Why Market Moves Have Been Misguided

Thursday, July 19th, 2012

by GCGodfrey, The Investment Insight

As U.S. stocks and the European equity index ended last week in positive territory, against a backdrop of disappointing data, market moves seems misplaced. Instead, Central Bank action is cosmetic not medicinal, a tool for reassurance not economic change. Developments from the recent EU Summit are either temporary or limited and capital remains restricted. However, economic deterioration heats up the pressure for action. Therefore, Central Banks are damned if they act and damned if they don’t. For sentiment to turn, we need to see signs of stability, as well as support.

Watch this being hotly debated on CNBC, with an entertaining edge…

Central Bank Action is Cosmetic Not Medicinal

Central bank action is being met with scepticism, and initial market rallies used as selling opportunities for profit taking. This is because moves are cosmetic and not medicinal, as in the short term they may reassure markets that measures are being taken, but they are of limited effectiveness at significantly boosting growth. Even Draghi himself, the President of the European Central Bank, argued “price signals (have) relatively limited immediate effect”. They won’t stimulate demand and, by potentially hurting bank profitability, could reduce the incentive to lend – the opposite of the target outcome.

Nevertheless, for the first time, we have seen the ECB cut the benchmark interest rate below 1%. In the same week, the Bank of England announced it will be increasing asset purchases by £50m. With weak US data and Bernanke already cautious, the pressure will be on to turn ‘Operation Twist’ into a more traditional waltz. Investors will be hoping the Fed will pump more liquidity into the system instead of ‘twisting’ or neutralising purchases by selling elsewhere along the yield curve.

Summit Moves Are Limited

The outcome of extensive talks at the EU Summit likewise fuelled a ‘false rally’. Spanish government bonds have since returned to hover around the unsustainable 7% level again despite developments. Instead, the 3 key ‘achievements’ are temporary or limited, as explained below…

1.     Senior not guaranteed: Investors have been moved higher up the pecking order and will now be repaid for loans made to Spanish banks before the bailout fund. Being the ‘first’ in line to get money back is indeed an improvement but crucially the risk of loss is still there and may continue to worry the markets.

2.     Wishful thinking? The government has been removed from the equation with bailout funds now able to offer loans to struggling Spanish banks directly. Removing government involvement in bank bailouts to protects sovereign bond yields ignores the possibility investors will continue to view the health of the banks as a driver of economic health.

3.     Bond buying boost limited: Bailout funds may now buy debt directly from “solvent countries” (read: Italy). However, this is a limited source of demand and again short-sighted.

Capital Remains Restricted

The size of the problem remains a key concern and a crucial measure missing from the Summit was a substantial strengthening of the ‘firewalls’. At €500bn, the rescue fund is only 20% of the €2.4tn combined debt burden of Spain and Italy. The risk that a lack of funding will leave European leaders unable to stop the crisis spreading remains.

Economic Deterioration Heats up the Pressure for Action

With a backdrop of a deteriorating economic environment, Europe is far from able to ‘grow out of the problem’. German manufacturing deteriorated for 4^th consecutive month. Relied upon as a rare source of growth, the outlook is dimming. European unemployment has reached its highest level since the creation euro. This is unlikely to spur spending and instead put the pressure back on Central Banks to do something to kick-start economic growth.

Therefore, Central Banks are damned if they act and damned if they don’t. For sentiment to turn, we need to see signs of stability, as well as support.

Note some of this article has been published by the Financial Times

Copyright © The Investment Insight

Tags: Asset Purchases, Bank Of England, Bank Profitability, Benchmark Interest Rate, Central Banks, Cnbc, ECB, Economic Change, Economic Deterioration, Edge Central, Equity Index, European Equity, Governmen, Initial Market, Investment Insight, Market Moves, Price Signals, Scepticism, Target Outcome, Yield Curve
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Emerging Markets Radar (July 16, 2012)

Saturday, July 14th, 2012

Emerging Markets Radar (July 16, 2012)

Strengths

• China’s second quarter GDP was up 7.6 percent, in line with the market expectation of 7.7 percent. Asia markets were up after the data release. Fixed asset investment growth accelerated on stronger infrastructure, increasing 20.4 percent year-over-year for the first half of the year versus the forecast of 20 percent. Consumption was stable, rising 13.7 percent in June, slightly down from 13.8 percent in May, but better than the estimated 13.4 percent. Clearly, China is growing at a slower speed, which makes it possible for the government to stimulate with easing monetary and fiscal policies.
• China’s June new loans were RMB 919.8 billion versus the estimate of 880 billion, but short-term lending is still high at about 50 percent. Household lending was 30 percent, which explains why housing sales went up 41 percent in June.
• Korea unexpectedly cut its benchmark interest rate by 25 basis points to 3 percent.
• For the China Region Fund we find that the current market is offering plenty of investment opportunities of growth at a reasonable price (GARP) in the China region. The Fund’s portfolio currently has an average dividend yield of 3.4 percent with average revenue growth at 25 percent.

Weaknesses

• China’s June industrial production was up 9.5 percent, lower than the estimate of 9.8 percent, but just slightly down from 9.6 percent in May. The growth of industrial production was still restrained by enterprises’ destocking and deleveraging, which has negative implication for the economic growth. As a leading indicator to China’s GDP growth, power output is in decline, flat in June, compared to 2.7 percent year-over-year growth in May.

Opportunities

Acceleration in Chinese Bank Lending Should Help Sustain Property Transaction Recovery

• After two interest rate cuts, China housing transactions have increased as home buyers can borrow at lower rate. In the meantime, the People’s Bank of China, the central bank, has encouraged banks to lend to first-time home buyers. The increased new loans in June are a positive sign that new loans are back on an upside trend.

Threats

• Although China’s June economic numbers are showing a steady economic growth, the trend can be on the downside, which makes the market believe the Chinese government will continue to spend to backstop growth weakness.

Tags: Asia Markets, Asset Investment, Bank Of China, Basis Points, Benchmark Interest Rate, China Region, Chinese Bank, Current Market, Dividend Yield, Emerging Markets, Fiscal Policies, Garp, GDP Growth, Housing Sales, Implication, Investment Growth, Investment Opportunities, Leading Indicator, Property Transaction, Quarter Gdp
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China Joins Global Easing Party By Cutting The Lending And Deposit Rates By 25 bps

Thursday, June 7th, 2012

Update: 9:00 am has come and gone… and no global bailout unlike November 30, 2011. Not a good sign for those expect a central-bank D-Day.

While minutes ago the Bank of England followed in the ECB’s footsteps, it was the China central bank that stole England’s thunder, announcing an unexpected rate cut moments before 7 am, and thus finally joining the global easing party: this was the first Chinese interest rate cut since 2008. As a reminder, hours before the global central bank intervention on November 30, China announced its first (50 bps) reserve requirement cut since 2008. Is today’s PBOC move, which is the first cut of deposit and 1 year lending rates also since 2008, a harbinger of something much bigger to come any second now?

From the PBOC:

The People’s Bank of China decided to cut financial institutions RMB benchmark deposit and lending interest rates since June 8, 2012. One-year benchmark deposit rate cut of 0.25 percentage points, year benchmark lending interest rate cut by 0.25 percentage points; other deposit and lending interest rates and individual housing provident fund deposit and lending rates be adjusted accordingly.

 

Since the same day: (1) the upper limit of the floating range of interest rates on deposits of financial institutions was adjusted to 1.1 times the benchmark interest rate; (2) loans from financial institutions interest rate floating range of the lower limit was adjusted to 0.8 times the benchmark interest rate.

And from Bloomberg:

China Cuts Interest Rates for First Time Since 2008

China cut interest rates for the first time since 2008, stepping up efforts to combat a deepening economic slowdown as Europe’s worsening debt crisis threatens global growth.

The benchmark one-year lending rate will drop to 6.31 percent from 6.56 percent effective tomorrow, the People’s Bank of China said on its website today. The one-year deposit rate will fall to 3.25 percent from 3.5 percent. Banks can also offer a 20 percent discount to the benchmark lending rate, the PBOC said, widening from a previous 10 percent.

European stocks and U.S. index futures extended gains as China’s move fanned optimism that policy makers around the world will do more to bolster growth. The announcement, two days before China is due to report inflation, investment and output figures, may signal that the economy is weaker than the government expected.

“This will be the beginning of a rate cut cycle and there will be at least one more reduction this year,” said Shen Jianguang, a Hong Kong-based economist with Mizuho Securities Asia Ltd. “The data to be released over the weekend must be very weak and inflation must have eased sharply.”

The MSCI All-Country World Index added 0.8 percent at 7:30 a.m. in New York. The Stoxx Europe 600 Index jumped 1.2 percent, extending yesterday’s biggest rally in six months, while the Standard & Poor’s 500 Index futures advanced 0.7 percent.

Slower Growth

The central bank last reduced benchmark interest rates in late 2008, when the government unveiled a 4 trillion yuan ($586 billion at the time) stimulus package to counter the effects of the global financial crisis. Interest rates have been unchanged since an increase in July 2011.

Industrial output in China, the world’s biggest producer of steel and cement, probably rose 9.8 percent last month from a year earlier, close to the slowest pace in three years, according to the median estimate in a Bloomberg News survey of 27 economists ahead of a National Bureau of Statistics report due June 9.

Inflation may have moderated to 3.2 percent in May from a year earlier after a 3.4 percent rate in April, a separate survey showed, the fourth month consumer prices have risen by less than the government’s 2012 target of 4 percent.

Today’s move signals policy makers are concerned that the cost of borrowing is crimping companies’ spending and holding back expansion in the world’s second-biggest economy. Three bank officials told Bloomberg News last month that the nation’s biggest banks may fall short of loan targets for the first time in at least seven years as demand for credit wanes.
Slowdown Worsening

The PBOC cut banks’ reserve requirements in November for the first time in three years, and again in February and May, to spur lending.

China’s manufacturing expanded at the slowest pace in six months in May, a government report showed on June 1, adding to signs the nation’s slowdown is worsening. A separate purchasing managers’ index from HSBC Holdings Plc and Markit Economics pointed to a seventh straight contraction, the longest stretch since the global financial crisis.

Premier Wen Jiabao and the State Council, or Cabinet, pledged last month to place greater emphasis on stabilizing growth after data showed April industrial production, new loans and exports all increased less than economists forecast. The data prompted banks including Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. to cut their economic-growth estimates.

Slowdown Worsening

The PBOC cut banks’ reserve requirements in November for the first time in three years, and again in February and May, to spur lending.

China’s manufacturing expanded at the slowest pace in six months in May, a government report showed on June 1, adding to signs the nation’s slowdown is worsening. A separate purchasing managers’ index from HSBC Holdings Plc and Markit Economics pointed to a seventh straight contraction, the longest stretch since the global financial crisis.

Premier Wen Jiabao and the State Council, or Cabinet, pledged last month to place greater emphasis on stabilizing growth after data showed April industrial production, new loans and exports all increased less than economists forecast. The data prompted banks including Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. to cut their economic-growth estimates.

Tags: Bailout, Bank Of China, Bank Of England, Benchmark Interest Rate, Bps, Central Bank Intervention, China, China Cuts, D Day, Debt Crisis, ECB, Economic Slowdown, Financial Institutions, Footsteps, Global Growth, Gold, Harbinger, interest rates, Pboc, Percentage Points, Provident Fund, Reminder
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Emerging Markets Radar (February 13, 2012)

Saturday, February 11th, 2012

Emerging Markets Radar (February 13, 2012)

Strengths

• The People’s Bank of China (PBOC) said on Tuesday that it will ensure first-home purchasers have access to credit, according to a statement published on its website. On Thursday, WUHU, a large city in Anhui Province, relaxed property restrictions, a sign that there are local-level adjustments to assist the housing market.
• China’s January exports were down 0.5 percent, less than the estimate of -1.4 percent, while imports were down 15.3 percent, worse than the market consensus 3.6 percent. There was also the Chinese New Year effect, according to analysts.
• The Natural Resources Defense Council (NRDC) has raised diesel and petro prices across China by roughly 3 percent each.
• Indonesia unexpectedly lowered its benchmark interest rate by 25 basis points to 5.75 percent, a third move after two cuts last year. The lower policy rate will add pressure to commercial banks on their net interest margins, but will be good for corporations and consumers, especially for developers and auto makers.
• Indonesia’s fourth quarter GDP rose 6.49 percent, better than market consensus. For 2011 the economy expanded 6.5 percent, the fastest since 1996.
• Philippine’s Consumer Price Index (CPI) rose 3.9 percent, easing to a 13-month low.
• In Turkey, December industrial production (IP) came in at 3.7 percent year-over-year, better than the consensus estimate of 2.6 percent.  While significantly down from 8.4 percent in November, base effects played a large role, as IP last December was very high at 16.7 percent.   On a seasonally and working day adjusted basis, IP has been trending up in the second half of 2011.

Weaknesses

• China’s January CPI was up 4.5 percent, higher than the market expectation of 4 percent. The vegetable price was up 26 percent, and was blamed for the higher-than-expected inflation number. The bad news didn’t dampen the market bullishness in China and Hong Kong since the consensus is that the disinflation trend is intact. The Producer Price Index (PPI) was down 0.1 percent for the month.
• Philippine’s exports dropped 20.7 percent year-over-year in December as electronics shipments dropped. The result was worse than expected and was a greater decline than November’s figure.
• The Hungarian regulator has released the latest data on foreign exchange (FX) mortgage repayments in the sector. According to this data, by the end of January 2012, 142,000 people have repaid FX mortgages worth Hungarian forint (HUF) 1,074 billion at spot FX rates and HUF 776 billion at fixed FX rates, causing the banking sector HUF 298 billion pre tax loss. Another 19,000 people have submitted the necessary documents by the deadline and are still expected to pay later on, potentially repaying another HUF 145 billion worth of FX mortgages at spot FX rates and HUF 105 billion at fixed FX rates, potentially causing a further HUF 45 billion pre tax loss to the banks before the whole scheme is wrapped up.

Opportunities

• China’s January exports were better than expected, and may have been supported by improving U.S. recovery in credit, payroll and consumer spending, and by the European Central Bank’s long term refinancing operation (LTRO) in increasing liquidities for European financial institutions. The U.S. ISM Manufacturing Purchasing Managers Index is a leading indicator for Chinese exports as shown below that it is pointing to improved demands for Chinese goods.

• There is generally a very strong correlation between GDP growth and non performing loan ratios of nations’ banks, and Turkey is no exception (see chart below). As evidenced by the strong industrial production number for December, the Turkish economy continues to expand, easing the provision burden on the banks.

Threats

• China’s higher-than-expected CPI for January may delay PBOC’s decision to cut the bank required reserve ratio (RRR).
• Bloomberg reported that Russia may charge a one-time levy on businessmen who acquired assets in “unfair” 1990s state sales, said Prime Minister Vladimir Putin, who is campaigning to return to the presidency in next month’s election. Thursday’s Vedomosti suggests that Putin may try to style this one-time “windfall tax” on the U.K. approach.  According to the article, in 1997 the U.K. imposed a one-time payment on the owners of assets acquired during privatizations of the 1980s.  The payment was a tax of 23 percent on the difference between: a) the average net profit of the privatized companies made in the first four years following privatizations, multiplied by the factor of 9.3 and b) the purchase price.

Tags: Adjusted Basis, Auto Makers, Bank Of China, Benchmark Interest Rate, Chinese New Year, Commercial Banks, Consensus Estimate, Consumer Price Index, Home Purchasers, Index Cpi, Inflation Number, Interest Margins, Market Consensus, Natural Resources Defense, Natural Resources Defense Council, Nrdc, Pboc, Property Restrictions, Quarter Gdp, Wuhu
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In the Bullring With Gold

Sunday, February 5th, 2012

by Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

After prices fell 10 percent in December, many investors wondered if the bull market in gold was running out of steam. That was before Federal Reserve Chairman Ben Bernanke swooped in with a “red cape” and fired the bulls back up. Since the Fed reassured the world that interest rates will remain at “exceptionally low levels” for another two years, gold has jumped more than three percent.

UBS described the situation simply, “if investors needed a (further) reason why they should be long gold now, they got it yesterday … a more accommodative policy is a very good foundation for gold to build on the next move higher.”

To gold bugs, two more years of near-zero, short-term interest rates means negative real interest rates are here to stay, and this has historically been a strong driver for higher gold prices.

Bernanke and the Fed aren’t the only central bankers in the fiscal and monetary bullring. Brazil has cut its benchmark interest rate a few times and China lowered its reserve rate for banks in December. According to ISI Group, 78 “easing moves” have been announced around the world in just the past five months as countries look to stimulate economic activity.

One of the main weapons central bankers have employed is money supply, which has created a ton of liquidity in the global system. Global money supply rose 8 percent year-over-year in December, or about $4 trillion, according to ISI. I mentioned a few weeks ago how China experienced a record increase in the three-month change in M-2 money supply following China’s reserve rate cut.

Together, negative real interest rates and growing global money supply power the Fear Trade for gold. The pressure these two factors put on paper currencies motivates investors from Baby Boomers to central bankers to hold gold as an alternate currency.

Adrian Ash from Bullionvault says global central banks are on a buying spree and they have been since the Fed cut interest rates by 25 basis points in 2007. Central bankers’ shift to buying gold was a significant sea change for the yellow metal.

You can see from the chart below that official gold reserves have historically been much higher, averaging around 35,000 tons. In the 1990s, central banks began selling, with reserves hitting a 30-year low right around the time the Fed began cutting rates. Adrian says that gold holdings are now at a six-year high with the current amount of gold reserves just less than 31,000 tons.

These are countries large and small. In December, Russia, which has been routinely adding to the country’s gold reserves since 2005, purchased nearly 10 tons; Kazakhstan purchased 3.1 tons and Mongolia bought 1.2 tons. UBS says “although reported volumes are not very large, it is still an extension of the official sector accumulation trend.”

Not all central banks are recent buyers, though. The “debt-heavy West” has sold its gold holdings, while emerging markets increased their gold reserves 25 percent by weight since 2008, says Adrian.

Reserves as a percent of all the gold mined has also declined, with “a far greater tonnage of gold … finding its way into private ownership,” says Adrian. Since 1979, you can see the percentage of reserves to total gold has declined at a much faster pace as individuals increasingly perceived gold as a financial asset.

Adrian points to China’s Gold Accumulation Plan as a recent example of this trend. A joint effort between the Industrial & Commercial Bank of China (ICBC) and the World Gold Council (WGC), the program allows Chinese citizens to buy gold in small increments as a way to build up their gold holdings over time. The WGC reported in September that the program had established 2 million accounts during its first few months in operation and the amount is growing by the day.

These programs open the door for gold as an investment to a whole new class of people in China but that’s only a fraction of the tremendous demand for gold that we are seeing from China. In addition to the Fear Trade, gold is driven by the Love Trade, which is the strong cultural affinity the East, namely China and India, has to the precious metal.

In 2010, the Indian Sub Continent and East Asia made up nearly 60 percent of the world’s gold demand and 66 percent of the world’s gold jewelry demand, according to the WGC.

Indian jewelry demand has historically increased during the Shradh period of the Hindu calendar, but last year, high prices and a volatile rupee kept many Indian buyers on the sideline.

If you thought $1,900 was too much to pay for an ounce of gold, imagine how Indians felt when the rupee fell against the U.S. dollar, causing a gold price spike in rupees. Gold in Indian rupee terms rose more than 35 percent from July to November, roughly three times the magnitude of gold priced in U.S. dollars, yuan or yen. This currency swing significantly impacted Indian gold imports, which dropped 56 percent in the fourth quarter, according to data from the Bombay Bullion Association.

“Indian buyers will be back” after they adjust to the higher prices, says Fred Hickey. In one of his latest editions of “The High-Tech Strategist,” he cites late 2007 as a recent example when the Indian gold market experienced a similar rough patch. That year, gold demand in India fell off a cliff after prices spiked more than $1,000 an ounce in one quarter, tarnishing the country’s love affair with gold for a “brief period.” Fred says their cultural affinity for gold as an important store of wealth and protection against inflation will drive Indian buyers back into the market.

The trend was already changing in 2012, as UBS reported that the first day of trading saw physical sales to India were twice what they usually are, according to Fred. Although this is a very short time frame, I believe the buying trend will continue in this gold-loving country.

In China, “just as in India, gold is seen as a store of wealth and a hedge against inflation,” says Fred. Demand has been growing, especially in the third quarter, when China’s gold purchases outpaced India. “Physical demand for gold from the Chinese has been voracious all year,” says Fred. As of the third quarter, China had already obtained 612 tons, eclipsing its total 2010 demand, according to the WGC.

Across the Chinese retail sector, gold, silver and jewelry demand was the strongest performing segment in 2011, says J.P.Morgan in its “Hands-On China Report.” Growth in this segment far outpaced clothing and footwear, household electrical appliances, and even food, beverage, tobacco and liquor, all of which experienced more modest growth.

J.P.Morgan says the bulk of the increase came from lower-tier cities “where income levels are rising the fastest and improvements in retail infrastructure have allowed for rapid store expansion.”

Increasing incomes coupled with government policies that support growth have been the main drivers for rising gold prices. Take a look at the chart below, which shows the strong correlation between incomes in China and India and the gold price. As residents in these countries acquire higher incomes, they have historically purchased more gold, driving gold prices higher.

We anticipated that the Year of the Dragon would spur an increase in the buying of traditional gifts of gold dragon pendants and coins. Gold buying did hit new records, says Mineweb, with sales of precious metals jumping nearly 50 percent from the same time last year, according to the Beijing Municipal Commission of Commerce.

This should serve as a warning to all of gold’s naysayers. Gold bullfighters beware—you now have to fight the gold bull while fending off a golden Chinese dragon.

Tags: Baby Boomers, Benchmark Interest Rate, Bullionvault, Bullring, Central Banks, Chief Investment Officer, Federal Reserve Chairman, Federal Reserve Chairman Ben Bernanke, Frank Holmes, Global Money, Global System, Gold Bugs, Gold Prices, Good Foundation, Isi Group, Money Supply, Paper Currencies, Running Out Of Steam, Term Interest, U S Global Investors
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Bill Gross: “QE 2.5 Today, QE 3, 4, 5, … lie ahead”

Thursday, January 26th, 2012

PIMCO’s Bill Gross commented/tweeted yesterday that “Financial repression” and possibly three more rounds of QE lie ahead, in response to the Fed’s statement.

From Bloomberg:

• The U.S. will suffer “financial repression” as the Federal Reserve implements additional quantitative easing, according to Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co.
• A third, fourth and fifth round of easing “lie ahead,” Gross wrote in a Twitter post.
• The Fed will probably hold its benchmark interest rate at near zero percent for at least the next three years, the post said. Chairman Ben S. Bernanke said yesterday the Fed is considering additional bond purchases to boost growth after extending its pledge to keep interest rates low through at least late 2014.

• “Financial repression depends on negative real yields and until inflation moves higher for a period of at least several years, central banks will hibernate at the zero bound,” Gross wrote in his monthly investment outlook on Jan. 4.
• Policy makers are “prepared to provide further monetary accommodation” and bond buying is “an option that’s certainly on the table,” Bernanke said after officials gathered for a meeting yesterday. The central bank has purchased $2.3 trillion of securities in two rounds of large-scale asset purchases known as quantitative easing.
• The Fed is in the process of replacing $400 billion of shorter-maturity Treasuries in its holdings with longer-term debt to “put downward pressure on longer-term interest rates,” based on a statement announcing the plan in September.
• Gross increased U.S. government and Treasury debt in the $244 billion Total Return Fund to 30 percent of assets in December, the highest in 13 months, after betting against the securities during a rally last year.

Tags: Asset Purchases, Benchmark Interest Rate, Bernanke, Bill Gross, Bond Fund, Central Banks, Downward Pressure, Federal Reserve, Financial Repression, inflation, Investment Management, Investment Outlook, Maturity, Pacific Investment Management Co, Qe 2, Term Debt, Term Interest, Treasuries, Trillion, Zero Percent
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Emerging Markets Radar (December 5, 2011)

Sunday, December 4th, 2011

Emerging Markets Radar (December 5, 2011)

Strengths

• The People’s Bank of China (PBOC) cut the bank required reserve rate (RRR) by 50 basis points, effective December 5. PBOC’s decision was announced just a day before the release of China’s official PMI number for November that sank into contraction. Goldman Sachs, among few in the market, believes this is a signal that points to the beginning of the cycle for an easing monetary cycle in China.
• Thailand central bank cut its benchmark interest rate by 25 basis points to 3.25 percent, citing that the industrial growth was affected by the flood more than expected. The country is expected to stimulate its economy with fiscal policy as well.
• S&P upgraded Bank of China and China Construction Bank from BBB+ to A-, and kept single A for Industrial and Commercial Bank of China, while it downgraded J.P. Morgan Chase & Co., Bank of America Corp., Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley. The reason for the upgrading of the Chinese banks is the Asian governments’ greater willingness to prop up their financial systems coupled with higher savings rates, according to S&P.
• Korea’s current account surplus widened to $4.23 billion in October, reaching a one-year high.
• Macau Gross Gaming Revenue (GGR) for November surpassed 23 billion, up 32 percent year-over-year, easily beating market expectation.
• Indonesia’s CPI rose 4.15 percent year-over-year in November, slowing for a third successive month.
• In November, Russian crude oil output was up by 0.9 percent year-over-year at 10.34 million barrels per day (same as in October), and gas production up 8.9 percent year-over-year.
• The seasonally-adjusted HSBC Russia Manufacturing PMI headline index rebounded from 50.4 in October to 52.6 in November. This was the strongest improvement in the manufacturing business sentiment since March and stands in contrast with weak PMI reports from the eurozone and China.

• Turkey PMI remained in expansion territory, easing to 52.3 in November from 53.3 in October. In response to further gains in new orders, Turkish businesses hired additional workers in November and the rate of job creation picked up to a seven-month high.

Weaknesses

• China’s November official PMI fell 1.4 percent from October and sank into contraction territory at 49 percent, after hovering between 50 to 52 percent in the last 6 months. A PMI reading below 50 indicates the industrial activities are contracting. Most importantly, weakened export and domestic orders pushed the new orders index to fall 2.7 percent to 47.8 percent, slipping into contraction territory for the first time since January 2009, and the production index was down 1.4 percent to 50.9 percent. If the production index falls below 50, it might indicate widespread unemployment. This is probably the reason that some in the market are expecting China to ease its monetary policy from here once inflation is tamed.
• HSBC final China PMI was also down to 47.7 versus 51 for October.
• Industrial enterprises’ profits grew 25.3 percent year-to-date in October on a year-over-year basis, down 1.7 percent from the year-to-date number in September, as growth has slowed for a fifth consecutive month. This suggests the moderation of aggregate demand has dampened sales and squeezed manufacturers’ profit margins.
• Korea’s industrial production rose 6.2 percent year-over-year in October, advancing at the slowest pace since August this year.
• Philippines’ budget deficit widened in October to $489 million as revenue growth eased and government spending rebounded. Philippine third-quarter GDP increased 3.2 percent, up from the prior quarter but below expectation.
• October housing transactions in China declined 25 percent from September and prices fell in 33 of 70 cities, Bloomberg News reported, citing Chinese government’s data. This is another area that the market is watching closely since the housing market is important to the overall economy in China.
• Indonesia’s exports rose 16.7 percent year-over-year in October, missing expectation and much smaller than September’s 46.3 percent gain. Imports rose 29.1 percent.
• Thailand’s CPI rose 4.19 percent year-over-year in November, holding above 4 percent for an eighth month as the flooding caused food prices to rise.
• Business conditions continued to deteriorate in the eurozone, with German November PMI dropping for the seventh consecutive month to 47.9, from 49.1 in October. Czech and Polish economies are linked to Germany’s, and PMIs in both countries followed suit, slipping into contraction territory for the first time since 2009.

Opportunities: China Monetary Policy Cycle

• This week’s bank required reserve rate (RRR) cut of 50 basis points by the PBOC might be just the beginning of China’s monetary policy moving from tightening to easing. Historically, as the chart shows below, Hong Kong and Shanghai stock markets began to rise when the PBOC eased and the stock market began to decline when the PBOC tightened money supply.
• While the U.S. Federal Reserve had been quick to turn on the money printing press when equity markets dropped in 2008, the European Central Bank (ECB) has been slow to respond to the eurozone periphery crisis. But with the likely sources of funding not being sufficient to cover the size of the European bailout fund, the ECB may have no choice but to print money as well.

Threats

• China’s November PMI indicates its economic activities are contracting. Given that PMI is a forward looking indicator, the economy could be in a downside momentum for several months as housing transactions are slowing, and export and domestic orders are shrinking. Some analysts are worried that the Chinese government may not be taking preemptive policy action to stop the down trend as, historically, they have been reactionary instead.
• Bond issuance by European banks has plunged this year. These markets have frozen up since July and European banks had to turn to borrowing through short-term interbank markets. While coordinated action by the central banks this week will ease pressure for short-term funding, European banks are facing long term-refinancing needs in 2012 (see the chart below from the Economist).

Tags: Account Surplus, Asian Governments, Bank Of America Corp, Bank Of China, Benchmark Interest Rate, Business Sentiment, China Construction Bank, Chinese Banks, Commercial Bank Of China, Crude Oil Output, Gaming Revenue, Goldman Sachs, Goldman Sachs Group, Goldman Sachs Group Inc, Gross Gaming, Industrial And Commercial Bank Of China, J P Morgan Chase, Morgan Stanley, Pboc, Sachs Group Inc
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Monetary Policy: Week in Review (October 30, 2011)

Monday, October 31st, 2011

The article below comes courtesy of Central Bank News, an authoritative source on monetary policy developments.

The past week in monetary policy saw 15 central banks announce interest rate decisions. Those that increased interest rates were: India +25bps to 8.50%, and Mongolia +50bps to 12.25%, while those that decreased interest rates were: The Gambia -100bps to 14.00%, Sierra Leone -300bps to 20.00%, and Georgia -25bps to 7.25%. Also announced was Angola’s central bank setting its new benchmark interest rate at 10.50%. The central banks that held interest rates unchanged were: Israel 3.00%, Canada 1.00%, Hungary 6.00%, New Zealand 2.50%, Japan 0-0.10%, Russia 8.25%, Namibia 6.00%, Sweden 2.00%, and Colombia 4.50%. Also in the news was the Bank of Japan announcing a 5 trillion yen addition to its quantitative easing program.

With just two months left in the year this week’s summary chart shows a good representation of monetary policy this year. The key word of course is diversity. On the one hand there is developed markets with unusually low interest rates (and low growth and low inflation pressures). While on the other hand is the emerging and developing markets with much higher interest rates (and relatively higher growth rates and inflationary pressures). Even within developing economies there is diversity in the trajectory of interest rates as some begin to feel the pinch of policy tightening, paired with the deteriorating outlook in western economies, and in particular the ongoing sovereign debt issues in Europe (short-term crisis-containment measures notwithstanding).

Some of the key quotes from the monetary policy makers are included below:

• Reserve Bank of India (increased rate 25bps to 8.50%): “both inflation and inflation expectations remain high. Inflation is broad-based, and is above the comfort level of the Reserve Bank. We expect these levels to persist for two more months. There are potential risks of expectations becoming unhinged in the event of a pre-mature change in the policy stance. However, reassuringly, momentum indicators, particularly the de-seasonalised quarter-on-quarter headline and core inflation measures, indicate moderation. This is consistent with the projection that inflation will decline beginning December 2011.”
• Bank of Japan (added 5 trillion to QE): “some more time will be needed to confirm that price stability is in sight and due attention is needed for the risk that the economic and price outlook will further deteriorate depending on developments in global financial markets and overseas economies. While steadily implementing its decision in August to enhance monetary easing, especially through the purchase of financial assets, the Bank deemed it necessary to further enhance monetary easing so as to ensure a successful transition to a sustainable growth path with price stability.”
• Central Bank of Russia (held rate at 8.25%): “Considering recent domestic and international macroeconomic developments and the effect of the monetary policy measures, implemented in recent months, the Bank of Russiajudged that the current level of money market interest rates is appropriate to balance the inflationary risks and the risks of economic growth slowdown in the nearest future”
• Bank of Mongolia (increased rate 50bps to 12.25%): “The rapid expansion of budget expense, cash hand-out from the Human Development Fund and the high increase in loans are contributing to higher demand. This sharp increase in demand builds the pressure on core inflation even the total supply and the real capacity of economy have not added on yet. The consecutive growth in prices of non-food products from the beginning of 2011 and the current stand in yoy 11.3% prove that the increase of total demand is bringing the growth of core price.”
• Riksbank (held rate at 2.00%): “The difficulties in resolving the public finance crisis in Europe has led to increased uncertainty regarding the future. In Sweden, growth is expected to be slightly weaker in the coming period. At the same time, inflationary pressure is low. The Executive Board of the Riksbank has therefore decided to hold the repo rate unchanged at 2 per cent and to wait to increase it until sometime next year.”
• Bank of Canada (held at 1.00%): “The global economy has slowed markedly as several downside risks to the projection outlined in the Bank’s July Monetary Policy Report (MPR) have been realized. Financial market volatility has increased and there has been a generalized retrenchment from risk-taking across global markets. The combination of ongoing deleveraging by banks and households, increased fiscal austerity and declining business and consumer confidence is expected to restrain growth across the advanced economies. The Bank now expects that the euro area—where these dynamics are most acute—will experience a brief recession.”
• Reserve Bank of New Zealand (held rate at 2.50%): “Given the ongoing global economic and financial risks, it remains prudent to continue to keep the OCR on hold at 2.5 percent for now. However, if global developments have only a mild impact on the New Zealand economy, it is likely that gradually increasing pressure on domestic resources will require future OCR increases.”

Looking at the central bank calendar, next week will be a very interesting week in central banking with the very important US Federal Reserve and European Central Bank both announcing monetary policy decisions. All eyes will be focused on whether the US FOMC announces or hints at any further quantitative easing; meanwhile people will be watching to see if the new ECB president, Mario Draghi, decides to cut the interest rate or provide any other supportive measures to aid the faltering Eurozone economies.

Source: Central Bank News, October 29, 2011.

Tags: Bank News, Bank Of India, Bank Of Japan, Benchmark Interest Rate, Canadian Market, Central Banks, Containment Measures, Debt Issues, Developing Economies, India, Inflation Expectations, Inflation Pressures, Inflationary Pressures, Interest Rate Decisions, Low Interest Rates, Outlook, Policy Developments, Reserve Bank Of India, S Central, Sovereign Debt, Sweden 2, Term Crisis, Western Economies
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Emerging Markets Cheat Sheet (October 17, 2011)

Saturday, October 15th, 2011

Emerging Markets Cheat Sheet (October 17, 2011)

Strengths

• China’s Consumer Price Index (CPI) is stabilizing at 6.1 percent for the month of September, 0.10 percent lower than the 6.2 percent a month earlier. The highest level reached was in July, with CPI at 6.5 percent. Although September’s CPI was not low enough for the People’s Bank of China (PBOC) to loosen monetary tightening, it provides time for the government to increase food supply. China’s Producer Price Index (PPI) was 6.5 percent, lower than market estimate of 6.9 percent.
• Korea’s unemployment rate was 3.2 percent for September, while it was 3.1 percent for August. It is still very close to the 10-year low of 3 percent, showing the economy and businesses are currently stable in spite of a deteriorating external economic environment.
• China’s Central Huijin, a government entity that owns SOEs, started buying Chinese big-four banks, i.e., Industrial and Commercial Bank of China, Bank of China, China Construction Bank of China and Agricultural Bank of China in the A-share market. This shareholder buyback indicates Chinese government support to the A-share market, which is positive for the Hang Seng Index.
• China’s State Council, the Cabinet, unveiled monetary and fiscal policy measures on Wednesday to help the country’s troubled small companies by forcing financial institutions to increase lending support. China recently had seen increasing financing troubles for small, privately-owned companies, particularly in Wenzhou, a booming town in the province of Zhejiang.
• China’s passenger-car sales to dealerships in September rose 8.8 percent from a year earlier to 1.32 million units, the China Association of Automobile Manufacturers said on Thursday.
• Bank of Korea (BOK) maintained its benchmark interest rate at 3.25 percent. This was the fourth successive BOK meeting where the rate remained unchanged.
• Indonesia cut its benchmark interest rate from 6.75 percent to 6.50 percent, while the market had expected no move. This is the first rate cut since August 2009. The government is ready to help the economy in case the European debt crisis hits hard on its export business.
• Korea’s producer price index climbed 5.7 percent on a year-over-year basis in September, growing at the slowest pace in nine months.
• Korea’s automobile production grew 10.3 percent year-over-year in September due to solid demand from both domestic and overseas markets.
• Malaysia’s industrial production gained 3 percent year-over-year in August as manufacturing and electricity output climbed. The result far exceeded expectations for a 0.4 percent jump. Malaysia is not an export-driven economy compared with other Asian countries.
• During China’s Golden Week holiday that ended on October 7, 302 million tourists traveled throughout the country, an 18.8 percent increase year-over-year. Tourism revenue for the week reached 145.8 billion Rmb, a 25.1 percent increase year-over-year. This shows consumer spending in China is still robust, probably a bright spot in the slowing Chinese economy.
• The Slovakian parliament approval removed the final obstacle to expanding the eurozone’s rescue fund. The measure received support from 114 members, with 30 voting against and three abstaining. The European Financial Stability Facility will be increased to $600 billion.

Weaknesses

• September’s inflation was still mainly due to food price hikes, which went up 13.4 percent on year-over-year basis and up 1.1 percent month-over-month, contributing 4.05 percent of total CPI.
• China’s September exports were up 17.1 percent, and imports were up 20.9 percent, versus consensus estimates of 20.5 percent and 24.2 percent. The slower growth rate in exports had been indicated in September’s Purchasing Manager’s Index (PMI) lower new order book.
• Thailand consumer confidence fell to 72.2 in September from 73.8 in August, falling for a second straight month due to the worst flooding in five decades. The Bangkok stock market fell on Wednesday reacting to the flood damages. However, Thailand Prime Minister Yingluck has said yesterday that the country has avoided the worst scenario by finding channels to redirect the waters out of Bangkok.
• Korea’s third quarter foreign direct investment declined 24.6 percent, the most since the first quarter of 2009. All indicators are pointing to an economic slowdown due to external factors that are the European and U.S. economies. A slowing Chinese economy is also negative for Korea since a third of its export goes to China.
• Philippine exports declined 15.1 percent year-over-year to $4.5 billion in August as sales of electronic goods dropped. The decline was the biggest since September 2009.
• Brazil inflation climbed after the 0.5 percent interest rate cut at the end of August. Inflation rate rose 7.31 percent in September from a year earlier, the highest level in more than six years.

Opportunities

• The Chinese corporate Inventory to GDP ratio remains at a decade low level.
• The chart below by BCA research shows that after destocking in 2009, Chinese corporate inventory has remained lean. That means if there is another 2008 shock in the export decline, a plummeting in inventory is less likely, so there would be less negative impact on Chinese production activities.  This is another positive factor that helps China’s soft landing.
• In a positive development for the Russian consumer sector, Unilever is acquiring cosmetics producer Kalina for $535 million. The deal comes at 46 percent premium to Thursday’s close and implies multiple of 12 times the enterprise value (equity plus debt), well above the average multiple for the sector.

Threats

• The U.S. Senate has just passed a currency bill to threaten China with a 30 to 60 percent tariff on all Chinese imports to the U.S. If it becomes law, a trade war between the two countries could start, though we believe it is unlikely the bill will pass in the Congress. The proposed law would hurt both China and the U.S.
• The main challenge of the newly elected government in Poland is to commit itself to cutting the budget deficit to 3 percent of GDP in 2012 from this year’s 5.5 percent of GDP. This should enable Poland to stay below the 55 percent of GDP public debt prudential threshold.

Tags: agricultural, Agricultural Bank Of China, Bank Of China, Benchmark Interest Rate, Brazil, China Association, China Construction Bank, Commercial Bank Of China, Consumer Price Index, Environment China, External Economic Environment, Gold, Hang Seng Index, Index China, Index Cpi, Industrial And Commercial Bank Of China, Monetary And Fiscal Policy, Passenger Car Sales, Producer Price Index, Producer Price Index Ppi, Supply China, Support China, Zhejiang China
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WSJ: Dark Side of Brazil’s Rise

Wednesday, September 14th, 2011

by Trader Mark, Fund My Mutual Fund

Brazil is probably the most exciting investment prospect in the Western hemisphere over the next decade, but with its rapid growth comes issues, some of which we’ve outlined in the past.

1. [Aug 1, 2011: Bloomberg - Bad Debts Begin to Snare Banks in Brazil, India, and China]
2. [Mar 25, 2011: Brazil's Housing Carnival Stokes Bubble Woes]
3. [Jan 12, 2011: Canada and Brazil Taking on U.S. Characteristics in Debt Exposure]

Much like India and China, they are having trouble dealing with all the easy money being created by Uncle Helicopter Ben (and Japan).  There is little need for that money in a limp U.S. economy, with low yields – so outside of times of crisis, that money flows globally creating dramatic impacts on those countries.  Brazil is one of the destinations, as the performance of its currency (despite efforts to tax foreign investment) has shown the past few years.  The WSJ delves further into the ‘dark side’ of this country’s rise.

• Brazil is booming amid a tectonic shift in global investing toward the developing world that has lifted its stock market, strengthened its currency and provided financing for new ports and World Cup soccer stadiums.  But while foreign investment is mostly a good thing, there are downsides. The abundance of cash has helped fund riskier bank loans and fueled a potential real-estate bubble. By some measures, the Brazilian real is now the world’s most overvalued currency, and many local factories aren’t competitive in global markets.
• Daily life has become so expensive that movies, taxis and even a can of Coke cost more in São Paulo than in New York. Rio de Janeiro apartment prices have doubled since 2008, and office space in São Paulo is suddenly more expensive than Manhattan.
• Concern about the strong real is a key reason why Brazil’s central bank late last month cut its benchmark interest rate by half a percentage point to 12%, reversing course after a year of rate hikes. The move risks spurring inflation and spawned a debate in Brazil on whether the central bank had succumbed to political pressure. But Brazilian officials say the country’s high rates have lured speculative foreign investments that pump up the real and hurt the economy.
• Brazil’s real has weakened 6% against the dollar since the central bank cut rates, but even so it is still up some 36% since Jan. 1, 2009.
• Some executives in Brazil fret that the cost of doing business has risen so fast that their country may be unable to become the manufacturing power it has aspired to be for generations. Brazilian industrial production actually fell 1.6% in June from May for the first time since the 2008 global financial crisis. Factories are losing their overseas markets and getting beat by cheap imports because Brazilian labor, parts and transport have first-world price tags—even though Brazil still has all its third-world drawbacks, like bad roads, poorly educated workers and high crime rates.
• Brazil isn’t the only developing country encountering problems of plenty. In China, heightened investment flows have contributed to food inflation in cities that some economists say may provoke social unrest. In Turkey, the government has tried a similar approach to the one just adopted by Brazil’s central bank—slashing interest rates to prevent inflows from strengthening the currency too much. But the lower rates have helped spark a big rise in bank credit and fears of a credit bubble.
• Money flows easily into Brazil because it has a free-floating currency and sophisticated stock, bond and derivative markets, unlike China. Indeed, many investors seeking exposure to China get it by investing in Brazil instead because it’s a major seller of raw materials to the Chinese. Brazil is the world’s biggest seller of iron ore, beef, chicken, sugar and coffee. And it just made new oil discoveries off its coast that could make it into a leading global producer of that as well.
• Of course, capital that floods into a country can flood out of it. Leaders in emerging economies are concerned that a financial catastrophe in the developed world—such as sovereign defaults in Europe—could cause a sudden reversal of investment flows. That would prompt jarring falls in currency, real estate and other prices that have soared in places like Brazil during the boom.
• Brazil President Dilma Rousseff’s eight-month-old administration has fought a difficult battle to keep the real from rising. Brazilian officials blame near-zero interest rates in the U.S. and Europe for making it possible for hedge funds to borrow cheaply in the rich world to place bets in Brazil.  “We have to defend ourselves from this immense, fantastic, extraordinary sea of liquidity that finds its way to our economies in search of returns that it can’t find in its own,” Ms. Rousseff told Latin American leaders on July 28 in Lima.
• Brazil has been announcing new measures almost monthly to stifle the flow, such as a tax on bond purchases, or to offset its impacts, such as a multibillion dollar package of subsidies for manufacturers hit by the soaring real. Manufacturers say the currency is still too strong and the subsidies aren’t enough.
• One reason the policies may fail: Even after cutting its interest rates to 12%, Brazil has among the highest real interest rates, or rates in excess of inflation, of any major economy. That makes Brazil a prime target for “carry trade” speculators who borrow money cheaply where interest rates are near zero, deposit it in Brazil and pocket the difference.
• It turns out that international capital flows a lot like water. Close one hatch and it pours in another. Brazilian officials suspect that when the country moves to restrict speculative investments, the money is being disguised as direct investments in companies. The evidence is a 260% spike in foreign direct investment to $38.5 billion in the first six months of the year.
• Armed with a strong currency and cheap financing, a new class of Brazilian jet setters are getting on planes and shopping like mad in countries where goods are cheaper. Brazilians spent $8.5 billion on overseas shopping sprees this year—60% more than last year. Malls near Miami are hiring Portuguese-speaking salespeople and opening Brazilian restaurants to serve them.
• Credit bubbles are another concern. Credit is rising rapidly in the big emerging-market countries—Brazil, Russia, India and China. Lately, loan-default rates have ticked up in Brazil.

Tags: Apartment Prices, Bad Debts, Bank Loans, Benchmark Interest Rate, Brazil, Brazil Carnival, Brazilian Real, Canadian Market, Dramatic Impacts, Easy Money, Foreign Investment, Global Markets, India, Percentage Point, Rate Hikes, Real Estate Bubble, Rio De Janeiro, Rio De Janeiro Apartment, S Central, Soccer Stadiums, Western Hemisphere, World Cup Soccer, Wsj
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