The Economy and Bond Market Radar (August 20, 2012)

Sunday, August 19th, 2012

The Economy and Bond Market Radar (August 20, 2012)

Treasury yields rose for a fourth week in a row.  Additionally, the benchmark 10-year yield is on the verge of breaking above the technically significant 200-day moving average.

Strengths

• The Thomson Reuters/University of Michigan preliminary August index of consumer sentiment increased to 73.6, the highest level since May, from 72.3 the prior month.
• The four-week average for initial jobless claims remains at its lowest level since March.
• According to the Conference Board’s gauge of Leading Economic Indicators, the economic outlook for the next three to six months increased 0.4 percent last month after a revised 0.4 percent drop in June. Economists projected the gauge would rise by 0.2 percent.

Weaknesses

• Initial jobless claims rose slightly to 366,000 this week, somewhat muddling the picture for the job market.
• Manufacturing in the Philadelphia region contracted in August for a fourth consecutive month as orders and employment declined.
• China July foreign direct investment fell 8.7 percent year-over-year to $7.58 billion, its lowest level in two years, which fuels concern that a slowdown in confidence in China’s growth prospects may restrain any economic rebound.

Opportunity

• The ECB appears ready to implement some form of QE in the very near future.
• With further weak economic data out of China, the odds of additional easing measures continue to move higher.
• Interest rates are likely to remain very low for the foreseeable future.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.
• China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.

Tags: Bond Market, Decisive Action, ECB, Economic Data, Economic Outlook, Economic Rebound, Foreign Direct Investment, Growth Prospects, Index Of Consumer Sentiment, Initial Jobless Claims, Leading Economic Indicators, Market Radar, Philadelphia Region, Qe, Reuters, S Gauge, Shifting Focus, Slowdown, Treasury Yields, Wildcard
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The Economy and Bond Market Radar (August 13, 2012)

Saturday, August 11th, 2012

The Economy and Bond Market Radar (August 13, 2012)

Treasury yields rose for the third week in a row. It is interesting that as we get closer to additional monetary easing in the U.S., Europe and China, the Treasury bond market has already anticipated that and is selling into the news. This would follow a similar pattern as the two quantitative easing programs in 2009 and 2010, as bond yields moved higher immediately after the announcements.

Strengths

• Initial jobless claims fell to 361,000 this week, indicating a somewhat better job dynamic than a couple of months ago.
• The Labor Department reported that job openings in June were the highest since July 2008.
• The U.S. trade deficit narrowed to $42.9 billion in June, lower by more than $5 billion. Exports grew while imports contracted.

Weaknesses

• New foreclosures rose 6 percent in July, the third monthly increase in a row.

• European economic data remains weak as Italian GDP has contracted for four quarters in a row.

• Economic news out of China was weaker than expected for July as exports grew a meager 1 percent and industrial production was weaker than expected.

Opportunity

• The ECB appears ready to implement some form of quantitative easing in the very near future.
• With weak economic data out of China this week, odds of additional easing measures continue to move higher.
• Interest rates are likely to remain very low for the foreseeable future.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.
• China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.

Tags: Bond Yields, Decisive Action, ECB, Economic Data, Economic News, Foreclosures, GDP, Hurry, Initial Jobless Claims, Italian Gdp, Job Openings, Labor Department, Market Radar, Quantitative Easing, Quarters, Shifting Focus, Trade Deficit, Treasury Bond Market, Treasury Yields, Wildcard
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The Economy and Bond Market Radar (August 6, 2012)

Sunday, August 5th, 2012

The Economy and Bond Market Radar (August 6, 2012)

Treasury yields were little changed this week as a tug of war continues between global central bankers and economic data. This week was all about the Fed and ECB announcements, which came in with a bang last week but went out with a whimper this week.  Neither central bank took action and, once again, tried to reassure the markets with words not action. Global economic data remains weak as can be seen in the JPM Global PMI chart below, which indicates a global contraction in manufacturing. Tempering this news was a better than expected employment report on Friday, potentially causing policy action indecision from the Fed.

Strengths

• July nonfarm payrolls grew 163,000 vs. the 100,000 that was expected and was the best showing since February.
• Retail sales posted surprising strength in July as same-store sales rose 4.4 percent.
• Consumer confidence unexpectedly bounced back in July, showing greater optimism about short-term business and employment prospects.

Weaknesses

• ISM’s July manufacturing index remained in contraction territory for the second month in a row.
• The Fed failed to take any action this week after it was widely viewed that the Fed planted those seeds in a widely disseminated story last week.
• The ECB also failed to follow through with any action and possibly lost some credibility with investors. The market has become used to a lot of talk from European officials but when the head of the Central Bank promises to do whatever it takes to save the euro and then is unable to articulate exactly what that entails, it raises credibility issues.

Opportunity

• The Fed and ECB are still talking about additional monetary stimulus and it may happen in the near future. Interest rates are likely to remain very low for the foreseeable future.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.
• China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.

Tags: Bond Market, Consumer Confidence, Contraction, Credibility Issues, ECB, Economic Data, Employment Prospects, Employment Report, European Officials, Indecision, Market Radar, Nonfarm Payrolls, Shifting Focus, Stimulus, Term Business, Treasury Yields, Tug Of War, Whimper, Wildcard
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The Economy and Bond Market Radar (July 23, 2012)

Saturday, July 21st, 2012

The Economy and Bond Market Radar (July 23, 2012)

Treasury yields headed modestly lower again this week. Retail sales were much weaker than expected. Inflation and manufacturing data were more or less in line with expectations, while housing data was mixed. By Friday, European financial concerns had resurfaced as Spanish 10-year bond yields spiked above 7 percent and hit new highs. Spain indicated its recession will likely continue into next year. U.S. treasuries remain a safe haven for global investors, pushing yields lower this week.

Strengths

• Industrial production rose 0.4 percent, ahead of expectations and a bright spot in an otherwise lackluster week for economic data.
• Real estate lending in China jumped 20 percent year-over-year in the second quarter and already shows Chinese policy-makers are taking aggressive action to combat the ongoing global slowdown.
• Housing starts rose 6.9 percent in June and the National Association of Home Builders confidence index had its biggest increase since September 2002.

Weaknesses

• Retail sales fell 0.5 percent and have now fallen for three months in a row, which bodes very poorly for second-quarter GDP growth.
• The Conference Board’s Leading Index fell 0.3 percent in June, also indicating lackluster growth.
• Auto sales in the European Union fell 2.8 percent in June for the ninth consecutive monthly drop.

Opportunity

• With growth tepid, the Federal Reserve will not only remain accommodative, it may increase accommodation in the next few months.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.

Tags: Aggressive Action, Auto Sales, Bond Market, Bond Yields, Chinese Policy, Confidence Index, Economic Data, Financial Concerns, GDP Growth, Global Investors, Global Slowdown, Housing Starts, Market Radar, National Association Of Home Builders, New Highs, Quarter Gdp, Safe Haven, Shifting Focus, Treasuries, Treasury Yields
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Muddling Through…But for How Long? (Sonders)

Sunday, July 15th, 2012

July 13, 2012

by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.,
and Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research
and Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research

Key Points

• Equity markets rebounded from their lows, but the move has been less than enthusiastic and convincing. Earnings season is upon us and corporate commentary and outlooks may take the focus away from the macro world—at least for a time.
• Muddling through is the popular phrase on the Street for what’s occurring in the US economy. But how long before a break is made one way or the other—both in the economy and the markets?
• Any progress made at the most recent European Union (EU) Summit appears to have been short-lived and any credible long-term solutions remain illusive. Additionally, Chinese growth continues to slow and concerns over a “hard landing” are growing.

Muddling through. Not the most inspiring phrase and we must admit that we are already tired of hearing it, even as we use it ourselves. But it appears to be the best description of what’s occurring in so much of the world currently. In Europe, policymakers continue to take one step forward, followed relatively quickly by one step back; avoiding a complete collapse, but really coming no closer to an actual resolution to their debt crisis and economic problems—muddling through. In China, growth has slowed and policymakers have been slow to respond and appear willing to accept a lower pace of improvement in exchange for deflating a real estate bubble and containing inflation—muddling through. And in the United States, stocks appear to be largely trading in a range, with neither the bulls nor the bears able to grab the reins and establish a trend; while economic data is mushy, but not overtly negative—muddling through.

The question is how long before the muddling stops and a sustainable direction is established? Unfortunately, while we believe a day of reckoning is drawing nearer and the ability of policymakers to use slight of hand to “fool” the markets into thinking solutions may be forthcoming is growing thin; it appears to still be at least a few months away, and the largely sideways action in stocks is likely to persist.

That doesn’t mean that investors who need to add to their equity exposure should wait until a definitive trend is established. By that time, much of the move will likely be passed and there is always the possibility of unforeseen events impacting the markets to a substantial degree—the so-called fat tail scenarios discussed in the last Schwab Market Perspective. For investors that have a time horizon of five years or longer, we continue to believe equities are attractive here. Valuations appear reasonable, but there are ample near-term hurdles, including the “fiscal cliff,” China’s growth, the US slowdown and the ongoing eurozone debt crisis. If the expectations hurdles have been set low enough , we could see some sharp rallies unfold among riskier asset classes, but there remain negative tail risks as well, and volatility and uncertainty are not likely going away in the near-term.

As we head into the peak of second quarter earnings season, corporations have the spotlight as the macro picture has entered a quieter zone. Judging by the elevated preannouncement ratio for the quarter, we expect to hear uncertainty and caution in the outlooks, as tax policy remains uncertain, the ultimate outcome in Europe continues to be illusive and China’s growth is slowing. With many companies having preemptively announced negative developments with their second quarter performance, expectations have been lowered, which would traditionally set up the possibility of upside surprises. However, we’re concerned that there may be further disappointments to come as the global economy continues to weaken. Regardless, it’s hard to imagine the corporate picture driving action for long as macro developments will likely again take hold as fall approaches.

Recession increasingly likely?

As mentioned above, the US economy appears to be muddling through, but concerns over a return to a recession have grown. Chief among the disappointing reports was the Institute for Supply Management’s (ISM) Manufacturing Index, which came in at 49.7, down from 53.5 and below the 50 level that denotes the dividing line between an expanding or contracting manufacturing sector. This was the lowest reading since July of 2009, but it’s important to note that the index traditionally doesn’t start to indicate recession for the broader economy until it drops below 44.

ISM indicates softness but no recession-yet

Source: FactSet, Institute for Supply Management. As of July 6, 2012.

More concerning was the new orders component-the more forward-looking part of the report-collapsing by 12.3 points, which was its biggest monthly drop since October 2001.

New orders are more concerning

Source: FactSet, Institute for Supply Management. As of July 6, 2012.

However, the service side of the ledger was a bit more positive. Although weakening, the ISM Non-Manufacturing Index remained above 50 at 52.1.

Additionally, the labor market continues to disappoint, although we do continue to see job additions. The ADP Employment report surprised on the upside at 176,000 new jobs for June but the broader government labor report was again disappointing, as only 80,000 new jobs were added. In contrast to the previous month, the unemployment rate remained unchanged at a still-elevated 8.2%. Remember, the unemployment rate is one of the most lagging of all economic indicators, and we have recently seen a positive reversal in unemployment claims, a leading economic indicator.

There are some automatic stabilizers that can help to stimulate economic growth when it slows. One that has been working quite well lately is the reduction in oil prices as demand growth has slowed, helping to put more money in consumers’ pockets. Additionally, other commodity costs have eased as well, although there is growing concern that the heat wave hitting much of the country is causing corn crop problems which has resulted in elevated corn prices. With corn used in so many food items, as well as in ethanol and other products, it is something we are keeping an eye on moving forward.

Government…muddling is thy name!

It’s difficult to imagine employers gaining a lot of confidence and willing to take additional risk by hiring a lot of new workers when they have so much uncertainty surrounding taxes, regulations and ongoing healthcare costs…exacerbated by the looming fiscal cliff. And while politicians on both sides of the aisle appear to recognize the problems this uncertainty is causing, definitive action still appears unlikely. At this point, we believe the most likely scenario is that the lame duck Congress following the elections will pass a three-to-six month extension of current policy so the new Congress can deal with it in 2013—thus avoiding the worst case scenario, but still leaving it hanging out there. One important note, however, due to the WARN Act, government contractors have to preannounce potential job cuts ahead of time. So if we still don’t have a deal before the election, we will likely have multiple mass layoff announcements made, especially from defense contractors, which could have a negative drag on sentiment.

Europe struggles to make progress

Speaking of a negative drag on sentiment, European policymakers have taken squabbling to an art form. More than two years into the sovereign debt crisis, progress remains disappointingly slow. Yet another European summit to curb the sovereign debt crisis has come and gone, and despite unveiling another “grand plan,” doubts remain, and muddling along continues.

The aim for the recent summit was to break the vicious cycle between weak peripheral countries and their weak banks. Low expectations were exceeded, but market relief was short-lived amid lack of details and still-missing components that are likely needed to quell the crisis. Meanwhile, each successive “grand plan” has had a shorter relief rally, as market participants are becoming less patient, while policymakers appear to lack urgency.

Market relief remains tenuous

Source: FactSet, iBoxx. As of July 10, 2012.

Spain remains a concern because its banking system needs capital, estimated at 37 billion euros by the International Monetary Fund (IMF), and 51-62 billion euros in stress tests conducted by consultants hired by the Spanish government. A separate audit on an individual bank-by-bank basis is due in late July.

The problem is the source of capital infusions for Spain’s banks:

• If banks are bailed out by the Spanish government, the Spanish government itself may need a bailout.
• One outcome of June’s summit potentially allows bailout funds to directly recapitalize banks. However, common eurozone-wide bank supervision is required first, and this is a complicated process that may not happen until the second half of 2013.
• The latest “plan du jour,” is to give Spanish banks 30 billion euros in emergency funding without expanding Spain’s government balance sheet. However, this stop-gap plan will not bolster confidence definitely in our opinion, as it not large or quick enough and lending nations remain resistant.

Incompatible cultures and politics hamper agreement on broad solutions and time has been wasted. As the debt crisis has become a crisis of confidence, each successive failure increases the risk that market confidence cannot be restored – once confidence is lost, it is difficult to gain back. From a long-term perspective, a break up of the euro remains an increasing possibility, which could improve the longer-term outlook, but would likely be accompanied by extreme volatility at the time of occurrence.

However, we don’t believe Europe will achieve either full union or break-up in the near-term, resulting in muddling through as the most likely scenario. As such, the rollercoaster loop of sentiment is likely to remain in place, and we continue to believe European stocks will be under-performers.

Global synchronized slowdown

The economic slowdown has gradually spread from Europe in the fall of 2011, to China in the first quarter of 2012, and now the United States appears to be joining. As a result, the JPMorgan Global Composite Purchasing Manager Index (PMI) shows global economic growth falling perilously close to contraction territory.

Global economy losing steam

Source: FactSet, Bloomberg. As of July 10, 2012.

A look under the hood is even more concerning, as the JPMorgan Global Manufacturing PMI has fallen to 48.9. The service economy has been a source of relative strength, but manufacturing has dropped, and manufacturing tends to lead economic trends, as it is more tied to the business cycle. Additionally, the new orders component of global PMIs dropped significantly in June, evident not only in the US ISM report mentioned earlier, but even China cited the United States as a new sign of weakness in June. Lastly, with inventories falling at a slower pace than orders globally, the implication is that an inventory destocking cycle could be upon us, which could result in lower economic activity in the future.

Is there a hard landing in China?

The gloomy sentiment stick appears to have been handed off from Europe, where slow growth appears to be “accepted” by markets, to China. The definition of a hard landing in China is debatable. We think of it as roughly a 3% decline from the potential growth rate of the economy, similar to the decline to zero growth in the United States. This would equate to roughly a 6% level for a hard landing in China, in our opinion.

If China’s gross domestic product (GDP) is still growing more than the 6%, what’s the fuss? We want to redirect the conversation away from “China hard landing” to the “stall speed” concept, where growth slows enough to become self-reinforcing. While an imprecise science, particularly in an immature economy, it feels to us like we are hovering around stall speed in China, much like we are in the United States.

We believe more fiscal stimulus needs to begin quickly to stave off the economic downturn in China. China’s response has been underwhelming thus far, either because growth hasn’t fallen enough, aging demographics have resulted in slower tolerable growth, the desire to not repeat prior mistakes and bubbles, or a desire to prudently allow steam to come out of the economy as it transitions to a consumer-based economy. Regardless, slower growth is likely to be the new normal for the Chinese economy in our view, a concept with which markets are still grappling.

China’s growth has global stock investment implications. Unrelated to economic growth, we believe the Chinese stock market has become less attractive over the intermediate term due to profit-reducing bank reforms, and the large weight of the financial sector in Chinese indexes.

However, we are still believers in the growth story of emerging markets (EM) as a group relative to developed markets. A more forceful fiscal stimulus in China has the ability to stimulate economic growth and stock performance in many Asian nations, which constitute the largest portion of the EM universe.

While a lot of negativity appears to be priced into EM stocks, the impact of the global slowdown is still being priced into developed market stocks, where earnings misses and negative stock reactions indicate that the extent of the weakness may not yet be priced in.

Lastly, we’d be remiss if we didn’t mention nuggets of good news, including inflation falling globally, a change in attitude from austerity to growth, and global central bank easings. Our base case is a global slowdown, not a crash, and investment opportunities remain. Read more international research at www.schwab.com/oninternational.

Important Disclosures

The MSCI EAFE® Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States and Canada. As of May 27, 2010, the MSCI EAFE Index consisted of the following 22 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

The MSCI Emerging Markets Index^SM is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. As of May 27, 2010, the MSCI Emerging Markets Index consisted of the following 21 emerging-market country indexes: Brazil, Chile, China, Colombia, the Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand and Turkey.

The S&P 500® index is an index of widely traded stocks.

Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly.

Past performance is no guarantee of future results.

Investing in sectors may involve a greater degree of risk than investments with broader diversification.

International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.

The information contained herein is obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not a solicitation or a recommendation that any particular investor should purchase or sell any particular security. Schwab does not assess the suitability or the potential value of any particular investment. All expressions of opinions are subject to change without notice.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Tags: BRICs, Charles Schwab, Chief Investment Strategist, Chinese Growth, Collapse, Debt Crisis, Earnings Season, Economic Data, Economic Problems, European Union, inflation, Liz Ann, Long Term Solutions, Lows, Macro World, Outlooks, Real Estate Bubble, Reins, Research Key, Sector Analysis, Senior Vice President
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The Economy and Bond Market Radar (July 16, 2012)

Saturday, July 14th, 2012

The Economy and Bond Market Radar (July 16, 2012)

Treasury yields headed lower again this week but not dramatically so. The minutes from the June Federal Open Market Committee meeting were released this week and indicate that Fed members remain divided on an additional round of quantitative easing (QE). In the past few years bonds have tended to rally into the QE announcement and sell off when announced as expectations are for the easing to boost the economy and financial assets. There was little in the way of real market moving economic data released this week in the U.S. but China released second quarter GDP results showing a deceleration to 7.6 percent on a year-over-year basis. This was the slowest growth since the financial crisis but is far from the “hard landing” that many were expecting. Treasury yields moved higher on Friday and the stock market rallied, in what was likely a “relief” rally for stocks.

Strengths

• We did get some inflation data this week with import prices and the producer price index; both continue to show a benign inflation environment.
• Brazil and South Korea cut interest rates this week, following the coordinated actions last week from the ECB, Bank of England and the Bank of China.
• Consumer credit hit a five-month high in May as the consumer appears to be more comfortable and banks are lending.

Weaknesses

• Chinese imports slowed dramatically in June to 6.3 percent, well below estimates. This raises concerns about the depth of the slowdown in China.
• Japanese core machinery orders plummeted 14.8 percent in May, dramatically below estimates.
• Quarterly earnings reports will pick up sharply next week but we had many companies warn this week that the economy is weakening. This was particularly true in technology and industrials.

Opportunity

• The Fed reaffirmed its commitment to an ultra low interest rate policy through 2014 and additional monetary easing is possible in the near future.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.

Tags: Bank Of China, Bank Of England, Bond Market, Chinese Imports, Deceleration, Ecb Bank, Economic Data, Federal Open Market Committee, Financial Assets, Import Prices, Inflation Data, Interest Rate Policy, Japanese Core, Machinery Orders, Market Radar, Open Market Committee, Producer Price Index, Quarter Gdp, Quarterly Earnings Reports, Treasury Yields
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4 Reasons to Like China

Thursday, July 12th, 2012

Last month, in my Investment Directions monthly commentary, I predicted that we’d see further stimulus from China this yearas officials try to keep Chinese growth at a respectable rate ahead of a fall 2012 leadership transition.

And as I suggested would happen, the Chinese central bank last week announced its second surprise rate cut within a month. The action from the central bank was an acknowledgement that the world’s second largest economy is slowing. In the first quarter, China’s growth decelerated to 8.1% year over year, the slowest pace since the summer of 2009 as a slowing United States and ongoing European sovereign debt crisis took a toll on Chinese exports.

Still, despite China’s economic slowdown, I continue to hold an overweight view of Chinese equities for the following four reasons:

1.)    Valuations: Chinese stocks are selling at a significant discount to both other Asian emerging market countries and to their own history, especially when you consider that Chinese inflation is decelerating. In addition, current discounted valuations appear to be already reflecting the risk of a hard landing, which I don’t believe is the most likely scenario for China.

2.)    Growth Expectations: While China is experiencing a slowdown, it’s important to put China’s growth in perspective. I expect second quarter Chinese growth to come in around 8%, a level consistent with a soft landing scenario, and not anywhere near the United States’ truly slow 2% growth. In addition, the preponderance of evidence – and the few bright spots among weak recent economic data — still suggest that China can engineer a soft landing and even if China ends up growing at 7% to 7.5% next quarter, Chinese equities still look cheap.

3.)    Economic Policy: That China lowered interest rates twice within a month suggests that Beijing is refocusing on, and is willing to go the distance to stabilize, growth. In fact, I continue to expect more stimulus from China as it tries to ensure a smooth upcoming leadership transfer and as cooling inflation in the country gives the government more room to focus on growth. In addition, the gradual liberalization of the financial industry is also a plus for long-term growth.

4.)    Relatively Low Risk: Based on my team’s analysis, China is not one of the 15 riskiest markets. In addition, China enjoys a relatively stable currency, which reduces the volatility of its USD returns.

To be sure, Chinese equities, along with other risky assets, are still vulnerable to the fortunes of the global economy, and an exogenous shock, such as a worsening eurozone crisis, could certainly knock China off of its trajectory. But in the absence of such an event, most evidence suggests that China can engineer a soft landing and its outlook seems more positive than investors may be discounting. I prefer to access Chinese equities through the iShares MSCI China Index Fund (NYSEARCA: MCHI) and the iShares MSCI China Small Cap Index Fund (NYSEARCA: ECNS).

Source: Bloomberg

Russ Koesterich, CFA is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog.  You can find more of his posts here.

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 investments in smaller companies may be subject to higher volatility.

Tags: Acknowledgement, Chinese Central Bank, Chinese Exports, Chinese Growth, Chinese Stocks, Debt Crisis, Economic Data, economic policy, Economic Slowdown, Emerging Market Countries, First Quarter, Growth Expectations, inflation, Investment Directions, Leadership Transition, Preponderance Of Evidence, Sovereign Debt, Stimulus, Surprise Rate, Valuations
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The Economy and Bond Market Radar (July 9, 2012)

Sunday, July 8th, 2012

The Economy and Bond Market Radar (July 9, 2012)

Treasury yields headed lower this week on disappointing economic reports and global central bank easing. Two key economic data points bookended the week, with a very weak reading from the ISM Manufacturing Index on Monday, followed by a subpar employment report on Friday. On Thursday we had what appeared to be coordinated global central bank policy easing with the ECB and the Bank of China cutting interest rates by 25 basis points, along with the Bank of England adding ?50 billion to their quantitative easing program. As can be seen in the chart below, the yield on the 10-year treasury fell to the lowest level in more than a month.

Strengths

• Economic data is weak globally, forcing central banks to act which is sparking a bond rally and pushing down yields.
• Domestic auto sales remain a bright spot for the economy with GM, Ford and Chrysler all posting strong sales growth in June.
• Factory orders for May rose 0.7 percent, beating expectations.

Weaknesses

• June nonfarm payrolls were weaker than expected, rising by a meager 80,000, little changed over the past few months.

• The ISM Manufacturing Index fell to the lowest level since July 2009 and indicated contracting manufacturing in June.

• European bond yields remain elevated even after central bank intervention and the EU summit the week before.

Opportunity

• The Federal Reserve reaffirmed its commitment to an ultra-low interest rate policy through 2014 and additional monetary easing is possible in the near future.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.
• China has obviously become more concerned about the economy and has eased twice in the past month.

Tags: 10 Year Treasury, Bank Of China, Bank Of England, Basis Points, Bond Market, Bond Yields, Central Bank Intervention, Central Banks, Domestic Auto, Economic Data, Economic Reports, Employment Report, Gm Ford, Interest Rate Policy, Ism Manufacturing Index, Market Radar, Nonfarm Payrolls, Shifting Focus, Strong Sales, Treasury Yields
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Unmasking the Asian Giant

Monday, July 2nd, 2012

Unmasking the Asian Giant

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

Chinese operas have been keeping audiences enthralled for hundreds of years with mythical characters, enchanting stories and elaborate masks that add drama and mystery. While this fantastical treatment is appreciated in the theatre, it isn’t in global markets. Investors don’t like mystery—think of how uncertainty has spooked markets in recent years.

Global investors are rarely privy to every detail about the economy; that’s why it’s necessary to rely on multiple data and research to make decisions and be cautious of extreme views that unnecessarily arouse suspicion, skepticism, and criticism. These opinions may grab headlines, but rarely do they help investors’ portfolios.

A recent article in The New York Times raised doubts about the quality in China’s macroeconomic reporting. The Times pointed to evidence from “prominent corporate executives in China and Western economists” who say that “local and provincial officials are falsifying economic statistics to disguise the true depth of the troubles.” The author alarmed many of our readers, so we immediately contacted numerous analysts—many of whom have front row seats to Chinese economic data—to get their reaction.

Some analysts preempted our request by independently sending out a rebuttal, including CLSA’s China Macro Strategist Andy Rothman, in his Sinology report titled, “Lies, Damned Lies…” Since 2006, global investors have come to rely on this company’s coverage of China because of its ability to “independently monitor mainland economic activity.” See Andy’s insightful views on China from a recent webcast.

Don Straszheim from ISI also emailed his view on the veracity of Chinese data. (We note that Don was correct on a recent call on China. When he visited our office at the beginning of June, he correctly predicted the interest rate cut, which China made two days after his visit.)

We’re all influenced by emotions, of course, and when used to our advantage, can help guide how we invest. However, we need to be aware of how outside biases can influence our judgment. In Thinking, Fast and Slow, Daniel Kahneman writes about a mechanism through which biases flow called an “availability cascade,” a term coined by Cass Sunstein and Timur Kuran. Kahneman says the availability cascade is a “self-sustaining chain of events, which may start from media reports of a relatively minor event and lead up to public panic and large-scale government action.” The vicious cycle goes like this: As people begin to worry, they seek more information and are attracted to similar news reports, which encourages additional coverage. The “availability entrepreneurs” are the ones who deliberately want to keep the negative news flowing.

This may not have been the intention of the Times—and other China bears—but its business is selling newspapers.

Kahneman focuses his discussion on how policies should take into consideration a combination of “experts’ knowledge with the public’s emotions and intuitions.” This thinking also relates to investment decisions, which is why our SWOT model is designed to help us review a variety of sources, along with emotion and intuition, and categorize the results in terms of strengths, weaknesses, opportunities and threats.

We encourage our readers to take this approach: Read the Times article and analyze it alongside what analysts are saying:

It’s not breaking news that China’s data is less-than-perfect. Analysts have been saying this for years. CEBM says simply that the Times article is “a true but not new story,” while ISI believes “the shortcomings of China data is a topic every China macro journalist writes on every year or so – with small variations and supporting anecdotes.”

Part of the reason the topic of China’s “disguise” keeps coming up stems from the fact that the country has not had a very long history of “professional independence from the political machinery in Beijing,” says ISI.  Unlike developed countries, ISI believes China’s data system continues to be opaque and primitive. The countries’ inadequacies are relatively common among emerging markets, as numerous analysts have pointed out.

This fact does not release China from its responsibility to make sure that investors have accurate information. Rather, because the country has become an economic powerhouse, it is under greater scrutiny, which means it needs to improve its checks and balances. CLSA says the central government has been aware of how local officials inflate their data and “has been taking steps to mitigate the problem.” For example, more than 700,000 companies now report their data directly to the National Bureau of Statistics, rather than the local governments. NBS data is typically used to forecast consumption of key commodities, says CLSA.

The Times discussed how electricity production and consumption is “a telltale sign of a wide variety of economic activity” and is a “gold standard” for finding out how the economy is doing. A few months ago, U.S. Global’s analyst, Xian Liang talked about how important electricity consumption was as a measure of activity—some commercial banks that lend to small companies would physically check the meters themselves.

As shown in the chart below, over the last few years, China has reported electricity consumption that was much more volatile than real GDP data. Noting the extreme at the end of 2008, it’s likely that GDP fell more than was reported, and at the end of 2009, GDP likely rose more than publicly reported, says ISI.

However, the logic of the Times article to think that local officials are “overstating” data seems misguided. According to Bank of America-Merrill Lynch, China’s local officials have little incentive to over-report the use of energy because “Beijing imposes increasingly restrictive regulations on energy use per unit of GDP on local governments.” Also, since 2011, many local officials have been trying to encourage the government to ease tightening measures, so it is not in their interest to over-report power data to mask a slowdown.

What’s needed before investing in any emerging market is an ability to decipher the mountain of data and use informed judgment.  Because “all data in China are not created equal,” ISI bases its opinion on data, giving more credibility to data that is independent and discounts data that is confusing or biased. Data including purchasing managers’ index, export and import volumes, auto and vehicle sales and production, transportation and People’s Bank of China are generally high-quality and credible, says ISI.

There’s no denying the importance of China. Take a look at McKinsey’s map showing the rapid shift in the world’s economic center of gravity. Beginning in AD 1, for nearly 2,000 years, the economic center of gravity was in Asia because population growth and migration were slow. Industrialization and urbanization in Europe and the U.S. quickly shifted the economic power west for the next century. Now, “China is urbanizing on 100 times the scale of Britain in the 18th century and at more than ten times the speed,” says McKinsey.

In fact, in the past three years, a combination of lower growth in the developed countries, combined with the fast urbanization of the emerging world, the economic power has reverted back toward the east at the “fastest rate of change” in history.

Here’s another way to visualize China’s reversion to the mean, which we showed a few days ago:

All the World’s Not a Stage
China is far from perfect: While actors can perfect their lines and use masks to captivate an audience, smart investors know better to use a wealth of information across numerous sources to guide investment decisions. Weigh the evidence and judge for yourself. As my friend, Investment Strategist Keith Fitz-Gerald recently said in an interview, “A powerful China is coming, and we have two choices. Either we’re at the table, or we’re on the menu.” To him this means, “Good news from China is good news for the U.S.; bad news from the Chinese economy is bad news here.”

Tags: Chief Investment Officer, chinese data, Chinese Operas, Clsa, Corporate Executives, Economic Data, Economic Statistics, Extreme Views, Frank Holmes, Front Row Seats, Global Markets, Insightful Views, Mythical Characters, New York Times, Provincial Officials, Rothman, True Depth, U S Global Investors, Veracity, Western Economists
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The Economy and Bond Market Radar (June 11, 2012)

Sunday, June 10th, 2012

The Economy and Bond Market Radar (June 11, 2012)

After hitting record lows last week, bond yields moved higher this week in what could be best described as a mini “risk on” trade. Economic data remains weak, Europe is still in turmoil and we saw interest rate cuts in China and Australia. It is somewhat counterintuitive that bonds would sell off under such a scenario but this is a similar pattern to other periods when the Federal Reserve enacted quantitative easing. The market has already priced in the easing, and by the time it actually happens, the market is already looking ahead.

Strengths

• China surprised the market by cutting interest rates by 25 basis points on Thursday. It has been speculated the rate cut was a preemptive move, anticipating weak economic data that China is scheduled to release over the weekend.
• Australia cut interest rates by 25 basis points to 3.5 percent, which is the lowest since 2009.
• The ISM Services Non-Manufacturing Index remained solidly in growth territory in May at 53.7.

Weaknesses

• Factory orders fell 0.6 percent in April and have been very weak so far this year.
• The eurozone Purchasing Managers’ Index (PMI) in May fell to the lowest level since June 2009.
• Both the Fed and European Central Bank (ECB) did not offer any additional monetary measures for the market this week, which disappointed the markets.

Opportunity

• Bonds continue to grind higher and appear to be forecasting benign inflation and slow growth.
• The Fed appears willing to increase monetary accommodation if necessary, which would be a boost to the bond market.

Threat

• China’s economy is slowing faster than expected and government policy makers responded this week by cutting interest rates. This likely indicates weak economic data in the near term.
• Europe remains a wildcard with austerity programs under pressure, creating significant uncertainty.

Tags: Austerity Programs, Basis Points, Bond Market, Bond Yields, China, China Economy, China S Economy, ECB, Economic Data, Federal Reserve, Government Policy Makers, Interest Rate Cuts, Ism, Market Radar, Monetary Measures, Pmi, Preemptive Move, Purchasing Managers Index, Record Lows, Turmoil, Wildcard
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