing, Oklahoma, where the world’s largest oil storage facility is located. The final stretch of the pipeline, which is expected to be completed by the end of next year, will drain the excess supplies from Cushing to the Gulf Coast. To accommodate the increasing oil output in Canada, a second pipeline from Alberta to Nebraska, which will join the existing pipeline, has also been planned. When completed, this project will potentially reduce the oversupply in the Midwest, and lift average prices for Canadian producers.

However, the pipeline expansion project from Alberta to Nebraska is now on hold after the U.S. government delayed permission on environmental concerns. The project will be reviewed again next year, only after a comprehensive environmental impact study is completed and alternate routes are evaluated. Nevertheless, the Cushing to Texas stretch of the pipeline was approved by the U.S. government earlier this year and is expected to be completed by the second half of 2013. In addition, an existing pipeline that now brings oil from the Gulf Coast to Cushing is being reconfigured and expanded to carry oil in the opposite direction.

Stung by the delays in the Alberta-Texas pipeline expansion, the Canadian government has been trying to speed up approvals for the $5.5 billion Northern Gateway Pipelines project connecting Alberta to British Colombia on the Pacific coast. The new transport project will seek to open new international markets for Canadian oil and thereby reduce the dependency on the U.S. market. What’s more, from the port of Kitimat in British Colombia, where the pipeline will end, the oil can then be easily transported to markets in Asia where demand remains high. Still, this project too has also been delayed on concerns over its impact on the environment and on the Native Indian population along the pipeline’s proposed route.

Another project to significantly expand the capacity of the existing Trans Mountain Pipeline System, which connects Alberta to refineries in the Vancouver area, has so far not faced much opposition. And the proposal to build a pipeline from Alberta to Montreal in the east, called the East Coast Pipeline Project, is at a very early stage and may take several years for the necessary approvals.

Nevertheless, lower energy export price realizations have become a drag on the country’s economic growth, as acknowledged by the Bank of Canada in its recent Monetary Policy Report. The central bank said ‘the price of oil that Canada exports has declined’ and the ‘deterioration in the oil-related terms of trade reduces Canada’s real gross domestic income’. Earlier studies by the central bank estimated that for every 10% increase in crude oil prices, real GDP growth gains by up to 0.3%.

The significance of the energy sector to the Canadian economy should only increase in the future as oil output expands, making it all the more important that these pipeline projects are completed without further delay. It is estimated that oil production in Canada will increase from the current 3.6 million barrels a day to more than 6 million barrels by the end of this decade. The Canadian Energy Research Institute expects that this increase in oil output will generate 700,000 jobs and add $3.3 trillion to economic output over a period of 25 years. The only apparent bottleneck that may prevent Canada from achieving this potential growth is the insufficient pipeline capacity. Promoting major infrastructure projects without ignoring environmental concerns demands a fine balance that most governments and policy makers find extremely difficult to manage. But it appears that Canada must find a way to untangle its energy pipeline projects and expand its export markets for energy. The alternative is living with the economically painful paradox of exporting cheap oil and importing the same commodity at higher prices.

 

Copyright © Thomas White

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Jeff Rubin: The End of Growth


Thursday, May 31st, 2012

 

 
Jeff Rubin, author of The End of Growth (his second best-selling instalment), discusses the effect and ramifications of expensive-to-produce oil, in the context of the developed world’s over-indebtness, with Pierre Daillie. He says our growth expectations, including those of Canada need to be adjusted downward, as low interest rates will not be sufficient to re-ignite growth, and the catch-22 of (high) oil prices will snooker (global economic) growth in the foreseeable future.

Rubin, former Chief Economist, CIBC World Markets, shares his current investment outlook as well.

At the heart of Rubin’s thesis is his well-informed premise that we’ve burned all the ‘cheap’ oil, and unless we learn to use less oil, growing global consumption of the black stuff can only come at growth’s expense.

Bottom line: We are destined to relinquish economic growth in return for the increasing global appetite for energy.

The End of Growth, by Jeff Rubin, is an eye-opener, an interesting and controversial perspective on the future of trending issues affecting global economic progress.

Discussion:
The End of Growth – Do You agree or disagree?

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India’s Demographic Dividends


Thursday, May 31st, 2012

India’s Demographic Dividends

Week of May 25, 2012

by Sunil Asnani, Matthews International Capital Management, LLC

The wine of youth does not always clear with advancing years; sometimes it grows turbid.—Carl Gustav Jung

Fortunately, India’s vast population of 1.21 billion, considered a “time bomb” not long ago, is increasingly being viewed as a positive. While its population has grown by roughly 18% over the past decade, the percentage of its children has actually fallen during this same period. This demographic shift could help India enjoy increasing national prosperity. The country appears to be at an early stage of declining fertility, leading to fewer young mouths to feed at the same time that it has a greater number of wage earners. This may result in a rise in income per person and the freeing up of resources for investment in economic development and family welfare. Popularly called “demographic dividends,” this phenomenon is expected to bridge regional economic inequalities as the poorer states in northern India catch up to their southern peers, which were early beneficiaries of this trend. Gender equality may also get a boost as women may have more freedom to work outside the home as their domestic responsibilities decrease.

This shift is worth a closer look. First of all, nations that have benefited from both declining fertility and advances in health care have eventually seen a resurgence in dependency ratios (a measure that expresses the number of a nation’s unemployed dependents—children under 15 and seniors over 65—to the total working age population) as their elderly populations rise in proportion. This means that today’s “dividends” will eventually have to be paid back. Granted, in India’s case, any reversal in fortunes is still a few decades away. But sooner or later, the country needs to develop a stronger culture of productivity and sustainable family planning. Secondly, India needs reforms that enable investments in social infrastructure and mobility within the labor pool while ensuring an adequate social safety net for all.

Cultivating the quality and skills of India’s young workforce is probably more important than the sheer increase in its employable population. Currently, at least a quarter of India’s population is illiterate. Having a workforce that has recently seen double-digit wage growth alongside a vastly unemployed and malnourished young population (the prevalence of underweight children in India is among the highest in the world) does not bode well. In addition to devoting further investment to improve nutrition, education and skill development for its citizens, the country must also reform its labor laws in order to attract more investment in the manufacturing sector. This segment has had a better track record of creating jobs than, for example, India’s “knowledge-outsourcing” industries. The timing arguably could not be better: China’s low-cost labor advantage is dwindling, and many companies with a presence in China are looking to base manufacturing operations in other countries.

India would do well to realize that this period of demographic shift is not merely a stroke of luck, but a window of opportunity. For growth to be sustainable requires some reforms in the way people live and work.

Sunil Asnani
Portfolio Manager
Matthews International Capital Management, LLC
The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than large companies.

 

Copyright © Matthews International Capital Management

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China Gives “Green” Light to Car Buyers


Thursday, May 31st, 2012

 

by Frank Holmes, U.S. Global Investors

China just made it a little more affordable to buy a car. Last week, the government announced a one-year, RMB 26.5 billion subsidy program devoted to energy-efficient products. About RMB 6 billion will be set aside for fuel-efficient cars, and the remaining incentives focus on LED lighting, high-efficiency motors, and air conditioners, refrigerators, washing machines and water heaters that comply with energy saving standards.

The last time China offered subsidies on autos and appliances, in 2009-2010, there was a tremendous increase in year-over-year production. At the peak, auto output jumped 120 percent while the production of appliances rose about 90 percent.

While the total budget for this program is only half of what the government offered in 2009, Morgan Stanley views this move as having a “positive influence on car demand.”

China also lowered gasoline prices lately, providing a “double benefit” for Chinese car buyers.

The subsidies should be welcome in a country that has become quite the car culture. Over the past decade, the auto industry has grown substantially, accelerating from only 2 million vehicles sold in 2000 to an estimated 20 million in 2012. Over the next three years, ISI estimates that another 22 million to 30 million cars will be sold each year.

Deutsche Bank says this government action strikes “a balance between immediate growth needs and long term goals of moving from an export/investment driven economy to a more self-sustaining consumer based economy.”

In Vancouver next month, I’ll be elaborating on the effect these consumer-friendly policies have on global resources at the World Resource Investment Conference. I hope to bring back plenty of investing ideas like this one to share with you.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

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Bill Gross: Investment Outlook (June 2012)


Thursday, May 31st, 2012


Wall Street Food Chain

June 2012

by William H. Gross, PIMCO

  • Soaring debt/GDP ratios in previously sacrosanct AAA countries have made low cost funding increasingly a function of central banks as opposed to private market investors.
  • Both the lower quality and lower yields of such previously sacrosanct debt represent a potential breaking point in our now 40-year-old global monetary system.
  • Bond investors should favor quality and “clean dirty shirt” sovereigns (U.S., Mexico and Brazil), for example, as well as emphasize intermediate maturities that gradually shorten over the next few years. Equity investors should likewise favor stable cash flow global companies and ones exposed to high growth markets.​

The whales of our current economic society swim mainly in financial market oceans. Innovators such as Jobs and Gates are as rare within the privileged 1% as giant squid are to sharks, because the 1% feed primarily off of money, not invention. They would have you believe that stocks, bonds and real estate move higher because of their wisdom, when in fact, prices float on an ocean of credit, a sea in which all fish and mammals are now increasingly at risk because of high debt and its delevering consequences. Still, as the system delevers, there are winners and losers, a Wall Street food chain in effect.

These economic and/or financial food chains depend on lots of little fishes in the sea for their longevity. Decades ago, one of my first Investment Outlooks introduced “The Plankton Theory” which hypothesized that the mighty whale depends on the lowly plankton for its survival. The same applies in my view to Wall, or even Main Street. When examining the well-known wealth distribution triangle of land/labor/capital, the Wall Street food chain segregates capital between the haves and have-nots: The Fed and its member banks are the metaphorical whales, the small investors earning .01% on their money market funds are the plankton. Yet similar comparisons can be drawn between capital and labor. We are at a point in time where profits and compensation of the fortunate 1% – both financial and non-financial – dominate wages of the 99% and the imbalances between the two are as distorted as those within the capital food chain itself. “Ninety-nine for the one” and “one for the ninety-nine” characterizes our global economy and its financial markets in 2012, with the obvious understanding that it is better to be a whale than a plankton. Not only do Wall Street and Newport Beach whales like myself have blowholes where they can express their omnipotence as they occasionally surface for public comment, but they don’t have to worry as yet about being someone else’s lunch.

Delevering Threatens Global Monetary System
Yet while the whales have no immediate worries about extinction, their environment is changing – and changing for the worse. The global monetary system which has evolved and morphed over the past century but always in the direction of easier, cheaper and more abundant credit, may have reached a point at which it can no longer operate efficiently and equitably to promote economic growth and the fair distribution of its benefits. Future changes, which lie on a visible horizon, may not be so beneficial for our ocean’s oversized creatures.
The balance between financial whales and plankton – powerful creditors and much smaller debtors – is significantly dependent on the successful functioning of our global monetary system. What is a global monetary system? It is basically how the world conducts and pays for commerce. Historically, several different systems have been employed but basically they have either been commodity-based systems – gold and silver primarily – or a fiat system – paper money. After rejecting the gold standard at Bretton Woods in 1945, developed nations accepted a hybrid based on dollar convertibility and the fixing of the greenback at $35.00 per ounce. When that was overwhelmed by U.S. fiscal deficits and dollar printing in the late 1960s, President Nixon ushered in a new, rather loosely defined system that was still dollar dependent for trade and monetary transactions but relied on the consolidated “good behavior” of G-7 central banks to print money parsimoniously and to target inflation close to 2%. Heartened by Paul Volcker in 1979, markets and economies gradually accepted this implicit promise and global credit markets and their economies grew like baby whales, swallowing up tons of debt-related plankton as they matured. The global monetary system seemed to be working smoothly, and instead of Shamu, it was labeled the “great moderation.” The laws of natural selection and modern day finance seemed to be functioning as anticipated, and the whales were ascendant.

Too Much Risk, Too Little Return
Functioning yes, but perhaps not so moderately or smoothly – especially since 2008. Policy responses by fiscal and monetary authorities have managed to prevent substantial haircutting of the $200 trillion or so of financial assets that comprise our global monetary system, yet in the process have increased the risk and lowered the return of sovereign securities which represent its core. Soaring debt/GDP ratios in previously sacrosanct AAA countries have made low cost funding increasingly a function of central banks as opposed to private market investors. QEs and LTROs totaling trillions have been publically spawned in recent years. In the process, however, yields and future returns have plunged, presenting not a warm Pacific Ocean of positive real interest rates, but a frigid, Arctic ice-ladened sea when compared to 2–3% inflation now commonplace in developed economies.

Both the lower quality and lower yields of previously sacrosanct debt therefore represent a potential breaking point in our now 40-year-old global monetary system. Neither condition was considered feasible as recently as five years ago. Now, however, with even the United States suffering a credit downgrade to AA+ and offering negative 200 basis point real policy rates for the privilege of investing in Treasury bills, the willingness of creditor whales – as opposed to debtors – to support the existing system may soon descend. Such a transition occurs because lenders either perceive too much risk or refuse to accept near zero-based returns on their investments. As they question the value of much of the $200 trillion which comprises our current system, they move marginally elsewhere – to real assets such as land, gold and tangible things, or to cash and a figurative mattress where at least their money is readily accessible. “There she blows,” screamed Captain Ahab and similarly intentioned debt holders may soon follow suit, presenting the possibility of a new global monetary system in future years, or if not, one which is stagnant, dysfunctional and ill-equipped to facilitate the process of productive investment.

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Cashin On Rumor Versus Reality


Wednesday, May 30th, 2012

 

The avuncular Art Cashin opines on the roller-coaster of unreality that has been the equity markets for the last few days as outcomes become increasingly binary and investors increasingly herded from one direction to another. His sage advice – as if spoken by the most-interesting-person-in-the-world – “Stay nimble”, my friends.

Via Art Cash of UBS,

Rumors Versus Reality With Rumors Resurgent At The Wire

Yesterday, there were rumors about that Chinese authorities were working on a new stimulus package. That cheered Asian markets and allowed European bourses to tiptoe around a deteriorating situation in Spanish banks.

Even before the U.S. markets opened, the semi-official Xinhua news agency of China began pooh-poohing the rumors. The rumormongers would have none of the denials.

A package would be announced after the markets closed (presumably in Europe – circa 11:30).

That backdrop allowed U.S. stocks to open better in a rather sharp, sigh of relief, oversold rebound.

They even shrugged off some lousy consumer confidence numbers at 10:00. Since the confidence data sharply countered Friday’s University of Michigan numbers, traders deemed them likely inconclusive.

The rebound rally held into the European close.

The rumors apparently morphed again. Simon Hobbs on CNBC said his sources suggested some announcement might come after the European close. The sense seemed to be that it would emanate out of Europe – not China.

After the 11:30 European close, U.S. stocks began to fade and rather rapidly at that.

The Euro fell through a trapdoor.

Was it just disappointment at no announcement? It looked a little too sudden and sharp for that.

Attention shifted to the cut in Spain’s rating by Egan-Jones. The timing was certainly coincidental, but did the somewhat small agency have that much clout?

Also contemporaneous with the Euro drop were analyses of an odd switch in a weekly ECB report.

There was a decline of over 25 billion Euros in collateral posted on the most recent LTRO. In another part of the ledger there was an increase of over 34 billion Euros in “other claims” (frequently smoke for emergency loans).

That raised speculation that the ECB may have “called” a loan, as the value of the posted collateral deteriorated. The bank, perhaps, could not find valid replacement collateral and shifted to emergency loan status.

While that seemed rather technical, if true, it raised fears that the banking situation in Spain, and elsewhere could even be worse than we knew.

The Euro-led selloff petered out around 1:30 EDT after cutting the morning gains in half.

As the day wore on, the China stimulus story began to resurface. That led to a bit of a flurry in the final half hour. Also, helping were media reports that election polls in Greece were shifting toward Euro-safe sentiments.

Overnight – EU Proposal Starts Roller-Coaster Ride – Pre-dawn this morning the situation in the Spanish banking community took several sharp turns.

The FT had reported that the ECB had vetoed the Bank of Spain’s plan to recapitalize its banks, particularly Bankia.

The Euro fell to a two year low before the ECB tweeted that there was no veto. European markets stabilized.

Then, the other shoe dropped.

Around 7:00 EDT, the EU commission issued a surprise plan to channel aid directly into European banks rather than through the treasury of their sovereign.

The announcement caught the European markets off-guard and sharp spike rallies erupted, erasing all, or most, of the earlier selloffs.

Then the doubts began to pop up. Would this clear the Merkel wing? Could it be set up within existing treaties?

The doubts stopped the rallies and prices faded but failed to go into freefall. That’s why I keep stressing staying nimble.

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As Draghi Fiddles And Madrid Burns, China Buys


Wednesday, May 30th, 2012

 

At this point it is no longer interesting to recap the ever-growing list of problems facing Spain – we all know the country needs billions and billions in aid to merely contain its implosion, let alone grow. And while as of as of minutes ago we just got another rumor of “Accelerated Kinetic Action In Close Proximity To Cash Dispensing Machines” which is the proper nomenclature, as the B-R word is not in good form these days it appears, the real news is that as the ECB fiddles, and Madrid burns guess who is buying? Why China of course.

From the WSJ:

A debt-laden Spanish construction firm became the latest European company to unload assets onto eager Chinese buyers, as Europe’s debt woes force firms to look to China for cash.

State Grid Corp., China’s government controlled power-grid operator, said Tuesday it would buy high-voltage electricity transmission assets in Brazil from Spain’s Actividades de Construccion y Servicios SA ACS.MC -0.55% for 1.86 billion reais ($938.2 million), including debt. The deal is State Grid’s second investment in Brazil and its fourth major investment overseas, and is the most recent in a string of deals in which a European company has looked to exit an investment amid financial troubles facing the region.

The story is a well-known one: boom years leading to exorbitant growth, following by a liquidity crunch as the easy money punch bowl is pulled away.

ACS’s standing has weaken because of its debts and the falling value of investments made during Spain’s boom years. Chairman Florentino Pérez, who is also the president of Spain’s soccer club Real Madrid CF, led ACS’s expansion when liquidity was abundant and Spain’s economy was booming on the back of a real-estate bubble that imploded about five years ago.

As credit dried up, ACS began to cut down on debt by shedding assets. ACS currently has more than €9.33 billion ($11.70 billion) in debt, about a half of what it had a few years ago.

Enter the white knight:

The move marks State Grid’s latest effort to expand into more lucrative areas than its tightly- regulated home market. State Grid oversees China’s power network over all but some southern portions of the country, giving it nearly nine tenths of the country.

Beijing also tightly controls the power market, limiting State Grid’s ability to seek terms from power suppliers or pass on costs to customers.

Beijing’s leaders over the past few years have pushed State Grid as well as other state-run behemoths to invest overseas as part of a broader effort to use China’s financial firepower to strike deals.

The pressure has been especially strong on China’s energy companies, which are seen as potential national champions in an increasingly competitive global market.

Perhaps this is why Greece is failing? Because China has realized it could buy Spain (and soon Portugal and Italy) for the same price, or even cheaper: remember – these are asset, not stock, purchases: one assumes liabilities as well. So $1 of equity value should be sufficient. And once China is done with the PIIGS, it can proceed to control the rest of the Europe… Which incidentally will still have to rely on Russia for its energy.

Is the New New World Order finally cristallizing to all?

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