Posts Tagged ‘Term Outlook’
Thursday, March 29th, 2012
Defence That Pays
Dividend Equities as a Long-term Strategy
by Alfred Lee, CFA, CMT, DMS
Vice President & Investment Strategist
BMO ETFs & Global Structured Investments
BMO Asset Management Inc.
March 29, 2012
- Despite the global macro-economic concerns that remain, year to date, investors have clearly favoured risk-assets as improving sentiment has led global equity markets to rally with significant breadth. Although, investors should not put too much focus on day-to-day headlines, last Thursday’s reading of Europe and China’s weak Purchasing Managers Index (PMI), shows how the global economic recovery remains vulnerable. While we have become more optimistic over the mid-term, we still remain concerned on the structural issues remaining over the long-term, and is why we continue to recommend that investors do not throw caution to the wind.
- News of Greece’s debt restructuring several weeks ago, has put concerns on the backburner; although we believe Greece’s solvency issues remain over the long-term. On a short-term outlook, this has lifted a major overhang on the equity markets. Investors should note, however, that credit default swap (CDS) prices of Portugal still remain elevated (Chart A). Moreover, China’s potential housing bubble and inflation handcuffs the nation’s ability to implement a wholesale monetary easing policy. Thus, unlike 2009, China will not be able to shoulder the global economy.
- The year-to-date rally in risk-assets hinges on whether U.S. economic data can sustain or continue to build positive momentum. Although we have increased our recommended allocation to Canadian equities, we still remain defensive in our composition. Concerns on China should weigh on some commodity-based equities over the short-term, so we recommend that investors look at non-cyclical areas such as dividend paying equities in Canada.
- In addition to being more defensive in nature, lower bond yields should lead investors to look to dividend paying equities to source yield. Currently, the 10-year government bond yield is less than the dividend yield of the S&P/TSX Composite Index (TSX) (Chart B). An aging demographic searching for income distributions should provide a further tailwind for dividend paying equities over the long-run.
- Improving economic data has also recently led the yield curve to shift upwards (Chart C), which has negatively impacted bonds, especially those of longer maturity. As we have become more bullish on equities over the short- and mid-term, investors may want to consider reallocating some bond exposure to dividend paying equities as a way of maintaining overall portfolio yield while decreasing duration risk. Investors should keep in mind that equities and fixed income do react to risk in different manners and therefore should keep in mind their overall portfolio risk composition.
- Investors may want to consider the BMO Canadian Dividend Equity ETF (ZDV) as an efficient way to gain exposure to a basket of 50 large and some mid-cap Canadian dividend paying stocks. Currently, the underlying portfolio yields 4.5%, diversified across eight different sectors and a management fee of only 0.35%. In addition to being eligible for a dividend reinvestment plan (DRIP) like our other BMO ETFs, ZDV pays a monthly distribution. We continue to recommend defensive holdings such as ZDV as core positions and more cyclical oriented themes around the peripheral as more tactically oriented themes.
Source: BMO Asset Management Inc., StockCharts.com
Source: BMO Asset Management Inc., Bloomberg,
Source: BMO Asset Management Inc., Bloomberg
*All prices as of market close March 27, 2012 unless otherwise indicated.
Information, opinions and statistical data contained in this report were obtained or derived from sources deemed to be reliable, but BMO Asset Management Inc. does not represent that any such information, opinion or statistical data is accurate or complete and they should not be relied upon as such. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.
BMO ETFs are managed and administered by BMO Asset Management Inc, an investment fund manager and portfolio manager and separate legal entity from the Bank of Montreal. Commissions, management fees and expenses all may be associated with investments in exchange-traded funds. Please read the prospectus before investing. The indicated rates of return are the historical annual compound total returns including changes in prices and reinvestment of all distributions and do not take into account commission charges or income taxes payable by any unit holder that would have reduced returns. The funds are not guaranteed, their value changes frequently and past performance may not be repeated.
Tags: Alfred Lee, Asset Management Inc, Backburner, BMO, Canadian, Canadian Equities, Canadian Market, Caution To The Wind, Cmt, Credit Default Swap, Debt Restructuring, Economic Concerns, ETF, ETFs, Global Economy, Global Equity Markets, Global Macro, Housing Bubble, Investment Strategist, Purchasing Managers Index, Structured Investments, Swap Cds, Term Outlook, Wind News
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Tuesday, November 29th, 2011
by Bob Doll, Chief Equity Strategist, Blackrock, Inc.
November 28, 2011
A Sharp Drop for Stocks
Equity markets sank sharply last week as the European debt crisis worsened and the US super committee failed to come to an agreement. For the week, the Dow Jones Industrial Average fell 4.8% to 11,231, the S&P 500 Index dropped 4.7% to 1,158 and the Nasdaq Composite sank 5.1% to 2,441. Because the political problems in the United States and the crisis in Europe could result in a nearly endless array of outcomes, investors are faced with a high degree of uncertainty. As a result, unless and until more clarity emerges, markets are likely to remain somewhat trendless in the near term.
Outlook Uncertain for the European Debt Crisis
While much of the focus on the euro crisis has been on Greece and its risk of defaulting, in recent weeks, that focus has shifted to a general lack of liquidity within the European debt markets as banks struggle to maintain credit ratings. Many large global banks are attempting to sell or reduce their exposures to troubled European sovereign debt, and the selling pressures are triggering a new surge in government bond interest rates. This, in turn, has been forcing more countries into higher debt burdens and bigger deficits.
At this point, it has become clear that the measures taken so far to stem the crisis have not been sufficient. In our view, it will probably require the creation of something like a commonly issued euro bond to contain the debt crisis. Although Germany has so far resisted that possibility, there are growing indications that such a solution may well be forthcoming.
Regardless of what happens in the debt crisis itself, a recession in Europe now seems a foregone conclusion. Should policymakers be able to come to an effective resolution soon, the recession is likely to be shallow, but risks are growing that the recession could be deeper. It is an open question as to how much a European recession would impact the United States and other global markets. The main risk comes in the form of the intertwined nature of the global credit markets since severe European bank deleveraging could negatively impact US credit availability as well.
Super Committee Failure Creates a Murky Debt Future
The failure of the super committee to provide a plan to reduce the deficit was certainly disappointing, but it would be a mistake to put too much stock in that specific incident. The deadline imposed by Congress was an arbitrary one and the automatic cuts set to take place as a result of the non-decision will not occur until January 2013. As a result, Congress still has an opportunity to address deficit reduction, but of course the fact that all of this is occurring with the backdrop of the 2012 elections means that uncertainty levels are elevated.
In our view, the more important question is whether or not Congress will be able to extend the payroll tax cuts and unemployment benefits set to expire at the end of this year. Should they be unsuccessful in doing so, it would likely create a significant fiscal headwind in 2012.
Stocks Likely to Remain Range-Bound
Somewhat lost amid all of the euro debt and US political headlines has been the fact that US economic data has continued a gradual improvement. The November payrolls report is set to be released this Friday and indications are that it will be decent. True, last week it was reported that third-quarter gross domestic product (GDP) growth was revised lower, but the inventory reduction that occurred may help set the stage for a stronger fourth quarter. At this point, fourth-quarter GDP looks to come in at 3% or possibly higher based on improved profits, a better labor market, increased capital expenditures and a low cyclical starting point for inventories.
Economic acceleration should create firmer footing for stocks, but for the time being, we believe markets will remain focused on the short-term headlines. Of all of the factors affecting the markets (US politics, the economic slowdown in China, etc.) the most critical remains the European debt crisis. Stocks are likely to remain range bound (trading between the 1,100 and 1,250 level for the S&P 500) for now, but should policymakers be successful in gaining some traction, markets could see some better results.
About Bob Doll
Bob Doll is Chief Equity Strategist for Fundamental Equities at BlackRock® a premier provider of global investment management, risk management and advisory services. Mr. Doll is also Lead Portfolio Manager of BlackRock’s Large Cap Series Funds. Prior to joining the firm, Mr. Doll was President and Chief Investment Officer at Merrill Lynch Investment Managers.
Sources: BlackRock, Bank Credit Analyst. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of November 28, 2011, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.
BlackRock is a registered trademark of BlackRock, Inc. All other trademarks are the property of their respective owners.
Prepared by BlackRock Investments, LLC, member FINRA.
Copyright © Blackrock, Inc.
Tags: Blackrock Inc, Bob Doll, Bond Interest, Debt Burdens, Debt Crisis, Debt Markets, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Average, Endless Array, Foregone Conclusion, Global Banks, Government Bond, liquidity, Nasdaq Composite, Open Question, Recession, Sovereign Debt, Strategist, Term Outlook
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Tuesday, November 29th, 2011
My notes below are somewhat cryptic as I am about to leave for abroad. However, the graphs should provide some food for thought regarding the short-term outlook for U.S. stocks.
Yesterday’s rally in the S&P 500 was mainly as a result of the PE10 closing the discount that opened the VIX last week.
The rally took the PE10 to 19.95 from 19.39 last Friday.
The PE10 remains under the 40-day moving average, with the latter topping out. I will not be surprised to see the 40-day moving average tested at 20.40 soon.
The PE10 is oversold but the RSI is still trending down. An unchanged to higher closing of the S&P 500 over the next three days is likely to break the RSI downtrend.
Both the 12-day and 26-day exponential moving averages of the PE10 are bottoming.
The MACD (26;12) of the PE10 is showing signs of bottoming. The nine-day moving average of the MACD is still trending down while the gap between it and the MACD indicates that a longer-term buying signal is still some way off.
The VIX is testing support levels around 32.
The RSI of the VIX has retreated somewhat from mildly overbought conditions but remains above the downtrend established in August.
The VIX is currently testing the 12-day and 26-day exponential moving averages.
The MACD (26;12) is slowly rolling over and the gap to its nine-day moving average(VIX Signal) is closing slightly.
The VIX MACD and the signal are a better indicator of PE trend changes than those of the PE10. The closing of theVIX’s MACD and the signal indicates that a buy signal could be imminent.
The RSI of the PE10 and the VIX (inverse) combined has tested the range of previous oversold levels. Although the RSI is still trending downwards, unchanged S&P 500 and VIX levels over the next three days will break the downtrend.
A break in the downtrend of the combined RSI is likely to lead to a significant rally in the S&P 500.
Tags: Amp, Break, Exponential Moving Averages, Food For Thought, Gap, Graphs, Last Friday, Macd, Moving Average, Rally, Rsi, Signs, Stocks, Term Outlook, Trend Changes
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Wednesday, November 23rd, 2011
by Russ Koesterich, Chief Investment Strategist, iShares
Many investors believe that all developed markets are stuck in a slow-growth purgatory characterized by high unemployment and excessive debt.
But truth is, while Europe, Japan and the United States are certainly slogging along in this slow-growth environment, certain smaller developed countries are doing much better than their larger counterparts.
Specifically, Canada, Australia, Singapore, Switzerland and Hong Kong — what I’m calling the CASSH countries — appear fundamentally stronger than most of the large, developed countries. Here’s why:
1.) Stronger Growth: These five countries are expected to grow by an average of 3.5% next year, roughly double the expected growth rate for the United States, Europe and Japan.
2.) Better Fiscal Situations: Beyond enjoying better growth prospects, these countries are less burdened by debt and structural deficits. They don’t suffer from the same fiscal imbalances as the United States, Europe and Japan.
3.) Profitable Corporate Sectors: These countries also have profitable corporate sectors that are at least as competitive as those in larger developed market countries. In fact, these five markets have an average return on equity of about 24%, higher than the similar measure for Japan and Europe.
But currently, equity prices of these five markets don’t reflect these better fundamentals. Investors can pay approximately the same price for a dollar of earnings in the CASSH countries as they would for the same cash flow in the United Sates, Europe and Japan. This potentially represents a long-term investment opportunity.
If you’re an investor who looks at a timeframe of a year or less, however, you should keep in mind that my near-term outlook for these countries isn’t overweight across the board. Due to country-specific factors, I currently hold overweight near-term views of Singapore and Hong Kong, and neutral near-term views of Canada, Australia and Switzerland.
Even more importantly, keep in mind that if there’s another recession, it’s going to impact all markets. It could hit the CASSH countries as hard, if not harder, than countries like the United States that continue to enjoy perceived safe-haven status.
Still, if the global economy continues to muddle along, as I expect it will, these five countries are likely to hold up much better in the long term than their larger neighbors.
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. Securities focusing on a single country may be subject to higher volatility.
Copyright © iShares
Tags: Austr, Canada Australia, Chief Investment Strategist, Corporate Sectors, Developed Countries, Excessive Debt, Fiscal Imbalances, Growth Environment, Growth Prospects, Investment Opportunity, Japan And The United States, Long Term Investment, Market Countries, Overweight, Purgatory, Return On Equity, Term Outlook, Timeframe, United Sates, Views Of Singapore
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Saturday, September 24th, 2011
by Trader Mark, Fund My Mutual Fund
Sometimes Jim Rogers gets repetative since he usually pounds the same theories – which is not bad from the viewpoint he has a long term outlook, but in this interview with CNBC yesterday there are some interesting items regarding his current positions (currently long dollar even though he does not believe it to be a safe haven), and some trade / currency tensions developing. I must have missed the news about Brazilian import tariff on Chinese goods.
For those newer to trading I think his view on the dollar is important to understand from a lesson standpoint. Even if you the dollar is ‘cooked’ long term, time frame is important. For the near term, the U.S. dollar still is considered a safe haven (best house on a street full of crack homes) and in panic people flee to U.S. Treasuries and the dollar. So while Jim believes U.S. leadership (I use that word loosely) is constantly doing damage to its currency, he understands the way the other people in the market will react and will take advantage of it. (Rogers is a huge long term bear on the currency)
8 minute video
- The U.S. dollar is going higher “against major currencies,” well-known investor Jim Rogers told CNBC Thursday. The dollar “is going up against everything right now” for a number of reasons, said Rogers. One may be that everybody is panicking “and for some reason they’re rushing into the U.S. dollar.” “The U.S. dollar is not a safe haven, if you ask me, but I do own it,” he added.
- Also, Rogers noted he would own the U.S. dollar, or the Swiss Franc, or agriculture. “Agriculture prices [are] getting banged right now. I am kind of planning on buying Swiss francs, more dollars and agriculture.”
- In addition, he weighed in on China’s economy, saying, “They’re doing their best to cool things off … I expect them to continue to do it, and that is causing more slowdown around the world.”
- But “the major problems are coming from the west,” Roger stressed. “They are coming from Europe and the [United States]. We are much worse off than we were in 2008 because the debt has gone through the roof.” “At least in 2008 there was the possibility that the governments could bail us out. Now, of course, the governments have gotten deep, deep, deep into debt themselves,” he added. “Everybody is in much worse shape.”
- Plus, there are all sorts of trade tensions and currency tension developing, Rogers went on to say. “Brazil is sort of ignited a trade war [by putting a 30 percent import tariff on China and Korea ]. And right now China is trying to get the Europeans to let them open up the trade with China more. The Europeans are saying no, so China is saying, ‘No, we won’t bail you out.’”
- “I hope the trade war doesn’t break out” because throughout history when it does it has “caused depressions,” Rogers added. “You saw what happened in the 1930s. It led to depression and it also led to war. So I hope it can be contained.”
- Ben Bernanke’s idea that low-interest rates are good, “is killing the people who save and invest, and that’s really hurting a very, very large part of the population,” concluded Rogers. (something we’ve said countless times) [Mar 31, 2010: Ben Bernanke Content to Sacrifice Savers to Recapitalize Banks and Benefit Debtors]
Tags: Agriculture Agriculture, Agriculture Prices, Brazil, Chinese Goods, Cnbc, Currency, Dire Straits, Import Tariff, Jim Rogers, Mutual Fund, Outlook, Safe Haven, Slowdown, Standpoint, Swiss Franc, Swiss Francs, Tensions, Term Outlook, Term Time, Time Frame, Treasuries, Viewpoint
Posted in Brazil, ETFs, Markets, Outlook | Comments Off
Monday, September 12th, 2011
Fed Policy – No Theory, No Evidence, No Transmission Mechanism
by John P. Hussman, Ph.D., Hussman Funds
On Friday, the yield on 1-year Greek debt surged above 90%, while Wall Street still has barely blinked, evidently convinced by the bailout mentality of the past three years that governments will simply make the problem go away with public funds. One thing is certain – public funds will indeed be used to address this problem. But it is also nearly certain that those funds will be used to recapitalize European financial institutions (ideally, restructured ones) following a major default of Greek debt. The reason for this is simple. With Greek debt now beyond 144% of GDP and on track toward 180% by year-end, neither a further extension of credit to Greece, nor a modest writedown of its debt, would be sufficient to restore Greece’s ability to service that debt over time.
It was only in June (see Greek Yields: “Certain Default, But Not Yet” ) that we published a schedule showing the probability of default implied by Greek yields, with several lines showing the probability of default depending on the expected date of default and the assumed “recovery rate” (the percentage of face value that bond investors could expect to recover in the event of default). That wistfully optimistic chart is reprinted below.
Amésos: Adv (Greek): Immediately, forthwith, straightaway.
As I noted in June, “At the point that a near-term default becomes likely, we would expect to see one-year yields spiking toward 40% and 3-month yields pushing past 100% at an annual rate (essentially pricing near-term bills toward the anticipated recovery rate). This temporarily reassuring situation, unfortunately, strongly contrasts with the longer-term outlook for Greek debt. Even assuming a 60% recovery rate (that is, assuming a default would wipe out 40% of the Greek debt burden), the implied probability of a Greek default within the next two years is effectively 100%. The only way you get a lower probability is to assume a far lower recovery rate.”
Tags: Bailout, Bond Investors, Bonds, Commodities, Debt Burden, Face Value, Fed Policy, Financial Institutions, GDP, Governments, Greece, Hussman Funds, Implied Probability, Mentality, Outlook, Term Bills, Term Outlook, Transmission Mechanism, Wall Street, Year End
Posted in Bonds, Brazil, Commodities, Markets, Outlook | Comments Off
Thursday, September 1st, 2011
Via email, Michael Pettis at China Financial Markets shared his outlook for China, Europe, and the world. The overall outlook is not pretty, and includes a breakup of the Eurozone, a major slowdown for China, and a smack-down of the much beloved BRICs.
Pettis Writes …
August is supposed to be a slow month, but of course this August has been hectic, and a lot crueler than April ever was. The US downgrade set off a storm of market volatility, along with bizarre concern in the US about whether or not China will stop buying US debt and the economic consequence if it does, and equally bizarre bluster within China about their refraining from buying more debt until the US reforms the economy and brings down debt levels.
What both sides seem to have in common is an almost breathtaking ignorance of the global balance of payment mechanisms. China cannot stop buying US debt until it engineers a major adjustment within its economy, which it is reluctant to do. Until it does, any move by the US to cut down its borrowing and spending will trigger a drop in global demand which will cause either US unemployment to rise, if the US ignores trade issues, or will cause Chinese unemployment to rise, if the US moves to counteract Chinese currency intervention.
The Big Picture
Rather than try to wade through all the news this month, much of which doesn’t seem to have much informational content, I thought I would duck out altogether and instead make a list of things I expect will happen over the next several years. We are so caught up in noise and market volatility – as the market swings first in one direction and then, as regulators react, in the other direction – that it is easy to lose sight of the bigger picture.
My basic sense is that we are at the end of one of the six or so major globalization cycles that have occurred in the past two centuries. If I am right, this means that there still is a pretty significant set of major adjustments globally that have to take place before we will have reversed the most important of the many global debt and payments imbalances that have been created during the last two decades. These will be driven overall by a contraction in global liquidity, a sharply rising risk premium, substantial deleveraging, and a sharp contraction in international trade and capital imbalances.
To summarize, my predictions are:
- BRICs and other developing countries have not decoupled in any meaningful sense, and once the current liquidity-driven investment boom subsides the developing world will be hit hard by the global crisis.
- Over the next two years Chinese household consumption will continue declining as a share of GDP.
- Chinese debt levels will continue to rise quickly over the rest of this year and next.
- Chinese growth will begin to slow sharply by 2013-14 and will hit an average of 3% well before the end of the decade.
- Any decline in GDP growth will disproportionately affect investment and so the demand for non-food commodities.
- If the PBoC resists interest rate cuts as inflation declines, China may even begin slowing in 2012.
- Much slower growth in China will not lead to social unrest if China meaningfully rebalances.
- Within three years Beijing will be seriously examining large-scale privatization as part of its adjustment policy.
- European politics will continue to deteriorate rapidly and the major political parties will either become increasingly radicalized or marginalized.
- Spain and several countries, perhaps even Italy (but probably not France) will be forced to leave the euro and restructure their debt with significant debt forgiveness.
- Germany will stubbornly (and foolishly) refuse to bear its share of the burden of the European adjustment, and the subsequent retaliation by the deficit countries will cause German growth to drop to zero or negative for many years.
- Trade protection sentiment in the US will rise inexorably and unemployment stays high for a few more years.
1. No BRIC Decoupling
Since most global consumption comes from the US, Europe and Japan, the collapse in their demand will ultimately be very painful for the BRICs and the rest of the developing world. The latter have postponed the impact of contracting consumption by increasing domestic investment, in some cases very sharply, but the purpose of higher current investment is to serve higher future consumption. In many countries, most notably China, the higher investment will itself limit future consumption growth, and so with weak consumption growth in the developed world, and no relief from the developing world, today’s higher investment will actually exacerbate the impact of the current contraction in consumption.
2. Near-Term Decline in Chinese Consumption
By 2013 Chinese household consumption will still not have exceeded the 35% of Chinese GDP reached in 2009. In fact it will probably be lower.
Premier Wen listed the need to raise the consumption share of GDP second in his speech last March before the unveiling of the new Five-Year Plan.
But I remain very, very skeptical. Low consumption levels are not an accidental coincidence. They are fundamental to the growth model, and the suppression of consumption is a consequence of the very policies – low wage growth relative to productivity growth, an undervalued currency and, above all, artificially low interest rates – that have generated the furious GDP growth. You cannot change the former without giving up the latter. Until Beijing acknowledges that it must dramatically transform the growth model, which it doesn’t yet seemed to have acknowledged, consumption will continue to be suppressed.
3. Chinese Debt Levels will Continue to Rise Very Quickly
The attempts to rein in debt growth will fail because they address specific areas of debt and not the overall tendency of the system to generate debt.
China funds almost all of its major investments with bank debt, and it long ago ran out of obvious investments that are economically viable – at least investments that are likely to be generated by what is a distorted system with very skewed incentives – so increases in investment must be matched by increases in debt.
To the extent that investments are not economically viable, this means that the value of debt correctly calculated must rise faster than the value of assets. By definition this results in an unsustainable rise in debt.
4. By 2013-14 Chinese GDP Growth will Slow sharply
I don’t expect a significant growth slow-down until after the new leadership takes power in late 2012, but my guess (and hope) is that by 2013 the stubborn refusal of consumption to rise as share of GDP, and the continuing surge in debt, will have convinced all but the most recalcitrant that China needs a dramatic change of policy.
Why do I say we will be talking about 3% growth soon? Two reasons. First, I am impressed by the bleakness of historical precedents. Every single case in history that I have been able to find of countries undergoing a decade or more of “miracle” levels of growth driven by investment (and there are many) has ended with long periods of extremely low or even negative growth – often referred to as “lost decades” – which turned out to be far worse than even the most pessimistic forecasts of the few skeptics that existed during the boom period. I see no reason why China, having pursued the most extreme version of this growth model, would somehow find itself immune from the consequences that have afflicted every other case.
Second, I just use a very simple calculus. Remember that rebalancing is not an option for China. It will happen one way or the other, and the sooner the less disruptive. And for China to rebalance in a meaningful way, consumption growth is going to have to outpace GDP growth by at least 3-4 full percentage points (and even then, at that rate, it will take China over five years to return to the 40% that was not long ago considered astonishingly low).
5. Non-Food Commodities Disproportionately Affected
The decline in Chinese growth will fall disproportionately on investment and, because of this, it will severely impact the price of non-food commodities. The implications are inescapable, although I think many people, especially in the commodities sector, have missed them.
6. Significant Slowing Could Start in 2012
What happens to real interest rates will determine when the process of Chinese adjustment begins. In fact there is a chance that we may see growth in China slow significantly in 2012, perhaps even to 7%, although I suspect that it will probably be in the 8-9% region.
What the PBoC does to interest rates is likely to be the outcome of a struggle in the State Council between policymakers that are worried about growth and those that are worried about imbalances. If the PBoC can hold off the former, and especially if wages continue rising, we might begin to see Chinese rebalancing taking place a little earlier than expected. Of course this must, and will, come with much slower GDP growth.
7. Social Unrest Not a Given
Growth rates of 3% will not necessarily lead to social and political instability. Most analysts argue that China needs annual growth rates of at least 8% to maintain current levels of unemployment. Anything substantially lower will cause unemployment to surge, they argue, and this would lead to social chaos and political instability.
I disagree. The employment effect of lower growth depends crucially on the kind of growth we get. Since rebalancing in China requires less emphasis on heavy investment and more on consumption, and since rebalancing also means a sharp reduction in free credit provided to SOEs and local governments and cheaper and more available credit for efficient but marginal SMEs, a rebalancing China would presumably see much more rapid growth in the service sector and in the SME sector, both of which are relatively labor intensive. Much lower growth, in that case, could easily come with minimal changes in overall employment. Japan is a useful reminder of what can happen.
8. Large-Scale Privatization
Because of its rapidly rising debt burden, the only way for China to manage a smooth social transition will be through wealth transfers from the state sector to the household sector. In the past, Chinese households received a diminishing share of a rapidly growing pie. In the future they must receive a growing share. This will probably be accomplished through formal or informal privatization.
9. Disruptive European Politics
European politics will become much more difficult and disruptive. The historical precedents are clear. During a debt crisis the political system becomes fragmented and contentious. If the major parties don’t become radicalized, smaller radical parties will take away their votes.
Remember that the process of adjustment is a political one. We all know someone has to pay for the massive adjustment countries like Spain must make. The only interesting question is about who will be forced to take the brunt of the payment – workers in the form of unemployment, the middle classes in the form of confiscated savings, small businesses in the form of taxes, large businesses in the form of taxes and nationalization, foreigners, or creditors.
Deciding who pays is a political process, and because the stakes are so high it will be a very bitter process. This means, among other things, that politics will degenerate quickly, and of course if Europe doesn’t arrive at fiscal union in the next year or two, it probably never will. This conclusion is also the reason for my next prediction.
10. Spain, other PIIGS Leave Euro
Spain will leave the euro and will be forced to restructure its debt within three or four years. So will Greece, Portugal, Ireland and possibly even Italy and Belgium.
The only strategies by which Spain can regain competitiveness are either to deflate and force down wages, which will hurt workers and small businesses, or to leave the euro and devalue. Given the large share of vote workers have, the former strategy will not last long. But of course once Spain leaves the euro and devalues, its external debt will soar. Debt restructuring and forgiveness is almost inevitable.
11. Germany Will Not Voluntarily Share Costs
Unless Germany moves quickly to reverse its current account surplus – which is very unlikely – the European crisis will force a sharp balance-of-trade adjustment onto Germany, which will cause its economy to slow sharply and even to contract. By 2015-16 German economic performance will be much worse than that of France and the UK.
For one or two years the deficit countries will try to bear the full brunt of the adjustment while Germany scolds and cajoles from the side. Eventually they will be unable politically to accept the necessary high unemployment and they will intervene in trade – almost certainly by abandoning the euro and devaluing. In that case they automatically push the brunt of the adjustment onto the surplus countries, i.e. Germany, and German unemployment will rise. I don’t know how soon this will happen, but remember that in global demand contractions it is the surplus countries who always suffer the most. I don’t see why this time will be any different.
12. Expect US Rising Trade Protection Sentiment
As the US fights over the fiscal deficit and whether or not it is the right way to expand domestic demand, more and more politicians will focus on the expansionary impact of trade protection. There will be an increasing tendency to intervene in trade – in fact I think of quantitative easing as a policy aimed at trade and currency imbalances as much as one aimed at domestic monetary management.
As unemployment persists, and as the political pressure to address unemployment rises, the US will, like Britain in 1930-31, lose its ideological commitment to free trade and become increasingly protectionist. Also like Britain in 1930-31, once it does so the US economy will begin growing more rapidly – thus putting the burden of adjustment on China, Germany (which will already be suffering from the European adjustment) and Japan.
Trade policy in the next few years will be about deciding who will bear the brunt of the global contraction in demand growth. The surplus countries, because they are so reliant on surpluses, will be very reluctant to eliminate their trade intervention policies. Because they are making the same mistake the US made in the late 1920s and Japan in the late 1980s – thinking they are in a strong enough position to dictate terms – they will refuse to take the necessary steps to adjust.
But in fact in this fight over global demand it is the deficit countries that have all the best cards. They control demand, which is the world’s scarcest and most valuable commodity. Once they begin intervening in trade and regaining the full use of their domestic demand, they will push the adjustment onto the surplus countries. Unemployment in deficit countries will drop, while it will rise in surplus countries.
That is a lengthy clip of ideas, yet hopefully within the spirit of Pettis’ guidelines on these emails. His PDF is 14 pages and will appear on his blog shortly.
I added the bold headlines in the detailed discussion points above.
Six Key Ideas
- China Will Slow Much More than China Bulls and Commodity Bulls Think
- Non-food Commodities Take Big Hit
- Eurozone Experiment Ends in Breakup
- US Protectionism Takes Hold
- Deficit Countries Control Demand, Thus Have the Best Cards
- Disaster Hits BRICs
Except perhaps for points three and four (and perhaps for all six points) investors and analysts have taken the opposite view. Most are looking to buy the dip, invest in commodities, invest in commodity producing currencies, and invest in the BRICs.
We did not have commodity producer decoupling in 2008 and there is no reason to expect it as debt-deflation plays out and China abandons its reckless investments in infrastructure.
I suspect China slows sooner than Pettis thinks, but no sooner than the next regime change in China. Markets, however, may react well in advance.
Global Deflationary Outlook
Pettis does not use the word “deflation” in his writeup, but he describes a very deflationary global outlook complete with protectionism, beggar-thy-neighbor policies, currency wars, and falling non-food commodity prices.
Pettis did not discuss energy, but the forces are clear: peak oil. vs. global slowdown. Given peak oil and the possibility of war over it, energy is a wildcard.
What Country Leaves Eurozone First?
The current political path including the dismissal of Eurobonds by Germany and France certainly indicates a breakup of the Eurozone. However, I wonder if Germany abandons the Euro first, rather than one of the PIIGS.
I doubt it matters much, at least from the perspective of Germany. However, should Germany leave the Euro, France would then be in the position Germany is in now, certainly unable to bailout the rest of the Eurozone.
One way or another, the grand experiment will fail. Historically speaking it never had a chance. There has never been a successful currency union in history that did not also include a fiscal union.
The question at hand is how much more will governments force down the throats of taxpayers (hoping to bail out the banks and the bondholders) before this mess cracks in pieces. The more politicians force down taxpayer throats, the bigger the eventual repercussions.
Shrink to Survive
Just as I typed the above thoughts a Bloomberg headline came in on this very subject: Prospect of New Core Euro Gains Traction
The euro area may need to shrink to survive.
As its sovereign-debt crisis nears a third year and rescue efforts fail to stop the rot in financial markets, economists from Pacific Investment Management Co.’s Mohamed El-Erian to Harvard’s Martin Feldstein say ensuring the euro’s existence may require members to leave the 17-nation currency region.
The result would be what El-Erian, Pimco’s Newport Beach, California-based chief executive officer, calls a “smaller, much better integrated, fiscally strong euro zone.” While leaders such as German Chancellor Angela Merkel consistently rule out that option, El-Erian told “Bloomberg Surveillance” with Tom Keene on Aug. 17 that they eventually may embrace it over the fiscal union required to maintain the status quo.
Don’ expect rational thinking from EU leaders. Instead, expect politicians to act in their perceived best interests and secondarily in the perceived bests interests of the banks and bondholders.
All it takes is for any country to leave, even Greece, before other countries consider the same thing.
There are lots of ideas in this post to consider, and I thank Michael Pettis for sharing his thoughts.
Reader Craig writes: “I was shocked by your commentary on 12. I thought for sure you would come out blasting U.S. trade restrictions as protectionist and leading to economic slowdown in the U.S. Instead, you basically said what Trump has been saying in every interview, and that is that China is playing us for fools and that we need to recapture our manufacturing from them. I thought you were a “free trader” to the max.”
Craig, I am indeed a free trade advocate and I certainly do not agree with Donald Trump and other protectionists such as Paul Krugman. I simply failed to point out every nuance in the article I disagree with. It is a mistake to assume I agree with “everything” in an article just because I agree with 90% of it. I made no specific comments on protectionism so there should not have been an implication of agreement.
I do not think the US gains by protectionism. Other countries will do the same and US exports will dive if imports dive as other countries retaliate. There is serious potential for another Smoot-Hawley with equally devastating consequences if Congress goes overboard.
Where I did comment and where I agree with Pettis’ contrarian thinking is that the brunt of the adjustment will be felt on trade surplus countries. Mathematically it has to, in any kind of rebalancing. Not every country can run a trade surplus. It is impossible.
Moreover, and as Pettis points out, the imposed austerity measures in Europe will impact Germany’s ability to export. The slowdown in China and the US will also impact Germany.
The question is whether or not adjustments come about in a reasonable manner or by trade wars and currency devaluations. No one wins in another Smoot-Hawley setup.
I have pointed out what I believe is the solution on many occasions. Rather than tariffs I have supported a return to the gold standard. I saw no need to bring it up yet again, but perhaps I should have.
Here are the pertinent links once again.
To that I would add we desperately need to get rid of fractional reserve lending.
I also want to add a note that peak oil (some say “peak everything”) will impact China’s ability to have an investment led economy based forever expanding infrastructure. Add peak oil to the list of reasons China will slow, whether they like it or not.
Tags: Balance Of Payment, Bluster, Bonds, BRICs, Chinese Currency, Commodities, Crueler, Currency Intervention, Debt Levels, Economic Consequence, Eurozone, Financial Markets, Global Balance, Global Demand, Global Predictions, Gold, Informational Content, Infrastructure, Market Swings, Market Volatility, Michael Pettis, Outlook, Payment Mechanisms, Slowdown, Term Outlook
Posted in Bonds, Brazil, Commodities, Gold, Infrastructure, Markets, Outlook | Comments Off
Tuesday, July 5th, 2011
According to BCA Research, silver’s risk/reward trade off is neutral.
The team’s argues as follows in a recent research note: “Although the price of silver is down 33% from its recent peak, it has handily outperformed gold and platinum since the 2008 bottom. Fabrication demand for silver has gone sideways for the past 10 years and primary supply has been in a steady uptrend. There are longer-term bullish influences at work for both physical and paper demand, but for the time being, the main driver is investment demand.
“This allows for a further correction in the coming months, and warns against bottom-fishing. At the same time, a long gold/short silver spread ‘trade’ is shaping up.
“However, the longer-term issue for investors is when to buy. The white metal should benefit from a multi-year period of low real interest rates, plentiful liquidity, incentives for currency devaluation and fiat money debasement.”
The BCA Research report concludes that the silver correction could see another 10-15% decline, but that the picture should brighten beyond the next 3-6 months.
Source: BCA Research Daily, June 30, 2011.
I share BCA Research’s comments regarding the longer-term outlook for silver. I also agree that a long gold/short silver spread could be profitable as silver is approximately 6% dearer than gold if I use the end of last year as a base.
Sources: I-Net Bridge; Plexus Asset Management.
I am of the opinion that the short-term correction you anticipate could be over sooner than the expected 3 to 6 months, though. My analysis indicates that silver’s seasonal trend as calculated by the CPM Group has a very close relationship with the seasonality of China’s CFLP manufacturing PMI, especially in the second half of the year. Both silver and the manufacturing PMI normally hit a yearly seasonal low in July and rebound through end September.
Sources: CFLP; Li & Fung; CPM Group; Plexus Asset Management.
By entering into a long gold/short silver spread you should therefore be acutely aware of the seasonal factors. Do not ride the position too long as the latest indicators show the wheels of the Japanese industry have started grinding again!
Sources: CFLP; Li & Fung; CPM Group; I-Net Bridge; Plexus Asset Management.
Sources: CFLP; Li & Fung; CPM Group; I-Net Bridge; Plexus Asset Management.
Tags: Analysis Indicates That, Asset Management, Bca Research, Bottom Fishing, Cpm Group, Currency Devaluation, Debasement, Fiat Money, Gol, Investment Demand, liquidity, Price Of Silver, Report Concludes That, Research Silver, Risk Reward, Seasonal Trend, Seasonality, Spread Trade, Term Outlook, Uptrend
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Thursday, April 28th, 2011
by Mark Mobius, Vice-Chairman, Franklin Templeton Investments
In my previous blog, I touched on some of the opportunities I saw in Africa. In this post, I will discuss what I think are the continent’s key challenges and my outlook for the region.
Corruption is a major problem in Africa. However, it takes two to tango, so accusations of corruption against African governments could also potentially be lodged against entities in the developed world that seek to buy the influence of these governments. One important development has been the Cardin-Lugar amendment to the Dodd-Frank finance reform bill in theU.S., requiring among other things, that oil, natural gas and mining companies registered on the New York Stock Exchange disclose any payment made to a foreign government for the purpose of the commercial development of oil, natural gas or minerals. Some believe that the Cardin-Lugar amendment is more important to Africa than the debt relief of the last decade.
The sentiments that arose in recent tensions in North African countries such as Tunisia, Egypt and Libya have spread not only to other African and Middle Eastern countries but also to Asia and other parts of the world. I believe regimes that do not have the support of the public and have not been elected democratically are likely to come under increased pressure going forward. Such a transition could lead to periods of volatility, as we continue to see in the Middle East and North Africa. While these events can be distressing and sometimes have a very high personal cost, it is important to consider how these developments can act as building blocks for the future, with increasing economic and political freedom being very positive for the welfare of individual countries as well as the overall region in the long term. Wherever we invest, we do consider these risks and factor them into our investment decisions.
Despite Africa’s problems, I believe the long-term outlook for the continent is bright. With its substantial wealth in natural resources such as gold, oil, platinum, iron ore, copper and large areas of arable land, Africa is well-placed to benefit from increased growth and higher demand in emerging markets such asChinaandIndia. In 2010, Anand Sharma, India’s Minister of Commerce and Industry, announced that the Indian government planned to invest US$1 trillion in Nigeria and other parts of Africa during the next decade. In countries such as Angola, Nigeria and Ethiopia, rapid economic growth has resulted in better living conditions, lower child mortality, higher primary school enrollment and greater access to clean water. As larger emerging markets increasingly invest in Africa, we are seeing a lot of money funneled toward infrastructure projects such as roads, bridges, schools and hospitals, all which are likely to benefit African economies over the years to come.
Tags: African Countries, African Governments, Cardin, Dodd, Finance Reform Bill, Franklin Templeton Investments, Gold, India, Infrastructure, Investment Decisions, Key Challenges, Last Decade, Mark Mobius, Middle Eastern Countries, mining companies, New York Stock, New York Stock Exchange, North Africa, Political Freedom, Term Outlook, Theu, Two To Tango, York Stock Exchange
Posted in India, Infrastructure, Markets | Comments Off
Thursday, April 28th, 2011
This post (with the exception of the two video clips at the end) is a guest contribution by Asha Bangalore, vice president and economist at The Northern Trust Company.
Today’s post-FOMC meeting analysis has two components: policy statement and Chairman Bernanke’s press conference. Starting with the policy statement, the Fed held the federal funds rate unchanged at the narrow band of 0 to ¼ percent. There were no dissents, although in recent speeches, Fed Presidents Plosser and Fisher (both voting members) had voiced their concern about imminent inflationary pressures.
The Fed’s views about the economy shows a minor difference from the March 15 policy statement. The first sentence of the today’s policy statement describes the economic recovery as “proceeding at a moderate pace.” The March statement upgraded the economic recovery to be on “firmer footing” from the January 2011 statement which simply noted that the “economic recovery is continuing.”
The Fed’s take on spending components of GDP was left intact, with housing sector continuing to be depicted as “depressed” and household expenditures and equipment and software outlays as expanding The Fed indicated that “inflation has picked up in recent months” but continues to view higher prices of energy and other commodities as “transitory.” Rhetoric about closely tracking inflation and inflation expectations was retained in today’s statement.
The policy statement settled the uncertainty about whether the Fed will complete the $600 billion purchase of Treasury securities, referred to as QE2, by noting that it “will complete” these planned purchases.
There was no change to the Fed’s near term outlook for monetary policy as the phrase “low levels for federal funds rate for an extended period” continues to be part of the policy statement.
The much awaited first press conference of Chairman Bernanke after an FOMC meeting revealed that the Fed plans to reinvest maturing securities and maintain the size of the balance sheet. Effectively, the amount of monetary policy easing will be unchanged after the completion of the $600 billion purchase. The Fed’s balance sheet as of April 20 stood at $2.67 trillion (see Chart 1). The Fed has purchased $548 billion of the $600 billion target so far.
The looming question at the present time is the course of monetary policy if oil prices continue to advance. Chairman indicated that the Fed expects oil prices to stabilize and trend down. In the event that this does not occur, Chairman Bernanke noted that the evolution of inflation expectations would be the Fed’s guide to monetary policy action. He went on to add that if inflation expectations fail to be stable and well anchored (which is the case at present) the Fed will have to take action. The five and 10-year break-evens obtained from Treasury inflation-protected securities are currently at levels seen prior to the onset of the financial crisis (see Chart 2). Markets will be tracking these levels closely in the days and months ahead.
Chairman Bernanke responded to a question about the meaning of the phrase “extended period” by noting that it would imply the Fed is unlikely to take any action for a “couple of meetings.” June 21-22, August 9 and September 20 are dates of the next three meetings of the FOMC .
There are many unanswered questions about the Fed’s exit strategy such as the actions it is likely to take to tighten monetary policy when economic conditions improve and inflation is a threat. Chairman Bernanke pointed out that the early step would be to stop reinvesting all or some part of maturing securities. In other words, if maturing securities are not replaced, the action would be akin to open market sale of securities, the action the Fed typically takes to tighten monetary policy.
The Fed also made available its latest forecast of real GDP growth, inflation, and unemployment rate today. The Fed has lowered projections of real GDP growth for 2011 and raised estimates of the unemployment rate, overall inflation, and core inflation for 2011 compared with the predictions published in January 2011.
In the two clips below, Fed Chairman Ben Bernanke takes questions on yesterday’s FOMC decision, the fate of QE2 and the Federal Reserve’s plan for dealing with creeping inflation.
Source: CNBC, April 27, 2011.
Source: CNBC, April 27, 2011.
Source: Asha Bangalore, Northern Trust – Daily Global Commentary, April 27, 2011.
Tags: Asset Purchases, Commodities, Dissents, Economic Recovery, Economist, Federal Funds Rate, Fomc Meeting, Footing, Household Expenditures, Inflation Expectations, Inflationary Pressures, Moderate Pace, Monetary Policy, Northern Trust Company, Outlays, Qe2, Rhetoric, Term Outlook, Treasury Securities, Voting Members
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