Monday, June 29, 2009

Quote of the week.

"The 40s, 50s and early 60s were spent under much tighter banking regulation, lots of government spending, higher taxes than we have now, and it was probably the single most prosperous era in American history."

-Justin Fox

He's also out with a new book, "The Myth of the Rational Market" which has received some rave reviews.

Good stuff!

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Friday, June 26, 2009

Hugh Hendry on deflation.

I’ve linked to Hugh Hendry's CNBC commentary before on this blog. Found these interesting excerpts via Zero Hedge:

Non confirmation of a new bull: Since early March the price of risk assets has again risen considerably; the Yuan has gone sideways. Perhaps the Chinese don't want to re-price their scarce exports amidst the economic weakness? I see this as a non-confirmation of the move in equities and commodities and it reinforces my bearish slant on the year. However, I happily contend that should the Yuan begin to appreciate once more and establish a new high vs. the dollar then I am just plain wrong with risk aversion and I will change the Fund’s posture; but so far it has been almost a year and nothing.

Deflationary trade: over the last couple of weeks we began purchasing out of the money call options on the current 30 year US Treasury bond. Do not be too concerned, we have only used about 20 basis points of the Fund’s NAV on such option premium so far. However it is our intention to add to this amount should the elevated levels of fixed income volatility subside. Given the capacity of this market to thrash around from extremes, it is not unrealistic to imagine that yields could match their lows of just six months ago. Should this happen before the year end, our options would payout 14 times our investment.

Read the complete document below!

Hat tip: Zero Hedge

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Wednesday, June 24, 2009

Book Review: Animal Spirits by Shiller and Akerlof

"Some books are to be tasted; others swallowed; and some to be chewed and digested."
-Francis Bacon

Animal Spirits clearly falls under the “chewed and digested” category. Economics is in a state of crisis and there's been much debate about the myth of efficient markets and rational human beings. This book presents a framework to explain the nature of markets, and the importance of human psychology in it. Don’t be fooled by the thin appearance! Instead of a quick read, you’ll find pages which challenge conventional wisdom every step of the way.

The authors are famous economists. Mr. Akerlof won a Nobel Prize in 2001, while Robert Shiller first gained prominent recognition with his book “Irrational Exuberance”, which was published just before the stock market peak in 2000. The second edition, out in 2005, warned about the bursting of the housing bubble.

So what are animal spirits? Animal spirits are essentially thought patterns that animate people’s ideas and feelings. The book describes five different aspects of animal spirits and how they affect economic decisions – confidence, fairness, corruption, money illusion and stories. Confidence is procyclical, and is similar to the Keynes multiplier. When confidence is up, asset prices start rising. Fairness basically influences wages. The authors consider whether concerns about fairness and social expectations trump the consequences of strictly economic motivations. Money illusion refers to the fact that participants can’t seem to see through inflation. “Stories” is a term to describe ideas that become widely accepted in the society. For instance, the internet mania in the late 90s and the “house prices never go down” mantra were widely accepted “stories”.

The authors use their animal spirits theory to answer the following questions:

"Why do economies fall into depression? Why do central bankers have power over the economy? Why are there people who can’t find a job? Why is there a tradeoff between inflation and unemployment in the long run? Why is saving for the future so arbitrary? Why are financial prices and corporate investments so volatile? Why do real estate markets go through cycles? Why does poverty persist for generations amongst disadvantaged minorities? “

For instance, to explain why economies fall into depression, they show how the previous depressions in the US occurred due to fundamental changes in confidence in the economy, in the willingness to press pursuit of profit to antisocial limits, in money illusion, and in changes in the perception of economic fairness. Their discussion on the power of the central bankers is extremely relevant in today’s environment.

The book makes a compelling case that it might be time to redesign financial regulations to take account of the animal spirits that often drive markets, to make markets work more effectively, and to minimize bailout costs. The question of animal spirits is important, as “the future of any country is in the hands of the business people who decide on investments, and it is in large measure dependent on their psychology."

Some of the unresolved questions which the authors ask in conclusion are actually being addressed by the financial reforms currently being debated. While Animal Spirits may not provide a miracle-cure for our current predicament, it’s an important first-step in understanding the role of human psychology in driving our economy. On a scale of 1 to 10, where 10 would be a gastronomical delight, I’d give this one an 8. Go check it out!

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Monday, June 22, 2009

Average first year of bull markets.

I have written earlier about the risk of missing the early bull market. Here’s the main points I’d given.

  • While bull markets have often lasted for multi-year periods, a significant portion of the gains have typically accrued during the early months of a bull market rally.
  • Within six months, more than one quarter (27%) of an entire bull market’s performance (on average) was already in the books.
  • The first 12 months of the average bull market has provided more than 40% of an entire bull market’s price appreciation, yielding on average 45% for investors.
  • Those who choose to re-enter after a few months of positive performance—when the climate feels “safe”—may miss a sizable portion of a bull market’s overall gain.

Came across this chart from Ned Davis research which nicely summarizes the above information in a chart form:

The numbers may be a little different, but the basic idea remains the same: Missing the early bull market can be extremely costly.

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Friday, June 19, 2009

Still a bear market rally?

Yet another collection of interesting market quotes. These are essentially predictions from famous market investors and technicians (Caution: lengthy!) Here's what I wrote the last time I posted something like this:

It’s always interesting to collate responses from different strategists. I find that recurrent themes makes it easier to filter out the noise. (Consider this to be similar to the "most widely held" consensus stock portfolio. Only in this case we’re trying to divine the "most widely held" very-smart money strategy. )

So let's find out what the smart money is saying:

Jim Rogers : A currency crisis is imminent, so investors should avoid shorting the market. I’m afraid they're printing so much money that stocks could go to 20,000 or 30,000. Of course it would be in worthless money, but it could happen and you could lose a lot of money being short.

George Soros: The rally may have further to go because there is a lot of liquidity, a lot of investors are on the sidelines. If the market keeps on going up, more of them may decide to join in. You never know how far the rally goes.But I certainly don't think we are at the beginning of a big bull market worldwide.

Byron Wien: I think we’ll get a 1000 on the S&P. I think it’s interesting Art said he’s expecting a pullback. He didn’t get it. We got sideways consolidation Ever since March 9th the market’s not giving people an opportunity to get in and I don’t think that’s over yet. Everybody wants a correction, everyone thinks the systemic risk is over. They are waiting for a pullback to get fully invested and the pullback never comes.

David Rosenberg: The equity bull-run looks overdone: The S&P 500 is priced for around $75 of operating EPS, something I don't see occurring before 2012 (probably won't get the number above $43 per share for this year). This rally has all been multiple expansion — from 15x on trailing EPS at the low to around 23x now. The market is NOT cheap.

With regard to the technicals, they are uber-bullish. Not only has the A-D line broken out to the high side, but the S&P 500 yesterday broke above the intra-day high of 943 set back on January 6, not to mention taking out the 200-day moving average. The ultimate retest will have to wait another day. This market is at risk now of melting up; and, as I said before when I was keeping an open mind regarding the longevity of this rally, notwithstanding my skepticism. That would mean a possible test to the high side of 1,200, believe it or not. That is an observation, not a forecast, by the way. Back when we hit that level last fall, it was a glass-half-empty feeling of being down 20% from the highs; this time around it is a cause for celebrating an 80% move off the lows! The S&P 500 is now up more than 4.0% for the year; the Nasdaq, which was the first of the major averages to break above the 200-day m.a., is up 16.0% year-to-date. The Dow is roughly flat.

Richard Russell: I’m of the opinion that this bear market rally is in the process of topping out. When a counter-trend rally tops out within an ongoing primary bear market, the odds are that the stock market will break to new lows during the period ahead. That means that the stock market will break below its March 9 lows in coming weeks. A violation of the March 9 lows would be a shocker to most investors, and it would be a forecast of an even worse economy coming up.

Louise Yamada: It is almost uncanny the degree to which 2002-08 has tracked 1932-38. Investors probably face years of frustration if they think a new, sustained bull market has begun. Structural bear markets typically last 13 to 16 years. Given the declines that have been suffered so far -- topped only by 1929-32 -- the structural bear has several years to go to complete the repair process.

Until proven otherwise, it could be a bear-market rally but we'll take what we can get. The 2002 low has been exceeded. That could be a very serious event. We don’t know whether it turns out to be a bear trap or if we have new lows ahead. I have no great compunction to be heavily invested. I think you have to be very agile and maintain trailing stop losses on any position.

I don’t think we can proclaim we are out of the woods yet. It’s the rallies and retreats that create consolidations, which eventually form bases for a new bull. For now, hone your trading skills. Best case, we are in an era of a trading range.

Michael Steinhardt : We’ve had a massive rally. We’ve had a massive injection of stuff into the economy: TARP etc. and the ultimate effect is hard to know at this point but my sense is this will not change the course of things. The economy is weak, it will remain weak. My net feeling is that this rally does not have that much more to go, and the dangers out there remain substantial.

Stephen Roach : This is an unusually synchronous recession for the global economies. Usually, in a global recession, half the world's economies contract while the other half is rising. So when the rate of contraction moderates, the balance swings pretty sharply towards expansion.

This time, as of mid-2009, 75% of the world's economies are contracting and so the balance between contraction and expansion is skewed towards weakness. That will limit the upside for the world economy.

Due to these reasons, the current global rally in equity is not justified based on fundamentals. The recovery being priced in is a V-shaped recovery which is unlikely. The markets have run ahead of themselves and should correct. The green shoots will turn brown this summer.

Jeremy Grantham : Everyone is looking at their cash and wondering what to do. Market isn’t too expensive or too cheap. It’s a very uncertain world, markets may not come down again materially, of course it may. Can’t risk being left behind for years. Even if the market comes back, it’s not the end of the world, because you still have cash left. If it comes down, you still have gap between neutral and maximum, and you pick your points.

I pointed out that there was a very strong 46% rally after the 1929 crash without the encouragement, without the moral hazard, without any increase in money. Markets once they hit a high and come down, have a half believe that they are entitled to go back. It would have probably come down without the exceptional circumstances, which are the massive stimulus and unprecedented degree of moral hazard. I picked out a number 1000-1100, which was basically a number which at 750 would have shocked. Cannot afford to be too bearish.

Robert Prechter: We hope people have enjoyed the nearly 40% rise in the S&P, nearly a 30% retracement of the decline from 2007. We’ve had response of the commodities and the corresponding decline in the dollar. I think this is part of the reflationary trade which should last through summer and it’s a good time for people to use the uptrend to their advantage.

Once you get into a net deflationary period liquidity is the entire driver. So you get falling markets all at the same time, and now you’re getting a rebound in all of this together. You need to look at market timing above everything right now because all the markets are coordinated moving more or less together.

When you are looking at longer term trends in the market, you need to look at longer term expressions of optimism and pessimism. For example, from 2000 to 2007, Dividend yields were really low at close to 1.4%, had very high PE ratios. Those have not improved, and that’s part of my argument why this is a bear market rally. We need to go down a number of years after this rally is over for those indicators to reach more normal bear market bottom type numbers.

The degree of rise we were predicting in late February was a primary degree, which indicates a pretty darn big rally. That also indicates a very strong turn towards optimism. So you’re seeing essentially a reflationary recovery. This is all classic. And it could take anywhere from a few months to a year for this partial recovery.

Economists will say the recession is over. People will say this is a new bull market. And that was THE bottom. And for us that was a very important bottom that’s why we got out of all our shorts. Similar to the rally from November to April 1930 which retraced 50% of the drop. People said the worse is over and we’re back in a bull market. I think this is a normal bear market rally but it’s a big one. It takes time to get used to it. In a few months people will be saying I get it , this is a new bull market., but remember at the bottom they weren’t saying that.

Kevin Lane, Fusion IQ : Since markets are a discounting mechanism they try to look ahead. Hence a few months back the markets were probably anticipating the not-so-bad economic data we are now seeing. Thus Friday’s bullish non-farm payrolls actually led to a sell-off after the initial euphoria faded. This selling on good news was most likely due to the fact that the news had been anticipated. Now one day of selling into a rally on bullish news does not make for a raging sell signal; however, it should at the very least make one start watching more closely to see whether bullish news in the coming days and weeks will lead to more of the same activity(i.e. selling the good news) that we saw on Friday.
At some point we are likely to get a testing sequence and selling the good news could be an early signal to take some chips off the table after a near 50% run off the lows.

Michael Kahn The broader market's been flat in the past week. A short-term rally could be in store. After internal market measures sprung to life in late May, the stock market broke out to the upside on June 1. But even with rather nice looking price action that day, the bulls have made zero progress since then.

There are two schools of thought on what this means. The first is the old Wall Street saw, "never short a dull market." Indeed, with shrinking volume and tight daily trading ranges, it does appear that the market is preparing another attempt to rally.

In technical classrooms, such diminished activity or, for lack of a better term, boring trading, tells us that the market is storing energy. On the charts, price action is coiling tighter like a spring and eventually that spring is going to uncoil.

Given that the trend from March is still up and market breadth is still pretty good, conventional wisdom of not selling this market short seems very reasonable. And faced with the same breakout from a similar trading range as we saw in May, I would make the same call -- more upside.

However, I want to reiterate what I wrote last week that despite the breakout, upside potential was limited. For the Standard & Poor's 500, the May trading range suggested an upside target of 982

Jeff Saut It is a mistake to get too bearish on equities. Maybe you don’t want to “play” as hard as we did at the March “lows,” but in terms of shorting stocks, we have NO interest! Manifestly, there is just too much liquidity supporting stocks

A Dow Theory “buy signal” will be rendered if the D-J Industrial Average and the D-J Transportation Average can better their respective January 6, 2009, closing highs of 9015.10 and 3717.26. If that happens, it would be termed a new bull market according to our interpretation of Dow Theory. Whether that occurs, or not, we think the emerging/frontier markets have already embarked on new bull markets.

Nevertheless, we are maintaining our cautionary stance. While we think the recent rise in interest rates, and the dollar’s dive, are head fakes, there are some worrisome signs. Corporate equity issuance is one of them. Indeed, corporate equity issuance has surged to an all-time high and insider buying is abnormally low. Meanwhile, risk appetites have risen dramatically and market breadth is deteriorating. Further, there are some inconsistencies with past initial “legs” of a new bull market. Firstly, the volume characteristics are lacking. Secondly, the number of stocks rising above their respective 200-day moving averages is short of historical precedence. And thirdly, Lowry’s Buying Power/Selling Pressure Indexes are short of all new bull market readings.

Mark Hulbert The recent surge in the supply of shares has caught the attention of Ned Davis, the eponymous head of Ned Davis Research. He has found through his research that it is optimal not to focus on monthly totals but instead on a rolling 13-week window. On this basis, according to Davis, recent corporate issuance has been exceeded historically only by two other occasions -- early 2000 and early 2008.

Those were "not great times to buy stocks," Davis notes dryly.

Davis also draws an even more ominous parallel to the recent corporate rush to sell stock: "This high level of [recent] supply is one of the key characteristics of the monster rally in November 1929 - April 1930."

According to TrimTabs, corporate new offerings since the beginning of May have been nearly five times greater than corporate purchases. TrimTabs is quite bearish, recommending that clients be 50% short U.S. equities. "Stock prices are going to fall hard," they predict.

Steve Leuthold : Market is still undervalued but not by much. June could be pretty impressive. A lot of institutions are underinvested. Waiting for a correction becomes harder and harder, you’ll see capitulation, you’ll see a number of institutions which are maybe 10% under benchmark and you’ll see a big move.

Endowment funds want to be closer to their benchmarks. You’ll see a gradual improvement in institutional psychology. If you want to capture the returns of the market, you need to be in this year, not next year. Market moves ahead of the economy, by the time economy comes out of recession, market could be up 50%.

John Murphy As good as the spring rally has been, I believe the market is still in need of some corrective action (or consolidation) before moving substantially higher. V bottoms are extremely rare. W bottoms are a lot more common. So are head and shoulder bottoms. It seems unlikely that the market will continue to rally in a straight line. More basing activity is most likely needed. And that’s going to require more time.”

John Hussman: Presently, the price-to-book ratio on the S&P 500 is about 1.9. If you think about the 1974 and 1982 lows, we observed price/book ratios at about 0.8, while price-to-normalized earnings multiples were at about 7. So the S&P 500 would have to drop by about 60% to match the best valuations that we've seen during the past 40 years. Investors shouldn't kid themselves that stocks are cheap – in the sense of being priced to deliver outstandinglong-term returns – just because we've observed a wicked decline. We're not even close.

I continue to believe that it is a mistake to treat the recent advance as if it has significant information content about the economy. We are observing only smaller negatives (and even those may only be a reprieve based on a temporary lull in the mortgage reset schedule).

What about the March low? Given the recent advance, shouldn't investors treat that as an “absolute” buy level now? While it may sound absurd, it is not at all clear to me that the March low was the final low of the current cycle. Yes, it might have been (and we are willing to accept some amount of market exposure if our measures of internals improve), but I believe that investors should not rule out even the 500 level on the S&P 500 as a plausible outcome over the coming 18 months.

David Fuller: I am certainly not moving away from my view that this is a bull, since much of what we have seen since last October and everything since March has been consistent with a new bull market. However, extreme rallies to break the previous downtrends are often prone to lengthy pullbacks and ranging, because they discount improving or less bad news very quickly.

Where the corrections occur, they are likely to be sharper in high-flying emerging markets but delay the next upward move on Wall Street for longer, because it is underperforming and is a much bigger market.

Albert Edwards: I have to report that one of the most reliable indicators of an equity bull market, the Coppock Indicator, has just delivered a massive equity buy signal. Of course, this would not be a problem if I were not still underweight equities…
This is one of the most reliable technical indicators, suggesting we are in a new long-term bull market.

Goldman Sachs: We believe that for the remainder of the year, equities will be far more dependent on the path of fundamental economic data than on the amount of new equity supply. Additionally, we believe the bigger risk for equities is dis-inflation turning into ingrained deflation, rather than capital raising.

Marc Faber I would say that the entry point for people who want to buy equities around the world is a high risk entry point because the global economy has bottomed out. There is little potential to grow very strongly. So, there will be disappointments in terms of earnings in the second half of 2009. The gravy is a bit out of markets. India was below 8,000 on the Sensex and has gone up almost 100%. I don’t think it is a very good time to make an entry into the markets except for traders.

The skepticism of many investors about the sustainability of this rally is reflected in the still relatively low bullish sentiment readings. I expect that before the current upside move comes to an end, the “Bulls/Bear Difference” will reach close to 40! At the same time, I would expect at the next market top to see at least 70% of stocks above their 200 day moving average.

Paul Kedrosky: Should not underestimate that there is a big unwinding still going on across all asset space, as institutional investors revisit how big should my allocation be given performance and how big my allocation be towards alternate assets, given that their portfolio size is shrinking.. Rebalancing across the board.

Wouldn’t surprise me at all to see us saw-tooth our way considerably higher through the year. the S&P could approach 1100 by year-end, which would translate into the Dow well above 10,000. And that’s because there continues to be so much skepticism about so many things which is the hallmark of a bear market, and I do believe the bear market hasn’t ended. This is the world hasn’t ended trade plus the inventory restocking trade.

My take is that we go considerably higher through the year as people continue to dismiss this rally, and then in the early part of 2010, you know what this looks like some sort of a double dip, and stocks should sell off again..

Chris Wood, Global Equity Strategist of CLSA: I was expecting what I call a counter-trend rally, driven by a counter-trend rally in the S&P this year. The key point is that the S&P in the fourth quarter last calendar year went further below its 200 DMA, and at any point since 1932, in the midst of the Great Depression. So, it was almost inevitable that we were going to have a counter trend rally at some point in 2009. Actually, I thought it would start with the arrival of the new administration in January-February, but it didn’t start so much.

My guess as to how far this rally can go is 1000-1050 on the S&P, but I am viewing this as a counter-trend rally in a secular bear market for the US. I have a different view for Asia and India. I believe Asia and India remain in a secular bull market. So I have a fundamentally different view for the Western world and Asia.

when people realise that it is an L-shaped situation in the US, not an U-shaped or V-shaped recovery, you will get renewed correction. But my view is that next time the Western stock markets go down the Asian markets will prove much more resilient. But this process is incremental; it is not going to happen on a 12-month view.

I would expect a retest of the 660 level in due course in the US if the equities correct and it coincides with the new dollar rally because the dollar rally is on deleveraging. But if the dollar keeps declining, the lows on the S&P need not be so large because some of the downside will be taken on the dollar.

I don’t believe in a world where the S&P revisits the lows of March. I don’t think the Asian equity markets, India, will revisit the lows because the Indian economy has demonstrated its domestic demand-driven resilience this year. We are now getting people talking of 5.5-6% growth - a few months back the RBI had come out with statements that growth was going to be much slower than expected and it said that growth was going to be 6%.

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Thursday, June 18, 2009

The 600 year silver bear market.

Update: This post was updated on 6/18/09.

The book Ascent of Money actually talks in depth about the discovery of the New World Potosi mines by the Spaniards. Apparently, a great metal monetary shortage was solved by this discovery. The Spanish ‘pieces of eight’ became the global reserve currency. But obviously this did not make the Spaniards wealthy in the long term. The increase in money supply merely increased the prices of all goods and services. The period from 1540 to 1640 was the only period where annual inflation of about 2% per annum actually existed before the era of fiat currencies. Refer to earlier post on interesting quotes from the book here. Check out the fascinating book below.

Coming back to the topic of this post, this is a 600 year graph of silver prices and silver/gold ratio from 1344 to 1998 as shown in 1998 dollars.

Also included in the chart is the silver/gold ratio. Note that gold is more counter cyclical then silver. So for insurance purposes, gold is obviously the preferred asset. Looking at the chart, one might be tempted to conclude that silver looks undervalued when compared to gold based on the silver/gold ratio. But when the primary trend in prices has been down over the course of the last 600 years, what does it mean to be in a bull market? Looking at this chart, even the great 1970s bull market in silver was essentially a bull market in a longer term downtrend. (While this data series is till 1998, the general trend would not change by extending it to 2008.)

The story of silver over the past 600 years has been one of declining inflation-adjusted prices. Just something to keep in mind.

600 Years of Silver Prices

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Tuesday, June 16, 2009

Should you be bullish now?

Technical Take nicely sums up why being bullish now may not be a smart move:

To embrace higher prices with sentiment so extremely bullish, you must embrace the notion that we are in a new bull market. You must embrace the notion that higher oil and higher interest rates don't matter. You must embrace the notion that second derivative growth will lead to real, sustainable growth. You must embrace the notion that our housing and commercial real estate troubles are all behind us. You must embrace the notion that a PE of 150 on the S&P500 doesn't matter. You must embrace the notion that we can have an economic recovery without any meaningful change in unemployment. And we can go on and on and on...

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Monday, June 15, 2009

Goldman Sachs predicts a lost decade.

Wow, I somehow completely missed this one.

Goldman Sachs (GS) is essentially predicting a lost decade for most of the developed world.

The graphs below are from the Goldman Sachs Global Economics team:

  • Output gap will not be filled till almost 2016-2018 for most of the developed economies.
  • Unemployment must remain high till this time. Chimes in nicely with PIMCO's Billl Gross who feels that unemployment will remain high on a structural basis (in what El-Erian calls a deleveraged, deglobalized and reregulated world).
  • I have a hard time believing the inflation theme given such data points. At the very least, inflation is 3-4 years away.
  • Mexico looks like it will suffer because of it’s proximity to the US and the swine-flu.
  • Indonesia and Australia are interesting non-mainstream ideas.
  • It clearly helps to be a commodity exporter. The commodity super cycle is alive and well.
  • Clearly, China and India look like the places to be. Sidenote: The domestic demand growth story of India is possibly the best secular growth story I can think of over the next decade, as opposed to depending on the “change” from an export dependent economy to a domestic demand driven economy in the case of China. Domestic consumption is already 60%+ of the economy in the case of India. Probably great news for the Indian Rupee as well.
  • I’m not convinced as to why UK should recover before US. The UK real estate market has been described by Jeremy Grantham as the only remaining asset class bubble, and I would generally expect Europe to lag US in recovery. The chart below illustrates that the real estate markets in Europe have been lagging those in the US.

Here’s what the team says:

  • Emerging markets are likely to see a return to trend growth about six months, on average, before advanced economies. Similarly, emerging markets on average will close their output gaps – the difference between actual growth and trend growth – about two years before advanced economies.
  • Equities should grind higher in the months ahead and long-dated equity vol is expensive relative to the improving macro backdrop.
  • Countries that get back to trend growth sooner should see their currencies strengthen.
  • Emerging markets, particularly Asia, should offer more opportunities for outperformance for equities and forex, and could support commodity prices, especially industrial metals.
  • Suggests going long GBP and short EUR/GBP
  • Carry trades should prove popular because of smaller current account imbalances.
  • Recommends Hong Kong (EWH), Taiwan (EWT) and Chinese (FXI) equity markets.

2009 so far looks like a repeat of the old weak-dollar, strong-commodities, strong-emerging markets story. Not sure how sustainable that’s going to be. The decoupling story is back in vogue.

Goldman: Past the worst

Fuller money

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Thursday, June 11, 2009

Ascent of Money by Niall Ferguson: Interesting quotes

Recently finished reading Ascent of Money: A Financial History of the World by Niall Ferguson and thoroughly enjoyed it. It’s very well written and covers a gamut of topics pertaining to financial history. While I’ll be posting a book review sometime later, just felt like sharing a few interesting quotes from the book. These are randomly taken, and in no way reflect the main contents of the book. You can read the reviews from this Amazon link to pique your interest.

On inflation in 2008: The coincidence of a dollar slide and continuing Asian industrial growth has caused a spike in commodity prices comparable not merely with the 1970s but with the 1940s. In mid-2008 we witnessed the inflationary symptoms of a world war without the war itself. Anyone who reads this without feeling anxious does not know enough financial history.

On the medieval crusades: The roman system of coinage outlived the Roman Empire itself. Prices were still quoted in terms of silver denarii in the time of Charlemagne. Difficulty was that by that time where was a chronic shortage of silver in western Europe. Precious metal tended to drain away from backward Europe. The crusades, like the conquests that followed, were as much about overcoming Europe’s monetary shortage as about converting heathens to Christianity.

On gold standard: Advantages: Exchange rate stability made for predictable pricing in trade and reduced transaction costs, while the long run stability of prices acted as an anchor for inflation expectations. Being on gold may also have reduced the costs of borrowing by causing governments to pursue prudent fiscal and monetary policies. Disadvantage: Policymakers are forced to choose between free capital movements and an independent national monetary policy. Not both. A peg means higher volatility in short term rates, as central bank seeks to keep the price of its money steady in terms of the peg. It can mean deflation(1870s 1880s), it can transmit financial crisis(like after 1929). System of money based primarily on bank deposits and floating exchange rates is freed from these constraints.

Why so much debt? The root cause must lie in the evolution of money and the banks whose liabilities are its key component. The inescapable reality seems to be that breaking the link between money creation and a metallic anchor has led to an unprecedented monetary expansion – and with it a credit boom the like of which the world has never seen. Measuring liquidity as ratio of broad money to output, this ratio has risen. At the same time capital adequacy of banks in the developed world has been slowly declining. Today banking assets are around 150% of countries combined GDP.

On Globalization: Globalization is not a new thing. In the 30 years before 1914, trade in goods reached almost as large a proportion of global output as in the past 30 years. In net terms the amounts invested abroad – particularly by rich countries in poor countries – were much larger in the earlier period. Over a century ago, enterprising businessmen could see that there were enticing opportunities throughout Asia. Capital was abundantly available, and British investors were more than ready to risk their money in remote countries. Yet, despite the investment of over a billion pounds, the promise of Victorian globalization went largely unfulfilled in most of Asia, leaving a legacy of bitterness towards what is still remembered as colonial exploitation.

Hyperinflation in Germany: A big reason Germany went into hyperinflation after First World War was the key role of the bond market in war and post-war finance. . Germany did not have access to the international bond market during the war. While the entente powers could sell bonds in the US or capital-rich British Empire, the Central powers were thrown back on their own resources. Much sooner, the German and Austrian authorities had to turn to their central banks for short-term funding. By the end of the war, a third of the Reich debt was floating or unfunded, and a substantial monetary overhang had been created

Hyperinflation is always and everywhere a political phenomena, in the sense it cannot occur without a fundamental malfunction of a country’s political economy.

One important history lesson is that major wars can arise when economic globalization is very far advanced and the hegemonic position of the English-speaking world fairly secure. A second lesson is that the longer the world goes without a conflict, the harder one becomes to imagine (and, perhaps, the easier one becomes to start). A third and final lesson is that when a crisis strikes complacent investors it causes much more disruption than when it strikes battle-scarred ones.

Three insights: First, poverty is not the result of rapacious financiers exploiting the poor. It has more to do with the lack of financial institutions, with the absence of banks, not their presence. Only when borrowers have access to efficient credit networks, when savers can deposit their money in reliable banks can it be channeled from the rich to the industrious poor. Second: if the financial system has a defect, it is that it reflects and magnifies what we humans are like. Money amplifies our tendency to overreact, to swing from exuberance when things are going well to deep depression when they go wrong. Booms and busts are products, at root, of our emotional volatility. Thirdly, few things are harder to predict than the timing and magnitude of financial crises, because the financial system is so genuinely complex and so many of the relationships are non-linear, even chaotic.

To read more about many more interesting topics, please be sure to check out the book. If interested, you can buy it directly from Amazon by clicking the link above.

Highly recommended.

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Thursday, June 4, 2009

Using stock market like ratios in personal finance.

Came across an interesting personal finance article which evaluates a person’s financial health using personal financial ratios similar to those used to analyze companies.

Just as stock ratios are primarily based on a company's earnings, the personal financial ratios are based on an individual's income. There are three ratios: savings to income (S/I), debt to income(D/I), and savings rate to income (SR/I). Benchmarks are then created for each ratio at different ages. The ratios are designed to serve as a road map so that investors can compare their individual ratios with the benchmarks to determine whether they are on track to retire by age 65, or any other desired retirement age. The ratios are derived from a series of assumptions including household budgets, post-retirement income replacement, rates of return, and retirement distribution rates.

Kind of shows you where you need to be at different stages of life to fund a retirement income. The ratios are designed to reasonably move people through their lives.

Households or advisers may design their own tables using whatever assumptions they believe are reasonable. The foundational theory for the ratio table, however, would remain constant, which is that there is a fundamental relationship between one's earnings, debt, and savings rate, and these ratios must change over time.

More here!

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Tuesday, June 2, 2009


Traveling this week, so posting will be erratic.

Quick thoughts: Shorting this market must be hurting! Looks like we're headed towards 980-1020 on the S&P 500. The trend is surely up..

Turns out DOW opted for a non dividend paying name like Cisco(they never had an explicit policy which stated so), though the obvious price-weighted disqualifiers like Google(GOOG), Apple(AAPL) and Goldman Sachs(GS) were indeed not considered. Actually, thinking further on this, Microsoft(MSFT)wasn't paying a dividend yet when it was inducted. So there's some precedent. I'll keep an eye on Cisco for starting that dividend stream sometime in the next 2-3 years.

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