Posts Tagged ‘Rebalancing’
Saturday, July 21st, 2012
Michael Pettis at China Financial Markets has some interesting comments via email regarding much needed China rebalancing and a timeframe for a possible Spain exit from euro.
Pettis On Spain Exit …
How will Spanish households react to a default on preferred shares and subordinated bonds, or even a very public discussion about the possibility of such a default? I don’t know, but I assume that it will speed up deposit withdrawals from the banking system even more. For that reason it continues to be a very good idea to keep an eye on Target 2 balances. These serve as a pretty good proxy, I think, for the behavior of depositors.
Things are evolving in Spain exactly as we would expect them to evolve according to the sovereign-debt-crisis handbook. Unless we get real fiscal union in Europe, or Germany leaves the euro, or Germany stimulates its economy into running a very large trade deficit, or the euro depreciates by 15-20% against the dollar in the next year – all very unlikely, I think – I really see no reason to doubt that Spain will leave the euro and restructure its debt within the next few years.
Mish Comments on Target 2
Target 2 stands for Trans-European Automated Real-time Gross Settlement System. It is a reflection of capital flight from the “Club-Med” countries in Southern Europe (Greece, Spain, and Italy) to banks in Northern Europe.
Please see Target2 and the ELA (Emergency Liquidity Assistance) program; Reader From Europe Asks “Can You Please Explain Target2?” for a more compete description.
There is much misinformation floating around on how Target 2 works, what Germany’s liabilities are, so please click on the above link if you are interested in target 2 balances.
The following chart from PIMCO article TARGET2: A Channel for Europe’s Capital Flight shows the capital flight through March. The problem has accelerated since then, because of fears in Spain and Italy.
Pettis On China Price Deflation…
China’s official GDP growth rate has fallen sharply – on Friday Beijing announced that GDP growth for the second quarter of 2012 was a lower-than-expected 7.6% year on year, the lowest level since 2009 and well below the 8.1% generated in the first quarter. This implies of course that quarterly growth is substantially below 7.6%. Industrial production was also much lower than expected, at 9.5% year on year.
In fact China’s real GDP growth may have been even lower than the official numbers. This is certainly what electricity consumption numbers, which have been flat, imply, and there have been rumors all year of businesses being advised by local governments to exaggerate their revenue growth numbers in order to provide a better picture of the economy. Some economists are arguing that flat electricity consumption is consistent with 7.6% GDP growth because of pressure on Chinese businesses to improve energy efficiency, but this is a little hard to believe. That “pressure” has been there almost as long as I have been in China (over ten years) and it would be startling if only now did it have an impact, especially with such a huge impact occurring so suddenly.
Adding to the slow economic growth, the country may be tipping into deflation. Last Monday the National Bureau of Statistics released the following inflation data:
In June, the consumer price index (CPI) went up by 2.2 percent year-on-year. The prices grew by 2.2 percent in cities areas and 2.0 percent in rural areas. The food prices went up by 3.8 percent, while the non-food prices increased by 1.4 percent. The prices of consumer goods went up by 2.3 percent and the prices of services grew by 1.9 percent. In the first half of this year, the overall consumer prices were up by 3.3 percent over the same period of previous year.
In June, the month-on-month change of consumer prices was down by 0.6 percent, prices in cities and rural went down by 0.6 and 0.5 percent respectively. The food prices dropped by 1.6 percent, the non-food prices kept at the same level (the amount of change was 0). The prices of consumer goods decreased by 0.9 percent, and the prices of services increased by 0.3 percent.
My very smart former PKU student Chen Long, who follows monetary conditions in China as closely as anyone else I know tells me:
The most interesting thing is that even if CPI remains stable month-on-month, it will turn negative year-on-year in January 2013. And if it continues to decline month-on-month at current rates, we could see negative year-on-year CPI as early as August/September.
Unlike some other analysts, in other words, I am not concerned about deflation persisting for long unless the PBoC cuts interest rates much more sharply than any of us expect. I know this may sound strange – most analysts believe that cutting interest rates will actually reignite CPI inflation – but remember that the relationship between inflation and interest rates in China is, as I have discussed many times before, not at all like the relationship between the two in the US. It works in the opposite way because of the very different structure of Chinese debt and consumption.
Pettis On China Rebalancing…
After many failed attempts, over the past six months we may be seeing for the first time the beginning of China’s urgently needed economic rebalancing, in which China reduces its overreliance on investment in favor of consumption.
Regular readers of my newsletter may be surprised to see me say this. For the past four or five years analysts have been earnestly assuring us that the rebalancing process had finally begun, and I had always insisted that it couldn’t have begun yet.
Why? Because as I understand it rebalancing is almost arithmetically impossible under conditions of high GDP growth rates and low real interest rates. Once the real numbers came in, it always turned out that in fact imbalances had gotten worse, not better. Typically many of those too-eager analysts have resorted to insisting that the consumption data are wrong, although even if they are right this does not confirm that rebalancing had taken place since errors in reporting consumption have always been there.
But this time seems different. Now for the first time I think maybe the long-awaited Chinese rebalancing may have finally started.
Of course the process will not be easy. With China’s consumption share of GDP at barely more than half the global average, and with the highest investment rate in the world, rebalancing will require determined effort.
How to rebalance
The key to raising the consumption share of growth, as I have discussed many times, is to get household income to rise from its unprecedentedly low share of GDP. This requires that among other things China increase wages, revalue the renminbi and, most importantly, reduce the enormous financial repression tax that households implicitly pay to borrowers in the form of artificially low interest rates.
Forcing up the real interest rate is the most important step Beijing can take to redress the domestic imbalances and to reduce wasteful spending.
And this seems to be happening. [Yet] Beijing has reduced interest rates twice this year, and reluctant policymakers are under intense pressure to reduce them further. [However] The students in my central bank seminar at PKU tell me that there are new rumors about the way the cuts were implemented. “Usually it is the PBoC that submits a proposal of rates cut to the State Council,” one of them wrote me recently, “but this time (July 5th) it was the State Council who handed down to the PBoC the decision to cut rates, so that the PBoC was not fully aware of the rates cut before July 5th.”
If my student is right (and this class has an impressive track record), this suggests that monetary easing is being driven by political considerations, not economic ones, which of course isn’t at all a surprise. But even with the rate cuts, perhaps demanded by the State Council, with inflation falling much more quickly than interest rates the real return for household depositors has soared in recent months, as has the real cost of borrowing. China, in other words, is finally repairing one of its worst distortions.
China bulls, late to understand the unhealthy implications of the distortions that generated so much growth in the past, have finally recognized how urgent the rebalancing is, but they still fail to understand that this cannot happen at high growth rates. The problem is mainly one of arithmetic. China’s investment growth rate must fall for many years before the household income share of GDP is high enough for consumption to replace investment as the engine of rapid growth.
As China rebalances, in other words, we would expect sharply slowing growth and rapidly rising real interest rates, which is exactly what we are seeing. Rather than panicking and demanding that Beijing reverse the process, we should be relieved that Beijing is finally resolving its problems.
As an aside, we need to make two adjustments to the trade surplus in order to understand what is really going on within the balance of payments. First, one of the causes of last month’s weak imports has been a sharp decline in commodity purchases. I have many times argued that commodity stockpiling artificially lowers China’s trade surplus by converting what should be classified as a capital account outflow into a current account inflow. If China is now destocking, then China’s real trade surplus is actually lower than the posted numbers.
Second, we know that wealthy Chinese businessmen have been disinvesting and taking money out of the country at a rising pace since the beginning of 2010. One of the ways they can do so, without running afoul of capital restrictions, is by illegally under- or over-invoicing exports and imports. This should cause exports to seem lower than they actually are and imports to seem higher. The net effect is to reduce the real trade surplus.
Since these two processes, commodity de-stocking and flight capital, work in opposite ways to affect the trade account, it is hard to tell whether China’s real trade surplus is lower or higher than the reported surplus. But once de-stocking stops, we should remember that the trade numbers probably conceal capital outflows.
How does all this affect the world? In the short term rebalancing may increase the amount of global demand absorbed by China, but over the longer term it should reduce it. Rebalancing will inevitably result in falling prices for hard commodities, and so will hurt countries like Australia and Brazil that have gotten fat on Chinese overinvestment. Rising Chinese consumption demand over the long term and lower commodity prices, however, are positive for global growth overall, and especially for net commodity importers. Slower growth in China, it turns out, is not necessarily bad for the world. The key is the evolution of the trade surplus.
There is much more in his email that I wanted to use, but I stretched the bounds of fair use already.
Those wishing to see more can follow Michael Pettis on his blog China Financial Markets which I consider one of the very few “must read” sites.
The above report should appear on his blog shortly, with more details. Thanks Michael!
Tags: Banking System, Capital Flight, China Gdp, China Price, Club Med, Debt Crisis, Deflation, Depositors, GDP Growth, Gross Settlement, Michael Pettis, Northern Europe, Preferred Shares, Rebalancing, Settlement System, Southern Europe, Sovereign Debt, Subordinated Bonds, Target 2, Trade Deficit
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Saturday, July 21st, 2012
Emerging Markets Radar (July 23, 2012)
- China’s big four banks made about Rmb50 billion of new loans in the first half of July, double the amount in June, Shanghai Securities News reported. Additionally, China’s outstanding real estate loans were up 10 percent year-over-year in the first half of the year.
- China is boosting this year’s railway investment plan by 9 percent to Rmb 448.3 billion ($70.3 billion).
- Turkish white goods manufacturers continue to gain market share, with sales increasing by 5 percent year-over-year in June. Domestic sales were up 3 percent to 634 thousand units, while exports were up 15 percent to 1.43 million units.
- On July 19 the Ministry of Land Resources and Ministry of Housing and Urban-Rural Development jointly held an urgent video conference with local governments on how to prevent a rebound of home prices, and asked them to increase land supply for ordinary residential units. Although it had prompted negative sentiment toward the property sector, the government didn’t issue new policies to slow housing transactions, which are vital to investment activities.
- China’s Premier Wen Jiabao warned that the economic rebound isn’t yet stable and hardship may continue for a period of time.
- Borrowing costs in the Czech Republic are to remain low after Moody’s reaffirmed the country’s A1 rating this week with a stable outlook, four notches above Italy and five above Spain.
- With the trade deficit on a downward path and inflationary pressures diminishing, BMI expects that the Reserve Bank of India has sufficient space to resume monetary easing.
- In its July 17 report, Citi Research says China’s economic rebalancing is positive to the economy and the market in the long term, but should introduce uncertainties in corporate earnings amid slower growth and reforms in the near term. It points out that slow investment and the de-capacity process will likely bring gains for telecommunications, staples, health care, utilities, transportation, discretionary and property.
- Although China is adding investments to help stabilize economic growth, the country still intends to reduce the weight of investment in the GDP. Sectors that are related to or relying on investments may see sales and earning growth being revised downwards going forward.
- Trade figures published by the Bank of Thailand in July indicate that exports are falling short of consensus expectations for a robust recovery in 2012.
- BMI revised its forecast for Mexico’s average inflation from 3.6 percent to 3.8, as a recent outbreak of bird flu has driven up egg and poultry prices in the country, while a growing concern over the drought in the U.S. has caused grain prices to spike.
Tags: Bank Of India, Corporate Earnings, Downward Path, Economic Rebound, Goods Manufacturers, Inflationary Pressures, Land Resources, Local Governments, Ministry Of Housing, Negative Sentiment, Premier Wen Jiabao, Property Sector, Real Estate Loans, Rebalancing, Reserve Bank Of India, Residential Units, Shanghai Securities News, Stable Outlook, Time Opportunities, White Goods
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Wednesday, April 18th, 2012
by Russ Koesterich, iShares
After a disappointing, frustrating and, at times, terrifying 2011, patient investors were rewarded with a stellar start to 2012. In the first quarter, equity markets banked a performance that would have been respectable for the full year. Developed markets gained nearly 11%, while emerging markets advanced more than 13%. However, equity markets have lost some steam in recent days, and now many investors are wondering if there’s anything to look forward to in the second quarter.
The good news is that even after the rally, valuations still appear reasonable. Developed markets are currently trading at around 14x earnings, no longer a screaming bargain but below historic averages. Emerging markets, meanwhile, are even cheaper, trading at less than 12x trailing earnings. In addition, inflationary pressures remain well contained and while last Friday’s disappointing employment report reminded everyone that the recovery will continue to be slow and uneven, both the US and global economies are stabilizing.
That said, I don’t expect markets in the second quarter to be all smooth sailing. While markets can still move higher, gains are likely to be predicated on earnings growth, which in turn will depend on further improvement in the global economy. And even if the economy continues to stabilize, we’re unlikely to see another round of quantitative easing until at least July as the Fed’s Operation Twist is set to continue through June.
Without the sedative of easier monetary policy, markets are likely to be more volatile. I expect volatility to be in the high teens to low 20s, above the mid-teen levels that characterized the first quarter. In fact, it’s probably fair to say that the first quarter rally was more a function of continuing, and arguably intensifying, central bank generosity rather than a reflection of fundamentals experiencing a complete turnaround.
Given this environment, as the second quarter kicks off, investors should consider repositioning their portfolios to access international equity income, prepare for more volatility and shift into investment grade credit.
As I’ve mentioned before, in an environment of slow growth and more volatility, higher income stocks are more likely to outperform. However, such stocks currently look expensive in the United States, meaning investors may want to cast a wider net to get their dividend exposure through vehicles such as the iShares Dow Jones International Select Dividend Index Fund (NYSEARCA: IDV) and the iShares Emerging Markets Dividend Index Fund (NYSEARCA: DVYE).
In addition, as the market becomes more volatile, investors may want to consider equity funds that employ a minimum volatility methodology that can potentially help insulate portfolios from wild market swings. Such funds typically hold lower-beta stocks than similar, cap-weighted benchmarks and have historically produced higher risk-adjusted returns over the long-term.
Finally, as I wrote earlier this month, while high yield can still offer a good coupon, investment grade debt, accessible through the iShares iBoxx $ Investment Grade Corporate Bond Fund (NYSEARCA: LQD), looks cheaper and should hold up better during a more volatile quarter.
The author is long LQD and IDV
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. There is no guarantee that dividends will be paid.
Minimum volatility funds may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful.
Bonds and bond funds will decrease in value as interest rates rise.
Past performance does not guarantee future results.
Tags: Asset Allocation, Columbia Management, Credit Crisis, Diversification, Earnings Growth, Emerging Markets, Employment Report, Financial Situation, First Quarter, Generosity, Global Economies, Global Economy, Inflationary Pressures, Investment Advisers, Investment Mix, Iranian Hostage Crisis, Ishares, Last Friday, Market Crash Of 1987, Market Fluctuations, Monetary Policy, Ned Davis Research, Patient Investors, Portfolio Holdings, Q2, Quarter Rally, Rebalancing, Reflection, Risk And Reward, Risk Tolerance, Russ, Second Quarter, Sedative, Smooth Sailing, Stock Market Crash, Stock Market Crash Of 1987, Substantial Market, Time Horizon, Turnaround, Valuations, Volatility, Weather Market
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Friday, March 23rd, 2012
by Russ Koesterich, Chief Investment Strategist, iShares
While investors are reasonably concerned about a hard landing, I believe such a scenario can be avoided in 2012. As a result, I continue to advocate overweighting Chinese equities for three reasons.
1.) Relatively Strong Growth Expectations: The lowered growth target isn’t necessarily a precursor to a hard landing. Why? The government’s 2012 growth target is a reasonable estimate for Chinese potential going forward.
The new target reflects the government’s endorsement of a beneficial, long-term rebalancing of the Chinese economy. China can’t, and probably shouldn’t, try to maintain the pace of growth achieved during the past decade as much of that growth came from fixed investments. In order to create a more sustainable long-term model, China needs to raise consumption and moderate investment, a rebalancing that will likely help support Chinese equities. Currently, China is unusual, even for an emerging market, in that only about 1/3 of its economic activity comes from personal consumption.
In addition, even if China grows at 7.5%, it still would be one of the world’s fastest growing economies and the government’s growth goal is typically a floor. In fact, actual Chinese growth is expected to be in the 8% to 8.5% range this year.
2.) Attractive Valuations: Assuming China can grow as expected in 2012 and engineer a soft landing, Chinese equities look attractive from a valuation perspective. While Chinese stocks are up significantly this year, the Chinese market is still down nearly 8% over the past 12 months. It’s now trading for less than 1.7x book value, a significant discount to where it has traded over the past five years and well below the emerging market average.
3.) The Inflation Outlook: Rising prices were a major problem in China last year, with consumer prices up 5.5% in 2011. But inflation in China is now decelerating. Currently, prices in China are up only 3.2% from a year earlier, and inflation is expected to stay low for the remainder of the year. Lower inflation will provide more latitude for the Chinese central bank to loosen monetary policy, which should further support the local economy and local stock prices.
To be sure, the Chinese market is not without risks, particularly surrounding local property prices. Still, as I expect China will most likely engineer a soft landing, the market’s decelerating inflation, cheap valuations and strong relative, and rebalancing, growth make it one investors may want to consider. For those looking to gain exposure to Chinese equities, my preferred methods of access are the iShares MSCI China Index Fund (NYSEARCA: MCHI), the iShares FTSE China 25 Index Fund (NYSEARCA: FXI) and the iShares MSCI China Small Cap Index Fund (NYSEARCA: ECNS).
The author is long FXI
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.
Copyright © iShares
Tags: 7x, Attractive Valuations, Chief Investment Strategist, Chinese Economy, Chinese Growth, Chinese Market, Chinese Stocks, Economic Activity, Economy China, Emerging Market, Growth Expectations, Growth Goal, Growth Target, Inflation Outlook, Personal Consumption, Precursor, Rebalancing, S Endorsement, Sluggish Growth, Term Model
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Monday, May 30th, 2011
The recent sluggishness in equity markets has certainly affected industrial commodities over the past few months, if not gold, which as pointed out earlier is just 2% below its nominal highs and rising despite the 4th margin hike on the Shanghai Gold Exchange overnight – once again gold is seen at the apex of the fiat currency replacement pyramid. So what could cause a rally in industrial commodities in the near term? Sean Corrigan lists the four key catalysts, whose occurrence listed in order of probability, could rekindle the recently faltering rally.
From the most recent edition of Sean Corrigan’s Material Evidence
So, the burning question now is whether commodity prices can shake off the disquiet caused by May’s sharp liquidation and validate the soundbite suppositions of the past few days.
With so much hot money still swilling around the world, readily available at low nominal and largely negative real rates of interest, we can never say never, but so many other beneficiaries of the Bernanke Bubble are either losing momentum and/or breaking trend, that it may be that the whole shell game has been busted pro tem.
Certainly, the fundamental backdrop is beginning to look less rosy, with Japan suffering a 13% decline in exports, Taiwan’s industrial expansion slowing, Thailand’s turning negative, US macro numbers registering a series of disappointments, UK businesses still cutting back on investment and broad swathes of China’s corporate landscape experiencing a severe margin squeeze.
Our feeling is that for a significant rally to take place from here (that is, without enduring any further, intervening weakness), one of four things has to happen soon, listed here in a loose order of their assumed probability:?
- The Japanese government will forego the chance to introduce the meaningful, permanent fiscal rebalancing to which it might accustom the electorate under the guise of a supposedly temporary, disaster?relief measure and inveigle the BOJ into monetizing (albeit at one remove) the vast reconstruction effort needed in the country instead.
- The Chinese will prematurely relinquish their fight against the inflation which was unleashed by their huge, unfocused stimulus’ efforts of the past two years, in the estimation that the threat to the regime’s predominance posed by slow growth and falling employment is now greater than that posed by rapidly rising prices.
- The Fed will find an excuse to revisit a programme of ’quantitative easing’ (i.e., money printing) without first being forced to sit by and watch a prolonged retrenchment in economic activity
- The US dollar will undergo a renewed, sharp decline, allowing existing carry?trades and ‘Risk On’ mixes to be reinstituted with the least demand for original thought. Here we should note that while, ceteris paribus, a flight from the dollar should not automatically boost commodity prices in other currencies, a combination of having a greater marginal impact in a much smaller market and the active contracting of paired trades does in practice tend to bring about such a broad appreciation.
If none of these US Cavalry troopers appear over the horizon in a timely enough fashion, or until there is unequivocal evidence that speculative appetite has otherwise fully returned, our worry is that the industrial commodities in particular remain at risk of another 10?15% correction and a more thoroughgoing purge of leveraged long positions before we can find some sort of meaningful base from which to re?enter a fuller exposure.
Copyright © Sean Corrigan, via ZeroHedge.com
Tags: Burning Question, Catalysts, Commodity Prices, Corporate Landscape, Corrigan, Disappointments, Disquiet, Fiat Currency, Gold Exchange, Hot Money, Industrial Commodities, Industrial Expansion, Japanese Government, Macro Numbers, Material Evidence, Rebalancing, Shell Game, Sluggishness, Suppositions, Uk Businesses
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Monday, January 17th, 2011
Liz Ann Sonders
Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.,
CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research, and
CFA, Senior Market Analyst, Schwab Center for Financial Research
January 14, 2011
- Stocks may be vulnerable to a near-term pullback thanks to elevated sentiment, and earnings season could provide an impetus for some profit taking. Looking ahead, however, the economy appears to be strengthening and we remain optimistic.
- Despite the economy showing signs of growth, the Federal Reserve seems insistent on seeing its second round of quantitative easing (QE2) play out, pointing to continued high unemployment and housing as issues still dragging on growth. The new US congress also has to deal with these issues, while attempting to pare deficit spending at the same time.
- International exposure is important for investors, but we recommend taking some profits and rebalancing if your emerging-market exposure gets above your target allocation.
Now that the new year has begun, focus has shifted from political issues to the economy and corporate health as fourth-quarter earnings season heats up. Expectations for earnings have ramped up during the past couple of months as estimates have moved in concert with better economic data.
Ironically, the pre-release positive momentum could set up for disappointments relative to elevated expectations, possibly providing the impetus for some profit-taking.
Sentiment (typically a contrarian indicator) remains extended as bullishness among investors is extremely high. However, despite the possibility of some near-term volatility, we remain optimistic as we look to the balance of 2011.
With the Fed still stimulative, tax cuts extended and expanded, confidence slowly returning to the corporate sector and positive seasonality trends (the third year of a presidential cycle is typically the best for the stock market), we believe stocks will continue to perform well.
We’ve already seen mutual fund flows begin to shift from bonds to stocks, and we believe this trend will continue as investors grow tired of the low (but rising) yields and increasing risk of falling prices in the bond market.
Economic growth continues
Boosting our confidence in stocks is the continued strength we’re seeing in the US economy. Since the start of the year, the Chicago Purchasing Managers’ Index posted a 22-year high reading at 68.6.
The wider-ranging Institute of Supply Management’s (ISM) Manufacturing Index rose to 57 in December, well above the 50 mark that signals expansion. Perhaps even more importantly, the new orders component of that report, an indicator of future activity, rose to 60.9—a seven-month high.
Continued Strength Indicated
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Source: FactSet, ISM, as of January 11, 2011.
The news was equally encouraging from the services sector, which makes up the lion’s share of the US economy, as the ISM Non-Manufacturing Survey rose from 55 to 57.1—the highest rate of expansion since May 2006.
Of course, not all is rosy, and there are still concerns regarding major segments of the economy, including housing and state and local municipal debt issues. However, it’s these concerns that can help to keep in place at least some of the “wall of worry” that markets so often like to climb.
The unemployment rate is still high, though it did drop a significant 0.4% in the latest report, from 9.8% to 9.4%. This was the 20th time in history that the rate plunged that much and only once did the decline reverse and head back up.
We’re cautiously optimistic that we’re starting to gain some traction in employment as the four-week moving average of initial jobless claims (a leading economic indicator) continues to move lower.
Additionally, the Automatic Data Processing report of private payrolls reported a December gain of 297,000 jobs, almost three times the consensus estimate. That said, payroll growth remains anemic and must improve before the economy (and confidence) can really pick up.
Positive Sign for Jobs
Click to enlarge
Source: FactSet, U.S. Department of Labor, as of January 11, 2011.
The news on housing is less encouraging:
- The recent S&P/Case-Shiller Index of home prices showed year-over-year declines for the fourth straight month.
- Mortgage rates have moved higher, recently touching seven-month highs.
- The latest existing home sales report failed to meet muted expectations.
We still believe we’ll avoid a “double dip” in housing broadly, but the risks are rising and there will still be geographical pockets of more weakness. Foreclosures are accelerating and banks continue to hold houses on their balance sheets that will eventually have to be put on the market for sale, adding to already-bloated inventories.
We believe housing is slowly healing and it’s going to take time, but a renewed substantial dip in housing is one of the bigger risks we presently see in the market.
Policymakers moving in opposite directions
It seems highly unlikely the federal government will step in as it has done in the past to try to provide support to the housing market. With the new US congress in place, attention is now focused on ways to cut spending in an attempt to pare massive deficits and debt.
Of course, it’s easier said than done. Much of the problem lies in so-called entitlement spending such as Medicare and Social Security, and neither seems likely to be addressed in the near term.
However, attacking the deficit through cutting spending or raising taxes alone doesn’t solve the crisis. We believe stimulating economic activity will help grow tax revenues as more income is earned and fewer people rely on government “help.”
To this end, we’re encouraged that the tax cuts were extended for two years, though we’d like to see a more permanent structure to enable businesses to better plan for the future. We’re also encouraged by talk that a corporate tax cut could be coming in the near term.
Contrary to austerity measures being considered by Congress, the Fed seems intent on remaining extremely stimulative. It remains concerned about employment and, despite clear improvement in the economy in the past few months, noted in its recent Federal Open Market Committee meeting statement that there’s a “high bar” in place to end QE2 early.
With so much money presently in the system, we continue to watch measures of velocity of money to determine if the Fed’s policies are actually helping by increasing lending activity. We still believe, despite current rhetoric, that there’s a small chance the program will end sooner than expected if unemployment continues to fall and/or core inflation heats up.
European debt—same story, different actor
In contrast to the United States, which has a proactive central bank and more time to address its debt situation, the euro-zone remains in crisis, primarily due to a common currency that can’t adjust for economies operating at different speeds and the lack of flexibility of the European Central Bank (ECB).
Last year saw bailouts of Greece and Ireland, and the current microscope is on Portugal. Meanwhile, yields on Spanish and Belgian debt are also spiking higher.
European Debt Anxiety Elevates Yields
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Source: FactSet, iBoxx, as of January 11, 2011.
While high euro-zone debt and deficits need to be addressed, the lack of coordination and strong support by European policymakers to address the “crisis of confidence” is propelling the situation into a self-fulfilling prophecy. Investor concerns result in rising yields, increasing debt funding costs to unsustainable levels—rates above nominal economic growth result in growing debt burdens.
Confidence is low in part because of ongoing talk of making bondholders share in bailout pain, inadequate progress by governments toward deficit-reduction targets, and because the ECB has made only small, reactive purchases of government debt. Current bailout mechanisms are insufficient if contagion spreads to the larger economies and the government debt markets of Spain and Italy, and as more nations become unable to assist in bailouts due to bailouts of their own.
Economic growth in the euro-zone will likely trail that in the United States due to European fiscal austerity and the combination of reduced spending and tax increases, while the United States is benefitting from continued monetary stimulus.
We’ve consistently said that policymakers need to make bolder, more proactive moves to address investor confidence. On this front, German politics appear to be a little less contentious, which could pave the way for progress.
A more-comprehensive solution could include modification to the current European Financial Stability Facility that includes some combination of access to lower interest rates, increased size of bailout funding, debt repurchases, short-term loans and debt guarantees.
If markets gain some confidence, a more-comprehensive solution can be reached and government yields should fall to more sustainable levels, meaning additional bailouts could be avoided. This would likely be met with a rally in euro-zone stocks due to current inexpensive valuations and low expectations, along with previous underperformance.
Euro-zone Stocks Underperformed
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Source: FactSet, MSCI, as of January 11, 2011. Indexed to 100 as of December 31, 2009. A number less than one denotes greater underperformance of the European Monetary Union (EMU) relative to each respective index.
US dollar largely influenced by the euro
The European debt crisis has resulted in episodes of weakness in the euro and thus US dollar strength, an “anti-euro” trade. A resolution to the European debt crisis could result in renewed US dollar weakness, although there are many factors that play into near-term currency movements.
Additionally, while China is likely to continue to diversify away from its heavy exposure to US dollar assets, the United States is unlikely to lose its reserve currency status anytime soon. The US dollar remains an important currency in trade transactions and the US Treasury market is the largest and most-liquid debt market in the world.
However, China’s moves deserve attention, and several new policies announced this year indicate currency reform has accelerated. China is gradually allowing its currency, the yuan, to be used outside of its borders. Recent reforms include allowing exporters keep revenues in overseas bank accounts and the state-owned Bank of China allowing US investors to trade the yuan.
However, these are gradual moves, and it will be quite some time (if ever) before the yuan becomes a credible alternative to the US dollar. Currently, the exchange rate remains controlled by the Chinese government, not markets.
Volatility while composition of China’s economy changes
Chinese economic growth has continued to shine, largely because the government has directed investment in infrastructure and allowed high levels of bank lending at low rates to assist the economic recovery.
However, continued large amounts of money plowed into increasingly less-economically viable infrastructure projects and investments, particularly given over-capacity in many industries, is not a good economic strategy. Meanwhile, domestic consumer spending remains a relatively small portion of the economy and income inequality is growing.
As such, the new Chinese five-year growth plan is likely to address inequality issues in housing, incomes and social safety nets. Additionally, 2011 policy is focused on increasing the flexibility of the yuan and containing lending that could fuel bubbles and expose banks to risks.
Strong economic growth, as well as overly stimulative interest rates and lending, has stoked inflation fears. While some measures of China’s inflation show signs of moderation, risks remain.
In particular is the risk of wage inflation due to tight job markets and the desire to reduce income inequality. Minimum-wage hikes have been ordered and worker unrest has resulted in businesses raising salaries.
We expect Chinese stocks to remain subject to uncertainty regarding the amount and aggressiveness of monetary tightening, and the degree of economic slowing China will experience in 2011.
Many emerging markets are struggling with the impact of food inflation given that food constitutes a higher proportion of spending than in developed markets. Food inflation can erode consumer discretionary spending and create the expectation of rising prices across an economy.
Lower discretionary spending, along with the need for monetary tightening to fight broader inflation, can combine to dramatically slow economic activity, particularly in countries with large contributions from consumers. Stocks in countries facing this dual dilemma, such as India, Indonesia and South Korea could underperform.
Emerging-market stocks outperformed in 2010, due to strong returns in a number of smaller markets and the asset class receiving strong inflows of money. We moved to a more-neutral view on emerging markets in November, concerned about high expectations and valuations.
We’re seeing the impact of high expectations on the markets of India and Bangladesh in 2010, both experiencing notable declines. We still like the longer-term emerging-markets story, but we believe growth needs some time to catch up with prior stock performance. We remind investors that emerging-market allocations should be a small part of a diversified portfolio and investments should be made with a long-term time horizon.
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 IndexSM 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: Brazil, Canadian Market, Charles Schwab, Chief Investment Strategist, Contrarian Indicator, Corporate Health, Corporate Sector, Currency, Deficit Spending, Earnings Season, Emerging Markets, Fourth Quarter Earnings, India, International Exposure, Liz Ann, Market Analyst, Market Exposure, Pullback, Rebalancing, Russia, Sector Analysis, Senior Vice President, Stock Mark, Target, Term Volatility, Us Congress
Posted in Brazil, Canadian Market, India, Infrastructure, Markets | Comments Off
Sunday, November 7th, 2010
Olivier Blanchard, economic counsellor at the IMF, talks to Romesh Vaitilingam about the two ‘rebalancing acts’ needed for a strong global recovery and the particular challenges facing the US, Europe and the emerging market economies. He also discusses fiscal consolidation, financial reform and ‘currency wars’. The interview was recorded on 4 November 2010 at the Centre for Economic Performance in London, where Blanchard was delivering a special lecture on ‘The State of the World Economy’.
(17 minutes 11 seconds)
Visit the website for ‘The State of the World Economy’, CEP 21st Birthday Lecture Series, here.
Tags: 21st Birthday, Blanchard, Cep, Challenges, Currency, Download Flash, Economic Counsellor, Economic Performance, Emerging Market Economies, Europe, Fiscal Consolidation, Flash Player, Global Recovery, Imf Talks, Lecture Series, London, Rebalancing, Voxtalks, World Economy
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Sunday, October 10th, 2010
By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors.
Commodity and international investments have a reputation for being risky. But once you get to know them, you might consider inviting them into your portfolio.
Roger Gibson, best-selling author of Asset Allocation: Balancing Financial Risk, joined us a few weeks ago to discuss portfolio construction and the benefits of diversification. A replay of the webcast is available for a limited time here.
Which asset class would you expect to have generated the best performance over the past four decades or so—domestic stocks, commodity-linked securities or a portfolio split evenly between the two?
Here is Roger’s chart showing a hypothetical investment of $1. He uses the S&P 500 Index for U.S. stocks and the S&P GSCI Commodity Index for commodities. For the combined portfolio, he assumes annual rebalancing to maintain the 50-50 allocation.
His math shows that an investment of $1 in the S&P 500 in 1971 would have grown to $36.26 by the end of 2009, and an identical investment in the S&P GSCI would have increased to $32.07.
But look what happens when you split that dollar between the two starting in 1971. By the end of 2009, that original dollar would be supersized to nearly $52.
As Roger put it in the webcast, “The whole outperformed the components. And it did so as a result of the reduction in volatility relative to the components. That is also an outcome that you did not ever have to predict what was going to happen in the short run. All you had to do is have balanced representation and keep rebalancing and keep holding.”
Even if it has the potential for lofty returns, portfolios also can’t be built on a mountain of risk. Optimal performance achieves the highest return with the lowest amount of risk.
To illustrate the importance of portfolio diversification, Roger set up an assortment of portfolios formed from different combinations of four asset classes:
- Asset Class A – U.S. Stocks (S&P 500 Index)
- Asset Class B – Non-U.S. Stocks (MSCI EAFE Index—labeled B)
- Asset Class C – Real Estate Securities (FTSE NAREIT Equity REITs Index)
- Asset Class D – Commodity-linked Securities (S&P GSCI Index)
Roger then back-tested these portfolios over the past 37 years, to gauge how each performed. You can see how each combination of asset classes fared from the chart. The y-axis measures each portfolio’s return while the x-axis measures its volatility, represented by its standard deviation. An ideal portfolio would show up in the upper left-hand corner of the chart—the highest returns with the lowest volatility.
This illustration shows just how powerful commodities are for a portfolio. In the upper left-hand corner (circled in red), you’ll see that the best-performing portfolios all have an allocation to commodities (Asset Class D). Adding a dash of international securities to the mix (Asset Class B) can increase the return but it also comes with an additional amount of volatility.
The chart also illustrates the long-term benefits of diversifying into multiple asset classes and rebalancing on a regular basis. You can see that a combination of all four asset classes outpaced the individual performance of any one asset class and with less volatility.
This webcast is only available for a limited time so I encourage you to listen to the replay soon. This week I spoke week with CNBC’s host Larry Kudlow about gold. If you haven’t already had a chance to watch the interview, you can do so here.
Tags: Asset Allocation, asset class, Balanced Representation, Benefits Of Diversification, Best Performance, Chief Investment Officer, Commodities, Diversified Portfolio, Domestic Stocks, Financial Risk, Frank Holmes, Gsci Commodity Index, Hypothetical Investment, Importance Of Portfolio Diversification, International Investments, Key Success Factors, Optimal Performance, Portfolio Construction, Rebalancing, Roger Gibson, U S Global Investors
Posted in Gold, Markets | Comments Off
Thursday, September 16th, 2010
Which asset class would you expect to generate the better performance over the past four decades or so – domestic stocks, commodity-linked securities or a portfolio split evenly between the two?
Roger Gibson, one of the nation’s most influential voices on asset allocation, offered his answer last week during an exclusive webcast with U.S. Global Investors. A replay of the webcast is available here.
Here’s Roger’s chart on the subject. He uses the S&P 500 Index for U.S. stocks and the S&P GSCI Commodity Index for commodities, and he assumes annual rebalancing to maintain the 50-50 allocation.
His math shows that an investment of $1 in the S&P 500 in 1971 would by the end of 2009 have grown to $36.26, and that an identical investment in the S&P GSCI would have increased to $32.07.
But look at what happens when 50 cents goes to each of the asset classes at the start – by 2010, that original dollar would be worth nearly $52.
As Roger puts it in the webcast, “The whole outperformed the components. And it did so as a result of the reduction in volatility relative to the components. That is also an outcome that you did not ever have to predict what was going to happen in the short run. All you had to do is have balanced representation and keep rebalancing and keep holding.”
This is just one of the interesting conclusions that Roger shares on the webcast, which will be available on our web site for only a limited time. I encourage you to consider listening to the replay and viewing his slides. You many even want to share it with your friends.
The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. The S&P GSCI is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities.
Diversification does not protect an investor from market risks and does not assure a profit.
Tags: 50 Cents, Asset Allocation, asset class, Asset Classes, Balanced Representation, Commodities, Commodity Futures, Commodity Sector, Common Stock, Composite Index, Diversification, Domestic Stocks, Gsci Commodity Index, Rebalancing, Roger Gibson, Stock Index, Stock Prices, U S Global Investors, Volatility, Webcast, Weighted Index
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Wednesday, August 11th, 2010
The article below is a guest contribution by Bernard Tan (courtesy Fullermoney).
The general consensus is that the US is suffering from chronic trade deficits and is frittering away its future wealth importing (and consuming) the production from the rest of the world.
Not many people realise that the US is in fact one of the biggest exporters in the world. In 2009, its exports totalled US$1.05 trillion. Only 2 countries exported more – China (US$1.20 trillion) and Germany (US$1.12 trillion).
The reputation for being “just a voracious consumer that produces nothing” comes from the size of its imports, which in 2009 totalled US$1.56 trillion!
But the trade balance is already shifting. The chart below shows the monthly trade balance of the US (exports less imports).
Note that the trade deficit actually peaked in late 2005/early 2006, well before the financial crisis and recession. This suggests that some structural adjustment in the US’s role in the world economy had already begun more than 4 years ago.
It is obvious that US exports have moved from generally single-digit YoY growth rates prior to 2004 to double-digit YoY growth. By mid-2008, before the global recession began, the trailing 12-month average of export growth had reached almost 17%.
Of course, the pattern has been interrupted by the recession/financial crisis. The data is only available up to May 2010 but I believe that the trend will resume in short order.
Another interesting phenomena is the volatility of exports. With each crisis/recession, the fluctuation in export growth rates become greater. Compare 1998/99 Asian financial crisis with the 2000/2001 dotcom collapse with the 2008/2009 global financial crisis.
The increasing sensitivity and volatility of US exports to global economic circumstances is exactly the type of behaviour traditionally exhibited by the Asian export powerhouses.
The US could be gradually (and stealthily) regaining its export powerhouse status!
In the final chart on the next page, I have plotted the ratio of US export growth to US GDP growth.
This chart proves beyond doubt that US export contribution to GDP growth has been rising sharply since 2006.
Everybody who reads economic or business pages is well aware of the need for rebalancing in the world economy – so that the US consumes less, produces more while Asia consumes more, produces less.
What I believe most people fail to realise is that this process has already begun and is well under way.
Perhaps in the not too distant future, Foxconn will build its factories in the US. I only hope that we won’t then see young workers in South Carolina jumping off the roofs of those Foxconn factories!
Tags: Asian Financial Crisis, Collapse, Consensus, Economic Circumstances, Fluctuation, Future Wealth, Global Financial Crisis, Global Recession, Phenomena, Powerhouse, Powerhouses, Rebalancing, Rest Of The World, Structural Adjustment, Trade Balance, Trade Deficit, Trade Deficits, Trillion, Volatility, World Economy
Posted in China, Markets | Comments Off